The emergence of the sukuk (Islamic bond) market in Saudi Arabia in the last year is a major boon, not only for the nascent Islamic capital markets but also for the involvement of Islamic finance in the Kingdom’s industrial and economic development.
Hitherto, Islamic finance in the Kingdom has been largely confined to consumer and commodity finance plus the odd project financed Islamically such as the Shuaiba East power project, funded by Al-Rajhi Bank.
It is not surprising that the sectors attracting an increasing amount of Islamic finance, whether through commodity trade finance (murabaha), sukuk, construction finance (istisna) and equity financing (mushraka), are oil and gas, petrochemicals, manufacturing and real estate. This is true of both state utilities and private sector corporates. Companies such as Saudi Aramco, Saudi Basic Industries Corp. (SABIC), Saudi Cable Company and Savola have been accessing millions of dollars of Shariah-compliant finance products set up over the last few years.
And yet the potential of Islamic finance in Saudi industrialization is only beginning to be recognized. Corporate sukuk issuances in the Kingdom, according to Trowers & Hamlins, the international law firm based in London, is set to take off in a big way over the next few years as companies seek financing for expansion, working capital or simply to refinancing existing debt.
The bond market is growing strongly, with sukuk, according to Trowers & Hamlins, accounting for 81 percent of the total new GCC bond issuance. In the first half of 2006, some $10.2 billion worth of bonds were issued.
According to Neale Downes, a partner at Trowers & Hamlins, this was due to the huge inflow of oil wealth into Islamic investment funds. Another interesting feature of the sukuk market is that global investors, including those from the West, are now becoming familiar with the risks and structures of sukuk. They are therefore increasingly comfortable investing in the instrument.
Several major and landmark Islamic financing deals have been done in the Kingdom this year. The benchmark transaction was undoubtedly the SR3 billion sukuk issued by SABIC in July and lead managed by HSBC. This was the first sukuk to be issued under the new Capital Markets Law and the first public sukuk to be issued in the Kingdom.
In fact, the emerging importance of Islamic finance in Saudi industrialization is highlighted by the fact that this year one group, SABIC and its affiliates alone, have accessed SR7.5 billion worth of Islamic finance through sukuk issuance, istisna and murabaha facilities. This indeed augurs very well for the future of the Islamic finance market, not only in the Kingdom but globally.
Another sukuk, the $23 million istisna-cum-ijara sukuk issued in July 2006 by Kingdom Installment Company and arranged by Unicorn Investment Bank in Bahrain, although much smaller, set new grounds especially in the way foreign investors can directly access Saudi real estate assets.
The role of the Capital Market Authority (CMA), the securities regulator in Saudi Arabia, as a facilitator for Islamic capital market products is important. The CMA introduced legislation governing sukuk in July in tandem with the actual structuring of SABIC’s debut issue.
Turki Ibrahim Al-Malik, head of authorization and inspection at the CMA, confirms that “there were many technical issues to be considered and resolved. We did not draft parallel regulations for an Islamic capital market and a conventional one. Our regulations come under a comprehensive capital market regulatory framework.”
SABIC CEO Mohamed Al-Mady was clear about the petrochemical giant’s role in opening up the Islamic nonequity market. “With this debut issue, SABIC is pleased to have led the way in opening up the nonequity capital market sector in the Kingdom. We are gratified that we were able to achieve our key objectives with this transaction, mainly further development of the Kingdom’s capital markets and providing investors with greater investment choice, and the first step in diversification of our funding sources,” he explained.
In fact, according to Mutlaq Hamad Al-Morished, SABIC’s chief financial officer, Islamic finance is now firmly on the radar of SABIC. It may indeed go to the market again to raise funds Islamically as and when the need arises. “The issuance in a sukuk format demonstrates SABIC’s continuing commitment to promote and lead Islamic financing,” he explained. “The participation of a diverse investor base within the Kingdom reflects confidence in SABIC and its growth prospects. Such confidence was also evident in the substantial oversubscription to the offering.”
