Islamic Finance Bulletin

April 2013

Islamic Finance Bulletin

Gulf One Lancaster Centre For Economic Research

www.lums.lancs.ac.uk/research/centres/golcer/

From the Editor It was a quieter month in March, and the bulletin this time has its eye on the key medium-term phenomenon in the development of Islamic finance, namely the evolution of the sukuk market, as much as on the twists and turns of the various other investment classes.

We feature a special contribution from credit rating agency Standard & Poor’s, which updates a research paper featured prominently in the media last month. Its core message is the solid momentum that sukuk has behind it, as issuers seek to diversify sources of funding, and investors take an interest in an asset that is steadily converting from alternative status to mainstream standing. Added to that are some market insights drawn from dipping into recent work by the consultancy Arabia Monitor.

Financial markets were generally unsure of the state of the world economy as the first quarter drew to a close. That element of doubt grew ironically from the distinct emergence of the US economy from its slump of recent years. A clutch of reassuring data releases reinforced the notion that bonds had clearly peaked, and that insofar as the Fed might be tempted not to keep providing liquidity in search of growth impetus, then stocks could not know where their main plank of support would come from in coming months.

Non-US markets were then primed to react to this uncertainty, and tracked either sideways or down, even as American stock indices broke record levels. Commodities in fact took more note of the remaining concerns about growth trends in the rest of the world. The second quarter was almost bound to bring greater clarity to these issues.

Contents HIGHLIGHTS (p.3) RECENT DEVELOPMENTS (p.4) VIEWPOINT (p.6) STOCK MARKETS (p.10) COMMODITIES (p.12) BOND AND CDS MARKETS (p.15) ACCOUNTANCY ISSUES (p.18) PERSPECTIVE (p.19)

Page 2

Highlights Sukuk: Global stock and bond markets entered into a period of some uncertainty during March, and sukuk encountered a degree of reversal in the short term in secondary markets by natural comparison with mainstream conventional fixed-income.

However, conditions in primary markets remained receptive, and both investors and issuers have clearly bought into the longer-term prospect of an investment and funding class that has powerful demand and supply drivers. Rating agency Standard & Poor’s has laid out the likely way ahead, likely to feature sovereign borrowers coming to market. Also mentioned this time are Arabia Monitor’s pointers on sukuk as an investment.

Egypt: While Egypt continues to struggle to convince the IMF of its ability to mend its economy and merit institutional financial support, its growing commitment to the development of Islamic finance has also run into a snag. Pending legislation for the issuance of sovereign sukuk, which might well enhance the government’s ability to deal with its parlous financial situation, has not met with initial approval by Muslim clerics in respect of their compliance with Sharia law. It represents another example of the scale of difficulties faced by an administration beset by a whole set of political, economic, financial and social tensions.

Sugar: Less featured among commodities, sugar nevertheless epitomised the shifting fundamentals of this overall asset class and as a staple resource amid doubts about the durability of what seems a tentative global economic recovery. While gold and oil also showed softening during the month, sugar moreover reflected how a period of high prices can lead naturally to lower levels when the business cycle moves on and capacity has adjusted to those signals. It also demonstrated the exaggerated market reaction that can come from competition when a few prominent producers seek to enhance their share in a falling market.

Page 3

Recent Developments in the Islamic Finance Industry Contention over Egyptian Islamic bonds law For the first time, a law which allows the Egyptian government to issue sukuk (Islamic bonds) has been passed for discussion. According to a panel of senior Muslim clerics, however, it tends to contravene Islamic law from a number of perspectives.

Ratification of the legislation is likely to be held up.

The Egyptian government, currently struggling with an overstretched budget deficit, hopes that Shariacompliant financing will permit billions of dollars to

Oman Islamic banks expands on foreign assets

be raised in the Islamic bond market.

Among noticeable cross-border attempts to sup-

Tension is still evident between the ruling Islam-

port the Islamic banking industry, the central bank of

ists and Al-Azhar -- the earliest ever institute (worldwide) for Islamic learning and stipulation of Islamic laws, located in Egypt -- whose scholars complained when the Muslim Brotherhood-led parliament approved the legislation and referred it to President Mursi without first consulting them, as required by the constitution. He now has a critical

Oman has granted Islamic banks a one-year relaxation of rules on the limit to the amount of foreign assets that can be held. The main objective is to give time for Islamic financial instruments to be developed domestically. These rules were stipulated by the central bank in December, to the effect that banks can hold no more than 40% of their net worth in the

situation to decide whether or not to refer the law

form of foreign currency-denominated assets.

back to parliament for alteration.

The requirement imposes serious pressure on profit-

Serious amendments may be required to nine of

ability, since Oman has not yet developed a market

the 31 articles in the legislation, including to put a 25-year limit on the maturity of Islamic bonds, since in Islamic law the period of investments must be “suitable for the lives of their owners”. Also, concerns were raised about the language used in the law seeking to allow state assets to be used as

in sukuk or other Shariah-compliant instruments which the banks could use to manage their liquidity.

Oman’s Islamic banks are permitted limited investment options as the country’s Islamic banking rules essentially ban the use of commodity Murabaha, a common tool used by Islamic banks around the

collateral for the bonds.

world to invest surplus funds.

