LONDON, 4 August 2003 — The Islamic Development Bank (IDB) has achieved a number of notable firsts with the closure of its first Islamic bond, the $400 million IDB Sukuk Bond on July 29. The remarkable achievement is that the Sukuk, was rated AAA and AA by international rating agencies Standard & Poor’s and Fitch — the same as the institutional rating of the IDB by the same agencies. As such the IDB and the issue have a rating higher than any of its equity subscribers, of which Saudi Arabia, Kuwait, UAE, Iran, Turkey, Libya and Egypt are the largest.
Another first is that this Sukuk is the first AAA rated paper from the Middle East — whether conventional or Islamic. A Dubai-based banker stressed that the IDB should be commended for this. “This Sukuk is a great development for the Islamic finance industry, and gives the industry respectability in the international financial markets,” the banker added. The IDB Sukuk is also the first international Islamic capital markets issue by a non-sovereign and only the second such issue — the first being the $600 million Malaysia Global Sukuk issued by the Ministry of Finance in Malaysia in June 2002.
Behind the euphoria, however, there are some signs that the IDB needs to do much more to be more competitive. A senior IDB management team has been on the road since June 21 when the issue was launched, giving presentations to institutions in Saudi Arabia, Bahrain, Malaysia, the UAE, Switzerland, and the UK. Though the issue was oversubscribed, the exercise “was a bit of a stretch” according to one banker. The reason is that despite the rating, and the quality of senior equity subscribers of the IDB, the institution as an issuer remains largely unknown to the international financial markets.
To get a proper benchmark pricing would require a series of international Islamic issues, preferably AAA rated. And the more diversified the issuers, the better. This will also add depth to the market and create a secondary market in the trading of these issues through securitization.
In the case of the IDB, not even its zero percent risk recently agreed by the Basel Committee and the BIS (Bank of International Settlements) could help it to raise funding, at least in this inaugural instance. Nevertheless, the rating will facilitate the integration of the IDB into the Basle Accord process.
IDB President Dr. Ahmad Muhammad Ali has confirmed that the bank has a planned program of mobilizing $2 billion of additional resources in the next few years. This will be primarily through the issues of Islamic paper such as Sukuks. There remains that small but vital issue of how the IDB will absorb all this extra liquidity, and if it does, how efficiently will these resources be utilized?
The IDB already has serious bottlenecks in utilizing funding especially for project and development financing. This is why much of the money allocated for this purpose is placed in short-term Murabaha, Istisna, and Installment Sale financing, and rolled over if necessary.
Increasing name recognition in the international capital markets is one thing, but with that comes greater scrutiny of the institution, its organization, its capital, its financial and operational soundness and performance. The senior shareholders of the bank effectively act as its lender-of-last-resort. But can that situation be sustained indefinitely, especially if the IDB goes to the market more often and builds a debt profile of its own?
In the debut $400 million Sukuk, the underpinning assets are comprised of leases and other Shariah-compatible IDB assets. These have been transferred to a special purpose vehicle, an SPV, called Solidarity Trust Services Limited for this transaction. However, the IDB has had to guarantee the performance of the Sukuk assets pool, and also to support the noteholders as a liquidity provider as well as the final purchaser of the Sukuk assets at the time of maturity. These guarantees contributed largely to why the Sukuk was rated AAA and AA by the two international agencies.
For an international capital market to flourish, there must be a much greater pool of international sovereign and non-sovereign issues. This is where IDB member countries, especially larger shareholders such as Saudi Arabia, Kuwait, the UAE, Turkey, Iran, Libya and Egypt will have to stand up and be counted. Some countries have issued a series of Sukuks and other papers but these have been domestic issues and marketed globally.
The larger IDB equity subscribers will have to make an effort to add some vital depth to the market. And it is not completely essential to have all issues AAA rated. There is a surplus of liquidity in some Muslim countries, where investors would be comfortable with BBB or even CCC ratings as with the Malaysia Global Sukuk.
On a wider scale, it will be corporate international Islamic bonds that will add the real depth to the market. In Malaysia the corporate Islamic bonds market is over 40 billion ringgit, but these are overwhelmingly domestic issues denominated in ringgit. This is the real challenge for Islamic finance, to nurture their corporate clients to issue Shariah-compliant bonds as a means of refinancing debt, or to finance working capital requirements and expansion.