Sukuk

COVER STORY

MAKING A STRONG RECOVERY

SUKUK MARKET

22 > QATAR TODAY > SEPTEMBER 2017

SUKUK MARKET

MAKING A STRONG RECOVERY

AFTER THREE CONSECUTIVE YEARS OF DECLINE, THE GLOBAL SUKUK MARKET HAS STARTED LOOKING UP WITH THE ISSUANCES TOUCHING $74.8 BILLION (QR272.27 BILLION) IN 2016, REGISTERING AN IMPRESSIVE GROWTH OF 13.2% COMPARED WITH THE PREVIOUS YEAR.

BY VL SRINIVASAN

23 > QATAR TODAY > SEPTEMBER 2017

COVER STORY

MAKING A STRONG RECOVERY

SUKUK MARKET

Of

this, corporate issuers dominated the market with $47.3 billion (QR170.28 billion) of issuance volume, a share of 63.2%, and these were mainly from the financial services sector, which accounted for 80.7% of total corporate issuances.

The biggest corporate sukuk issuances were $1.5 billion (QR5.46 billion) from IDB Trust of the Islamic Development Bank, $1.2 billion (QR4.36 billion) from Dubai’s DP World, $1 billion (QR3.64 billion) from Emirates Islamic Bank, $500 million (QR1.82 billion) from Qatar’s Ezdan Holding Group, and from several financial institutions in Malaysia.

In fact, Malaysia continued to be the main driver for sukuk issuance for the year with a market share of 46.4% of total issuances, followed by Indonesia and the UAE which accounted for 9.9% and 9% of the market share, respectively. Turkey too issued a record sukuk of $4.1 billion (QR14.92 billion) in 2016 and even countries such as Senegal, Jordan, Ivory Coast and Kuwait also raised money through sukuk issuances.

Despite the adverse economic conditions around the world, the global sukuk market has been growing as the demand for sharia-compliant assets continues to outpace supply, albeit at a slower rate, as highlighted by the Kuala Lumpur-based Islamic Financial Services Board (IFSB).

The inclusion of sukuk in the global bond index in 2016 has also improved the pool of demand and the Sovereigns' need to plug the deficit gap from lower oil revenue led to

GLOBAL SUKUK ISSUED IN 2016 BREAKDOWN BY STRUCTURE Sukuk Structure

Amount Issued ($ Million)

Number of Sukuk

Wakalah

$12,136

23

Murabahah

$11,201

116

Ijarah

$7,269

26

Musharakah

$2,725

21

Modarabah

$2,537

66

Al- Wakalah Bel-Istithmar

$1,945

3

Al Salaam

$699

79

Mudarabah-Murabahah

$533

1

Al-Istithmar

$267

1

Ijarah-Musharakah

$267

1

Bai Inah

$242

2

24 > QATAR TODAY > SEPTEMBER 2017

bigger funding requirements including sukuk, and the dominance of Sovereign sukuk in H1 2017 is expected to continue for the remaining part of the year – from Oman, Bahrain and Kuwait.

Sukuk has been included in the Emerging Markets Bond Index (EMBI) and JP Morgan Asia Credit Index (JACI) indices published by investment banker JP Morgan later this year. This is viewed as a positive development as more global debt investors from around the world will focus their attention on the different kinds of sukuk, and it would increase the liquidity of sukuk instruments.

Though the US Federal Reserve has raised the rate twice this year (three times since December 2016), with another hike likely by the year-end and plans to reduce its holdings in Treasuries – it is expected to hypothetically drive yields.

Nonetheless, corporate issuers may stay on the sidelines or look for alternative funding avenues, including local currency sukuk, loans or equities.

Significant growth in GCC In the GCC region, the total issuances stood at $19.6 billion (QR71.34 billion) during the year, compared with $18 billion (QR65.52 billion) the previous year, due to higher issuances from Sovereigns, indicating that sukuk remained a major source to meet the budgetary deficits of the region’s governments in a scenario of low oil prices and a fall in export earnings.

