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Regarding the thesis that “the outlook for [GCC investment banking] is broadly positive” as “the region’s investment and project finance needs are growing enormously,” Global Finance notes this month (“Banking on Stability”) that “after M&A, fees from debt capital markets operations (DCM) constitute the largest portion of investment banking fees in the Middle East.” The piece quotes Mohammed Ali Beyhum, executive general manager at Lebanon’s Bank Med, who opines that the “Islamic bond, or sukuk, markets could hold great promise in 2011.” Analysts in general have been calling for a sukuk ‘convergence’ of sorts ever since Dubai’s debt crisis, which some observers blame for unfairly calling into question the entire premise of Islamic financing structures. “It is important to note that during 2010, the sukuk market lagged the conventional bond market, as the former was hit by the aftermath of Dubai’s debt restructuring and the accompanying series of defaults on high-profile sukuk issuances,” Beyhum said. And recent regional turmoil may have only added further fuel to market discrepancies as well as to upside resurgence: Markaz, a Kuwaiti asset management firm, reported earlier this month that yields on Dubai’s Islamic bonds had dropped to a five-month low, leading a GCC sukuk rally, on speculation that UAE and Qatar would be spared from protests that toppled the governments of Egypt and Tunisia. To that end, a recent New York Times article stated that while uncertainties “may have lowered appetite for sukuk introductions and made issuance more costly by raising premiums,” the long-term trend appears in tact. Per Paul-Henri Pruvost, an analyst with S&P, while Malaysia accounted for nearly 80 percent of last year’s issuances, activity in the Gulf [in Saudi Arabia, Qatar and UAE in particular] is destined to flourish given not only the region’s “huge pipeline of [planned] government projects and infrastructure,” but also the need to “develop a more solid fund-raising market for Islamic banks and insurance companies . . . typically constrained in terms of the asset classes they can invest in.” One U.S.-based law firm, in fact, projected that by next year already GCC-based Shariah-compliant financing will account for nearly one-third of the global market, up from 12.5% five years ago. Said Pruvost: “These institutions in the Gulf and Asia are trying to make their balance sheets very liquid, so they are very hungry for this kind of instrument.” Finally, it will be important for investors to weigh the long-term effects of recent measures taken by Qatar’s Central Bank, which earlier this year banned Islamic banking in conventional institutions, and the possibility of related policies in surrounding countries. At first blush, the move (designed purportedly to squash co-mingling of conventional and Islamic funds) would appear to greatly benefit a handful of domestic Islamic banks such as Qatar International Islamic Bank (QIIB), whose shareholders gave approval earlier this month for a sukuk issuance later this year.
Kuwait-based Abyaar Real Estate Development Company (Abyaar), which develops and manages properties in the UAE and in Dubai in particular, recently announced a net profit for the first nine months of 2009 of KD5 million ($17.5 million) and an EPS of 6.90 fils (a subdivision of currency used in many Arab countries, where KD1 roughly equals 1000 fils). Per its chairman, Hesham Abdul Wahab Al Obeid, the firm reduced financing debt during the period by 30%, down to KD 77 million, compared to KD108 million during the same period of 2008. Owners’ equity also increased, up to KD146 million.
The strong showing begs the question how quickly Abyaar will return to the debt markets; in October 2008 it postponed a proposed sale of Islamic bonds worth up to $1 billion in order to finance its expansion plans. Rashed Al-Rashdan, its managing director, said in the summer of 2008 for instance that the developer was looking to expand “aggressively” into other “high growth” markets in the region, including Saudi Arabia and Qatar. At least the market seems convinced of its future operating and financing revenue stream–earlier in the year the company successfully increased its capital base from KD 53 million in 2008 to KD 106 million in 2009 through a new share subscription.
According to many analysts, global sukuk issuance may receive better pricing than other types of bonds given the relatively comfortable liquidity levels of Islamic institutions vis a vis their conventional counterparts. For instance, the Abu Dhabi-based Tourism Development & Investment Company (TDIC), whose inaugural $1bn conventional bond tranche under a$3bn Global Medium Term Note (GMTN) Program this past summer was oversubscribed while being priced to yield 390 basis points over U.S. Treasuries, is hoping to raise close to another $1bn for general corporate purposes, per two unnamed bankers. Among other current endeavors, TDIC is working on “spin-offs” of the Louvre and Guggenheim museums in the UAE capital. Additionally, last month the Jeddah-based Islamic Development Bank raised $850 million through a five-year sukuk priced at par that yielded 40 basis points over five-year mid-swaps, and 77 points over five-year benchmark U.S. Treasuries respectively. Meanwhile, ratings agencies Fitch and Standard & Poor’s both assigned an AA rating to the TDIC issue, while Moody’s assigned Aa2. Per S&P, the sukuk market has languished in 2009, falling roughly 16%. That said, the agency sees a “strong pipeline” of issuance in waiting. Nevertheless, citing a tepid investor response to a four-year lockup period, HSBC recently delayed the launch of its first Sukuk-based fund.
