Sukuks: new finance era

Sukuks: new finance era

The Islamic financial services industry has witnessed a frenetic pace of growth during the last decade. Since its inception three decades ago, the number of Islamic financial institutions worldwide has risen to over 300 at present in more than 75 countries. They are concentrated in the Middle East and Southeast Asia, and they are also expanding into Europe and the United States. According to Standard and Poor’s, the Islamic finance industry is worth about $500bn in assets, and has been growing at about 10 percent a year for the last decade. Conservative sources put total assets of Islamic financial institutions at $230bn, and they are expected to grow by over 15 percent during the next 5 years. The fact remains that the industry is too small compared to the size of its potential market. The Sukuk market has emerged in 2002 where with the Malaysian government’s $600mn Sukuk issue; Sukuk issuance has been concentrated in parts of Asia and countries of the GCC. There, the development of the Sukuk market has been facilitated by sovereign benchmark issues that have been growing strongly (up 40 percent in the first 6 months of 2007 compared to 2006 as a whole). In value terms, about 36 percent of these issues originated in Asia, primarily Malaysia , Pakistan and Brunei, and 62.1 percent in the GCC during the period 2001-2007.

In terms of countries, the UAE was leading in terms of issues’ size during 2001 till 2007, where it contributed 36.2 percent of total world Sukuk issuance. Malaysia contributed 32.1 percent in the same period despite the fact that Malaysia had the largest number of Sukuks issued amounting to 137 issues, as compared to the total number of issues of 29 in the UAE. It is important to note that the UAE had a few huge Sukuk issues in 2006 and 2007 which helped the UAE surpass Malaysia in total Sukuk size. A few examples of these are the $3.52bn Nakheel Sukuk, the $3.5bn PCFC Sukuk, and the $2.5bn Aldar Properties Sukuk. The demand for sukuk has grown exponentially since 1988. Many sukuk offerings have been made by governments, notably in the Gulf States and Malaysia. Marking the first sukuk offering by a Western government, the German sukuk of Saxony Anhalt raised £100mn from both Middle Eastern and European investors through the issuance of a AAA-rated, five-year, Shari’ah-compliant bond backed by real estate assets held in a trust organized in the Netherlands.

Corporate issuance has expanded rapidly where they increased from $0.4bn in 2003 to $9.9bn in 2006. While Asia, specifically Malaysia, accounted for the bulk of all Sharia-compliant corporate issues in 2004 (close to 90 percent), issuance in the GCC has picked up rapidly. Most recently, sukuk offerings have been shifting to the utilization of musharaka- and wakala based structures as opposed to the more popular ijara-based structure. In terms of the types of Sukuks issued, Sukuk al Ijara was the most popular amongst corporate and governments wanting to raise funds in the Islamic debt markets. Sukuk al Ijara issues contributed 43.6 percent of total issues, followed by Sukuk al Musharaka at 27.5 percent, and then Sukuk al Mudaraba at 18.4 percent. The total number of Sukuks issued in the world during the last six years is close to 360 Sukuks. Industry experts predict Sukuk issuance will reach $100bn in the next five years. According to recent statistics, Islamic Sukuk issuance worldwide have reached $39bn in the first 10 months of 2007.

Despite the strong potential for the Sukuk market, as is the case with any evolving securitization market, a number of economic, legal, and regulatory challenges remain, irrespective of Shariah compliance. These include the substitution of standard structural features in conventional securities, such as credit enhancements, which are not normally contractually permissible in the Islamic context; legal uncertainty arising from the fact that the transaction structure needs to satisfy commercial as well as Islamic law, in particular in non-Islamic countries; and, regulatory differences between national regulators. Ongoing efforts by key Islamic regulators — notably the Accounting and Auditing Organization for Islamic Financial Institutions, the International Islamic Financial Market, and the Islamic Financial Services Board — to facilitate harmonization of standards and practices should help overcome some of these teething pains.

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