Issuing potential: A new law is set to revive the use of Islamic debt for public and private financing alike

In mid-November 2015 the Capital Markets Authority (CMA), Kuwait’s investment sector regulator, released a new set of rules aimed at streamlining the issuance of sharia-compliant debt instruments. After steady growth in new sukuk (Islamic bond) listings in the early and mid-2000s, the country’s corporate debt market has seen declining levels of activity in recent years. This drop has been attributed both to domestic and regional economic volatility following the 2007-08 international economic downturn and, more recently, the fall in the price oil that began in mid-2014.

The new rules have the potential to jump-start activity not only in terms of corporate sukuk issuance, but also in the sovereign debt market. Indeed, in mid-2015, in the run-up to the release of the CMA’s new sukuk legislation, the Ministry of Finance (MoF) announced that the state was in the process of drawing up legislation to facilitate an Islamic bond issue of its own. Assuming this plan moves ahead, it will be Kuwait’s first sovereign sukuk issuance to date.

A Vital Source

This flurry of activity in sukuk issuance is expected to have a far-reaching impact on Kuwait’s Islamic financial services (IFS) sector and across the wider economy. Given the recent poor performance of the Kuwait Stock Exchange (KSE), which ended 2015 down almost 15% on the previous year, many local firms are looking for new sources of financing. A revitalised local sukuk market has the potential to meet this demand. Similarly, with the government’s budget deficit for 2016/17 expected to reach KD12.2bn ($40.4bn) – up almost 50% on the previous year, according to the state’s forecasts – sukuk may serve as a vital new source of government revenues in the years to come. “It is hoped that the regulations will provide a platform for Kuwait to start competing for a share of the lucrative global sukuk market,” Paul McViety, legal director and head of Islamic finance at global law firm DLA Piper’s Dubai office, told regional media in November 2015. “[This] market has seen approximately $120bn of sukuk issued annually for each of the last three years.”

Rapid Development

Kuwait’s sharia-compliant fixed-income market dates back to the mid-2000s, when strong market conditions and rising demand for financing led to the rapid development and implementation of IFS products and services throughout the Gulf region. Kuwait was one of the largest sources of conventional debt instrument issuance during this period. Indeed, from 2003 through to 2009 the country was responsible for $99.7bn in new bond issuance, which was equal to 40% of the entire $247.7bn GCC bond market during the same period. The government was the single most important source of debt issuance in Kuwait during this period, accounting for nearly 93% of all new listings, according to Markaz, the research arm of Kuwait Financial Centre.

The first sukuk to be issued in the country was a dollar-denominated $100m listing by the Commercial Real Estate Company in April 2005. Between 2005 and 2008 Kuwait saw 15 Islamic debt issues, all on the corporate side, worth a total of around $2.1bn. These sharia-compliant listings account for about 30% of total new fixed-income instruments put forward in Kuwait between 2003 and 2009. Following the initial 2005 listing, Islamic debt products grew in popularity, overtaking conventional listings for the first time in 2007. During that year they accounted for over three-quarters of the total amount of new financing raised by debt issuance. During 2006 and 2007, 12 sukuk were successfully listed – a high point which, as of almost a decade later, had yet to be topped.

The Islamic listings put forward during this period have a number of shared characteristics. All but one were five-year issues, for instance, and almost all of them were denominated in US dollars and originated in either the financial services sector or the real estate industry, both of which were growing rapidly during the early and mid-2000s. Similarly, while sukuk issues have varied in size from $50m to nearly $500m, the most common sizes have been $100m and $200m.

