GLOBAL SUKUK MARKET
The total Global issuance of sukuk amounted to US$147.4 billion in 2021, slightly lower than US$148.4 billion in 2020. According to the S&P Global Ratings forecast, global sukuk issuance will range between US$145 billion to US$150 billion in 2022.
Global sukuk issuance is forecast to be slightly lower in 2022 compared to the previous year, mainly as a result of higher global oil prices and higher global interest rates. These concerns, coupled with the ongoing spread of the Omicron variant of COVID-19, current negative investment sentiment and the complexity of issuing and investing in sukuk may negatively impact the market. However, the increase in Environmental, Social, and Corporate Governance (ESG) linked sukuk issuances and the emergence of new issuers will provide a bright spot for the global sukuk universe.
ESG-linked sukuk are likely to continue to see strong activity and growth. ESG sukuk are debt instruments where Shari’a-compliant sukuk align with ESG principles like the environment and sustainability. They are linked to an issuer’s ESG framework. Issuers that have sold either green or sustainable sukuk include the Islamic Development Bank, the governments of Indonesia and Malaysia, Saudi Electricity Company and the UAE’s Majid Al Futtaim. The most notable ESG-linked sukuk issuance in 2022 was Saudi National Bank’s US$750 million 2.342% 5-year sustainable sukuk in January.
GLOBAL BOND MARKET
A quick comparison between the sukuk and bond market statistics at a global level is presented below which indicates that the sukuk market has a huge untapped potential. As of June 2022, Barclays Corporate and Investment Banking Group estimated that the overall size of the global bond markets in terms of USD equivalent notional outstanding, is approximately US$130 trillion.
SUKUK MARKETS IN MALAYSIA
Malaysia has maintained its leadership position in the global sukuk market in 2022. As per IIFM (International Islamic Financial Market) Sukuk report 2021, Malaysia commands a market share of 45.1% of the global sukuk outstanding, followed by the Kingdom of Saudi Arabia with 24.6%. Increased volumes have been driven by corporates with a 57.5% share of total issuance for the year. Malaysia also contributed to 45.4% market share of the total global corporate issuance in 2020.
The domestic sukuk market in Malaysia continues to serve as an important and attractive platform for government and corporate entities to raise long-term funds forvarious economic, business and infrastructure development needs. In 2021, sukuk issuances by the Government and corporates amounted to RM114.28 billion, representing 61.06% of total sukuk and bond issuances, a slight increase compared with RM104.58 billion in 2020 due to the COVID-19 pandemic. Total sukuk outstanding amounted to around RM1,104.26 billion or 63.43% of total sukuk and bonds outstanding in 2021, compared with RM1,017.79 billion in 2020. Corporate sukuk issuances represented 79.98% of total corporate bonds and sukuk issuances while corporate sukuk outstanding accounted for 81.42% of total corporate bonds and sukuk outstanding in 2021. At end of December 2021, corporate sukuk outstanding reached RM629.27 billion compared to RM593.43 billion at the end of 2020.
Factors contributing to the rapid growth of sukuk in Malaysia:
- Superior and Stable Returns: As a fixed-income asset class, Malaysian Sukuk, which includes local corporate sukuk, have consistently produced steadier and better returns over the past five years as compared with the Malaysian government bonds. Malaysian Sukuk have demonstrated to have lower volatility, as measured by five-year rolling standard deviation, as compared with other fixed income categories, such as Malaysian government bonds and Asian bonds, for five-year periods, such as from end-December 2012 to end-December 2017. The low volatility of Malaysian Sukuk is partly due to its stable investor base. The Malaysian Sukuk market is anchored by long-term focused institutional investors, many of which have strong capital positions, long investment horizons and limited Shari’a-compliant investment options.
