Dubai: Huge demand for long term funding from the European corporate sector in the context of rising regulatory capital requirements faced by banks and financial institutions, there is a huge opportunity for sukuk to emerge as an alternate funding source, according to recent study by Deloitte.
While European corporates are looking for viable long term funding source, Asian and Middle Eastern investors are on lookout for western asset classes suitable for their portfolios. Experts say the complementarity of demand for and supply of such instruments makes sukuk an ideal financing solution.
“The need from European corporate to finance long-term projects that require large capital upfront is challenged by the scarcity of debt finance. At the same time, there is a need from Middle Eastern and Asian investors with funding capacity for Sharia-complaint assets in maturing economies. This correlation between the needs of European corporates and investors in the Middle East and Asia points to strong potential for initiation of Sukuk products and market,” said Joe Al Fadl, partner and Financial Services Industry leader at Deloitte Middle East.
While the global financial crisis has exposed market vulnerabilities such as high volatility and lack of liquidity in capital markets, it also has increased the call for alternative financing asset classes which will have balanced risk and return characteristics that enhance regulatory capital and equity buffers in the financial industry.
“Responding to several global forces, financial services institutions are now required to comply with fundamental regulatory capital changes. The Basel III requirement emphasises on capital quality and the need for improvement of common equity. Basel IV emerged to supplement these requirements and addresses the importance of capital instruments and debt exposures not only in the banking institutions but also in the corporate world. It further proposes the revision for credit risk,” said Dr. Hatim Al Tahir, Leader, the Deloitte ME, Islamic Finance Knowledge Center.
While progress has been made on the regulatory front, the Islamic capital market has introduced innovative equity and debt instruments which are seen to have strengthened the capitalisation and liquidity positions of Institutions offering Islamic Financial Services (IIFS). The development of High Quality Liquidity Asset (HQLA) sukuk, hybrid and perpetual sukuk are examples.
On the corporate debt front, different project financing structures have been introduced in recent years and are used by government and private sectors. Key markets such as include the GCC, Malaysia, Turkey, Pakistan, Indonesia and Europe use these structures.
Experts say Islamic capital market is uniquely advantaged in the current climate to create innovative Sharia-compliant debt and equity instruments that will address the increased demand for funding infrastructure projects in both developing and maturing economies. Currently, developing countries spend about $1 trillion a year on infrastructure and an additional $1-1.5 trillion will be needed through 2020 in areas such as water, power and transportation projects, according to the World Bank.
Although there are clear sings of new opportunities, experts say future depends on a number of factors. “This is subject to the existence of the right regulatory and legal frameworks to ensure protection to investors, and apply the right governance and risk management over deployed funds, thus creating an opportunity to let it develop and grow in a market that is active and liquid,” said El Fadl.
A number of European states have introduced laws and regulations to facilitate the growth of the sukuk market. The most prominent issue in Europe to date took place in Britain and raised £200 million. It was significantly oversubscribed by 10 times the amount raised, attracting investors from the UK, Middle East and Asia.
The Deloitte study provides a number of case studies of possible scenarios in which sukuk could be applicable to certain industries in European countries. Sukuk are used to finance specifically designated socially responsible investment and holdings of sukuk securities are regarded as ethical investments. Germany’s renewable energy sector is one such industry that fits the ethical investment category and whose need for high collateral upfront makes alternative financing such as Sukuk a possible solution.
(Gulf News Banking / 21 December 2015)
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