islamic finance bulletin april 2013

Islamic Finance Bulletin

April 2013

www.lums.lancs.ac.uk/research/centres/golcer/

Gulf One Lancaster Centre For Economic Research

From the Editor

It was a quieter month in March, and the bulletin this time has its eye on the key medium-term phenom-enon in the development of Islamic finance, namely the evolution of the sukuk market, as much as on the twists and turns of the various other investment classes.

We feature a special contribution from credit rating agency Standard & Poor’s, which updates a re-search paper featured prominently in the media last month. Its core message is the solid momentum that sukuk has behind it, as issuers seek to diversify sources of funding, and investors take an interest in an asset that is steadily converting from alternative status to mainstream standing. Added to that are some market insights drawn from dipping into recent work by the consultancy Arabia Monitor.

Financial markets were generally unsure of the state of the world economy as the first quarter drew to a close. That element of doubt grew ironically from the distinct emergence of the US economy from its slump of recent years. A clutch of reassuring data releases reinforced the notion that bonds had clearly peaked, and that insofar as the Fed might be tempted not to keep providing liquidity in search of growth impetus, then stocks could not know where their main plank of support would come from in coming months.

Non-US markets were then primed to react to this uncertainty, and tracked either sideways or down, even as American stock indices broke record levels. Commodities in fact took more note of the remain-ing concerns about growth trends in the rest of the world. The second quarter was almost bound to bring greater clarity to these issues.

ContentsHIGHLIGHTS (p.3)

RECENT DEVELOPMENTS (p.4)

VIEWPOINT (p.6)

STOCK MARKETS (p.10)

COMMODITIES (p.12)

BOND AND CDS MARKETS (p.15)

ACCOUNTANCY ISSUES (p.18)

PERSPECTIVE (p.19)

Sukuk: Global stock and bond markets entered into a period of some uncertainty during March, and sukuk encountered a degree of reversal in the short term in secondary markets by natural compari-son with mainstream conventional fixed-income. However, conditions in primary markets remained receptive, and both investors and issuers have clearly bought into the longer-term prospect of an investment and funding class that has powerful de-mand and supply drivers. Rating agency Standard & Poor’s has laid out the likely way ahead, likely to feature sovereign borrowers coming to market. Also mentioned this time are Arabia Monitor’s pointers on sukuk as an investment.

Egypt: While Egypt continues to struggle to convince the IMF of its ability to mend its economy and merit in-stitutional financial support, its growing commitment to the development of Islamic finance has also run into a snag. Pending legislation for the issuance of sovereign sukuk, which might well enhance the government’s ability to deal with its parlous financial situation, has not met with initial approval by Muslim clerics in respect of their compliance with Sharia law. It repre-sents another example of the scale of difficulties faced by an administration beset by a whole set of political, economic, financial and social tensions.

Sugar: Less featured among commodities, sugar nevertheless epitomised the shifting fundamentals of this overall asset class and as a staple resource amid doubts about the durability of what seems a tentative global economic recovery. While gold and oil also showed softening during the month, sugar moreover reflected how a period of high prices can lead naturally to lower levels when the business cycle moves on and capacity has adjusted to those signals. It also demonstrated the exag-gerated market reaction that can come from com-petition when a few prominent producers seek to enhance their share in a falling market.

Highlights

Recent Developments in the Islamic Finance Industry

Contention over Egyptian Islamic bonds law

For the first time, a law which allows the Egyptian government to issue sukuk (Islamic bonds) has been passed for discussion. According to a panel of senior Muslim clerics, however, it tends to contra-vene Islamic law from a number of perspectives. Ratification of the legislation is likely to be held up.

The Egyptian government, currently struggling with an overstretched budget deficit, hopes that Sharia-compliant financing will permit billions of dollars to be raised in the Islamic bond market.

Tension is still evident between the ruling Islam-ists and Al-Azhar -- the earliest ever institute (worldwide) for Islamic learning and stipulation of Islamic laws, located in Egypt -- whose scholars complained when the Muslim Brotherhood-led parliament approved the legislation and referred it to President Mursi without first consulting them, as required by the constitution. He now has a critical situation to decide whether or not to refer the law back to parliament for alteration.

Serious amendments may be required to nine of the 31 articles in the legislation, including to put a 25-year limit on the maturity of Islamic bonds, since in Islamic law the period of investments must be “suitable for the lives of their owners”. Also, concerns were raised about the language used in the law seeking to allow state assets to be used as collateral for the bonds.

