Sukuk has been a favoured asset class within the Islamic finance industry over the past decade. As a tradable instrument, often launched via public capital markets, it has the capacity to draw attention in the financial media.
Volumes have grown and international borders are frequently crossed. The World Bank Group estimates that sukuk represents approximately 15 per cent of the $1.8 trillion (Dh6.61 trillion) in global Islamic assets, growing at around 20 per cent per year for the past five years.
Looking forward, market conditions should continue to support growth but we also need to consider what structural changes will add depth to the GCC market and assist it in moving to the next level.
To date key drivers of the sukuk market growth have included the need for banks’ to prudently manage funding risks and address changing regulatory requirements. Non-bank issuers have followed suite to diversify their funding sources and access cheaper financing.
In an environment of abundant liquidity, fuelled by quantitative easing, the sukuk market has proven to be attractive to yield hungry investors. These reasons have encouraged constant innovation and sukuk has evolved to serve a variety of new purposes such as the issuance of bank regulatory capital with perpetual maturity, project and infrastructure funding and creditor payments.
Furthermore, the range of market participants has expanded to include non-traditional issuers sourcing Islamic funding, and an investor universe increasingly indifferent to sukuk or bonds within their chosen segments.
The current trend of influential factors should continue to be supportive for the GCC sukuk market. Growth in bank balance sheets will require sukuk issuance to address the pressures of capital adequacy, maturity mismatches and depositor concentration.
Basel III requirements for bank liquidity portfolios will increase the demand for sukuk and should also provide an incentive for supply from organisations’ whose securities will qualify as High Quality Liquid Assets.
International and non-Islamic issuers are expected to continue to expand their funding programmes and will consider sukuk in order to appeal to the widest possible range of GCC investors. Finally, uncertainty about the future of oil prices will likely see the region’s governments and related entities seeking to launch, or relaunch, programmes to access public funding markets.
These drivers will no doubt play a role in the development of the GCC sukuk market. However if we want to move beyond just volume growth and add depth and maturity to the sukuk market, then there are additional factors that must be addressed. The first of these is improved public disclosure by issuers. A brief scan of the funding markets quickly identifies the gap between GCC issuers and frequent issuers from mature markets such as the US and Europe. Improving the amount, quality and frequency of disclosures builds confidence within the investor community that can add depth to the market. Investors don’t like uncertainty and when there is an absence of information the worse outcome is often expected.
Along with increased disclosure there is also the important challenge of improving investor knowledge. The quality of investor relations programmes employed by GCC issuers varies significantly. For institutional investors, a well structured investor relations platform that provides clear and comparative information, along with an avenue for regular access to management, enhances trust in the issuer. At an individual investor level the range of risks that come with the various sukuk options, which often amplify when using leverage, needs to be clearly explained. A stable sukuk market needs institutional and individual investors to be fully informed and confident.
The third structural development required is that of sukuk market liquidity. A robust market requires a core group of secondary market makers to support trading. The traditional global liquidity providers are steadily reducing their GCC footprint. Local institutions need to take the initiative and fill the gap so that capital can continue to flow amongst participants during good and bad weather. Business strategies and regulatory pressures unrelated to the region can result in the withdrawal of appetite and capital by offshore entities. To reduce the impact of these shocks locals need to become more active and less dependent on the offshore players.
Finally, for the sukuk market to achieve significant growth we need to observe continued innovation in the products offered. Local currency sukuk issuance continues to be a stumbling block in some GCC countries. Each financial system has a natural need for tradable securities issued in their own currency and more thought needs to be put into this matter. Shorter dated issuance would also be of benefit to the market as would sukuk with floating rate profit disbursements.
As we look forward to the continued development of the sukuk market there will of course be headwinds. Ample bank liquidity will compete with sukuk issuance as banks try to attract customers with cheaper alternatives. Lower oil prices may necessitate more regional sukuk issuance but it will also deter investors from outside the region. Likewise geopolitical risks will continue to weigh on investors’ minds. These headwinds reinforce the need to continue with the structural development of the sukuk market.
The writer is Treasurer, Noor Bank. The opinion expressed here is the writer’s own and does not reflect the views of the bank or the newspaper.