The regularity with which the Kuwaiti government has issued bonds over the past decade has driven aggregate bond growth – sovereign and corporate – and helped to establish the country as a leading issuer of bonds’ sharia-compliant equivalents, sukuks. While the global economic crisis has seen a dropoff in bond and sukuk issues across the region, a return to economic growth and ambitious infrastructural development programmes underpin a recovery in the fixed-income market – and Kuwait is no exception in this regard.
However, a new economic climate, and a more circumspect approach to lending and borrowing, calls for new market controls. For Kuwait, defaulting sukuks in 2010 highlighted the need for increased governance of future offerings, and in 2011 attention turned to proposed regulatory changes that aim to restore trust in locally originated sukuks and help the country retain its position at the vanguard of fixed-income financing.
THE RISE OF SUKUK: The first sharia-compliant fixed-income offering by a Kuwaiti corporation took place as recently as 2005, with the Commercial Real Estate Company’s $100m sukuk. The issue fell on fertile ground, taking place in the middle of a period of sustained domestic bond growth, which saw new issuances from 2003 to 2009 amount to $99.7bn – accounting for 40% of the entire GCC total bond market of $247.7bn, according to Markaz Research.
Kuwaiti sovereign issues represented 92.9% of the aggregate market during this period, and the enthusiasm with which the government embraced the fixed-income model and the yield curve it established in doing so did much to ease the passage of the nation’s corporations to the bond and sukuk markets. Kuwait’s first sukuk was followed just a few months later by the Investment Dar Company’s $100m issue – by the end of 2009, a total of some 15 sukuks had successfully launched, together raising a total of about $2.1bn in revenue for the sector.
During the 2003-09 period conventional bonds retained their dominant role in the market, accounting for 70.3% of total corporate issuances, or $5bn against the $2.1bn raised through the issuance of sukuks, but the increasing popularity of the sharia-compliant model was easily discernable, and in 2007 sukuk issuances overtook their conventional counterparts for the first time, accounting for 75.6% of the total amount raised that year. The 2006-07 period represents the high water mark for the Kuwaiti sukuk market, with the two years accounting for 12 issuances between them.
SUKUK CHARACTERISTICS: Of the 15 corporate sukuk issuances seen to date in Kuwait, five were structured under the pure ijara model, by which certificates are issued on standalone assets identified on the balance sheet, while rates of returns can be designated by the originator as either fixed or floating. Two sukuks were issued using the mudaraba model, by which certificates represent ownership of units in the mudaraba equity and are granted returns according to the percentage of ownership share, while a further seven were of the musharaka type, which differs from mudaraba only in the ability of certificate holders to form a committee which can be referred to concerning investment decisions.
A single sukuk issue took on the form of a murabaha, by which the issuer of the certificate is the seller of the murabaha commodity, the sukuk holders are the designated buyers of it and the realised funds are its purchasing costs.
While Kuwait’s conventional corporate bonds have featured tenors of as much as 15 years, the majority have been five-year issues, and this characteristic is even more pronounced in the sukuk market, where all issues have been of five-year duration with the exception of AREF Investment Group’s $200m sukuk in November 2006. The local sukuk market has shown a similar conformity in terms of economic sector of origination, with the real estate and financial services industries accounting for the vast majority of issues (with seven and six issues, respectively). The $100m issue from the National Industries Company for Building Materials (from the construction sector, as defined by the Kuwait Stock Exchange) in 2006 and the $475m sukuk from the National Industries Group Holding (from the conglomerate sector) in 2007 provide the only exceptions to the norm. The latter also represents Kuwait’s largest ever sukuk offering, while the smallest came courtesy of Kuwait Resorts Company – a $50m ijara issuance launched in July 2007. As with local conventional bonds, the most popular issue size has been $100m, accounting for five sukuks, while three $200m sukuks represent the second-most-frequent occurrence to be seen in the sector.
A NEW ERA: The growth of the sukuk market in Kuwait, like fixed-income markets across the globe, was abruptly curtailed by the economic crisis that began in late 2008. The $190m issue by Gulf Holding Company in May of that year will mature in 2013 – by which time all of Kuwait’s current sukuks will have matured. This muted performance reflects a similar slowdown in the wider region which saw the value of bonds and sukuks issued in the GCC during 2010 decrease by 27.6% from 2009 to $57bn, but Kuwait’s fixed-income market has been particularly troubled by the aftershocks of the global credit crunch. In 2010 just $1bn of conventional bonds originated in the country, representing 3.5% of the GCC total, while the sukuk market remained entirely inactive during the same period of time.
As with other markets, the challenging economic situation faced by both the real estate and financial services sectors is the primary cause of the bond and sukuk hiatus, but the problem in Kuwait has been exacerbated by two widely publicised sukuk defaults. After Global Investment House (GIH) shook the market by defaulting on a syndicated loan in 2008, in 2009 the Investment Dar (TID) became the first investment company to default on a sukuk, followed by the International Investment Group (IIG) in 2010. The successive defaults effectively acted as a block to any new sukuk issuance during 2009 and 2010, but their effect in the long term has been mitigated by the manner in which the companies concerned responded to their situation.
By 2009, GIH had entered into several formal restructuring agreements with all of its financiers, establishing new three-year amortising facilities with its lending banks, and after a strategic review of its operations has decided to concentrate on its core, fee-based activities. TID, after a process of litigation, has avoided liquidation and is restructuring its debt with the approval of the Central Bank of Kuwait. The shareholders of IIG, meanwhile, voted in 2010 to reduce the company’s capital by around 55% to cover losses, although the scale of its debt may require the sale of assets, a capital injection from a new investor, or the dissolution of the company.
LESSONS LEARNT: While the responses of the affected companies to their balance sheet problems have been widely seen as appropriate, the sukuk defaults in Kuwait have highlighted the need for increased governance when it comes to the sharia-compliant fixed-income market.
At present, there is no specialised legislative framework which the central bank can apply to sukuk activity in the country, a regulatory omission that places it at a disadvantage in the region. Gulf Investment Corporation’s decision to raise $1.1bn through a sukuk in Malaysia, which boasts one of the most advanced Islamic legislative frameworks in the world, illustrates the ability of well-governed jurisdictions to attract issuers to enter the market.
The government of Kuwait, however, has moved to address the regulatory problem with the new sukuk and trust laws, which will establish a robust governance framework for sukuk issuances in the future. The new laws promise to provide a significant fillip to the local market, which will also benefit from a more general drive to improve the regulatory environment in which Kuwait’s corporations operate.
The most significant step taken in this regard has been the creation of the Capital Markets Authority (CMA), which began operations in 2011 and is expected to improve the business and investment climate in the country as it sets about tackling issues such as compliance and transparency, though some feel the CMA has some staffing issues to overcome.
“The CMA needs capable technical people that really understand the rules,” Issam Z Al Tawari, the chairman and managing director of Rasameel, a financing company, told OBG. “The mentality of transparency is improving, but the law needs to be enforced. This will help attract foreign direct investment and emerging market funds to Kuwait.”
The years since the global economic crisis have been difficult ones for potential sukuk issuers, but the groundwork is being laid for what many hope will be a resurgence in sharia-compliant activities.
