Business | Opinion
Islamic bond decree delivers rude shock to sukuk market
Borrowing costs on projects have risen after ruling by scholars that most bonds ran afoul of religious rules.
- By Haris Anwar, Bloomberg
- Published: 23:28 September 6, 2008
- Image Credit:
The fastest-growing part of the global bond market is faltering, and it has nothing to do with subprime mortgages or the credit crunch.
Sales of Sharia-compliant debt, which financed Dubai's Palm development, the world's largest man-made island and where David Beckham and Donald Trump have homes, fell 50 per cent in 2008 and prices dropped an average 1.51 per cent, according to HSBC Holdings index data.
The so-called sukuk market, which has doubled each year since 2004 and grown to $90 billion, is declining after a Bahrain-based group of Islamic scholars decreed in February that most bonds ran afoul of religious rules. Only one that complies with the edict has been issued, pushing up borrowing costs on projects including $200 billion of real-estate developments in the UAE capital.
"In times of distress, the first thing investors sell are the credits they don't fully understand," said James Milligan, Dubai-based head of Middle East fixed-income trading at HSBC, the biggest underwriter of sukuk bonds in the Gulf last year. "This has hit spreads hard in the region," he said, referring to the relative level of the Islamic bonds' yields.
The bonds satisfy Islam's ban on interest by allowing investors to profit from the exchange of assets, rather than money. Sales of the debt fell to $11 billion from January to August, from $21 billion in the same period of 2007, according to data compiled by Bloomberg.
They peaked at $38.6 billion last year, growing from virtually nothing six years earlier, the International Monetary Fund said. The decline in prices is worse than the 1.25 per cent drop in U.S. corporate bonds, HSBC data show.
Restrictions
Banks sell sukuk by using assets to generate income equivalent to interest they would pay on conventional debt. The money can't be used to finance gambling, guns or alcohol.
The Accounting and Auditing Organisation for Islamic Financial Institutions ruled in February that bonds don't meet religious requirements if they haven't transferred ownership of collateral to holders. About 85 per cent of sukuk failed this test, the board said.
The judgment meant the value of the underlying collateral may decline amid falling real-estate prices, rather than being paid at face value in a default as in a conventional asset-backed securitisation. Sukuk are traded on exchanges in financial centres including Bahrain, Dubai and Malaysia.
As demand for Islamic-compliant bonds waned, yields rose to 2.94 percentage points more than the London interbank offered rate, or Libor, near a record and compared with 2.43 percentage points for an equivalent non-Islamic bond, Bloomberg data show. The spread was 1.08 percentage point a year ago and about double that in February.
"I wouldn't add anything to" our ruling, said Shaikh Mohammad Taqi Usmani, chairman of the accounting board and a retired justice of the Pakistan Supreme Court. "We're just pronouncing what's compliant to Sharia and what's not," said Usmani, who advises HSBC, Dow Jones, the Central Bank of Bahrain and the Islamic Corporation for the Development of the Private Sector.
The ruling was intended to introduce "unified rules" to the market, said Mohammad Al Chaar, secretary general of the board, whose rulings are binding in six Arab countries.
Sorouh Real Estate, Abu Dhabi's third-biggest property company, sold Dh4 billion ($1.1 billion) of bonds on August 13, the first sukuk that's "fully compliant" with the Sharia Board's ruling, according to Robin Ward, a director of structured finance at arranger Citigroup.
Panel of scholars
Citigroup's panel of Sharia scholars in London is led by Shaikh Nizam Yaquby, former chairman of the Bahrain-based accounting board. Yaquby declined to comment.
"This is a true Islamic sale," said Ward. "You need a tangible asset, and in this case, we had a freehold of land. There's no recourse back to the originator, which is the way previous sukuk have been done."
The clincher for getting the board's approval, said Ward, was transferring ownership of the underlying asset when the bonds were sold. The bulk of the debt paid interest of 200 basis points more than the one-month Emirates interbank offered rate, according to Citigroup.
"In essence, the previous sukuk structure was replicating a western bond where you get your money back and that's it," said Majid Dawood, chief executive officer of Yasaar, a Dubai- based consultancy that advises Societe Generale, Royal Bank of Scotland Group and Bank of Ireland.
More than half a trillion dollars in worldwide credit writedowns and losses squeezed lending in the Mideast as the Dubai Financial Market Real Estate Index of property-related stocks dropped 19 per cent since January. Morgan Stanley analysts predict a 10 per cent decline in property prices by 2010.
More from Business Opinion
More from Business
Business Editor's choice
-
Saudi-Bahraini economic ties hit new high
Whilst press reports continue speculating on a possible new political structure defining ties between Saudi Arabia and Bahrain, facts on the ground confirm ever- stronger economic ties between the two neighbours
-
Cupid targets the Fed with early tweets
Declarations range from pure romance to cute overtures and racier fare
-
Do unemployment figures flatter to deceive?
Jobseekers and recruiters give out mixed signals ranging from optimism to downright despair even as official data show recovery
