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Islamic Finance news Guide 2008
Developments in Global Islamic Financial Markets
in 2007 and Prospects for 2008
By Professor Rodney Wilson
The aim of this review is to examine trends in the
markets for Islamic securities, usually designated
as Sukuk, and Shariah compliant equities and
equity funds, the performance of which can be
measured against benchmarks such as the Dow
Jones Islamic Indices. In contrast to 2006, when
Shariah compliant equities underperformed,
partly refl ecting the slump in share prices in Gulf
markets, 2007 has been an excellent year for both
direct equity investors and those placing their
money in Shariah compliant mutual funds.
For investors in Sukuk, fortunes have been more mixed, as
although 2007 witnessed record issuance, the overall market
could not escape the effects of the subprime crisis which
affected all types of bonds and notes, including those that
were Shariah compliant. Prospects for Shariah compliant
equities look even more promising for the year ahead, with
Gulf markets fairly valued.
Medium- and longer-term prospects for Sukuk are also
favorable especially once the true extent of subprime
provisions becomes apparent and structured products are
more accurately priced, refl ecting market fundamentals
rather than dubious mathematical calculations.
Impact of subprime crisis
The subprime home lending crisis inevitably had an impact
on the Sukuk market, especially in the Gulf where most of
the Sukuk are US dollar-denominated and local currencies,
with the exception of the Kuwaiti dinar, remain pegged to the
dollar. There is little possibility of default with Sukuk in the Gulf
as issuers can easily meet their payment obligations, given
the record oil prices that approached US$100 per barrel by
November 2007. Rather, the problem was with major fi nancial
institutions reluctant to lend to each other through inter-bank
markets, global bond markets that became suddenly less
active from August with new issuance slowing down and much
less secondary trading.
Had it not been for the global credit crunch, 2007 would have
been a superb year for Sukuk issuance with signifi cant trading
activity in Gulf markets, notably through the Dubai Financial
Market and the Dubai International Financial Exchange. By
August, Gulf borrowers had raised over US$13.2 billion in
Sukuk issuance compared to US$9 billion during the whole
of 2006, easily overtaking the value of issuance in Kuala
Lumpur for the fi rst time.
A further US$10 billion of issuance was planned by Gulf
corporate issuers but after August, it was either necessary
to postpone new Sukuk placements or accept much higher
fi nancing costs. While in June 2007 Ijarah Sukuk, the most
popular issuance, were being offered at 65 basis points
(bps) over the London Inter-Bank Offered Rate (LIBOR) for US
dollars, by August, rates had risen to 125bps over LIBOR.
This rise of 60bps had implications for existing as well as new
Sukuk issuance, as with Ijarah Sukuk the rate of return varies,
usually in line with movements in LIBOR. As the US Federal
Reserve cut rates, the relative difference in returns between
new and existing Sukuk increased as the 60bps had to be
added to a lower number.
The credit crunch meant the gap widened between LIBOR,
and hence Ijarah Sukuk rates, and Fed rates. If there had
been an active market in Sukuk in the Gulf, prices of existing
Sukuk would undoubtedly have fallen. However, most of
Sukuk trading occurs in the Kuala Lumpur market rather
than the Gulf, but in Malaysia the issuance is largely ringgit
denominated, and the value of the ringgit is determined by a
trade weighted basket which has appreciated against the US
dollar, hence Sukuk pricing in Malaysia is less affected by Fed
interest rate decisions.
Widening participation in Sukuk issuance
The probability is that Sukuk spreads will remain higher in
2008, although the costs to the issuers will be offset by
declines in LIBOR, and indeed SIBOR and KIBOR, the Saudi
and Kuwaiti offered rates respectively. There has been some
reluctance to cut interest rates in Saudi Arabia because of
infl ationary pressures, but cuts in the coming months are
likely, which should encourage Sukuk issuance.
At present, Malaysia and the UAE continue to account for over
75% of global Sukuk issuance, but this dominance is likely to
be reduced in 2008 as corporations in Saudi Arabia and other
Gulf Cooperation Council (GCC) states see the advantages
of securitized fi nancing. Saudi Arabia already accounted for
almost 20% of global issuance in 2007.
The opening of offi ces by leading international investment
banks in Riyadh partly refl ects prospects for Sukuk issuance,
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