The order book was $4.7 billion for the five-year deal which represents Hong Kong’s first Sukuk issuance. The Sukuk was priced at 2.005% profit rate.

By investor type, 11% was distributed to fund managers, 56% to banks and private banks, 30% to sovereign wealth funds, central banks and supranationals, and 3% to insurance companies. Close to half of the issue was allocated to investors from Asia, while Middle East investors took 36 percent, the U.S. 11 percent and Europe 6 percent.

Hong Kong is attempting to position itself as an Islamic Finance centre and Financial Secretary of Hong Kong, Mr John C Tsang, said “The success of this transaction demonstrates that issuance of sukuk using Hong Kong’s platform is a viable fund-raising option and widely accepted by investors around the world. I hope that the Sukuk issuance will catalyse the further growth of the sukuk market in Hong Kong by encouraging more issuers and investors to participate in our market.”

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

Sharjah, one of the emirates of the United Arab Emirates has issued its first Sovereign Sukuk denominated in US Dollars for the value of $750 million. The maturity of the Sukuk is 10 years and was priced at a profit rate of 3.764 per cent.

In line with market expectations demand for the Sukuk was around 10 times the amount with the order book totalling $7.85 billion with interest from around 250 different investors.

Allocation of the Sukuk was Middle East is 50 per cent, UK 20 per cent, rest of Europe 11 per cent, Asia 14 per cent and others five per cent. The UAE was allocated 27 per cent within the Middle East.

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

The 10-year sukuk drew strong investor demand – order books were worth $10.2 billion. The Sukuk was priced at 4.35% profit rate.

By investor type, Fund managers bought 57%, central banks, sovereign wealth funds and supra-nationals bought 13%, banks bought 28% and others bought 2%. Indonesian investors bought 10%, other Asia investors bought 20%, US investors bought 20% and European investors bought 15%.

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

Malaysia and Dubai have been at the forefront of the sukuk market in the last few years. Malaysia, in particular has been very successful in taking their sukuk market to the rest of the world, playing a very important role in the global sukuk market. Now that the United Kingdom has issued sukuk, will it stop there? After all, the United Kingdom has not expressed intentions to build on their sukuk issuance to create a real curve or long term business model. Will the much touted UK sukuk be a one-of event? Perhaps by following Dubai’s model, London can create a truly successful domestic market. Local sukuk issuance can then lead to success on the world stage. The fact is that the main reason for the UK to continue issuing sukuk is to make sure that their domestic market will benefit, and there is little reason to believe this will happen unless steps are taken to create a successful domestic market for Islamic financial instruments in the UK.

Perhaps London has already missed the boat when it comes to becoming the worldwide or European center for sukuk. However, there is reason to believe that the potential for growth as an Islamic finance hub is there. Their first sovereign sukuk issuance was a great first step that was the result of years of work. However, it does not stop there, especially because the UK sukuk wasn’t particularly substantial. More frequent issuing of sovereign sukuk can create a market curve that can allow more accurate pricing and a more dynamic market. It is also important to note that the economic crisis in many Western countries has made many investors in GCC states wary of investing in Western economies, traditionally the destination for most of their oil revenue. Fixed income securities, which include sukuk, are a great way of fostering investor confidence. What better way to court investors in Muslim countries than by actually issuing more Islamic financial instruments? When faced with the choice between sukuk and conventional bonds with the same projected returns, the choice for a Muslim investor is clear.

The recent history of Islamic finance makes it clear that Malaysia and the GCC states will continue to be the global centers of Islamic finance. The bulk of the capital and investors is in the GCC states, with many important Islamic banks with substantial government backing concentrated in this region. Malaysia has the legal framework, demand, and disposition to create a dynamic, successful sukuk market. Since 2012 the securities market in the GCC states has been mostly about sukuk rather than about conventional bonds. This was brought about by favorable pricing conditions in 2012 and has continued as a long term trend.

Today, the UK stands at a favorable position to play an important role in the global sukuk market. Let’s examine some of the reasons for and against this possibility. First let us remember that English law already plays an important part in the sukuk market. Although most sukuk are issued in United States dollars, even when the assets and sukuk are completely unrelated to the United States, the legal platform of choice all around the world for these financial instruments is based on English law. However, there is no doubt that the critical mass of market activity lies in the relationship between the GCC states and the Malaysian market, which reached a new level after important Malaysian sukuk listings appeared in the Singapore market. In this critical mass is the difference between a market hub and a market center, and the principal driver of these events is the presence of constant, growing activity in the markets. Although London is well positioned to become a center for Islamic project financing and wealth management, it’s sukuk market does not seem to contain the needed activity for London to become a center for the global sukuk market. The UK’s sovereign sukuk was a great gesture of goodwill and disposition, but unless very large scale projects or corporate sukuk based in the UK are released, matching the enormous capitals that are managed by GCC issued sukuk, further market growth is unlikely to match that of the GCC states or Malaysia.

