Even as he attended a local sukuk conference where speakers decried the lack of liquidity in the regional sukuk market, Chavan Bhogaita, head of credit research at HSBC, noticed his trading manager make three trades on his Blackberry while they both listened to the panel of speakers.
“It is one of my pet hates - the widespread misconception that there is no liquidity in the GCC secondary market for bonds and sukuk,” says Chavan Bhogaita. The regional market is liquid, with prices available for the vast majority of the bonds and sukuk issued out of this region, he says. “The facts speak for themselves - if you look at the secondary market for GCC bonds, HSBC trades more than 100 Middle East debt instruments, and we quote prices on these virtually 24 hours a day - we can give you a price at any time on, for example, Aldar convertible sukuk, Nakheel bonds, etc.”
Clearly, the market has not reached the maturity of European and US bond markets, but it is far from illiquid, Bhogaita says, although volume figures are difficult to measure precisely due to the nature of the industry. At the moment, the sector is dominated by a handful of market makers such as Barclays, Dubai Islamic Bank, Deutsche Bank, Liquidity Management Center and Shuaa, apart from HSBC. There is clear evidence, though, that there is international investor interest in the secondary sukuk market. “The main players in the secondary sukuk market are European funds, and to a lesser extent, Asian funds,” Arul Kandasamy, head of Islamic financing solutions at Barclays Capital told Zawya.com. “In the Middle East, we see interest from the treasuries of banks, but the market is dominated by European and Asian investors.” Barclays Capital claims it is the leading market maker in the secondary sukuk market. “We trade around $15 million-$20 million of sukuk on average per day - much higher than anyone else. This has been built on the back of our strong market position and success in working on the largest sukuk ever issued such as DP World, PCFC, Nakheel and Aldar sukuk.” HSBC also claims to be the market leader in the secondary sukuk market, while Shuaa Capital daily trade values average around $5 million. According to our estimates and those of market insiders, the value of average daily sukuk trades stand around $80 million-$100 million.
The sukuk market has certainly taken off. An avalanche of sukuk have come flooding in the past couple of years, and this trend looks set to continue with around 50 sukuk with an estimated combined value of $17 billion expected to be issued before the end of 2007.
Already, the industry has seen $13.45 billion worth of sukuk closed across the world this year - nearly double last year’s value. Can the avalanche continue for the next few years, or will the recent global credit crunch dampen the mood?
Ratings agency Moody’s notes that the Gulf corporate bond issuance alone may reach at least $30 billion in 2007, with sukuk issuance expected to represent a substantial share due to increasing investor acceptance outside Islamic markets and greater standardization. “2006 was the breakthrough year for the industry,” says Philipp Lotter, vice-president, senior credit officer, corporate finance at Moody’s, adding that he sees real interest rather than hype surrounding the industry.
“We are starting from a very low base. The debt culture in the region has really started in the last eighteen months - what you are seeing is the emergence of a debt market. So far the region has relied heavily on equity, whereas the development of debt/sukuk market is new and is not only finding investors in the region, but also outside the region.” At the moment, UAE-based companies appear to be leading the way, but Saudi and Qatari companies are fast catching up. “Saudi Arabia’s fledgling sukuk market is beginning to take off, with deals increasing in size and asset pools increasing in sophistication,” Andrew Coats, partner at City-based international law firm Clifford Chance, said recently. The trajectory has come thanks to new regulations put in place by the Kingdom’s Capital Market Authority. Innovations by international financial institutions are also helping the industry. Bhogaita expects the complex Credit Default Swaps (CDS), for example, to keep the sukuk industry innovating. “There is little doubt that a CDS market will develop alongside the cash bond market in the GCC. However, while trading CDS with ‘conventional’ investors is likely to be straightforward, the practicalities of trading CDS with ‘Islamic’ investors are a little more complex,” says Bhogaita.
There are caveats on the way, though. The interest rate environment, for example, could have a bearing on the bond and sukuk market going forward. Pricing of Dana Gas’s $1 billion convertible and Ithmaar Bank’s $300 million sukuk has been delayed due to weaknesses in the global credit markets. “We have seen a few examples of that with the delay in Ithmaar Bank and First Gulf Bank (bond) issuances,” says Barclays’ Kandasamy. “It has had a knock-on impact, but there are two ways of looking at it. Of course, it is unfortunate that the markets here are impacted, but it can also be viewed as a positive development because it means that the Middle East market is now plugged into the global market.” Concerns in the US subprime markets have made investors more risk averse, widening spreads on many bonds, especially in emerging markets, and making borrowing expensive. Bu analysts don’t expect long-term risks to the regional conventional bond or sukuk industry on account of jittery market sentiment.
More worrying is the evident lack of sophistication among some investors and issuers. “There are a lot of people who don’t know enough about sukuk in general, and that always bring with it the risk of unexpected events and surprises,” says Lotter. Also, the companies issuing such sukuk also have to change their mindset as they enter the global debt markets. “By tapping this new source of funding, companies will have to become far more transparent in terms of disclosure of information, and be more open with corporate governance issues, as investors are very conscious about these matters,” says Bhogaita. “The disclosure levels of some companies here in the GCC have improved significantly and they are making a conscious effort to be more transparent over time.”
(Yadullah Ijtehadi is managing editor at Zawya.com, Dubai.)
