As they were reviewing the banks funding needs
recently, executives at HSBC Holdings decided to take a fresh
look at sukuk, or Islamic bonds. Three years earlier the
London-based bank had announced plans to issue up to
$5 billion of sukuk under a medium-term financing program,
but it never proceeded because the sukuk market, which seized
up during the financial crisis, failed to recover. In recent
months, however, a decline in yields and a revival of activity
persuaded HSBC that the time was right to dust off its
In June the banks subsidiary HSBC Bank Middle East
sold $500 million of five-year sukuk priced to yield an
expected 3.575 percent. It was the largest
sharia-compliant financing ever arranged by a non-Islamic
institution. The deal saved money: ?At a yield of 155 basis
points over midswaps, the cost was 15 to 20 basis points
cheaper than the bank would have paid on a conventional bond
issue. The offering also helped HSBC deepen ties with investors
in the Gulf, an increasingly important market for the bank.
We wanted to ensure we were capturing as much of the
Islamic investor base as possible, says Mohammed Dawood,
head of global capital financing at HSBC in Dubai. With
this issue we ticked all of the boxes in terms of geographic
distribution, Islamic accounts going into the transaction and
overall successful secondary market trading as well.
About half of the deal was placed with investors in the Gulf,
primarily family offices.
Once again, the sukuk market is open for business in the
Gulf. In addition to HSBC, a number of regional entities have
tapped the market recently. In May, Sharjah Islamic Bank, a
leading Islamic lender in the United Arab Emirates, sold
$400 million of sukuk yielding 4.75 percent and the
Jeddah, Saudi Arabiabased Islamic Development Bank raised
$750 million at 2.35 percent. Several other banks in the
region are said to be considering entering the market later
this year, and bankers say the Palestine Monetary Authority
plans to offer its debut Islamic bond, worth about
$50 million, this summer.
The market revival is part of the broader global economic
recovery, says Afaq Khan, chief executive officer of Standard
Chartered Saadiq in Dubai, the London-based banks Islamic
banking subsidiary. As the cost of capital has come down
and adjusted to the new financial growth rates and companies
are again looking at expansion, were seeing a growth in
sukuk issues, he says. There is a lot of liquidity
looking for a good credit, good management and a good growth
In addition, the market upturn reflects some factors
particular to sukuk. A lack of Gulf issuance over the past two
years has created pent-up demand and lowered the yields
available to borrowers, bankers say. Investor confidence has
also recovered in the wake of defaults by two borrowers in
2009: Kuwaits Investment Dar defaulted on a
$100 million sukuk, and Saudi Arabias Saad Trading
Contracting & Financial Services Co. failed to make
payments on its $650 million issue after its owner, Maan
al-Sanea, was hit with a multibillion-dollar fraud suit by
Ahmad Hamad Algosaibi & Brothers Co., a Saudi conglomerate.
Even Dubai, which roiled global markets in late 2009 when its
flagship Dubai World conglomerate declared a standstill on
billions of dollars in debt, appears to be on the mend
following a bailout from the UAE.
There are various sukuk maturities that are coming up
this year and next. You have a dearth of supply, says
Yavar Moini, an executive director at Morgan Stanley in Dubai.
And Dubai credit is in better shape following the Dubai
World resolution. There is a feeling amongst banks that the
worst of the provisioning is behind them.
Last month, Nakheel, the property arm of Dubai World,
announced it would issue about $1.36 billion in sukuk to
its contractors and other trade creditors as part of its
restructuring plan. The companys existing
$3.52 billion sukuk, issued in 2006, remains the largest
corporate issue ever. Markets indicate a growing confidence in
Dubais fiscal health, with credit default swaps on Dubai
debt trading at 335 basis points in mid-June, well below the
peak of 702 basis points reached in 2009, when Dubai World
declared its standstill.
You cant underestimate Dubai in developing the
market and setting the benchmark for sukuk in the region,
says Adnan Hawari, head of fixed income at Zawya, a financial
news and data provider based in Beirut.
The net result of these developments has been dramatic.
