Sukuk As A Tool For Infrastructural Development In Nigeria, Osun Blazing The Trail

Considering the huge infrastructural deficit facing Nigeria, and the challenges being faced by the Federal Government of Nigeria due to a decline in oil revenue amongst other related issues, it has become imperative for State Governments and corporates to access alternative financing techniques to meet their capital development needs.

Activities in the equities market in Nigeria have slowed down considerably from the levels seen during the equities boom of 2004 – 2008 which has compelled corporates and governments to embrace the debt market by floating bonds. From 1960 to November 2013, there have been 80 corporate bond issuances in Nigeria and 34 state and local bond issuances; with state bond issuances dominating the market in recent times.

This article examines the potentials for using sukuk as a tool for capital raising and infrastructural development in Nigeria and discusses the recent sukuk issuance by the Osun State of Nigeria under the State’s N60 Billion Debt Issuance Programme. The sukuk issuance attracted international acclaim by winning the IFN Africa Deal of the Year Award 2013.

Sukuk as a tool of Islamic Finance

Sukuk provides access to a vast and growing Islamic liquidity pool in addition to the conventional debt and are commonly referred to as Islamic Bonds. However, this representation is not entirely correct.

Sukuk is defined in the Rules and Regulations of the Securities and Exchange Commission (SEC Rules 2013) as investment certificates or notes of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or investments in the assets of particular projects or special investment activity using shariah principles and concepts approved by the Securities and Exchange Commission (“the Commission”). In simple terms, sukuk can best be called trust certificates.

In addition, under a sukuk structure, returns to sukuk holders (Investors) represent rights to receive payments from a trade transaction or ownership of a particular asset or business venture, while the returns to conventional bondholders represent the right to receive interest for borrowed monies.

Traditional bonds are not allowed in Shariah-compliant transactions due to their interest based nature as interest is prohibited in Islamic law as aforesaid. It is important to note that the underlying asset for a sukuk issuance must itself be Shariah-compliant. For example, a building does not qualify as an underlying asset for sukuk issuance if the major tenant will be a producer of alcohol.

The Commission explicitly recognizes the following sukuk structures under Rule 571 of the SEC Rules:

• Sukuk Ijarah – (lease contract)

• Sukuk Musharakah– (sharing contract)

• Sukuk Istisnah– (exchange contract)

• Sukuk Murabahah– (financing contract)

Legal Framework for the Issuance of Sukuk in Nigeria

Several Laws regulate the issuance of sukuk in Nigeria including the Investments and Securities Act 2007, the SEC Rules and the state law authorizing the sukuk issuance. The Commission in recognition of the development of Islamic finance introduced new rules on February 8, 2013 to regulate the issuance of sukuk in Nigeria. Rule 572 of the SEC Rules provides that all public companies (including SPV’s), state governments, local governments, and Government agencies as well as multilateral agencies are eligible to issue, offer or make an invitation of sukuk upon seeking the Commission’s approval.

The Rules apply to:

i. sukuk which are offered by local or foreign entities that are within the regulatory purview of the Commission;

ii. sukuk which are denominated in Naira or in foreign currencies; and

iii. sukuk which are listed, convertible, exchangeable, redeemable or otherwise.

From the wording of Rule 572, sukuk issued by private companies appear not to fall within the regulatory purview of the SEC. In a similar vein, a strict interpretation of Rule 567 will suggest that bonds issued by private companies will not be regulated by the SEC as this Rule specifically mentions only bonds issued by public companies, foreign public companies and supranational bodies. However, the SEC will exercise its supervisory powers over any instrument issued to the public by private or public companies.

In addition to the advisers who advise on bond issuances, an issuer of sukuk must appoint a Shariah adviser who shall inter alia advise on all aspects of the sukuk including documentation and structuring and who shall also issue shariah certification which outlines the basis and rationale of the structure and mechanism of the sukuk.

Osun Sukuk Company Plc.’s Sukuk Al –Ijarah – Blazing the Trail

The Government of Osun State (“OSG”) through a wholly owned Special Purpose Company, Osun Sukuk Company Plc issued on the 8th of October, 2013 the first sukuk in Sub-Saharan Africa worth N11.4 billion ($70.6 million) under the Osun State N60 Billion Debt Issuance Programme to fund the development of 20 High Schools, 2 Middle Schools and 2 Elementary Schools in Osun State.

