Sukuk markets evolve and mature
We have written a lot about Sukuks, but it may be time for an update. If you are looking for a primer, see our piece from 2013.
A confluence of factors continue to push Sukuk issuance; continued low yields across fixed income markets globally, weak economic conditions in Muslim countries necessitating more financing and a more sophisticated institutional investor base that is increasingly comfortable with the structure of Sukuk. The major rating agencies have really formalized their rating approach for Sukuk; Fitch, in particular, has gone from the ugly step-sibling of Moody’s and S&P as it relates to typical corporate issuance to a leading player in the Sukuk market. Fitch has a good press release from April here, which highlights that Sukuk issuance continues to grow in key markets like Turkey, Malaysia, Singapore, and Pakistan. Sukuk issuance is poised to become the dominant form of financing in these countries by 2020. With Kuwait, Cote D’Ivoire, Nigeria, Saudi Arabia, Brunei, and Jordan entering the Sukuk market in 2016, the asset becomes deeper and more liquid.
Total outstanding Sukuks at the end of 2015 were approximately $300bn, 10x the amount outstanding in 2005.
As more and more developed markets enter negative rates, those searching for extra yield continue to search for it wherever it can be found; high yield debt, emerging market debt, private debt, venture debt and the topic of conversation, Sukuks. Sukuks for Malaysia, for example, tend to yield 25 – 30bps more than conventional government debt. Rather than inherent risk in the structure, the premium is largely driven by reduced liquidity. This is unlikely to change in the near-term, and so these securities provide a valuable opportunity for investors to get yield pick-up in a market where it is exceedingly difficult to do so.
A large opportunity to grow the Sukuk market fizzled earlier this year when Qatar and Abu Dhabi issues a combined $14bn in conventional bonds rather than sukuks. There was tremendous concern that the Sukuk market simply isn’t large enough to absorb that size, however, it is noteworthy that not even some of the issuance was channeled to the Sukuk market. At the same time, Indonesia scrapped the tax on income derived from Sukuk investments in a bid to grow the market in Indonesia.
Another interesting area is the continued growth of Sukuk issuance that is Basel III-compliant and is considered Tier I capital by US regulatory standards. There have been 10 total issuances including most recently by University Bank, a Michigan-based lender. This is an area that could see substantial growth in the second half of 2016.
So long as the global economy shifts sideways, rates are likely to remain low in most of the world. In this environment, Sukuk issuance won’t be growing due to a flurry of construction or new business. Rather, Sukuk issuance will grow because of the nature of the instrument and the yield premium offered.
A good primer for the distinction between conventional bonds and Sukuks is shown in the table here.
As always if you have any questions, please let us know.