If 2013 was a year of consolidation following the record year of 2012 especially for Sukuk origination and syndicated Murabaha loans, then the coming year of 2014 promises to be a potential game changer in several key respects for the global Islamic finance industry. MUSHTAK PARKER looks at what’s ahead.
Judging by developments in the last quarter of 2013, the key trends and momentum that are emerging for the New Year become self-evident. These, inter alia, pertain to five key areas: the Sukuk market; cross-border regulation; Syndicated Murabaha; Commodity Murabaha (Tawarruq); and mainstreaming Islamic finance.
Whether this year indeed lives up to the expectation of game changer will, however, depend on several factors. These include political stability especially in the Arab Spring countries and several other MENA markets; the political will to see through policies relating to Islamic finance beyond mere ambition and rhetoric; the adoption of necessary outstanding regulatory measures and enabling legislation; further liberalisation of the financial markets; value-added product innovation beyond merely mimicking conventional financial products; market education; and the adoption of financial inclusion policies.
The Sukuk market has caught the headlines following the UK Prime Minister David Cameron’s announcement last October that the UK Treasury is working on issuing the country’s debut sovereign Sukuk with a volume of £200m.
Not surprisingly Luxembourg and South Africa, which both announced more than a year ago their intention to issue inaugural sovereign Sukuk, the subject has suddenly found a second wind and, seemingly, those two nations are in a race with the UK regarding Sukuk origination amongst non-Muslim sovereign issuers.
The potential developments in the Sukuk sector in 2014, however, must be differentiated into several market segments – Sukuk for liquidity management; sovereign and quasi sovereign Sukuk; corporate Sukuk; social Sukuk and Sukuk insurance as a credit enhancement tool.
In terms of meeting the short-term cross border international liquidity requirements of Islamic financial institutions (IFIs), the International Islamic Liquidity Management Corporation (IILM) is poised to issue its next Sukuk imminently following its debut issuance of $490m in August 2013.
Dr Zeti Akhtar Aziz, governor of Bank Negara Malaysia (the central bank) and a member of the governing council of the IILM, said, “Of course they (the IILM) have to keep up the pace of regular issuance. They have announced a US$2bn Sukuk Issuance Programme and they have issued $490m thus far. So the next issuance has to be in the next few months towards completion of the programme. They have said that during that period they will have to have regular issuances and following the exhaustion of the programme they will announce a new programme for the subsequent year. And they have to have the underlying high-quality assets for it.”
The IILM was set up in October 2010 as an international institution by central banks, monetary authorities and multilateral organisations to create and issue short-term Shariah-compliant financial instruments to facilitate effective cross-border Islamic liquidity management. By creating more liquid Shariah-compliant financial markets for IFIs, the corporation aims to enhance cross-border investment flows, international linkages and financial stability.
Governor Zeti emphasised that there was no difficulty getting member countries of the IILM contributing assets. “All these countries that are members have high-quality assets. However, the legal documentation was highly challenging and, therefore, it took a long time for the legal process to be completed. As many will know, when it comes to dealing with legal counsels,they are very meticulous, and rightly so.
“As such, it is not an issue of lack of assets; there are immense assets. In fact, this is the advantage of such an arrangement because even countries that just have investment grade ratings, can have high-quality assets and, therefore, there is a chance for them to actually monetise these high-quality assets.”
However, it remains a secret as to how many and which of the IILM member countries contributed assets to the debut Sukuk issuance. In any case, the asset pool is a collective one to which any member country can contribute.
At first glance, the primary dealer network for the first $490m Sukuk issuance involved no banks from Saudi Arabia, the single largest market for Islamic finance. But Zeti said that Al Rajhi Bank of Saudi Arabia, the largest Islamic bank in the world in terms of balance sheet, is involved and has gone through the primary dealer appointment process like the other banks.”
