The relatively moderate growth in sukuk volumes in 1Q18 highlights continued interest in the asset class, but also the structural constraints on faster expansion, Fitch Ratings says. Issuer funding needs and investor appetite for the remainder of the year will be determined by various factors including oil prices, tighter global financing conditions, and investor sentiment in the light of regional tensions in the Middle East.
The total volume of sukuk rated by Fitch stood at USD80 billion at the end of the first quarter, a net increase of 6% from end-2017. New sukuk issuance with a maturity of more than 18 months from the Gulf Cooperation Council (GCC) region, Malaysia, Indonesia, Turkey and Pakistan was USD14.9 billion in 1Q18, a 1% increase compared to a year earlier.
Seasonal patterns will affect quarterly issuance, which may pick up in the second half of the year following Ramadan and the summer break. But if the first quarter rates of growth are broadly maintained over the course of 2018, the annual increase in outstanding volumes would be broadly consistent with that seen in recent years.
1Q18 issuance was driven predominantly by the GCC, whose funding needs are likely to fall if oil prices stay high, although they may choose to issue as part of their efforts to deepen local debt markets and diversify funding sources for themselves and corporate borrowers in the region. Investor sentiment may also be vulnerable to geo-political tensions in the Middle East and the pace of US monetary policy tightening.
The authorities in major Islamic finance jurisdictions continue to promote the development of the product and capital markets. For example, the Saudi Capital Markets Authority announced in April that government debt instruments, including sukuk, would be listed on the Saudi Stock Exchange, which could increase the depth and liquidity of the market. Innovation has continued – for example, in February, Indonesia issued the first green sovereign sukuk.
However, we think that structural constraints mean growth may be steady but unspectacular. Standardisation remains a significant challenge. Variations in product structure and documentation, financial and accounting reporting, supervisory and regulatory frameworks, sharia codification, and law and dispute resolution persist. Greater standardisation in these areas would help sukuk gain wider acceptance among international investors, especially if it helped set out rights and obligations in all circumstances. A key constraint remains the lack of a track record of legally enforcing creditor rights in many key Islamic finance jurisdictions.
The potential for variations in interpretation of sharia principals and a lack of legal precedent have both been highlighted by Dana Gas’s attempt to have its mudaraba sukuk declared unlawful on the grounds that it is not sharia-compliant. The company said this month that it had reached agreement with the ad hoc committee of sukuk holders on a restructuring and refinancing offer, subject to the consent of shareholders and sukuk holders.
If the offer proceeds as planned, it would demonstrate the tendency for debt restructuring in the UAE to be via an out-of-court process. This continues to highlight the limited amount of legal clarity on enforceability and on how court interpretations of commercial law might be influenced by sharia.