GOLCER perceives these current arguments

GOLCER considers that this initiative might set a

around the Islamic bond law -- in one of the leading Arab countries, with a high concentration of Muslims investors -- as a natural result of the persistence of political instability, which obviously could have an adverse impact on the development of Islamic finance in the country.

Source: Reuters, April 15th

practical model for other Arab countries that seek to restore their economies after the political turmoil of the Arab Spring. Success for Oman’s approach is expected to increase foreign direct investment and develop Islamic banking in the country Source: The Arabian Business News, April 2nd

Hesitancy in Malaysian Takaful industry Given its position among the foremost players in the takaful industry (Islamic insurance) in particular and

Page 4

Islamic finance in general, Malaysia is seeking to

Turkey working to set up Islamic bank

internationalise its Islamic finance sector. However,

The largest state-run lender, Ziraat Bank, is plan-

a certain lack of expertise and low risk appetite are slowing down the fast development of the industry.

Malaysia’s takaful firms are already major investors in domestically-issued sukuk, holding over 60% of their 19 billion ringgit ($6.1 billion) of assets in domestic private and government debt securities as of December 2012. But recently firms failed to reach the old limit on foreign investment, indicating that it is likely to be not the rules but their own inclinations that curtail overseas activities, with some firms have no foreign exposure at all.

ning an Islamic bank, known locally as a ‘participation bank’, with a targeted partnership with a foreign lender. The bank has so far not received a partnership request for the venture, but says it would be open to talks.

There are currently four participation banks operating in Turkey: Albaraka Turk, Bank Asya, Kuveyt Turk and Turkiye Finans. Kuveyt Turk, a unit of Kuwait Finance House, issued the country’s first sukuk in 2010. After proceeding slowly with the development of Islamic finance for years, given a secular

GOLCER thinks the important obstacles tending to

political system, Turkey has recently begun to move

impede global recognition and the ability to in-

with faster steps toward Islamic finance, issuing its

novate are the poor experience of some Malaysian

first sovereign sukuk last September.

takaful firms and their limited creativity compared to conventional insurers.

GOLCER believes that Turkey’s sukuk and the quick expansion of the Islamic finance sector will have im-

Source: Reuters, April 15

th

Islamic assets with GCC institutions increase

portant global implications, since the fast-growing economy could become a major issuer of Islamic debt and influence trends throughout the industry.

Islamic banking assets with commercial banks in

Turkey is now also working on new regulations to

the GCC recorded remarkable growth in 2012,

allow the wider use of Islamic bonds, which could

with a 14% rise to $445 billion from $390 bil-

see sukuk issues employed by the government and

lion in 2011. According to Ernst & Young’s Global

corporations for project finance and infrastructure

Islamic Banking Centre, the outlook for the Islamic

development.

banking industry in the Gulf region is expected to remain positive in 2013. Qatar was the fastestgrowing market, showing Islamic banking assets to have grown by more than 23% in 2012. Globally, Islamic banking assets with commercial banks stood at $1.55 trillion at last year-end, projected to exceed $2 trillion by 2015. However, the quality of that growth is still an issue.

GOLCER thinks that, as compared to conventional counterparts, Islamic banks suffer from intensive competition and also are technologically disadvantaged, with software systems primarily designed for financial institutions based on conventional banking frameworks. While the industry regulators are looking to tackle this issue, it remains a concern, leading to significantly higher operational and commercial risk.

Source: Khaleej Times, March 21st

Source: Reuters, April 13th

UAE Islamic banks repay past support Dubai Islamic Bank and Abu Dhabi Islamic Bank have paid back a combined 6 billion dirhams ($1.6 billion) in financial support, which was given by the United Arab Emirates government during the global crisis of 2008-2009. DIB said that it had repaid 3.8 billion dirhams as received in 2008. Last month it raised $1 billion by issuing sukuk to boost its Tier 1 capital. This comes after several UAE banks have been repaying such support in the past several weeks, as the terms of the government instruments mean their value has declined over time, and since banks are now able to obtain finance much more cheaply from the markets.

Source: Reuters, April 7th

Page 5

Viewpoint Investor appetite pushes sukuk into the mainstream

by Paul-Henri M Pruvost

There is little to hinder another strong performance by the sukuk market in 2013.

We at Standard & Poor’s anticipate yields on bonds will remain low in the coming quarters, although we do not expect yields to decline meaningfully further. Global issuance expanded for the fourth year in a row in 2012, growing 64% to about $138 billion, and we expect another strong few years.

Despite the growth spurt, the sukuk market is still a

Source: Standard & Poor’s, Zawya Sukuk Monitor Database

small segment of the global fixed-income world.

Largely dominating issuance are sovereign and sovereign-related issuers from Malaysia, and, to a

we may now have reached the trough.

lesser extent, from the countries of the Gulf Coop-

A number of banks, particularly, will come to mar-

eration Council (GCC).

ket, we believe, needing to refinance their existing

While still considered an alternative investment, we believe sukuk have the potential to grow and join the mainstream.

