Wednesday, September 14, 2011

UAE sukuk market evolution

An article from the Business & Banking Review (via Zawya) describes the evolution of the UAE sukuk market.   One of the most interesting parts of the article (the whole thing is well worth a read) comes at the beginning:
In 2004, only three sukuks were issued in the UAE with an aggregate value of $1.165 billion. Two years later, the number of sukuk issues had increased to seven and the value grew eight-fold to $8.755 billion. The height of the sukuk market was certainly 2007 with eleven issues with a value of $10.8 billion.
What is interesting to me is not the growth (827% over four years), but the average size of the sukuk issued in the UAE, which grew from about $385 million in 2004 to $1.25 billion in 2006 and nearly $1 billion in 2007.  This size is significantly larger than many of the sukuk issued since the financial crisis (excluding some of the sovereign issues from Malaysia).

Many of these sukuk were for real estate-related projects, or for financial institutions which financed real estate investment.  While it is not unusual to see a large volume of sukuk (and conventional bonds) come from financial institutions and real estate companies, the large size of the projects in the UAE (particularly Dubai) were financing a real estate bubble, in many cases supported by the government (the issuers were often partly state-owned or quasi-government companies).

During the boom, these sukuk were snapped up quickly, as demand for nearly any sukuk overwhelming the supply, even in the mega sukuk (a significant amount came from the three Nakheel sukuk, $2.5 billion issued in 2006, $750 million in 2007 and $3.6 billion in 2008).  Now that the sukuk markets are recovering to some degree, the demand is still there, but it is not being met by mega-sukuk.  In many cases (for example, when GCC-based institutions have traveled to Malaysia to issue sukuk), the average size has shrunk significantly, although there are still a good share of "benchmark" sized sukuk.

This is not a bad thing for the market overall.  While a smaller issue may not generate the same secondary market liquidity (given the proclivity of many buyers to hold-to-maturity), they provide more diversity in issuers, currency, ratings, industry, etc.  This is positive because it provides more opportunities for sukuk investors to diversify, so long as they can get an allocation of new sukuk or find them in the secondary market, which is never a given.

Overall, however, I think the current situation is preferable because 1) there was little secondary market activity in the sukuk pre-crisis; 2) there were far too few diversification possibilities for investors away from real estate and related financial institutions; and, 3) the real estate on which the sukuk were based turned out to have been overvalued, leading to a near collapse of the primary market for sukuk.  Risks remain from a global economic slowdown and geographical diversification is still nearly impossible.  However, the market is on the right track.  Again, I would suggest reading the whole article because there is a lot more there. 


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