Everyday I try to make it through as much of the Financial Times as I can, and have yet to feel worse off for my efforts. Some frontier-related musings from Monday:
- Per John Dizard, “it’s worth keeping an eye on the continued willingness of the Baltic states to maintain their [Euro] pegs at such a high cost,” especially since “any subsequent revival in their economies as they regained competitiveness would serve as an ominous example for holders of, say, euro- denominated Spanish assets.” Latvia remains the most likely to de-peg, Dizard writes.
- In light of Prime Rate Capital’s announcement that it will launch Europe’s second sharia-compliant money market fund, Sophia Grene pens an informative overview on the “gap” in Islamic Finance and the role that sharia committees or “scholars” play in authorizing and supporting new products. For instance, the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (Aaoifi)–whose board carries “great weight” in the Islamic investment community–was reported as saying a few years ago that 80% of then-current sukuk structures were not Islamic. “Largely as a result of the uncertainty surrounding sukuk’s sharia status, issuance in 2008 was less than a third that of a year before,” Grene notes, and 2009 issuance levels look to be far short of their 2007 peak. Another reason, however, has been issuer default and the lack of established methods of restructuring the debt. Moreover, the lack of a liquid secondary sukuk market has thus far hampered asset managers who wish to buy and price assets. Yet what market there is (caused in part by sellers not keen on the concept’s relative infancy) has been well-received by new sukuk funds such as those run by HSBC Amanah, the global Islamic financial services division of the HSBC Group.
A Dow Jones report published last week quoted Standard & Poor’s Financial Services as theorizing that the $700 billion global Islamic finance industry would “weather the financial crisis” and moreover would resume its growth on the support of “high demand for Shariah-compliant products, which are considered less risky than conventional debt.” While the global issuance of sukuk fell 35% to $5.3 billion in Q2 compared with last year, a 164% surge in volume in this year’s second quarter compared to the first signaled renewed and robust interest, according to analysts. In fact, Standard Chartered Bank’s CEO of Islamic banking predicts a primary market of “close to $10 billion” by year’s end. The biggest sukuk issuers YTD have been Malaysia and Indonesia, followed by Bahrain and Saudi Arabia, the largest Middle East economy.
Facilitating sukuk’s global growth will be certain legal changes (i.e., tax system overhauls) currently under advisement in countries such as France, Hong Kong, Kenya and Nigeria to assist the introduction of Islamic financial products, which includes not only sukuk but also Murabaha (cost-plus-financing), which is used primarily in commodity finance. According to French authorities, such “tax neutrality” laws will put Islamic products on equal footing with similar, more conventional products, and thus promote equitable tax treatment while boosting their commercial viability.
For example, under new law, a financier’s taxable profit from the deferment of payment granted to the purchaser under Murabaha would be spread evenly throughout the period during which payment is deferred. And in the case where said financier does not reside in France, but his customer is a French national, the profit in question would be exempt from the French withholding tax. And K.C. Chan, secretary for financial services and the Treasury, Hong Kong government, noted earlier this year that changes would be made such that Islamic-derived profits would be made exempt. Hitherto, Hong Kong didn’t impose tax on interest payments, but taxed profits earned, putting Islamic bonds at a disadvantage. Chan added that Hong Kong sees itself as a “gateway for Islamic finance to opportunities in mainland China and other countries in the region including Taiwan, Korea, Vietnam, Laos and Kampuchea.”
An interesting feature in this week’s Economist (“Face Value: Godly but ambitious”) focuses on Adnan Yousif (pictured right), who in 1980 with the Bahrain-based Arab Banking Corporation was one of the first to establish an Islamic-finance practice and is now the chairman of the Union of Arab Banks and chief executive of Al Baraka Banking Group. At the time, a glut of petrodollars in the Gulf was largely invested in bonds [namely American] whose yield was verboten under sharia. Twenty years later, “there were more than 200 Islamic banks and Mr. Yousif was leading from the front.” That said, what the industry lacked, and still lacks today, Yousif argues, is a veritable, global Islamic bank. “Today $700 billion of global assets are said to comply with sharia law. Even so, traditional finance houses rather than Islamic institutions continue to handle most Gulf oil money and other Muslim wealth.”
