Bring on the bonds: More expected from the world’s second-largest sukuk issuer

Having had the best year on record in 2011, sharia-compliant bonds, known as sukuks, have come back in full force from a post-financial crisis lull. The year 2012 is also set to see some major issuances in Qatar, which has already established a role for itself as a key international player in the sukuk market.

ISSUANCES RISING: In 2011 a total of $84.4bn in sukuks was issued worldwide, 62% more than in 2010. The Middle East and North Africa region accounted for 23% of all these issuances, with the GCC countries issuing sukuks worth a total of $9.66bn, according to the Kuwait Financial Centre. This was up substantially from the $6.6bn issued in 2010 by GCC member states. It was also nearly double the raw number of issuances, which in 2010 stood at 10, but jumped to 19 in 2011.

Broken down by country in terms of value, Qatar issued around 11% of all sukuks issued globally in 2011, the second-highest share of the total after Malaysia – which had 69% – and well ahead of regional peers. The Qatari figure was well up from 2010 too, when the country was responsible for 4.1% of global sukuk issuance.

In addition, the largest individual sukuk issue worldwide was the Qatar Sovereign Sukuk 2014, valued at $9.06bn with a three-year tenor. This was around seven times the size of its nearest rival, tranche 1 of the Malaysian sovereign Wakala Global Sukuk.

SAFE HAVEN: Behind the increased popularity of sukuks lie a number of factors. First of all, there was the heightened volatility of global equity markets in 2011, exacerbated by the ongoing Eurozone debt crisis. There was also the continuing growth in liquidity in the global Islamic finance market, with sukuks being one of the few avenues available for sharia-compliant investment. This drove demand for sukuks to new heights, as Islamic finance houses sought to mop up this excess.

At the same time, investors, aware of the difficulties in gaining credit from banks, have been heading increasingly towards capital markets, where bonds (and sukuks) are a natural choice.

Indeed, HSBC Amanah, the bank’s sharia-compliant wing, announced in March 2012 that it expected this trend to continue, forecasting global sukuk issuance to be up as high as 50% year-on-year. In the Middle East sukuk issuance could reach as high as $14bn, according to HSBC.

Also boosting sukuks’ popularity have been several moves to address inconsistencies in the regulatory framework across countries. These issues include the standardisation of products and rules in the market, both of which have hindered the pricing of products and raised concerns over compliance.

NEW BENCHMARK RATE: Key to moving forward on the pricing issue was news agency Thomson Reuters’ launch of the Islamic Interbank Benchmark Rate (IIBR) in 2011 in conjunction with 16 Islamic banks worldwide. The Qatar Islamic Bank (QIB), along with the 15 other banks, contributes data on its rates to Reuters. The agency then calculates an average to produce the IIBR, which then enables a wide range of Islamic products, including sukuks, to be priced in an alternative way to the interest-rate based benchmarks used by conventional banks.

The move is a major sign of the sector’s growing maturity by building further investor confidence in its products and thus adding to global demand. The Gulf Bond and Sukuk Association (GBSA) also issued a set of standards for bond and sukuk issuances in the region in November 2011.

This was the first time the GBSA, which is an industry association representing the Gulf’s debt market, has been able to achieve a common agreement on standards and guidelines amongst all its members.

Those in the industry now expect the global sukuk market to diversify, with more countries and institutional players entering it, boosting competition as well as increasing depth. It is also expected that the variety of products on offer will increase.

In 2011, around 45% of all issues were murabaha-style sukuks, with about 25% using the ijara model – the Qatar Sovereign Sukuk 2014 being an example of the latter type. A murabaha sukuk is essentially the part ownership of a debt, while the ijara sukuk is part ownership of an asset.

