Work begins as IILM announces August debut sukuk

With the IILM releasing for the first time the issue size and tenor of its debut sukuk, it becomes more likely that the sukuk will be issued on schedule than with previous deadlines.  However,  once the first issuance is completed, the work will continue for the IILM in order to provide enough supply for primary dealers to effectively support secondary market liquidity.  

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IILM secondary market success may depend on time elapsed before its second sukuk

The inaugural IILM sukuk issuance is important for the Islamic finance industry, but that body’s second sukuk may be more important in signaling to the market the total outstanding amount of sukuk to anticipate.  Providing the market—and market makers in particular—with confidence that the IILM will not just be a one-off or occasional issuer will provide more support when making their decision about how actively to participate in developing liquid secondary markets, which will be a key factor for the success of the IILM sukuk. 

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Absence of Saudi Arabia, Bahrain deprives IILM of key markets but peripheral Islamic markets should benefit

The absence of Bahrain and Saudi Arabia from the IILM deprive the institution of entry to key markets for Islamic finance, and may have cost the institution its top rating. While the reason for Saudi Arabia’s withdrawal, it could be due to concern over the possible use of IILM sukuk in Islamic repo transactions, or fears that the IILM sukuk program might curtail commodity murabaha participants profits. Even Qatar, which is more involved in the IILM as a result is showing signs it may not be confident in the IILM’s ability to succeed where others have failed by announcing its own plans for regular sovereign sukuk issuance.

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Saudi Arabia exits IILM, clouding the prospects for sukuk issuance

The withdrawal of Saudi Arabia from the IILM is an ominous development for the body which said in March that it was in the “final stage” of launching a $300 to $500 million sukuk.  It would be hoped that, for the good of the Islamic banking industry which needs additional liquidity management tools, no further delays will occur to the IILM’s maiden sukuk, but the withdrawal of Saudi Arabia could just be the first storm cloud gathering above that institution’s prospects, following several previous delays.

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IILM ready for maiden sukuk, but it should get ready to issue a lot more

The International Islamic Liquidity Management Corp (IILM) appears close to issuing its first sukuk for between $300 - $500 million early next year, with the issuance eventually reaching $2 billion per year.  For all the need for such a relatively low risk sukuk for banks to hold and be able to trade into a liquid market to manage liquidity, the long delay since it was established in October 2010 is disappointing and perhaps some of that delay is due to internal challenges resulting in the departure of the CEO, which has yet to be fully explained. 

One thing that I noticed when reading the plans for $2 billion in annual issuance from the IILM once it ramps up to full volume is how small the amount seems now compared to when the IILM was first announced. And the market has changed since 2010 when it was announced.  Issuance that year worldwide was just above $50 billion while it is on pace for well over $120 billion in 2012 once the year comes to an end.

Sure, it will make a difference to have $2 billion in relatively safe sukuk issued by a multilateral institution.  But with the demand for the latest sukuk from ADIB (a $500 million sukuk that was increased to $1 billion after receiving $15 billion in orders), there is clearly a lot of excess demand for sukuk and maybe the IILM should upsize its issuance to $1 billion per issuance, several times a year (maybe doubling or more its annual issuance).

However, this is likely to be difficult because they have been working on the assumption that issuance would be around $2 billion per year and have to find assets from IILM member countries to back the sukuk issuance.  With the delay already having taken place, it is probably not palatable to anyone involved to go back to the drawing board on any issuance.  And it would probably be a mistake to delay further the issuance by IILM.

However, the changed market circumstances, where issuance is expected to reach $292 billion in 2016, makes the IILM's first order of business once it gets issuance underway to find additional assets to increase the capability for new issuance now, starting with a goal of $4 billion per year and probably looking to increase its capacity as much as it can in case the projections are accurate for the sukuk industry's growth trajectory over the next 4 years.  If the overall sukuk markets jumps by another 1.5 times in that period, the IILM sukuk issuance should at least keep pace, and that puts a target for them of having capacity to issue $10 billion a year by 2016. 

IILM announces new CEO, no mention of current CEO's departure

Mysterious news released late on a Friday evening from the International Islamic Liquidity Management Corporation announcing new CEO, with no mention of their current CEO Mahmoud AbuShamma.  Requests for comment have, understandably, not been returned yet since it is Friday night local time in KL.

