In a further sign of demand for Islamic bonds far outweighing supply, the sukuks structuring agent, Bahrain-based Islamic Finance Consultants (IFC), combed the market in search of another Islamic bond in which to invest to meet the 33 per cent asset-backing sharia-compliance requirement. They could not find one. ‘We were not able to find a sukuk in the market for sale with a rating that we could buy and invest in,’ says Abdelhak

el-Kafsi, managing director of IFC.

The alternative was to buy a physical asset, in this case palladium. ‘We would have preferred to find a government of Malaysia or Islamic Development Bank sukuk,’ says El-Kafsi. ‘It would have provided the client with a better return and cleaner investment. Holding metal is expensive you need to warehouse it and sukuks have a higher yield.’

The demand for Islamic bonds is high, although the global sukuk market is still small at about $13,000 million, with $5,000 million in sovereign issues and $8,000 million in corporate issues. But the rate of growth has been impressive. The first regional sukuk was launched just five years ago, when the government of Bahrain issued a $100 million sharia-compliant bond. The market was expected to reach $15,000 million by the end of the decade but looks set to top that figure by next year.

The cost of issuance is increasingly competitive compared with conventional bonds, as the nuts and bolts of structuring a deal, such as the paperwork, become more standardised. The trend to seek a rating improves buyers ability to compare an Islamic issue with a conventional bond. Products are also more innovative, although the market is still far behind that for conventional debt.

The market remains illiquid because the number of eager buyers far outstrips the number of issuers. ‘Ive never seen a seller of a sukuk that couldnt find a buyer,’ says Bahrain-based Liquidity Management Centre (LMC) chief executive officer (CEO) Ahmed Abbas.

Regional banks that are snapping up sukuks lead the demand, particularly Islamic institutions. ‘Banks in the GCC are looking for good Islamic assets, which are limited in number and especially in quality,’ says El-Kafsi. ‘They will buy and hold a sukuk issue as if it is a medium-term loan and if they sell, they are not guaranteed they will be able to find a replacement. If there were larger issues, theyd be more tradeable.’

According to El-Kafsi, these are likely to come in the GCC, particularly from Saudi Arabia. In April, the Capital Market Authority approved the first sukuk under its new rules the SR 3,000 million ($800 million) fully tradeable sukuk for Saudi Basic Industries Corporation (Sabic).

A sukuks 33-51 per cent asset-backing requirement the percentage depends on the opinion of its sharia advisory board means it is a perfect mechanism through which to raise capital to fund infrastructure projects, such as oil and gas ventures, utilities, construction and also shipping. On the supply side, it fits the profile of economic development in the Gulf. As for demand, sukuks satisfy the search by regional investors for sharia-compliant investment opportunities. Beyond siphoning off liquidity, sharia-compliant bonds are also a way to alternate funding streams. Conventional institutions are attracted by the pricing and risk reward. ‘Id not be surprised to see institutions outside the region opting for sukuks for the purposes of funding diversification,’ says El-Kafsi.

But hopes for a secondary market in sukuks remain distant. ‘With the oil price so high and liquidity so high on the deposit side, there wont be a secondary m