In the wealth management classes I conduct in the middle-east I include a small session on Islamic-based financing and particularly the Sukuk. In presenting these sessions what has struck me is how little awareness there is out there of this growing branch of finance and the eagerness of the participants to learn more. While the topic of ‘Islamic finance’ grows in popularity, with many new books on the subject being launched on a regular basis, it seems that awareness and knowledge is still quite limited even in countries you would think would naturally take the lead it.  

Let’s briefly survey this relatively ‘new’ financing tool, the Sukuk, that is now making ground in unlikely new territory and the potential it holds for institutions and banking professionals within the GCC and elsewhere.

What is a Sukuk?

A Sukuk is similar to a traditional bond, except it complies with the requirements of Shari’ a law. Essentially under the Koran interest earned on money is not permitted, but other types of structures are. While a Sukuk is similar to an asset-backed bond it does not offer a fixed annual interest rate, rather its returns to investors are derived from leases, profits from property transactions and joint venture businesses etc. These transactions are structured to provide the equivalent of a fixed return, similar to a bond, yet not defined as an ‘interest’ payment.

Sukuk’s are normally priced in the same way as a conventional bond, with a spread based on an established interest rank benchmark such as LIBOR.

Who uses Sukuk’s?

There are two main users of Sukuk’s. Surprisingly Western and Asian countries are increasingly using Sukuk’s to tap into the vast petro-dollar reserves in the Gulf region, and on the other side Gulf borrowers are using them to raise cash overseas to fund expansion in their home countries.

The growth in issuance of Sukuk’s is evident. Between January and October this year, $16.9 Billion was raised, 43% more than last year. Leading the race in total amount raised was Malaysia with over US$10.1 Billion followed by the UAE with US$3.9 Billion, according to figures published in the Wall Street Journal. The attraction for UAE is the infrastructure projects that can be financed using the Sukuk with the funds being used for a specific project on which returns can be generated.

Logically there is much upside for firms to enter into this type of Islamic financing as Shari ‘a compliant bonds can be placed both in traditional Islamic countries and also readily into Western, non-Islamic countries, but it cannot always happen the other way around.

Another spur to the market is the desire of some central banks to diversify away from US dollar-denominated assets, with Islamic bonds being an alternative.

Who are the players?

As previously noted Malaysia is the number one issuer of Sukuk which is where the first bond was sold, in 1990, by Shell Malaysia. While retaining its status as the global ‘headquarters’ of Sukuk many other countries and banks are moving in on what is potentially a big growth market.

In addition to local banks, the large global banks are also moving into this business, an example being HSBC which launched its Amanah finance in 1998 as its global Islamic banking division based in Dubai. It offers a wide range of Islamic products including arrangement of Sukuk offerings.

The Opportunity

But are there enough products out there to satisfy the demand? This is where the opportunities lie in this field with institutions desperate to find talented people to create, distribute and sell Islamic products. The Head of Islamic Banking in Asia for Citigroup, Rafe Haneef, was recently quoted in an article stressing this need. He said there was now a global shortage of Islamic investment products to match the needs of the rich, predominantly Muslim investors from the Middle East, “Too much liquidity chasing too few Islamic products”.

Only the Start

In only a short time the Sukuk and wider Islamic finance has moved from a relatively niche position for most global investors and borrowers to now being firmly in their consideration set when considering financing options. The challenge for finance professionals is to start investing in learning about this type of finance to meet the growing appetite of their clients.