By Bashar Al Natoor, Global Head of Islamic Finance, Fitch Ratings
The sukuk market has the potential to grow considerably in the near to medium term as key Islamic capital markets develop. Four key areas need to be harnessed to fast-track corporates as a significant player in the sukuk and the debt capital markets, namely:
- Cost and time optimisation
- De-sophistication and standardisation
- Processes and execution costs need to be optimised
Shifting corporate funding in the Gulf Cooperation Council (GCC) region from bank loans to sukuk and bonds is seen as more costly and time consuming. Banks in region are also primarily funded by deposits from customers and governments rather than capital markets, and we do not expect this to change significantly in the short to medium term. This is because many potential issuers see the economics for issuing sukuk or even bonds as less advantageous than taking out a loan from a bank. Therefore, the regulations, processes and costs for sukuk and debt capital markets in general need to be optimised so that they can compete with traditional loans.
- Issuers need incentives to enter the debt capital markets
Issuers must be given monetary and technical incentives (apart from tax-neutral policies) to make sukuk an attractive alternative for them. Such incentives are already implemented by Indonesia, for example, where it provides lower registration fees for corporate sukuk issuances.
- Sukuk must be de-sophisticated
Sukuk standardisation remains elusive on local, regional and global level due to its complexity, as can be seen in the chart below. Therefore, reducing the sophistication of sukuk, which is currently a key obstacle preventing or limiting the desire for capital users, is critical.
- Issuers need to be educated about sukuk’s benefits and risks
Capital market education may seem like a low priority, but it is actually key to removing an important barrier to growth in the corporate issuing sukuk market. This can be done by conducting robust public awareness and education programmes that inform issuers about the benefits and risks of funding from capital markets, sukuk and other sharia-compliant products as an alternative to bank loans.
The same holds true for investors. There are four key issues that need to be resolved that could boost growth:
- Build and develop the relatively small and shallow local and regional institutional investors, such as pension funds, Takaful/insurance companies and mutual funds (with the exception of Malaysia that has a more developed market).
- Establish greater confidence in the regulatory/legal framework, as it is currently yet untested and under developed. The adoption and implementation of effective and efficient regulatory and legal structures are key catalysts to bolstering the Islamic finance industry, and are crucial to creating reliable investor protection.
- Addressing the fact that sukuk in many countries still lacks the scale and mass of issuances to meet some of the international investors’ prerequisites, like the limited secondary market liquidity, either due to sukuk structure tradability issues or buy and hold inventories, or the under-developed diversification of products.
- Build a strong regional track record in economic sukuk performance and then increase investor confidence in key areas, such as risk levels, ease of access, cost and transparency, to attract international investors.
The return to debt issuance in 2018 by many governments (although not at the same level of 2017) helped to encourage growth in the private sector’s sukuk market. In addition, efforts to establish a basic sukuk market ecosystem and enhance infrastructure and processes for corporate debt issuance are making sukuk more attractive for corporate and financial institution (FI) issuers.
As capital markets in the 10 largest sukuk countries become more efficient, sukuk could become an attractive alternative of funding for corporates. Total Islamic finance assets are projected to grow by 58% to $3.8 trillion in 2023 from $2.4 trillion in 2018. By adequately addressing the 4 x 4 keys to unlocking growth - cost optimisation, incentives, de-sophistication and education – the global corporate sukuk market should be able to reach its full potential.