Islamic bonds: then there was light

Islamic bonds: then there was light

It’s no fun being a bond investor these days. You either invest in safe havens like US and German bonds and get a negative return, or go on adventure in countries like Spain and can’t be sure you’ll get your money back.

So the emergence of Shariah compliant sukuk offers an appealing middle way. With the London 2012 Sukuk Summit being held on June 6 and 7, beyondbrics reviews the latest developments in the market.

First to catch the eye is a steady rise in sukuk indices in the last few months. The Dow Jones Sukuk Index, for example, which measures the total return on US dollar denominated Islamic bonds, ended higher in May for the sixth time in as many months. Since 2009, the index has performed twice as well as the Barclays Capital Bond Composite Global Index, a benchmark for bonds.

The amount of sukuk outstanding is at an all-time high. In the first quarter of this year, $40bn was added to the pile, an increase of 48 per cent in new issuance compared with the same period last year.

Islamic bonds: then there was light


Demand is strong for both corporate and sovereign sukuk, according to Tariq Al-Rifai, Dow Jones’ director of Islamic market indexes. A recent $4bn issuance by the Kingdom of Saudi Arabia was three times oversubscribed. A $1.75bn issue from the Saudi Electricity Company, the largest corporate sukuk of 2012, was ten times oversubscribed.

What explains this surge in popularity?

Since it was first re-introduced in Malaysia in the early 90s, the Shariah compliant bond type has enjoyed a steady rise in popularity in the Islamic world, both for issuers and for buyers. In the six years since its inception, the HSBC/Nasdaq Dubai US Dollar Sukuk Index has returned on average more than 5 per cent a year, notwithstanding the severe debt crisis in Dubai in 2009 which destroyed the value of many sukuks.

Until recently, the market was dominated by Malaysia. Now, a small sukuk renaissance is taking place in the Middle East. First banks and then companies in the Gulf region have started embracing sukuk issuance, explaining a large chunk of the increase in supply. Saudi Arabia is leading the way.

According to Nick Stadtmiller, head of fixed income research at the Emirates NBD bank, the roots for this remarkable sukuk awakening lie in the financial crisis in the developed world.

“About this time last year, a lot of Gulf-based issuers couldn’t get their traditional bonds sold because the markets in Europe were drying up,” he says.

This led some key institutions to rethink their attitude towards sukuk issuance. Before, the strict rules on sukuk made many of them conclude the game wasn’t worth the candle. Unlike bonds, sukuk have to be based on underlying assets, and they must be approved by Shariah scholars.

But the exceptional market circumstances made some issuers think again. Last year, conventional Arab banks like the First Gulf Bank and the Abu Dhabi Islamic Bank began issuing sukuk with success.

The same became true for some major Arab companies this year, such as Saudi Electricity ($1.75bn), the Saudi General Authority of Civil Aviation ($4bn) and recently the shopping mall operator Majid Al Futtaim ($400m).

The result is that sukuk supply is slowly catching up with demand, which had been increasing at the speed of sound in recent years – or better, at the speed of oil pumped out of Islamic soil.

For Stadtmiller, the fact that sukuk are now used as a replacement for a corporate loans means the market is at a “watershed moment”.

“I think we’ll see a lot more of these corporate sukuk in the future, many with a longer duration,” he says. (Sukuk can run for up to 10 years, whereas bank loans are often restricted to two or three years.)

There is no reason why the sukuk’s rise should stop at the borders of the Islamic world.

“There is also a strong appetite for sukuk among corporates in developed markets, such as GE Capital,” says Al-Rifai at Dow Jones. “If more western companies look to issue sukuk, they are bound to find a lot of interest from investors.”

That’s indeed very likely, as recent oversubscriptions suggest. Many wealthy investors in the Middle East can buy only sukuk as they want to comply with the Islamic ban on receiving interest. Western investors, from their side, don’t mind buying sukuk either. As sukuk are asset-based and many Islamic funds hold them to maturity, they are seen as a relatively safe investment.

But those looks can nevertheless be deceiving. Among all the optimism, you could almost forget that sukuk is a whole class of assets, not a homogenous product like US Treasuries.

