Thursday, May 19, 2011

Malaysian 10-year sukuk

Sukuk in the global markets have been by and large confined to the short end of the yield curve with few issues (particularly if one excludes Malaysian mortgage-backed bonds from Cagamas) more than ten years. One reason for this is that there are no sovereign bonds with maturities of longer than about 5 years. However, if reports are correct, Malaysia is planning a 10-year, US dollar denominated sovereign sukuk later this year for between $500 million and $1.7 billion. Within the last year, Malaysia issued $1.25 billion in 5-year sukuk, its first global sukuk in 8 years.

Interest in Malaysia have come from both the strong recovery in Islamic capital markets in the country as well as the country's strong currency. Several GCC-based issuers have issued sukuk in Malaysia since the sukuk market activity in that region shrunk dramatically following the credit crisis. The added benefit for those issuers is by issuing sukuk denominated in ringgit, they stand to benefit from lower payments if the value of the Malaysian currency falls back towards the average of the past 10 yearsin relation to the US, to which their currencies are pegged.

The sukuk markets in Southeast Asia (Malaysia and Indonesia) have been strong in recent years because of the previously noted swiftness of market recoveries and strong currencies (the rupiah has also strengthened significantly against the US dollar). Indonesia, which has a much less developed sukuk market, had faced difficulty issuing sovereign sukuk at competitive yields to their conventional bonds because of illiquidity, but may see an inflow of capital to both conventional bonds and sukuk if the country has its ratings bumped up to investment grade, which the government expects to occur in 2011.

Returning to the issue at hand, if a 10-year sovereign sukuk were issued, it could encourage corporate issuers to issue longer-term debt. This would fill out the yield curve which is rather stunted currently with most sukuk maturing in five years or less. A Malaysian 10-year would encourage, in particular, longer maturity sukuk in that country, but could also serve as a benchmark to US dollar or dollar-linked global sukuk outside of Malaysia.

This outcome is far from guaranteed, but it could serve as the stepping stone for a politically and economically stable sovereign issuer in the GCC to come out with its own 10-year sukuk (Qatar would probably be the most likely, but Abu Dhabi also comes to mind as a possibility given the stabilization recently in Dubai that limits the potential for future bailouts from the oil-rich emirates).

Now that attention has finally turned towards developing short-term liquidity management tools (e.g. the International Islamic Liquidity Management Corporation), the next important frontier is the long end of the curve and sovereigns will most likely have to take the lead. With its headstart (Islamic banking laws formalized the industry in Malaysia beginning in the mid-1980s) and large market share for Islamic finance overall (more than 20% of total banking assets as of 2010), Malaysia could take a leadership role in expanding the offerings of longer-term sukuk if the reports of a 10-year USD sukuk are correct. With growing harmonization of Shari'ah standards between Malaysia and the GCC, it will take longer than it used to for developments in the former to spill over to the latter.

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