Saturday, December 11, 2010

GCC issuers looking to Malaysian sukuk markets

An article in Malaysian newspaper The Star describes a potentially troubling development for sukuk markets in the GCC.  The article describes the growing likelihood that Gulf-based corporates will look to Malaysia when they choose to issue sukuk.  The sukuk market in Malaysia (primarily denominated in Malaysian Ringgit) is much more developed than the GCC, particularly the secondary markets for sukuk.  If corporates from the GCC become issuers in Malaysian markets, it would hurt the development of secondary markets in the GCC and could also cause difficulties for the GCC firms themselves depending on the direction of the dollar's value (to which most GCC countries have pegged their currencies).

The article describes that corporate issuers are issuing Ringgit-denominated sukuk to tap an investor base that is estimated at US$79 billion, much of which can only invest in Ringgit-denominated assets.  This would undoubtedly be a positive for Malaysian markets and investors.  Investors would have a larger prospect for diversification among sukuk issuers than they have now and the larger number of sukuk could put the secondary market development into a self-reinforcing (positive) cycle of more sukuk leading to more secondary market trading, which would then lead to more issuance.

However, exactly the same logic of a self-reinforcing cycle could start in the GCC with fewer sukuk being issued in the GCC, which would lead the secondary market to become squeezed for new issuance to make up to redeemed or defaulted sukuk. This would see a contraction in the already small trading volumes of sukuk, which would further limit the supply of new sukuk.

Another potential problem this could create for GCC-based issuers of sukuk is that they would have exposure to exchange rate risk.  This could be a positive for those issuers with a significant share of revenues and expenses denominated in Ringgit.  These issuers would then have debt payable in the same currency as their revenues, which would act as a currency hedge.  However, issuers with most of their revenue denominated in USD or UAE dinar or any of the other GCC currencies that are tied to the US dollar would be at risk of having their debt service grow in local currency (USD/AED/SAR) terms if the Malaysian Ringgit appreciates further against the US dollar (and effectively appreciates against GCC currencies).

It may be that the issuers of these sukuk expect the appreciation of the Ringgit against the dollar to reverse, which would lower their debt service in their local currency.  However, with underdeveloped mechanisms of hedging against currency risk in a Shari'ah-compliant framework, creating mismatches between the currency where the cashflow is generated and the currency in which debt service payments are made it adds a risk that could hurt the companies that could issue sukuk within the GCC as its sukuk markets develop.

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