Financing infrastructure projects in Africa: the promise of sovereign Sukuk

The promise of sovereign Sukuk FINANCING INFRASTRUCTURE PROJECTS IN AFRICA:

GHASSEN BOUSLAMA, ASSOCIATE PROFESSOR OF FINANCE, NEOMA BUSINESS SCHOOL – FRANCE WRITES EXCLUSIVELY FOR ISLAMIC BUSINESS & FINANCE

28 Islamic Business & Finance | ISSUE 119 A young man near Timbuktu in Mali, which issued a Sukuk in 2018.

After recording its lowest level for more than two decades, economic growth in subSaharan Africa has recovered significantly since the beginning of 2017, and should reach 2.5 per cent by the end of 2019. This recovery has been turnaround by the growth of the continent’s principal economies (Nigeria, South Africa, and Angola) after the dramatic slowdown in 2016. According to recent World Bank data, several countries continue to demonstrate economic resilience by achieving annual growth rates above 5.4 per cent between 2015 and 2017 (Ivory Coast, Ethiopia, Kenya, Mali, Rwanda, Senegal, and Tanzania). For such growth to continue, the continent inevitably will require greater industrialisation, and this will necessitate infrastructure development, both commercial and social. Overcoming the significant lack of such infrastructure will require considerable investment, around $90 billion annually over the next ten years, according to the World Bank.

African governments have permanently used traditional financiers, such as multilateral agencies institutions, development funding institutions and private sector participation to finance their infrastructure projects. However, these traditional funding sources are becoming scarce. Due to problems with raising funds on traditional financial markets, reduced margins, and the return of concerns about a new cycle of debt in Africa, it has become vital to look actively for alternative financing sources.

Given the large Muslim population in Africa and the abundance of liquidities in a number of Gulf states, Islamic finance appears today as an extremely credible alternative funding source for the continent. Some African countries have recently adjusted their tax system and developed a suitable legal framework for the issue of Islamic financial instruments. This will enable them to diversify their sources of finance and facilitate access to Gulf state investors for project financing on the continent, who will require Shari’ah-complaint instruments. One of the most suitable Islamic instruments for financing infrastructure project is Sukuk. This financial instrument is underlying to a tangible, identifiable economic asset, which is naturally appropriate for the long-term investment projects.

THE AFRICAN SOVEREIGN SUKUK MARKET While the use of Sukuk issuances on the continent is currently marginal, less than one percent of total

30 Islamic Business & Finance | ISSUE 119 global volume, growth prospects for this niche are extremely promising. Indeed, the African Islamic bond market has seen an increase in the number of sovereign issuances in recent years by several African countries such as Senegal, Ivory Coast, Nigeria, Togo, Mauritania, Mali and South Africa. Other countries have also announced their attention to issuing these instruments in the coming months, including, Tanzania and Kenya (see table 1).

TABLE 1 – NUMBER OF SUKUK ISSUANCES IN AFRICA (JANUARY 2001 – DECEMBER 2016)

Country Number of Sukuk Total amount in millions of US dollars

Gambia 210 136

Ivory Coast 2 460

Nigeria 3 133

Senegal 2 445

South Africa 1 500

Sudan 28 19,378

Togo 1 245

Mali 1 285

Total 248 2549,378

SOURCE: Bloomberg, 2019

Sudan was the first African country to issue Sukuk, in 2007, at a time when African governments were not yet interested in Islamic finance. More recently, South Africa became the third non-Muslim country, after Hong Kong and the United Kingdom, to issue a sovereign Sukuk. In September 2014, South Africa issued a Sukuk Al Ijara of $500 million, with an interest rate of 3.9 per cent, which created strong demand, and was subscribed more than four times over. This was the second issuance in US dollars made by an African country on the international market, after the Sudanese issuance ($130 million). All other issuances have been in the local currency.

Since 2014, several West African countries, with the support of the Islamic Corporation for the Development of the Private Sector (ICD), the private sector arm of the Islamic Development Bank (IDB), have issued a wave of successful Sukuk. This opened the door for other countries to consider the instrument, particularly those in East Africa.

Some of them have begun to study or adopt legal and regulatory changes so as to create a legal framework in line with the requirements of Islamic finance and Shari’ah.

SOVEREIGN SUKUK ISSUANCES IN WEST AFRICA Mauritania declared its aim of developing the Sukuk market in 2012. The country’s efforts since then finally came to fruition in May 2017 with the issuance of its first Islamic treasury bonds. According to the Mauritanian central bank, this issuance is initially based on raw materials markets, with the dual objective of raising funds for State funding and broadening its banks’ product portfolio, whether they are Islamic or not, by making available an instrument for managing excess liquidities. Nigeria has not been left behind. It has also made three Sukuk issuances. Indeed, the regulatory and legal environment is very advanced in Nigeria and the Securities and Exchange Commission has also published guidelines on the management of Sukuk issuances.