To fill the gap Yousif wants to create “Istikhlaf” (“doing God’s work”), a sharia-compliant investment bank which will be listed on the Bahrain Stock Exchange and NASDAQ Dubai via an impending, $3.5 billion fourth-quarter IPO, following a $6.5 billion private placement that will comprise its capital base. Per analysts, such larger Islamic banks will be crucial for the industry to realize its growth potential and to compete with Islamic windows or subsidiaries of Western conventional banks that have large market shares in wholesale banking services (Deutsche Bank, HSBC and Citigroup dominate the field presently).
The piece also touches on the practical concerns surrounding the fundamental viability of the concept of Islamic banking itself. Namely: “the rules for Islamic finance are not uniform around the world. A Kuwaiti Muslim cannot buy a Malaysian sukuk (sharia-compliant bond) because of differing definitions of what constitutes usury. Indeed, a respected Islamic jurist recently denounced most sukuk as godless. Nor are banking licences granted easily in most Muslim countries. That is why big Islamic banks are so weak. Often they are little more than loose collections of subsidiaries. They also lack home-grown talent: most senior staff are poached from multinationals.”
According to Mohieddine Kronfol (pictured left), managing director of Algebra Capital, a Dubai-based investment firm, pricing of Bahrain’s $750m, five-year sovereign sukuk (Islamic bond) issue–which is being managed by Calyon S.A., Deutsche Bank and HSBC and is expected to yield somewhere 340-350 basis points above similar maturity U.S. Treasuries–is on the “low end of expectations” and will thus limit liquidity. Abu Dhabi’s conventional April issuance yielded 400 points, for instance. “It would have been better had they left some juice in there to attract a wider audience,” he said, adding that more generous pricing would have helped to ensure secondary trading and liquidity “for the long-term interest of the region.” Yet critique of the pricing aside, Kronfol did admit that “the issue would be a success regardless the pricing, as Islamic banks in the region have enough liquidity to absorb it.” He also told Bloomberg that Algebra, which manages a fund dedicated to Islamic bonds, is investing in the issue.
Bahrain’s sukuk is the first Islamic sovereign issue from the Persian Gulf region this year. According to S&P, global sukuk markets fell by roughly 56% last year from 2007, down to to $14.9bn. Experts note that a mature sovereign bond market in the Gulf is needed to help serve as a benchmark for corporate issuers who, upon seeing adequate movement in the sovereign markets, can feel relatively secure in issuing higher-yielding paper with which to raise cash.
Nice aside in FT’s Lex Column yesterday regarding its reservations towards sukuk—Islamic bonds:
Islamic finance is beset by uncertainties. One is how the claims of sukuk holders stack up against those of other stakeholders in the event of default. Last week’s default on a $100m sukuk bond by Investment Dar, a Kuwaiti investment company that owns half of Aston Martin, the UK sports car maker, will be a test case. Courts in general must decide if sukuk – whose returns are based on an ownership claim on assets rather than cash flows – should be lumped in with bonds or be treated more like equity.
Islamic scholars, meanwhile, must agree standards for sharia compliance. Uncertainty on both fronts partly explains why the spread on HSBC’s leading sukuk index remains at four times pre-crisis levels, compared with three times for its conventional Gulf counterpart. Until a more mature regulatory and legal environment emerges, investors who do not face religious restrictions would be wise to stay on the sidelines.
The Gulf Cooperation Council (GCC) will realize faster growth in the Islamic bonds (sukuk) market and “tap into the massive potential that the segment hold” by adopting regulations and measures such as credit ratings, say analysts. “Sukuk is important when it comes to overall financial market. The region, with its huge capital needs, but [only] a small debt market needs to look into opportunities,” said Kamal Mian, Head of Islamic Finance, Saudi Hollandi Bank. While the GCC holds a significant share of global sukuk market (estimated at $130 billion, Dh477bn) when it comes to volume, regulations and policy guidelines are relatively sparse, especially when compared to Malaysia, according to Moinuddin Malim, Head of Corporate and Investment Banking, Badr-Al-Islami, Mashreq. Malaysia, with its proper regulatory measures and incentives, has managed to create a success story of its sukuk market and “investors from various countries such as Korea and Japan too are going there to issue sukuks”.
“Rating for sukuks in Malaysia is mandatory. Besides, they have created a platform to quote sukuks on a daily basis so people would know the fair value of the instrument,” said Dr. Mohd Daud Bakar, Managing Director, Amanie Islamic Finance Learning Centre. “The government in Malaysia has also incentivised issuances when it comes to the taxation aspect of it,” he added. “From the day of issuance to redemption, everything is clear.” Analysts also point out that credit enhancement structures in bond market can be used for sukuks as well and should be studied.