JEDDAH – The sukuk market continues to evolve and innovate. Last year saw the introduction of Tier 1 hybrid sukuk in bank capital structures, longer-term tenors (Saudi Electricity Co.'s 30-year Islamic finance tranche, for example), and corporate and infrastructure sukuk 144A programs enter the market, Standard and Poor's Rating Services said. By contrast, the Islamic capital markets have not yet seen significant diversity beyond the traditional ijara, mudaraba, and murabaha structures, or structured and project finance sukuk. What's more, long-term institutional investors (such as pension and institutional funds) dedicated to investment in sukuk finance are notably missing in key markets such as the GCC, along with an absence of any significant secondary market trading in sukuk in key markets. Without standardization and a long-term investment architecture to support the industry, we are of the opinion that it is unlikely that the sukuk market will reach a new dimension. Despite some headwinds, Standard & Poor's Ratings Services believes the long-term prospects for the sukuk industry remain promising as regulators continue to build and strengthen their frameworks to minimize barriers in the market and deepen liquidity. Malaysia already benefits from a broad sukuk investor base and liquid debt market. So the increased interest from issuers, notably in the Middle East and Asia, in tapping the Malaysian ringgit and US dollar market should in our view continue over the next few years as Malaysia cements its leading position in the industry. After a slowdown in 2013, with sukuk volumes declining by 13' percent, we anticipate that the sukuk industry will expand again in 2014, partly driven by corporate and infrastructure issuers in the Gulf. What's more, total issuance will exceed $100 billion for the third year in a row if yields remain attractive for issuers. And, after weakening in 2013, we believe issuance could pick up again in Malaysia in 2014 as its investment program resumes. S&P believes that the demand for sukuk from GCC corporate and infrastructure issuers is likely to continue to grow in the year ahead after posting a solid increase of 17 percent in 2013 (2012: 24 percent) to reach $28.2 billion. Prospects for 2014 largely depend on the direction of interest rates, and to a lesser extent on the relative attractiveness and pricing of other forms of conventional financing compared with sukuk. Sukuk issuance at historically low rates and long tenors by companies such as Saudi Electricity Co., and Dubai Electricity and Water Authority signal to us an increasing depth and maturity of the regional Islamic finance market. These large issuances favor denomination in U.S. dollars to attract international investors, and the Saudi Electricity issue broke a record in tenor with its 30-year maturity, illustrating that the market is broadening and innovating. Global sukuk issuance declined by 13 percent in 2013 (see chart 1). This slowdown coincided with the U.S Federal Reserve's announcement that it would taper its quantitative easing program. As the dominant sukuk issuer, Malaysia experienced a 25 percent decline in 2013, in the context of slower investment growth. Over the past decade, a large public investment program has spurred issuance in Malaysia. Now that the country is adopting private sector investment, we believe non-sovereign issuance could accelerate in 2014-2015, continuing the trend witnessed in 2013 at a global level. For the first time since 2007, corporate issuance rose in 2013 as sovereign issuance declined. As a sign of possibly changing market characteristics, non-sovereign issuance increased by 20 percent, while sovereign issuance declined sharply by 26 percent. Global sukuk market activity across all asset classes largely reflected the trend in Malaysia. “As Malaysia follows its policy of supporting private sector investment, we believe non-sovereign issuance could accelerate in 2014-2015, continuing the trend witnessed at the global level. However, a handful of jumbo-size issuances, like we've seen in the past two years from government and government-related issuers, could easily negate this trend,” S&P said. Regulation is a hot topic that we expect to remain center stage over the next few years. The huge demand for finance and the growing popularity of sukuk as a mainstream asset class among fixed-income investors in Asia and the Gulf is pushing countries to establish or enhance their regulatory frameworks. Malaysia is working to cement its position at the head of the sukuk market by attracting global issuers and investors. Over many years, it has built up a strong Islamic debt capital market--alongside its conventional capital market--with well-defined regulation, standard sukuk structures, and a large pool of liquidity. Its successful $2 billion dual-tranche issue in 2011 further contributed to increase supply in the market, deepening liquidity and broadening the acceptance of sukuk structures, including to GCC-based investors. We believe that more non-Malaysian issuers will issue in the Malaysian market in local currency and US dollars in 2014. – SG