The proceeds of the sukuk are earmarked for general corporate purposes and to fund the equity of projects such as the Saudi Kayan petrochemical plant.
SABIC’s new-found commitment to Islamic finance as part of its funding diversification policy is further underlined by the SR1.2 billion Islamic facility raised by its affiliate National Industrial Gases Company (GAS) in July 2006 and lead arranged by Banque Saudi Fransi. The facility is being used to finance the expansion of GAS’ plants in Jubail and Yanbu aimed at increasing production capacity to seven million tons per year.
In May this year, Deutsche Bank arranged a $10 billion murabaha syndication facility for SABIC, the proceeds of which are being used to finance the company’s ambitious expansion and future investments program. SABIC also raised the largest ever Islamic finance facility for a greenfield project for the financing of its affiliate Yanbu National Petroleum Company (Yansab).
The future prospects for Islamic finance in Saudi industrialization look very rosy. But Islamic banks need to be much more proactive in marketing their products and educating corporates about their efficacy, viability, profitability and structures.
The reasons for the relative absence of Islamic finance from the oil, gas and petrochemicals sectors, especially in the Middle East until recently, are many and various. The general lack of awareness of Islamic finance structures even among the top corporates is revealing. Islamic project finance, structured finance, capital market products such as sukuk, private equity, construction finance (istisna) and equipment leasing (ijara) are all ideally suited to these sectors, especially from an investor risk-reward point of view. This knowledge gap seems to be changing, not least because of the involvement of Western banking majors in Islamic finance, who perhaps are more adept at market education and distribution.
The other important reason is the lack of legal and regulatory frameworks to facilitate the above Islamic financial products. Most of the GCC countries, especially Saudi Arabia until July this year, lack or lacked sukuk laws, trust laws and laws relating to the establishment of special purpose vehicles (SPVs) which are often used in sukuk structures.
Therefore, corporates and banks shied away from such structures because of the legal risks and also the potential costs of pioneering such instruments. The economic reform program in the Kingdom in the last few years has meant a much more receptive culture among Saudi lawmakers and the Shoura Council to Islamic finance.
According to Samba Financial Group, one of the leading banks in Saudi Arabia, the Kingdom is planning capital and expansion projects worth $283 billion over the next few years, of which the oil and gas sector alone accounts for a quarter. Saudi Aramco alone has a capital expenditure plan of over $190 billion over the next decade.
The two sectors attracting the lion’s share of Islamic investment are the real estate and oil and gas industries. The contribution of the real estate sector to GDP in the GCC countries, according to Kuwait-based Global Research, totaled $27.2 billion in 2004, some 5.8 percent of GDP. Of this, Saudi Arabia accounted for $12.8 billion. The market capitalization of listed real estate companies in the GCC totaled some $74.9 billion in February 2006, some 6.7 percent of the total. Of this, Saudi Arabia accounted for $17.7 billion.
Similarly, according to the Saudi Arabian Monetary Agency (SAMA), some $40.6 billion will be invested in the Saudi petrochemical industry in the five-year period starting 2006.
Other Saudi corporates have also entered the Islamic finance market recently. HSBC Amanah, for instance, earlier this year acted as financial adviser to Saudi Aramco and Sumitomo Chemical on the $600 million Islamic facility for the Rabigh refinery and petrochemical project. This is the largest such facility to date and is based upon the procurement of a number of core project assets and an Islamic lease of those assets to the project company.
Saudi Aramco, has also accessed Islamic finance in the last year for leasing some of its tanker fleet for transporting crude oil. The Saudi oil giant, the world’s largest oil exporting company, also operates the largest tanker fleet.
However, out of some 70 vessels, it owns only 19. The rest of the fleet is chartered.
Last year, ABC International structured and co-underwrote the $26 million Al-Safeena Ijara Sukuk — a facility which combined Islamic equity with conventional debt for the same asset, the Venus Glory VLCC (very large crude carrier), owned by Pacific Star, a subsidiary of Saudi Aramco.