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GACA issue could pave the way for Kingdom's debut sovereign sukuk

By MUSHTAK PARKER It is not that the SR15 billion sukuk offering a few days ago by the General Authority of Civil Aviation (GACA) was three times oversubscribed, but the fact that this was the first major Saudi quasi-sovereign to raise funds from the Saudi riyal market though a sukuk issuance.

Hitherto it was utilities such as Saudi Electricity Company (SEC) and government owned entities such as Saudi Aramco Total Refining and Petrochemical Company (SATORP), a joint venture between Saudi Aramco and Total S.A. of France; and entities such as Saudi Basic Industries Corporation ( SABIC ), in which the government retains a 40 percent or so stake; that have lead the way in sukuk origination in the Kingdom usually through publicly listed local currency issuances.

In fact, the Capital Market Authority (CMA) in December 2011 announced that "in continuance with its efforts to develop and diversify investment channels in the capital markets via offers of securities," it has approved a request by SABIC , the world's largest petrochemicals exporter, to issue and offer sukuk with a value that does not exceed SR5 billion. This would be SABIC 's 4th sukuk issuance, easily the most proactive player in the oil and gas sector in the world to raise Shariah-compliant funds as part of a diversification of sources of funding strategy.

The GACA sukuk, which is much bigger and ambitious than the SABIC issuances, according to Islamic banking sources in the Kingdom and in markets such as Malaysia, may well pave the way for that elusive debut sovereign sukuk the global market is desperately awaiting from Riyadh. It is an important step in that direction, according to the above sources, which the new governor of the Saudi Arabian Monetary Agency (SAMA), Fahd Abdullah Al-Mubarak, who assumed office in December for a four-year term, ought to lobby for with the Saudi Ministry of Finance and the Council of Ministers.

Despite unconfirmed reports that Riyadh indeed is considering to issue a full debut benchmark sovereign sukuk in 2012, it is unlikely that it will happen during this year. The reasons however are compelling even though the Kingdom officially does not need to raise funding from the debt market. The total 2012 budget announced in December 2011 amounts to SR1.392 trillion ($371.2 billion) of which total expenditure is projected at SR690 billion ($184 billion) and total revenues are projected at SR702 billion ($187.2 billion). This is based on an oil price of $74 per barrel, which in reality is hovering currently around $100 per barrel.

Any talk about Saudi Arabia issuing sukuk as a monetary policy management tool or as a liquidity management mechanism for Islamic banks must be highly premature given the under-developed regulatory and legal architecture pertaining to Islamic finance in the Kingdom.

While the GACA sukuk will contribute towards the depth of the Saudi sukuk market, its impact will be undermined by the under-developed secondary trading market through the Saudi Stock Exchange (Tadawaul's) platform. In the first 21 days of January 2012, for instance, there were only two trades of the eight or so listed sukuk on Tadawul amounting to a mere SR2.828 million and SR38.46 million respectively.

At best a Saudi sovereign sukuk would set the beginnings of a sovereign sukuk benchmark and yield curve which could be used by utilities and corporate issuers. At the same time the Kingdom has huge infrastructure spend projected for the next two decades which does not include the oil, gas and petrochemicals industries. These would include facilities for a young and growing population and the rehabilitation of badly neglected urban infrastructure including the SR35 billion Jeddah Rehabilitation Program which is currently being undertaken by the Jeddah Development Company.

It is clear that the Islamic finance industry is expected to contribute its fair share in crucial areas such as the financing of small-and-medium-sized enterprises (SMEs) primarily to generate employment especially for the youth; the provision of mortgage or housing finance and housing development finance; funding infrastructure and projects including through PFI (Public Private Financing); and helping Saudi corporates to diversify sources of funding away from bank finance to raising finance through the capital markets, predominantly through sukuk origination.

The proceeds of the SR15 billion GACA sukuk, indeed will be used to part finance the construction of the SR27.1 billion ($7.23 billion) new King Abdul Aziz International Airport in Jeddah. The issuance which was lead managed by HSBC Middle East, which was also the sole bookrunner, has a 10-year tenor and was priced at the tight end of the guidance at a profit rate of 2.5 percent.

GACA director general, Prince Fahd bin Abdullah, was upbeat about the issuance whose oversubscription he stressed showed investor confidence in the Saudi economy. "We have offered sukuk worth SR15 billion for sale and that was oversubscribed more than three times thanks to the tremendous response from the investment firms, banks, government organizations and leading companies in the Kingdom. This will be the first batch of sukuk, which will be followed by other issues. The expansion would increase the airport's annual capacity to 30 million. By issuing these sukuk, the government intends to open new channels of investment and saving and provide economically viable projects to the private sector," he stressed.

GACA had earlier agreed with the Saudi Finance Ministry and the SAMA to launch sukuk to fund the new $7.2 billion Jeddah airport project. The sukuk issuance is fully guaranteed by the Saudi Ministry of Finance.

The offering, sale and delivery of the 10-year SR15 billion sukuk, which matures in 2022, is limited solely to Saudi nationals and sophisticated investors and those other legal persons with a permanent establishment in the Kingdom holding a current commercial registration number issued by the Ministry of Commerce and Industry. The sukuk issuance was offered to financial institutions, mutual funds, insurance companies and pension funds as well as individuals, who were able to subscribe to the sukuk subject to the subscription terms and conditions.

An interesting suggestion has been that the GACA sukuk are included among certificates and bonds that are acceptable in repurchase agreements (Repos) offered by SAMA.

Liquidity management instruments used inter alia by central banks and governments include Standing Central Bank Credit Facilities based on Murabaha or tied to Mudharabah deposit rates of banks receiving credit, or through buyback arrangements for specified sukuk held by banks. The Bahrain-based International Islamic Financial Market (IIFM) is trying to develop an Islamic alternative to Repos through its I'aadat Al Shira'a (Repurchase) project.

Bankers stress that Repos are important tools in cash and liquidity management; in creating liquidity in the underlying instrument; in financing and leveraging the investment; in credit enhancement and greater volume; in playing a role in other structured products (derivatives, swaps etc); and in oiling the wheel of the bond market. The objectives of the I'aadat Al Shira'a (Repurchase) project, according to IIFM, include the funding the positions of sukuk and other instruments; better asset, liquidity and cash management; assisting in sukuk credit and yield pickup and increasing secondary market liquidity in sukuk; a useful tool which can be used by central banks to control money supply and to better fulfill reserve requirements.

© Arab News 2012