The structure of Sukuk through the creation of Special Purpose Vehicles (SPVs) provides better transparency thereby reducing corruption and wastage as productive assets must be put to work in order to generate rental incomes for investors, rather than disappearing into offshore banking centres or participating in deliberately over priced projects.

Corruption and abuse of state funds affects many countries and Organisation of Islamic Cooperation (OIC) countries are no exception. Corruption has a devastating impact for many reasons, one of which is whilst funds are siphoned off abroad, the debt remains on the countries balance sheet and accrues interest charges, compounding larger year after year.

In its annual report, Transparency International ranks countries based on expert opinions of public sector corruption. Countries scores can be helped by open government where the public can hold leaders to account, while a poor score is a sign of prevalent bribery, lack of punishment for corruption and public institutions that don’t respond to citizens needs.

The 2014 report makes interesting reading with Denmark, New Zealand and Finland ranked as the least corrupt countries and unfortunately a host of OIC countries coming out towards the wrong side of index, with the notable exception of the UAE and Qatar which rank 25 and 26 respectively, better than the likes of France, Portugal and Poland.

Sukuk Reduces Risk of Corruption and Theft of Funds

In addition to the traditional benefits of sukuk, such as diversifying an investor base and accessing investors who do not invest in interest based bonds, a less discussed value add of sukuk is its structure, particularly the Ijara structure which to a greater deal over conventional bonds prevents the wastage of funds through corruption and theft.

Taking the example of the sukuk issued by the Government of Luxembourg in 2014, three government properties – two towers of the Gate of Europe in Kirchberg and the Gutenberg building in Strassen were sold to a Luxembourg SPV for which the Luxembourg Government was the single shareholder.

The SPV was securitised by means of the sukuk holders investing €200 million who whilst receiving this value back at maturity (when the Government buys back the properties from the SPV), would receive a benchmark linked profit rate of 0.436% to be generated from the rental income received by the SPV from the tenants of the three properties securitised.

This asset linked profit generation means investors get to understand the underlying asset and are more involved in the project. All money raised has to be accounted for as it is used by the SPV to purchase the properties, the funds cannot go missing, or be wasted.

Transparency will Increase Investors Confidence to Fund Big Infrastructure Projects

Increased transparency can be used to inspire investor confidence and trust thus leading to increased foreign direct investment (FDI). For countries which face the challenges of corruption as well as those seeking to avoid the injustices of interest based bond borrowing, sukuk represent an opportunity to tap a new investor base, one that is ethical and provides the borrower more rights and prevents abusive interest charges in case of default.

At a recent Islamic finance conference in Nigeria, Usman Hassan, CEO of Jaiz Bank, a Nigerian based Islamic Bank set up in 2003, urged the Nigerian government to take a closer look at sovereign sukuk issuances to fund infrastructure projects. He stated “Sukuk are very apt for Nigeria, as you cannot have failed projects…for every project you have, you are raising government money and it has to be accounted for, the financier (investor) will not allow abuse”. He urged to government to look at the structure of sukuk to see how it can be of benefit to the economy as a source of FDI from a new diverse investor base.

After a slow start to the year in the primary Sukuk market, RHB Research is expecting a slew announcements in final month of 1Q15.

In Asia Queuing in the pipeline are issuances from sovereigns including Malaysia, Indonesia and potentially Hong Kong, which may be coming to the market again after its debut issuance last year. From the corporates, Petronas is eyeing an USD7bn issuance and EXIM Malaysia may also come to the market.

In the Gulf, this week Qatar Islamic Bank received shareholders’ nod for a Tier 1 sukuk issuance, whilst Emirates Airlines announced a UK backed sukuk of up to USD1bn to fund for the its A380 fleet expansion. RHB Research is expecting a more active primary market toward the end of 1Q15 going into 2Q15.

