Why are sukuk in the GCC issued with short maturities?

Mubadala, the Abu Dhabi sovereign wealth fund says that there needs to be a better developed secondary bond market for longer-term bonds to come to market. It also pointed to the need for a 'strong local bid'. Given that the GCC is the source of a large share of the sukuk issuance, and most sukuk outside of Malaysia are of maturities of 5 years or less, this poses a question of whether the Islamic financial industry can step in to fill the gap.

The sukuk secondary markets are notoriously illiquid, although there has been an improvement in this area as the number of new issues has declined in the past year or two. With a shortage of new issues, there has been an uptick in the trading of outstanding sukuk in the secondary markets. There has also been the nascent steps towards provide more opportunities for secondary market trading with the launch of bond and sukuk trading on the Saudi exachange Tadawul. However, even with these steps, there are few listed sukuk, with most trading on either NASDAQ Dubai (formerly the Dubai International Financial Exchange) or the Bahrain Stock Exchange.

As I have described before, the secondary market for sukuk has been caught in a chicken-or-egg problem (which came first?). During the boom times, there were a number of new issues, most of which were heavily oversubscribed. A decent proportion of these sukuk were listed on secondary markets theoretically giving investors who were not able to subscribe in the offering the chance to pick them up in the secondary markets. However, there wasn't much activity in the secondary markets.

This can be ascribed to two things. First, the secondary markets weren't active because the secondary markets weren't active. Although a tautological argument, it was true. If you subscribe to a sukuk and receive an allocation, then sell it on the secondary market, you would generally hope to be able to take the proceeds and purchase a new sukuk to replace it. In an illiquid secondary market, for one you could probably not receive what you perceive to be the fair value, but also, you would likely have to overpay for a replacement. Without the benefit of a market maker in the sukuk, the gap between bids and offers in the market perpetuated the illiquidity.

Second, the continuing stream of new issues made it less beneficial to chase the offer in the secondary market if there was a chance of getting in on a newly issued sukuk. Why pay up if there is a chance that another similar sukuk might come along that you might be able to receive an allocation at par?

However, this equation changed after the financial crisis when credit was generally scarce and expensive and there were few companies willing to issue new sukuk. In addition, the outstanding issuers were affected by the growing economic crisis so that their ability to repay came into question (in some cases, they defaulted on their sukuk). The investors in these sukuk, either through concern over the sukuk or their own need for cash, became more willing to participate in the secondary markets.

This created some market turmoil, with many sukuk trading far below par and yielding higher than may have been justified by the fundamentals of the companies and sukuk. However, it also created an opportunity for a few sukuk funds which launched over the past year to step in on the buy side of the market and create additional liquidity by narrowing the spread between the bid and ask of listed sukuk.

No sukuk exemplifies this transformation perhaps more than the Nakheel sukuk which matures in December. In an illiquid market, with concerns about Nakheel's ability to repay, the bond traded down to nearly 60% of its par value even though the payment on maturity, if made, would be nearly 115% of par. Since reaching this point, the sukuk has become more actively traded and has rebounded in the trading price to greater than par. Some of this rebound was due to the fundamental ability of Nakheel to pay, albeit with support from the Dubai government, but some could be chalked up to the greater liquidity and the entrance of bidders for the sukuk.

To be clear, the sukuk market remains illiquid in many listed sukuk names, but there has been a greater level of activity in secondary markets as of late. Returning to the initial point of what is needed for longer-term maturities, it is generally the case (even in US Treasuries, some of the most liquid bonds in the world) that longer maturity products are less liquid and more volatile in price than shorter-dated bonds. Without a liquid secondary market for shorter maturity bonds and sukuk, it is unlikely that investors would purchase longer-dated sukuk.

Mubadala's point is well taken and the sukuk market, largely as a result of external events, has begun to liquify. This is a necessary, but probably not sufficient, precondition for the introduction of longer maturity sukuk. The resolution of sukuk through cases of default will also go a long way towards reassuring investors that they will not be trappen in a 10-year or longer sukuk regardless of what happens. To see a possible future, the experience of Malaysia is instructive. The Malaysian secondary markets are active and there have been numerous resolutions of sukuk defaults. Consequently, there have been several longer-dated sukuk--for example, the Cagamas residential mortgage-backed securities which have maturity dates of over 10-years, something that has not happened in the GCC...yet.