The sukuk was issued at a rate of 14.75% per annum at N 1,000 per unit and matures on 8th of October, 2020. The issue which was rated A by Agusto & Co was successfully subscribed to by domestic investors with the price set through a book building process that lasted for 10 days.

Structure of the Osun Sukuk

The SPC, Osun Sukuk Company Plc is a wholly owned Special Purpose Company of the Osun State Government incorporated with an authorised share capital of N1, 000,000.00 (One Million Naira) with Ninety Nine Percent of the shares held by the Osun State Government and One percent held in trust by the Attorney General of Osun State on behalf of the State.

The sukuk was structured as an Al-Ijarah; with the Osun Sukuk Company Plc. issuing sukuk certificates to the investors.

In accordance with Islamic law principles, each certificate represents an undivided beneficial ownership interest in the sukuk assets (i.e. the Schools). The sukuk assets are however held in trust for the sukuk investors by the Issuer. The sukuk investors’ payment for the certificates represents the cost of construction of the schools. Holders of the Certificates have no recourse to any assets of the Issuer other than the sukuk assets. Since the sukuk holders are the owners of the assets (schools), they are free to trade the certificates in the secondary market. The land upon which the schools will be built was transferred by the OSG to the SPC and a Certificate of Title (Certificate of Occupancy) was issued to the SPC.

The Issuer under an Agency Agreement, appointed the OSG as its agent to inter alia engage a construction company to construct the schools, obtain all government approvals, manage the operational and financial aspects of the construction for a prescribed fee and transferred the agreed cost of construction to the OSG.

The SPC forward leased the schools to the State Government against rental payments which will be remitted to the Issuer to make distributions to the sukuk investors; thus earning income for the investors during the construction of the schools.

A Purchase Undertaking was executed by the OSG in favour of the Issuer to give assurances that at the end of the lease/maturity of the sukuk or upon the occurrence of an event of default or early termination of the lease under the Ijara Agreement, the OSG will purchase the sukuk assets; with the purchase price being used by the Issuer to redeem the sukuk certificates at maturity.

The Purchase Undertaking is essential in Islamic Finance as it creates a debt obligation on the part of the OSG which eliminates market risk on the part of the investors. A Sale Undertaking was also executed by the Issuer in favour of the OSG in like manner.

Sukuk – What Lies Ahead

The issuance of the first state sukuk by Osun Sukuk Company Plc attests to the huge potentials for Islamic Finance in Nigeria, while its subsequent international acclaim creates integrity within the market which has the propensity to promote foreign direct investment.

The Central Bank of Nigeria (CBN) has so far registered Jaiz Bank Plc. to provide full Islamic Banking Services and has licensed Stanbic IBTC Plc to operate an Islamic Banking Window. In addition, Sterling Bank Plc has also been given an approval in principle to operate an Islamic Banking Window.

With the right team of professional advisers, it is clear that focusing on substance over form can contribute significantly to the rapid development of the Nigerian economy through the issuance of Islamic Finance products. Nigeria should not miss out on this opportunity.

About the Author

Oladele is called to the Nigerian Bar and is a qualified solicitor in England and Wales. He currently heads the Banking and Finance law Practice of Kola Awodein & Co. Lagos, Nigeria. He obtained his Masters Degree (with Distinction) from the University of Warwick, UK. He has advised on several capital market transactions.

(Osun Defender / 18 October 2014)

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Islamic finance gets interest from African states

AFRICAN markets are gradually opening to Islamic finance, buoyed by governments’ debut sales of sovereign sukuk (Islamic bonds) and legislative efforts to make the sector more attractive for companies across the region.

Despite the strong growth of Islamic finance in its core markets of the Middle East and south-east Asia, the industry has lagged behind in Africa, which is home to one in four of the world’s Muslims. But this year a string of transactions is helping to broaden the sector.

Governments across the continent are using sukuk as a way to attract cash-rich Islamic investors, with South Africa making a $500 million (R5.6 billion) issue last month.

The Tunisian government could soon follow with a dollar-denominated deal that it hopes to place by year-end; Kenya is considering a sukuk issue.

Nigeria’s Osun State made a small local currency sukuk issue last year and Gambia has been issuing short-term Islamic paper in its own currency for years, but the region’s booming dollar-denominated bond market could hold the greatest promise.

