Sukuk is the basis for the global Islamic financial market. However, as the appeal of Islamic financial instruments grow, buyers from all around the world have flocked to sukuk.

In fact, this has prompted apprehension about sukuk possibly threatening Western markets rather than existing alongside them. Initial sukuk offerings were met with disbelief. Avoiding industries that are traditional money makers such as weapons and entertainment and eschewing the entire concept of interest, there were plenty of analysts that considered sukuk impossible. However, on the foundation of centuries of Middle Eastern culture and sound economic principles which do away with speculation and uncertainty, sukuk has thrived. In this article we take a look at who are the main investors in sukuk today.

There is no doubt that the principal investors in Islamic finance are backed by revenue from oil, mostly based in GCC nations. However, the percentage of investors from outside the Middle east, particularly from the United Kingdom has increased enormously in the last five years. Before 2009, it was common to see sukuk issued in GCC nations with more than eighty percent of backing from banks in GCC nations. Today, GCC investment is still highest, but at a much lower percentage.

Generally, most sukuk today include investment in a proportion of about 60:40 between Middle East and Non Middle East investors. Although some United States offshore investment is often involved, most of the Non Middle East investors come from Europe. Within Europe, the United Kingdom leads the way, with sukuk investments that equal the rest of Europe combined, in most cases. Although there is Asian investment in sukuk, the capital invested by Asian sources outside of the Middle East is generally below that invested by European sources, despite the fact that Southeast Asia is the undisputed leader in sukuk issuance when compared to Europe, both in corporate and sovereign sukuk.

Banks are still the main investors in sukuk, with a vast majority of funding coming from these financial institutions. Corporate sources may account for ten to twenty percent of investment, with hedge funds and asset managers accounting for another twenty to thirty percent. Most banks involved in financing sukuk are still backed by governments, mostly in the GCC region. Private banks, especially outside of countries traditionally involved in Islamic finance are increasing their involvement in sukuk, but are still far from reaching the investment levels of established Islamic financial institutions.

The year 2015 may represent a turning point in Non Middle East involvement in sukuk financing. About 49 percent of a recent sukuk issued in Dubai was bought by European investors. However, private European investors generally still cannot match the liquidity among private Islamic investors. This year has seen a general outreach by financial institutions in Europe to invest money in sukuk around the world. Turkey and Slovenia, for example, were involved in two successful sukuk deals recently. In the case of the Dubai issue, fund managers accounted for about 65 percent of the transaction.

Although the rapid expansion of Islamic banking in recent years has been quite impressive, it is important to note that the variety of available investments that are compliant with Shariah is still quite limited when compared to conventional Western finance. Non-Muslim banks can invest in a wide variety of government issued financial instruments, both for short term and long term gain. However, Islamic finance still falls short when it comes to an alternative to Treasury Bills that offers similar convenience and returns.

Fortunately, sources in Islamic finance have stated that there has been progress in creating sukuk that can help solve this gap in short term liquidity. These sukuk are based on Salam. This type of Islamic finance allows quick access to cash for the investor. In Salam, a sale contract involves an advance payment for the delivery of products with prior agreement of quantity, quality, and dates. This unavailability of short-term financial instruments had been a challenge to the Islamic finance industry in recent years. The situation is quickly changing thanks to the emergence of Salam based sukuk.

It is important to understand that sukuk is backed by tangible assets with value rather than by debt. Because of this, short-term liquidity had been a challenge. The emerging sukuk with high short term liquidity are backed by oil imports. In short, the government seeks investment from Islamic banks for purchase of oil and oil-based products for import. The agreements stipulate that that the transaction is then settled from the sales of these oil-based products in a period of up to six months, essentially a Salam agreement between the two parties. This financial instrument greatly improves the ability of Islamic banks to manage their liquidity in the short term and also helps boost a secondary market for shorter term investment.

Of course, there is still room for improvement. One difficulty of Islamic finance is that there is still a shortage of structured Islamic financial instruments, leading to problems of redundancy and lack of diversity in investment. Currently, recent short-term sukuk offer about eight percent return, which still puts them at a disadvantage compared to six month treasury bills and comparable bonds.

Critics of the sukuk market have noted that the sukuk market is more local or regional rather than a true international market. There is basis to this assertion. The very nature of sukuk indicates that it is based on assets, projects, and services, which are necessarily localized to particular regions and local markets. Although sukuk has grown impressively in the last decade, international sukuk issuances still only account for about a sixth of the total yearly issuances. The biggest challenge for the Islamic financial market is to cross borders and gradually move outside of the largest sukuk markets in the GCC (Gulf Cooperation Council) states and Malaysia. The recent issuance of sukuk by the United Kingdom is a step in the right direction.

