LONDON, 20 October 2003 — The $700 million Islamic bond (sukuk al-ijara) issued by the Qatar Ministry of Finance in September is an encouraging sign of the international appetite for such issues. There are several rumors that Saudi Arabia, Pakistan, Indonesia, and even the Philippines are interested in issuing Islamic bonds. But apart from Saudi Arabia, it would be difficult for the other countries to attract an A or AAA rating for their issues from international rating agencies such as Moody’s, Standard & Poor’s (S&P), and Fitch. Subscribers are keen to build a diversified portfolio of Islamic bonds ranging from the zero-coupon Bai-Salam sukuks, to issues with varying maturity, pricing, and rating profiles.
At best it may spur Bahrain which has issued a program of sukuk al-ijara totaling just under $1 billion, the last one a $250 million issue through the Liquidity Management Center (LMC) in Manama. But these have been domestic bonds, not marketed internationally.
The entry of the Saudi Ministry of Finance would be a major psychological boost for the Islamic capital market. The Kingdom is by far the largest market for liquidity. It would also signify a vote of confidence by the Saudi authorities for the Islamic bond market. Iran, which is contemplating going to the Eurobond market with two new issues, could contribute by issuing an Islamic Eurobond. An Iraqi reconstruction bond issue, underwritten and guaranteed by the IDB, could also go a long way in adding market depth and political credibility.
Malaysia set the ball rolling last year with its $600 million Malaysia Global Sukuk, the first Islamic bond to be issued. It was rated BBB and Baa2 by S&P and Moody’s respectively. The Islamic Development Bank (IDB) in June this year launched an Islamic bond, a $400 million sukuk al-ijara, which was rated AAA and AA by S&P and Fitch.
The reasons why the sukuks al-ijara seem to be so successful are many. They are new and there is behind-the-scene pressure put on domestic subscribers. But above all, there is a dearth of investment opportunities with varying maturity profiles for Islamic financial institutions, awash with liquidity especially short-term investments.
The result is that there is a serious mismatch between their short-term deposits and their long-term assets. Thus, the need for tradable instruments that can be liquidated easily when cash is required becomes paramount. The Malaysia Global Sukuk is listed on the Labuan International Financial Exchange and the Luxembourg Stock Exchange. In the first six months after issue, the sukuk saw only two trades on the Labuan exchange. It was only listed on the Bahrain Stock Exchange three weeks ago, becoming the first Malaysian bond to be listed on a stock exchange in MENA countries. Qatar aims to use some funds raised from its sukuk to finance the construction of the $450 million Hamad Medical City in Doha, which will initially be used as the athletes’ village for the 2006 Asian Games in Doha.
But there can also be a downside. Malaysia and the IDB, for instance, are both liquidity rich and do not need to go to the international markets for funds. The Malaysians for instance prior to and during the September World Bank Group annual meetings in Dubai went on a road show for a second Malaysia global sukuk issue but since then the enthusiasm for such a issue has dampened. Unconfirmed reports suggest that the issue has been postponed indefinitely.
After all the players involved are largely the same. HSBC and Citigroup have emerged as the two prominent structurers, lead managers, and bookrunners. The pricing for the Qatar sukuk is 40 basis points over six-month LIBOR (London Interbank Offered Rate). The issue has a tenor of seven years, callable in five years. This is compared to the IDB sukuk which had a tenor of five years and a pricing of 3.738 percent — equivalent to a margin of 16 basis points over the five-year mid swap rate, at the tighter end of the indicated pricing range of 15-20 basis points. In further contrast, the Malaysia Global sukuk was priced at 6 months LIBOR plus 95 basis points which translates into 2.92 percent.
In the case of the Malaysia Global sukuk, the original ceiling was supposed to be $1 billion.
But this was brought down to $500 million then increased to $600 million, giving the impression that the issue had to be raised due to demand. In fact, some Middle East investors passed on the Malaysia issue due to some (albeit minor) reservations over some aspects of Shariah-compliance relating to income streams of the land parcels that were securitized. Similarly, the IDSB sukuk, although eventually oversubscribed, according to one banker “was a bit of a stretch” because the international capital market was not familiar with the IDB as an institution nor the structure of the sukuk.
The challenge for Islamic bond structurers also is to come up with a more varied profile of issues, beyond the bai-salam sukuk and the sukuk al-ijara. These would include al-istisna bonds, mudaraba bonds, and musharaka bonds. Even seasoned Islamic bankers agree that to add depth to the market, the innovators will have to get their thinking caps on. After all the sukuks-al-ijara depend on quality assets which are then securitized. The Muslim world does not have that depth of quality assets. Furthermore, these assets have to be acceptable from a Shariah compliance point of view; and have to have proven rental and other income streams to effectively guarantee the securitization process.