Sukuk: Strength In Numbers

One thing to note about last year’s market turbulence is the fact Sukuk is more resilient than bonds in the secondary market. Middle East Sukuk have returned 0.9 per cent by end of 2018, compared with a 0.1 per cent return for conventional bonds, according to JPMorgan Chase & Co.’s (JPM) indexes.

The same also goes to GCC bonds performance and the emerging market ones (Gulf bonds have returned an annualized 0.6 per cent by end of 2018, compared with a 4.6 per cent loss for other emerging markets, according to JPMorgan gauges).

International investors who would be researching GCC credits more after JPM inclusion, should be aware of these figures for their portfolio diversification.

Reaching banks’ lending limit pushes borrowers toward debt

From a GCC perspective, the main drivers for Sukuk issuance would be due to at least two things:

• The suitable cost of the borrowing environment which we have witnessed in the early start of 2019, i.e. the low yields from US Treasury bonds had a positive affect across all GCC securities in the secondary markets (this is compared with the last two months of 2018 when some investors decided not to subscribe into new securities (from the primary market) and wait until it traded in the grey/secondary markets and then buy it at a discount (due to market turbulence). Unlike other emerging market (EM) countries (whom their currencies are floated), GCC currencies are pegged to dollar.
• Some GCC borrowers have exposure to all their relevant local lenders. Thus, these banks cannot exceed certain lending limits, prompting borrowers to seek external or internal funding sources via debt issuance. Note that in Saudi Arabia, the preferable debt instrument (among investors) is Sukuk.

Change mentality

There are no concerns that sovereign Sukuk issuances are crowding-out the corporate ones. For instance, in Saudi Arabia the Debt Management Office monitors the local debt capital market (DCM) and ensures that there is no crowding out effect.

The challenge we have in Saudi is how to change the mentality of corporates to tap the DCM market instead of over-relying on banks’ lending. Local lenders also share the blame in not developing the corporate side of DCM.

Local GCC regulators should be proactive

 While greater standardisation in the Sukuk market would be welcomed, I can see that the industry has adjusted to that shortcoming. Standardisation would be much needed in the local DCM market by capital market regulators in order to cut the cost of transaction documentation to borrowers.