Principles of Islamic banking and finance/PIBF203/Sukuk/Global sukuk market

==Overview of the global sukuk market: IIFM Report (2016) ==

Since 2011, Sukuk market has maintained its growth trajectory and year 2012 and 2013 witnessed record Sukuk issuances at domestic as well as international level. However, during 2014 and more so in 2015 the Sukuk issuances entered into a phase which can be best described as consolidation phase where external forces such as ongoing uncertainties in the global financial system, sharp drop in oil price and possible up-ward revision in the reference rate has had its impact on Sukuk issuance to some extent. The other major event in 2015 was Bank Negara Malaysia (BNM) strategic decision to stop issuance of its Short Term Sukuk and shift of issuance focus from providing investment opportunities to liquidity management for Islamic banks.

Among the positives is continuation of Sukuk issuances from regular sovereign and quasi-sovereign issuers such as Bahrain, Islamic Development Bank, Indonesia, Turkey, Malaysia, Saudi Arabia, UAE, Brunei, Qatar etc. The Sukuk issuances from corporates and financial institutions has also shown signs of revival in these Sukuk issuance jurisdictions. Another positive development is the appeal of Sukuk as an alternative source of financing from new jurisdictions ranging from Europe, Asia, CIS and Africa and emerging sign of possible direct entry from North America. The other essential element, which will keep the growth potential of Sukuk alive, is the types of issuers. It is indeed a good sign that there is diversity of Sukuk issuers and the market has moved from initial Sukuk issuances by financial institutions to issuers ranging from infrastructure development, aircraft financing, socially responsible investing, Takaful sector, Tier 1 &2 capital enhancement purposes,fulfillment of general needs of corporate sector, sovereigns and sovereign wealth funds.

The continuation of longer tenor Sukuk issuances, for tenor up to 30 years by sovereigns such as Malaysia and Indonesia as well as by quasi-sovereign entities in GCC, is another positive development. This will not only attract investment from investors with appetite for long term fixed income profile instrument but will also help in the creation of yield curve which is necessary for secondary market development. The issuances of short term Sukuk by increasing number of jurisdictions from Far East, GCC & Africa as well as by entities such as International Liquidity Management Corporation (IILM), Kuveyt Turk Participation Bank etc., is helping in fulfilling the short term liquidity requirements of Islamic financial institutions.

Another related development is increasing use of IIFM Unrestricted Wakalah Standard, where a reference pool consisting of Sukuk portfolio is created to provide alternate liquidity management option to Islamic financial institutions. Moreover, Central Bank of Bahrain has developed a short-term liquidity product for Islamic retail banks based on IIFM Unrestricted Wakalah standard by using Sukuk portfolio, which has resulted in providing level playing field to Islamic banks. Sukuk is one of the main instrument used for liquidity management and IIFM standard based on collateral is another liquidity management arrangement that is now actively used by the market participants where Sukuk is generally used as an underlying security. Through this standard, the institutions can use their idle Sukuk portfolio for creating liquidity, freed liquidity can be channeled to invest in new Sukuk issuances, enhancing the credit exposure or keeping this arrangement for contingency purposes. During last few years, the investor base is continuing to show signs of widening and Sukuk investors now include fund managers, Takaful operators, high net worth individuals, corporate investors etc. The possible entry of sovereign wealth funds as investor will provide further boost to Sukuk market. The entry of retail investors particularly in Indonesia and Bahrain has opened another stable investor base for Sukuk market.

The low profit rates on bank deposits offered by financial institutions has resulted in shift of retail investors to Sukuks, which is a healthy sign for Sukuk market. As far as challenges are concerned, 2015 must be seen in the backdrop of a weakening global economy and tight supply of liquidity in the global financial system due to falling oil prices, fiscal deficits in oil producing countries, slowdown in China, tightening of credit market and the possibility of reference rate increase. The effect of this global slowdown has been felt in the Sukuk market to some extent. But the major fall in International Sukuk issuances has been avoided due to continuation of issuances from existing jurisdictions plus entry of several new jurisdictions from Europe, Asia and Africa which has maintained the Sukuk appeal as a viable capital market fixed profile instrument.

The challenge is increasing the share of Sukuk issuances from corporate sector which is still slow to respond in most of the established as well as new Sukuk issuing jurisdictions. On domestic front, in January 2015 Bank Negara Malaysia announced a strategic decision to discontinue issuing its short-term Sukuk which were used by both domestic and international investors as an investment opportunity rather than liquidity management. The decision has resulted into drop of around USD40 billion in short term Sukuk market. However, based on public information Bank Negara Malaysia (BNM) in January 2016 has already starting issuing Short Term Murabahah Sukuk with tenor of 9 & 12 months for liquidity management purposes; hence the sharp drop in Sukuk market during 2015 cannot be considered as negative for Sukuk market development. As per IIFM discussion with several market makers, the secondary market trading of Sukuk is taking place though limited and a number of Sukuk from various jurisdictions are trading at premium due to the demand from various investors such as retail, high net-worth, institutions, fund managers etc.