Although growing in global value, sukuk still lack liquidity

Global Islamic bond issuances last year more than doubled to $31bn compared to 2008. On March 7, Saudi real estate giant Dar Al-Arkan paid back a $600m sukuk. National Bank of Abu Dhabi, the largest bank in the oil-rich emirates, also sold a $750m five-year sukuk in March.

This is good news for the sector, and it comes after a tricky year. In 2009 two sukuk defaulted, one from Kuwait-based The Investment Dar (TID), and the other from Saudi Banking group Saad.

"These defaults have raised questions about this relatively young market", says Dr Mohamed Damak, Islamic Finance Credit Analyst at Standard and Poor's in Paris. One sukuk with a par value of $3.52bn of Dubai World's real estate subsidiary Nakheel avoided default at the last minute when Abu Dhabi promised to guarantee a $10bn credit to Dubai.

Sukuk - not sukuks as it is often written (the Arabic singular is Sak which means certificate) - must be asset-backed in order to be acceptable or halal, according to Islamic Shariah law. A pure monetary underlying is considered to be haram. This is why sukuk are regarded as less risky than most conventional bonds.

Increase in issuance size

Nevertheless, the development in crisis-driven 2009 was encouraging. "Sukuk issuance was down in numbers from 160 in 2008 to 140 in 2009, but the average size increased to $170m from $93.1m", says Damak. "Malaysia became the No.1 issuing country with 54.1% of the value of sukuk issued." One quarter was based in the United Arab Emirates. According to Damak some $20bn worth of sukuk have been announced for 2010 (as yet), while an additional $10bn are talked about behind closed doors.

But although sukuk have been on the forefront of spreading Islamic finance globally, they never reached became commonly used. Launched at triple million figures and traded over-the-counter by institutional investors, Islamic Bonds are still regarded as something far away from daily financial issues and abstracts. Only in the UAE, where National Bonds, a Shariah-compliant bond scheme established to motivate private individuals and families to save money, is headway being made into reaching out to everybody.

Defying the crisis

On the institutional side, steps have been taken to keep the market growing, and interest is picking up: "A number of companies BLME has spoken to have expressed interest", says Humphrey Percy, CEO of Bank of London and The Middle East, adding that, "this situation is likely to change in 2010 in light of the Finance Act of 2009 which provides a framework for issuance of Alternative Finance Investment Bond."

The UK is preparing for parliamentary elections, and both the governing Labour party and the opposition Conservatives have expressed their will to support London's ambitions to remain Shariah finance's beachhead in Europe. But the French parliament is also taking the last steps towards legalising sukuk in a European country with over five million Muslims

Back in England, hurdles remain. "It is important that the Bank of England is encouraged to conduct commodity Murabaha with Islamic banks - so far this has not been achieved - in order to spur liquidity", Percy stresses. Under Murabaha, a commodity is bought by the financier and sold to the investor in installments at an annuity which is the bank's profit rate. "Murabaha and Ijarah (Islamic leasing) structures accounted for three quarters of the total volume globally, while issuers shy away from Musharakah (bank financed joint venture structures) and Salam (Islamic forward structure) sukuk", S&P's Damak notes.

UK listings

At the London Stock Exchange (LSE), there are 25 sukuk listed worth £9.1bn. "Sukuk are not traded on the Exchange's electronic order book system but over the telephone", explains Gillian Walmsley, Product Manager Fixed Income at the LSE.

"There is very little liquidity in the market for smaller sized sukuk", says BLME's Percy. This might change due to innovation at the LSE. "We have actually just recently a launched a new electronic bond market aimed at private investors. On this new market, we have made available a number of 'retail-size' issues, tradeable in small denominations (usually around £1,000 but even as low as £100 and no higher than £10,000)", says Walmsley.

"There is no reason why a new Sukuk issuer couldn't admit their issue to trading on this new electronic order book, provided the bonds are tradeable in retail size and meet all of the admission and listing requirements for our regulated market".

The objectives are clear: Providing a liquid platform and reaching out to the man on the street should be catalysts to maintain healthy growth in the global Islamic bond market.