The International Islamic Liquidity Management (IILM) has successfully reissued USD990 million benchmark size short-term Sukuk.

i) A USD490 million 3-month tenor priced at 0.56260% profit rate, which received total bids of $1.1 1 billion from 11 bids.

ii) A USD500 million 6-month tenor priced at 0.78570% profit rate, which received total bids of just over $1 billion from 14 bids.

The reissuance of USD990 million Sukuk auction was fully subscribed by IILM primary dealers.

The Sukuk rated A-1 by Standard and Poor’s Rating Services (S&P’s) were reissued in two different series as listed above.

The IILM is an international institution established by central banks, monetary agencies and multilateral organisations to introduce and facilitate effective cross-border Shari’ah-compliant liquidity management.

IILM sells its Sukuk through its primary dealers, who consist of: Abu Dhabi Islamic Bank, AlBaraka Turk, CIMB Islamic Bank Bhd, Luxembourg’s KBL Private Bankers, Kuwait Finance House, Maybank Islamic Bhd, National Bank of Abu Dhabi, Qatar National Bank, Standard Chartered Bank and Barwa Bank.

Market shows signs of increased activity

After a quiet start to 2015, Sukuk market activity picked up this week a short-term issuance by the Bahrain Central Bank and with announcements of upcoming issuances from Gulf Finance House, Qatar Islamic Bank, Indonesian national air carrier Garuda Indonesia, and the Islamic Development Bank.

The International Islamic Liquidity Management (IILM) will be auctioning Tuesday, 24th February 2015 2 short-term Sukuk with maturities of 3 and 6 months, as part of its regular issuance program. Combined value of Sukuk will be $990 million

Details of the sukuk are as follows:

1st Auction Amount: USD 490 Million
Auction Settlement Date: Friday, 27th February, 2015
Maturity Date of Certificate: Wednesday, 27th May, 2015
Bids Submission Opening Time: 15:00 Kuala Lumpur time
Bids Submission Closing Time:18:00 Kuala Lumpur time
Auction Result Announcement: 19:00 Kuala Lumpur time

2nd Auction: (USD 500MM for 6  Month Tenor)
Auction Date: Tuesday, 24th February 2015
Amount:USD 500 Million
Auction Settlement Date:Friday, 27th February, 2015
Maturity Date of Certificate:Thursday 27th August, 2015
Bids Submission Opening Time:15:00 Kuala Lumpur time
Bids Submission Closing Time:18:00 Kuala Lumpur time
Auction Result Announcement: 19:00 Kuala Lumpur time

IILM last issued a Sukuk on 22 January, a $860M issued at a profit rate of 0.553% with a 3 month maturity.

About IILM

The IILM is an international institution established by central banks, monetary agencies and multilateral organisations to introduce and facilitate effective cross-border Shari’ah-compliant liquidity management.

IILM sells its Sukuk through its primary dealers, who consist of: Abu Dhabi Islamic Bank, AlBaraka Turk, CIMB Islamic Bank Bhd, Luxembourg’s KBL Private Bankers, Kuwait Finance House, Maybank Islamic Bhd, National Bank of Abu Dhabi, Qatar National Bank, Standard Chartered Bank and Barwa Bank.

GCC Sukuk issuances by volume declined 52% y-o-y to USD2.08bn in January 2015.

Sukuk issuances by volume declined 52% year on year to USD2.08bn in January 2015; however, the value increased by USD1.93bn from the earlier month. Issuances in terms of volume in January 2015 were more or less equally split between sovereign (52%) and corporate issuances (48%). There were four sovereign issuances from the Central Bank of Bahrain (worthUSD1.08bn) and one large corporate issuance from the Dubai Islamic Bank (worthUSD1bn).

Download Rasameel- 2015 Rasameel GCC Market Update Jan 2015.

Standard & Poor’s stated the global sukuk market is heading
into another solid year in 2015, though some emerging headwinds could
slow its progress compared to 2014. The report
published was today, “For Sukuk Issuance, Emerging Headwinds May Cause Turbulence
In 2015.”