Of the eight West African Economic and Monetary Union countries (UEMOA), four have already succumbed to Sukuk fervour (Togo, Senegal, Mali and Ivory Coast) and two others have announced their intention to issue them (Niger, and Burkina Faso). All of these issuances (see table 2) have been organised by the Islamic Corporation for the Development of the Private Sector. In January 2017, this same institution organised a regional consultation to draw up a “model Sukuk law” at the headquarters of the Central Bank of West African States in order to harmonise Sukuk issuance practices between the member countries of this institution.

In 2013, UEMOA launched the agency UEMOATitres, whose purpose is to help states in the union raise the resources they need to fund their economic development policies on capital markets at an affordable cost. For West African countries, this is a crucial instrument that could lead to increased numbers of Sukuk issuances in the years to come. The agency is responsible for identifying the most appropriate ways to mobilise resources for State funding on regional and international capital markets. In this regard, the region would benefit from developing specific regulations, which are extremely necessary, to accelerate the development of Sukuk issuances. These regulations need to include arrangements for Islamic type securitisation and for dealing with cases of default.

www.cpifinancial.net In October 2016, Senegal, Togo and Ivory Coast released their Sukuk for quotation on the regional securities market (BRVM) in Abidjan (Ivory Coast). With the equivalent of $1.2 billion of Islamic bonds listed, BRVM became the leading Sukuk market on the African continent, ahead of Khartoum ($130 million). In addition to making the securities liquid on the market, the declared ambition for CFA zone countries is to make the market particularly attractive for future issuances. Other countries in the same zone are also planning Sukuk issuances and have undertaken fiscal and regulatory reforms to accelerate such operations, particularly Burkina Faso, and Niger, which has already signed an agreement with ICD for a Sukuk issuance in the next few months.

A SUKUK ISSUANCE BY A TRANSNATIONAL INSTITUTION: AFRICA FINANCE CORPORATION This frenetic series of Sukuk issuances has also involved a transnational institution, the Africa Finance Corporation (AFC). This pan-African financial institution, specialising in multilateral and project development, issued its first Sukuk in January 2017. Initially, the institution planned to raise $100 million, but as a sign of the operation’s success, the Sukuk was oversubscribed by more than 100 per cent, resulting in the transaction eventually being closed at $150 million, and with a final order book worth around $230 million.

This Islamic bond, of the Murabaha type, was the first Sukuk issued by an African supranational entity. Rated A3 by Moody’s, it will mature in three years, on 24 January 2020. These Sukuk were offered to international investors outside the United States as a private investment and were domiciled in the Cayman Islands. Around 63 per cent of the investors who subscribed to this Islamic bond were from Asia, 23 per cent from the Middle East, 13 per cent from Africa, and the remaining one per cent from other regions. This bond issuance is not the AFC’s first experiment with Islamic Finance. In 2015, the firm accepted a funding offer of $50 million over 15 years from the Islamic Development Bank, to finance Islamic finance projects in numerous African member countries of the bank.

THE ADVANTAGES OF SOVEREIGN SUKUKS FOR AFRICAN STATES The main advantage of sovereign Sukuk is to diversify the geographic and institutional investors. The Sukuk

issued by the Africa Finance Corporation and the South African Treasury illustrate this aspect fairly well. The Sukuk issued in January 2017 by the AFC attracted more than 63 per cent of subscribers from the Middle East and Asia. Conversely, the Eurobond issued in April 2017 attracted only four per cent investors from the Middle East. Similarly, the Sukuk issued in 2014 by the South African treasury for $500 million succeeded to attract 59 per cent of investors from the Middle East and Asia. However, for two of its conventional issued bonds, 62 per cent of investors were from the United States, 19 per cent from the United Kingdom, 17 per cent from Europeans and two per cent from the rest of the world.

The musharakah, mudarabah or murabahah sovereign Sukuk are instruments allowing to finance investment projects taking into account the common ownership of assets or services and thus the sharing of risk between issuer and investors. In this sense, if the state does not commit to providing a fixed income Another advantage of Sukuk lies in its flexibility. Indeed, this instrument is ideally suited for financing infrastructure projects that could generate stable or variable cash flows, such as hydroelectric projects. Depending on the nature of the Sak, the rents or dividends paid to Sukuk holders will have the regularity of interest paid under conventional bank loans. In the event of a change in sales prices or productivity, Sukuk holders would be predisposed to accept changes in the cash flows received. In this context, the Sukuk offer flexibility that benefits both the sovereign issuer and the investor. Based on the principle of profit and loss sharing, the Sukuk can offer other advantages to the sovereign issuer enabling it to face the various challenges facing infrastructure financing. Sukuk allow risk sharing between groups of investors through a securitisation mechanism. Indeed, tying the Sukuk to the performance of an underlying asset makes them asset-backed securities offering less risky investments to the State.