GOLCER perceives these current arguments around the Islamic bond law -- in one of the leading Arab countries, with a high concentration of Muslims investors -- as a natural result of the persistence of political instability, which obviously could have an adverse impact on the development of Islamic finance in the country.

Source: Reuters, April 15th

Oman Islamic banks expands on foreign assets

Among noticeable cross-border attempts to sup-port the Islamic banking industry, the central bank of Oman has granted Islamic banks a one-year relaxa-tion of rules on the limit to the amount of foreign as-sets that can be held. The main objective is to give time for Islamic financial instruments to be developed domestically. These rules were stipulated by the central bank in December, to the effect that banks can hold no more than 40% of their net worth in the form of foreign currency-denominated assets.

The requirement imposes serious pressure on profit-ability, since Oman has not yet developed a market in sukuk or other Shariah-compliant instruments which the banks could use to manage their liquidity. Oman’s Islamic banks are permitted limited invest-ment options as the country’s Islamic banking rules essentially ban the use of commodity Murabaha, a common tool used by Islamic banks around the world to invest surplus funds.

GOLCER considers that this initiative might set a practical model for other Arab countries that seek to restore their economies after the political turmoil of the Arab Spring. Success for Oman’s approach is expected to increase foreign direct investment and develop Islamic banking in the country

Source: The Arabian Business News, April 2nd

Hesitancy in Malaysian Takaful industry Given its position among the foremost players in the takaful industry (Islamic insurance) in particular and

Recent Developments in the Islamic Finance Industry

Islamic finance in general, Malaysia is seeking to internationalise its Islamic finance sector. However, a certain lack of expertise and low risk appetite are slowing down the fast development of the industry.

Malaysia’s takaful firms are already major investors in domestically-issued sukuk, holding over 60% of their 19 billion ringgit ($6.1 billion) of assets in do-mestic private and government debt securities as of December 2012. But recently firms failed to reach the old limit on foreign investment, indicating that it is likely to be not the rules but their own inclinations that curtail overseas activities, with some firms have no foreign exposure at all.

GOLCER thinks the important obstacles tending to impede global recognition and the ability to in-novate are the poor experience of some Malaysian takaful firms and their limited creativity compared to conventional insurers.


Islamic assets with GCC institutions increase

Islamic banking assets with commercial banks in the GCC recorded remarkable growth in 2012, with a 14% rise to $445 billion from $390 bil-lion in 2011. According to Ernst & Young’s Global Islamic Banking Centre, the outlook for the Islamic banking industry in the Gulf region is expected to remain positive in 2013. Qatar was the fastest-growing market, showing Islamic banking assets to have grown by more than 23% in 2012. Glob-ally, Islamic banking assets with commercial banks stood at $1.55 trillion at last year-end, projected to exceed $2 trillion by 2015. However, the quality of that growth is still an issue.

GOLCER thinks that, as compared to conventional counterparts, Islamic banks suffer from intensive competition and also are technologically disadvan-taged, with software systems primarily designed for financial institutions based on conventional banking frameworks. While the industry regulators are looking to tackle this issue, it remains a concern, leading to significantly higher operational and commercial risk.

Source: Khaleej Times, March 21st

Turkey working to set up Islamic bank

The largest state-run lender, Ziraat Bank, is plan-ning an Islamic bank, known locally as a ‘partici-pation bank’, with a targeted partnership with a foreign lender. The bank has so far not received a partnership request for the venture, but says it would be open to talks.

There are currently four participation banks operat-ing in Turkey: Albaraka Turk, Bank Asya, Kuveyt Turk and Turkiye Finans. Kuveyt Turk, a unit of Kuwait Finance House, issued the country’s first sukuk in 2010. After proceeding slowly with the develop-ment of Islamic finance for years, given a secular political system, Turkey has recently begun to move with faster steps toward Islamic finance, issuing its first sovereign sukuk last September.

GOLCER believes that Turkey’s sukuk and the quick expansion of the Islamic finance sector will have im-portant global implications, since the fast-growing economy could become a major issuer of Islamic debt and influence trends throughout the industry. Turkey is now also working on new regulations to allow the wider use of Islamic bonds, which could see sukuk issues employed by the government and corporations for project finance and infrastructure development.