Other News

• The performance of the Dow Jones Islamic Market Indexes for October are now available.
  
• The IFC sukuk was priced at 25 basis points over mid-swaps, which is the tightest pricing yet for a sukuk, although the sukuk received a higher pricing (by 10 basis points) over what conventional debt issued by the IFC would be priced at.
  
• Germany's financial regulator jumps into the mix of European countries wanting to attract Islamic finance shortly after France passed laws defining the rules for Islamic financial products, but far behind the U.K., which has so far led the EU in its accommodation of Islamic finance.
  

Dubai issues $1.93 billion in sukuk

Dubai announced the results of its 5-year sukuk issuance today. There were two tranches, one for $1.25 million of USD-denominated sukuk and the other was $680 million in AED denominated sukuk. The sukuk were priced at 375 basis points over mid-swaps. Bloomberg reports that the USD sukuk were priced to yield 6.39%. The AED tranche are floating-rate notes based on a spread over EIBOR, priced to yield 5.65% according to the same Bloomberg article.

The nearly $2 billion issuance is the first issuance of bonds by Dubai since April 2008, before the real estate markets in Dubai began to tumble in the wake of the global credit crisis. There are a number of maturing debt issues--some $6.8 billion in the fourth quarter of 2009--none more crucial to Dubai's reputation than the $3.52 billion Nakheel sukuk. The Nakheel sukuk is not officially sovereign debt, but it is a government-related entity guaranteed by Dubai World, the government-linked holding company.

Nakheel, the developer of the palm-shaped islands off the coast of the Emirate, has run into severe difficulty following the property crash in Dubai, and has confirmed it has received money from Dubai's Financial Support Fund, although the amount has not been disclosed. Although the funds raised in this sukuk issuance will go to the government, in part to pay maturing sovereign sukuk, there will soon be another $10 billion bond issuance, a part of the $20 billion bond program that was started with a $10 billion bond issued to the UAE central bank.

Nakheel has been reported to be in restructuring talks over the $3.52 billion sukuk, which could include a tender offer involving equity. However, a number of investors have publicly criticized the possibility of recieving equity for their investment. Due to the deferred lease payments throughout the sukuk, the total amount payable on maturity is around $4 billion. Were the Nakheel sukuk to not be fully redeemed upon maturity, it would send a bad signal to the bond markets about the credit-worthiness of other highly-indebted government-related entities and could affect the Dubai government's ability to raise future debt.

However, the ability of Dubai to access the international capital markets, as well as the support from the UAE central bank through the earlier bond, sends a positive signal that Dubai will not allow Nakheel to default on its debt. The outcome is still uncertain, although the secondary market trading in Nakheel suggests that there will be a favorable outcome. The latest pricing is 107 - 108.5 as of October 28th. The final maturity value of the Nakheel sukuk is near 115.

Other News

• Indonesia plans its next sukuk in mid-November. The first two auctions have seen investors demanding higher yields. The first auction had all bids rejected and the second auction saw less than 5% of the total bids accepted.
  
• Jordan continues to consider issuing a sukuk, although the discussions are in an early stage.
  
• Next year may see $20 billion in sukuk issuance according to a poll. The issuance was $9.3 billion in the first seven months of 2009. The total sukuk issuance this year could be around $15-17 billion. However, with a pipeline estimated at $45 billion, this would be less than some expect.
  

Sukuk markets recovering, IFC sukuk listed in Dubai and London, Islamic asset management faces a 'chicken-or-egg' problem

The sukuk market is expected to recover following signs that Nakheel will avoid default and GE Capital Corporation, which has a joint venture with Abu Dhabi-based Mubadala, was reported to be considering issuing a sukuk. The recovery in Nakheel's sukuk have come following the $10 billion in bonds issued by Dubai and the prospect for the Emirate to issue $6.5 billion in bonds and sukuk. The sukuk-reported to be $2.5 billion of this amount-are reported to be priced near 6%. The funds from the bond and sukuk issuance are expected to be administered by the Dubai Financial Support fund, which has provided some assistance to Nakheel.

