* Sukuk issuers aided by tax legislation, structure clarity
* But market misperception on cost, complexity remains
* Premium for some issuers remains, though can be mitigated
By Bernardo Vizcaino
DUBAI, May 22 Islamic finance has been one of
the fastest-growing sectors in global finance but the industry
has yet to shake off perceptions about high costs and complexity
that are holding back some issuers.
Sukuk, or Islamic bonds that follow religious principles
such as a ban on interest and speculation, are now a major
funding tool for companies in the Middle East and southeast
Asia, and are becoming increasingly attractive to sovereign
Britain, Luxembourg, Hong Kong and South Africa all are keen
to make maiden sukuk issues, to diversify their funding sources
and tap liquidity provided by increasingly wealthy Islamic
Those plans are not new: the Luxembourg government first
mooted a sukuk issue in 2010, followed by South Africa in 2011,
while Britain has been considering an Islamic bond since 2007.
These and other plans have been delayed by factors including
double-taxation on some sukuk structures and a difficulty in
identifying assets to underpin the transactions, although
Islamic finance experts say such drawbacks have largely been
Jurisdictions such as Hong Kong and Luxembourg have enacted
legislation in the past few years to remove double or even
triple tax duties that sukuk can attract due to multiple title
transfers required. Rising demand for sukuk has also depressed
"These recent developments strongly signal growing
international acceptance and will facilitate future issuance,"
said Badlisyah Abdul Ghani, chief executive of CIMB Islamic
, one of the industry's top sukuk arrangers.
As a result, first-time issuers that would have expected to
pay a premium on their sukuk in previous years can now achieve
levels comparable to conventional bonds, he said.
"Issuers that have existing conventional bonds will have a
benchmark curve to refer to and the sukuk should be priced flat,
if not potentially lower, than the conventional points of
reference. They should not pay a premium when raising sukuk."
Issuance of sukuk globally hit an all-time high of $134.3
billion in 2012, but fell to $114.3 billion in 2013 as jitters
about U.S. monetary policy constrained emerging market assets.
Growth of the market is expected to pick up again this year
as the pool of Islamic funds in the Gulf and southeast Asia
continues to expand. A Thomson Reuters study predicts sukuk
issuance of as much as $130 billion in 2014.
Increased clarity on sukuk structures has helped: the design
and approval process has become generic as more sharia advisory
firms have entered the market, pushing down costs, said Noel
Lourdes, Dublin-based executive director at Amanie Advisors, a
Malaysia-based Islamic finance consultancy.
"It is a lot cheaper now. For corporates, it is broadly in
line with Eurobond or private dollar-denominated placement
transactions," he said.
Still, the British government's plans for a 200 million
pound ($338 million) issue are a downsized version of the
original, partly to pass the UK Treasury's value-for-money test.
And there is still a perception in financial markets that sukuk
are generally more expensive or more complex than conventional
bonds, or both.
When Hong Kong passed a bill in March to allow its AAA-rated
government to issue a sukuk, potentially worth around $500
million, local traders said it would have to offer a yield of
almost double that on its five-year Hong Kong-dollar bond, which
was yielding 1.26 percent.
Islamic bankers dispute that, saying sukuk is highly sought
after and pricing would be comparable with conventional bonds.
"The suggestion (Hong Kong would pay double) is absolutely
out of whack. Sukuk pricing, like bond pricing, is a function of
credit and the market," said Abdul Ghani at CIMB Islamic, citing
the experience of the AAA-rated Islamic Development Bank
The Saudi-based IDB has issued sukuk since 2003, pricing
them with gradually lower yields, some as low as 12 basis points
over Libor for five-year paper, said Abdul Ghani, whose bank
helped arrange the latest IDB sukuk in February.
Other multilateral bodies that could issue sukuk, such as
the Asian Development Bank (ADB) and the African
Development Bank (AfDB), should expect pricing similar
to their outstanding conventional debt, he said.
AfDB, which issued a three-year conventional bond at
mid-swap +1 in March, is still concerned about the cost of a
"For some years now, we have been in touch with banks to
keep abreast of the market. However, so far it has not been cost
effective for us as compared to other sources. Thus, we continue
monitoring," an AfDB treasury official said.
LACK OF AWARENESS
While bankers say a sukuk premium has broadly disappeared
for top-rated issuers and Gulf-based companies, some
Muslim-majority countries do still face higher issuance costs as
investors demand bigger yields due to limited trading activity
in secondary markets for sukuk.
In Indonesia, profit rates for government sukuk - the
equivalent to a coupon on conventional bonds - are on average 86
basis points higher than comparable conventional government
bonds, a March report by the ADB found.
Other potential issuers also claim costs are high, including
the Canadian government which last week ruled out a sukuk.
"A new unconventional product would likely lead to higher
issuance costs," a Canadian finance ministry spokesperson told
Reuters. "The increased costs would be inconsistent with our
objective of raising stable, low cost funding to meet the
government's financial needs."
Companies that have not tapped the fixed income market at
all or those with sub-investment grade ratings could also have
to pay a premium on sukuk, although Amanie's Lourdes said this
can be mitigated with shorter tenors or plain vanilla Islamic
debt facilities of between $50 million and $100 million.
"A tenor of more than five years is more challenging,
especially if it is a first-time credit. We focus on BBB- or
above, anything below that is difficult to take to Islamic
finance investors unless the name is known," he said.
Many chief financial officers remain sceptical or just
unaware of sukuk as an alternative funding option, so some level
of education is needed to increase familiarity with sukuk and
with the Islamic finance community.
"The pipeline will probably be a little bit more colourful
if those issues are addressed," said Lourdes.
($1 = 0.5925 British pounds)
(Additional reporting by Dmitry Solovyov in Astana and Louise
Egan in Ottawa; Editing by Susan Fenton)