The numbers look good for the Islamic bond market.
Issuance hit a record high in 2011 and figures for the first half of 2012 show that volumes are already up another third. It is widely expected that issuance of sharia-compliant bonds, or sukuk, will top the $100bn mark before the year is out.
Despite this rise, however, questions remain as to whether the increase in issuance is enough to match investor demand. According to consultancy Ernst & Young, the answer is no.
It says the global supply of sukuk is less than half that of investor demand and the gap may widen further unless more institutions emerge capable of launching new issues.
The consultancy says current outstanding demand for Islamic bonds totals some $300bn, and is expected to grow to $900bn by 2017. “One of the foremost challenges faced by the sukuk market is the supply side constraint, as demand continues to outpace new issuance,” says Ashar Nazim, Islamic finance services leader at Ernst & Young.
He says the exponential rise is primarily a result of double digit growth of the Islamic banking industry, and the increasing appetite for credible, sharia-compliant, liquid securities.
“The demand comes from Islamic financial institutions as well as fund managers and high net worth individuals. Conventional institutions are also showing renewed interest in investing in sukuk as a result of the eurozone debt crisis as these Islamic products are backed by real assets,” says Mr Nazim.
Rafael Dalmau, head of sharia-compliant portfolio management at BNP Paribas Investment Partners, agrees: “The organic growth rate of the market is on a clear upward trend, with no signs of slowing down in the near or medium term.”
He says: “In addition to the natural demand for sukuk, non-Islamic investors have also taken notice of the sound returns that this sector has delivered over the last three to five years. Liquidity used to be a deterrent for non- Islamic investors but, nowadays, liquidity is in line with conventional bonds of similar credit profiles.”
Just last month Qatar Islamic Bank, the Gulf Arab state’s largest sharia-compliant lender, returned to the debt markets with a $750m Islamic bond sale.
Order books for the issue were reportedly in excess of $6bn ahead of launch and much of this is said to have come from cash-rich Islamic investors held back by limited sukuk supply in the market. The hope is more issuers will follow suit.
“Issuance can certainly meet demand if more conventional issuers choose to structure their bonds in a sharia-complaint manner as GE and Nomura have chosen to do in the past,” says Nigel Denison, head of wealth management at Bank of London and The Middle East. “We expect to see more issuers entering the market.”
For those many entities whose remits are suitable for Islamic securitisation, adds Mr Dalmau: “There is a widespread view that costs may be higher and/or structures deemed to be too complex” when launching sharia-compliant paper.
“In order to overcome these perceptions, the investment banking industry, both Islamic and non-Islamic, needs to be more proactive in inviting global multinational companies to diversify their funding sources,” he says, adding that the global sukuk market is already being used by a large global AA-rated multinational company and a couple of large global banks.
“We will see this trend [of new issuers coming to the market] continuing, albeit at a very slow pace. But signs are encouraging and a good example is the Republic of Ireland’s recent efforts in bringing new sukuk issues – both sovereign and quasi-sovereign – to market.”
According to figures for the first six months of 2012, Malaysia issued more than 70 per cent of global sukuk, while Saudi Arabia grabbed second spot with a 13 per cent share of global issuance. The first sukuk were issued by Malaysia in 2000.
Mohammed Dawood managing director, global capital finance, HSBC Amanah, says: “Yes, the sukuk market has really taken off in the past 12 to 18 months, particularly in the [Gulf Co-operation Council] and Malaysia. We’re seeing it becoming a preferred mode of financing.
“But there are still challenges in structuring a sukuk – those being the availability of sharia-compliant assets as well as the legal and taxation frameworks in different jurisdictions. In some cases, the legal and tax frameworks still render sukuk issuance uneconomical.”
Mr Denison adds: “The sector is still considered niche by some issuers, and the apparent additional complexity of meeting sharia standards may be assumed to be costly.
“Until awareness spreads of the standard structures used in sukuk, traditionally conventional investors and issuers may continue to shy away.”