The eurobond market in sub-Saharan Africa saw a record $14bn in issuance last year and the figure was $10bn so far this year, said Megan McDonald, the global head of debt primary markets at Standard Bank.

Eventually, 15 percent to 20 percent of such issues could be sukuk, as the market would develop over two to three years, McDonald said.

McDonald added: “We do expect to see others, firstly government-linked institutions in South Africa such as Transnet, Eskom and Sanral, which the Treasury is hoping can tap the market.”

South Africa attracted $2.2bn in orders for its sukuk and had not ruled out tapping the market again. Interest in making issues was also coming from other state and national governments, McDonald said.

“The Treasury is open to coming back to the market.”

Islamic finance follows religious principles including a ban on interest and gambling. To obey these rules, contracts often attract double or triple tax as they require multiple transfers of underlying assets. Countries are now studying tax treatment for sukuk.

(Business Report / 17 October 2014)

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Portfolios: GCC Sukuk Attractive Amid Rising Rates Prospects

While the ongoing conflict in the Middle East raises concern over the outlook for the sukuk market, the Islamic equivalent of bonds, portfolio managers remain positive both on fundamentals and technicals for sukuk, which also offer a potentially attractive alternative amid prospects of rising interest rates.

Issuers from the Gulf Cooperation Council emerge as the most popular.

As the Federal Reserve prepares to exit its zero interest rate policy, but with the "new normal" promising a still low-rate environment that could continue to starve investment managers for yield for some time, sukuk are considered as an attractive option for those whose mandate allows to test new boundaries.

At Franklin Templeton Investments, Mohieddine Kronfol, chief investment officer of Global Sukuk and MENA fixed income, told MNI that "the lower duration and persistent strong demand from Islamic financial institutions should continue to support the market and allow it to perform well relative to other fixed income sectors, particularly those that have higher average durations."

In a written commentary, he had also argued that "the volatility of Sukuk has historically been more subdued - something that could prove important in a rising interest-rate environment."

He added in his commentary that, "Sukuk provide exposure to some of the fast-growing and most financially sound economies in the Gulf Cooperation Council."

Similar to conventional bonds, the rising interest rate environment is definitely challenging the sukuk market, acknowledged Lim Say Cheong, Executive Vice President, Head of Investment Banking Group Al Hilal Bank.

"Escalation of interest rates/benchmarks over the next 12 to 18 months is inevitable but issuers will still need to borrow to diversify one's source of funding and investor base," he told MNI.

Besides, rates are unlikely to "go over the roof at a rapid pace."

At Azzad Asset Management, Ihab Salib, the lead portfolio manager for the firm's sukuk fund, the Azzad Wise Capital Fund (WISEX), argued that despite the prospects of rising interest rates, "due to the specifics of the sukuk market and the fact that most of the securities are closely held, one could argue the effects of rising rates may not be as pronounced in the sukuk world."

For mandates allowing portfolio managers to invest in sukuk, the GCC region is particularly in demand.

Konfrol is "constructive" for the sukuk market overall, "with the GCC serving as a strong anchor."

He told MNI that while all GCC countries are attractive, "we believe that the UAE, Saudi Arabia and Qatar present the most opportunities at the moment."

Developments in the Middle East, notably the coalition's bombings in Syria and the potential for a worsening of global geopolitical tensions have, however, put stress on the sukuk market.

Still, Kronfol expects a "very limited" impact overall.

"The unfortunate events in Syria have had very limited impact on financial securities in the region and this is expected to remain the case," he told MNI.

"Highlighting this insulation from regional geopolitical issues is the fact that at the height of the Syrian conflict in 2013, three of the worlds' best performing stock markets were in the GCC, led by the Dubai Financial Market," he argued.

Azzad Asset Management's Salib told MNI he particularly sees value in non-conventional issuers.

"As maiden issuers in the market, they need to price the sukuk generously so as to tempt investors," he commented.

Salib sees "some value in the Dubai complex" despite the spread tightening since the beginning of the year, especially the hospitality and retail sectors.

More generally, from a fundamental standpoint, the GCC, which includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, "offers the market the greatest support," he commented.

"Being a low population, hydrocarbon rich region whose governments run fiscal and current account surpluses, the economic backdrop is extremely conducive," said Salib, who also pointed out the solid balance sheets of individual issuers, many of them government owned.