With the listing of the World Bank Group's IFC sukuk, NASDAQ Dubai expects the sukuk and bond markets to pick up before the IPO market. The sukuk will be listed on both NASDAQ Dubai and the London Stock Exchange and is rated Aaa by Moody's.

The Islamic asset management industry faces a 'chicken-or-egg' problem as the industry has a shortage of investments to choose from, particularly in the fixed income area, while there are few investments available because of questions about the strength of demand. The increasing involvement by governments is a double-edged sword, notes an article from Reuters. Governments can provide a source of issuers willing and able to issue sukuk, but could crowd out other issuers, particularly lower-rated issuers. So far this year, roughly 80% of sukuk have come from government issuers and many of the others were issued by high-grade corporate issuers.

Emirates Business 24/7 has an interesting article about the debate over standardization in Islamic finance. There are many views on how standardization should happen, whether it should be a goal at all and what aspects of the industry should be standardized.

Other News

• The International Swaps and Derivatives Association (ISDA) is expected to release guidelines on Islamic derivatives, and these could come by December. The standardized agreement, being jointly developed by the ISDA and the International Islamic Finance Market (IIFM), would provide a standardized contract for Shari'ah-compliant hedging products.
  
• The opening of the country's first Islamic bank led German paper Das Spiegel to write a good article that provides an overview of the industry's development.
  
• Tamweel, the troubled Dubai-based Islamic mortgage company, made a periodic payment on its sukuk due in 2013.
  
• The Irish Revenue Service has clarified its rules on the taxation of Islamic finance products and a summary is available from Arab News.
  
• The CIO of CIMB-Principal Islamic Asset Management Dr. Zeid Ayer believes that Brunei should open its sukuk up to international investors to broaden the base of investors. The sultanate issues sukuk despite large oil reserves and little need to raise financing as a way to promote the growth of its Islamic finance industry.
  
• The results of an Islamic Finance Perceptions survey are summarized in an article.
  
• As Malaysia issues RM3 billion ($888 million) in sukuk, it has also extended the tax exemption on Islamic financial products to 2015 that have helped the industry grow rapidly in the country.
  

Dubai wades back into international capital markets, sukuk coming back or are defaults too strong a headwind for the next year

Dubai Civil Aviation may issue sukuk and conventional bonds to refinance $1 billion in debt maturing in November, in signs that Dubai may be re-approaching the sukuk and bond markets despite uncertainty about the level of debt in government-related entities like Dubai World and Nakheel, which has a $3.52 billion sukuk maturing in December. The ability of Dubai to tap capital markets has been buoyed by the return of risk appetite among investors as well as the repayment a month early by Nakheel of over $1 billion in bank debt extended earlier this year. However, there is still skepticism about Dubai's ability to restructure its debt and government-related entities.

A senior executive at Nomura believes that there will be a further uptick in the issuance of new sukuk by corporate and sovereign issuers in the next 18 months. The issuance through the end of September was $13.5 billion, primarily out of Saudi Arabia, which accounted for 44% of issuance and included sukuk from Saudi Electric Company and the Islamic Development Bank. Other more recent data shows that $18 billion in sukuk have been issued so far this year.

The sukuk market remains in a state of flux because of the unresolved issues about asset-based and asset-backed sukuk, which is discussed in an article in the Financial Times. The important point brought up in the FT article is that not all sukuk transfer ownership of the underlying asset to the investors. In many cases of asset-based sukuk, the asset is transferred to the SPV that issued the sukuk but with a repurchase agreement that requires the issuer to repurchase the asset in the case of default. This means that the asset ownership transfers back to the company and the sukuk holders are given essentially an IOU that the company will redeem the principal of the sukuk in a default. This is different from an asset-backed sukuk where ownership is transferred to the sukuk holders, who then have legal right to the asset. This was the case in the East Cameron sukuk, which was based on an overriding royalty interest that entitles the sukuk holders to a share of production in the underlying lease. Other sukuk transfer ownership of a tangible asset (the ORRI is legally recognized as real property in Louisiana, but is not a transfer of the underlying properties being drilled, which are leased from the US government).

Other News

• The World Bank's IFC sukuk price guidance is 35-40 basis points over 5-year US Treasuries.
  
• Jordan is considering offering sukuk to cover its growing budget deficit.
  