Sukuk issuance reached $116.4 billion in 2014 compared with $111.3 billion in
2013, and S&P expect total issuance to cross the $100 billion mark again in
2015.

“Supporting sukuk issuance is the still-positive economic performance of core
markets such as nations in the Gulf Cooperation Council (GCC) and Malaysia,
the implementation of new regulatory requirements such as the Basel III
liquidity coverage ratio, and increasing interest in sukuk from countries that
have not yet tapped the sukuk market looking to diversify their investor
base,” said Standard & Poor’s credit analyst Mohamed Damak, who is also the
company’s global head for Islamic finance.

“At the same time,” Mr. Damak said, “we foresee some turbulence ahead that
could cause overall issuance volumes to be lower in 2015.”

Since hitting a peak of $131Bn in 2012, Sukuk issuances have been gradually falling year on year despite new issuers entering the market.

The current dry run should act as a wake up call to the industry to pursue greater cross border standardisation as well as becoming masters of their own destiny and starting to issue more local currency sukuk and loosening currency pegs to the US Dollar.

The Gulf demand side of the Sukuk market is slowing through reduced liquidity bought on through a combination of uncertainty created by the oil price drop and a surging US Dollar. As the demand side waits on the side-lines, the supply side too is pausing for breath as issuers delay entering the primary market, a Gulf-based Islamic banker said.

Graphic: Chart showing drop in value of Brent Crude Oil price and a surging US Dollar against the Euro.

Oil Price Collapse and Drop in Sukuk Demand Side Liquidity

The speed and depth of the price drop of oil from recent highs of $110 to current lows of $50 has caused a heart attack for the fiscal positions of Gulf economies, and as anyone living or doing business in the region can testify, spending and projects are being put on hold.

Buying Sukuk is not spending though; it is investing, a place to park your cash in uncertain times. The demand for this parking seems to be on the wane. The recent Dubai Islamic Bank Sukuk issuance, whilst still twice oversubscribed, failed to reach oversubscription levels of its previously offering, as well as to comparable offering made only a few months back by other corporates. Furthermore it priced 500 basis points above a similar offering by Dubai Islamic Bank just under 2 years ago indicating buyers were more thin on the ground this time around.

Strong Dollar

A quick analysis of late 2014 Sukuk issuances demonstrates the Middle East continued to supply most of the demand side up to November. Middle East accounts bought 68% of the Sukuk issued by IIFFIm, 30% of the Government of Pakistan Sukuk, and 81% of Mumtalakat Holding Sukuk .

As Gulf buyers step back, increased interest from Asia and Europe should be sufficient to fill the void in normal circumstances. However, two issues present challenges both linked to the surging value of the US Dollar.

Firstly, the biggest Sukuk market is the Malaysian market; but it is largely a domestic market with its buyers purchasing in Ringgit and tending not to stray abroad, and even if they did, they would not possess the buying power currently left vacant by the Gulf.

Secondly, the failure of the Gulf to detangle themselves from fixed US Dollar pegs as well as, Saudi Arabia apart, a failure to develop local currency issuances is coming home to bite as the market has become benchmarked in US Dollar denominated Sukuk.

The surging US Dollar makes European buyers domiciled in Sterling, Euro or Swiss Francs think twice. Buyers in Sterling for example would now be paying around 11% more for the same Sukuk than they would have paid just 3 months ago, and with many pundits pointing to a continued and prolonged Dollar bull market, European buyers seem unlikely to fill any liquidity voids left by lack of Gulf demand.

Malaysia through its government and corporates remained the single most populace Sukuk issuer in 2014, whilst British banks and legal firms continued to dominate the arrangers market.

New Debuts

Traditional Sukuk issuance bases of South East Asia and the Gulf were joined in 2014 by Europe, Africa and East Asia as Sukuk went global.