This was primarily due to the jumbo local and foreign currency issuances by some GCC governments, including the $9 billion (QR32.76 billion) sukuk issued by Saudi Arabia in April, which is said to be one of the largest sukuk issued globally so far.

Explaining the reasons behind the growth, Hani Ibrahim, Managing Director and Head of Debt Capital Markets at QInvest, says while the Middle East faced adverse economic conditions due to the decline in oil prices over the last two years, the oil price and the financial markets started to stabilise in the recent past.

Though the liquidity positions of regional banks which are the main investors in sukuk declined due to the economic conditions, they are keeping more of their liquidity in cash and liquid instruments due to tighter underwriting standards and slower growth in the loan market. For Islamic banks in particular this has meant that the amount of liquidity available to them to go into sukuk has remained strong.

“In addition, many of the regional Sovereigns continue to post deficits which are partly funded through the issuance of bonds and sukuk, both local and international.

Many of the sukuk issued in 2017 have been large Sovereign transactions to address this funding gap. Combining this with the fact that globally there continues to be a strong demand for emerging market credit assets, a 37% increase in sukuk issuance between H1 2016 and H1 2017 has been recorded,” says Ibrahim.

A good year In a report, global ratings agency Standard & Poor’s says while this growth augurs a good year for sukuk, it represents

an exception rather than a new norm as some of the large issuances of 2017 are unlikely to be repeated in 2018.

The total global sukuk issuance is also expected to be around $75 billion - $80 billion (QR273 billion-QR291.2 billion) in 2017, up from previous expectations of $60 billion-$65 billion (QR218.4 billion-QR236.6 billion).

On the upward revision in its forecast, the ratings agency says there were two main reasons. While the governments were not under pressure to raise funds quickly and wanted to diversify their investor base, the other reason has been the regional and global liquidity which remained good.

The GCC governments, which were facing a liquidity crisis following a slump in oil prices for more than two years, heaved a sigh of relief as OPEC announced a cut in oil production by about 1.2 million barrels a day, which came into effect from January this year, and this helped in stabilizing the prices.

Even certain policies initiated by the GCC governments, such as cutting down unnecessary expenditure, and issuance of large bonds also helped in easing liquidity pressure. These governments have not only raised money from the conventional sources but also turned to the sukuk market to diversify their investor base to meet the demand for project funding.

The agency, however, still foresees significant financing needs for GCC governments, particularly the UAE and Qatar, which are hosting the World Expo in 2020 and the FIFA World Cup in 2022, respectively, and estimate the same to be around $275 billion (QR1 trillion) between 2017 and 2019 to complete the various mega infrastructure projects.

“We think that around 50% will be debt-financed, through a combination of bonds and sukuk. Governments are likely to continue to prefer bonds over sukuk,” the agency adds.

Dr Mohamed Damak, Senior Director, Global Head of Islamic Finance, S&P Global Ratings, says the strong performance also stemmed from the good liquidity conditions in the GCC and in global financial markets generally.

The GCC investors, particularly the banks in the region, are among the main investors and major players in sukuk but in the last two years the liquidity has come down due to lower deposit inflows. However, this situation started limping back to normalcy in the first half of 2017, thanks to the stabilization of oil prices.

“At the local and regional levels, the banks’ liquidity improved following the stabilization of oil prices and also due to large issuances of conventional bonds by GCC governments, and a part of the proceeds was injected into the local and regional economies. At the global level, liquidity remained abundant in the first half of 2017 and we expect this will continue until the end of the year,” says Damak.

He says even the European Central Bank (ECB)'s Quantitative Easing (QE) programme, the slow increase in the Fed's interest rates, and good liquidity in some Asian countries will continue to support demand for both bonds and sukuk.