TABLE 2- SOVEREIGN SUKUK ISSUANCES IN WEST AFRICA (2011- 2016) Country Type of Sukuk Total amount (billions) Currency Maturity (years) Rate Date of issuance Ivory Coast Ijara 150 CFA 5 5.75 per cent 2015

Ivory Coast Ijara 200 CFA 5 5.75 per cent 2016

Senegal Ijara 100 CFA 4 6.5 per cent 2014

Senegal Ijara 150 CFA 10 6 per cent 2016

Togo Ijara 150 CFA 10 6.5 per cent 2016

Mali Ijara 150 CFA 7 6.25 per cent 2018

SOURCE: Bloomberg, 2019

for Sukuk holders, it would significantly reduce the burden of public debt. On the other hand, sovereign wakalah, ijara or murabahah Sukuk allow financing economic activities without considering this source of financing as a debt for the issuer, but as a partnership between issuers and investors. This category of Sukuk does not appear in the balance sheet, but simply in the footnotes of the issuer's income statement. From there, the Sukuk have a significant advantage for a sovereign issuer, specifically the reduction of public debt. Indeed, African public debt weighs heavily on the state budget and reduces the growth of gross domestic product by repaying external debt. In addition to the advantages mentioned above, Sukuk would also have real added value in terms of reducing the risks of corruption and embezzlement, particularly for Ijara-type issuances. The creation of an ad-hoc entity that manages the underlying assets financed by the Sukuk and the intermediation between the issuer and the Sukuk holders, ensures the transparency of the transaction and the traceability of the cash flows exchanged between different stakeholders. The existence of an underlying asset generating profits allows investors to understand the nature of the cash flows and to be more engage in the project. The

funds collected should be accounted for, because the SPV uses it to acquire the assets. Funds cannot therefore be lost, wasted or misappropriated. This transparency would increase investor confidence and thus lead to an increase in foreign direct investment (FDI). Sukuk therefore represent an opportunity for countries facing the challenges of corruption.

REGULATORY CHALLENGES OF SUKUK ISSUANCES IN SUB-SAHARAN AFRICA Issuing Sukuk in Africa is not a simple process. The implementation of a legal and regulatory frame that favours Islamic finance can take years, particularly as potential issuers and decision makers have limited knowledge of Islamic financial instruments. In South Africa, which hosts the most developed financial markets on the continent, Islamic finance regulations took around four years to become law. Legal measures to enable the development of Islamic finance in Africa are thus an essential feature. The existence of supranational regulations in Africa, such as OHADA law (Organisation for the Harmonisation of Corporate Law in Africa) facilitates the inclusion of clauses compatible with the demands of Islamic finance. However, legal experts are unanimous about the difficulty of creating a single “Islamic business law” for the continent and of harmonising practices.

In this regard, the UEMOA, which has had the largest number of Sukuk issued on the continent, would benefit from having specific regulations more than necessary to accelerate the development of sovereign Sukuk. This must contain in particular fittings relating to Islamic securitisation and the treatment of default cases. Today, if the trend for Islamic finance and the Sukuk in this region is certain, the regulatory framework remains weak. The Central Bank of West African States (BCEAO) is also planning to adopt a legal framework regulating Islamic finance soon.

Sukuk issuances by countries that already have sophisticated and liquid financial markets could make sense, and enable them to diversify their financial resources, as in the case of South Africa for example. But such issuances could be more complicated and costly in other African countries. Sukuk issuances need to be underwritten by tangible assets. Thus, governments must obtain the necessary approval and pass legislation to sell/buy state property. This is a long process and unless the government is a regular

www.cpifinancial.net Sukuk issuer, investment in such a procedure can be very costly.

Countries that have so far issued Sukuk have already a degree of maturity in terms of bond issuances on international euro-band financial markets, particularly Nigeria, Ivory Coast, Senegal, and South Africa. Moreover, Sukuk issuances still face problems insofar as most investors in this market concentrate on securities rated Investment grade (rated BBB-/Baa3 at least), which is not necessarily the case for several sovereign issuers in Africa. To attract liquidities from the Gulf states to African Sukuk issuances, some kind of improvement of credit terms, such as a partial guarantee of the underlying risk, could make it possible to achieve ‘investment grade’ rating. This type of structure might stimulate the development of Sukuk issuances throughout the region.

CONCLUSION Given the size of the Muslim population on the continent, the African Sukuk market is still at an embryonic stage, and the Islamic banking infrastructure is almost inexistent. An improvement of the legal frame of banking, regulatory reforms, and investment in training with regard to Islamic financial instruments should boost the status of the African continent as a destination for Islamic finance. If such progress materialised, and if the continent managed to take even a marginal share of a world Sukuk market that exceeds $100 billion annually, Islamic finance could become an important additional source of funding for Africa’s needs, and to reduce its gap between its infrastructure investment and that of the rest of the world.

To make further progress, it is also essential for African entrants to the Sukuk sector recognise the multidimensional challenges that they will have to face. Awareness and detailed understanding of products that conform to the Shari’ah, and the use of a coherent marketing strategy are important to inform and convince new clients, and thus to increase penetration levels. In addition, the creation of a favourable environment for the deployment of Islamic finance, and the implementation of a national strategy to develop the sector successfully also need to be adapted to the country’s specific features, including the size of its economy and its traditional financial system. If appropriate measures are taken, Islamic finance in general, and Sukuk issuances in particular, can contribute to the development of sustainable, inclusive growth for Africa.