DIVERSIFICATION: There are signs this diversification in products is occurring already. In 2011, aside from the giant Qatar sovereign issue, Almana Sukuk 2011 was the other Qatari sukuk issuer, doing so via a floating rate $215m wakala-type sukuk, with a five-year tenor. This type of Islamic bond involves the establishment of a special purpose vehicle (SPV) to manage the investment on behalf of investors. Almana Sukuk 2011 is such an SPV, incorporated in the Cayman Islands and launched by Qatar’s Almana Group. The wakala-type sukuk is a relatively new innovation in Islamic finance and is currently more popular in Malaysia than in the Gulf.

Another key hope in this market’s development is that it will move away from its current domination by sovereign issuers towards more corporate participation. In 2011, 78% of all sukuks issued globally were sovereign, with 8% quasi-sovereign. Qatar was no exception to these ratios, with the giant sovereign issue dwarfing all other sukuks.

ENERGY ISSUANCE: However, 2012 and 2013 are due to see a major step forward in issuer variety, with the projected issuance of a number of corporate sukuks. For example, state-linked oil and gas giant Qatar Petroleum (QP) announced in March 2012 that it was considering such an offering at a corporate level. It would be the first such initiative by a Middle Eastern national oil company.

The sukuk issuance, which might take place as early as 2012 or 2013, would be undertaken to help finance a major series of expansion projects, including a new $8bn petrochemicals plant being developed jointly by QP and Shell. The Qatari giant is also looking to expand its overseas investments, with some discussion of heightened participation in the rival Australian LNG market.

QP officials have told local media that they are working on developing structures to tap the sukuk market for their future financing needs. This could involve products that are specifically tailored to meet the requirements of the oil and gas sector specifically, making Qatar a potential world leader in developing this kind of sukuk.

BANKING ISSUANCES: In addition, three Qatari banks – Masraf Al Rayan, QIB and the Qatar International Islamic Bank – are now also in the 2012 sukuk pipeline. Masraf Al Rayan’s board first approved a $1bn sukuk issuance in March 2011 in order to partly fund its expansion plans. It was scheduled to take place in the fourth quarter of 2011, but was later postponed due to the heightened risk-aversion amongst international investors, primarily due to the worsening Eurozone debt crisis.

QIB, meanwhile, which debuted its $750m sukuk in October 2010, announced in May 2011 that it would hold a second five-year issuance in the $ 500m1bn range. In September 2012 the bank confirmed that it planned to issue a dollar-denominated sukuk under its recently approved $1.5bn sukuk programme. It mandated four banks – Deutsche Bank, HSBC, Standard Chartered and QI nvest – as the joint lead managers for the sukuk sale, which took place in the beginning of October 2012 and raised $750m. The QIB priced the five-year sukuk at a profit rate of 2.5%, and a spread of 175 basis points over midswaps, which was tighter than the earlier guidance after receiving strong investor interest.

Qatar’s fourth Islamic bank, Barwa Bank, has also announced that it intends to issue sukuks after it gets a rating, probably in 2013. The timing of such issuances will likely depend on perceptions of investor appetite. Risk aversion combined with good liquidity of Qatar’s Islamic banks and their strong overall performance in late 2011 led to postponements in issuing sukuks. Under the circumstances, bank boards see no reason to rush into raising more funds.

KEY CHANNEL: Yet going forward, the large investment plans put forth by the government (around $130bn is expected by 2016 in infrastructure, oil and gas) have created a great demand for project financing ahead. Issuing sukuks will likely be one way the Qatari authorities, along with government-linked and government-owned companies, try to raise funds. Likewise, banks looking to expand and compete may also go to the sukuk market.

Therefore, it is widely expected that sukuk issuances in Qatar will expand in the years ahead and it is likely that interest in sukuks will come from beyond the Islamic world. “Who subscribes to sukuks?” asked Farah Ahmed Hersi, the executive manager of Economics and treasury at Masraf Al Rayan. “These days, they are from the West, China and South-east Asia too. Sukuk are a nice, neat, safe, high-yielding product that give diversity to any portfolio. It’s Islamic in nature, but also universal.”