“Each one of us nominated five or six primary dealers and it depends who was ready first. Because the initial issuance was quite a small size ($490m), each one of us ended with only one actual nomination. I think there were only about seven primary dealers for this first issuance so not every name out of the pool of about 60 primary dealers participated in that.”
Indeed, seasoned Saudi banker Abdulrazzak M Elkhraijy, executive vice- president and head of the Islamic Banking Development Group at National Commercial Bank (NCB), one of Saudi Arabia’s largest banks, confirmed that the involvement of Saudi banks and the development of short-term cross-border liquidity management instruments for Islamic banking is very important. He is confident that Saudi banks will take the lead in many such initiatives and that NCB plans to complete the IILM primary dealer appointment process.
There is no doubt that more traction is much needed in the primary Sukuk market, which over time will lead to secondary market activity, which outside Malaysia is almost non-existent.
Judging by the last two years quasi-sovereign issuers will continue to dominate. However, as the UK government announcement shows, sovereign Sukuk, especially by high-profile issuers, exude a certain market momentum. Of the Gulf Cooperation Council (GCC) states, only Bahrain, Qatar and the UAE (Dubai) have issued Shariah-compliant sovereign papers.
The biggest boost to the market would come from a debut-full Saudi sovereign Sukuk. But local bankers are coy about the issue of a Saudi sovereign Sukuk, where the momentum has been set by government-owned or linked companies.
The encouraging sign in the sovereign space is that past issuers are now becoming repeat issuers. These include Bahrain, Qatar, Dubai, Malaysia, Indonesia, Brunei, Pakistan and Turkey, albeit the market would like to see them become frequent issuers. The indications are that all the above will go to the market again in 2014 through further issuances.
The buzz will come from the potential new entrants to the market: the UK, Luxembourg, South Africa, Hong Kong, Tunisia, Egypt, Senegal, Nigeria, Jordan and Kazakhstan – all of which have the Sukuk legal frameworks in place and have indicated their interest in issuing Sukuk.
The National Treasury in South Africa is the most advanced having appointed lead advisers and arrangers more than a year ago, which include Liquidity Management House, a subsidiary of Kuwait Finance House, and Saudi-owned Albaraka Banking Group, which is incorporated in Bahrain.
The three most important market for quasi-sovereign Sukuk – Saudi Arabia, Malaysia and the UAE – will continue to dominate with airport authorities, state-owned airlines, infrastructure companies, oil and gas entities, and utilities of various sorts setting the pace. These include the General Authority of Civil Aviation (GACA) in Saudi Arabia, Saudi Electricity Company, SABIC (the Saudi petrochemical giant), Saudi ARAMCO, the world’s largest oil company; Malaysia Airports Holdings Berhad (MAHB), Prasarana and Dana Infra (the two Malaysian infrastructure companies); PLUS Berhad (the Malaysian highways agency); Emirates Airlines; Malaysian Airlines; etc.
All the above entities have been very active in the Sukuk market in 2013 with GACA successfully closing its second Sukuk offering totalling SR15.211bn ($4.056bn), which is guaranteed by the Saudi Ministry of Finance and is the largest single-tranche Sukuk in the world to date.
However, the biggest fillip for the next few years especially for infrastructure and allied services will come from Qatar and Dubai, which are hosts for the FIFA World Cup 2022 and the World Expo 2020 respectively. Both countries have indicated that Islamic finance and Sukuk will feature alongside other forms of financing.
In addition, Sheikh Mohammed Bin Rashid, the Ruler of Dubai launched the inaugural Global Islamic Economy Summit in November and announced that the emirate aims to become such a hub by 2016.
The Islamic economy, which includes Islamic finance, halal food, halal business including industrial products and pharmaceuticals, is estimated in excess of U$6.8 trillion serving a global Muslim population of 1.3 billion, and, according to Dubai Chamber of Commerce, will form an important component of World Expo 2020 in Dubai.