True demand however remains solidly rooted in South East Asia and the Gulf as amongst the debut issuers of United Kingdom, Luxembourg and Hong Kong the motivation was driven by laying foundations and setting their credentials as destinations for the growing Islamic Finance market than any need to diversify their investor base. Only South Africa and Senegal were driven by the need to fund real infrastructure projects.

Halal Money into Kosher

International financial institutions jumped onto the bandwagon too with Goldman Sachs raising $500 million in its debut Sukuk in September. Motivation for the issue was likely unfinished business from its aborted issue in 2012 and time will tell if turning Halal money Kosher with the unfortunate blessing of a number of prominent scholars is a wise move or a Trojan Horse into the Sukuk market, the secondary market performance points to the latter.

Malaysia Leads Issuance Market

In June, Bank of Tokyo-Mitsubishi UFJ became the first Japanese bank to issue Sukuk, selling both yen- and dollar-denominated instruments through its Malaysian unit.

Malaysia, which pioneered Islamic finance three decades ago, remains the world’s biggest sukuk market. Ringgit-denominated Sukuk continue to be mainly sold to domestic investors.

UK Banks and Law Firms Continue to Dominate Sukuk Market

The UK’s success in the Islamic Finance market was not Her Majesty’s Treasury debut Sukuk, which whilst a success, rather the continued dominance of British power house banks of HSBC and Standard Chartered who dominated the arrangers market, between them carving up most of the market outside of Malaysia in a trend likely to continue into 2015 and beyond.

The continued dominance of English law in Sukuk allowed the City’s leading law firms through their London or regional offices to lead the way in the legal sector with the likes of Allen & Overy, Dentons, Linklaters, Slaughter and May, King and Spalding, and Clifford Chance advising on a number of Sukuk deals.

Letting the team down was the London Stock Exchange, as issuers preferred technical listings on the Irish Stock Exchange and Nasdaq Dubai rather than listing on the London Stock Exchange and accessing its deep liquidity pools which currently seem not of relevance to issuers as primary subscriptions continue to exceed supply.

Sukuk can play an important part in the development of an Islamic market and banking system. The main advantage of sukuk is to comply with Sharia while boosting the standard of living in Islamic society and developing these societies’ economies. However, sukuk also bring several other important benefits.

Sukuk provide an ideal way of financing large projects for the public good that would otherwise not be possible. There are many economic activities or projects that are out of reach of individuals, companies, or, in the case of various developing Islamic economies, governments. In these cases, sukuk are perfect for financing these projects without falling into interest-based debt. This makes sukuk an important avenue for redistribution of wealth and achievement of social justice. The use of sukuk to fund large projects means that investors in sukuk are incentivized to help economies develop by creating and producing rather than by consuming or manipulating others. Islamic finance is based on principles of fairness and justice which are achieved by avoiding Riba.

Investors on the secondary market that are looking for investments that can be liquidated easily will find that sukuk are ideal. Thanks to the secondary market for Islamic securities, investors can sell their securities and obtain the cost of their certificates. If the projects that back their sukuk certificates have generated profits, this results in a quick return in investment.  This means that Islamic financial instruments are well suited for fund management. Banks or institutes can use part of their funds to purchase Islamic securities and then sell them on the secondary market when liquid assets are needed.

Sukuk are well suited for smart management of risk. Uncertainty is a big part of investment. Islamic securities can be issued with varying degrees of risk and yield, allowing investors to choose a portfolio best suited for their risk management profiles. It is important to note that risk in sukuk is more difficult to manipulate artificially than is the case in other types of securities. This is because the value and risk of sukuk is always related to real assets with provable, tangible value, rather than on artificial manipulation of debt and credit ratings.

Sukuk has certain implicit features that makes them different from Riba securities. The most clear difference between them is in what owning them means. In the case of sukuk, investors own part of the capital and receive benefits from increases in its value.

Read full article at islamicfinance.com: Understanding Ownership and Capital in Sukuk