Sukuk issuance hasnât matched 2013âs record level, but the arrival of a new issuers from Nigeria and elsewhere has encouraged investors in Islamic bonds. George Mitton reports.
Osun is a state in south-west Nigeria that produces cocoa and palm products and is thought to be rich in minerals such as gold and kaolin.
Though deeply important to the Yoruba people, who believe man was created there, the state is hardly well known outside Nigeria.
Yet in October, Osun state showed itself to be something of a trailblazer by becoming the first institution in the country, and the first in a major sub-Saharan economy, to issue an Islamic bond, a sukuk.
The 10 billion naira ($62 million) issue is not large, but for managers of funds investing in sukuk, it is a good sign that issuance of sukuk of spreading.
By the end of September, total issuance of sukuk in 2013 was at $77 billion, a quarter less than had been issued the previous year, according to Standard & Poor’s.
This was something of a disappointment to the investors and analysts who had trumpeted the asset class after a record year of issuance in 2012.
However, sukuk have continued to perform well compared to other fixed income instruments. The Dow Jones Sukuk Total Return Investment Grade Index has stayed steady in a year when nearly all other bonds have fallen in value.
The performance helps to prove the asset class is doing well despite the decline in issuance, says Mohieddine Kronfol, chief investment officer, global sukuk and Mena fixed income, Franklin Templeton. “You’re perhaps running on about 10 to 15% less issuance than last year. But if you just look at the number you mask an important development which is that we have had new issuers come to the market.”
Kronfol points to a string of significant sukuk issues in Saudi Arabia, such as the General Authority of Civil Aviation and dairy and food company Almarai, though this latter issue was available only to Saudi investors. Turkish banks have been active issuers as has the Export-Import Bank of Malaysia. “A lot of what characterises the sukuk market, innovation and growth, that story is still intact.”.
Some bond investors say it is misleading to compare this year’s issuance figures with those of 2012 because market conditions were different then.
“Ever since the tapering talk started, fixed income assets have had a tough time,” says Usman Ahmed, head of fixed income, Emirates NBD Asset Management. “The sukuk market also sold off. That closed the window on sukuk for two or three months, whereas last year, the window was open pretty much the entire year.”
The reason sukuk have generally yielded better returns than other bonds during these difficult months is because they tend to be short-dated and high quality, says Ahmed. Sukuk have these qualities because their natural investors are Islamic banks and providers of Takaful, or sharia-compliant insurance, which typically buy the bonds to hold them to maturity, not to trade.
However, this tendency has meant there is less secondary trading of sukuk than of some of debt instruments.
“It’s a bit of an inconvenience,” says Ahmed. “The free float of any sukuk is quite small. In order to source the sukuk, in the secondary market, buying it in large sizes can be an issue. You can always trade $2-5 million here and there, but if you want to do a block trade, it can be tough, because usually sukuk are sitting in hold-to-maturity books.”
The market is developing, though, both in terms of the types of sukuk being issued and the amount of secondary trading.
This year, Abu Dhabi Islamic Bank issued a perpetual sukuk and Dubai Islamic Bank followed suit. The first 30-year sukuk was issued by Saudi Electric Company.
“The structure of the sukuk market is changing,” says Ahmed. “Last year, we only saw five-year senior and secured sukuk issuances. This year, there’s been issuances on the ten-year and 30-year which are longer-dated than most Takaful companies and banks are comfortable holding to maturity, as well as perpetuals. We think the market will change structurally, which will facilitate fund managers like ourselves.”
Not everyone agrees that there is too little of a secondary market for sukuk. Doug Bitcon, head of fixed income funds and portfolios, Rasmala, says limited liquidity does not prevent his team buying and selling the bonds they want to.
“As a fund manager I would love it if we had ten basis points bid-offer spread. If you wanted to do relative value trades, you’d be able to do it a lot easier. But people get carried away by saying there is no liquidity.
There is liquidity. There aren’t many issues that we cannot buy or sell within twenty minutes.”
There is certainly no shortage of buyers in the market. The Almarai issue, in Saudi Arabia, was priced “eye-wateringly tight”, says Bitcon. This was because there is so much demand from Saudi institutions for debt securities from blue-chip Saudi companies.
With such demand, it is not a surprise that many Saudi institutions are looking to the sukuk market to raise capital. They are being encouraged to do so by the Saudi regulator, the Capital Market Authority.
However, a brake on growth is that moving to the debt markets requires a change in mindset that does not always come naturally.
“In the capital market, you need a lot more disclosure than Saudi companies are prepared to provide to investors, so their preferences is to rely on bilateral bank lending, which doesn’t have the disclosure requirements,” says Bitcon.
Another factor preventing issuers from coming to the sukuk market is the uncertainty in macroeconomic events, particularly the prospect of huge economic disruption should the US fail to resolve its debt ceiling debate.
“Where you have uncertainty, investors tend to sit on their hands,” says Bitcon. “You don’t want to come to the market as an issuer and risk having a failed transaction, because the next time you try to tap the market, investors remember that.”
Another factor that could affect sukuk issuance in future are the Basel III rules on banking capital requirements, which are likely to be implemented in the Mena region in some form. Some of the structures allowable under sukuk, such as hybrids, which share some qualities with equities, may be looked upon favourably as a means to raise capital under the regulations. This could encourage banks in the Mena region to issue more of these instruments.
Michael Grifferty, president of the Gulf Bond and Sukuk Association, a trade group representing fixed income investors in the Gulf, says central banks in the region are at different stages of preparation for the Basel III rules.
“Saudi and Kuwait are relatively advanced on this,” he says. “The UAE is still in the studying stage. Qatar has put out a consultation paper. Bahrain banks are expecting something later this year.
“We’d like to get clarity so that transactions for sukuk to help banks bolster their capital will be meeting the requirements of the central banks.”
If banks in the Gulf are encouraged by these regulations to issue more sukuk, it could give a valuable push to the market, adding to the momentum provided by new issuers such as the Nigerian state of Osun.
©2013 funds global mena