With Dubai winning the World Expo 2020 bid, the emirate requires approximately $43bn (47 per cent of the estimated 2013 GDP) to significantly upgrade its infrastructure according to a research report by Deutsche Bank. Some of the major infrastructure, projects expected over the next few years include the expansion of the Dubai Metro Red line; new concourses at the recently opened Maktoum International Airport; interchanges on the Sheikh Mohammed bin Zayed Road; and the construction of the main Expo 2020 centre close to the airport.
However, the reality shows very little connectivity hitherto between the Islamic finance industry and the Halal business sector, especially the Halal food manufacturing and processing industry.
Indeed, in a recent interview no less a person such as Dr Ahmad Mohamed Ali, president of the Islamic Development Bank (IDB), warned that “Islamic banks’ comfort zone seems to be in real estate/infrastructure, as it is a business model they have understood (in risk exposure and control), which has produced performance. Islamic banks’ balance sheet is small, hence, exposure will be minimal to other new sectors and industries. On the other hand, the Halal economy/industry needs to explain its business model and its focus, and to demonstrate its performance. The Halal industry and supply chain starting from certification bodies to government bodies to companies have been focusing on the ‘halalness’ or compliance to certifications. The industry/economy has put less focus on hard assets generating, growth revenue, repeat orders and consumer non-cyclical”.
Dr Ali also observed that the Halal economy/industry is fragmented with small and medium companies in the supply chain. “Critical mass and economies of scale is not yet achieved – ie, consolidation is needed for it to be viewed as a ‘bankable’ opportunity. Both Islamic finance and the Halal economy/industry have to overcome certain challenges to benefit from the opportunities each sector can provide to another.”
An important game changer could be Saudi Arabia, which is threatening to overtake Malaysia as the largest single Sukuk origination market. Despite its ambivalence on its Islamic banking policy, the government, the Saudi Arabian Monetary Agency (SAMA) and the Capital Market Authority (CMA) are keen to develop the Islamic capital market in the Kingdom primarily through encouraging local utilities and private sector corporations to raise financing through Sukuk issuance rather than more expensive bank financing.
Indeed, Sukuk issuances by locally-incorporated banks including Banque Saudi Fransi, Saudi Hollandi Bank, Saudi British Bank, to support Tier Capital or for balance sheet purposes is not unusual. The latest Saudi bank to raise money from the market is Riyad Bank, which closed a SR4bn ($1.07bn) 7-year local currency Sukuk last November.
The Sukuk market, according to Bank Negara Malaysia, has progressed from an outstanding amount of U$33bn in 2006, to more than an eightfold increase to $292bn by December of 2012. Global Sukuk outstanding reached $245.3bln as at end-first half 2013. The secondary Sukuk market in Malaysia remained the largest totalling $148.2bn and accounted for 60.4 per cent of the total market as at end-first half 2013.
Primary Sukuk issuance globally totalled $61.2bn in first half 2013, down on the $67.2bn in the corresponding period in 2012. Total Sukuk issuance in 2012 amounted to a record $135bn and given the 53.5 per cent slump amongst Malaysian corporate issuers in first half 2013, the figure for 2013 is expected to fall short of the 2012 mark, according to bankers in Dubai.
Governor Zeti of Bank Negara Malaysia is confident that the “future growth prospects for the Sukuk market is supported by the positive growth prospects in both the GCC and Asian regions and the increasing funding needs for infrastructure projects in these regions. In the Asian region, it is estimated that $8.3 trillion is required for infrastructure development until the year 2020. Infrastructure spending has also been one of the key drivers of economic growth in the GCC in the recent decade. In the MENA region, the changing energy landscape towards more renewable energy and clean, efficient technologies presents significant potential for the use of Sukuk to meet such financing requirements.”
