Gulf conventional bonds issuances leap ahead of sukuk issuance for first time

Gulf corporates have issued $12.8bn in conventional bonds over the past 12 months to (June 31), compared to just $4.3bn in sukuk.

Trowers & Hamlins explains that there was jump of 15% in the value of conventional corporate bond issuance in the Gulf from last year's $11.2bn, whilst sukuk issuance fell 74% from last year's $16.9bn.

Trowers & Hamlins says that as the turmoil in the capital markets finally swept into the Gulf the price of corporate sukuk fell much further than the region's corporate bonds. At one point the yield on corporate sukuk increased to 17% whilst the yield on the comparable index of Gulf corporate bonds at that point only increased to 11%.

Trowers & Hamlins explained that as investors were demanding such high yields on sukuk it made sense for Gulf corporates to switch to issuing conventional bonds.

Neale Downes, Regional Banking & Finance Partner in the Trowers & Hamlins Bahrain office, comments:

"The fact that conventional corporate bond issuances have overtaken corporate sukuk issuances by such a large margin is unprecedented in the relatively short history of the Gulf's debt markets."

Neale Downes explains that there were a combination of commercial or market-related factors that led to the steeper falls in the price of sukuk:

- During times of financial stress investors tend to avoid newer, complex and less tested forms of investment for more traditional investments - a trend from which sukuk are more likely to suffer from than conventional bonds;

- Real estate and construction companies have been relatively heavy issuers of sukuk so, as property prices in the Gulf took a hit, this may have had a knock on impact on investor's attitude towards sukuk issued by companies in those sectors. In 2007-2008 38% of sukuk issuance was by real estate companies whereas only 5% of conventional Gulf corporate bond issuance in the same period was from real estate companies.

Neale Downes also says that enthusiasm amongst some Islamically compliant investors for sukuk might have taken a temporary knock when questions were raised as to whether all sukuk structures were strictly in accordance with shariah law at the beginning of 2008.

Broader legal problems:

Neale Downes says that of possibly even greater significance to how investors assess sukuk has been uncertainty whether, on the default of a sukuk, the investors will really have security over the assets on which the sukuk is based.

Explains Neale Downes, "When some originators have found themselves in financial trouble or, worse, have become insolvent, sukuk investors have found themselves unexpectedly competing with the general body of creditors, rather than simply enforcing against or taking possession of the assets "supporting" their sukuk."

Neale says that the recent defaults in relation to the East Cameron sukuk and the uncertainties now hanging over Saad's "Golden Belt" sukuk, have called into question the integrity of sukuk structures.

Adds Neale Downes, "Subscribers to sukuk are meant to be part owners of assets so their credit and risk profiling should be based on an assessment of the revenue generating potential of those assets, instead of just the paying ability and balance sheet of the company issuing the sukuk. In the absence of such a treatment, sukuk become no different from conventional corporate bonds."

The defaults have highlighted the disparities between English/Common law, by which nearly all sukuk documentation has been governed and civil law systems that prevail in most of the Gulf states calling into doubt the validity of:

- the transfers of assets from the balance sheet of originators to issuer SPVs; and,
- the trust arrangements upon which issuers hold assets for the benefit of their investors.

Says Neale Downes, "The Islamic finance community is working hard on the development of more transparent, comparable and tradeable sukuk structures and generally on the harmonisation of Islamic finance documentation and interpretation of Shari'ah standards."

Downes adds, "Sentiment towards corporate sukuk has recovered substantially since the worst of the market in early 2009 and their yields are now moving close to their levels pre the collapse of Lehman Brothers."

Downes states, "Government intervention in the region's economy is beginning to bear fruit and the rise in oil prices should add extra fuel."

"We are not out of the woods yet but if the market recovery continues it may be that the sukuk market will come back fundamentally stronger having survived its first real test," Downes points out.

"The long term appetite for shariah compliant investments is most definitely there and the need for private sector funding of the growing Gulf economies is a given," says Downes.

The average length of time to maturity of GCC corporate sukuk issued over the last 12 months was 6.9 years versus 7.4 years in the previous twelve months which also suggests a reduced risk appetite amongst sukuk investors over the last year.