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The next frontier: project sukuk

By Yousif Haider of Credit Agricole
The slowdown in bank financing over the past few years due to the global financial crisis has forced borrowers to shy away from the traditional wholesale bank market and seek alternative sources of financing to meet their funding requirements. Capital markets have therefore emerged as a viable source of financing, whether through bonds or sukuk.

According to the Thomson Reuters Zawya Sukuk Perceptions Forecast Study 2013, the total value of the 1,486 sukuk issued between 2010 and the third quarter of 2012 amounted to USD 248.5 billion. This a massive 60+% of the 2,790 sukuk worth USD 396.4 billion issued between 1996 and Q3-2012 came in the past two years alone.

This growth is driven by increased investor demand for quality Shariah-compliant assets at attractive yields. Many Islamic banks have substantial cash on their balance sheets, and one way of satisfying their asset growth ambitions is through investing in sukuk. The demand for quality sukuk exceeds supply, as evidenced by the high over-subscription rates that recent issuances have experienced.

Another important factor in driving sukuk growth is the significantly lower cost of issuing the instrument. Costs related to documentation and structuring have come down as products have become more "standardized". In addition, it is estimated that the price of a sukuk can be as much as 20 basis points lower compared to the pricing on a conventional bond. This is an obvious advantage for borrowers seeking to raise financing at the lowest possible cost.

Although the sukuk market can be considered to be in its infancy, one area that has been largely untapped, especially in the MENA region, is the issuance of project sukuk. To date, there has only been one regional issuance, that of the SAR 3.75 billion (USD 1 billion) SATORP sukuk in September 2011 to partly finance the USD 14 billion Jubail refinery project. The issuance was over-subscribed almost 3.5 times.

Another interesting facet of the SATORP sukuk was its 14-year tenor, which is in the typical range of project finance transactions. However, this tenor is longer than those of recently issued sukuk, which usually tend to be between five and seven years. Although it can be argued that investors found the 14-year tenor acceptable because it is a "project finance" sukuk, it also signals growing investor confidence and comfort in longer tenor sukuk.

Another case in point is the Saudi Electricity Company sukuk that was issued in March 2012 with a 10-year tenor. The argument, therefore, that investors will shy away from any sukuk with a maturity greater than the "sweet spot" of five to seven years may not necessarily hold true anymore.

Zawya Projects data show an estimated USD 239 billion worth of infrastructure projects are expected to be executed over the next few years in Saudi Arabia alone. This provides a natural opportunity for more project sukuk to be issued in the kingdom. Strong demand from an existing domestic investor base, a lower cost of issuance, attractive pricing and increased standardization will continue to positively influence the growth of sukuk in general, and project sukuk specifically.

Yousif Haider, CFA, is a director at Credit Agricole's Global Islamic Banking Group.

© Zawya 2013

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