Funding needs and large infrastructure investments in Malaysia and the GCC, combined with better global investor sentiment, are behind today’s momentum in the sukuk market. For that reason, we believe that GCC issuers especially are likely to come to market with bigger issues that are more commensurate with the potential suggested by their asset size.

debt and seeking larger amounts to match the credit needs of their corporate clients, especially in project finance.

In turn, we anticipate that supportive GCC-Asian trade policies and the global search for yield will add to the attraction of GCC sukuk as an investment proposition, most notably to Asian investors.

Sukuk issuance New issuance of sukuk worldwide could top well above $100 billion again this year, according to our base-case scenario for investment spending and

Yields in the region have been declining, and even

economic growth, along with assumptions about

dropped below those on conventional debt. Add-

continued high oil prices and low bond yields.

ed to that is strong domestic appetite for Islamic

Global sukuk issuances already stood at about

finance and sound liquidity, as well as greater

$30.6 billion as of the first quarter of 2013, out of

political willingness to move ahead with sizable

which $3.8 billion was from the UAE.

infrastructure projects. We have noticed a small uptick in yields in 2013Q1, however, suggestsing

Page 6

In addition, jumbo issuance may pick up further, mainly on the back of huge infrastructure projects

from sovereigns. Turkey, Qatar, and Malaysia is-

also help to cover external financing needs and

sued more than $1 billion over the past two years.

support reserve building. This is important for

Sustained investment spending and ample domestic liquidity are likely to support sukuk issuance, especially in Malaysia, Saudi Arabia, Qatar, and the UAE. Investment spending could see high-single-

countries with sizable fiscal funding needs, such as Malaysia or those in North Africa (less so for GCC countries, which generally enjoy healthy fiscal and external accounts).

digit growth for 2013 if it continues at the rates we

Sovereign-related issuance reached a record

have seen in the first quarter.

$115 billion globally in 2012, comprising about

We believe that sovereign and sovereign-related

80% of total issuance for the fourth year in a row.

issuance will continue to dominate, shape, and un-

Additionally, we believe that the GCC and Asia

derpin the sukuk market, as it has in the past several

will remain the key engines for growth of the

years (see box).

sukuk market in the coming 18-24 months. New

Sovereign sukuk are generally the first inroad into Sharia-compliant funding in any given country, enabling the gradual creation of reference prices over

issuers may be seen, most probably sovereigns, though with modestly-sized issues to test the waters and investors’ risk appetite.

time, to which private-sector entities can bench-

And we may see the debut of issuers outside

mark themselves.

these two regions, like the Development Bank of

From a sovereign perspective, Islamic bonds can give governments access to a new investor class by diversifying sources of fiscal funding. They can

Kazakhstan with its MYR1.5 billion sukuk program in 2012. The pace and frequency of issuance in those frontier markets will depend in our view greatly on their capacity to develop Islamic finance infrastructure.

Further afield, we don’t rule out the possibility that more African sovereigns will enter the market. Some African countries have been growing strongly over the past few years, and most have huge infrastructure investment needs.

So far, only two African sovereigns have come to the domestic market with sukuk -- Gambia and Sudan -- but we understand that a number of them are considering either domestic or global issuance.

The Asian and GCC sukuk markets are becoming more interdependent as the number of crossborder transactions between the regions pick up, and because of increasing use of the Malaysian ringgit as a preferred currency of choice.

Islamic Artwork

Page 7

More generally, last year’s non-Malaysian entities, such as China-based Noble Group Ltd. and the Development Bank of Kazakhstan, issued upward of $1.5 billion.

The ringgit is becoming a growing, credible alternative to the US dollar for non-Malaysian issuers. Interestingly, in 2012 issuance in the Malaysian currency by all issuers (domestic and foreign combined) actually exceeded those by Malaysian entities for the first time.

Malaysia has well-defined regulations and developed capital markets (both conventional and A streetscene in Downtown Kuala Lumpur, Malaysia

Islamic), a large and diversified pool of investors, standardized sukuk structures with available liquidity, as well as its status as a potential

Both regions have relatively strong economies

gateway to other fast-growing Asian economies

and are seeking huge amounts of capital to fund

such as Indonesia and China.

new infrastructure, support economic development, and entice more private-sector investment.

Cross-border trends Cross-border issuance should continue to gather steam, with Malaysia as the main benefactor, as

Since its infancy in the 1990s, the sukuk market has experienced exponential growth -- that is until the financial crisis of 2008, which dampened investor appetite globally, and across the board.

in the past few years.

GCC-based entities have been crossing the figurative border with ringgit-denominated issues over the past few years, beginning with pioneering entities such as Abu Dhabi National Energy Co. PJSC, Bahrain-based Gulf Investment Corp., and National Bank of Abu Dhabi.

Most recently, Saudi-based Al Bayan Holding became ( on April 24th, 2013), the first Saudi corporate to venture into the Malaysian debt capital market, by issuing a MYR200 million ($65.4 million) sukuk.

Even though the amounts remain low, ringgitdenominated sukuk issuance in the GCC has been steadily increasing, to $571 million in 2012 from $323 million in 2010.

