Late-year flurry could boost the sukuk market

Unsplash/Carlos Torres

• Market may rally says Fitch
• Diversification fuels issuance
• Down 25% from 2022

Sukuk issuance fell in the first nine months of 2023 – but this year’s total could yet equal that of 2022, Fitch Ratings’ Islamic finance chief told AGBI. 

Gulf governments and corporations are issuing sharia-compliant bonds to diversify their funding and ease their reliance on bank borrowing.

Sukuk were developed as an alternative to conventional bonds which are not considered permissible by many Muslims as they pay interest, and also may finance businesses involved in activities not allowed under Sharia law. 

From January to September, $154.6 billion of sukuk was issued, down 24.7 percent on the same period a year ago, according to the ratings agency.

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Yet a late-year burst of activity may see 2023 matching 2022’s total issuance of $261.9 billion of sukuk, said Bashar Al-Natoor, global head of Islamic finance at Fitch Ratings.

“The pipeline and issuance of sukuk remains resilient despite emerging market and geopolitical volatility and higher interest rates,” said Al-Natoor.

Total outstanding sukuk was $823.4 billion as of September 30, up 9.8 percent year-on-year. Of this, 28 percent is from Saudi Arabia, 6 percent from the UAE and 3 percent from Turkey, Fitch data shows.

Various factors support sukuk issuance, said Al-Natoor. These include oil exporters’ determination to diversify their funding sources.

“In previous eras, high oil revenues would have meant that many GCC sovereigns would not issue debt because they didn’t need to borrow, but that’s changing,” said Al-Natoor, highlighting recent local currency sukuk issuances by Saudi Arabia and the UAE.

Oil producers with budget surpluses have been issuing sukuk as part of efforts to develop local capital markets.

“Saudi Arabia’s giga-projects won’t just be funded directly by the government or through banks, and part of that could come from debt capital markets, including sukuk,” said Al-Natoor.

Saudi Arabian banks’ liquidity has tightened over the past two years as lending demand outstripped deposit growth. Historically, Saudi banks have relied on funding from customers’ deposits.

“That will persist, but Saudi banks will also seek to reduce this reliance by diversifying their funding through issuing more sukuk,” said Al-Natoor.

Gulf corporations, which historically were reliant on banks’ borrowings, could also increasingly issue sukuk, he predicted.

Muslim-majority countries with budget deficits including Kuwait, Bahrain and Turkey may seek to meet this shortfall in part through selling sukuk, Fitch wrote in an October report.

One size does not fit all

Yet differing interpretations of sharia compliance limits sukuk “acceptability and investment options”, Fitch warns, noting UAE Islamic banks were unable to invest in certain sukuk from Saudi Arabia, Malaysia and elsewhere due to these failing to meet guidelines from the UAE central bank and Bahrain’s Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI).

The UAE central bank launched the Higher Shari’ah Authority in 2018, with the aim of harmonising Islamic finance rules. The authority largely follows AAOIFI’s sharia standards.

“A lack of standardisation hasn’t stopped the sukuk market growing,” said Al-Natoor. “Yes, it does cause extra time, complexity, and cost, but the strong Islamic investor base, specifically Islamic banks, which is a significant part of the GCC banking sector, brings sizeable liquidity to the sukuk industry.”

Islamic investors primarily deploy a buy-and-hold sukuk strategy due to insufficient supply, Fitch wrote.

“The shallowness of the secondary market isn’t due to a lack of potential buyers,” said Al-Natoor. “As more supply arrives, the secondary market will grow, and the buy-and-hold strategy of many investors could diminish.

“It’s also related to the development of the Gulf’s debt capital markets more generally. As we get a wider spectrum of issuers, and investors, Islamic banks might become more willing to buy and sell rather than just buy-and-hold.”

Potential sukuk issuers outside the UAE are increasingly seeking assurance that the terms meet UAE regulations so that UAE Islamic financial institutions can invest, said Al-Natoor.

Separately, retail investors have little scope to invest directly in sukuk, with the minimum dollar tranche typically in five or six figures.

Although sukuk are sharia-compliant and so do not pay interest, but a profit rate, the Islamic instruments price in relation to benchmark interest rates.

The higher-for-longer interest rate era, with the US Federal Reserve unlikely to cut rates substantially until at least 2025, has impacted demand for emerging market debt; previously near-zero interest rates had pushed developed market investors to invest further afield to earn higher yields.

The same dynamics have also affected sukuk, although to a lesser extent, added Al-Natoor, because dedicated Islamic investors tend to be from emerging markets themselves and so need to invest in sukuk. There is a scant alternative in developed markets.