The International Islamic Liquidity Management Corporation (IILM) Governing Board wishes to announce the appointment of Dr. Rifaat Ahmed Abdel Karim as Chief Executive Officer of the IILM
effective today, 19 October 2012.

Dr. Rifaat, an international multi-award winning Islamic finance expert, was the founding Secretary General of the Islamic Financial Services Board and the inaugural Secretary General of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). He has written and published extensively on Islamic finance.

Commenting on the appointment of the new CEO, Dr. Mohammad Y. Al-Hashel, Governor of the Central Bank of Kuwait and current Chairman of the IILM Governing Board said, “Dr. Rifaat has an
impressive career track record in Islamic finance and will certainly add value to the work of the IILM. The Governing Board wishes him every success”.

Dr. Rifaat said, “I would like to thank the members of the Governing Board for their confidence on me. It is indeed an honour to be given the opportunity to serve the IILM and assist in achieving its objective, which will certainly support the Islamic financial institutions in effectively managing their liquidity.”

 Drop any thoughts on the move in the comments.  If you have any specific information on the leadership change, please email me at blake@sharingrisk.org. 

IILM ready for maiden USD sukuk in "a matter of months"

The International Islamic Liquidity Management Corporation emerged from a period of silence to say it was 85% ready to issue between $300 and $500 million in US dollar ijara sukuk, backed by sovereign assets of its member countries.  The sukuk are expected within "a matter of months" according to the IILM CEO Mahmoud AbuShamma.

It will not be a one-off sukuk, or as AbuShamma described: "It's not our mandate to issue one sukuk and go off on a holiday, we should be manufacturing a continuous supply of it".  The plan is for up to $2 billion in issuance per year.  This should be a minimum requirement because the IILM has spent the last 2 years preparing for issuance, a large part it describes as facing the "big challenge to ensure it complies with laws in all of the 12 countries in which its members are".

The distribution is expected to be through a dealer network, with up to 2 dealers per member country, and the dealers will be to "underwrite the issuance and create a secondary market".  And that is the biggest challenge for the IILM.  It will have to generate a sukuk that is both desirable for Islamic banks and also in sufficient supply to allow for secondary market activity.   These to goals are, in some respect, pulling in different directions.

For the desirability, the IILM is targeting an area of the market that is not as well served by local central banks (highly-rated, US dollar issuance).  And, the supply of $2 billion per year as a goal to meet demand may fall short.  For example, through the third quarter of 2012, there had been $109 billion in sukuk issuance (per Zawya's Sukuk Quarterly Bulletin), and the pace will likely grow in 2013. 

That means that the $2 billion per year will represent under 2% of the total market, and while the dealers should provide some liquidity to the issuance, nothing can stop the buyers of the sukuk from just holding onto their sukuk (particularly if there are delays in further issuance).  That will drive up the scarcity value of IILM sukuk and lead to even higher levels of illiquidity. 

The challenge to creating a liquid secondary market is based on whether there are sufficient assets that the members are willing to contribute to the IILM to use for new issuance at a high enough pace to meet market demand.  It will also be interesting to see how they deal with sovereign immunity issues if the description in the Reuters article of an "asset-backed leasing structure" is accurate.

I look forward to seeing how the IILM's maiden sukuk issuance is received in the market, and to see whether a secondary market develops (and to see what maturities the IILM decides to issue).  It could be an important development for the Islamic finance industry, if it is done well. 

Sukuk market development

As I was finishing up my weekly newsletter, I had a few extra thoughts to add to what I included in the newsletter.  Here's a portion of the newsletter (sign up on the right hand side of the blog, old issues of the newsletter are available at the Sharing Risk website) for context: 

I ran across a presentation from 2005 where the head of IIFM, Ijlal Alvi (PDF) lays out a broad prediction for sukuk markets (with a few recent relevant news items added):  

• Increasing demand from issuers to tap sukuk markets (South Africa is planning to issue sovereign sukuk) IFIs want tradable sukuk with fixed income profile
• Development of sukuk funds followed by growing demand for sukuk, causing issuance to “surge exponentially” (Indonesian sukuk fund managers want to expand fund size, but fear demand for sukuk will outstrip supply.  This is also true in Malaysia).  
• Sukuk will be used for liquidity management and as a money market instrument.  (IIFM held a meeting on collateralized murabaha with sukuk as collateral, which is rapidly becoming the standard alternative for unsecured commodity murabaha in inter-bank lending markets)

The items for the sukuk market to develop laid out by Mr. Alvi 7 years ago seem to be falling into line quite well, after being interrupted by the financial crisis.  There is however, a key item missing in the sukuk markets across the items above: tradability is possible, but it remains limited.  