Page 8

A view of Dubai Mall with Burj Al-Khalifa at the back, Dubai UAE

Sovereign players Two bodies are actively and increasingly helping in the development of sovereign sukuk: the Saudi-based Islamic Development Bank , AAA/ Stable/A-1+, and the Malaysia-based International Islamic Liquidity Management Corp.

The IDB is a multilateral development financing institution, whose stated purpose is to foster economic development and social progress in 56 member countries in accordance with Sharia principles. In A passenger ferry on the Bosphorus Sea in Istanbul, Turkey

Growth thereafter resumed when confidence returned,

that regard, it invests in sovereign sukuk, and issues sukuk with the aim of providing low-cost funds to member countries.

largely on the back of comparatively brighter economic

The IILM, founded in 2010 by central banks, mon-

prospects in emerging markets.

etary authorities, and multilateral organizations,

Future global growth of the sukuk market, in our opinion, depends directly on greater liquidity and better price formation.

seeks to play a vital role in developing much-needed short-term Sharia-compliant liquidity solutions for Islamic financial institutions. The IILM recently established a financing vehicle, rated by S&P, to

Liquidity is tight because the market is still small and

issue short-term Sharia-compliant money-market

viewed as an alternative asset class. This situation is

instruments backed by long-term sovereign sukuk.

improving as larger and more frequent issues come to market, and as sukuk gain greater acceptance as a mainstream debt instrument.

We note the increasing number of sukuk that are being rated and listed on international stock exchanges, with healthy competition by exchanges to attract issuers.

However, most sukuk issued globally are not listed and remain over-the-counter instruments, and rated ones are the exception rather than the rule -- although the absolute number of issuers seeking ratings is on the rise.

As we look toward the future, Standard & Poor’s believes the ability of the Islamic financial industry to overcome questions related to Sharia interpretation, standardization of sukuk structures, and creditworthiness, plays directly into the globalization of the sukuk market and its wider acceptance by international investors.

Paul-Henri Pruvost is an Associate Director at Standard & Poor’s Ratings Services, based in Dubai, UAE

Page 9

Stock Markets GCC While equities overall across the GCC showed a positive aggregate performance, the underlying reality remained mixed. The dominant Saudi Arabian Tadawul bourse led indices higher, strengthened by the heavyweight petrochemical sector, whose momentum has continued since a weak 2012, and notably by retail as well. Against a backdrop of stable oil prices, the lead given by the Saudi measure induced some measure of optimism across the region. Qatar’s index was boosted by industrials and banks & financial services, with similar impetus seen in Kuwait, uplifted by encouraging earnings data and hopes of buoy-

major French bank’s local operation. A 10% tax was to be imposed on shareholders in National Societe Generale Bank who turned a profit from selling their stakes to Qatar National Bank. The timing and nature of the announcement affected

ant government spending. Modest increases were

the mood of investors generally. At the same time

to be found also in Oman and Bahrain. By contrast, the UAE indices fell back, Abu Dhabi dragged by real estate, and Dubai (by over 5%) by both banking and real estate, notwithstanding an almost 10% improvement in telecoms. Overall trading activity rose on the month, most notably with a surge in Kuwait.

sentiment was affected by negotiations over the payment of back taxes by Orascom Construction Industries, with investor concern growing at the apparent targeting of private interests. Lebanese stocks were impacted by the resignation of Prime Minister Mikati, as the spillover from the two-year civil conflict in Syria spread its damaging effect.

Meanwhile, Turkey’s index made further upward

MENA

strides.

Continuing turmoil in Egypt kept the dominant regional market in decline in March. Its benchmark EGX

Far East

30 index slumped to its lowest for the year so far late

Stocks in Asia were generally supported by the

in the month, putting it among the worst perfomers

lead given by the US market, responding to the

globally, when the country’s tax authority said it

idea of concerted recovery in play, although

would impose a capital gains levy on the buyout of a

Malaysia was subdued by political uncertainty.

Chinese economic data gave help, while Europe’s

99.5

70

97 96.5

68

96

67.5 67 01−Jan

Page 10

97.5

95.5 18−Jan

04−Feb

21−Feb

10−Mar

29−Mar

95

Egypt Islamic Index

68.5

98

Conventional Index

Islamic Index

Correlation (1 mth) 0.945587

360

860

98.5

69

365

880

99

69.5

MENA

900

100

Correlation (1 mth) −0.348715

840

355 350

820

345

800

340

780

335

760 01−Jan

18−Jan

04−Feb

21−Feb

10−Mar

29−Mar

330

MENA Aggregate Index

GCC

70.5

1.16 x 10

US dollar and equities became a green light for

1.15

and Thailand reached and hovered in the vicinity of record levels, and Korea took note of additional government stimulus in the offing. The ���������������� main Philippine index surged to unprecedented heights upon upgrading by Fitch of its sovereign rating to investment grade. The quarterly gain in Asian measures

Malaysia Islamic Index

associated bourses on the Pacific Rim. Indonesia

nonetheless suggested a slowing of momentum,

415 Correlation (1 mth) 0.714966

410

1.14

405

1.13

400

1.12

395

1.11

390

1.1

385

1.09 01−Jan

perhaps signifying overbought territory.