Similarly, IDB president Dr Ali has already confirmed that the multilateral will go to the international markets in 2014 to raise in excess of $1bn per year through Sukuk issuances. In addition, the bank will also continue to issue Sukuk through private placement possibly by using Dubai as its major Sukuk origination platform. The IDB board last year approved a $10bn Sukuk issuance programme. IDB AAA-rated Sukuk are much sought after in the market because of a dearth of AAA-rated issuers. As such, the bank is under pressure from its board of governors to raise a more substantial portion of its resources through the capital markets rather than on relying on call-able and new capital from its equity subscribers.
Saudi bankers such as NCB’s Abdulrazzak Elkhraijy are bullish about the local Sukuk market in 2014. “We now see that there is more and more demand from Saudi companies to finance their activities through the Sukuk, which is a very positive sign. The market is there but we need to be more active and to move at a faster speed. I believe that with all the state-sponsored infrastructure projects that are going on in Saudi Arabia, the government is encouraging the financing of these projects through the Sukuk. We just saw a Sukuk being issued to finance the airports in Jeddah and Makkah. In Saudi Arabia there are many transportation projects that have been signed. I expect the Sukuk market to move really very fast in Saudi Arabia.”
To him, the increasing number of new entrants to the market, including smaller issuers, is a good sign that the Sukuk market is moving in the right direction.
Of course, new entrants are not confined to the Kingdom. They are springing up all over the world. In recent weeks Abu Dhabi’s Al Hilal Bank PJSC, which is capitalised at AED4 billion and wholly-owned by the Abu Dhabi Investment Council, the investment arm of the government of Abu Dhabi, successfully closed its debut five-year $500m Mudaraba/Wakalah Sukuk; Tilal Development Company SAOC (TDC), successfully issued Oman’s first corporate Sukuk – a OMR50m ($130m) Sukuk Al Ijarah; Indian-owned GEMS Education, which operates 100 private schools across the Gulf Co-operation Council (GCC) region, closed a $200m, perpetual non-call five year hybrid Mudaraba Sukuk; and Osun State in Nigeria became the first entity – sovereign or private – to issue a Sukuk in Africa – a landmark seven-year 11.4bn Naira Sukuk Al-Ijarah.
In Europe, FWU AG Group, the Munich-based financial services company with growing interests in the Takaful sector, following on from its debut US$55m Sukuk Al-Ijarah in 2012, launched a unique landmark $100m insurance-linked Sukuk Al Wakala Programme, of which the first tranche of $20m with a tenor of five years was issued.
Innovation is not merely confined to sovereign and corporate Sukuk. A new phenomenon in Sukuk origination – the social Sukuk – is emerging which in the 2014 National Budget of Malaysia received official endorsement by the government of Prime Minister Mohd Najib Abdul Razak. Kuala Lumpur is promoting the country as a market for Social Responsible Investment (SRI) and the government has asked the Securities Commission Malaysia, the securities regulator, to introduce a Framework of Socially Responsible Sukuk or SRI Sukuk to finance various sustainable and responsible investment initiatives.”
The Muslim world has got trillions of dollars of Waqf (endowment) and other types of social assets. Only one Sukuk, a SG$25m issuance, to date in more than 35 years of contemporary Islamic finance, has been issued against a Waqf asset, by the Islamic Religious Council of Singapore (MUIS). And yet it has never been repeated since then.
“This touches on a very important point,”
explained NCB’s Abdulrazzak Elkhraijy. “Waqf is a unique Islamic endowment trust institution.
Unfortunately, its administration is mired in bureaucracy and lack of adequate regulation, which means the Waqf assets are not generating any returns. We should seriously look at developing a framework for regulating Waqf and business-minded institutions to administer and leverage them under the Shariah guidelines so as to generate investment returns for the benefit of the communities they are meant to help by helping to alleviate poverty and to generating employment.”
Another factor that might help the Sukuk market in 2014 is the emergence of credit enhancement facilities for Sukuk origination. Countries such as Malaysia have a national agency, Danajamin, whose main objective is to support the bond and Sukuk market through credit enhancement in the form of guarantees.