- Strong Islamic Finance Regulations and Guidelines: To augment their marketability and attractiveness as a fixed-income asset class, Malaysian Sukuk are backed by strong Islamic finance regulations and guidelines, sound supervisory structure and established legal framework in Malaysia, which offers legal recourse and the necessary protection to sukuk investors. Besides being the largest issuer of sukuk globally, Malaysia is widely recognised as the most developed Islamic financial market in the world, as measured by the Refinitiv’s Islamic Finance Development Report 2021, which ranked the country as number one for the eighth consecutive year from 2013-2021.
- Tax Policies: Malaysia’s tax policies have also been conducive to the issuance of sukuk in the country. Currently, sukuk issuers in Malaysia enjoy a tax deduction on issuance cost as well as stamp duty exemption. Likewise, Malaysian Sukuk investors receive a tax exemption on income received. The country’s tax-neutral framework and tax deductions for sukuk issuance expenses further enhance the competitive advantage of these Shari’a-compliant fixed-income securities versus conventional bonds.
- First Mover Advantage: Besides launching the world’s first sukuk in 1990 as well as the original global corporate sukuk in 2001, Malaysia also rolled out the world’s first green sukuk last year. Green sukuk are essentially Shari’a-compliant renewable energy financing instruments. The inaugural issuance of the planet’s only green sukuk by Tadau Energy Sdn Bhd back in July 2017 epitomizes Malaysia’s leadership in the global sukuk market when it comes to innovation. The launch also showcases the country’s dedication towards green, sustainable and socially responsible investments (SRI).
- Healthy Economic Growth: Fixed-income investors are concerned with higher interest rates, rising inflation and higher volatility in the global bond markets. Investors, however, can take comfort that Malaysian Sukuk are domiciled in a country that is generally regarded as a “defensive market” in the Asian region due to its relative economic stability and low market volatility. Malaysia’s economic growth is expected to be healthy over the next few years. The real GDP growth for Malaysia in 2022 is projected to be at 5.5%, with growth supported by sustained domestic demand, particularly from private sector expenditure. (Franklin Templeton)
- Customised Solutions: The sukuk market provides customised solutions to government and corporate issuers through a variety of sukuk structures using different Islamic contracts such as murabaha, mudharaba, musharaka, wakala, ijara or hybrid structures based on combinations of Shari’a contracts. The sukuk structures are backed by real economic activity and have the ability to tap a wider investor base from both the Islamic and conventional spectrum including foreign investors.
- Novel Initiatives: To cement its position as the world’s leading sukuk marketplace, Malaysia has taken further steps by issuing the country’s first digital sukuk in its economic recovery effort to cushion the impact of the COVID-19 pandemic. The first-of-its-kind RM666 million Sukuk Prihatin which was issued in September 2020 received a notable mention in the non-IPO fundraising category for its innovative elements. Sukuk Prihatin is the first Malaysia sukuk that is available for fully online subscription where it can be accessible through the digital banking platforms of 27 banks in Malaysia.
SUKUK MARKETS IN PAKISTAN
The sukuk market has emerged as one of the important segments of the Islamic finance industry of the country. Pakistan’s first sukuk was an international sovereign sukuk, amounting to US$600 million, issued in 2005. So far, Pakistan has tapped the international market four times by issuing international sukuk valuing US$3.6 billion.
In Pakistan’s domestic market, the first sukuk was issued in 2006, which was a corporate sukuk. The Government of Pakistan (GoP) has been issuing sovereign ijara sukuk in the domestic market since 2008. On an overall basis, 141 sukuk amounting to PKR2,341.4 billion have been issued in the domestic market till December 31, 2020, out of which 31 are GoP Ijara Sukuk while the remaining 110 sukuk have been issued by corporate and quasi-sovereign entities.
Fitch Ratings, a US-based credit ratings agency, has said that the Islamic finance industry in Pakistan is expected to continue its growth trajectory over the medium term, driven by a strong governmental push and steadily rising public demand for Islamic products.
