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Thursday, 21 February 2019

Against the odds

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Asia’s sukuk market has defied predictions of doom linked to the fall in oil prices, with sovereign and infrastructure-linked issues potentially pointing to a record year for new issues.

The Asian sukuk market has bounced back this year from a 2015 in which demand was subdued on fears of Federal Reserve rate tightening. The recovery has surprised many market players who believed the oil price collapse would dent confidence, but liquidity remains strong and sukuk demand is outstripping supply.

“Despite the wealth effect of lower oil prices on the oil exporting countries in the Middle East and Asia, liquidity has remained sufficient to support new sukuk deals,” said Dato Mohammad Effendi Abdullah, head of Islamic finance at Ambank in Kuala Lumpur.

Issuance of sukuk sank almost 30% globally last year as oil prices slumped and investors awaited Fed clarification on interest rates, but it has since recovered.

The slowdown in Asian issuance was less marked, declining from US$20.2bn-equivalent in 2014 to US$19bn-equivalent last year. By contrast sukuk issuance from the region has been brisk at US$11bn-equivalent in the first half of 2016. A ream of infrastructure-linked deals and refinancings is expected to produce record-breaking sukuk issuance for the full year.

For Malaysia, the region’s most fertile source of Islamic bonds, issuance has rebounded even in the face of a scandal involving state investment company 1MDB which was seen in some quarters as likely to place the country on a negative ratings trajectory.

“Despite the wealth effect of lower oil prices on the oil exporting countries in the Middle East and Asia, liquidity has remained sufficient to support new sukuk deals.”

While the noise surrounding 1MDB, which is the subject of multiple government investigations around the world, lingers in the background, the ringgit has stabilised and sound government finances have encouraged foreign investors to pump money back into the country.

The rethink was never more in evidence than when the Malaysian sovereign managed to raise US$1.5bn via a two-tranche sukuk in April. There was no hefty new issue premium to get the 10 and 30-year paper away and the successful placement underscored the depth of liquidity prevailing among regional buyers of sharia-compliant debt.

Indeed, the Malaysia deal underlines a supply trend which many regional Islamic banking professionals believe will distinguish 2016: the issuance of sovereign sukuk. Sri Lanka has mooted sukuk issuance and it remains on the country’s radar despite the successful print in mid-July of a US$1.5bn Reg S/144A dual trancher.

Sri Lanka’s funding requirement is not filled yet, paving the way for sukuk issuance. And, as the new administration of President Rodrigo Duterte in the Philippines eyes an increase in government spending to fund an ambitious infrastructure programme, sukuk is very much on the table.

If anything proved that the sukuk bid for sovereign paper anchored in the Middle East investor base is alive and kicking it was the US$2.5bn trade in March from the Republic of Indonesia, wherein the five and 10-year tranches came handsomely inside initial guidance to the tune of 30bp and 25bp, respectively. Asian sovereign debt offices circling the sukuk market should note the heavy allocation into Middle East accounts: 42% and 28% on the respective tranches.

Meanwhile, the Malaysian sukuk market has been enlivened with infrastructure-related deals, placing Islamic debt at the centre of much sought-after solutions to Asia’s vast infrastructure financing needs.

“There has been more government-guaranteed sukuk this year in Malaysia to fund large infrastructure projects in the rail and road sectors which has boosted supply. More issuance from the infrastructure sector is expected over the rest of this year and next, and with the corporate space facing a heavy refinancing need, overall supply will pick up,” said Abdullah.

Waiting in the wings as a standout in size terms is the financing for the Pan-Borneo Highway, a project earmarked for M$27bn (US$6.8bn), of which 60% of the project cost is planned to be raised from sukuk issuance in ringgit, off a M$13bn shariah MTN programme. A federal government credit wrap from Danainfra Nasional will provide ratings enhancement for the planned financing.

Around M$7.5bn of sukuk issuance from the Malaysian infrastructure sector is waiting in the pipeline, with the deals expected to have an easy ride given their government linkage via ownership or credit guarantee.

“The usual players – the financial institutions including Islamic banks, the insurance companies, the pension funds such as the EPF, KWAP, Lembaga Tabung Haji and the asset management companies – have been in evidence supporting deals and now that the picture with regard to US short-term interest rates is less uncertain, confidence has rebounded. With EPF account holders able to nominate portfolio products in the Islamic space, this is expected to boost demand for domestic sukuk,” said Abdullah.

Corporate sukuk issuance from Indonesia is also set for a boom as the government of Joko Widodo actively encourages local companies to tap the sharia bid. The country’s Financial Services Authority has requested that 53 out of 119 state-owned companies raise funds through the sukuk market to fund the building of infrastructure. Just around 4% of Indonesia’s outstanding corporate debt is in sukuk format.

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