UAE Islamic banks repay past support Dubai Islamic Bank and Abu Dhabi Islamic Bank have paid back a combined 6 billion dirhams ($1.6 billion) in financial support, which was given by the United Arab Emirates government during the global crisis of 2008-2009. DIB said that it had repaid 3.8 billion dirhams as received in 2008. Last month it raised $1 billion by issuing sukuk to boost its Tier 1 capital. This comes after several UAE banks have been repaying such support in the past several weeks, as the terms of the government instruments mean their value has declined over time, and since banks are now able to obtain finance much more cheaply from the markets.


http://uk.reuters.com/sectors/industries/overview?industryCode=128&lc=int_mb_1001

Investor appetite pushes sukuk into the mainstreamby Paul-Henri M Pruvost

There is little to hinder another strong performance by the sukuk market in 2013.

We at Standard & Poor’s anticipate yields on bonds will remain low in the coming quarters, al-though we do not expect yields to decline mean-ingfully further. Global issuance expanded for the fourth year in a row in 2012, growing 64% to about $138 billion, and we expect another strong few years.

Despite the growth spurt, the sukuk market is still a small segment of the global fixed-income world. Largely dominating issuance are sovereign and sovereign-related issuers from Malaysia, and, to a lesser extent, from the countries of the Gulf Coop-eration Council (GCC).

While still considered an alternative investment, we believe sukuk have the potential to grow and join the mainstream.

Funding needs and large infrastructure investments in Malaysia and the GCC, combined with bet-ter global investor sentiment, are behind today’s momentum in the sukuk market. For that reason, we believe that GCC issuers especially are likely to come to market with bigger issues that are more commensurate with the potential suggested by their asset size.

Yields in the region have been declining, and even dropped below those on conventional debt. Add-ed to that is strong domestic appetite for Islamic finance and sound liquidity, as well as greater political willingness to move ahead with sizable infrastructure projects. We have noticed a small uptick in yields in 2013Q1, however, suggestsing

we may now have reached the trough.

A number of banks, particularly, will come to mar-ket, we believe, needing to refinance their existing debt and seeking larger amounts to match the credit needs of their corporate clients, especially in project finance.

In turn, we anticipate that supportive GCC-Asian trade policies and the global search for yield will add to the attraction of GCC sukuk as an investment proposition, most notably to Asian investors.

Sukuk issuance

New issuance of sukuk worldwide could top well above $100 billion again this year, according to our base-case scenario for investment spending and economic growth, along with assumptions about continued high oil prices and low bond yields. Global sukuk issuances already stood at about $30.6 billion as of the first quarter of 2013, out of which $3.8 billion was from the UAE.

In addition, jumbo issuance may pick up further, mainly on the back of huge infrastructure projects

Source: Standard & Poor’s, Zawya Sukuk Monitor Database

Viewpoint

from sovereigns. Turkey, Qatar, and Malaysia is-sued more than $1 billion over the past two years.

Sustained investment spending and ample domestic liquidity are likely to support sukuk issuance, espe-cially in Malaysia, Saudi Arabia, Qatar, and the UAE. Investment spending could see high-single-digit growth for 2013 if it continues at the rates we have seen in the first quarter.

We believe that sovereign and sovereign-related issuance will continue to dominate, shape, and un-derpin the sukuk market, as it has in the past several years (see box).

Sovereign sukuk are generally the first inroad into Sharia-compliant funding in any given country, en-abling the gradual creation of reference prices over time, to which private-sector entities can bench-mark themselves.

From a sovereign perspective, Islamic bonds can give governments access to a new investor class by diversifying sources of fiscal funding. They can

also help to cover external financing needs and support reserve building. This is important for countries with sizable fiscal funding needs, such as Malaysia or those in North Africa (less so for GCC countries, which generally enjoy healthy fiscal and external accounts).

Sovereign-related issuance reached a record $115 billion globally in 2012, comprising about 80% of total issuance for the fourth year in a row.

Additionally, we believe that the GCC and Asia will remain the key engines for growth of the sukuk market in the coming 18-24 months. New issuers may be seen, most probably sovereigns, though with modestly-sized issues to test the waters and investors’ risk appetite.

And we may see the debut of issuers outside these two regions, like the Development Bank of Kazakhstan with its MYR1.5 billion sukuk program in 2012. The pace and frequency of issuance in those frontier markets will depend in our view greatly on their capacity to develop Islamic finance infrastructure.

Further afield, we don’t rule out the possibility that more African sovereigns will enter the mar-ket. Some African countries have been growing strongly over the past few years, and most have huge infrastructure investment needs.

So far, only two African sovereigns have come to the domestic market with sukuk -- Gambia and Sudan -- but we understand that a number of them are considering either domestic or global issuance.

