Jul 30 2012
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Debt market- Sukuk stepping up
Appetite among investors to launch Shari'a-compliant bonds to an increasingly receptive audience points to a bumper year ahead for the Gulf's sukuk issuers
The Gulf is driving an impressive uptick in Islamic debt security issuance, as corporate issuers hit the debt capital market with renewed vigour in 2012 - continuing the sukuk market rally that began in earnest in 2011.
According to Kuwait Finance House (KFH), the global sukuk market grew nearly 40 per cent year-on-year to the end of May, with $55 billion issued as of the end of May, and a further $8.4 billion placed during that month.
Other data for the first quarter of this year bears out this trend. According to figures from Saudi Arabia's National Commercial Bank ( NCB ), overall global sukuk issuance reached $43.3 billion in the first three months, more than double the $21 billion recorded in the fourth quarter of 2011.
The sukuk pipeline is still dominated by sovereign or quasi-sovereign issuers, which account for 60 per cent of the volume on the market. And though Gulf Co-operation Council (GCC) corporates have had an active few months, it is still Malaysia - whose government has adopted a strategic approach to encouraging sukuk issuance - that dominates global deal flow. More than 70 per cent of the world's sukuk currently emanate from Kuala Lumpur.
Putative sukuk issuers in the Gulf are, nonetheless, astutely taking advantage of lower funding costs and significant investor appetite to launch Shari'a-compliant bonds to a receptive audience. A healthy pipeline of sukuk is in store this year as it emerges as the preferred mechanism of capital raising for a growing number of Gulf companies.
One compelling reason for corporates to structure debt instruments in a Shari'a-compliant way is the ability to tap into additional liquidity pools provided by sukuk investors. This is particularly appealing for companies more used to conventional bond issuance. Uncertainty emanating from the Eurozone has hit bond markets in emerging markets, forcing some issuers to look again at sukuk, which is better insulated from Europe's crisis. Pricing for sukuk is concomitantly better than for conventional bonds, because the investor base is less affected by Eurozone-related problems.
Of the GCC issuers who are starting to make more of an impression on the market, Saudi Arabia has taken the lead. The kingdom has emerged as the largest regional sukuk issuer, eroding the historic dominance of the United Arab Emirates. Saudi Arabia's volume of $6.4 billion in the first quarter of 2012 significantly outpaced the $1.9 billion issued by UAE names, and accounted for more than 15 per cent of global sukuk issued. According to figures from Dealogic, a reference platform used by global and regional investment banks, sukuk issuance from Saudi Arabia reached $7.2 billion in the first five months of the year.
The year got off to a bang in Riyadh with a $4 billion, Saudi riyal-denominated 10-year sukuk by the General Authority of Civil Aviation (GACA) in January, intended to help finance the new King Abdul Aziz International Airport in Jeddah. That issue was 3.5 times oversubscribed, confirming robust investor appetite for sovereign-linked Saudi issuance. But the best appetite was reserved for the Saudi Electricity Company's $1.75 billion US dollar-denominated sukuk, which attracted in excess of $17.5 billion in offers - an impressive 10 times' oversubscribed.
Saudi banks have also started issuing sukuk. Saudi British Bank launched an SR1.5 billion ($400 million) issue via a private placement and this was followed in May by a $750 million sukuk from Banque Saudi Fransi via a special purpose vehicle registered in the Cayman Islands - attracting orders worth more than $4 billion.
The GACA sukuk issue was particularly important, treated as a quasi-sovereign issue with the provision of a sovereign guarantee. According to NCB , in the absence of direct sovereign issuance in Saudi Arabia, GACA acquired benchmark status for a local currency sukuk, while providing Saudi banks with welcome long-term investment opportunity. The much yearned-for local yield curve would, NCB suggested, assist banks in acquiring longer-term funding. The model appears to have been mimicked in Dubai - a $1.25 billion sukuk in late April will fund an expansion of Dubai International Airport.
One reason for the renewed popularity of sukuk in the Middle East is a greater maturity in the region and the fact that the lessons of Dubai World are being digested, says Jarmo Kotilaine, chief economist at NCB .
"Back in 2008 there was lot of debate about what the appropriate sukuk structure should be, and then you had the defaults and restructuring at various Saudi and Kuwaiti institutions, then the Dubai World affair, so there was a lot of anxiety about what you should do when things go wrong," says Kotilaine.
Those concerns have by and large been allayed. "There is much more market clustering around certain structures that are popular and easier to place and a much better understanding of what to do when things go wrong. Compared to four years ago there are more market professionals, lawyers and advisers around, so in a sense the risks have become much better understood and more manageable than they used to be," says Kotilaine.
Underpinning this has been some positive structural developments to increase the applicability of sukuk. Saudi Aramco Total Refinery and Petrochemical Company's (Satorp) $1 billion 'project sukuk', launched in October 2011, has shown the potential for Shari'a-compliant debt instruments in broader project finance structures.
"Things are pointing in the right direction and because of the pioneering moves from new issuers they may be able to replicate structures that are cheaper and faster," says Kotilaine. Debt capital market specialists are cautiously optimistic about the outlook for sukuk issuance. NCB anticipates this year will exceed last year's $85.4 billion in global issuance, and cross $100 billion. The Gulf will account for a sizeable slice of this, it reckons.
Saudi Basic Industries Corporation (Sabic) has permission to issue up to $5 billion of sukuk, and could be joined by other prominent Saudi issuers like state mining company Ma'aden and Saudi Aramco, the state oil company. Other Gulf corporates are getting in on the act. Qatar Petroleum is understood to be considering a corporate sukuk this year, potentially leading the way for other state-backed Qatari entities to diversify their funding sources.
The Gulf sukuk spike is welcome but there is much more that Gulf issuers, both sovereign and corporate, need to do to create a sustained market for the instrument. Some may be inclined to take a leaf out of Malaysia's book - its commitment to sukuk undergirded by a raft of supportive regulatory initiatives and tax incentives that make ringgit-denominated sukuk the dominant global form of Islamic debt issuance.
Malaysia's dominance is unlikely to be materially shifted by the Gulf's renewed appetite for sukuk, leaving the GCC free to its own portion of an increasingly large pie.
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