Activity in the global sukuk market continues to be buoyant with a steady pipeline of issuances since the beginning of this year and Saudi Arabia and Malaysia leading the way. Over the last weeks, for instance, Saudi Electricity Company (SEC) successfully closed its debut international sukuk, a $1.75 billion dual-series issue; Saudi Fransi Bank launched its $2 billion sukuk program; the government of Dubai successfully closed its two-tranche, $1.25 billion sukuk; and even Alrajhi Bank is contemplating a sukuk issuance in the Malaysian ringgit market through its Kuala Lumpur-based investment banking branch. But in a timely warning lest sukuk origination euphoria sets in, Dr. Nik Ramlah Mahmood, Deputy Chief Executive, Securities Commission Malaysia, the securities regulator, maintains that "while the outlook for sukuk remains bright not only in Malaysia but also globally we cannot and must not rest on our laurels reminiscing about past achievements. Efforts to broaden the base of both issuers and investors of sukuk must be more vigorously pursued." In fact, further innovation, emphasizes Dr. Ramlah, is not an option but a necessity as issuers seek the most optimal structures to meet their respective needs while addressing the investors' preferences. In her keynote speech to the Islamic bonds (sukuk) Outlook Conference in Kuala Lumpur last Thursday, she outlined the significant challenges for the sukuk market that need to be effectively addressed for it to realize its full potential. These include: • Lack of liquidity in the secondary market remains a key issue for sukuk, including the lack of secondary trading, the scarcity of supply, lack of infrastructure, trading mechanisms that are not globally accepted and unresolved issues over valuation. There is therefore a need to develop a more robust secondary market for sukuk that would enhance its appeal especially to active investors, such as fund managers. • Differing views among international Shariah scholars on the trading mechanisms, and indeed the tradability, of sukuk pose a key challenge to achieving a global sukuk market. Furthermore, differences in acceptability of certain sukuk structures are also limiting the marketability of such sukuk internationally. In order to overcome this challenge, sukuk issuers that seek to maximize their investor base are now opting for structures that are more broadly accepted by most jurisdictions. • The operationalization of the International Islamic Liquidity Management Corporation (IILM) should help to mitigate the lack of market liquidity. The IILM has been established to facilitate cross-border liquidity management among institutions offering Islamic financial services by making available a variety of Shariah-compliant instruments, including sukuk, on commercial terms, to suit the varying liquidity needs of these institutions. The IILM, of which the Saudi Arabian Monetary Agency (SAMA) is a founding member, is due to launch its debut benchmark sukuk any moment now and the plan is to issue up to $3 billion of sukuk on a regular basis. • Disparity in legal, tax and regulatory frameworks across the various jurisdictions currently represents another major challenge in achieving a truly internationalized sukuk market as it effectively narrows the scope for cross-border offering of sukuk. Legal, tax and regulatory frameworks that do not provide for a level playing field between sukuk and conventional bonds within a jurisdiction also serve to discourage the growth of its domestic sukuk market due to commercial or practical disadvantages. The Ministry of Finance, SAMA and the Capital Market Authority (CMA) in Saudi Arabia could do well by noting the sentiments of the experienced Dr. Ramlah, who effectively is in charge of regulating and supervising the Islamic securities and capital market (ISCM) in Malaysia. The reality of the global sukuk market is that while issuances are proliferating, the concomitant ISCM infrastructure is lagging in an overwhelming number of member countries of the Islamic Development Bank (IDB). In fact, in the case of UK, France, Luxembourg, Singapore, Ireland and even Hong Kong, it is easier to facilitate the issuance of sukuk because of tax neutrality and other enabling provisions than in many of the Muslim jurisdictions. That in itself is a sobering thought of how far the sukuk market still needs to mature. A Saudi-Malaysian discourse is vital for the future development of the global sukuk market, for two simple reasons. The first reason is that Malaysia is by far the most developed systemic Islamic financial market in the world and has many of the regulatory, legal, accounting and market architecture in place, including a new Islamic Capital Market Master Plan for the next decade and critical mass of issuances and an active secondary trading market. The second reason is that Saudi Arabia has the largest