“The currently difficult operating environment offers

“THE CURRENTLY DIFFICULT OPERATING ENVIRONMENT OFFERS FEW OPPORTUNITIES FOR LENDING GROWTH, AND SOME BANKS MIGHT INVEST A PORTION OF THEIR LIQUIDITY IN ASSETS THAT GENERATE HIGHER INCOME THAN CASH AND MONEY MARKET INSTRUMENTS. IN THIS CONTEXT, BONDS AND SUKUK APPEAR MORE ATTRACTIVE THAN INTERBANK OR CENTRAL BANK DEPOSITS, DRIVING FURTHER INTEREST IN THE SUKUK MARKET.”

DR MOHAMED DAMAK

Senior Director, Global Head of Islamic Finance S&P Global Ratings

GEOGRAPHICAL DISTRIBUTION OF ISSUANCE GCC

Malaysia

Other Asia

Other Countries

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1H 2016 GCC: Gulf Cooperation Council

1H 2017

Source: S&P Global Ratings

25 > QATAR TODAY > SEPTEMBER 2017

COVER STORY

MAKING A STRONG RECOVERY

SUKUK MARKET

“THE GLOBAL MARKETS ARE A VERY DEEP SOURCE OF CAPITAL, BOTH IN BOND AND SUKUK FORMAT, AND WILL FORM A GREATER SHARE OF THE SOURCES OF FUNDING FOR PROJECTS IN QATAR, WHICH CAN BE IN THE FORM OF CORPORATE/ SOVEREIGN BONDS AND SUKUK, OR THROUGH PROJECT-SPECIFIC STRUCTURES SUCH AS PROJECT FINANCE OR PUBLIC-PRIVATE PARTNERSHIPS.”

HANI IBRAHIM

Managing Director and Head of Debt Capital Markets QInvest

few opportunities for lending growth and some banks might invest a portion of their liquidity in assets that generate higher income than cash and money market instruments. In this context, bonds and sukuk appear more attractive than inter-bank or central bank deposits, driving further interest in the sukuk market,” says Damak.

Scenario in Qatar

In the wake of the diplomatic rift between Qatar and three other GCC countries, and the demand for project funding on the rise in Qatar, the crisis and political risks may have dampened the demand for Qatar-related sukuk in addition to the rating deterioration despite their relatively strong fundamentals in general.

However, Damak believes liquidity will continue to leak into the sukuk industry from developed markets, although this might be tempered by the recent developments in the GCC. For Qatar, the volume of issuance, both domestic and international, will depend on how the recent events evolve in the coming days.

“We are of the view that recent events will result in a higher nervousness and lower appetite from investors, and higher costs for Qatari issuances. It remains to be seen for how long the current situation will persist and how it will be resolved. In the absence of any significant improvement, we do not foresee large issuance from Qatari issuers.

Financing needs may also decline if non-core projects are delayed,” says Damak.

Hani Ibrahim says that, given the current diplomatic crisis, entities need to carefully consider the diversification of their sources of capital. “The global markets are a very deep source of capital, both in bond and Sukuk format, and will form a greater share of the sources of funding for projects in Qatar, which can be in the form of corporate/ sovereign bonds and Sukuk, or through project-specific structures such as project finance or public-privatepartnerships,” he says.

In order to access these sources of capital, entities need to prepare and be ready for the transparency, disclosure and due diligence requirements of this investor base, he says, adding that many of the GCC sovereigns have already accessed the sukuk market in the first half of 2017.

“We understand there is a healthy pipeline of transactions

TOTAL SUKUK ISSUANCE 2011-2017 (BIL $) 160 140 120 100 80

Source: S&P Global Ratings.

60 40 20 0

26 > QATAR TODAY > SEPTEMBER 2017

2011

2012

2013

2014

2015

2016

1H2016

1H2017*

"We have used June 15, 2017, as a proxy for the performance of the market during the first half of 2017. This is because the next two weeks will coincide with the end of Ramadan, which is usually a period where sukuk market activity is slow.

which are looking to access the market from September onwards. Many of these are likely to be from governmentrelated entities (GREs) and financial institutions. Focusing on Qatar, we could see some sukuk activity in the rest of 2017 and into 2018 as the entities look to diversify their investor base. A sukuk allows these entities to access the global investor base by using a standardized, globallyrecognised and listed instrument,” he says.