Whether the issuers chose sukuk or regular bonds, their own creditworthiness is in the end what makes the difference. Investors who bought Dubai issued sukuk before 2009 will know what that means.

But in these uncertain times, sukuk remain highly valued among investors. With an average yield of 3.8 per cent, it is not hard to see why. Chances are the Sukuk Summit that started on Wednesday in London will only solidify that reputation.


Qatar Islamic Drops as Earnings Miss Estimates, Dividend Cut: Doha Mover

Qatar Islamic Bank (QIBK) led declines in the nation’s banking stocks after profit missed analysts’ estimates and the Shariah-compliant lender reduced its dividend.

The shares of the Persian Gulf country’s biggest Islamic bank dropped 3.1 percent, the most since March 14, to 80.3 riyals, at the 1 p.m. close in Doha. Doha Bank QSC (DHBK) lost 2.9 percent after reporting earnings that matched estimates.

Qatar National Bank SAQ (QNBK), the country’s biggest lender, retreated as much as 0.5 percent. QIB and Doha Bank had the biggest percentage declines on the country’s benchmark stock measure, the QE Index, (DSM) which fell 1.1 percent.

QIB’s “net income missed consensus by a significant amount which is now being priced in,” said Ali Khan, London-based head of Middle East and North Africa equities sales at Royal Bank of Scotland Group Plc. “The dividend has been reduced as well, which usually creates negative price action.”

The bank’s full-year net income was 1.37 billion riyals ($376 million) after 1.26 billion riyals a year earlier.

The mean estimate of eight analysts was for a profit of 1.46 billion riyals, according to data compiled by Bloomberg. The lender plans to pay a 4.5 riyal-cash dividend compared with 5 riyals a year earlier.Qatar’s QE Banking Index dropped 1.5 percent, bringing its drop for the year to 4.4 percent.

Doha Bank, the emirate’s third-largest bank by total loans, posted an 18 percent increase in 2011 profit to 1.24 billion riyals. The company may increase the size of a $500 million bond it plans to sell this quarter, said Chief Executive Officer Raghavan Seetharaman.

Benchmark a major step for Islamic finance

Last month, the world’s first Islamic interbank benchmark rate (IIBR) was launched. It was the result of a collaborative approach taken by many Islamic financial institutions, industry associations and Sharia scholars over the course of 24 months to address a decades-old industry challenge:

how to decouple Islamic finance from a conventional western pricing benchmark (Libor) when an “Islamic” alternative was not available. The objective was to support and preserve Islamic finance authenticity.

The IIBR is an interbank benchmark that offers a reliable and realistic standard to better measure the cost of funding for Islamic financial institutions. As contributed pricing for Sharia-compliant funding, it represents the DNA of an Islamic banking industry that is today focused on commercial banking over investment banking.

IIBR brought together more than 20 Islamic finance institutions to create a proprietary Islamic pricing benchmark. It is a major indication to the world that Islamic finance has come of age and can be seen as a sustainable and rapidly developing feature of global financial markets.

The benchmark is designed to be used to price a number of Islamic instruments including common overnight to short-term treasury investment and financing instruments such as murabaha, wakala and mudaraba, retail financing instruments such as property and car finance, and sukuk and other Sharia-compliant fixed-income instruments. It can also be used for the pricing and benchmarking of corporate finance and investment assets.

We expect the benchmark to grow organically as industry use and acceptance increase. As the industry gets used to the idea of its own proprietary benchmark and its scope becomes more global, we expect to see banks use the rate to price their interbank liquidity placements.

As that gains traction, banks will start to use it for their corporate and retail banking facilities. The rate has reached its full potential when we see investment banks providing syndicated Islamic financing (loans) and debt (sukuk) issuance using the rate.

Since the launch of IIBR, it has received much attention around the world for the positive step that it is.

Understandably though, the significance of IIBR and what it means for the Islamic finance industry, indeed the very position of Sharia-finance in Islam and the wider world, means that it provokes strong opinion and debate.

And we must address the critics if we are to achieve the full potential of this initiative. After all, these commentators are important additional stakeholders.

All collaborations start with open minds and transparent dialogue, and so here I hope to address some of the key points raised.