• A columnist in the Guardian discusses the role of regulation and religion in finance.
  
• Emirates Development Bank, the government funded bank that is anticipated to take over Islamic mortgage lenders Amlak and Tamweel is one step closer to launch, although the fate of Amlak and Tamweel remains uncertain.
  
• Saudi Electric may tap sukuk markets again to finance a new contract the firm signed.
  
• There is a nice article is in a Minnesota paper about local organization African Development Center, which offers Shari'ah-compliant home and business financing.
  
• An English paper has a good article about the growth of Islamic finance.
  
• Korea needs incentives for investments in sukuk, according to the head of Doha Bank's representative office in the country.
  
• Islamic Finance Resources links to a recent paper on the history of Islamic finance in France, a relevant article given the recent French law about Islamic finance that was struck down by the constitutional court on procedural grounds.
  
• Ithmaar is offering a rights issue as well as a 5-year mandatory convertible sukuk.
  
• Gatehouse Bank, based in the UK, joined Paris Europlace, a Paris-based organization that promotes the French financial industry and established an Islamic Finance Commission in December 2007.
  

FSA rules on Islamic finance, France law struck down, 10-20% growth in 3 years in Islamic finance, other news

The Financial Services Authority has released the suggestions received on its regulatory proposal for sukuk (Alternative Finance Investment Bonds) that was initially released late last year. The comments are incorporated into a revised proposed law that is open for comment until November 6, 2009.

France's new law on Islamic finance was struck down by the country's high court on procedural grounds although the opposition Socialists who asked for the review by the Constitutional Council who oppose it as a violation of the secular principles of France.

A study by BDO based on a poll of 173 financial services executives involved in Islamic finance puts the growth prospects for the industry at 10-20% over the next 3 years. A substantial percentage, 23%, said the industry could grow quicker and an equal percentage believed there would be little growth, between 0% and 10%, in the next 3 years. The industry continues to enjoy unsaturated markets and growing recognition by companies not necessarily considering Islamic finance based on a need for Shari'ah-compliant funding sources. However, there has been a severe economic downturn that has hurt the industry, a shortage of experienced practitioners and there are a number of issues remaining to be resolved, particularly how sukuk are treated if the issuer defaults on periodic payments. This is not necessarily going to be a quick process and it could be one of the reasons for the large percentage of sukuk this year coming from high-grade companies and sovereign issuers where the probability of default is far lower than some of the issuers in previous years.

The World Bank's International Finance Corporation is planning a $100 million sukuk to show its commitment to the Middle East and Islamic finance. The Reuters article notes that "they [the IFC] have only a few ijara contracts, that's really the limiting factor". This suggests that the structure they are considering would be similar to the Islamic Development Bank sukuk, which is based on a pool of financing provided to other parties by the Bank which can include murabaha and istisna'a, but must have at least 51% in ijara because they represent an underlying asset and not just a debt receivable.

Indonesia rejected all of the bids in its first monthly sukuk auction because investors were asking for higher yields than the Ministry of Finance was willing to accept. The decision is not seemed to be a significant setback because there is an expectation that the Indonesian central bank may raise interest rates. If the Ministry of Finance accepted higher yielding bids from investors in sukuk, it could increase the cost of raising conventional debt.

Investors in the Golden Belt 1 sukuk issued by the Saad Group do not know whether the next periodic payment will be made according to Citigroup, the sukuk trustee.

There is continues to be controversy about whether there need to be more safeguards for borrowers in Malaysia who default on bai' bithaman ajil (BBA) sales contracts. In some cases, a defaulting borrower can end up owing more than the amount of the financing originally taken. There has been controversy before around the BBA contract. A lower court said that the sale was not genuine and there was no difference between the profit charged and interest, although this was reversed by a higher court.

Other News

• The Dubai Financial Services Authority (DFSA) issued proposals for changes to how it regulates Islamic financial services.
  
• Shariah Capital, based in the US, is considering offering a Shari'ah-compliant ETF in the US and the UK, although no timeline for its launch is provided.
  
• Etisalat plans a bond and sukuk raise that would begin with a $500 million tranche.
  
• Bursa Suq Al-Sila', the Malaysian-based commodity murabaha exchange is expanding into the GCC.
  