The Fitch Ratings shared that the size of the Pakistani Islamic finance industry is estimated to have crossed US$42 billion at the end of 1Q22. The Islamic banks are the largest contributor to the Islamic finance industry at 67% (total assets), followed by sukuk at 26% (outstanding amount), Islamic funds at 6% (total assets) and takaful at 1% (total contributions), Pakistan’s sukuk market is developing with outstanding volumes of US$11 billion at end-1Q22, with 82% in local currency. Also, guidelines on issuing green sukuk and bonds were issued in 2021 by the Securities and Exchange Commission of Pakistan. Sukuk in Pakistan are issued by the companies either by way of public offering or by way of private placement under section 66 of the Companies Act, 2017. Majority of the sukuk issued in Pakistan are through private placement.
In case of privately placed sukuk, the issuers are required to comply with the Sukuk (Privately Placed) Regulations 2017 and the Private Placement of Securities Rules 2017. On the other hand, the issuer of public offering sukuk is required to obtain approval of the Securities and Exchange Commission of Pakistan (SECP) for issuance, circulation and publication of the prospectus. However, Fitch Ratings pointed out that Islamic banking faces key challenges that could slow its growth such as the still-developing Islamic finance regulatory framework. This includes the Islamic finance regulatory framework, limited supply of Shari’a-compliant products and gaps in the distributional channels, with limited outreach in the populous rural areas. The financial sector in general also remains underdeveloped, with a challenging business environment.
- Foreign Direct Investment: Foreign investment in the country is positively related to financial development. Precisely, the inflows of foreign investment are particularly associated with the development of the bond market in the recipient country. Foreign Direct Investment has remained low in Pakistan for years due to high inflation rate, depreciating currency and political instability.
- Stage of Economic Development: Income per capita and the need for financial instruments are positively related which shall lead to the demand for sukuk securities (Smaoui & Khawaja, 2016). The higher income per capita comes with the reliability of contract, better institutional environment, less volatile environment and more investors’ rights. These aspects altogether lead to the development of the sukuk market.
Pakistan has one of the lowest income per capita in the world, approximately ~7 times lower than that of Malaysia.
- Interest Rates and Volatility: Volatility in interest rates creates uncertainty in the economy which declines the confidence of investors. Therefore, investors will not be willing to keep holding sukuk securities for the future. In addition, long-term sukuk issues will particularly be discouraged because of interest rate variability as is the case in bonds. Interest rate volatility influences the risk of declining purchasing power of investors for long-term bonds. Thus, we argue for the negative relationship of interest rates variability with the sukuk market. Due to high inflation and depreciation of currency, Pakistan has one of the highest interest rates at 16% whereas Malaysia’s interest rate stands at 2.25%.
- Regulatory Hurdles: Developing the bond markets in Malaysia has become one of the most important policy issues since the financial crisis of 1997/98. The need for a credible credit rating process is to ensure the efficient functioning of the Malaysian bond market. The Malaysian Securities Commission as part of measures to liberalise the financial sector and broaden the corporate bond market has no minimum instrument rating requirement whereas the qualified issuer has a rating of AA-. On the other hand, Pakistan has stricter regulations set by SECP. The issuer’s rating shall be triple B minus (BBB-) or above and the instrument’s rating must not be lower than triple B (BBB), assigned by a credit rating company registered with the Commission under the Credit Rating Companies Rules.
- Lack of Customised Solutions and Variety of Products: In Malaysia, the sukuk market provides customised solutions through a variety of sukuk structures. Whereas, in the Pakistani sukuk market, ijara-based structures dominate the market with 83.82% value of the total sukuk issuances, followed by musharaka at 11.25%. The lack of customised/novel structures results in fewer options for investors and contributes to slower growth of the sukuk market.
CONCLUSION
The demand outlook for Islamic financial products and in particular sukuk will continue to be strong globally including in Pakistan. Pakistan should learn and adopt the best practices of the regulatory and Shari’a compliance framework of Malaysia. Malaysia can be the benchmark for modifying and revamping the framework for promoting Shari’a-compliant financing instruments and in turn, promote the growth of Debt Capital Markets.
