The Kingdom has the potential to become the world leader in sukuk issuance but the lack of government policy support; regulatory inertia to facilitate origination; untried and untested court procedure especially relating to sukuk default and the rights of sukuk certificate holders over other creditors; and the near absence of secondary trading of sukuk despite the fact that the Saudi Stock Exchange (Tadawul) did launch a trading platform in 2009, all conspire to hold back the systemic and holistic development of a Saudi sukuk market.
Saudi quasi-sovereign entities including Saudi Aramco, the world's largest oil producer and exporter have in the recent past talked about raising funds from the financial markets including through sukuk issuances, but nothing has materialized thus far. Saudi Aramco though has accessed several Islamic financing facilities over the last two years, and some of its joint ventures such as Saudi Aramco Total Refining and Petrochemical Company (SATORP), a joint venture between Saudi Aramco and Total S.A. of France, did successfully close its debut SR3.75 billion sukuk in October.
Saudi Aramco, however, has the potential of almost single-handedly influencing the development of the Saudi and the global sukuk market. Saudi Aramco could be the “swing producer” equivalent for the sukuk and Islamic capital market, given the projected $160 billion or so project financing that it has earmarked over the next decade or so.
The latest Saudi quasi-sovereign to confirm that it is planning to issue sukuk to fund the new $7.2 billion Jeddah Airport project is the General Authority of Civil Aviation (GACA) in Saudi Arabia. The Director General of GACA, Prince Fahd bin Abdullah, recently confirmed in an interview with Al Arabiya TV that the authority has "agreed with the Saudi Finance Ministry and the Saudi Arabian Monetary Agency (SAMA) to launch sukuk. The $7.2 billion sukuk program will be self-financing instruments of the General Authority of Civil Aviation, but if there is any shortage in the funding, the Ministry of Finance will cover it to curtail any delays in the project."
This suggests that the issuance may carry Saudi government guarantees, with the Ministry of Finance being the issuer probably through a standalone special purpose vehicle (SPV) and the obligor.
However, this process will be dependent on the restructuring of GACA into a stock-holding company with four separate constituent companies - one specializing in international airports, one in domestic airports, one in air navigation, and one in technology transfer and information services. It will also be dependent on the separation of the Kingdom's Civil Aviation function from the Ministry of Defense pursuant to a Royal Decree to that effect. How long the above processes will take is not clear.
While sukuk issuances by Saudi Aramco and GACA would be important from a market point of view, they still won't trump a genuinely debut sovereign benchmark issuance by the Ministry of Finance on behalf of the Kingdom of Saudi Arabia. Such an issuance would become the seed of building a yield curve for Saudi issuance, which is bereft of such an indicator because of the low number of conventional bond and sukuk originations in the Kingdom.
Equally importantly, a Saudi benchmark sovereign sukuk would give confidence to investors, future issuers and the domestic and global sukuk market in general. To merely rely on corporate issuances to set the benchmark or yield curve is missing the point and betrays a fundamental misunderstanding of the dynamics of how the sovereign bond market works and its importance as a monetary policy management tool and to manage liquidity and reserves of Islamic banks authorized in a particular jurisdiction.
A Saudi sovereign benchmark sukuk would have several important benefits for the Kingdom's monetary policy and financial system management. It will make it easier to price future sovereign, quasi-sovereign and corporate sukuk in the Kingdom.
It will give Saudi corporates and non-bank issuers and important tool to diversify their sources of funding away from bank finance, which dominates the funding landscape in the Kingdom. Muhammad Al-Jasser, former SAMA governor, has already urged Saudi corporates to think seriously of raising financing through the issuance of sukuk, which he explained, "have a very great potential in the Saudi and Gulf market. The Saudi market is moving from traditional sources of financing such as bank credit to corporate bond and sukuk. This is a development issue and has started to happen. The banks may not be able to meet local funding requirements from traditional sources given the rapid expansion of infrastructure and projects in the Saudi economy. But this also depends on demand and supply dynamics of the market. SAMA encourages banks and corporates to go down the sukuk route. We would like to see the local credit market diversified from bank finance to corporate bonds and sukuk."
Hopefully the new SAMA Gov. Fahd bin Abdullah Al-Mubarak will push for sovereign issuances more strongly.
Ask any issuer to date in Saudi Arabia and they will stress that one of the reason why they are raising funds through sukuk is to contribute to the development of the capital market in the Kingdom. This may be true but the real reason is that it gives them access to longer-term financing, which banks are loathed to do because of an inherent mismatch between short-term deposits and longer-term liabilities. This is the bane of corporates in most markets whether in the developed or developing markets.
Indeed the Kingdom has the potential to play the same role in managing the liquidity as the US Treasury does in the US dollar market. There is no reason why the Kingdom for instance could not play the same role say in an Islamic Dinar market, with the currency pegged say to the SDR (Special Drawing Right) of the International Monetary Fund (IMF) or any acceptable alternative international currency.
Gov. Zeti Akhtar Aziz of Bank Negara Malaysia in a recent forum in Kuala Lumpur explained the importance of an Islamic finance equivalent of US Treasuries. "In conventional finance, it is the US Treasury that issue Treasury bills which the whole world buys. These are highly traded. For Islamic finance there are no sovereign short term debt issuances or papers of that nature," she stressed.
Malaysia after all has issued its third sovereign Sukuk in addition to several quasi sovereign issuances - both domestic and international - through its sovereign wealth fund, Khazanah Nasional Berhad, and through the National Mortgage Corporation of Malaysia (Cagamas Berhad) which is one of the world's largest investors in sukuk and the largest securitization house in Malaysia if not Asia.
Other Saudi quasi-sovereign issuers have been active in the market especially SABIC (Saudi Basic Industries Corp.), which has already issued three sukuk, and Saudi Electricity Company (SEC). This has been complemented by a number of corporate issuances including by Saudi Hollandi Bank, Saudi International Petrochemical Company (Sipchem), Binladin Group, Dar Al-Arkan Real Estate Development Company (DAAR) and one or two smaller issuers.
Indeed the Board of Commissioners of the Capital Market Authority (CMA) of Saudi Arabia last week approved an application by Al-Khair Capital Saudi Arabia, a subsidiary of Bahrain-incorporated Al-Khair Investment Bank (formerly Unicorn Investment Bank) to launch the Al-Khair Capital Sukuk Fund.
Indeed, the two major drivers of sukuk origination out of Saudi Arabia, where issuances have largely been local currency public issuances confined to Saudi citizens and institutional investors or the odd foreign institution registered in the Kingdom to do so, could very well be the Islamic Development Bank and the International Islamic Liquidity Management corporation (IILM).
IDB President Ahmad Mohamed Ali confirmed that the bank is under pressure to leverage its AAA rating to raise funds from the financial markets, in addition to equity and callable capital. "We will start soon with our new strategy. We had our board meeting in December 2011. We want to be every year in the market. It is important for the bank to raise funds from the market. In the past we did not give enough attention to this. We will finish our current $3.5 billion Islamic Trust Certificates Program and then go to market every year with a sukuk offering. The size will depend on market conditions and pricing. Our board is putting pressure on us to raise money from the capital markets rather than finance activities through capital and equity. We need to do both," he maintained.
Ali confirmed that the IDB will definitely embark on a new Sukuk program although it was too premature to say what the size would be, although it is most likely to be in the same region as the last one.