The much-awaited Sukuk Insurance Policy of the Jeddah-based Islamic Corporation for the Insurance of Export Credit and Investment (ICIEC), the export credit agency of the Islamic Development Bank (IDB) Group, is ready to roll out. As such new sovereign issuers such as Tunisia, Egypt and Senegal are already talking to ICIEC.
Dr Abdul Rahman Taha, CEO of ICIEC, confirmed that “the product is ready, and we are receiving a lot of enquiries. But we have not yet received a solid application to date. It depends to what extent the project is institutionalised in the civil service”.
The policy for the moment is aimed only at sovereigns and at Sukuk Al Ijarah (leasing certificates). A major drawback of the Sukuk Insurance Policy is that ICIEC can guarantee only up to $125m of an issuance, because of its lack of capacity. However, it has reached agreement with the insurance majors to provide further capacity for sovereign Sukuk issuances.
The logical solution for this drawback is to launch a Sukuk Insurance Fund to mobilise resources from the market to support this project, added Dr Taha.
Alongside Sukuk, Murabaha (cost-plus financing) whether syndicated vanilla or commodity-based personal finance (cash management) or corporate finance (Tawarruq) also showed strong growth in 2013 and, according to bankers and commodity brokers, this trend will continue in 2014.
This, despite periodical adverse market comment about Murabaha-based contracts, especially Tawarruq, and their market application.
Some institutions such as intermediaries and commodity brokerage firms such as DDCAP Limited place a major emphasis on adherence to client stipulation, transparency and best practice especially in Shariah governance.
The reality is that Murabaha is a legitimate Islamic financial debt and sales contract and continues to be well-entrenched in the Islamic financial transaction chain since the beginning of the contemporary Islamic finance movement in the 1970s. It would seem that a sizeable percentage of Islamic financial and capital markets issues and other structured financing solutions do include a Murabaha component. This includes vanilla syndications; personal cash management; structured corporate finance solutions; reserve management of banks by central banks and monetary authorities; short-term liquidity management by banks; components of stand alone and hybrid capital market instruments such as Sukuk; component of the investment universe of retail banks and Takaful companies, and so on.
Turkish participation banks and GCC corporates are the main proponents of raising funds through Murabaha syndications. Albaraka Turk Participation Bank, for instance, raised $430m through a syndication last quarter that saw the participation of 23 banks from 15 countries. The market also witnessed regular Murabaha financing facilities in the GCC and Bai Bithaman Ajil facilities in Malaysia.
The interesting development is that of new entrants to the market such as Saudi Arabia’s The National Industrialisation Company (Tasnee), which raised SR4bn through a Murabaha Syndication; and Alok International Middle East FZE, a wholly-owned subsidiary of Alok Industries Limited, one of the largest textile companies in India, which raised $150m.
Similarly, the shipping transport sector has also been very active raising funds through Murabaha facilities, including the $662.4m Murabaha refinancing facility arranged by Qatar Islamic Bank and Barwa Bank in 2013 for Maran Nakilat Co. Ltd. to finance the expansion of the company’s fleet of LNG carriers; and the $300m senior secured syndicated Islamic financing facility for Stanford Asia Holding Company, a wholly-owned subsidiary of Stanford Marine Group, which is owned by the Dubai-based Abraaj Group and Waha Capital PJSC, an Abu Dhabi based listed diversified investments holding company.
NCB’s Abdulrazzak Elkhraijy is adamant that the future of Murabaha and Tawarruq is well-established and will continue to thrive in the GCC especially Saudi Arabia. “We were the first bank to introduce Tawarruq and today a big chunk of our personal finance is done through Tawarruq. The reason we started Tawarruq is because the personal finance alternative was very costly for our customers. Of course we have full Shariah Board approval for Tawarruq, which initially was based on international commodity contracts. Today all of the retail side is done through the local market,” he explained.
