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Saturday, 11 July 2009

US interest in the sukuk market raises new hopes for its future

Dubai: The sukuk, or Islamic bond market, has been severely tested over the past 18 months. After five years of growth in issuance, size and investor appetite, last year saw a contraction of 50 per cent in the value of sukuk issued. The second half of 2008 and the first quarter of this year saw the market effectively closed.

While governments and investment-grade corporates in North America, Europe and Asia were issuing record amounts of bonds in the first and second quarters of this year, their Middle Eastern counterparts were also issuing - but in the conventional markets, not the sukuk market.

A well-publicised criticism of the mudaraba sukuk structure made by Shaikh Taqi Usmani, a prominent Sharia scholar, in February 2008, is often blamed for the drying up of the market. Of more impact, though, was the global credit crunch that struck shortly afterwards.

But recent months have seen developments that indicate a significant shift in the market, and which have profound implications. New buyers and sellers have emerged, at the same time as traditional participants have rediscovered their appetite for Islamic debt.

Indonesia's $650 million (Dh2 billion) sukuk issued in April effectively re-opened the market. Since then, Bahrain has raised $750 million, and last week Saudi Electricity Company tapped its home market for $1.9 billion, issued in Saudi riyals.

But study the detail of these issues, and new trends appear. Perhaps the most important is the emergence of the US as a source of sukuk investors.

Historically, the US has not featured on issuers' wish-lists of investors. The education needed to convince US investors to buy this asset class was too time-consuming, too costly and had little guarantee of success. And in the good times there was plenty of demand from the Middle East and Asia, so who needed the US investor? So went the perceived wisdom.

And yet, when HSBC was marketing the Indonesian sovereign sukuk this year, it received strong demand from US institutions, without any prior sukuk education.

Perhaps this demand should not have been surprising after all, the sukuk was issued to comply with the US 144A rule that allows marketing to onshore clients in the US. This was only the third sukuk offered in 144A format, and indicates a growing willingness by issuers to be offered in the US.

By complying with 144A, the sukuk becomes on a par with conventional bonds in terms of the documentation, legal framework and disclosure levels. We are now seeing sukuk issuers lean towards 144A offerings as a matter of course, which bodes well for the market.

The US is not the only new investor sector to have emerged: Islamic private bank investors have also become significant, with 10 per cent of the Bahrain issue being subscribed by this segment. Perhaps it is not surprising that such investors see the attractions of sukuk, given the volatility of other asset classes, but like the US investor base, demand has suddenly appeared.

The most visible result of these new investors entering the market has been the level of subscriptions. Bahrain's $750 millions offer was five times subscribed; Indonesia's was seven times subscribed, receiving commitments of $4.6 billion.

In both cases, this strong interest allowed the borrower to issue at pricing tighter than guidance, and, in the case of Bahrain, to increase the issue from $500 million to $750 million. The SEC issue was even more popular, receiving commitments of more than $5.3 billion.

So what can we conclude from these developments, and how do we see the market developing? First, more sukuk will be issued under 144A regulations, the documentation and transparency levels of which will boost demand across geographies and investor types.

Second, the US will become a leading target for sukuk issuers, and as familiarity with the asset class increases, the investor base will broaden.

Finally, the emergence of private banking investors will open another investor segment that will require its own marketing and approach.

Overall, these developments mean the sukuk market has made a strong comeback.

(By Mohammed Dawood, Financial Times)

- The writer is director, debt capital markets, HSBC Amanah

Islamic finance links:
Islamic finance consulting and training (GlobalPro Consulting- Kuala Lumpur,Malaysia)
Islamic finance consultant and trainer (Ahmad Sanusi Husain-Kuala Lumpur,Malaysia)

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