Islamic finance: Has the sukuk market’s time come?
Issuance is booming but barriers will continue to hold back the market’s potential.
Issuance of Islamic bonds, or sukuk, had a record year in 2011. This year looks set to be even better. Issuance volume last month was more than three times as high as in January last year, according to Dealogic. One good example from last month was the biggest-ever sukuk from Saudi Arabia: a SAR15 billion ($4 billion) 10-year deal for the General Authority for Civil Aviation, led by HSBC Saudi Arabia. This was the first government-backed sukuk in the Kingdom. It will be used to finance an expansion of Jeddah airport, a hub for pilgrims to Mecca and Medina.
Another example was the $300 million five-year deal by Dubai’s phoenix-like mortgage company Tamweel. Led by Citi and Standard Chartered, the notes pay a profit rate of 5.154%.
A report by Ernst & Young shows the Islamic fund management industry resumed strong growth in 2010, reaching almost $60 billion after a couple of flat years after the 2008 global crisis. Ernst & Young estimates that Islamic commercial banks – a key investor in sukuk – will see assets rise to $1.1 trillion in 2012: a 33% increase from 2010.
The arrival of new Islamist-leaning governments thanks to the Arab Spring has reinforced the trend of new countries opening to Islamic finance in the Middle East and North Africa.
Tunisia’s new government, for example, has stated its intention to make Tunis a hub for Islamic banking. Partly as a result of this trend, Ernst & Young reckons Islamic banking assets in this Arab World will more than double between 2010 and the end of 2012.
As retail demand for Islamic banking continues to grow, high oil prices keep up the flow of funds to oil-rich Islamic countries, such as Kuwait and Saudi Arabia. Economic growth also continues to shift eastward, towards countries with larger Muslim populations, such as Indonesia and Turkey.
Islamic capital markets have lagged. Today, the majority of Islamic banking assets are commodity murabaha on the London Metals Exchange. Islamic investors need to diversify, and the sukuk market might be finally catching up.
Issuers around the world, including sovereigns, are by necessity waking up to Islamic investors’ pent-up demand for new assets. In December, the government of South Africa asked for pitches for an advisory and structuring mandate for a sukuk. Ireland is mulling issuing sukuk when it returns to the bond market next year.
However, it was only a couple of years ago that the sukuk market’s very existence was thrown in doubt when a prominent scholar said 80% of sukuk went contrary to Islamic law. More recently, Goldman Sachs has had to contend with a debate over whether the $2 billion sukuk programme it announced in October would be Shariah compliant.
These legal challenges are a reminder that the sukuk market might have inherent limits.