The vulnerability of sukuk markets

The resurgence in sukuk issuance since the twin shock of the global financial crisis and the Dubai debt crisis has been nothing short of remarkable.  One of the most surprising indicators of how much demand for sukuk has rebounded is that the Dubai sovereign sukuk--issued by the very sovereign that was at the center of a storm in December 2009--has seen its yield drop from 6.396% when it was issued to just 3.2% yesterday.  There have been a few hiccups in the 'year of the refinance' (notably with Arcapita's $1.1 billion syndicated murabaha), but many new sukuk have been issued, including the largest sukuk in history, the $4 billion Qatari sovereign sukuk which priced to yield 2.1% which reportedly left enough buyers out that they flooded the secondary markets, bidding prices up.

The development of the Islamic repo market (as nascent as it may be) has likely also encouraged a few extra buyers for sukuk, since they can realize some liquidity from their sukuk holdings through Islamic repo that allows them to hold onto that sukuk.  This is true in particular for investment-grade sukuk like Qatar's sovereign sukuk.  At the same time, reports suggest Western investors are becoming interested again with sukuk, through both primary and secondary markets.

This is a good thing.  More demand and better secondary market liquidity will help bring new issuers into the market to provide more supply to meet the demand, which is clearly growing.  However, the rapidity with which the market has boomed should be a cause for some concern.  There will undoubtedly be a break in trading activity once Ramadan begins, but after the Eid, will there continue to be the same confluence of financial market conditions to support the prices for sukuk?

Will Western investors return to Europe if there is a pathway to a solution of the Eurozone debt crisis?  Will there be geopolitical tensions in the GCC that affect local investment demand in sukuk versus 'safe' assets like US Treasuries (since not all investments from that region are dedicated entirely to Shari'ah-compliant investment strategies)?  These are always concerns for the market, but when it has risen as quickly as it has recently, the risk of something happening that spooks an already relatively illiquid market rise. 

In the long-run, sukuk markets are likely to continue to grow as Islamic finance increases its share of the financial markets in the GCC, but that does not mean the growth will occur along a straight line.  There will be rough patches (hopefully not as challenging as the last five years), but the demand for sukuk is robust and the more mature that market becomes, the more it is likely to attract new potential investors and issuers.