What surprised me is how well articulated the needs for the sukuk market have been over several years when the global economy and financial markets have gone through significant changes.  The problem for Islamic finance is not necessarily that the problems are not articulated, it is that there are so many different factors in play, and the sukuk market is not a unified market, so different markets around the world have a different set of items to change that have moved to the top of the list for stakeholders.

For example, the GCC is largely dominated by sovereign (and government-related entity) issuance, which probably mitigates some of the risks to coporate sukuks that are more common in Malaysia, but the GCC sukuk markets are relatively illiquid and dominated (in terms of size) by fewer, larger sukuk.  The Malaysian market is more liquid, with a larger number of issuers, particularly corporate issuers, although there are a number of very large government- or GRE-issued sukuk (the difference is that the secondary market is better developed).  

From the top-down perspective, the GCC would be served by a greater diversity of issuers, while Malaysia is attracting more buyers chasing the available sukuk that causes the market to become relatively more illiquid if holders of sukuk don't wish to part with their holdings in fear of not being able to find another sukuk to replace it.  The discussion above itself is mostly from a high-level, and there are many other nuances that distinguish aspects of the sukuk markets in these regions and across the countries in the GCC.  

However, with different needs in different markets, it is difficult to address the underlying difficulties to even accomplish and agreed-upon goal: creating an Islamic repo product.  This is being adopted, using a collateralized murabaha structure, in both the GCC and Malaysia (the latter in part to provide GCC-connected banks with acceptable short-term liquidity management products as a substitute to the domestic inter-bank market which those banks won't use).  

An Islamic repo product in order to remain viable even in periods of financial stress, need to have highly-rated and liquid collateral (an equivalent to US Treasuries for conventional repos).  There is a shortage of this collateral, which is in part what the IILM will provide (if an inaugural sukuk is ever launched), will have to be issued in large enough supply and with enough diversification across the short end of the yield curve and across different currencies to get a secondary market developed. Otherwise, issuers will be forced to pick and choose from among the sukuk outstanding, which could lead to increased pricing distortions in the yields between liquid and illiquid sukuk as banks bid up the liquid sukuk to use for repo transaction. 

So, while individual markets will have their own challenges to address, it is important for the Islamic finance industry to find areas where there are similar challenges--and solutions--to tackle in a cooperative way.  One of these challenges is liquidity management and the solution, which is on the right path even if it is taking far too long, is the IILM. 

Islamic Development Bank sukuk shows the buyers for future IILM sukuk

The Malaysian International Islamic Financial Centre (MIFC) June newsletter had an interesting article about the latest Islamic Development Bank sukuk, which had a 5-year tenor and a 1.357% yield.  The sukuk was issued for $800 million, with $900 million in orders.  Particularly interesting was the breakdown of buyers: 55% central banks and regulatory authorities, 35% banks, 6% pension funds and insurance/takaful companies and 4% fund managers. 

The breakdown of buyers with most of the issue subscribed by central banks and banks--making up 90% of the total subscriptions--should be seen as supportive for future sukuk issuance by the International Islamic Liquidity Management Corporation (IILM), which is now expected to issue its first $1 billion in sukuk later this year (a target which has been pushed back several times as the IILM waits for a credit rating). 

The same investors who bought the IDB sukuk (central banks and Islamic banks) are likely to be the same ones who will buy IILM sukuk.  The IDB sukuk, based on its high credit rating, is likely to be a commonly used sukuk in Islamic repo, which is becoming more standardized around a collateralized murabaha structure. 

That they are demanding such a low yield on IDB sukuk suggests significant demand for highly-rated sukuk (the 1.357% yield compares to the 0.50% yield on similar maturity German Bunds and 0.67% yield on US Treasuries).  The low yield is partly due to the preferred creditor status it has with preferred creditor status (financing projects in OIC member countries), as well as its ability to call additional capital from non-borrowing member countries ).  Now the next step, presumably, for the IILM to begin issuing sukuk is getting a rating.