• The CIMA Certificate in Islamic Finance was launched recently. SHAPE Financial has launched its own certified Islamic financial analyst program.
  
• Despite a downgrade to the Originator, a Tamweel Residential ABS sukuk did not have its rating changed by Moody's.
  
• Sorooh is planning a Shari'ah-compliant fund to invest in European commercial property. ING is planning its own Shari'ah-compliant real estate fund with Amiri Capital that will invest in UK commercial property.
  
• An opthamologist in Dubai proposes an Islamic economic system that I cannot even comprehend, but there is a $1 million reward to anyone who can prove that it wouldn't work.
  

Islamic securitization, other news

A lawyer from Patton Boggs has an article in Islamic Finance News about the requirements for Shari'ah-compliant securitization to develop in the Middle East. Securitization markets across the world have been restricted following the credit crisis, but the securitization if done in a Shari'ah-compliant way would allow Islamic banks to increase the diversification of their assets and would free up capital for additional financing.

Other News

• The Islamic Development Bank's $1.5 billion sukuk program and the first issue of $850 million in sukuk received a AAA rating from Fitch's and Standard & Poor's and a Aaa rating from Moody's Investor Services.
  
• Malaysian ports operator Pelabuhan Tanjung Pelepaas plans to raise MYR1.5 billion ($441 million) from sukuk issues with a maturity of up to 10 years.
  
• Standard & Poor's will be responsible for maintaining and calculating the National Bank of Abu Dhabi's NBAD UAE Listed Islamic Index.
  
• The fate of Islamic mortgage firms Amlak and Tamweel continues to be discussed as a UAE state panel oversees their restructuring.
  
• Swiss Re received approval to launch a retakaful unit in Malaysia. The takaful industry has been growing, but there is a shortage of retakaful firms forcing many takaful providers to use conventional reinsurance.
  
• France sees Islamic finance as a potential way to deal with the credit crunch, although Islamic finance is not immune from similar crises that began in the U.S. in 2007.
  

Nakheel sukuk, Khazanah exchangeable sukuk in 2010, US Islamic mutual fund and ETF launching

Nakheel's $3.52 billion sukuk traded at 107, its highest value since doubts emerged about the ability of Nakheel and Dubai World, which guarantees the sukuk, to repay. The rising price indicates that there is greater certainty that Dubai will ensure the sukuk is redeemed at maturity. The redemption value includes principal plus deferred lease payments, so the redemption value is greater than par. A blog post at The National notes that the sukuk is an unsecured obligation of the company, something that is clear in the prospectus but which had been questioned following the reported transfer of properties from Nakheel to Istithmar.

Khazanah Nasional plans more exchangeable, USD-denominated sukuk next year to reduce its stake in several of its holdings. Khazanah issued an exchangeable sukuk a couple years ago backed by shares of Telekom Malaysia. The sukuk was structured where the common shares were the assets on which the sukuk was based and the profits paid to investors were covered by the dividends paid on the common shares. The investors in the sukuk were able to later exchange their sukuk into shares of Telekom Malaysia.

The United States Islamic investment market is getting a lot deeper as Saturna Capital launched its Amana Developing World Fund and ShariahShares ETF should be launched in Q1 of 2010, managed by California-based Florentez Investment Management. The new Amana Fund will be invested in developed country-based companies with significant revenue from international operations. The ShariahShares ETF will likely include two passively-managed funds, one based on the FTSE Yasaar Shari'ah U.S. Index and the other on FTSE Yasaar Shari'ah Developed World ex-U.S.

In another sign that the sukuk market is still very undeveloped for longer maturity sukuk, even from sovereign issues, the Indonesian regular sukuk will likely have less than 15 years maturity. The Finance Ministry director in charge of Islamic markets told Reuters that "The maturity of the sukuk will likely be shorter [than 15 years because] the sukuk market is still not yet developed".

Other News

• There is a good summary of the French legal changes to accommodate Islamic finance in the country, specifically the changes relating to murabaha and sukuk.
  
• A few sovereign sukuk issues will come next year including Indonesia, Pakistan and South Korea. Not to mention the potential for the U.K., Singapore, Hong Kong and the Japan Bank of International Cooperation, which could also come next year.
  