Far East

4

18−Jan

04−Feb

21−Feb

10−Mar

29−Mar

World Conventional Benchmarks

1600

380

730

1580

725

1560

720

Following an uneven February, leading markets

1540

715

trended to the upside in March, primarily moti-

1520

710

1500

705

1480

700

in both the S&P 500 and Dow Jones Industrial

S&P 500

Rest of the World

vated by US pick-up. Record highs were touched

1460

Average indices. Economic data releases included

Correlation (1 mth) 0.790962

1440

rebounding manufacturing activity, with a strong

1420

increase in auto production, better job growth,

1400 01−Jan

the lowest unemployment rate and fastest factory

Aggregate Far East

breaking of negative correlation between the

695

Euronext 100

messy Cyprus bailout proved not disruptive. The

690 685

18−Jan

04−Feb

21−Feb

10−Mar

29−Mar

680

orders for four years, and a firming housing market. The signs were that American sentiment was

World Islamic Benchmarks

2450

shrugging off softer outlooks elsewhere. That mo-

1800

mentum was to be contrasted against the halting

1780

European picture, darkened by a difficult bailout for Cyprus, casting doubt on the prospects for the to be ticking along, while Japan’s Nikkei index continued to react to the stark pledges to dramatic monetary stimulus.

DJ Islamic Index

eurozone despite its small size. China appeared

1760 2350

Correlation (1 mth) 0.986519

1740 1720

2300 1700

FTSE Shariah World Index

2400

Sources: GIC, Global Investment House, Markaz, Emirates NBD, Reuters, Bloomberg

2250 01−Jan

18−Jan

04−Feb

21−Feb

10−Mar

29−Mar

1680

Page 11

Islamic Stock Indices Islamic or Shariah compliant indices exclude industries whose lines of business incorporate forbidden goods or where debts/ assets ratios exceed 33%.

The increasing popularity of Islamic finance has led to the establishment of Shariah compliant stock indices in many stock markets across the world, even where local Muslim populations are relatively small, such as in China and Japan.

Evolution of Islamic Stock Markets in March 2013 for GCC, Far East, Middle East North Africa (MENA) and Rest of the World markets. Prices represent the closing price of the respective index at 29/3/2013. Percentage Month-to-Month (MTM) Change and percentage Volatility. Source: Datastream

Conventional Stock Indices

Volatility is a measure of uncertaincy of market returns. It is calculated as the standard deviation of the returns in the reported month. The formula for the standard deviation is: Ďƒ=E[(X-Îź)2]1/2

Evolution of Stock Markets in March 2013 for GCC, Far East, Middle East North Africa (MENA) and Rest of the World markets. Price represent the closing price of the respective index at 29/3/2013. Percentage Month-to-Month (MTM) Change and percentage Volatility. Source: Datastream

Page 12

Commodities Oil

120

A sideways trend in March consolidated the softer

115

tone to Brent and related series. The sense of global zone fears were rekindled by the messy handling of the Cyprus bailout. According to OPEC, reduced refinery

110 USD/barrel

economic rebound was less in evidence, while euro-

Crude Oil Brent Oil Dubai Oil WTI Oil

demand due to maintenance efforts worldwide was a key factor too. WTI, however, picked up, both with

105 100 95

the impression that the US was giving clearest signs

90 01−Jan

of recovery and the easing accumulation of mid-West

18−Jan

04−Feb

21−Feb

10−Mar

29−Mar

stocks. Although the WTI-Brent tightened, as North Sea production rose, the market continued to shift towards

Natural Gas

4.5

Brent as benchmark in terms of contracts outstanding on

Natural Gas

the exchanges.

USD/MMBTU

Natural Gas The surge of gas prices through the month owed once again predominantly to a helpful weather pattern. The Henry Hub index rose 15%, with US natural gas breaking

4

3.5

through $4 mBtu, as low temperatures extended wintry conditions into the spring, remaining near freezing in New York and Chicago, for instance. Inventory draw-

3 01−Jan

downs surpassed expectations over several weeks, and

18−Jan

04−Feb

stocks were claimed from storage. In the UK a pipeline outage added to price pressure, with some concern aris-

21−Feb

10−Mar

29−Mar

Gold

1700

2250

ing even of national supplies running out.

having lost safe-haven appeal with the increasing rotation into equities and other risk assets. The scale of redemptions in ETF funds was a further sign of the tide

1650

over three years, as well as some pick-up in demand

2100

1600

2050

having turned. In mid-month, however, prices perked up upon the highest monthly increase in US inflation for

2150

1550 01−Jan

Precious Metals Index

18−Jan

04−Feb

21−Feb

10−Mar

29−Mar

Precious Metals Index

Gold was already on the defensive coming into March,

2200 USD/Troy Ounce

Gold

2000

from India and China in response to the previous dip.

The market softened again, though, with the impression that the mix of news on economic growth and contained inflation were depriving the precious metal of key supportive momentum.