Dollar-denominated sukuk issued by entities in the six-nation
Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi
Arabia and the UAE) were yielding about 4.6 percent in early
June, down from about 6 percent three months earlier, according
to the HSBCNasdaq Dubai GCC sukuk index. By
contrast, the GCC conventional bond index was yielding 4.9
percent in June.
Total sukuk issuance between January and mid-June reached
$40.9 billion, nearly three times the year-earlier volume
of $14.2 billion, according to Zawya data.
Malaysia continues to account for the lions share of
the market. Borrowers and investors there suffered relatively
few negative effects from the financial crisis. The market
recovery in the Gulf has been dramatic, though. GCC issuers
accounted for $12.8 billion of the volume through
mid-June, compared with $6.9 billion for all of 2010.
Much of the Gulf activity reflects a single jumbo issue. In
January the Qatar Central Bank issued $9 billion of
three-year sukuk to local banks to mop up excess liquidity.
Aside from that deal, however, the pace of Gulf issuance has
picked up notably in recent months. The increase is all the
more remarkable because it has taken place amid social and
political turmoil following populist uprisings in Tunisia and
Egypt. The Arab Spring protest movement has shaken regimes
across the region and prompted a violent crackdown on Shiite
protesters by Bahrains Sunni government, but it
hasnt impeded a recovery in the sukuk market.
Despite the tragic events in Bahrain, the market is
optimistic about the situation in the Gulf, says
Sukuk adhere to principles laid out in Islam. The
instruments cannot relate to businesses involved in practices
forbidden by the religion, including gambling and the
production or consumption of alcohol. Interest is forbidden, so
sukuk are structured in such a way that investors receive
rental income or profit-sharing instead.
The main source of demand remains Muslim investors in the
Middle East, for whom sharia-compliant investments have a
strong appeal. However, conventional investors are also
returning to the market as a diversification move, bankers say.
Were seeing orders from all kinds of Islamic banks,
takaful [Islamic insurers] and investment managers, says
Standard Chartered Saadiqs Khan. Were also
seeing pockets of orders from pension funds. Its very
broad-based. Theyre looking at the risk-reward
trade-off and finding sukuk attractive.
As welcome as the recent revival has been, bankers and
lawyers say more needs to be done to ensure a lasting recovery.
The money is now there, but banks are being more
selective by way of the credit profile and the structures that
are being used, says Ayman Khaleq, managing partner at
law firm Vinson & Elkins in Dubai. You dont
have a high tolerance for risk anymore.
A large portion of the sukuk issued in Dubai between 2004
and 2007 were real estate leaseback transactions. When the
emirates debt crisis hit, many investors discovered that
they wouldnt be able to seize the underlying property if
the borrowers defaulted, because the property hadnt been
registered in the name of the financing vehicle that actually
issued the sukuk. There was no true sale of the assets
that transfers the assets from the balance sheet of the
borrower to the sukuk issuer, Khaleq says. In the
UAE you have to register the sale with the authorities,
or the sale can be considered void.
These days investors are being more diligent. Now
theyre spending more time going through covenants and
making sure security packages are more enforceable, says
Khaleq. Its not enough to say, Heres a
sale contract. There has to be a transfer of title in the
[Dubai] land department.
The sukuk market also needs greater diversity. Nearly 90
percent of this years issues have come from sovereign or
quasisovereign entities, according to Zawya. There should be
more corporate issues for a truly robust market to develop,
says Khaleq. Eventually, he says, he would like to see the
development of specialized desks at Islamic banks, much like
those at international investment banks. We need to
create larger Islamic banks with energy, telecom, what have
you, as opposed to smallish banks, so they can lead the
syndicates like the Wall Street banks do, he says.
The Gulf market continues to suffer from a lack of
standardization of ?bond documents. Underwriters need to hire
their own sharia scholars and obtain a fatwa, or ruling,
that their issues comply with Islamic law every time they bring
a borrower to market; this adds cost and complexity to each
deal. It almost has to be bespoke each time, Khaleq
says. Each deal is created differently, whereas Malaysia
has standardized these documents.