issue no. 163 - january–march 2007 / muharram–rabi al awwal 1428

NEWHORIZON Muharram–Rabi Al Awwal 1428
ANALYSIS: SUKUK
use to manage their short- and mediumterm
investments and to adjust their risk
levels.
Traditionally (if this word can be used to
describe such a new instrument), investors
bought part of a sukuk issue with the
intention of holding that investment to
maturity. There are a number of reasons
for this phenomenon, several of which are
linked to the small size and number of
sukuk issues. For example, there have been
so few benchmark issues, that a significant
investor could take part in each new one
without having to liquidate any existing
sukuk holding. Also, should that investor
sell an existing holding, there are few viable
alternative issues with which to replace it.
With sovereign issues offering a premium
return, there is little incentive to sell prior to
maturity. Without investors selling prior to
maturity, there can be no secondary market.
There are early signs that selling prior
to maturity may be about to become
more commonplace. In the last few months,
several sizeable sukuk issues have attracted
international attention. Abu Dhabi Islamic
Bank’s (ADIB) issue in November 2006 of
$800 million sukuk bonds was rated A2 by
Moody’s and A by Fitch. That issue was
originally planned as a $400–$500 million
issue but was increased due to demand. In
March of this year, Dubai Islamic Bank
(DIB) came to market with its first US
dollar denominated sukuk worth $750
million. That issue gained an A1 rating
from Moody’s. Both of these issues were
listed on the Dubai International Financial
Exchange and the London Stock Exchange.
No doubt fuelled by their international
listings and investment grade ratings,
these issues attracted investment, not
only from Islamic investors but from
conventional investors around the world.
In the ADIB issue, for example, the Middle
East accounted for 50 per cent, Europe
accounted for 37 per cent, Asia accounted
for twelve per cent, and the US one per
cent. There were also different types
of organisations that invested, with
banks accounting for 58 per cent of the
transaction, fund managers 31 per cent,
corporates eight per cent and other investors
(including individuals) three per cent. The
presence of investors from areas other than
the Middle East, as well as fund managers,
suggests that those investments were made
for strategic reasons and not simply to
‘buy-and-hold’. That in turn suggests
that the investments will be sold once their
investment objectives are met. These sales
will add to the size of the secondary market.
Other factors will need to be present before
a secondary market can be considered to
be efficient. These will include regulation,
the presence of standard sized instruments,
standard settlement procedures, and
market-makers who are prepared to step
in and provide liquidity to the market itself.
Over the last 25 years or so, the Islamic
banking community has built infrastructures
when they have been needed and this is
another such case in point.
Some Islamic banking centres, including
Malaysia and Bahrain, already have much
of the necessary infrastructure in place
as a result of hosting parallel Islamic and
conventional banking markets. Specifically,
in the capital markets space, Dubai and
London are keen to promote their depth of
market expertise, regulators, ready-made
pool of investors and market support
professionals.
It will take time to build up a deep
secondary sukuk market. More sukuk
issues, made more frequently, would help
that growth. Until now, many of the sukuk
issues have been ‘one-off’ events, introduced
to raise money for a specific purpose.
Regular and frequent issues with different
maturity dates – along the lines of Gilt
issues in the UK or T-Bills in the US – would
add depth to the market. That depth would
facilitate banks buying and selling sukukbased
instruments ‘on demand’. Once that
is in place then Islamic banks will be able
to use the sukuk to invest excess cash and
manage liquidity to suit their needs.
How the Dubai Islamic Bank’s
March 2007 sukuk issue works
In March of 2007, Dubai Islamic Bank
(DIB) issued a $750 million sukuk. DIB
was founded in 1975 in Dubai and claims
to be the world’s first fully Islamic bank.
For this sukuk issue, it was assisted by
Barclays Capital, Citigroup and Standard
Chartered Bank. The issue gained an A1
rating from Moody’s.
The structure of the issue was based on
two entities, DIB and a special-purpose
company that was set up specifically for
the issue, called DIB Sukuk Company Ltd.
That company was the entity that actually
issued the sukuk certificates to investors
(the sukuk-holders). The funds raised are
used to buy assets consisting of lease and
musharakah assets (equity participations,
profit and loss sharing) from DIB, with
the two companies becoming co-owners
in the co-ownership assets.
The day-to-day management of the assets
will be performed by DIB, as managing
agent. It will collect all rental and profit
payments from the lease and musharakah
contracts. It will pay DIB Sukuk Company
an amount sufficient to fund the required
periodic distribution amount to the sukukholders
on each distribution date. Any
excess payments from the co-ownership
assets will be paid to DIB as an incentive
fee, while any shortfalls will be covered
by DIB to ensure that the required
periodic distribution amount is paid.
DIB has also agreed to purchase the
DIB Sukuk Company’s interest in the
co-ownership assets at a pre-agreed price
on maturity. This will be the source
of principal repayment.
www.islamic-banking.com IIBI 39