Editor's Note:
If you haven't heard of the Sukuk
market before you should definitely read today's SUSRIS IOI that
explains the Sharia-compliant instrument. It shows signs of
becoming more important in the Saudi financial sphere with the
potential "to become a major funding tool for companies and
avenue for portfolio diversification for investors." This
review of Sukuk, written by Haitham al-Fayez of Jadwa Investment,
explains the concept of Sukuk and its current position and
expected growth in the Saudi marketplace. This IOI provides the
overview and background of the Saudi Sukuk market. Check the
related links below for a full text version of the report,
accompanied by insightful charts. We thank Jadwa's Chief Economist
Brad Bourland for sharing these reports with SUSRIS readers.
COMPLETE REPORT:
The
Saudi Sukuk Market - Jadwa Investment - August 2009
The Saudi Sukuk Market
Haitham al-Fayez
Jadwa Investment
The global market for sukuk (Sharia-compliant bonds) has grown tremendously in recent years. Total outstanding sukuk rose from $8 billion in 2003 to around $100 billion in 2008. Sukuk provides companies and governments with access to financing and liquidity and offer a much needed Sharia-compliant instrument to investors. While the growth of the fixed income market in the Kingdom has been dwarfed by that of the equity market, we think that conditions are in place for strong growth in sukuk issuance and trading.
An important step was the launch by Tadawul of an automated order-driven secondary market for sukuk in mid-June. Previously, sukuk transactions were in an over-the-counter market, meaning that they were executed through bank treasuries and settled by Tadawul. Liquidity was very low, as most sukuk issues were held until maturity. The introduction of the new platform is intended to encourage investors to more actively trade sukuk. With the new system, investors can buy and sell sukuk through their brokers.
With the new trading platform in place, we think the following factors will stimulate supply from issuers and demand from investors in Saudi Arabia:
- Predictability and portfolio diversification: The collapse in the stock market last year has encouraged investor interest in more predictable assets such as sukuk. Given the very limited investment channels open to investors in the Kingdom, sukuk could also play in important role in portfolio diversification.
- Problems raising finance from traditional sources: Companies needing to raise finance have generally used a combination of bank loans and IPOs. With banks reluctant to lend and low valuations making IPOs unattractive, sukuk issuance should emerge as an important source of funding.
- Balance sheet mismatches: Little long-term bank lending is available, meaning that companies borrowing to finance long-term projects face an asset-liability mismatch on their balance sheets. Long-term sukuk would ease this problem.
- Healthy sukuk pipeline: Following two successful sukuk issues earlier this year, other local companies have announced their intention to issue sukuk, in addition to some GCC governments.
Notwithstanding the bright future for sukuk, there are still formidable challenges may impede growth. Liquidity is very low; there were only 50 transactions in the first two months of trading on the sukuk market. In addition, the local market lacks breadth and depth (there are only five listed sukuk) and there are no indications that the government will begin actively issuing sukuk (government support is generally a key factor in the development of debt markets). Furthermore, the lack of skilled human resources, Sharia-compliance standardization and innovative product development remain serious issues.
Background
Sukuk (plural of sak) are Sharia-compliant bonds. The main difference between sukuk and bonds is that sukuk holders take direct ownership of an underlying asset or pool of assets, whereas a bond is purely the financial debt of the issuer. Sukuk do not pay interest; rather they generate a return through actual economic transactions in the form of sharing or leasing the underlying assets. Nonetheless, in most other aspects sukuk and conventional bonds are similar.
The use of sukuk has become increasingly popular in recent years both for governments and companies. In part this has stemmed from the dramatic growth in Islamic banking that has been the result of the large inflows of liquidity (primarily oil revenues) into the Islamic world and a greater appetite among businesses and individuals to conduct their finances in a Sharia-complaint way. As the take up of Islamic financial services grew, demand from issuers for a product that performs a similar function to a bond leapt. Demand from investors has also surged as growing wealth within the Islamic world has made regional credit risk more attractive and greater understanding of the instrument and clarity of documentation, supported by credit ratings from international agencies, has enhanced investor comfort with sukuk.
Malaysia accounts for around 47 percent of global sukuk issuance by market value, followed by the GCC, which is the source of a further 46 percent. Sukuk issuance is not limited to Islamic countries and there have been issues from institutions in Singapore, Sri Lanka, Canada, Thailand, the UK and US. Recently, the second largest bank in Russia, VTB, indicated that it is considering a sukuk. The growing interest in sukuk worldwide reflects the spread of Islamic banking and the desire of foreign issuers to tap the liquidity within the GCC. As it is the structure of the instrument that has to be Sharia-compliant, rather than the issuer or the purchaser, the supply and demand for sukuk is set to grow in nontraditional markets.
Sukuk are generally built around one of six main contracts: Ijara, Mudaraba, Musharaka, Murabaha, Istisina and Istithmar. Ijara accounts for around 32 percent of global sukuk issuance followed by Musharaka and Mudaraba. The Saudi sukuk market is dominated by the Istithmar. The variation in the dominance of structures is explained by the lack of Sharia-compliance standardization. It is the responsibility of Sharia boards to determine what structures are Sharia-compliant and given that there are no universally agreed standards, boards across countries exercise considerable discretion in arriving at their opinions. Some countries adopt a conservative interpretation of Sharia, while others are more flexible, leading to an inconsistency about what is considered Sharia complaint. For instance, most Ijara structures that have been issued in other countries do not meet Sharia-compliance requirements in Saudi Arabia. This lack of Sharia standardization poses a great challenge to growth of sukuk.
Source: Jadwa Investment
COMPLETE REPORT:
The
Saudi Sukuk Market - Jadwa Investment - August 2009
Jadwa Investment:
Jadwa Investment is a Saudi Closed Joint Stock company operating under the supervision of the Saudi Arabian Capital Markets Authority (CMA). Under the CMA decision published on August 21, 2006, Jadwa was awarded a license to offer all types of investment services including: dealing, managing, custody, arranging and advising.
All investment services offered by Jadwa Investment are supervised by a Shariah Supervisory Board and are fully
Shariah-compliant.
COMPLETE REPORT:
The
Saudi Sukuk Market - Jadwa Investment - August 2009
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