Page 13

Copper/Base Metals The unconvincing nature of global recovery, and its sepa-

Copper

8400

3700

in London Metals Exchange warehouses, and speculative short positions climbed during March to record highs. The Cyprus bailout fiasco noticeably damaged fragile sentiment. Prices have tracked trends in PMI (manufacturing) indices, and particularly the decline in Chinese imports, exaggerated by the reversal of overstocking. Expected global demand slumped against a backdrop of ample

USD/MT

generally. Stocks more than doubled in the first quarter

8200

3600

8000

3500

7800

3400

7600

3300

7400 01−Jan

stocks relative to current and pending usage.

Base Metals Aggregate Index

18−Jan

04−Feb

21−Feb

10−Mar

29−Mar

Sugar

20

660

Sugar/Agriculturals

producer and exporter. However, the story for the remainder of the month was one of sharp decline, reflecting a price war and competition for market share amid fall-

USD cents/lb

delayed deliveries at ports in Brazil, the world’s largest

source, Thailand, raised output from its enhanced capac-

650 645

19

640 18.5

ing revenue. Farmers in Brazil increased plantings so mills would operate at full utilization, while the second dominant

655

19.5

Early March saw a temporary lift in sugar prices owing to

3200

635 630

18

625 17.5 01−Jan

Agriculture Aggregate Index

18−Jan

04−Feb

21−Feb

10−Mar

29−Mar

620

Agriculture Aggregate Index

by the continuing downshift in copper, and base metals

Base Metals Aggregate Index

ration from the surge in stock markets, was well expressed

ity. Traders anticipated that ample supplies would come 860

encouraged funds to take short positions.

850

Edible Oils

840

Conditions were uneven in vegetable oils through the month, with no particularly strong sense of direction, and participants awaiting further guidance from pending industry data. US soybean stocks were reported at sufficiently

Palm Oil (USD/MT)

weaker Brazilian real, prompting higher local sales, also

15

14.5

830 820 810

14

800

high levels to put pressure on the competition from palm oil

790

too, with firm exports and stockpiles in Malaysia, but there

780 01−Jan

was technical reaction from chart levels once the market

Palm & Soybean Oil

Soybean Oil

18−Jan

04−Feb

21−Feb

10−Mar

was deemed oversold.

Sources: Financial Times, OPEC, Bloomberg, Reuters

Evolution of highly traded commodities in March 2013. MTM Change and Percentage Volatilities. US $ and US c indicate United States Dollar and United States cent repsectively. bbl = billion barrels, MMBTU = Million British Thermal Unists, MT = Metric Tonne, LB = Pound and Bsh=Bushel. Prices represent the price of the respective commodity at 29/3/2013. Source: Datastream

Page 14

29−Mar

13.5

Soybean Oil (USD/Bsh)

on the international market also from India and Mexico. A

Bonds and CDS markets The market lost some degree of confidence in the

367

2.5

366

2.45

365

2.4

364

2.35

363

underpin perceptions of the US as a safer haven for

2.3

362

all investment classes again, the Gulf’s belonging

2.25

361

2.2 01−Jan

to emerging or frontier categories meant that the spell had been broken. A modest sell-off occurred, restrained by the essentially firmer financial condi-

9

tions prevailing in the region itself, besides technical,

still be overcooked, reflecting paper having been chased up too far. New issuance has still drawn high levels of interest and momentum, but that prompt on the primary side led again to underperformance in

gravated the already strained situation in the country, which remains devoted to securing a multi-billion

230 220 210

6

200

5.5 18−Jan

04−Feb

21−Feb

10−Mar

Malaysia Bond Yields & Prices

29−Mar

190

278.5 278

1.8 Yield to Maturity (%)

rioration, although its central bank denied any sig-

in imported food and fuel led to shortages that ag-

240

1.85

ated in the Mena space with Egypt’s financial dete-

sovereign rating during the month. A sharp decline

Egypt Bond Yields & Prices

6.5

1.9

The downtrend denoted at global level was exagger-

January 2011 revolution. Moody’s downgraded the

360

29−Mar

7

Egypt / MENA

decline of about two-thirds in the two years since the

10−Mar

7.5

5 01−Jan

secondary trading.

nificant, further draining of reserves in March, since a

21−Feb

8 Yield to Maturity (%)

market watchers say local fixed-income prices may

04−Feb

8.5

chart support. The depressive conditions in the eurozone also capped the rise in yields. In fact, regional

18−Jan

Bond Index

stronger economic news in the States served to

277.5

1.75 1.7

277

1.65

276.5

Bond Index

CDS spreads widened more markedly. Whereas

Yield to Maturity (%)

US Treasuries, and their subsequent turn into reverse.

368

2.55

GCC in March, caught by the apparent curtailment of the long uptrend there had been emanating from

Qatar Bond Yields & Prices

2.6

Bond Index

GCC

1.6 276

1.55 1.5 01−Jan

18−Jan

04−Feb

21−Feb

10−Mar

275.5 29−Mar

loan from the IMF that should trigger other financial handouts. That deal was said to have been delayed to mid-year, and investors will have perceived a circularity in the need with the circumstances on the ground, in terms of political instability and social unrest, that would give the supranational institution any comfort in expecting its conditions to be applied.

Consequently, yields on international instruments that had been drifting in the region of 7% at end-February had spiked out to 9% by end-March.

