In numbers

$47bn: The combined value of global sukuk issuance in the first half of 2011

$1bn: Value of the sukuk by Saudi Aramco Total Refining and Petrochemical Company

Sources: KFH Research; MEED

In late August, troubled Dubai property developer Nakheel announced that it was close to launching a sukuk (Islamic bond), expected to be around $1.3bn in size, to its trade creditors.

The sukuk will be issued as the final stage of paying off Nakheel’s creditors for work done before the financial crisis brought the company to its knees. Bond traders are talking excitedly of a return of interest in trading sukuk and the Nakheel deal is playing a large part in stimulating this revival.

The irony is that it was Nakheel’s $3.5bn sukuk due in November 2009 that the firm was unable to repay until Abu Dhabi gave it the money, which has played a big part in depressing the market.

Bond issuance back in favour

After the market was slow throughout 2008 and 2009, 2010 signalled that sukuk issuance was back in favour once again. The total global Islamic bond issuance in 2010 of $51.2bn was a record high for the industry. It was a major turnaround from 2008 when total issuance dropped to around $20bn and beat the market’s previous peak, in 2007, by 34 per cent.

More promisingly, the expectation is that 2011 could be better still. In the first half of 2011, sukuk issuance reached $47bn according to KFH Research, a division of Kuwait Finance House. That puts the sukuk market already ahead of 2007 levels.

The Middle East has been attractive for investors because of the higher returns offered

UK-based bond trader

Globally, a new trend has been emerging. The bulk of new deals are increasingly coming from Malaysia, with large government sukuk dominating the market. According to US ratings agency Standard & Poor’s, Malaysia accounted for 62.8 per cent of all sukuk issuance between 1996 and 2010. The second-largest country for issuance was the UAE, with 15.8 per cent.

Despite this, there have been several important deals coming out of the Middle East, which have shown that Islamic bonds are becoming acceptable investment instruments for global investors, and particularly Asian investors.

Global sukuk issuance
  ($bn)
1996 0.8
1997 1
1998 0
1999 1
2000 2
2001 3
2002 4
2003 6
2004 5
2005 13
2006 26
2007 38
2008 20
2009 34
2010 51.2
Source: Standard & Poor’s

The most significant of these deals has been the return of Dubai corporates to the sukuk market. Emaar Properties issued a $500m sukuk in January, followed by several other issuers in the conventional market. These bonds showed that despite the debt problems in the emirate, investors are still willing to put money into Dubai as long as the returns are right. Several other deals, including sukuk issued by Sharjah Islamic Bank and HSBC Middle East were well-received by the market internationally.

The investor base for Islamic project bonds in the Middle East will still need a bit longer to develop

Project finance banker

The Sharjah Islamic Bank deal raised $400m in May, despite not being a well-known name outside the region. Its investor base was comprised predominately of Middle East buyers, making up 42 per cent of the offering, but Asian investors made up a further 24 per cent of the deal. Regional investors and Asian investors accounted for 87 per cent of the HSBC Middle East deal.

Part of the attraction of Middle East sukuk issues has been the high yield offered to investors. The Emaar deal paid 8.5 per cent, a reflection of several factors including the highly structured nature of the deal and its exposure to Dubai real estate. It still managed to secure an order book for the transaction of $1.7bn. All the issues from the Middle East that followed were also massively oversubscribed, although that was also true for conventional bond issues.

“With global yields so low, the Middle East has been attractive for investors because of the higher returns offered,” says a UK-based bond trader at an international investment bank. “That has meant that even with the Arab Spring, there has been a few successful deals.”

London Stock Exchange listings
  Number Value ($bn)
2006 3 1.3
2007 13 9.8
2008 3 1.8
2009 6 3.9
2010 5 1.7
Q1 2011 1 0.5
Source: Gatehouse Bank 

In fact, global economic woes have impacted the Middle East capital markets more than local concerns. A spate of debt issues out of the region were put on hold in July as worries about European sovereign debt hit markets. This has also affected plans for more sukuk issuance. The window for new deals before the end of the year is now quite small.