What is the difference between IIBR and Libor – the London interbank offered rate? Put simply, IIBR measures expected profit while conventional benchmarks such as Libor measure interest rates.

The IIBR question for contributors explicitly refers to the cost of raising Sharia-compliant funding and is therefore based on returns generated by Islamic assets.

The IIBR rates represent the aggregate risk profile of Islamic financial institutions, by way of their assets on the balance sheet, and the geographies in which they operate. This is important for two reasons.


On an economic level, now more than ever, conditions in Europe or the US do not necessarily reflect the conditions in the Middle East funding market, although there will inevitably be a connection as global financial markets are always intertwined.

How is IIBR representative and reflective of global Islamic finance treasury funding costs?

This is only a beginning. At present, we have a strong base in GCC countries, we have three major Malaysian banks and are in conversations with others, and we have started conversations with banks in Turkey, Pakistan and other jurisdictions.

How will IIBR address cross-border funding costs?

The precondition for cross-border funding is establishing local rates, and we are starting a dialogue with more countries with established Islamic banking industries. The more important point is that a transparent process or methodology is in place for price contributions, and its integrity is overseen by our benchmark committee with rules that will punish banks, including expulsion, that violate the agreement they have signed.

Why are only murabaha contribution rates used?

Murabaha is the predominant form of funding for Islamic banks. However, the IIBR is instrument-neutral as decided by the Islamic benchmark committee, and in the future, when other instruments such as wakala or mudaraba become more widespread, a higher proportion of contributions could be derived from other rates.

Is IIBR only for Islamic financial institutions?

IIBR, like Islamic finance, is for all people and institutions for all times. As an accurate and transparent measure of market activity, it is suitable for a variety of uses in the modern financial markets of the world. With IIBR, conventional banks will now have more confidence in their counterparty Islamic banks because their rates will be benchmarked and publicly available.

Islamic bonds – SA makes its move A possible sukuk

In a move that could position SA at the forefront of the global Islamic Sharia law-compliant sukuk (bond) market, national treasury has called on banks to submit proposals for the issue by government of a sukuk.

“A sukuk would create a benchmark for other emerging markets and corporates,” says treasury spokesman Bulelwa Boqwana.

The nature of the possible sukuk has yet to be clarified and banks involved in the tendering process are not permitted to divulge any information.

But a sukuk would differ markedly from a conventional bond. Islamic Finance Resource, an information service, explains that in their purest form sukuk are ownership claims on physical assets.

A sukuk issue would be to domestic and foreign investors and its size dependent on government’s funding requirements, to be unveiled in the next national budget, says Boqwana. That it would be a success seems assured.

“There is a lot of local and foreign interest in it,” she says.

For SA, a sukuk issue would open the door to a source of foreign investment beyond traditional Western funding, finance minister Pravin Gordhan said in a recent speech. Though not on the vast scale of the Western funding machine, the sukuk market is significant, with new issues in 2010 of US$50bn, Ernst & Young (E&Y) says. Sukuk issues hit $63bn in the first nine months of 2011, according to research firm Zawya Sukuk Monitor.

Behind the sukuk market there is also the huge Islamic financial services asset base, which E&Y puts at $1trillion. Deutsche Bank predicts this total could rise to $1,8trillion by 2016 and drive a significant increase in the global sukuk market, which now accounts for a mere 1% of all bonds in issue.

For Gordhan’s strategy to establish SA as the hub for Islamic product development in Africa, a sukuk issue would be a big step forward. But SA cannot afford to drag its feet. Kenya, which has expressed similar ambitions in Africa’s Islamic finance market, aims to issue its first government sukuk in June 2012. A $500m issue is planned.

Also in the running is Nigeria, which is set to issue its first government sukuk within 18 months. Senegal has also expressed interest in tapping into the sukuk market.

Almarai Acquires Argentina’s Fondomonte for $83 Million

Dec. 21 (Bloomberg) — Almarai Co., Saudi Arabia’s largest food producer by market value, acquired Fondomonte SA, a company that owns and operates three farms in Argentina, for 312 million riyals ($83 million).