Malaysia / Far East Movements in Asian bonds showed a conspicuous parallel with other emerging markets in responding to the fallout from the US benchmark, that’s to say a moderate retreat. That move was tempered, however, by lingering confidence, aided by research reports suggesting that whereas yields themselves are unlikely to drop back to levels recently seen, the

Page 15

scope for currency appreciation makes Asian bond markets distinctly attractive still for the medium

Sovereign Bond Markets

term. The suggestion is that they now represent strategic exposure rather than a risk categorization on an international basis. Market deepening and favourable supply and demand dynamics created an ongoing cushion of support for investor sentiment, though a drift could be seen to shorter durations and longer exchange positioning, given that US T-bonds had probably turned a big corner.

Global Benchmarks Volatility was more in evidence in key markets, where mixed economic news kept the underpinnings to bond instruments in limbo. Improved performance in the US economy had a double-edged effect, indicating that Treasury yields should be rising, while investors could justify taking a stake in an outperforming economy on the global stage. A safe-haven effect could be seen as well in German bunds, considering the continued fracturing of European solidity, for which the Cyprus fiasco provided

Evolution of Bond Markets in March 2013 relative to the previous month.

The table reports the price index on which the MTM Change is calculated (month-to-month) and the Yield of sovereign bond maturities typically between 6 months and 25 years. Data as at 29/3/2013.

clear evidence. Economic data out of Europe also favoured core bonds, with retreats in industrial pro-

Credit Default Swap Markets

duction and purchasing managers’ indexes, with rising unemployment. Peripheral eurozone bonds suffered, itself aggravating the financial difficulties faced in the midst of austerity-oriented policy settings. In the US rate moves were contained, nearly flat across the curve.

Sources: GIC, Invest AD, HSBC, Reuters, Bloomberg

2.1

US Bond Yields & Prices

156

2.05

Yield to Maturity (%)

1.95

154

1.9 153

1.85 1.8

152

1.75 1.7 01−Jan

Page 16

18−Jan

04−Feb

21−Feb

10−Mar

29−Mar

151

Bond Index

155

2

Evolution of CDS Spreads in March 2013 relative to the previous month. The index reported here represents the average basis points (bp) of a 5-year CDS for protection against sovereign bonds. Data as at 29/3/2013. MTM Change refers to the change relative to the previous month.

Islamic Bonds (Sukuk) Lack of activity prevailed in Gulf secondary sukuk

2.95

conventional benchmark bonds having found some

2.9

in the US. The downward pressure from the possibility that a resumption of growth might keep the Fed out of the market, while leading to higher yields, was conceivably offset by confidence in ongoing central bank support in the face of any such threat, besides weakness evident in other regions of the world, especially

2.8 2.75

2.65 2.6 01−Jan

In 2013 so far, it has become apparent, however, that Malaysia is dominating global sales of sukuk, a trend

10−Mar

99.5 29−Mar

108.5

3.75

Yield to Maturity (%)

ing the market’s evolution, with the need for encour-

was delivered, a pioneering development.

21−Feb

Middle−East Conventional Bond Index (MEBI)

by fund managers identifying that factor as constrain-

new issues. In the last case a $1bn 30-year offering

04−Feb

3.8

depriving the market of liquidity, in line with remarks

Bank Asya and Saudi Electricity came forward with

18−Jan

Source: HSBC Nasdaq Dubai

a sense of direction, and investors stayed sidelined,

activity in the primary sphere, where Emirates Airlines,

100

2.7

In other words, there was no obvious conviction as to

Attention within the GCC was focused instead on

100.5

2.85

Europe.

agement by relevant authorities.

101

108

3.7

107.5

3.65 107

3.6

Clean Price

kind of neutrality from the signs of economic rebound

Yield to Maturity (%)

trading during March, with the key comparison of

HSBC−NASDAQ Dubai Sukuk Index (SKBI)

Clean Price

3

106.5

3.55 3.5 01−Jan

18−Jan

04−Feb

21−Feb

10−Mar

106 29−Mar

Source: HSBC Nasdaq Dubai

highlighted in a recent report by Standard & Poor’s, further elaborated in this edition of the bulletin (see special feature). Issuance in ringitt could account for in excess of 70% of issuance worldwide this year, the agency has suggested.

In recent weeks the Malaysian market has in fact been anxious ahead of elections to be held by mid-year, as reflected in an increase in the cost of insuring against sovereign default by the use of credit default swaps.

Still, confidence remains among economists and analysts convinced of the country’s financial and regulatory proposition, as well as issuers, including from the

Sukuk is the Arabic name for financial certificates, but commonly refers to the Islamic equivalent of bonds. Since fixed income, interest bearing bonds are not permissible in Islam, Sukuk securities are structured to comply with the Islamic law and its investment principles, which prohibits the charging, or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and nontradability in the secondary markets.

Gulf, interested in diversifying sources of funding.