Qatari firm strikes gold Doha-based Ezdan Holding Group, one of the largest real estate development companies in the GCC and ranked 42nd in the all-industries category on the Forbes list of 500 largest Arab corporations in 2015, made its debut in the sukuk market by issuing a $500 million (QR1.82 billion) sukuk, which is the largest real estate capital market transaction from Qatar.

Issued in May 2016, the Ezdan sukuk was the first corporate sukuk in 2016 from Qatar and was well received by investors, despite making its debut, because of the reputation of the company as a leading player in the real estate market, and was oversubscribed 1.67 times by 71 investors. The sukuk is the first tranche of $2 billion (QR7.28 billion) which was approved by the company’s shareholders in April 2016.

The sukuk was subscribed by a good mix of investors both by geographic area and investor type. Investors from the Middle East took the biggest chunk of the sukuk and by investor-type banks took up the offering. The sukuk was issued on May 18 and eventually generated a total order book of around $800 million (QR2.91 billion) by investors from various geographies including MENA, Europe and Asia, demonstrating strong investor appetite for debut issuers with robust credit profiles despite the volatile market environment.

Media reports said that Qatari conglomerate Al Faisal Holding was planning to tap international debt markets for the first time to raise around $200 million (QR728 million) via a US dollar-denominated Islamic bond.

The group has reportedly received banks' proposals for an Islamic bond, or sukuk, and is also said to be considering securing a loan connected to the Islamic debt issuance.

However, the size of the planned loan was not made available.

Besides these two firms, another real estate company , Katara Hospitality, was also said to be seeking to raise US dollar debt.

Major debt instrument Qatar Central Bank considers sukuk as one of the major government debt instruments used by the government to provide the necessary liquidity for project funding and as one of the monetary policy instruments and low-risk investment instruments as well.

Qatar Financial Centre Authority (QFCA) chief economic adviser Dr Haitham Al Salama says Qatar has been among the most active issuers of sukuk, or Islamic bonds, with last year’s sovereign issuance attracting the attention of global investors, especially those from Asia.

“MORE COUNTRIES ARE INTEGRATING SUKUK INTO THEIR TAX CODES, ESPECIALLY AS THE SUCCESS OF SUKUK AND ISLAMIC FINANCE BECOMES MORE APPARENT.”

DR HAITHAM AL SALAMA Chief Economic Adviser QFC Authority

He says conventional bonds and sukuk have huge potential to support the social and physical infrastructure needs across the Middle East and establishing a robust market infrastructure to support sukuk issuance would be key in making the market more globally accessible.

Addressing a conference entitled “Bonds, Loans and Sukuks Middle East” in Doha recently, he says there is tremendous potential in the sukuk market and as the demographics improve in the Muslim world the sukuk market would evolve and develop.

Emphasizing the importance of the growing sukuk market, Haitham said: “More countries are integrating sukuk into their tax codes, especially as the success of sukuk and Islamic finance becomes more apparent.”

Sukuk as a niche product delivers a more stable return compared to regular bonds, he said, adding that increasing investor demand made countries work on the integration of sukuk into their regulations, including tax regimes.

Major impediment Damak believes standardization to be one of the major impediments to the growth of the sukuk and Islamic finance industry. There has been some progress on reducing the complexity of issuance, but the process for sukuk issuance is still more complex and time-consuming compared with conventional instruments, he feels.

He further says that sukuk issuance in the GCC will remain relatively good for the remainder of 2017. Given the current low interest rates in developed markets, emerging market issuers with good credit stories might still be on investors’ radar, as shown by the significant oversubscription of some recent transactions, he adds 27 > QATAR TODAY > SEPTEMBER 2017