The Riyadh-based company financed the transaction from its cashflow and Islamic banking facilities, Almarai said in a statement to the Saudi bourse today. Almarai is expanding its supply chain and access to feed for its dairy herd and poultry business, “in line with the Saudi government’s trend to secure supplies and preserve local resources,” the company said.

Saudi Arabia, the Arab world’s largest economy, is encouraging food companies to invest in Africa and Asia to reduce local grain production and conserve water. The government is seeking to end the cultivation of water-intensive crops, including wheat, in the country by 2016.

A group of Saudi Arabian investors said in October 2009 they planned to establish the International Agriculture and Food Investment Co., a 2 billion-riyal company to invest in agricultural projects. Savola Al-Azizia United Co. said in October it agreed to buy 78 percent of two Egyptian food companies for 556.5 million Egyptian pounds ($93 million).

Almarai is expanding outside the Arabian Peninsula’s most populous country to meet rising demand for dairy and poultry products. The company plans to raise 1.5 billion riyals next year from the sale of Islamic bonds to fund growth, Chief Financial officer Paul-Louis Gay said on Nov. 30.

“We estimate that feedstock comprises some 30 percent of Almarai’s direct input costs, so any savings will translate into attractive gains in margins,” said Asim Bukhtiar, an equity analyst at Riyad Capital. “The key risk with the transaction is further correction in agriculture commodities, which could erode benefits.”

Almarai’s shares rose 1.3 percent to 98 riyals at 11:06 a.m. in Riyadh, giving the company a market value of 22.5 billion riyals. The stock has lost 12.8 percent this year, compared with a 4.5 percent loss for the benchmark Tadawul All Share Index.

Group launches first Islamic interbank benchmark

Nov 22 (Reuters) – A consortium of Islamic banks and financial industry associations launched the industry’s first Islamic interbank rate on Tuesday, providing a sharia-compliant alternative to traditional interest-based benchmarks.

The Islamic Interbank Benchmark Rate (IIBR), based on rates contributed by 16 Islamic banks and Islamic sections of conventional banks, is the average expected return on sharia-compliant, short-term interbank funding.

Its creators hope IIBR will be used as a basis for pricing a wide range of Islamic financial instruments, including sukuk (Islamic bonds), corporate financing and common Islamic treasury agreements. Tenors for IIBR will range from overnight to one year.

“The establishment of the IIBR marks an important milestone in the maturation of Islamic money markets by providing an international reference rate for interbank transactions,” said Nasser Saidi, chairman of the committee which sets the rules for the new system.

IIBR addresses a source of tension within the Islamic finance industry, which is estimated to have reached $1 trillion in assets: Islam forbids the use of interest in any transaction, but the industry has long used the London Interbank Offered Rate (LIBOR), a system of interest rates, as a benchmark in the absence of sharia-compliant alternatives.

The new system is based on the rate of return on capital used by Islamic banks, representing the average profit rate at which bids are made for sharia-compliant interbank transactions, such as murabaha and wakala deals, between top Islamic financial institutions.

Murabaha is a cost-plus-profit structure used for funding, while wakala involves the use of an agency agreement in which one firm accepts funds from another to invest on its behalf in a sharia-compliant manner.

Some bankers believe the launch of IIBR shows Islamic finance, which has existed in modern form for several decades, is finally maturing to a level at which it can compete broadly with conventional finance at a time when turmoil in global financial markets has raised questions about risks in the conventional system.

Because Islamic finance bans pure monetary speculation that is not based on an underlying asset, its proponents present it as a less risky, more stable alternative to conventional finance.

But it still faces big obstacles to widespread adoption, including a lack of tools that commercial banks and central banks can use to adjust liquidity. Disputes between scholars on acceptable practices, and a lack of trained staff and investor familiarity with instruments, also hinder Islamic finance.

IIBR was launched by Thomson Reuters Corp , which publishes this news service, in cooperation with the Islamic Development Bank, Islamic regulatory body Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), the Association of Islamic Banking Institutions Malaysia, the Bahrain Association of Banks, the Hawkamah Institute for Corporate Governance, the Statistical Economic and Social Research Center for Islamic Countries, and 19 Islamic banks, most of them based in the Gulf.