Sukuk are increasingly catching global investors' attention, especially as non-Muslim countries - such as the UK government in June and Luxembourg at the beginning of October, which was the first EMU sovereign to issue in a sukuk structure - are joining the pool of issuers.

Going forward, investors are expecting both demand and supply to increase.

From a portfolio standpoint, GCC and Southeast Asian countries "are often underrepresented in many traditional bond indexes and funds," Franklin Templeton's Kronfol said.

He told MNI that in a global bond portfolio, depending on investors' objectives and risk tolerance, "a single digit percent allocation may be reasonable, complemented by improving emerging market allocations in South East Asia and an increasing selection of credits that are diversified by geography, sector and capital structure."

When surveying opportunities within the sukuk market, "broadly speaking, we envisage the primary sukuk supply pipelines as still very much originating from sovereigns - we may see one or two new names from Africa - government-related entities (GREs) and corporates," said Al Hilal Bank's Lim.

"We may still witness a selective range of issuers from the GCC," he predicted.

"From the GRE and corporate perspectives, it may encompass the transport, property development, construction, and utilities," he added.

Lim cited a range of factors supporting demand.

"From the buyer and investor perspectives, the abundance of liquidity resulting from, among others, upcoming maturities, heavy redemption profiles across loans, bonds and sukuk originating from 5 years ago across the GCC/MENA regions, certain geopolitical tensions that have encouraged further inflow of funds seeking relative safe havens, new investment homes, as well as declining loan-to-deposit ratios of local and regional banks - as opposed to 4-5 years ago - creates a stronger momentum among investors as they continue to search for new investment opportunities," he told MNI.

So clearly, new supply would be welcomed and likely absorbed.

In fact, Salib stressed the lack of issuance altogether.

"Compared to our colleagues in the conventional bond market, sukuk issuance is understandably much lower, and with issues such as the recent Indonesian sukuk issue being in the region of 8 times oversubscribed, this is another challenge managers face when constructing a portfolio," he said.

He said it is estimated that Islamic financial assets globally are expected to exceed $2 trillion by 2016.

"The Islamic finance industry is expected to continue growing at nearly 20% per year, and the pool of investors interested in Shariah-compliant securities is expected to rise along with it," Kronfol said in his Beyond Bulls & Bears commentary titled "Sukuk: An Asset Class Goes Mainstream."

Citing research from Kuwait Finance House, Kronfol said the sukuk market topped US$269.4 billion at the end of 2013.

Zooming in to the sovereign sector, Moody's estimated in a September report that sovereign sukuk issuance would rise by $30 billion by the end of this year to $115 billion, with both Islamic and non-Islamic governments tapping the market.

"Moreover, we expect demand and liquidity in the market will improve as the sector attracts more global investors," the rating agency said.

The arrival of major non-Islamic countries this year - the UK, Hong Kong, South Africa, Luxembourg - indicates "a significant change in the potential size, depth and liquidity of this market," it added.

By Moody's estimate, the total sovereign outstanding accounted for 36% of the $296 billion outstanding sukuk as of July 2014.

"Demand from global investors will grow as they become more comfortable with this asset class and it will support their search for yield and portfolio diversification," Moody's also predicted.

On the issuer's side, Al Hilal Bank's Lim pointed out the increasing level of sophistication in the market, citing senior secured and amortizing Sukuk-type transactions and perpetual/hybrid capital type Sukuk instruments issued or structured by "pure corporates" in addition to the more traditional financial institutions.

In fact, his own institution, Al Hilal Bank, issued "the first of its kind Basel III language-compliant Tier 1 Sukuk" that was largely oversubscribed.

Azzad Asset Management, for its part, hopes "to be given a green light soon to use profit rate swaps which swap a set of fixed profit rate cash flows into floating rate cash flows."

"We are also looking to introduce a whole new asset class into the fund in the not so distant future," Salib said.

While issuers and the investor base are diversifying, maturities are increasing, Lim noted, from the 5-year "sweet spot" to 7- to 10-year or even 15-year instruments.

(Deutsche Borse Group / 14 October 2014)

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Lawmakers, sukuk debutantes open Africa to Islamic finance

African markets are gradually opening to Islamic finance, buoyed by governments' debut sales of sovereign sukuk (Islamic bonds) and legislative efforts to make the sector more attractive for companies across the region.

