The domestic sukuk market is poised for a period of expansion

As a major regional centre for Islamic banking and other sharia-compliant financial services, Kuwait is widely expected to take a leading role in the rapidly expanding sukuk (Islamic bond) market in the coming years. In the early and mid-2000s both sukuk and conventional bonds were considered to be a major source of funding, both for the government and for private sector firms. While debt activity was reduced in the wake of the 2007-08 international economic downturn – due primarily to a widespread lack of demand – since mid-2013 Kuwait has been on the brink of a surge in new issuance.

In recent years a handful of major local players have announced that sukuk issuance will once again be a major part of their fundraising efforts. In early December 2013, for example, Kuwait Airways, the country’s state-owned flag carrier, announced that it was looking into using sukuks or conventional bonds to finance the purchase of 25 new Airbus air-planes. While details of this plan had yet to be finalised at time of publication, given the cost of new aircraft it has the potential to be one of the single largest debt offerings in Kuwait’s history.

Turning Points

While a number of potential sukuk issuances are currently on the cards, as of early 2014 activity on the market had yet to fully return to pre-crisis levels. Issuers and investors remain wary due to a perceived lack of transparency at the Capital Markets Authority (CMA), the government’s regulatory arm; a dearth of understanding among many investors as to how sukuks actually work; and ongoing low levels of investor confidence in capital markets in general since the downturn.

Despite these hurdles, 2014 is expected to be a turning point for Islamic bonds in Kuwait. In addition to the potential Kuwait Airways listing, a number of other companies have announced sukuks of their own. In late 2013 the Kuwait-based Rasameel Structured Finance Company announced that it was working on two sukuk issuances for Kuwait-based corporates, for example, including one for Al Ghanim Industries, a major Kuwait-based conglomerate that is active in a variety of countries throughout the Gulf. Additionally, in June 2013 Kuwait Finance House (KFH) – the second-largest sharia-compliant financial services company in the world – announced the establishment of a $100m sukuk fund, to be used to purchase sovereign and corporate investment-grade US dollar notes in a variety of markets around the world. With these developments in mind, and taking into account the steady growth of global sharia-compliant debt markets in recent years, the future of Kuwait’s sukuk market appears to be looking up.

Past Development

From 2006 through the end of 2013 Kuwait posted $1.75bn ($6.15bn) in total sukuk issues, according to data from Rasameel, a sharia-compliant investment company (IC) that was set up in 2006. The great majority of this issuance took place in the years leading up to the economic crisis. Kuwait’s first sukuk was issued in April 2005 by the Commercial Real Estate Company, a local IC. The $100m listing was followed later that year by another issuance of same size by The Investment Dar (TID), another local IC. Sukuks accounted for 16.6% of total corporate debt issuances in 2005, according to data from the Kuwait Financial Centre (Markaz). In 2006 this figure more than doubled, reaching nearly 38%, as sharia-compliant listings jumped in popularity throughout the region.

Six corporate sukuk listings took place in Kuwait that year, at a total value of $800m, according to Markaz. New sharia-compliant debt sales increased further in 2007, when six new sukuks were issued in Kuwait at a total value of $900m. In 2008 new listings dropped off quickly as a result of the downturn. Only one sukuk was issued in Kuwait in 2008 – a $190m instrument put forward by the Villamar Sukuk Company, a special-purpose vehicle launched by the Kuwait-based Gulf Holding Company to finance a large-scale mixed-use real estate project in Bahrain.

Subdued Activity

In total, between 2005 and 2008 some 15 sukuks were issued in Kuwait at a total value of $2.09bn, compared to conventional corporate bond issuances of $2.97bn during the same period, according to Markaz. The sukuks put forward in the country during this period have a number of shared characteristics. All 15 were dollar-denominated and issued outside of Kuwait itself, as a result of the lack of a distinct IFS regulatory framework in the country during this period.

Indeed, the fact that Kuwait continues to lack a comprehensive legal framework for sharia-compliant financial products and services to this day is widely regarded as one of the major challenges in the industry. All but two of the 15 sukuks issued in Kuwait during the 2005-08 period were by real estate or financial services firms, which is representative of the close relationship between the property and IFS industries during this period. All but one of the issuances featured a five-year tenor.

Since 2009 there has been very little sukuk activity in Kuwait, as a result of declining demand, and the default of some ICs, in the years immediately following the downturn. Indeed, between 2009 and 2012 there were only a handful of new issuances from Kuwait-based firms. One of these, a $93m issuance made by the First Investment Company in 2011, was tied to that firm’s restructuring efforts. Finally, in 2013 Al Ghanim issued a KD12.5m ($43.95bn) sukuk in two tranches. According to Al Ghanim’s management, this 2013 sale was a trial run, meant to test market depth and investor demand for future similar listings.

Model Structure

The great majority of the sharia-compliant debt issues made in Kuwait since 2005 have been structured as either ijara or musharaka deals. Under the ijara model, each investor in the sukuk is effectively purchasing a portion of the underlying asset and leasing it to the issuer for a fixed period of time. In return, each investor is entitled to a return on their investment. Under the musharaka model, meanwhile, the investors and the issuer enter into a joint venture contract, wherein all parties agree to share capital costs, profits and losses at prearranged ratios.

Other sukuk models that have been used in Kuwait since 2005 include mudaraba issuances, where investors are considered to be silent partners in the underlying asset and share profits at a prearranged ratio; and murabaha issuances, where the issuer uses up investor capital to purchase an asset before effectively buying it back from investors. This is done at a pre-arranged price that takes into account the base cost of the asset plus profits for the investors over a prearranged period of time.

Global Rankings

According to the 2014 Sukuk Perceptions and Forecast Study, which was released by Thomson Reuters and Zawya, from 1996 through the end of September 2013 Kuwait was the 10thlargest sukuk origination market in the world in terms of issuances by volume, with $2.99bn in total sukuks. As of early 2014 Kuwait was widely considered to be poised for a rapid jump in terms of Islamic bond issuances. Broadly, this reflects the steadily improving regional economic situation in recent years and the related expansion of sharia-compliant debt issuances elsewhere in the Gulf. In 2013 issuances from GCC countries as a whole topped $25bn, up from around $23bn in 2012, less than $20bn in 2011, less than $10bn in 2010 and only $4bn in 2009, for example. The majority of the growth of this market has taken place in Saudi Arabia, Qatar and the UAE. Indeed, in 2013 sukuks that originated in Saudi Arabia made up more than 59% of total GCC issuance for the year. More than half of all GCC sukuks in 2012 and 2013 were sovereign issuances. The great majority of sovereign issuances in recent years have been used to fund infrastructure programmes, which include power and utility expansion projects and transport-related developments.

While Kuwait’s government has issued a considerable amount of conventional debt in recent years, due to the lack of an IFS-specific regulatory framework the state has not issued sukuk of its own, despite the fact that the country is in the midst of a large-scale infrastructure development plan.

Based on the success of its 2013 listing, Al Ghanim is working to issue another sukuk before the end of 2014. While details about the deal remain unclear, most local media reports put the total value of the issuance in excess of $50m. Additionally, according to Rasameel, a Kuwait-based information technology firm – as yet unnamed – is working to prepare a $90m sukuk to launch before the end of the year.

Moreover, the potential for a large-scale sharia-compliant debt issuance from Kuwait Airways in the future has resulted in rising interest in sukuks among Kuwaiti investors. With this upcoming activity in mind, and taking into account the steadily improving economic situation in Kuwait and throughout the wider GCC in recent years, the domestic sukuk market looks set to strengthen in the coming years.