The Asian and GCC sukuk markets are becoming more interdependent as the number of cross-border transactions between the regions pick up, and because of increasing use of the Malaysian ringgit as a preferred currency of choice.

Islamic Artwork

Both regions have relatively strong economies and are seeking huge amounts of capital to fund new infrastructure, support economic develop-ment, and entice more private-sector investment.

Cross-border trends

Cross-border issuance should continue to gather steam, with Malaysia as the main benefactor, as in the past few years.

GCC-based entities have been crossing the figurative border with ringgit-denominated issues over the past few years, beginning with pioneering entities such as Abu Dhabi National Energy Co. PJSC, Bahrain-based Gulf Invest-ment Corp., and National Bank of Abu Dhabi. Most recently, Saudi-based Al Bayan Holding became ( on April 24th, 2013), the first Saudi corporate to venture into the Malaysian debt capital market, by issuing a MYR200 million ($65.4 million) sukuk.

Even though the amounts remain low, ringgit-denominated sukuk issuance in the GCC has been steadily increasing, to $571 million in 2012 from $323 million in 2010.

More generally, last year’s non-Malaysian enti-ties, such as China-based Noble Group Ltd. and the Development Bank of Kazakhstan, issued upward of $1.5 billion.

The ringgit is becoming a growing, credible alternative to the US dollar for non-Malaysian issuers. Interestingly, in 2012 issuance in the Malaysian currency by all issuers (domestic and foreign combined) actually exceeded those by Malaysian entities for the first time.

Malaysia has well-defined regulations and de-veloped capital markets (both conventional and Islamic), a large and diversified pool of inves-tors, standardized sukuk structures with avail-able liquidity, as well as its status as a potential gateway to other fast-growing Asian economies such as Indonesia and China.

Since its infancy in the 1990s, the sukuk market has experienced exponential growth -- that is until the financial crisis of 2008, which damp-ened investor appetite globally, and across the board.

A streetscene in Downtown Kuala Lumpur, Malaysia

A view of Dubai Mall with Burj Al-Khalifa at the back, Dubai UAE

Paul-Henri Pruvost is an Associate Director at Standard & Poor’s Ratings Services, based in Dubai, UAE

Growth thereafter resumed when confidence returned, largely on the back of comparatively brighter economic prospects in emerging markets.

Future global growth of the sukuk market, in our opinion, depends directly on greater liquidity and better price formation.

Liquidity is tight because the market is still small and viewed as an alternative asset class. This situation is improving as larger and more frequent issues come to market, and as sukuk gain greater acceptance as a mainstream debt instrument.

We note the increasing number of sukuk that are being rated and listed on international stock exchanges, with healthy competition by exchanges to attract issuers.

However, most sukuk issued globally are not listed and remain over-the-counter instruments, and rated ones are the exception rather than the rule -- although the abso-lute number of issuers seeking ratings is on the rise.

As we look toward the future, Standard & Poor’s believes the ability of the Islamic financial industry to overcome questions related to Sharia interpretation, standardiza-tion of sukuk structures, and creditworthiness, plays directly into the globalization of the sukuk market and its wider acceptance by international investors.

A passenger ferry on the Bosphorus Sea in Istanbul, Turkey

Sovereign players

Two bodies are actively and increasingly help-ing in the development of sovereign sukuk: the Saudi-based Islamic Development Bank , AAA/Stable/A-1+, and the Malaysia-based Internation-al Islamic Liquidity Management Corp.

The IDB is a multilateral development financing in-stitution, whose stated purpose is to foster econom-ic development and social progress in 56 member countries in accordance with Sharia principles. In that regard, it invests in sovereign sukuk, and issues sukuk with the aim of providing low-cost funds to member countries.

The IILM, founded in 2010 by central banks, mon-etary authorities, and multilateral organizations, seeks to play a vital role in developing much-need-ed short-term Sharia-compliant liquidity solutions for Islamic financial institutions. The IILM recently established a financing vehicle, rated by S&P, to issue short-term Sharia-compliant money-market instruments backed by long-term sovereign sukuk.

GCCWhile equities overall across the GCC showed a posi-tive aggregate performance, the underlying reality remained mixed. The dominant Saudi Arabian Tad-awul bourse led indices higher, strengthened by the heavyweight petrochemical sector, whose momentum has continued since a weak 2012, and notably by retail as well. Against a backdrop of stable oil prices, the lead given by the Saudi measure induced some measure of optimism across the region. Qatar’s index was boosted by industrials and banks & financial services, with similar impetus seen in Kuwait, uplifted by encouraging earnings data and hopes of buoy-ant government spending. Modest increases were to be found also in Oman and Bahrain. By contrast, the UAE indices fell back, Abu Dhabi dragged by real estate, and Dubai (by over 5%) by both banking and real estate, notwithstanding an almost 10% improve-ment in telecoms. Overall trading activity rose on the month, most notably with a surge in Kuwait.

