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Saturday, 30 May 2015

As sovereign issues grow, pricing and design stymie corporate sukuk

Sukuk issuance by governments around the world is expanding, helping to bring Islamic finance into the mainstream. But in one respect, the sovereign issues are proving a disappointment: they are not encouraging sukuk sales by companies.
Legal and product design issues as well as pricing - it can be considerably more expensive for companies to issue sukuk than conventional bonds - are deterring corporate activity.
Last year saw debut sukuk issues by the governments of Britain, Hong Kong, Luxembourg, Senegal and South Africa. Hong Kong tapped the market for a second time this week with a $1 billion deal.
Demand among international investors has been strong. Large pools of Islamic funds in the Gulf and southeast Asia are hungry for sharia-compliant instruments.
But expectations that the sovereigns would pave the way for companies to issue sukuk, by demonstrating the viability of Islamic bonds and by building a benchmark yield curve, have so far been dashed. Since the five debut sovereign sales, no company has issued sukuk in those five economies.
As a result, sovereign and quasi-sovereign issuers accounted for 85 percent of the $113.9 billion of sukuk deals done globally in 2014, and that proportion shows no sign of changing. Outside Malaysia, Saudi Arabia and the United Arab Emirates, corporate sukuk remain rare.
"In 2015 we will continue to see sukuk issuance, but in the context of the global capital markets I expect that it will remain a niche product for some time," said Richard O'Callaghan, Islamic Finance partner at law firm Linklaters, which advised Britain and Luxembourg on their maiden sukuk deals.
O'Callaghan said he hoped to see a number of corporate sectors, including telecommunications and utilities, explore the possibility of issuing sukuk.
South African National Roads Agency Ltd (Sanral) and power utility Eskom have been considering issues since the South African government conducted a $500 million sale last August.
But companies face a new set of legal and tax issues when they use sukuk. For example, the asset-backed nature of Islamic bonds means multiple asset transfers may be required for an issue, creating a heavy tax burden for the issuer unless special legislation is in place.
Sanral has studied sukuk for years but has faced some challenges relating to the transfer of assets and its tax status, Vusi Mona, Sanral's general manager of communication, told Reuters.
In Malaysia and the Gulf, investors are familiar enough with sukuk to demand little if any premium to buy them; in the Gulf, it has sometimes been cheaper for companies to issue sukuk than to sell conventional bonds. Elsewhere, the investor environment is different.
Both Sanral and Eskom said they would only sell sukuk if that was cost-effective versus other funding sources.
"The sukuk market remains an option for Eskom. The SA government sukuk benchmark and its post-issuance performance remains a guide for us," the company said in response to Reuters questions.
The specific structure of sukuk is another important consideration for companies and investors, and may partly explain why companies have not so far followed the sovereigns.
Britain, Hong Kong, Luxembourg and South Africa all used a lease-based format known as ijara for their debut deals, apparently because they wanted to ensure wide investor uptake. Ijara requires underlying tangible assets to back the entire transaction amount, however, and while that requirement may be easy for governments to satisfy, it can be difficult for companies.
For its second sovereign issue this week, Hong Kong used a hybrid format with an agency-based wakala contract, where only a third of the deal needed to be underpinned by tangible assets.
This could provide a more practicable model for potential corporate issuers in the territory, as Hong Kong authorities suggested.

"The use of the 'asset light' structure can set a benchmark for potential issuers in the private sector," Financial Secretary John Tsang said in a statement on Thursday. 
(Reuters / 29 May 2015)
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