IFSB seminar ponders sukuk market prospects

LONDON: The effects of the global financial crisis, the statement by the Shariah Committee of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in 2008 regarding Shariah compliance relating to ownership of underlying assets and guarantees of principal by issuers of musharaka and mudaraba sukuk issued so far, the lack of standardization and several sukuk defaults, including The Investment Dar, East Cameron Gas and Golden Belt issuances, have seen the global sukuk market seek flight into the safety of ijara (leasing) structures, although musharaka and wakala structures can be used applying limited recourse to project/structured finance disciplines.

IFSB seminar ponders sukuk market prospects

Some market players are clearly hankering for a mindset change in pursuing asset-backed and true-sale sukuk as opposed to asset-based transactions. But a growing emerging consensus seems to be that the global sukuk market needs a fundamental modernization by effectively going back to basics to financing and impacting real economy assets.

This consensus was apparent at the seminar on “Issues in Sukuk Development,” which was organized by the Islamic Financial Services Board (IFSB), the prudential and supervisory standard setting organization for the global Islamic financial sector, and the Islamic Research and Training Institute (IRTI), a member of the Jeddah-based Islamic Development Bank (IUDB) Group, and which was held in London last week.

The seminar attracted the participation of a number of dignitaries and prominent speakers led by Sir Michael Savory, Lord Mayor Locum Tenens, City of London, and Rifaat Abdel Karim, secretary-general of the IFSB.

But despite the difficult market conditions, especially in 2009, Dr. Mohamed Damak,
associate at international rating agency, Standard & Poor’s Financial Services, was bullish that the sukuk market is reviving in 2010 but issuance volume will continue to depend on market conditions. His long-term expectations are that prospects remain positive with more than $30 billion of sukuk either announced or talked about in the market this year.

The upside for the sukuk market is evident. Investors are increasingly seeking to invest in products that are compliant with their beliefs. The infrastructure projects investment in the GCC is in excess of $1.2 trillion over the next two decades according to one estimate. Several non-Muslim countries/issuers are looking to diversify their investor base.

Professor Simon Archer of the ICMA Center, University of Reading in the UK, reminded delegates that the danger of “toxic sukuk” were limited by the constraints of Shariah compliance, which reduces potential prudential concerns, although systemic and macro-prudential risks remain. Even the few defaults that the market has seen is helpful in providing the market with interesting information on sukuk resolution (access to the underlying assets; guarantee enforcement).

The AAOIFI guidelines on the Ownership of Underlying Assets require that “all [tradable] sukuk must represent ownership in the underlying real assets (real, usufruct, services) with all rights and obligations), which can be owned and sold in accordance with Shariah and applicable law. Transfer of ownership must be recorded in the seller’s books as per Shariah and applicable legal requirements and should not be shown as the assets of the seller or the manager.”

Another major market constraint is the lack of liquidity and secondary markets, and a global yield curve for sukuk. This can be remedied by a critical mass of issuances led by sovereigns, corporates and financial institutions. Most sukuk are indeed OTC (over the counter) instruments.

Many market players agree that the creation of a Saudi sukuk and bond market might help to improve the liquidity of sukuk listed on the Tadawul Stock Exchange, which in turn could have a knock-on effect on trading elsewhere in the region.

Mohammed Dawood of HSBC Amanah explained that the sukuk market has been characterized by limited issuance in the Gulf, and during turbulence in credit markets, there has been a flight to quality.

He urged more sovereigns to issue sukuk to support this flight to quality and called on GCC governments to support “this indigenous industry.” He advised the creation of benchmark levels for corporate issuances; longer tenors of up to 10 years for issuances which would stimulate a secondary market; the need to create a wider investor base which allows for longer maturities; the development of a project finance sukuk market and Shariah-compliant repos, which would allow Islamic investors access to liquidity from central banks, and more retail sukuk issuances.

Dr. Mohamed Akran Laldin, executive director of ISRA, emphasized that the restriction in the right of asset disposal poses serious doubt whether asset-based sukuk structure truly complies with the principles of Shariah. “Coupling restriction on disposal with the price of Purchase Undertaking at par effectively changes the nature of the underlying Shariah principles, especially for equity based instruments,” he advised. This is because it undoubtedly implies a guaranteed return with guaranteed principal.

There is a need to move toward Asset-Backed Sukuk Structures, he said.
Sami Al-Suwailem, deputy director of the Islamic Research and Training Institute (IRTI), IDB Group, warned that sukuk design needed genuine reform and any new designs must improve both the efficiency and credibility of the structures and transactions.

David Bailey, manager, Financial Services Authority (UK), stressed that sukuk have an important role for Islamic institutions and that the UK remains committed to provide a level playing field for Islamic finance. “Changes will continue to be made, where necessary, to achieve this policy goal,” he added.

Sukuk are important to meet the lack of availability of short term, liquid money market instruments (international issue). In fact, the FSA expanded the liquidity regime to incorporate Islamic Development Bank sukuk. The UK approach is to provide a level playing field for issuance of sukuk with comparable conventional products and to achieve the goal of facilitating Islamic finance within the UK without compromising regulatory standards.

Anouar Hassoune, vice president, Moody’s Investors Service, stressed that sukuk structures continue to evolve based on needs of borrowers and investors. Once markets normalize, the sukuk market should resume an average growth of 30 percent per annum in the next five years.

In terms of securitization, the “truly” asset backed nature of these financings means they are well suited to sukuk. More issuance means more market liquidity, and hence more efficient disintermediation in Islamic capital markets.

Hassoune identified several enabling regulators to boost the Islamic finance market. These include building parallel legislation for Islamic finance, enabling the creation of level playing-field, increasing the “real economy” impact of Islamic finance with a greater emphasis now on equity-based instruments.

The industry also needs top-class intellectual talent to drive a new creativity phase; and regulators, practitioners and Shariah scholars need to set a common agenda for the industry going forward. At the same time, the current industry players have limited scale and reach. As such, there is a need for global foci-shift and inter-regional ties and joint ventures.

http://arabnews.com/economy/islamicfinance/article65445.ece