The Islamic bond (Sukuk) is fast rising in popularity and so lucrative is the potential market that conventional international banks are falling over themselves to set up Shariah-compliant operations. With abundant oil-windfall revenues and a raft of infrastructure mega projects either underway or on the drawing board, the Gulf is fast becoming the logical choice for new and established players alike to set up shop.
As conventional bonds are “off limits” to Muslims because interest is paid to those who invest in them, the Gulf debt market was until recently underdeveloped. This is changing because Sukuk offer a share in the proceeds from a business venture rather than paying out interest.
Bahrain has been a leading “offshore” banking center for decades and its central bank, the Bahrain Monetary Agency, is one of the pioneers of Islamic banking. However, until recently, the “capital” of Islamic finance was Malaysia. Competition is certainly building up, Swiss banks are now making efforts to understand, embrace and implement some elements of Islamic finance and the UK’s chancellor of the exchequer, Gordon Brown, has said that he wants London to become the global Islamic finance center.
The latest Sukuk deal from the Gulf Cooperation Council (GCC) bloc is Saudi Basic Industries Corp’s (SABIC’s) $800 million issue. This is significant because it is the first Saudi Sukuk to be issued under the new Capital Market Law and the debt market in the Kingdom is relatively untapped. If SABIC becomes a Saudi trendsetter, there is no doubt that the GCC will become the global hub for Islamic finance. The only question is if the likes of Merrill Lynch and Goldman Sachs will pitch their headquarters in Dubai, Manama or Riyadh? According to the Islamic Finance Information Service, there were three key players in terms of issuing Sukuk in 2005 — GCC countries, Malaysia and Pakistan. To date, most Sukuk have been corporate, not sovereign. For instance, the only major sovereign bond issue in the GCC countries during 2005 was by the government of Bahrain ($79.5 million). It therefore follows that the potential Middle Eastern sovereign Islamic bond market could be huge in the future.
In 2005, a Malaysian company, Jimah Energy Ventures, issued the largest Sukuk for the year — $1.27 billion; Malaysian companies also issued the second and third biggest Sukuk last year (Musyarakah One Capital’s Sukuk for $658 million and PLUS Expressway’s for $634 million). However, the tables turned in early 2006 with DP World launching the largest Sukuk in history. The $3.5 billion issue by Dubai Ports, received more than $11 billion in subscriptions! The Malaysian bank, Commerce International Merchant Bankers, was the leading Sukuk manager (as of Q2 2005) with $1.39 billion, but the UAE’s Dubai Islamic Bank was in third place having managed three Sukuk worth $633 million. Interestingly, and indicative of the trend in conventional banks moving into Islamic finance, HSBC Amanah was last year’s second most important Sukuk manager having helped various entities raise $ 882 million, in seven separate issues.
The overall pool of assets managed by Islamic banks, according to estimates by Reuters, is between $250 billion and $400 billion. Over the past five years the Sukuk market has grown significantly — the latest data from Bahrain’s Liquidity Management Center indicates that there is almost $ 18 billion worth of outstanding issues; of this, no less than 52 percent originates from the GCC countries.
Various changes have taken place or continue to take place and all bode well for the Gulf’s nascent financial centers. The first is that much more of the region’s oil windfall revenues are being retained within the region than in previous oil booms. Ongoing reforms, particularly in the region’s real estate sectors, are attracting significant levels of this retained capital. The second is the region’s increasingly bullish private sector. All regional governments are investing heavily in their respective infrastructures and unlike the past, most of today’s projects are generating growth, and not white elephants.
Thirdly, governments and regulators in various GCC countries are being proactive in promoting Islamic banking and are developing custom-built regulatory frameworks, rather than simply following Malaysia’s lead. Combined, these changes mean that more local entities are seeking to raise money via Sukuk issuance and domestic investors are more willing to invest in such bonds. Many of the Sukuk issued in the Gulf till now have been oversubscribed due to high demand, but many more are in the pipeline. The head of Islamic Finance at the Dubai International Financial Center, Khalid Yousaf, estimates that the GCC countries are likely to see another $9 billion worth of new Sukuk between now and the end of the year. Many of the Gulf Sukuk that are open to foreign subscribers are not just attracting Middle Eastern and Asian investors, but increasingly European and US ones too. Furthermore, Western companies are also starting to seek Islamic debt. For instance, the Gulf East Cameron Partners from the United States recently became the first American firm to issue a Sukuk ($166 million).
As the sophistication of Shariah-compliant products increase (particularly the emergence of a secondary market for trading issued Sukuk, as is happening in Dubai and Manama), a far higher number of Muslims and Islamic countries will opt for Sukuk as opposed to conventional bonds. And, why not? For all intents and purposes, the financial returns are comparable; the only real difference is that one is just that bit more ethical than the other.
(Emilie Rutledge is an economic researcher at the Gulf Research Center in Dubai.)
