6 minute read
A transformative opportunity
The Islamic finance sector continues to demonstrate modest growth globally however at a slower rate compared to 2019/20 because of the economic fallout due to the outbreak of the COVID19 pandemic and low oil prices owing to plunging demand amid measures to contain the virus in core Islamic economies.
Advertisement
In 2021, narrowing fiscal deficits across the GCC region will likely drive a plunge in new Sukuk issuance. But despite the decline, Islamic bond issuance is expected to remain above the prepandemic annual averages mainly due to governments financing requirements due to the prolonged pandemic.
Moody’s estimated that the gross longterm global sovereign Sukuk issuance will hit the $96 billion mark this year compared to $109 billion issued in 2020.
However, the current economic challenges have created opportunities to accelerate and unlock the long-term potential of the Islamic finance sector, S&P Global said in its report, Islamic Finance Outlook 2021 Edition. These pandemicinduced challenges are expected to put the Islamic finance industry back on environmental, social and governance (ESG) investors’ radar, streamline Sukuk issuance to encourage the industry’s attractiveness and leverage technology to create a nimbler finance industry.
Sustainable finance
The twin shocks of COVID-19 and plunging oil prices are expected to enhance the appetite for sustainable instruments as governments and corporates in the Gulf region seek to revive their economies amid diversification from hydrocarbonbased economies and transition to sustainable financing.
“Islamic finance social instruments can help core countries, banks, companies and individuals economically affected by the pandemic navigate current conditions, with market participants eyeing Qard Hassan, Zakat, Waqf, and Social Sukuk,” said S&P Global.
As GCC countries are tapping debt markets – taking advantage of low borrowing costs and investor demand for higher returns – to finance projects and plug their budget deficits, analysts expect Islamic finance social instruments to widen the appeal of Islamic bonds beyond traditional markets in the Middle East and South Asia to include ethical investors in Western countries.
“The Sukuk instrument overall remains attractive to issuers because it provides investor diversification and access to the Islamic pool of liquidity, which is growing in line with the market share of Islamic finance in the core Islamic countries,” said Ahsan Ali, Managing Director, Global Head of Islamic Origination, Standard Chartered Bank.
Gulf region Islamic lenders are seeing a growing frenzy for green bonds although the appetite is still in its infancy as more investors are committing to responsible investment. Last year, the overall green bond market was worth over $230 billion, and it reached $2 billion in the Middle East region with the potential to grow further.
“Whilst not mutually exclusive, Shari’ah finance offers a framework that embodies the social and ethical values of ESG investing, providing Middle East investors with an attractive opportunity to adopt more sustainable, responsible investment strategies – and, ultimately, the ability to tap into the significant value potential from ESG and the global shift towards sustainability,” said Soumaya Hissoussi, Senior Vice President, Lombard Odier Abu Dhabi Branch.
The Gulf region’s first $587 million green bond was issued by First Abu Dhabi Bank (FAB) in March 2017. The Abu Dhabibased lender also issued a five-year Hong Kong dollar-denominated green bond
worth $96.77 million through a private placement last June.
Last October, Abu Dhabi’s Etihad Airways issued a five-year “transition” $600 million green Sukuk to support its shift to a greener future. Having issued its $1.2 billion (EUR 1 billion) debut green Sukuk in November 2019, Saudi-based Islamic Development Bank also issued a five-year $1.5 billion debut sustainability Sukuk to support its members revive their economies post-COVID.
Finance raised from green Sukuk typically supports investments in renewable energy or other environmental assets such as solar parks, biogas plants, wind energy projects, as well as renewable transmission and infrastructure projects, according to S&P.
Although overall Sukuk issuance is gathering steam in some of the world’s largest financial hubs like London, the market for green Islamic bonds remains small compared to the conventional Sukuk market.
Harmonizing Islamic finance
Regulation of Islamic finance differs from one country to the other and the conceptual regulatory framework of the Basel Committee on Banking Supervision is the default framework, said Moody’s. However, there is a push towards the standardization of Islamic finance.
Standardized supervision of Islamic finance is expected to lead to greater market confidence and restoration of its attractiveness to issuers. But standardization poses challenges in terms of implementation and adoption, particularly in realigning existing products.
S&P Global stated that Sukuk issuance remains more complex and timeconsuming than conventional bonds, hence when Islamic finance issuers need swift access to capital markets, they typically use conventional instruments.
In 2018, Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and Malaysia’s Islamic Financial Service Board (IFSB), two institutions that have traditionally worked independently on their respective mandates in the past, signed an MoU to create a level playing field and foster harmonization and standardization of regulations.
Last May, the UAE set an example in the region towards much-needed standardization in the Islamic finance sector by launching the Higher Shari’ah
Authority. Overseen by the central bank, the Higher Shari’ah Authority is a national regulator entrusted with overseeing the Islamic financial sector, approve financial products, and set rules and principles for banking transactions per Islamic jurisprudence.
Moody’s said that the initiative by the UAE is credit positive for Islamic finance institutions because it addresses the sector’s main impediment to growth – the complexity and diversity of legislative frameworks and practices across regions and geographies, which creates additional risks and uncertainty in case of litigation.
Since its inception, the Higher Shari’ah Authority ordered the Shari’ah boards of financial institutions in the UAE to apply the Shari’ah Standards issued by AAOIFI as of September 2018.
Elsewhere, Bank Negara Malaysia issued a revised Shari’ah Governance Framework which was to be implemented in April 2020 to strengthen board oversight and the responsibilities of Shari’ah governance. In January 2020, the central bank of the Philippines, Bangko Sentral ng Pilipinas implemented the Islamic Banking Act, a legislation that is seen as the foundation of Islamic banking and financial inclusion in the country.
Hassan Jarrar, Chief Executive Officer of Bahrain Islamic Bank, said, “A global set of standards that would be acceptable to all stakeholders is still lacking although the Accounting and Auditing Organization for Islamic Financial Institutions, the
Islamic Financial Service Board and the International Islamic Financial Market are working together to drive this agenda.”
– S&P Global
Sukuk issuance Q1 2021
Moody’s projected that Sukuk issuance this year will likely stabilize after a record in 2020 and five consecutive years of growth. Last year, Islamic issuance surged by 15% to hit the $205 billion mark driven by large sovereign funding needs due to the economic fallout caused by the pandemic and a plunging oil price.
“We expect issuance to consolidate around $190-$200 billion in 2021, supported by GCC sovereigns’ high financing needs as oil prices remain moderate and fiscal deficits remain wide and as the sovereigns raise the share of Sukuk in overall debt,” Moody’s added.
Saudi Arabia, the Middle East region’s biggest economy, projected a deficit of $79.4 billion (SAR 141 billion) in 2021 (4.9% of GDP), while the UAE’s budget deficit – including consolidated accounts of the federal government and the emirates of Abu Dhabi, Dubai and Sharjah is estimated to be 9.9% of this year’s GDP.
