• Increase in sovereign sukuk in 2014 are an important development
  • The market lacks liquidity due to the relatively small number of issuances
  • Corporate issuers have been discouraged by legal opacity

The GCC sukuk market is starting to take off, and structures are gradually becoming more standardised, said Islamic finance experts at the CFA Institute’s sustainability in investing and finance seminar in Dubai on 19 May.

The increased number of sovereign sukuk issuances was the most significant development, especially by non-Islamic sovereigns such as South Africa, Luxembourg and the UK.

“This development shows an endorsement by non-Islamic nations that Islamic finance is a product area which is growing very fast and particular countries would like to put forward their own financial centres as centres for Islamic finance,” says Bilal Ahmed, partner at London-based law firm Allen & Overy. “It’s an acknowledgement that because the pool of Islamic finance funds is growing at such a rate that it provides issuers with an opportunity to benefit from pricing advantages.”

Sovereign sukuk are helping to develop Islamic finance markets and are met with a strong appetite.

Sukuk made up 26 per cent of bond issuance in the GCC and seven other major Islamic finance centres in the first quarter of 2015, according to London–based Fitch Ratings agency.

“The idea is not to raise money, but to tap the market as an alternative investment, whether it is strategic or they actually need the money,” says Bashar al-Natoor, director of corporates and Islamic finance at Fitch. “And unlike conventional investors Islamic banks can’t place liquidity elsewhere, they can’t buy treasuries or European bonds, and local governments aren’t issuing, like Abu Dhabi and Qatar.”

The lack of market liquidity and a scarcity of corporate bond issuances are the next challenges.

“Islamic investors have a finite number of facilities they can invest in,” says Fawaz Abusneinah, head of debt capital markets at the National Bank of Abu Dhabi. “So they seize assets and hold onto them and the market is less liquid.”

The solution is more issuances, from sovereigns and corporates, who have been slow to take up sukuk, despite relaxed regulations in Dubai.

“There is a scarcity of sovereign sukuk, but corporate sukuk, for all practical purposes, are non-existent,” says Sharif Eid, portfolio manager for US-based Franklin Templeton. “There are pockets of liquidity, but they are very hard to find you cannot have high-yield sovereign funds, which are needed to take the market to the next level.”

Local conglomerate Majid al-Futtaim issued a $400m sukuk in 2013, one of the few corporate issuances in the region. Others have been held back by legal uncertainty, although structures are becoming clearer.

“The process of evaluating sukuk was unknown and it seemed complex so they stayed away,” says Shrimati Damal, senior vice president of group treasury at Majid Al-Futtaim. “The sovereigns coming in was a critical step and corporates will follow. Corporates from this region have to be leaders on this. Majid al-Futtaim is already established and it wasn’t too hard to do.”

Another factor holding the market back is a lack of clarity over what would happen in the event of a default, due to a lack of precedent and differing legal regimes.

“The legal enforceability of documents is key, and if you are in a more evolved jurisdiction like English law that gives some comfort,” says al-Natoor. “The way that [defaulting] sukuk and bonds have been restructured was in a friendly way outside courts, so we don’t have a concrete precedent.”

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