Saudi opportunities for sukuk

The exception to this is Saudi Arabia, which promises to be a real growth market for the sukuk industry. A combination of the huge liquidity within the kingdom, the pious nature of the local population and the capital markets being largely closed off to foreign investors has made sukuk a market with huge potential. Because foreign investors cannot invest on the Tadawul (Saudi Stock Exchange), it is also more insulated from swings in global sentiment.

Nasdaq Dubai sukuk listing*
2006 4
2007 9
2008 9
2009 2
2010 0
2011 YTD 0
*=Including matured deals; YTD=Year-to-date. Source: Nasdaq Dubai

The Saudi Aramco Total Refining and Petrochemical Company (Satorp) is due to sell a $1bn sukuk by October, offering investors one of the few chances to get directly involved in  Saudi Arabia’s oil sector. The deal, being run by Germany’s Deutsche Bank along with the local Samba and Banque Saudi Fransi, has been in the planning stages for more than a year. Bankers in the kingdom say some of the complexities of the sharia-compliant structuring have delayed the issue.

Approval for the sukuk to go ahead was finally granted by the local regulator, the Capital Market Authority (CMA), after Ramadan. The deal is expected to be offered to the market in late September or early October.

The government has indicated that a sukuk could form part of the financing for the new airport project at Jeddah and the new mortgage law could also stimulate sukuk issuance by private sector companies.

Infrastructure funding from sukuks

The Satorp deal promises a lot for the sukuk market in Saudi Arabia. If sukuk can successfully be used in the financing of major projects in the region, then a new source of liquidity for funding infrastructure will open up.

“With banks becoming less interested in long tenor deals like project finance, the debt capital markets are often seen as a potential alternative for funding,” says a project finance banker at a large Islamic bank in the region. “Because Islamic finance is based on real assets, it is more suited to use in project finance, but the investor base for Islamic project bonds in the Middle East will still need a bit longer to develop.”

Malaysia has already used sukuk structures to fund infrastructure development, showing that the potential is there, even if it is not yet developed in the GCC.

The Satorp deal will be the latest in a string of deals to hit the market and more are expected in 2012. “There is definitely a strong pipeline for local sukuk issues,” says one banker based in Riyadh. “There is so much liquidity available and coupled with such a pressing need for new investment, the prospects are very strong. We are seeing that reflected in clients coming to us and asking for pitches on deals.”

As markets like Saudi Arabia become more active in the sukuk market, the GCC is expected to become a much more important player in global issuance. Paul-Henri Pruvost, analyst at Standard & Poor’s says the GCC “may catch up with Malaysia and begin to play a larger and more sustainable role in the market in the next five years.” He picks issuers from Saudi Arabia and Abu Dhabi as being the leaders of this trend.

So far most of the sukuk issuance out of the region is from sovereign, or sovereign-related entities. One of the largest deals recently has been from Qatar Central Bank, which issued a $9.1bn sukuk in January, along with a conventional bond of around half that size, in order to soak up excess liquidity in the banking sector.

The growth prospects for Middle East issuers extend further than just issuing in dollars for international investors or local currencies for regional ones. National Bank of Abu Dhabi (Nbad) completed two deals denominated in Malaysian ringgit in 2010 that totalled an equivalent of $325m. The deals showed that Gulf issuers could successfully tap the deeper Malaysian ringgit market, and more Gulf issuers are expected to follow suit. The ringgit is overwhelmingly the currency of the sukuk market, with dollar denominated deals making up only 23.7 per cent of the market since 1996 and the ringgit representing 59.2 per cent.

However, it is London that remains the most popular destination for listing sukuk. In total, there are 31 sukuk listed on the London Stock Exchange, with a total value of $19bn. The Nasdaq Dubai lists 16 sukuk with a value of $11bn.

Standardisation needed for Islamic bonds

Like other areas of the Islamic finance industry, more needs to be done to standardise sukuk, which should help make transactions easier to structure and complete. It will also help global investors become more familiar with the concepts behind these deals.

Whatever happens in the final few months of the year, the sukuk market has staged a significant recovery after going through its first major challenges. In the past few years alone, it has coped with defaults, restructurings, a global economic meltdown and a regional political crisis. That 2011 could be another record year in terms of new deals is testament to the interest investors have in this industry.

After nearly bringing the sukuk market to its knees with the industry’s first defaults, the Middle East has shown instead the resilience of the sector, and helped shape the next few years of its future.