AMMAN, 8 December 2003 — The interest of investors in the Islamically structured debt instruments, commonly known as sukuk, has been on the rise recently and demand for these instruments will continue to surge. The list of sovereign issuers of these bonds has grown to include Bahrain, Qatar, Lebanon, Turkey and Malaysia in addition to the Islamic Development Bank. Corporate issuers have also started to tap this market, with Emaar Properties and Tabreed, both of the UAE, issuing sukuks of $50 million and $100 million respectively. Not only Islamic financial institutions are seeking to invest in the Shariah-compliant bonds, but also the investment community at large is showing interest in these instruments.
The Bahrain Monetary Agency (BMA) issued the first tradable sukuks in September 2001. Since then the pace of issuance has quickened with the BMA tapping this market seven more times, brining the total value of the sukuks issued by Bahrain close to the $1,000 million mark. There has been a $600 million sovereign issue from Malaysia that came to the market in June 2002, $400 million from the Islamic Development Bank issued in July 2003, $700 million from Qatar issued in September 2003 and Lebanon is planning for a $200 million issue before year end.
The government of Bahrain wants to reinforce the country’s role as a global Islamic finance hub. Serious attempts are being made to establish the Bahrain Stock Exchange as the core market for listing and trading of sukuks.
The main reason for the success of Islamic bonds is that they offer a solution to one of the main problems that have slowed the growth of Islamic finance, that of liquidity management. Islamic Financial Institutions are not allowed to deposit the excess balances they have in short-term debt instruments, or to draw on the interbank market for that purpose. As a result, most Islamic financial institutions end up having highly liquid balance sheets with rising liabilities, but only limited opportunities on the asset side. Sukuks have, over the past two years, been creating new venues for the short-term placement of funds.
Sukuks must be asset-backed and as such they are structured as bundles of ijara, or leasing transactions. Sukuks are tradable because they are backed by real assets. Murabaha contracts, on the other hand, in which a client makes payment to a bank for a good that the bank has bought for the client cannot be traded because they represent money owed, not tangible assets.
If an Islamic Financial Institution wants to tap the debt market in a Shariah compliant way, a special purpose company needs to be established, call it Islamic Global Sukuk (IGS). The IGS will issue trust certificates or sukuks to potential investors and will use the money raised to purchase a rent generating property from the Islamic Financial Institution. IGS will then rent the property back to the financial institution for say a five year period corresponding to the duration of the trust certificates or sukuks, and will keep the property or the asset in trust for the holders of the sukuks. The lease rental payments from the Islamic financial institution to the IGS will exactly match the periodic payments due to the holders of the sukuks. These rental payments are not fixed and may be calculated based on six months US dollar Libor plus a margin. All claims due to IGS, the special purpose company issuing the sukuks, including the rent that will fund the periodic payments on the trust certificates are a direct, unconditional and irrevocable obligations of the Islamic financial institution under the agreement. The Islamic financial institution is also obliged to purchase from the IGS upon the maturity of the lease the asset or the property leased at the agreed exercise price which will be used for the repayment of the principle to the holders of the sukuks.
Not only Islamic financial institutions are tapping the Shariah-compliant bond market, but also sovereign borrowers and corporates. For example, Bahrain’s $250 million sukuks issued in May 2003 are backed by an ijara lease on the country’s airport, Malaysia’s global sukuk, launched in June 2002, is similarly backed by an ijara lease on a single piece of government property. The money raised by the government of Qatar will be partly used to finance the construction of the Hamad Medical City. The $50 million Islamic bonds arranged by the Bahrain-based Liquidity Management Center for Emaar Properties of Dubai will be used to fund Emaar’s expanding portfolio of new commercial and residential projects in and around Dubai.
With around $2.5 billion worth of sukuks either issued or in the pipeline, the market is still small but growing fast. The government of Bahrain is committed to replace its short-term conventional debt with medium term sukuks. Qatar’s diversification of its sources of funds implies future issues of Islamic bonds. Rather than drawing on its shareholders, the Islamic Development Bank intends to raise an additional $4 billion mainly through issuance of sukuks. Turkey and Iran are understood to be examining the sukuk option. But the market will only come of age when corporate sukuks are issued with regularity, and only then activities in the secondary market will pick up. So far, a small proportion of the sukuks issued are traded, with investors taking a buy and hold approach. However, once more paper are issued, investors may be tempted to sell in order to buy bonds which are better priced than the ones already being held. The BMA is encouraging the local banks and private institutions (in and outside Bahrain) to issue sukuks. It is also introducing a new system which will allow Islamic banks to sell their sukuks to the BMA, who will then sell it back to them. This transaction, which is called a repurchase agreement or ‘repo’ in the conventional bond sector, is aimed at providing banks with short-term liquidity.
Not only future supply of Islamically structured debt instrument will be on the rise, but also the demand for these instruments is expected to surge. For Islamic investors seeking a Shariah-compliant means of managing excess liquidity, the appeal of sukuks requires little explanation. However, what is more encouraging is that Islamic bonds are being considered by the global financial heavyweights as well. For example, 48 percent of subscriptions for the Qatari sukuks came from conventional investors, including 24 percent from institutional investors, 11 percent from fund managers and 13 percent from central banks and government institutions.
(Henry T. Azzam is chief executive officer at Jordinvest)