Sources: Rasmala, Bloomberg, Zawya, Gulf News

Page 17

Accountancy Issues Rules and Regulations Saudi Arabia quits industry body

Saudi’s Sedco Capital plans sukuk funds

A prominent matter this month has been that of

Jeddah-based investment firm Sedco Capital is

Saudi Arabia leaving the International Islamic Liquid-

aiming to expand its range of Islamic funds to more

ity Management Corp (IILM) which is preparing to

than fifteen by this year-end. The plan adds mo-

launch its first, long-delayed sukuk since inception in

mentum to the Gulf’s Islamic funds industry, which

2010. The IILM is an entity backed by central banks

was obviously affected by the global financial crisis

located mainly in Asia and the Middle East, which

but is now attracting regional firms such as Qatar’s

aids Islamic banks in managing their liquidity as well

QInvest. The main objective is to create a range of

as facilitating liquidity across the sector’s instruments.

asset classes, introducing products in commodities,

The central banks of Qatar and Malaysia bought out

real estate and private equities.

Saudi Arabia’s share. IILM did not give a reason for this exit. Issuance of the first sukuk has been delayed twice, as the organization has faced a major challenge in ensuring compliance with laws in all its twelve member countries, situated across Asia and the Middle East.

Source: The Arabian Business News, April 7th

Kingdom Tower at night in Riyadh, Saudi Arabia

Page 18

GOLCER finds this to be an initiative that would improve financial market sentiment and change investor attitudes in Saudi Arabia.

Source: Reuters, April 3rd

Perspective Talking the book is increasingly talk about sukuk, and fairly so

by Andrew Shouler Very much helped by the inherent strength of the Gulf region in its oil-buoyed finances, and the welcoming currency play of the Asian emerging markets, the growth of sukuk as a market instrument has become

retained and this exemplar of the Asian growth story

a cornerstone of current investment-oriented discus-

resumes its cheery tale.

sions in Islamic finance.

Of particular interest to investors, though, would be

Both the GCC and Malaysia especially are bringing

the consultancy’s observation that sukuk, in the GCC

also a determined pursuit of the institutional frame-

space at least, have outperformed conventional

work necessary to entice both issuers and investors

bonds, using data from HSBC/Nasdaq.

into the fray, though the tendency for primary activity to dominate over secondary is somehow a familiar characteristic in markets literally emerging.

With sideways trading the approximate outcome in fixed-income of the year to date, the Gulf’s sukuk index was up 1.3%, compared to the conventional

Meanwhile, those following the fortunes of the

counterpart’s 0.9%. The turmoil of the Mena region’s

Islamic finance sector are bound to come across the

Arab Spring, and the flight-to-quality phenomenon

succession of stories of countries turning to sukuk to

witnessed on-and-off through the global financial

both tap into and diversify prospective funding.

crisis, have not noticeably upset the stability of sukuk

In this edition of the bulletin we have reported on

trading.

the implicit clash between the short-term reverse in

Moreover, though briefly expressed here, examining

Islamic bond markets, by association with the turn-

the relative value opportunities in Mena sovereign

around in US Treasuries since the new year, and

sukuk compared to similarly-rated sovereign bonds,

the medium- and long-term prospects offered by a

Arabia Monitor deduced that, from the holder’s

market with such convincing structural drivers.

perspective, the spread characteristics are “virtually

Naturally, this topical evolution draws attention from serious analysts, and this month we have been fortu-

identical”, implying an investable opportunity when market discrepancies occur.

nate enough to host refreshed reporting by Standard

Such analytical insights suggest that not only does su-

& Poor’s of their recent research documenting these

kuk development appear to be coming an established

trends. Further to which, only last week the consul-

norm in the global financial architecture, with a firmly

tancy Arabia Monitor put out its findings in watching

upward trajectory, but that these instruments are offer-

the sukuk market’s progression.

ing a comparability in investment terms underpinning

Its report noted the decline overall of global issuance

their acceptability and performance.

so far this year, though actually higher in the Gulf.

At this point, the issue for observers becomes whether

Figures for Malaysia have been down by about a

this process develops towards the flowering and frui-

third, pending elections due next month. A pick-up

tion that the market’s supporters hope, or whether

can be expected there later in the year, given the

bumps in the road may introduce unexpected jolts and

relative appeal of that country’s announced infra-

impediments. On those matters this publication will

structure programme, provided sufficient calm is

hope to keep vigil and report.

Page 19

Marwan Izzeldin Director m.izzeldin@lancaster.ac.uk Andrew Shouler Editor a.shouler@lancaster.ac.uk

Research Team Gerry Steele g.steele@lancaster.ac.uk Vasileios Pappas v.pappas@lancaster.ac.uk Marwa El Nahass m.elnahass@lancaster.ac.uk

DISCLAIMER This report was prepared by Gulf One Lancaster Centre for Economic Research (GOLCER) and is of a general nature and is not intended to provide specific advice on any matter, nor is it intended to be comprehensive or to address the circumstances of any particular individual or entity. This material is based on current public information that we consider reliable at the time of publication, but it does not provide tailored investment advice or recommendations. It has been prepared without regard to the financial circumstances and objectives of persons and/or organisations who receive it. The GOLCER and/or its members shall not be liable for any losses or damages incurred or suffered in connection with this report including, without limitation, any direct, indirect, incidental, special, or consequential damages. The views expressed in this report do not necessarily represent the views of Gulf One or Lancaster University.

Redistribution, reprinting or sale of this report without the prior consent of GOLCER is strictly forbidden.