liquidity pool in Islamic finance and as such is potentially the largest sukuk origination market in the world. However, the differences between the two markets could not be more stark. a) Trading on the Tadawul of sukuk is only about four trades in the first quarter of 2012 (albeit Tadawul does not distinguish between sukuk or conventional bonds in its data); b) Most of the Saudi sukuk to date have been local issuances, mostly public issuances with a few private placements; c) There have very few international issuances. The latest SEC sukuk offering is its first global sukuk after three domestic issuances; d) Saudi Arabia has yet to issue a benchmark debut sovereign sukuk, and the likelihood of such an issuance is receding at least for this year given the huge projected surplus the Kingdom is in for because of high oil revenues due to the high oil prices; e) SAMA is of the opinion that a sovereign sukuk is not necessary given the number of quasi-sovereigns issuing sukuk including the General Authority for Civil Aviation (GACA) which issued its debut SR15 billion sukuk in January 2012; SABIC which is in the process of finalizing its fourth sukuk; SEC and subsidiaries or joint ventures of Saudi Aramco such as SATORP. f) SAMA believes that a yield curve for sukuk/bond issuances in the Kingdom, can be built up through the above sukuk or other conventional bond issuances offered by quasi-sovereigns in the Kingdom. As such, it is not necessary for sovereign issuances to develop the yield curve, a point which analysts and bankers disagree with. g) The Kingdom has an untried and tested court process especially in the case of sukuk default; in terms of priority of creditors in the case of a default (sukuk holders or other general creditors); tax neutrality measures for equivalent products; and implications of which inheritance laws apply especially in the case of foreign parties. In contrast, as Dr. Ramlah maintains the sukuk market is very important to Malaysia. "The Islamic capital market has contributed significantly to the development of the overall capital market in Malaysia and now represents over half of the total size of the Malaysian capital market," she added. According to the latest data of the Securities Commission Malaysia, between 2000 and 2010, the First Capital Market Masterplan period, the local Islamic capital market more than tripled in value to RM1.05 trillion, growing at an annualized rate of 13.6 percent. The total value of sukuk issued globally in 2011 amounted to $92 billion, representing a 68 percent year on year increase, of which Malaysia accounted for 73 percent or $67 billion. Malaysia is also the domicile for 68 percent of the $210 billion total sukuk outstanding globally as at end-2011. Indeed, the outlook for the the Malaysian sukuk market could not be more bullish. The Second Capital Market Masterplan, or CMP2, which spans the ten-year period to 2020, projects the size of Malaysia's Islamic capital market will expand at an average rate of 10.6 percent per annum, to reach RM2.9 trillion by 2020. The sukuk segment is expected to account for RM1.3 trillion or 46 percent of this total, translating to an average annualized growth forecast of 16.3 percent over this period. The growth drivers for this are further internationalization of the Islamic capital market; greater diversity of domestic and foreign issuers; more issuances in non-ringgit currencies including US dollar, euro, renminbi and Singapore dollar; various tax and other incentives as outlined in the Malaysian National Budget 2012; and demand from a wider investor base from different geographical and economic regions. These drivers are also inter-connected with the growth of Malaysia's direction of external trade and investment, which in turn are linked to financing and funding requirements among Malaysian businesses and their foreign counterparties. In this respect receiving countries such as the UK, France, ASEAN and some East asian countries have adopted a more facilitative regulatory environment including tax neutrality measures for sukuk which is facilitating greater cross-border investments in sukuk thus widening the demand base substantially. Similarly, on the domestic front, stresses Dr. Ramlah, the Economic Transformation Program (ETP) of the government of Prime Minister Mohd Najib Abdul Razak, projecting RM1.4 trillion in investments, whereby 92 per cent of the total funding is expected to come from the private sector. "The sukuk market is primed to benefit from the rollout of projects, such as the integrated urban mass rapid transit system which is said to require an overall investment in excess of RM36 billion. For various reasons, particularly in respect of the highly competitive pricing for sukuk in Malaysia, funding requirements for some if not most of these projects will likely be met through sukuk issuance," she added. __