Despite the strong growth of Islamic finance in its core markets, the Middle East and southeast Asia, the industry has lagged in Africa, which is home to one in four of the world's Muslims. This year, however, a string of transactions is helping to broaden the sector.

Governments across the continent are using sukuk as a way to attract cash-rich Islamic investors, with South Africa making a $500 million issue in September and Senegal raising 100 billion CFA francs ($208 million) in June.

The Tunisian government could soon follow with a dollar-denominated deal that it hopes to place by year-end; Kenya is considering a sukuk issue.

Nigeria's Osun State made a small local-currency sukuk issue last year and Gambia has been issuing short-term Islamic paper in its own currency for years, but the region's booming dollar-denominated bond market could hold the greatest promise.

The eurobond market in sub-Saharan Africa saw a record $14 billion in issuance last year and the figure is $10 billion so far this year, said Megan McDonald, global head of debt primary markets at South Africa's Standard Bank.

Eventually, 15 percent to 20 percent of such issues could be sukuk, as the market will develop over the next two to three years, said McDonald, whose bank was joint lead manager of South Africa's debut sukuk issue.

"We do expect to see others, firstly government-linked institutions in South Africa such as Transnet, Eskom and SANRAL, which the Treasury is hoping can tap the market."

South Africa attracted $2.2 billion in orders for its sukuk and has not ruled out tapping the market again, and interest in making issues is also coming from other state and national governments, McDonald said.

"The Treasury is open to coming back to the market. The sukuk programme is set up in such a way they can do that."

LEGISLATION

Islamic finance follows religious principles including a ban on interest and gambling; to obey these rules, contracts often attract double or even triple tax duties as they require multiple transfers of underlying assets.

South Africa spent over two years preparing its sukuk issue, mainly to secure legislative requirements for the deal, Lawmakers are now studying tax treatment to facilitate corporate issuance, efforts being mirrored elsewhere on the continent.

Countries studying tax treatment for sukuk include Morocco, Egypt, Tunisia, Nigeria, Senegal and South Africa, said Qudeer Latif, Dubai-based partner and global head of Islamic finance at law firm Clifford Chance.

"Certain jurisdictions have either passed or are in the process of passing new laws. Morocco is a good example of this."

Such legislation is prompting new entrants into Islamic finance, including two of Morocco's biggest banks, BMCE and BCP, which plan to launch Islamic subsidiaries.

At present, there are only 38 Islamic finance institutions on the entire continent, an August working paper from the International Monetary Fund showed.

Multilateral lenders are taking note, such as the Jeddah-based Islamic Development Bank (IDB) which is helping finance infrastructure projects in the region. This month, the IDB extended a small sharia-compliant tranche as part of a much larger financing package for a $2.6 billion power project in Morocco, the first cross-border financing of this type in the country.

The tranche was strategically important for the IDB as it showed Islamic finance can be used as a funding source for other African infrastructure deals, said Latif, whose firm advised on the transaction.

The Islamic tranche used an innovative structure which combined an istisna arrangement with a wakala structure, Clifford Chance said. Under istisna, a price is paid for goods that are subsequently manufactured and delivered on a stipulated date; the format is seen as suited for infrastructure and project financing. Wakala is a common sukuk structure in which an agent manages the assets underlying the issue.

The private sector arm of the IDB is also increasing its activities in Africa, helping to set up new sharia-compliant banks, leasing companies and insurance firms. 

(Reuters / 14 October 2014)

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Pakistan's Islamic banking push faces industry gaps -study

Pakistan's central bank has released a study of Islamic banking, the first of its kind in the country, which shows latent demand for sharia-compliant finance but many obstacles such as small branch networks and a lack of product awareness among consumers.

Consumer outreach, rural banking and the need for stand-alone Islamic banks are among issues that must be addressed if the industry is to reach a regulatory target of 15 percent of total banking assets, from under 10 percent now, the study said.

Pakistan is the world's second most populous Muslim nation and the study, based on a nationwide survey of 9,000 households and 1,000 companies, confirmed widespread consumer acceptance of the ban on interest payments which underpins Islamic finance.

But the study also showed customers' choice of bank was only partly driven by religious belief, with only 23 percent of respondents citing this as the main reason to use Islamic banks, behind customer statisfaction and quality of service.

