This has been a banner year for the Islamic finance industry, thanks to a slew of new high-profile Islamic bonds from an unusual source: non-Muslim governments in Europe, Asia and Africa.
The UK won the race to be the first government from the western world to tap the fast-growing market for so-called sukuk, by structuring and selling a £200 million Islamic bond in June. It was followed by Hong Kong, South Africa and Luxembourg.
These non-Muslim countries have not chosen the arduous, complex task of issuing debt-like securities that adhere to Sharia due to their religious beliefs.
In terms of overall volumes, there has been about $32 billion of sukuk sales this year, according to Dealogic - respectable, but unlikely to break the $44.8 billion record set in 2012. But the quality and prestige of the sovereign sukuk sales clearly makes this a vintage year for the market, and constitutes a fillip to the wider industry.
“Four non-Muslim countries coming in a year suggests there’s a lot of momentum,” says Neil Miller, a veteran Islamic finance lawyer at Linklaters, who worked on the UK sukuk.
This has implications also for the Gulf’s increasingly vibrant Islamic finance industry. Malaysia remains home to the largest and most developed market, but the biggest potential is in the oil-rich Gulf, where Islamic banks are now in many markets competing head to head against conventional lenders — and gaining ground.
But one longstanding problem has been a lack of Sharia-compliant, liquid assets in which to invest excess deposits. Samad Sirohey, head of Islamic banking at Citi, points out that these have been building rapidly in recent years due to low credit growth in their domestic markets.
The spate of new sukuk debutantes have therefore given the cash-rich Islamic banks in the Gulf a sorely needed outlet.
Demand seems to be ravenous. The UK attracted more than £2 billion of demand for its £200 million sukuk without breaking a sweat. Appetite is particularly strong from the Gulf. For example, more than 60 per cent of Luxembourg’s €200 million debut went to Middle East investors.
Even lower-rated countries face little difficulty in borrowing from Islamic investors desperate for more supply. Indonesia returned to the Islamic bond market in early September with a $1.5 billion issue that saw more than $10 billion of orders. South Africa’s maiden $500 million sukuk garnered a $2.2 billion order book.
“The supply-demand dynamic is still tilted towards demand,” Sirohey says.
The crucial question many in the industry are asking is whether the clutch of western sovereign issues encourage more companies — whether western or in the Gulf — to follow suit, and transform a healthily growing but still relatively narrow, thinly traded market into a vibrant financing tool on par with other bond markets.
Typically, governments are the first to tap bond markets, setting a benchmark that banks and companies use to price their own issues.
Sovereign sukuk sales are arguably even more important in laying a path for companies, especially western ones, as it can help make the often-complex legal structures more understandable.
“Companies don’t necessarily want to be the first issuers in a new market, so we need governments to pave the way,” says Miller.
There are some encouraging signs. Goldman Sachs shrugged off a controversial attempt to issue a sukuk three years ago that ended in failure and returned to the market this year, becoming only the third global bank to structure and sell a sukuk, after HSBC and a small issue from Nomura.
Bankers and lawyers are now hounding companies in the UK, Africa and Asia to follow in the footsteps of London, Johannesburg and Hong Kong by tapping this eager investor base.
“What we’re excited about are the corporates coming,” says Tamim Al Kawari, chief executive of QInvest, a Qatari Islamic investment bank, and one of the banks that worked on Goldman’s sukuk.
“Sovereigns coming is good, but I really hope that corporates come in on the back of them.”
It remains questionable how many western companies will do so, given the additional legal and financial legwork required to structure sukuk.
It is notable that western companies that have issued Islamic bonds — including HSBC, General Electric, Nomura and Tesco’s Malaysian arm - have not returned to the market. That is understandable. Why go through the long, expensive process of dealing with Muslim scholars, lawyers and bankers to issue a sukuk, when it has never been easier and cheaper to sell conventional bonds?
But Kawari argues that companies that ignore the potential of the sukuk market are missing a trick, by cutting off an alternative funding tool that is becoming increasingly viable. The Qatari investment banker points out that the time it takes to issue an Islamic bond has been shortened considerably in recent years, as structures and the legal documentation have become more standardised.