FIXED INCOME: Desperately seeking sukuk

Shopping_mallSharia-compliant investors would like to see more bond issues from the likes of Majid Al Futtaim, a family-owned developer of shopping malls. George Mitton reports.

Islamic bonds are having a great year. There were $40 billion of these instruments, known as sukuk, issued in the first quarter, according to the Kuwait Financial House – 48% more than were issued in the same quarter of 2011. These issues helped expand the secondary market for sukuk to more than $200 billion for the first time.

Malaysia is the heartland for sukuk, accounting for 70% of issuance in the first quarter. But it is rapid growth among Gulf issuers that is pushing the record figures. A $4 billion issue by Saudi Arabia’s aviation authority in January was three times oversubscribed. A $1.75 billion issue from Saudi Electric in March was ten times oversubscribed.

The financial crisis has helped stimulate supply by making traditional bonds harder to sell and bank loans harder to come by. Meanwhile, Islamic institutions that can only invest in a sharia-compliant manner are keen to stock up on sukuk, which are tied to real assets and approved by sharia scholars.

But despite the growth, critics point to a lack of diversity in the market. What these people would like to see is more issuance from the likes of Majid Al Futtaim, a shopping mall developer.

What is interesting about Majid Al Futtaim, whose $400 million issue – its first – was four times oversubscribed, is that it is a family-owned business. To date, leaving aside sovereigns, the majority of issuers of sukuk have been banks such as Emirates Islamic Bank or state-owned entities such as the Abu Dhabi National Energy Company.

Industry watchers, such as Michael Grifferty of the Gulf Bond and Sukuk Association, want to see more corporates issuing sukuk, particularly industrial companies, and would like to see more bonds from across the credit scale. This could greatly enlarge
the pool of issuers and allow investors in sukuk to obtain diversification.

“It’s been a super year for issuance, especially on the Islamic side,” he says. “But it’s not diverse. Government-sponsored entities tend to predominate.”

Grifferty suggests legal changes could encourage more companies like Majid Al Futtaim to seek debt financing, by making it a smoother process for gaining approval, he says.

One reason there are few corporates issuing bonds in the Gulf is the same reason few of these companies are listed on local stock exchanges. Many such firms are family-owned businesses that are wary of giving up control.

Some argue that Gulf companies’ reticence about the stock market could help sukuk, though, because issuing bonds can be less painful than going public.

“Family-owned groups are reticent to seek public money because it means being transparent,” says Eric Swats, head of asset management at Rasmala Investment Bank, which has launched a sukuk fund. “Debt can be a good way to start the process.”

However, the lack of a centralised sharia board in the Gulf may be holding back the development of the sukuk market. In Malaysia, the government regulates the sukuk market. But in the Gulf there is no centralised sharia board to oversee sukuk products.

In a recent speech, Saif al-Shamsi, assistant governor for monetary policy and financial stability of the United Arab Emirates (UAE), called for a centralised committee in his country. “Despite the advanced state of the UAE in issuing Islamic sukuk, we believe that we still need to do more,” he said. “This includes finding a unified body for the main fatwas [decrees] in the Islamic financial services domain, as is the case in Malaysia.”

Short supply
A centralised body could help boost the lacklustre secondary market for sukuk. An association of central banks, the International Islamic Liquidity Management, has proposed to be a market maker, but this has yet to happen. Financial institutions, which are the big buyers of sukuk, tend to want to buy and hold.

But Debashis Dey, partner at law firm Clifford Chance in Dubai, is not convinced a centralised board would have a great impact. The scholars who issue fatwas on sukuk deals in the Gulf now are the same candidates who would be likely to appear on a central committee, he says.

Dey argues the weak secondary market for sukuk is simply a function of the supply shortage. The extent to which the Saudi Electric issue was oversubscribed underlines the point.

Amin El-Kholy, managing director of Arqaam Capital, says he recently visited a Malaysian pension fund manager with $370 billion to invest in Islamic bonds. It took her a year to deploy that amount in sukuk (see our round table on pages 28-35).

Unusual appeal
This high level of demand is good for issuers that are willing to go to a sharia board and gain sukuk status. Indeed, these issuers will be able to command better rates than issuers of traditional bonds if this demand continues – effectively charging a sukuk premium.

And yet, despite this incentive, the range of issuers in the Gulf remains limited. Dey says Majid Al Futtaim was an unusual case and there may not be a repeat for a while.

“I don’t really see who will be the next Majid Al Futtaim, given that a non-government-related company needs a strong credit profile and performing assets to issue a sukuk.”

It is also notable that much of the appeal of Majid Al Futtaim as an issuer is that it owns millions of dollars of real estate.

Will there be more corporate bond issuance, of sukuk and otherwise? Bonds make up a smaller proportion of the capital markets in the Middle East than in the rest of the world. One reason is that in the past it was easy for companies to get bank loans.

Some in the industry would like to see regulators intervene to make bank loans less common, thereby pushing corporates to the bond market. It may be that the financial crisis achieves the same result more quickly, by diminishing banks’ willingness to lend.

©2012 funds global

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