The findings have policy implications and could influence the strategies of incumbent Islamic banks as well as a number of conventional banks which plan to expand into the sector.

The study found 74 percent of bank customers were willing in principle to switch to Islamic banking, but 69 percent said the lack of an Islamic bank in their area was the reason for not switching.

As of December, Islamic banks had a combined network of 1,304 branches across Pakistan, with half concentrated in the urban centres of Karachi, Lahore and Islamabad.

Meanwhile, over 83 percent of customers of all types of bank did not understand Islamic banking services; unbanked respondents were further behind.

Forty-seven percent of respondents did not see a difference between the terms "sharia-based" and "sharia-compliant", and some said such terms were confusing and should be avoided. Sharia-compliant banking merely obeys the industry's rules, while sharia-based business also follows Islamic principles such as an emphasis on transactions based on real economic activity rather than monetary speculation.

There was also a mismatch when it came to the types of financial products on offer. Islamic banking customers were more familiar with equity-based contracts, even though most products on offer are debt-based; a product known as murabaha accounts for 40 percent of all Islamic financing contracts in Pakistan.

NEVER CONVENTIONAL

Pakistan introduced Islamic banking in the 1970s but for most people, it remains a new phenomenon: two-thirds of Islamic banking clients have had such a relationship for fewer than three years.

Conventional banks want to retain clients and several plan to offer Islamic financial products, but in doing so they will have to ensure a clear segregation of the two businesses.

More than half of all bank customers and 64 percent of nonbanked respondents, however, said they would "never" become a client of a conventional bank offering Islamic services.

Close to 70 percent of all respondents said lenders should offer Islamic banking either by establishing separate companies, or by converting themselves into full-fledged Islamic banks.

More than half of the companies in the study said they would prefer to raise finance though Islamic products, although most were neutral when it came to using Islamic bonds.

The study, conducted by London-based Edbiz Consulting and financed by Britain's Department for International Development, recommended that the role of sharia scholars be enhanced and made more public to help promote the industry.

(Reuters / 13 October 2014)

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IMF launches consultations on Islamic finance

The International Monetary Fund has held its first consultation with an external advisory group of Islamic finance industry bodies, as regulators across the globe seek to address structural issues in the sector.

Islamic finance, with its core markets in the Middle East and southeast Asia, is under growing regulatory scrutiny as it takes a greater share of the banking sector in some Muslim-majority countries and makes inroads in Western markets.

The nine-member external advisory group includes industry bodies such as the Malaysia-based Islamic Financial Services Board and the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions.

The group is an IMF initiative which aims to identify policy challenges in the industry and encourage coordination among bodies. The meeting, held in Washington last week, discussed topics including how to improve financing to small and medium- sized businesses as well as the implications for Islamic banks of Basel III regulatory standards.

Islamic banks face a shortage of high-quality liquid assets which they can hold to meet the standards, and there is uncertainty over regulatory treatment of their deposits.

The industry is trying to develop tools to ease the shortage, such as the short-term Islamic bonds issued by the Malaysia-based International Islamic Liquidity Management Corp (IILM), which is also part of the advisory group.

But the shortage is aggravated by activities of conventional firms which are free to buy sukuk, Kuwait central bank governor Mohammad al-Hashel said at an IILM seminar in August.

Because sukuk sometimes offer better yields than conventional bonds, they attract buyers among conventional banks, which can out-muscle smaller Islamic banks in bidding for such instruments in the open market.

Also, since Islamic banks can't buy interest-bearing debt, they tend to hang on to their sukuk and rarely trade them in the secondary market, further reducing their availability, al-Hashel said.

"Empirical evidence suggests that as a direct consequence of the above factors, reliance of Islamic banks on cash is much higher compared to their conventional counterparts."

Islamic commercial banks held about $1.2 trillion worth of assets at the end of last year, according to a study by Thomson Reuters. They accounted for roughly a quarter of deposits in Gulf Arab countries and over a fifth in Malaysia.

(Reuters / 13 October 2014)

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Non-Muslims tap sukuk market

This has been a banner year for the Islamic finance industry, thanks to a slew of new high-profile Islamic bonds from an unusual source: non-Muslim governments in Europe, Asia and Africa.

