Sukuk success: The local market for Islamic bonds continues to rebound from its slump

The sukuk (Islamic bond) market in Dubai saw some spectacular surges in 2012, with yields diving on high demand. This has echoed global trends that have thrust sukuks more into the international investment spotlight in recent times, with the global market hitting $20.5bn of issuance in the first half of 2012, up 36.7% on June 2011, according to HSBC Amanah. Indeed, “This is the year of the sukuk,” Michael Grifferty, from the Gulf Bond and Sukuk Association, told OBG. “This year, sukuk has proved itself, with a sound investor base and far more issuance out of the Gulf than ever before.”

STRUCTURES & ISSUES: The most common variety of sukuk currently issued in the region and within Dubai is the sukuk al ijara, or asset-backed security. This is the most widely accepted in terms of its compliance with sharia law, and its ability to be traded. Sukuk return a “profit rate” rather than the interest rate of a conventional bond, with the profit rate a measure of the productivity of the asset on which the sukuk al ijara is issued, rather than a currency-based return. Globally, however, the murabaha-type sukuk is more popular – in 2011, 45% of all sukuk issued internationally were of this type – confirming Malaysia as the world’s largest sukuk issuer, with murabaha being more popular in the South-east Asian country than in the Gulf.

The structural difference with conventional bonds provided by sukuk al ijara explains the heightened interest in sukuks globally, and not just from Islamic investors. The fact that these sukuks are asset-backed gives extra security for the investor – and thus, in times of global uncertainty, sukuks can take advantage of risk via flights to safety, as well as providing conventional investors with more diversity in their portfolios.

The global expansion of the Islamic finance sector over the past decade – with figures of 15-20% annual growth – has increased demand from Islamic finance houses, banks, funds and insurers for sharia-compliant instruments. Given that the Islamic investment products market is globally limited, with fewer options than for conventional investors, this has tended to mean that sukuk issues are keenly watched by Islamic institutions, keeping demand high. On the supply side too, sukuks represent one of the few sharia-compliant options available to Islamic institutions seeking to raise financing for their expansion. Yet, the global financial crisis diminished both demand and supply. In Dubai, too, with most assets on which Islamic financial activity was based being real estate developments, the bursting of the real estate bubble added to negative impacts.

GLOBAL CHALLENGE: Worldwide, the market for sukuks slumped. According to Zawya Sukuk Monitor, global sukuk issuance peaked in 2007, at $37.79bn, with $18.2bn of this in the GCC region, as per Bloomberg. In 2008, however, the global figure fell to $19.93bn.

In Dubai, corporate issuance came to an abrupt halt altogether in July 2008, when Tamweel PJSC, a mortgage lender run by Dubai Islamic Bank (DIB), issued a large sukuk. (DIB has continued this trend, including a $500m sukuk in a $2bn in 2012.) In 2009 a $1.25bn sovereign sukuk was issued, with a five-year maturity, yielding precisely 6.396%, but then the emirate went quiet. Even so, it did not take long for the global sukuk market to come back. Dominated in terms of number of issuances by Malaysia, which offers considerable tax advantages for sukuk launches, while also having what many in the Gulf see as a more relaxed attitude to compliance, the figures show $52.23bn in issuances in 2010, followed by a record-breaking $84.92bn in 2011.

By that year, Dubai too was ready to return to the sukuk market. Emaar launched a $500m sukuk al ijara in January 2011, consisting of trust certificates with a five-and-a-half-year maturity and a profit rate, or yield, of 8.50%. The issuance was widely supported and marked a significant turning point for the emirate’s global financial standing, as well as for Emaar’s. After a long absence and some major challenges, Dubai was being given a cautious welcome back to global markets.

These issuances, and others thereafter, to all intents and purposes, have acted as indicators of popular sentiment for Dubai’s economic and financial recovery.

The sovereign sukuk issued in 2009 at 6.396%, for example, was yielding just 3.2% in July 2012. Indeed, the shrinkage of this particular yield accelerated dramatically in 2012, with 2.35 percentage points coming off between February and July alone. Another sukuk issued by Emaar in early July 2012, a seven-year $500m paper, debuted at 6.4% – already two points down on the 2011 offering – yet within a week this fell to 5.78%. Reuters reported in November 2012 that Abu Dhabi Islamic Bank has issued a hybrid Islamic bond. The bank is expected to raise at least $500m to shore up core capital and comply with tighter Basel III global standards.

RECOVERY: Analysts point to a variety of factors behind the recent shrinkage. In Emaar’s case, however, market confidence has risen since the dark days of 2008-09. The company’s profits for the second quarter of 2012 were expected to be 106% higher than the first quarter of 2011, according to Bloomberg. Given that Emaar is at heart a property development company, the real estate and construction sector in Dubai may also now be stabilised and ready to go forward again – a key sign given the emirate’s recent financial history. Concurrently, confidence in Dubai itself has been rising, as evidenced by falling rates on Credit Default Swaps (CDSs). The emirate’s five-year CDS was at 323 basis points in July 2012, a one-year low. Yet, there are also some grounds for caution in analysing Dubai’s improved performance in the debt market. Mid-2012 coincided with many sukuks globally reaching their maturities, freeing up an unusual amount of Islamic funds for new issuances. As Ramadan began in late July, most purchases took place in the period just before the beginning of the holy month. Nevertheless, the signs are that Dubai is now benefitting from better investor sentiment and the successful restructuring of legacy debts.

In addition to July’s Emaar issuance, 2012 saw another sovereign sukuk in Dubai, this time a double tranche adding up to $1.25bn. The first tranche was a $600m five-year sukuk, with a yield of 4.9%, and the second a $650m 10-year issue at 6.45%. The total amount bid for these issuances was $4.5bn, making them around 3.6 times oversubscribed. This is an indicator of strong demand and the pressures Islamic investors are under in finding instruments to buy, despite 2012 being a banner year globally for issuances. This undersupply has aided the secondary sukuk market as well, as those able to obtain them sell them on.

Thus the NASDAQ Dubai, formerly known as the Dubai International Financial Exchange, which has increasingly been making a major push to establish itself as a regional debt market, now lists a growing number of sukuks. The oldest is a Dubai World issuance from 2007, which had a profit rate of 6.25% on July 2, 2012, while the youngest is the Emaar sukuk mentioned above.

In June 2012 a $650m, seven-year Jebel Ali Free Zone (JAFZ) sukuk was also admitted, as a dual listing with the Irish Stock Exchange, onto NASDAQ Dubai. The issue was priced at 7%, with this widely expected to tighten to around 6.5% in the second half of 2012. It was also some 3.1 times oversubscribed.

NEXT STAGE: Developing the sukuk market in Dubai is a major objective of the emirate’s financial planners, as well as its exchanges. Part of fulfilling this objective lies in widening demand for locally issued sukuks beyond the emirate and the region. The JAFZ sukuk mentioned above saw 65% of demand come from the Middle East and North Africa region, 26% from Europe and just 7% from Asia, with the rest from the US. Crossing the divide to the Asian sukuk market will be a crucial next step.

Going forward, the lack of standardisation of Islamic products is a key challenge, although recent times have seen progress. The Gulf Bonds and Sukuk Association (GBSA) issued a set of standards for issuances in November 2011, while issues of pricing were also advanced by the creation of the Islamic Interbank Benchmark Rate. Other schools of thought view standardisation as less desirable; instead, providing a range of products can also be a strength for the global sukuk sector. Greater diversity in sukuk types is perhaps more likely, with the GBSA currently exploring “green” sukuks that are used to finance sustainable energy initiatives.


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The Report: Dubai 2013

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