Issuance and listings of sukuk expected to surge

Dubai: Based on the size of the Islamic finance industry, its composition, and its growth trajectory, Standard & Poor’s estimate the need for high quality liquid assets (HQLA) to reach about $100 billion (Dh367 billion) in the next few years.

The demand for these instruments and their current scarcity are likely to push their yields downward and align them more with the yields of similar conventional instruments.

Standard & Poor’s believes that sovereigns, central banks, multilateral lending institutions (MLIs), and specialised entities such as the Islamic Development Bank (IDB) or the IILM can play a key role in addressing the lack of liquidity management instruments in the industry. These institutions could ramp up their issuance of sukuk in order to bolster HQLA offerings. Such issuance could be eligible for the classification of Level 1 HQLA.

“We believe that sukuk listings on organised markets will become more frequent. At year-end 2014, 29 per cent of the sukuk issued were listed on organised markets, while the rest consisted of over-the-counter (OTC) instruments. This ratio increased to 51.5 per cent in the first quarter of 2015, although the increase is partly a result of a major drop in issuance from the Central Bank of Malaysia, which decided to switch to other instruments for liquidity management rather than sukuk,” said Mohammad Damak, a credit analyst with Standard & Poor’s.

Islamic banks’ profitability is expected to benefit from the current regulatory changes because sukuk instruments generally carry higher yields than other eligible HQLA instruments such as cash and central bank reserves on banks’ balance sheets. As other longer-term instruments become eligible, banks might benefit from increasing their holding of these instruments to comply with LCR requirements.

The positive effect on profitability will probably be short-lived because higher demand on these instruments could eventually push their yield downward. In addition, given the current needs and the structure of Islamic banks assets, may not result in significant impact on profitability.

“We do not expect any rating impact of this development alone. Still, we see new liquidity rules as being to the overall benefit of Islamic banks and a step in the right direction,” said Damak.