Tough Times

In the wake of the 2007-08 downturn, two Kuwait-based investment companies – namely The Investment Dar (TID) and the International Investment Group (IIG) – defaulted on their sukuk. This, along with the broader economic slowdown brought about by the crisis, put a damper on new debt listings of all kinds in Kuwait during the following years. TID, which defaulted in 2009, entered into a process of litigation in 2011 and is in the process of restructuring its debt as part of a programme overseen by the Central Bank of Kuwait (CBK). Indeed, in March 2016 the firm put forward a new KD813m ($2.7bn) restructuring plan, which had yet to be approved by its creditors at the time of writing. IIG, which defaulted on a $3.35m payment on a $152.5m sukuk in April 2010, also began restructuring efforts with the state’s assistance soon after the downturn.

As banks and other local firms looked to shore up their budgets and operations in the wake of the downturn, conventional and Islamic debt issuance alike dropped off considerably. Consequently, there were no new sukuk issues in 2009 or 2010. In 2011 the First Investment Company issued $93m in Islamic debt as part of a corporate restructuring effort. This was followed in 2013 by the issuance of a KD12.5m ($41.4m) sukuk in two tranches by Al Ghanim Industries, a leading Kuwaiti conglomerate. In late 2013 and early 2014 a number of firms announced plans to sell Islamic debt in Kuwait, citing steadily improving market conditions and rising demand for financing across the region. However, the period of lower oil prices that began in June halted these plans, with the result that no sukuk were issued in Kuwait in 2014 or 2015, according to data from Markaz.

Potential Revitalisation

An often-cited reason for the slowdown in sukuk issuance in Kuwait since the downturn is the lack of a dedicated legal framework for Islamic debt issuance. As such, the regulation issued by the CMA in November 2015 was widely considered to be a major move forward in this regard. The rules lay out a broad framework within which sukuk issuance may be carried out in Kuwait, including the general terms and structures of standard Islamic debt products, the rules on governance and ensuring sharia compliance, and the regulatory requirements mandated by the CMA and the CBK, both of which must sign off before a new listing is allowed to go ahead. One key change will see all new sukuk issues required to obtain a credit rating in order to sell debt to the public, which aims to ensure investors’ safety. As Fitch recently noted with regard to the legislation, “the lack of a specialised legal framework for sukuk has been a key factor in the limited issuance in Kuwait over the past few years and the new rules could therefore be a significant step.”

A Positive Outlook

As of the mid-2016 the new law appears to have already had a positive impact, with a handful of new listings already completed in the first half of the year or planned for the near future. In late April 2016 Boubyan Bank, Kuwait’s third-largest sharia-compliant lender by assets at the end of 2015, launched a $250m sukuk listing that went on to be five times oversubscribed, reaching $1.3bn in total. The bond, which was listed on NASDAQ Dubai and the Irish Stock Exchange, bears profit at a rate of 6.75%.

Boubyan’s sukuk was issued as part of the institution’s effort to enhance its Tier 1 capital in line with the Basel III capital requirements, which are being instituted across the banking sector under an official mandate issued by the CBK in 2014. While Basel III is not expected to be in place in the nation until 2019, many institutions have already begun to implement components of the programme in an effort to future-proof their balance sheets. Indeed, as the Kuwait City-based KIPCO Asset Management Company recently noted, in 2015 conventional bond issues in the country reached $5.2bn, up more than three times from $1.6bn in 2014. A considerable percentage of this expansion was due to domestic banks issuing Basel III-related debt. The National Bank of Kuwait, in particular, has been active in this effort. In the wake of the Boubyan listing, many analysts expect to see other banks issue Islamic bonds in the coming years.

Perhaps more significantly, the government is expected to begin floating sukuk of its own before the end of 2016. While other GCC member states have issued sovereign sharia-compliant bonds since the early 2000s, Kuwait has yet to do so. However, given the country’s budgetary challenges, plus the widely assumed long-term challenge of oil priced at less than $60 per barrel, recently the state has moved to cut costs and diversify its revenue sources. Debt sales are widely expected to be a key source of short-and medium-term income for the country in the coming years. While the MoF has yet to release detailed information about Kuwait’s sukuk issuance programme, according to Fitch much of the debt would likely be purchased by the domestic banking sector.