LONDON, 19 July 2004 — The roadshow for the first Islamic Eurobond commences this week following the confirmation by the central German state of Saxony-Anhalt on July 14 that it is to issue the first European-based and backed Islamic bond (sukuk) at the end of this month.
The 5-Year 100-million-euro asset-backed sukuk is lead arranged by Citigroup and will be marketed primarily in the Gulf Cooperation Council (GCC) states; Malaysia; Turkey; and in the US and UK; and will be listed on the Luxembourg Stock Exchange. The transaction, according to Trowers & Hamlins, the City of London-based international law firm, which has a thriving Islamic finance business, is essentially a sale (to a special purpose company) and leaseback (to Saxony-Anhalt) of certain previously state-owned real estate assets. The issuer will pay investors in the sukuk a return derived from rents paid to it under the leases by the state. Interest payments are forbidden under the Shariah (Islamic law). As such returns based upon and generated by the ownership of assets and income from genuine trading transactions are however permitted, and indeed transactions of this nature are actively encouraged.
Saxony-Anhalt, with a population of about 2.54 million and whose capital is Magdeburg, is one of the poorer former East German states. At end 2003 it had a GDP of 44.2 billion euros and a GDP per capita of 17.438 euros — well below the level for the West German states such as Bavaria and Hamburg.
The issue, if successfully subscribed, will have important implications for the global Islamic finance industry and further underlines the inroads Islamic finance is making into mainstream banking. It could open the floodgates for a whole spate of European countries, especially central and East European states, to issue sovereign sukuk, which could be followed by corporate issues. The sukuk (especially the asset-backed Sukuk-Al-Ijara or Islamic leasing bond) is a flexible and relatively competitive structure, which is now fast gaining acceptability in international finance.
The three sovereign sukuk that have been launched to date have all been lead arranged by either Citigroup or HSBC, who are both building up a considerable expertise in structuring sukuk and the running the books for such transactions.
Indeed, the Ministry of Finance of Saxony-Anhalt has been working on this issue for three years, following a visit to Bahrain in 2001, where officials met both conventional and Islamic bankers. Gulf investors had already participated in one or two conventional bond issues floated by the German land, whose latest program calls for the issuance of 1 billion euros worth of fixed-rate bonds.
The Ministry of Finance of Saxony-Anhalt initially intended to issue the sukuk in 2003. But in a post 9/11 environment, there was initially some political opposition to issuing an Islamic bond. The sukuk structure itself posed no problem from a legal and regulatory point of view. The German state is also keen to broaden its investor base; to reduce its finance cost; and to attract inward foreign direct investment into Germany.
Saxony-Anhalt’s benchmark Islamic Eurobond also puts the spotlight strongly on the Islamic Development Bank (IDB) member countries. Out of the 55 or so IDB member countries only Malaysia, Qatar and Bahrain have actually issued global sovereign sukuk — the $600 million Malaysia Global Sukuk in June 2002; the $700 million Qatar Global Sukuk in September 2003; and the $250 million Bahrain Global Leasing Sukuk in Feberuay 2004. In addition the IDB itself issued a $400 million IDB Sukuk Bond.
Is it indeed a reflection of the state of the global Islamic finance sector that a former East German state, which by West German standards is considered as under-developed and emerging, should issue a sovereign sukuk ahead of countries such as Saudi Arabia, Iran, Turkey, Indonesia, Egypt, Oman — the list is endless? There have been reports that the Kingdom is planning to issue its debut benchmark sovereign sukuk. Pakistan, Lebanon, and even Turkey are reportedly considering issuing sukuk.
However, it seems that Muslim governments need more convincing that sukuk are indeed bonafide and efficacious capital market instruments and that they are cost efficient and competitive.
The governments, through their ministries of finance, are less keen to invest in doing the basic research and building up the case for sukuk, both as tools to raise funds for infrastructure development and for monetary policy management. Perhaps the Citigroup and HSBC are also doing the bidding for the sukuk as they do for conventional bonds, especially if there is increased demand and appetite for such instruments by Islamic investors.
Trowers & Hamlins stresses that Islamic bonds (sukuk) are becoming more popular amongst conventional investors as they seek to diversify their holdings away from G-7 borrowers who are suffering from increased public deficits. The coupons, says Trowers & Hamlins, are also highly attractive, although as more issues occur and the sukuk market matures, pricing will certainly become finer. In fact, almost half of the $700 million Qatar Global Sukuk was subscribed by conventional institutions in the US, UK, Europe, and Southeast Asia.
The sovereign sukuk are fully guaranteed and underwritten by the issuing governments, although the actual issues are usually done through their ministries of finance, or through special purpose vehicles (SPVs) formed by them. The Saxony-Anhalt issue is investment grade and will most probably carry the same rating as the sovereign rating of the state: AA- (Standard & Poor’s); AA3 (Moody’s); and AAA (Fitch). All three ratings have a stable outlook.