So, currently, how global is the global sukuk market? The fact is that about sixty percent of sukuk investors are from the two regions mentioned above. S & P has noted in its April report that sukuk operates as a collection of local markets, centered mainly around Malaysia and the GCC states. Although the Central Bank of Malaysia has been the leader in the global Islamic financial market, its strong involvement has led to claims of rigging of the market and of excessive localization. The Central Bank of Malaysia has issued more than forty percent of worldwide short term sukuk in 2013.

There is an element of suspicion related to the fact that most sukuk was not issued in US dollars or listed on major international exchanges. This is an element that Islamic banks around the world have recognized. Currently, new sukuk issuances and Islamic financial products and instruments are being developed to help sukuk truly become international. As Western governments participate in increasing number in the Islamic financial market, there is little doubt that this will be a successful goal in the coming years. The main driver that may help sukuk overcome this perception of being confined to a particular region is the increased interest outside of traditional sukuk. Although about half of sukuk investors invest in sukuk because of religious motivations, according to S & P, there is a growing interest in investors with considerable assets that are more interested in the impressive growth these financial instruments have had in the last decade.

The Citi Sukuk Index shows a continued upward rise in the index. The index includes US Dollar-denominated, investment-grade sukuk. Download report from Citi Sukuk Index.

Rasameel released its monthly report provided an overview of recent developments within the GCC debt market. Download report from Rasameel.

The September report provides insight into the underlining economic indicators driving the GCC debt capital and Sukuk market.

View report GCC Market Update September 2014.

Saudi Arabia’s Sukuk market is exposed to certain structural challenges that need to be addressed before the success of the Malaysian Sukuk market can be replicated.

The following measures could help Saudi Arabia realize its true Sukuk market potential and establish itself on the global Sukuk map:

Robust Regulatory Framework

The establishment of a separate and robust regulatory framework for Sukuk would ensure standardization and minimize the difference of opinion among Shariah scholars. For this, coordinated efforts need to be taken by key regulatory bodies such as SAMA, the Finance Ministry and CMA. For instance, Malaysia established the Malaysia International Islamic Financial Centre (MIFC) in August 2006 through collaborative efforts between financial regulatory agencies, including the Central Bank of Malaysia (Bank Negara Malaysia), the Securities Commission (SC), Bursa Malaysia (Kuala Lumpur Stock Exchange) and the Labuan Offshore Financial Services Agency (the regulator for the international center of Labuan), and participation from the Islamic financial industry in Malaysia.

MIFC lays down guidelines relating to Sukuk issuance and provides various incentives to international issuers, including granting licenses and tax incentives. Furthermore, the SC has established a centralized Shariah Advisory Council (SAC) to advice on issues related to Sukuk and other Islamic capital market products. This, in turn, ensures that Sukuk issuances comply with Islamic principles. SAC also provides guidance to investors, the government and industry.

Active Secondary Trading Market

One of the key components of the success of Sukuk market in Malaysia is the presence of an active secondary market. To encourage secondary trading of Sukuk, KSA needs to encourage the issuance of Sukuk with varied maturities, credit qualities, currencies and risk profiles.

This would provide investors various options in the Sukuk market, and encourage retail participation. For instance, the current Sukuk framework in Malaysia allows issuance of both ringgit and non-ringgit Sukuk. Market makers and brokers should also assume greater role in the secondary market for Sukuk. Intermediaries such as brokers, investment bankers, and fund managers could facilitate secondary trading by underwriting and advising on complex Sukuk transactions.

Besides, secondary trading in KSA Sukuk market can be enhanced further by upgrading the technological infrastructure similar to Bursa Malaysia. Tadawul’s current electronic Sukuk trading platform should be equipped to handle central order booking, trade reporting and negotiation. The electronic trading platform should ensure the comprehensive dissemination of price, yield and trade.

A Leading Islamic Finance Centre

The establishment of an Islamic centre of excellence to impart knowledge in the domain of Islamic finance would increase the number of local qualified Shariah experts. Malaysia, for instance, established several academic institutions under the MIFC umbrella to develop Islamic finance talent. These include the Islamic Banking and Finance Institute Malaysia (IBFIM), the International Center for Leadership in Finance (ICLIF), and the Securities Industry Development Corporation (SIDC).

Aljazira Capital.

The order book was $1.5 billion for the five-year deal which represents Goldman Sachs first Sukuk issuance. The Sukuk was priced at 2.844% profit rate.

Following an aborted sukuk issuance in 2011, Goldman changed the structure of its sukuk plan for this issuance. While its 2011 scheme was based on murabaha, its current plan has a hybrid structure and envisages operating only 49 percent though murabaha and 51 percent through a structure called wakala.

Full details of the Sukuk can be found in our Sukuk profile section here.