It is important to note that London has the deepest pool of capital, the deepest liquid market. However, for the UK to become an Islamic finance center, it will need to access the enormous liquidity in the GCC states and Southeast Asia. A true center of Islamic finance will demonstrate that it has the needed market and circumstances to provide a safe home for this liquidity. Wealth and asset management, currently the UK’s strongest Islamic finance areas are not likely to access this capital at the same level as sukuk, where the UK is lagging behind many other nations.

Islamic finance has already played an important part in transforming London with enormous infrastructure projects of recent years. The Shard, Harrod’s, Chelsea Barracks, and the Olympic Village were all financed in whole or in part through Islamic financial instruments. The key question is, are these projects examples of Islamic finance done well, or are they simply conventional infrastructure projects that were financed by Muslim sources using conventional financial instruments? Today, the UK needs all the money that it can get. Due to the National Infrastructure Plan, there are billions of USD that are required for investment around the country. There is no doubt that the wealth in sovereign sukuk from GCC states and Malaysia could very well help meet these investment requirements.

Corporate sukuk issuance would play an enormous role in helping the UK’s finances. However, corporate issuances require sovereign sukuk issuance as a way of setting precedents and benchmarks for these Islamic financial instruments. If the UK were to follow Malaysia’s model, then a substantial boost from the government, both in the form of regulation and sovereign sukuk issuance would be needed to nudge corporate issuers into following suit. This type of help from the government would not be unprecedented in the UK. It is an often overlooked fact that the world center for finance is not Wall Street, it is London. The combination of London opening its doors to banks around the world in the 1960s and 1970s and the enormous changes in regulation in the 1980s, all boosted by the British government led to positioning the UK as a center for world finance, even better suited for the task than New York thanks to its conveniently located time zone. If the UK is thinking in the long term, a similar movement for removal of restrictions (not unlike what Malaysia did in the last decade) could actually create the circumstances for a well developed sukuk market. However, this is unlikely to happen soon, and Malaysia already has an enormous head start.

There is a curious fact about the economies of Muslim nations when it comes to sukuk. These countries are either too rich to need to issue large sukuk to finance their projects, as is the case of the oil producers, of are not so well off that they can issue many sukuk (this is the case of many North African nations, which are unable to issue large sukuk while backing them in a way that would alleviate investor concerns.) This particular set of circumstances has often been an obstacle for Islamic banks and is one of the reasons why nations in Southeastern Asia have been so successful in creating an active sukuk market. Increased issuance of sovereign sukuk from London would provide an additional outlet for this inactive capital and give sukuk a much needed boost to becoming global financial instruments with a wider acceptance.

Today, there is no question that the Malaysian market is the largest, most active sukuk market in the world. However, Malaysia has not been entirely successful in helping the sukuk market grow outside of its borders – perhaps to their benefit, since sukuk have played such an important role in helping Malaysia’s domestic finances and economic development. On the other hand, London is nowhere near Malaysia when it comes to issuing sovereign sukuk. However, when it comes to trading and listing sukuk, the UK already plays a very important role in the global market. Most sukuk issuers choose to list and trade sukuk on the London Stock exchange. In fact, there are about $44 billion USD worth of sukuk listings on the London Stock Exchange, the highest in the world, surpassing the other three important stock exchanges: Bursa Malaysia, NASDAQ Dubai, and the Luxembourg Stock Exchange. Thanks to the LSE’s preeminence as the center of world finances and the high number of Islamic finance listings, London has become an important hub for Islamic finance investment and trade. However, this does not reflect that the vast majority of the sukuk listed have their assets and activity centered around the Malaysian market and the GCC states.

For sukuk to be successful in countries outside of the main sukuk hot spots (Northern Africa, the GCC states, and Southeastern Asia,) it is important for these nations to create the necessary legal framework for these Islamic financial instruments to thrive. More countries are starting to integrate sukuk into their tax codes, especially as the success of sukuk and Islamic finance becomes more apparent. Not wanting to miss out on the investment opportunities that are available from the vast resources that are concentrated in Muslim regions, countries in the West have started to update their tax systems and financial regulations to accommodate Shariah compliant financial instruments.

One of the most important factors that is necessary for sukuk when it comes to tax regulations is to ensure that there is a parity between taxation on sukuk and conventional bonds. If the tax system favors one of these, this creates an unfair market where it is impossible for the financial instrument in disadvantage to thrive. Currently, most tax systems around the world are structured to handle conventional bonds, but lack some of the specific attributes necessary to work with sukuk and other Islamic financial instruments.

There are several reasons why the appropriate legal structures are necessary for the use of sukuk. These types of Islamic bonds usually involve multiple transfers due to the nature of how they are backed by real assets rather than working on the basis of interest. Legal structures that are not designed to handle this will tax every transfer, creating an unsustainable situation for those involved in the sukuk transaction. The main reason for this is that sukuk often require that ownership of the asset covered by the sukuk be transferred repeatedly from one party to another. Ownership of assets in many regions requires additional tax duties and often involves other legal transactions that incur additional costs. Without special provisions for sukuk, this characteristic of Islamic financial instruments puts them at a severe disadvantage if the right legal frameworks do not exist. A typical example is an Ijara sukuk structure. In these cases, the initial transfer of asset ownership can trigger capital gains, sales tax, holding tax, and stamp duty. Each time a transfer of ownership occurs, which will happen at least twice, these taxes would be required, unlike convetional bonds which would only be taxed according to their capital gains.