The UK won the race to be the first government from the western world to tap the fast-growing market for so-called sukuk, by structuring and selling a £200 million Islamic bond in June. It was followed by Hong Kong, South Africa and Luxembourg.

These non-Muslim countries have not chosen the arduous, complex task of issuing debt-like securities that adhere to Sharia due to their religious beliefs.

In terms of overall volumes, there has been about $32 billion of sukuk sales this year, according to Dealogic - respectable, but unlikely to break the $44.8 billion record set in 2012. But the quality and prestige of the sovereign sukuk sales clearly makes this a vintage year for the market, and constitutes a fillip to the wider industry.

“Four non-Muslim countries coming in a year suggests there’s a lot of momentum,” says Neil Miller, a veteran Islamic finance lawyer at Linklaters, who worked on the UK sukuk.

This has implications also for the Gulf’s increasingly vibrant Islamic finance industry. Malaysia remains home to the largest and most developed market, but the biggest potential is in the oil-rich Gulf, where Islamic banks are now in many markets competing head to head against conventional lenders — and gaining ground.

But one longstanding problem has been a lack of Sharia-compliant, liquid assets in which to invest excess deposits. Samad Sirohey, head of Islamic banking at Citi, points out that these have been building rapidly in recent years due to low credit growth in their domestic markets.

The spate of new sukuk debutantes have therefore given the cash-rich Islamic banks in the Gulf a sorely needed outlet.

Demand seems to be ravenous. The UK attracted more than £2 billion of demand for its £200 million sukuk without breaking a sweat. Appetite is particularly strong from the Gulf. For example, more than 60 per cent of Luxembourg’s €200 million debut went to Middle East investors.

Even lower-rated countries face little difficulty in borrowing from Islamic investors desperate for more supply. Indonesia returned to the Islamic bond market in early September with a $1.5 billion issue that saw more than $10 billion of orders. South Africa’s maiden $500 million sukuk garnered a $2.2 billion order book.

“The supply-demand dynamic is still tilted towards demand,” Sirohey says.

The crucial question many in the industry are asking is whether the clutch of western sovereign issues encourage more companies — whether western or in the Gulf — to follow suit, and transform a healthily growing but still relatively narrow, thinly traded market into a vibrant financing tool on par with other bond markets.

Typically, governments are the first to tap bond markets, setting a benchmark that banks and companies use to price their own issues.

Sovereign sukuk sales are arguably even more important in laying a path for companies, especially western ones, as it can help make the often-complex legal structures more understandable.

Encouraging signs

“Companies don’t necessarily want to be the first issuers in a new market, so we need governments to pave the way,” says Miller.

There are some encouraging signs. Goldman Sachs shrugged off a controversial attempt to issue a sukuk three years ago that ended in failure and returned to the market this year, becoming only the third global bank to structure and sell a sukuk, after HSBC and a small issue from Nomura.

Bankers and lawyers are now hounding companies in the UK, Africa and Asia to follow in the footsteps of London, Johannesburg and Hong Kong by tapping this eager investor base.

“What we’re excited about are the corporates coming,” says Tamim Al Kawari, chief executive of QInvest, a Qatari Islamic investment bank, and one of the banks that worked on Goldman’s sukuk.

“Sovereigns coming is good, but I really hope that corporates come in on the back of them.”

It remains questionable how many western companies will do so, given the additional legal and financial legwork required to structure sukuk.

It is notable that western companies that have issued Islamic bonds — including HSBC, General Electric, Nomura and Tesco’s Malaysian arm - have not returned to the market. That is understandable. Why go through the long, expensive process of dealing with Muslim scholars, lawyers and bankers to issue a sukuk, when it has never been easier and cheaper to sell conventional bonds?

But Kawari argues that companies that ignore the potential of the sukuk market are missing a trick, by cutting off an alternative funding tool that is becoming increasingly viable. The Qatari investment banker points out that the time it takes to issue an Islamic bond has been shortened considerably in recent years, as structures and the legal documentation have become more standardised.

(Gulf News.Com / 13 October 2014)

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Islamic Investment Malaysia: www.islamic-invest-malaysia.com

GCC Islamic finance prospects bright

The GCC Islamic finance industry is expected to maintain its rapid growth over the coming years despite mixed results across the sectors in 2014, according to Standard & Poor’s Ratings Services (S&P).

