Colourful mosaic develops in Gulf bond markets

Contrary to much misinformation, while it is true that the GCC bond markets are at a relatively nascent stage when compared with the well-established markets of Europe or the US, there is indeed an active secondary bond market in the GCC for both conventional and Islamic (sukuk) bonds.

Thanks to rapidly rising bond issuance in the primary market, the development of a broader range of debt instruments, and increasing investor appetite, the secondary bond market in the GCC has been developing at a healthy pace, and there is clearly much scope for further growth.

Meaningful levels of bond issuance in the GCC began in 2003 and 2004, and since then issuance levels have accelerated rapidly, with year-on-year growth of 89 per cent in 2004, 134 per cent in 2005 and 164 per cent in 2006.

While the pace of growth in bond issuance is likely to weaken (after all, the growth rates witnessed in those three years are not sustainable over the longer term), the absolute levels for 2007 are still likely to be higher than those of 2006 (see the graphs).

The pie chart below shows that companies based in the UAE have been the most active out of the whole GCC region in terms of bond issuance (by value) in the period 2003 to 2007 (year-to-date). In fact, the total value of bonds issued by the UAE in this period is almost double that of the other five GCC countries combined.

Since 2003, while the dominance of UAE-based issuers is clear, it is important to note the emergence of Saudi Arabia as an important player.

Issuance from companies based in Bahrain and Kuwait has clearly been noteworthy in some years, but diminished to much lower levels in others.

Split

The number of types of different debt instruments issued in the GCC has been growing steadily, as both the issuers and market participants become more comfortable with the general environment. The high level of demand shown by investors has provided further confidence for the issuers, who have gradually expanded into what is now a credible, diverse, and still growing range of debt instruments (see illustration above).

In broad terms, these instruments fall into two categories - conventional and Islamic (sukuk). On the conventional side, there are corporate bonds, senior financial bonds, subordinated bonds and sover-eign issues. Together, these provide a solid base for the GCC bond markets. On the sukuk side there has been an impressive diversification in the type of debt instruments used by the issuers (and hence available for the investors).

"Plain vanilla" sukuk bonds were quickly followed by convertible sukuk bonds (ie those where the terms of the bonds provide bondholders with access to the equity of the issuer) which have proved to be very popular with investors. More recently, issuers have ventured even further into new territory with subordinated (or Lower Tier 2) sukuk, and even "ABS" sukuk that are backed by residential mortgages.

Some way to go

Clearly, the GCC market still has some way to go in this regard, and the obvious "next big step" is Credit Default Swaps (CDS). There is little doubt that a CDS market will develop alongside the cash bond market in the GCC. However, while trading CDS with "conventional" investors is likely to be straightforward, the practicalities of trading CDS with "Islamic" investors are a little more complex.

There are various issues thatwould need to be resolved, but in our view these can and will be overcome, and soon there should be a development in the CDS market alongside the cash bond market.

CDS can and will provide opportunities for investors to take directional and relative value views--on a short or longer-term basis- - on individual credits without having to worry too much about the liquidity of the underlying debt instruments. The additional liquidity provided by CDS should certainly play an important role in the ongoing evolution of the Gulf bond markets.

(*)HSBC alone trades over one hundred GCC debt instruments (with around a quarter of these being sukuk and the remainder being conventional) and provides active prices on these twenty-four hours a day.

- The writer is Head of Credit Research, HSBC Bank Middle East Limited, Dubai.