Al Bayan A Closer Look At Sukuk

Vijay Valecha, Chief Market Analyst, Century Financial Brokers expands on the most Successful bonds in the region. (Source: CPI Financial)

Sukuk is a Shari’ah-compliant debt instrument that is in line with Shari’ah principles and guidelines set forth by governing Islamic scholars. Since the UAE market is governed by Shari’ah principles, Sukuk are particularly suited to individuals and institutions with a strict mandate to invest in Shari’ah-compliant instruments.

Sukuk securities are also attractive to a broad range of investors who wish to diversify their investment portfolios by seeking exposure to some of the fastest-growing economies in the GCC region and Southeast Asia – which are often less-represented in many traditional bond indexes and funds.

Sukuk serve as an alternative to conventional bonds for Islamic and non-Islamic investors and have the following features:

Rather than offering the prohibited riba or interest, Sukuk instruments offer depositors a stake in the actual investments instead.
Sukuk are based on collecting funds from their owners and investing them through appropriate financing and investment contracts.
Immediate money is not offered to finance-seekers in exchange for future money; Sukuk investors instead hold shares in the bond’s underlying assets and receive regular payments comprising revenue generated by the assets, a structure which is compliant with Shari’ah law.
In Sukuk, fixed income profit is paid to investors at predefined regular intervals, ensuring investors enjoy a steady cash flow.
There is no lock-in period for Sukuk as with other investments; this means an investor who is squeezed for cash can easily redeem his Sukuk holdings for money almost instantly.

Sukuk can be structured in different ways to produce payments for investors. Structures include:

Sukuk Al Ijarah, based on ownership of an asset
Sukuk Murabahah, based on ownership of a debt
Sukuk Al Musharakah, based on ownership of a business
Sukuk Al Istithmar, based on ownership of an investment.

Recent data compiled by the International Islamic Financial Market (IIFM) has revealed that the total Sukuk issued globally between 2001 and 2015 reached a staggering $767 billion (Dh2.82 trillion). Around 96 per cent of the issuances originated in the GCC region and Asia, with the two regions contributing 22 per cent and 74 per cent, respectively. Malaysia led the global list of countries for the highest outstanding Sukuk issuances (57 per cent), followed by Saudi Arabia (16 per cent), the UAE (10 per cent) and Indonesia (6 per cent).

According to RAM Rating, Global Sukuk issuance reached $22.2 billion as at March 2017, a marginal decrease from $24.1bil recorded in the same period last year, with Malaysia maintaining its leadership by accounting for 38.5 per cent of the total issuance. Indonesia was next at 24.7 per cent followed by Qatar (9.9 per cent) and the United Arab Emirates (9 per cent).

Advantages of Sukuk

According to the data by the IIFM, 61 per cent of all Sukuk securities issued between 2001 and 2015 were linked to governments. This makes Sukuk much safer than conventional bonds, since governments typically enjoy better credit health and control, in most cases.
Sukuks enjoy greater liquidity than their conventional equivalents. This is primarily due to the demand that influences the Sukuk markets; while demand is international, supply is currently limited to the GCC UK and Asia regions. This factor reduces the liquidity risks when investors wish to sell their holdings.
Another important factor favouring Sukuk is that as securities, they are anchored in actual assets – ownership in particular projects, properties or special investments – while bonds are more or less debt instruments.
Perhaps most importantly for investors, Sukuk securities are becoming the preferred choice over fixed deposits. This is mainly because of the profit rates that each instrument offers. Sukuk securities can offer on average a return of 4-5 per cent per annum, while fixed deposits for the same period and currency (usually US dollar) pay 1-2 per cent per annum at best.

As with any other investment, Sukuk is not without risk. Some of the most inherent ones are credit risk, default risk, price risk, interest rate risk and liquidity risk. All these risks are somewhat interrelated – in the sense that they complement each other in practice. Moreover, there are many intangibles that play a crucial role in the quality of Sukuk, especially in the GCC. Since the Sukuk securities are governed by the Shari’ah principles, there is a high regulatory risk attached with these securities.

(Dana Gas- attempted to declare its bond issue unlawful, leading to a court battle. The company in June 2017 informed its investors that it could not make payments on its $700million Sukuk bond because its structure has been deemed unlawful under Emarati Law)

Amongst the sukuks, AHB Sukuk Co Ltd has the highest rating at A+ with a coupon rate of 3.27 per cent maturing in October 2018. However, EI Sukuk Co Ltd (rated A) maturing in November 2018, offers the highest coupon rate of 4.15 per cent amongst the A category rated sukuks.

Amongst the BBB category, JAFZ Sukuk (rated BBB) maturing in 2019 is offering the highest coupon rate at 7 per cent. The BBB+ rated sukuks are offering an average coupon rate of 3.5 per cent. The BBB rated sukuks & BBB- rated sukuks are offering an average coupon rate of 4.9 per cent.

The popularity of Sukuk has been growing worldwide as an attractive investment option, especially given its link to the rapidly growing Islamic economy. These securities appeal to a broad range of investors – institutional and individual, Islamic and non-Islamic.

Sukuk are a comparatively safer alternative to conventional bonds because they are backed up by actual underlying assets and thus, they can be part of a vibrant investment portfolio, yielding attractive returns. Although these securities have a regulatory risk attached to them, the probability of this risk transpiring is unlikely.

Ultimately, it’s important for investors to assess their appetite and ability to bear market-related risks and carefully analyse available options.

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