One hurdle when creating the necessary legal framework for sukuk in a country’s legislation is the differential treatment between profit and interest. Most of the time, interest payments are tax deductible. On the other hand, profit is taxable. Some types of transactions are affected by additional duties. For example, Murabahah sukuk must pay sales tax or Ijarah sukuk often suffers from additional stamp duty payments. Currently, the United Kingdom, Malaysia, Qatar, and Turkey are the four countries that have some of the best conditions when it comes to taxation systems and frameworks for Islamic financial instruments.

In 2010, the United Kingdom, France, Luxembourg, and Ireland issued tax neutrality laws that ensured that sukuk transactions would be tax neutral with conventional bonds. Laws issued generally use conventional bond taxation as a model for applying taxes to sukuk in order to facilitate the different transfer transactions involved in a typical sukuk agreement. Legislation involved in these cases usually considers sukuk certificates as securities, treating investment returns on sukuk in the same way interest would be treated on a security. Sukuk issuers are entitled to the appropiate deductions, comparable to how conventional bond interest payments are taxed. Necessary tax regulations enacted in these countries also included amendments to stamp acts and other applicable taxes to ensure that sukuk are considered an exemption from payment.

There have been failures by governments around the world to integrate sukuk into their finances. For example, South Korea failed to find an appropriate strategy for these financial instruments. The fact that these bills are not being approved in some countries should serve as a warning for the global Islamic banking system that sukuk are still not at the level of acceptance where they should be to become truly competitive on a global scale. The recent issuance of sukuk, classified as “alternative investment bonds”, by the United Kingdom in 2014 will certainly ensure that these Islamic financial instruments gain wider acceptance and are integrated into more countries’ financial legal frameworks in coming years.

Sukuk have also made advances in other countries around the world. France and Luxembourg have published tax regulations that specifically show how Islamic financial products are treated according to their tax codes. Singapore has also made amendments to its income tax regulations to clarify how Islamic banking is handled in detail. In the case of Singapore’s Finance Ministry, steps have been taken to detail the legal framework for other Islamic financing schemes such as Islamic partnership agreements, joint financing and projects, and interbank transactions in an Islamic banking system. Although North African countries have played an important role in sukuk since its inception (in fact, some of the first Islamic banks were founded in Egypt,) they have been relatively late in creating the legal framework for a true impact of sukuk on their markets. It was only in late 2013 and 2014 that comprehensive legal frameworks and tax regulations for these countries were put into place.

There is also the case of Malaysia, which is considered one of the most important, if not the most important sukuk market in the world. Curiously, the way taxes on sukuk are handled in Malaysia is somewhat different to what would be expected from other economies. The reason for this is that the Malaysian government has made sukuk a very important part of their economic development plan moving into the future. Malaysia’s intentions to become the global center for Islamic finance have certainly been successful in recent years. To attract more Islamic investment and sukuk into the country, Malaysia’s tax code provides substantial incentives which actually put sukuk at an advantage over conventional bonds. Rather than being tax neutral, sukuk in Malaysia are tax positive thanks to these incentives.

The Secretary-General of the Islamic Financial Services Board (IFSB) underlined the implications of Basel III on Islamic finance in a speech on before Ramadan.

He confirmed that the IFSB is reviewing Sharia requirements and the balance sheets of institutions offering Islamic financial services (IIFS) against the proposed Basel liquidity parameters so that these specificities are fully considered in the calculation of ratios.

The IFSB are concerned with three factors hampering the performance and competitiveness of IIFS vis-à-vis conventional financial institutions. These factors are:

• A shortage of Sharia-compliant securities
• The lack of active Sukuk trading
• A lack of a reliable Sharia-compliant deposit insurance scheme.

The shortage or unavailability of Sharia-compliant securities/Sukuk in many jurisdictions compels IIFS to maintain a higher level of cash and non-earning liquid assets than conventional institutions. In those jurisdictions where Sharia-compliant securities/Sukūk are available, the lack of an active trading or repurchase (repo) market remains an ongoing problem.

More generally, the IFSB note that in the majority of jurisdictions there is a lack of Sharia compliant lenders of last resort to protect the soundness and stability of IIFS in situations of serious liquidity stress.

In most jurisdictions deposits and profit sharing investment accounts of the IIFS are not covered by a reliable Sharia-compliant deposit insurance scheme.

The Hong Kong government mandated HSBC, Standard Chartered, CIMB and National Bank of Abu Dhabi to arrange its debut Sukuk. The Sukuk likely to be issued in September will likely be for USD1Bbn.

Secondary market prices

Secondary market prices for Gulf Sukuk were little changed this week, as the region nears the end of the holy month of Ramadan and awaits the holiday of Eid.