Oct 03 2012
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The Sukuk Dilemma: What will happen when the market hits the glass ceiling?
The sukuk market has been one of the most talked about sectors in Islamic finance over the past few years, yet it makes up less than 8% of the overall Islamic finance market. According to Zawya, 2011 was a record year for sukuk issuance, which reached USD 84.4 billion. 2012 is already shaping up to be a record year with USD 68 billion issued in the first half, an increase of 55% over the same period of 2011. However, at some point in the not-so-distant future, this rapid growth will probably hit a glass ceiling, unless the market can grow outside of its Islamic boundaries.
Like other financial instruments, sukuk have had to face the financial crisis. There were a few high-profile defaults in 2009 and the beginning of the following year. Later in 2010, sukuk issuers and investors regained confidence and the market took off again. This stellar growth is expected to continue in the next couple of years, even though it has some limits.
The chart below shows the performance of the Dow Jones Sukuk Index since 2008, compared to the DJIM GCC Index and the DJIM Malaysia Titans 25 Index. From the chart, it is clear why sukuk have been in such high demand since the financial crisis.
Why Some Issuers Got into Trouble
One of the major problems for sukuk is that they have been short-term focused. There has never been a 30-year sukuk issued out of the GCC, and even 15-year sukuk are fairly rare. Most sukuk have three to five-year maturities, which doesn't play well among global debt buyers, as most of them seek long-term debt to hold. There have been a few exceptions, mainly from Malaysia where sukuk are primarily denominated in Malaysian ringgit and have longer maturities.
This short-term mentality was problematic for issuers, as short-term money was financing medium-term projects. Middle East issuers believed that there was little appetite for long-term sukuk issues. This worked well until the financial crisis of 2008, when maturing sukuk issues no longer had a place to go. Once financial markets opened up again, issuers realized that refinancing, if possible, would cost them a lot more than they had expected.
What is driving the sukuk market is a strong demand from the Middle East region. This has led to a dilemma in the long term; how can investor demand be satisfied by the limited amount of sukuk issuers based in GCC and Malaysia?
The key to seeing the sukuk market develop to its full potential is two-fold. First, international buyers need to enter the market. These buyers will only enter the market when longer-term maturities are available. This is already happening with Saudi Aramco's 14-year sukuk issued in 2011, but it needs to happen at a faster rate.
Second, and more importantly, international issuers need to enter the market, not only to satisfy demand, but also to give international recognition to sukuk as a viable funding alternative for companies in Europe and the U.S. A great example of this is the USD 500 million GE Capital Sukuk issued in 2010, even though there is a long way to go before international issuers make up a meaningful slice of the pie. The sukuk market has to breach these two obstacles, in order to become more than a niche within Islamic finance.
As director of Islamic market indices for S&P Dow Jones Indices, Tariq Al-Rifai works closely with index support and development as well as sales, marketing and public relations to drive the Dow Jones Islamic Market Indices business. He also promotes and represents S&P Dow Jones Indices as a speaker and educator at industry conferences and events, and maintains relationships with financial institutions globally.
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