Growth driver: Sukuk issuance has increased considerably in recent years

Qatar has been recognised as a leading player in the increasingly active global sukuk arena since its stellar year in 2011, when it raised around $3.1bn in 11 separate offerings and was responsible for 11% of global sukuk issuance, according to Markaz Research. That memorable year also saw Qatar lay claim to the largest single issuance, valued at $9.06bn with a three-year tenor. This was around seven times the size of its nearest rival, tranche one of the Malaysian sovereign Wakala Global Sukuk. Together with Saudi Arabia and the UAE, the gas-rich state is responsible for more than 95% of total issuance in the GCC, and as an expanding centre of Islamic finance it is likely to remain at the forefront of a trend that is establishing the sharia-compliant debt-instrument in the financial mainstream.

Demand Drivers

The principal growth driver underpinning sukuk issuance in Qatar has been the rapid expansion of the Islamic banking sector. Between 2006 and 2012, the nation’s sharia-compliant banks grew their domestic loans and resident deposits by an average compound growth rate (CAGR) of 46% and 40%, respectively, according to Malaysia-based Islamic Finance News, compared to 31% and 23% for the entire banking system. Islamic banks have been steadily eating into the market share of their conventional rivals, expanding the amount of domestic credit on their books from 13% of the total in 2006 to 25% at the beginning of 2013, while their share of resident deposits increased from 13% to 28% during the same period.

This trend is expected to continue over the coming years, as Qatar’s Islamic banks grow their assets on the back of a sizeable infrastructure pipeline derived from the government’s economic diversification strategy and the construction projects associated with the Qatar 2022 FIFA World Cup. As a result, the balance sheet of Qatar’s Islamic banks is expected to expand from $60bn at the end of 2013 to around $100bn by 2017. This anticipated growth augurs particularly well for the sukuk concept due to the challenge that financing of this scale presents to Islamic banks. The problem lies in the fact that the tenors of such major deals tend to be in the longer range, whereas the contractual maturity of the deposits collected by Islamic banks is generally short term. This mismatch between deposits and financing has implications for risk management, and in order to establish a more robust funding profile Islamic banks frequently find themselves turning towards debt capital markets – where sukuk represent a sharia-compliant alternative to conventional instruments.

Another driver of sukuk in Qatar is the fact that, despite the rising number of issuances over recent years, the global demand for Islamic investment instruments from highly liquid Islamic populations continues to outstrip supply. It has taken some time for companies and banks to equip themselves with the knowledge and skills to adopt the sukuk model, and for many of them the strategic emphasis in recent years has been placed squarely on rebuilding balance sheets in the wake of the global economic crisis rather than issuing debt. Estimates vary as to how long the global supply and demand gap might persist, but consensus is building around a shorter term change: a recent report by Thomson Reuters projected that the gap between global demand and supply of sukuk will peak in 2014, rising to $229bn from $211bn in 2013. Nevertheless, the outlook for sukuk issuance remains buoyant, according to the organisation, with some $130bn in the pipeline for 2014, rising to $237bn by 2018.

Improving Environment

As well as rising demand, the growth of sukuk has been aided in recent years by an improving regulatory and pricing environment.

Organisations, such as the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and the Gulf Bond and Sukuk Association (GBSA) have led a drive to address inconsistencies in the regulatory framework across countries that have hitherto acted as a block on sukuk development. 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. Qatar, too, is playing a part in this movement. 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. Qatar Islamic Bank (QIB), along with the 15 other banks, contributes data on its rates to Reuters. The agency then calculates an average to generate 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 that are used by conventional banks.

Central Bank Policy

The nation’s financial regulator is also assisting in the ascent of sukuk as a source of funding. Given the predominance of sovereign sukuk in the overall sharia-compliant debt issuance mix, the actions of the Qatar Central Bank (QCB) are central to the development of the instrument. The size of sukuk issued by the four Islamic banks amounted to about QR800m ($219.1m) at the end of the first quarter of 2013. March 2013 saw a change in the approach of the QCB to sukuk issuance, whereby it shifted from its previous policy of single issuances to implement a regular programme of quarterly QR1bn ($273.9m) offerings. This brings numerous advantages: the regular issuances expand the QCB’s policy arsenal, and the nation’s banks are granted more options in managing liquidity. The issuances also help to establish a benchmark for local currency corporate sukuk offerings.

Notable Deals

As well as the developments concerning sovereign sukuk issuance, the past year has also seen a number of significant corporate sukuk issuances. QI nvest, one of the nation’s leading investment banks and a significant player in the Islamic financial services market, has alone advised on sukuk transactions worth $3.5bn in 2013 – one of the most interesting of which from a development viewpoint was the $1.25bn, five-year offering by Ooredoo, the rebranded Qatar Telecom, which was four times oversubscribed and forms part of a $2bn debt programme. The offering, which will mature on December 3, 2018 and will have a profit rate of 3.039%, was unusual in that it used phone airtime as the underlying asset on which the sukuk is based. Under this model investors share the profit generated by the asset held by the issuer, rather than paying a coupon. This shift to an intangible asset represents a step away from the normal asset classes on which sukuk are generally formulated, such as land and property, and brings two major advantages. First, the scale of the Ooredoo sukuk was not limited by the size of the company’s tangible assets and, secondly, the use of airtime as the underlying asset allows the company to issue sukuk on a regular basis in the future. While Ooredoo is not the first telecoms firm to utilise its airtime in this way, the model that this leading regional company has adopted is an important innovation for the Gulf and will provide a framework for others. Innovations like this are likely to continue to play a part in the growth of the relatively new financial concept, as Qatar’s Islamic banks expand on the back of a buoyant economy and government-linked firms continue efforts to secure funding for the nation’s development plans.