Murabaha and Tawarruq are also being used in government papers and Sukuk origination. Bank Negara Malaysia, for instance, recently introduced a new Islamic monetary instrument, the Collateralised Murabahah, which “is essentially a Shariah-compliant financing secured by assets in which the financier has the right to sell the asset should the client fail to repay the financing. It combines the widely accepted Murabahah financing transaction with Sukuk that forms as the pledged asset to back the transaction”.
According to the central bank, the Collateralised Murabahah will be a new low credit-risk financial instrument that enables collateralised interbank transactions in the Islamic Money Market in Malaysia. It will add diversity to the existing liquidity management tool and further promotes greater liquidity in the Islamic financial market.
Collateralised Murabahah can be used by Islamic financial institutions to obtain liquidity from the bank under the standing facility and it will also be expanded to facilitate daily Islamic money market operation in the interbank market.
Recently also, Cagamas Berhad, the National Mortgage Corporation of Malaysia, successfully concluded the country’s largest Commodity Murabaha Sukuk issuance amounting to RM4.2bn.
On the regulation of Islamic banks, while the Islamic Financial Services Board (IFSB) will continue with its pioneering work on coming up with standards relating to different aspects of prudential and supervisory regulation, two key developments in 2014/15 are the establishment by the UK government of the Global Islamic Finance and Investment Group (GIFIG), comprising financial regulators and chief executives from the OIC countries; and the inclusion of Sukuk (usually AAA-rated papers) by central banks and monetary authorities in the HQLA (high quality liquid assets) of Islamic banks as suggested under the Basle Committee’s new Liquidity Coverage Ratio (LCR) for banks which was introduced in early 2013.
UK Financial Secretary to the Treasury, Sajid Javid, who first announced the forming of GIFIG on the sidelines of the World Islamic Economic Forum in London in October last year, confirmed that the group will meet regularly to identify and address the critical factors that will drive the global Islamic finance market over the next five years, including regulatory and enforcement issues.
The group is chaired by UK Foreign & Commonwealth Office Minister, Baroness Saeeda Warsi, who is also the co-chairman with Sajid Javid of the UK Government Islamic Finance Task Force launched in March earlier this year. Lord Green, Minister of Trade and Alan Duncan, Minister for International Trade, are also key members of the ministerial team in the Task Force.
GIFIG, according to a statement by the British Treasury, will hold its inaugural meeting in January 2014 under the auspices of the UK government to consider the issues surrounding Islamic finance and how best to work together to promote its development.
On the LCR, Malaysia, according to Bank Negara Governor Zeti, will start implementing the standard from fiscal year 2015 and this will include Sukuk.
In Jeddah, in her lecture on financial stability and banking at the Islamic Development Bank (IDB) as the winner of the IDB Prize for Islamic Banking 2013, Zeti warned that there needs to be urgent further progress on two important fronts.
The first is to “continue to evolve a more refined distinction within prudential and financial reporting frameworks to reflect the different nature and profile of risks under risk-sharing contract arrangements”.
The second is the need “to accelerate efforts to further strengthen the infrastructural underpinnings for the development of the overall Islamic financial system. While the broad regulatory principles and standards developed in the aftermath of the global financial crisis can be applied to most Islamic finance transactions, a broad- brush application of these rules would limit the ability of Islamic financial institutions to implement the more unique risk-sharing contract arrangements”.
She explained that Islamic banks today continue to be confronted with limitations in the availability of a sufficiently deep and diverse pool of Shariah compliant instruments – in both domestic and international currencies – in which they can invest. Under the strengthened international capital and liquidity standards, this can result in higher costs of compliance, inefficiencies in funding structures and increased risks of funding mismatches.
However, a further response to strengthen the global Islamic financial system should also include measures to make the infrastructural underpinnings and building blocks of the industry stronger, including cross-border liquidity management, financial safety nets such as deposit insurance and lender-of- last-resort facilities in an Islamic financial system.