Set with sukuk: Using the debt instrument to bolster institutional investment

The sukuk, a form of Islamic bond, has become one of the most popular and recognisable Islamic financial instruments globally. In Brunei Darussalam, sukuk issuance has been growing steadily, but it remains in its infancy and investors have few options in the fixedincome market. In the medium term, sukuk is likely to be a key component in creating a capital market in the country and a popular place for investors adhering to sharia principles to deposit their money.

SUKUK STORY: As Islamic financial instruments have to be asset-backed, the sukuk deploys a slightly different mechanism than the conventional bond. The sukuk represents an ownership claim to a basket of assets through which the investor is entitled to a share of the revenues. Conventional bonds, on the other hand, are a contractual debt obligation under which the issuer is obligated to pay the investor interest and the principle. Despite the differences, the two perform the same function in the investment milieu. Like the bond, the sukuk is seen as a relatively cheap way for companies to raise capital, and for investors – individual or institutional – and funds like pensions that are limited as to where they can deposit money, it is a relatively safe and stable means of generating returns.

The current environment for sukuks is challenging. Javed Ahmad, managing director of Bank Islam Brunei Darussalam (BIBD) told OBG, “It has not been a great period for investors because the rates are so low and the impetus to deposit is not there. You have returns of 25-30 basis point scenario and inflation is at 1.5% to 2%. If you are at 2% for fixed paper, where do you actually go? A lot goes to fees and administration and you are left with little for clients.”

This is not only a challenge for funds and individual investors, but for the banks as well. Indeed, both conventional and Islamic players in the banking sector are highly liquid. The liquidity-to-asset ratio averaged 63.3% in 2011, and 55.1% for Islamic banks, according to the IMF. However, banks are having difficulty placing excess liquidity in the local market.

LAYING THE FOUNDATION: With the Brunei Darussalam economy still dominated by the public sector, the impetus is on the government, to some extent, to lead the way in issuing debt. The market has not been totally inactive. Since the first government issuance in April 2006, there has been a steady uptick in the number of sukuks offered within the Sultanate. Indeed, since 2006 the value of sukuk issuances has increased by 73.9%.

In 2011 alone issuance grew by 52.7% to BN$991m ($771.8m), according to the IMF. This is a significant rate of growth, but Brunei Darussalam is operating from a low base. Global sukuk issuance was worth around $60bn in 2011, with Brunei Darussalam’s neighbour, Malaysia, issuing over half of that with $38bn worth of sukuks. The second-largest issuer was the Gulf Corporation Council (GCC) region, which issued $19bn.

Despite the increase in the volume of debt raised in the Sultanate, there continue to be challenges related to the type of issue that affect the market’s ability to attract local and international investors. The government has issued over BN$4.85bn ($3.8bn) of short-term sukuk since the first issue in April 2006, according to the Autoriti Monetari Brunei Darussalam. The latest issue in October 2012 was the state’s 80th. The $100m issue had a 91-day tenor and a rental rate of 0.16%.

LOOKING TO THE LONG TERM: Although the government’s continued sukuk issuance is a positive sign, the above terms illustrate the challenges of expanding and developing the sukuk market. Ahmad told OBG, “In 2011 there was greater willingness by the government to issue sukuks and for financial institutions to take them up, but the problem is they were under one-year issues.”

The current predominance of short-term issues means that the market is one-dimensional, and as such, there is little ability to trade in fixed paper and move towards the development of a capital market. However, with the government likely to push on with its infrastructure programme in the next five years, there should be a substantial amount of assets with which to issue longer-term sukuks, thus developing the market.