• An American firm developed a 'longevity-linked investment platform'.
  
• Rushdi Siddiqui, the global head of Islamic finance for ThomsonReuters, recreated the Palm Jumeirah in his garden.
  
• A new Islamic investment firm, Fajr Capital, launched with shareholders including Malaysian Khazanah Nasional, Brunei Investment Agency and the Abu Dhabi Investment Council.
  
• The CEO of Unicorn Investment Bank discusses the investment bank's growth.
  
• Daimler Financial will offer Shari'ah-compliant financing in the UAE.
  
• The Kerala government in India will finance infrastructure projects and other investment opportunities through a Shari'ah-compliant investment company.
  
• Syria is seeing growth in takaful.
  
• The merger between Amlak and Tamweel, two troubled Islamic mortgage firms will 'take time' according to UAE central bank governor Sultan Nasser al-Suweidi.
  
• Bahrain Financial Exchange launched two product development working groups, one devoted to developing Shari'ah-compliant products.
  
• The Managing Director for the MENA region for Boeing says there will be growth in Islamic finance including in aircraft finance.
  
• The Qatar Investment Authority and Malaysian Khazanah Nasional Bhd are working to set up a joint investment fund.
  

Sukuk in default, Amlak and Tamweel resolved?, Islamic law firm

Malaysian ratings agency RAM Ratings Service has a very detailed overview of how sukuk function in cases of default comparing both the asset-based and asset-backed sukuk, as well as the differences between the Gulf and Malaysia. In asset-based sukuk, the asset is used to structure the transaction, but is not actually transferred to investors. The sukuk investors therefore become unsecured creditors of the issuer through a purchase undertaking that compels the issuer to repurchase the assets in cases of default. In asset-backed sukuk, the assets are sold to the SPV used to structure the transaction and the investors have recourse to this asset, which the sale to the SPV protects from the claims of the issuer's other creditors.

The problems at Amlak and Tamweel, two Dubai-based Islamic finance companies could be close to a resolution that sees them merged together into an Islamic bank that is partially government-owned. The two companies have not been providing any financing as their fate has been determined largely by the government of Dubai and the United Arab Emirates. The resolution proposed in some way resembles the conservatorship that was the end result of Freddie Mac and Fannie Mae in the U.S. with partial government ownership of the combined companies that would support the two companies' debt load.

An article provides greater detail about the workings of a Shari'ah-compliant law firm. In a time when law firms along with their financial clients are tightening it is interesting that there is a law firm that is beginning with a self-imposed limitation on the types of clients it will accept.

Other News

• The Investment Dar announces that it has appointed a Chief Restructuring Officer following the Standstill Agreement with its creditors.
  
• DIFC and the World Bank's Multilateral Investment Guarantee Agency are working together to develop the GCC's bond and sukuk markets. A more detailed summary of the issue is available from Emirates Business 24-7.
  
• Malaysia continues to plan for a 20% market share for Islamic banking and takaful in 2010. The share for Islamic banks is currently about 17% and for takaful 7%.
  
• China could be the next large market for Islamic finance, although regulatory hurdles remain.
  
• The Islamic Bank of Britain is offering 2-year Islamic CD's yielding 4.5%, which will be fund the bank's Shari'ah-compliant financing. The bank recently revealed it had faced increases losses because of low interest rates that decreased the net interest margin on its financing activities.
  
• QFinance launched an online reference guide to finance, including Islamic finance.
  
• An Islamic cooperative bank has been opened in India. It marks another step on the slow development of the Islamic finance industry in India.
  
• Islamic banking has begun to grow in Kazakhstan eight months after it changed laws to accommodate the industry.
  
• The most recent issue of sukuk al-salam from the Central Bank of Bahrain were 100% oversubscribed with BD12m in subscriptions for the the BD6m issued.
  
• Dow Jones has released the performance for September of its Islamic indices.
  
• In an interview, the CEO of Hilal Bank is asked about the need for central regulation of Shari'ah-compliance, as well as the fallout from the credit crisis and the potential conflict of interest caused by Shari'ah boards being employed by the institutions they oversee.
  
• Abu Dhabi's Tourism Development and Investment Company issued a $1.45 billion sukuk al-ijara that will have a AA rating from S&P.