The industry’s expansion is expected to be driven by the GCC’s robust economic prospects, continued infrastructure needs and rising issuance from governments and government-related entities.

S&P managing director and regional head (Middle East) Stuart Anderson (pictured) said, “We remain upbeat on the outlook for the GCC Islamic finance industry, but we have seen mixed fortunes across sectors this year and a broad spectrum of structural issues continuing to pose challenges. Despite growth, the industry remains a demand-driven market, with limited supply. The expansion and enhancement of existing Islamic finance centres in the GCC, and a more transparent regulatory environment are critical to accelerate growth.

“S&P’s 3rd Annual Islamic Finance Conference in Dubai this week will discuss the outlook for the industry with a focus on the role of regulation in facilitating its development.”

Prospects for the sukuk sector will be one of the event’s key themes. The sector has registered healthy volumes in 2014 with $20.3bn worth of issuances in the GCC (as of October 5); 27.3% higher than the same period last year.

The fall in the issuance of corporate and infrastructure sukuk by almost a third compared to the same period in 2013 was more than compensated by higher issuance from governments and financial institutions. S&P believes the sukuk issuance in 2014 is on course for a 5% growth from last year. Refinancing needs from maturing sukuk and the good economic prospects for the GCC underpin our expectations.

Meanwhile, GCC Islamic banks have continued to increase their market share in the region. Although S&P expects the growth of Islamic banks to gradually converge with that of their conventional peers over the next decade, the market share of Islamic banks will continue to rise in the next few years. S&P expects total GCC (Gulf Co-operation Council) banking assets - both conventional and Islamic - to rise to $2tn by end-2015 from $1.7tn in 2013. In contrast to the Islamic banking sector, the takaful sector in the GCC underperformed their conventional peers. Continued resistance to the concept of insurance has left the market dominated by compulsory lines of business and weakened by fierce price competition.

S&P estimates the GCC takaful sector to generate just over 10% of total market premiums. The sector is dominated by medical and motor insurance, while the provision of life savings products, the mainstay of mature markets, is still undeveloped in the region.

Current and expected trends in Islamic finance, especially the increasing role of regulation in shaping market development will be key themes of the conference in Dubai on Tuesday.

The role of regulation in market development will be a major focus of the S&P event. The ratings agency believes that the Islamic Financial Services Board’s (IFSB) revised capital adequacy standard could give the industry an opportunity to resolve some of its long standing structural weaknesses.

(Gulf Times / 12 October 2014)

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Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com

Etisalat eyes potential debut sukuk - bankers

Abu Dhabi-based telecoms firm Emirates Telecommunications Corp (Etisalat) is planning its first ever sukuk issuance in a follow-up to its debut conventional bond earlier this year, bankers told IFR.

The firm, rated Aa3/AA-/A+, is in talks with banks for the potential Islamic bond issuance, proceeds of which are set to go towards infrastructural improvements of its telecommunications network.

The company will have the documents ready in the coming weeks, but the deal is more likely to be launched in early 2015, added the bankers.

"This issuer is going to be opportunistic as it is pretty cash generative, and the way the market is, I can't see them coming this year," said one Gulf-focused banker, referring to a recent widening of credits in the region.

"But the docs are pretty much ready so if there is a massive turnaround, they have the capability to hit the market very quickly," he added.

The initial indications are that the company will not raise much more than US$500m from the trade, said one Dubai-based debt capital markets banker.

"It is going to be a small deal, probably around benchmark . Certainly nothing like the last trade," he said.

The telecoms firm completed a US$4.25bn-equivalent dual-currency four-tranche deal in June, a trade that was launched to support the acquisition of a majority stake in Maroc Telecom.

Etisalat wanted to raise the Maroc funds by issuing sukuk, but the Islamic market did not have the same depth as the conventional market, the bankers said.

The fact that euro investors were bullish on emerging markets at the time helped convince the issuer to issue a conventional bond denominated both in US dollars and in euros. However, it remains keen to establish a benchmark in the Islamic bond market.

Deutsche Bank, Goldman Sachs, HSBC and RBS were the active leads on the conventional bond deal, while Mitsubishi UFJ, Morgan Stanley, Natixis and National Bank of Abu Dhabi were passive bookrunners.

(Reuters / 10 October 2014)

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Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com