MENA

Continuing turmoil in Egypt kept the dominant re-gional market in decline in March. Its benchmark EGX 30 index slumped to its lowest for the year so far late in the month, putting it among the worst perfomers globally, when the country’s tax authority said it would impose a capital gains levy on the buyout of a

major French bank’s local operation. A 10% tax was to be imposed on shareholders in National Societe Generale Bank who turned a profit from selling their stakes to Qatar National Bank. The timing and nature of the announcement affected the mood of investors generally. At the same time sentiment was affected by negotiations over the payment of back taxes by Orascom Construction Industries, with investor concern growing at the apparent targeting of private interests. Lebanese stocks were impacted by the resignation of Prime Minister Mikati, as the spillover from the two-year civil conflict in Syria spread its damaging effect. Meanwhile, Turkey’s index made further upward strides.

Far East Stocks in Asia were generally supported by the lead given by the US market, responding to the idea of concerted recovery in play, although Malaysia was subdued by political uncertainty. Chinese economic data gave help, while Europe’s

01−Jan 18−Jan 04−Feb 21−Feb 10−Mar 29−Mar67

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Stock Markets

messy Cyprus bailout proved not disruptive. The breaking of negative correlation between the US dollar and equities became a green light for associated bourses on the Pacific Rim. Indonesia and Thailand reached and hovered in the vicinity of record levels, and Korea took note of additional government stimulus in the offing. The main Philip-The main Philip-pine index surged to unprecedented heights upon upgrading by Fitch of its sovereign rating to invest-ment grade. The quarterly gain in Asian measures nonetheless suggested a slowing of momentum, perhaps signifying overbought territory.

Rest of the World

Following an uneven February, leading markets trended to the upside in March, primarily moti-vated by US pick-up. Record highs were touched in both the S&P 500 and Dow Jones Industrial Average indices. Economic data releases included rebounding manufacturing activity, with a strong increase in auto production, better job growth, the lowest unemployment rate and fastest factory orders for four years, and a firming housing mar-ket. The signs were that American sentiment was shrugging off softer outlooks elsewhere. That mo-mentum was to be contrasted against the halting European picture, darkened by a difficult bailout for Cyprus, casting doubt on the prospects for the eurozone despite its small size. China appeared to be ticking along, while Japan’s Nikkei index continued to react to the stark pledges to dramatic monetary stimulus.

Sources: GIC, Global Investment House, Markaz, Emir-

ates NBD, Reuters, Bloomberg

01−Jan 18−Jan 04−Feb 21−Feb 10−Mar 29−Mar1.09

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Islamic or Shariah compli-ant indices exclude indus-tries whose lines of busi-

ness incorporate forbidden goods or where debts/

assets ratios exceed 33%. The increasing popular-ity of Islamic finance has

led to the establishment of Shariah compliant stock

indices in many stock markets across the world, even where local Muslim populations are relatively

small, such as in China and Japan.

Volatility is a measure of un-certaincy of market returns. It is calculated as the standard deviation of the returns in the reported month. The formula for the standard deviation is:

σ=E[(X-μ)2]1/2

Islamic Stock Indices

Conventional Stock Indices

Evolution of Islamic Stock Markets in March 2013 for GCC, Far East, Middle East North Africa (MENA) and Rest of the World markets. Prices represent the closing price of the respective index at 29/3/2013. Percent-age Month-to-Month (MTM) Change and percentage Volatility. Source: Datastream

Evolution of Stock Markets in March 2013 for GCC, Far East, Middle East North Africa (MENA) and Rest of the World markets. Price represent the closing price of the respective index at 29/3/2013. Percentage Month-to-Month (MTM) Change and percentage Volatility. Source: Datastream

CommoditiesOilA sideways trend in March consolidated the softer tone to Brent and related series. The sense of global economic rebound was less in evidence, while euro-zone fears were rekindled by the messy handling of the Cyprus bailout. According to OPEC, reduced refinery demand due to maintenance efforts worldwide was a key factor too. WTI, however, picked up, both with the impression that the US was giving clearest signs of recovery and the easing accumulation of mid-West stocks. Although the WTI-Brent tightened, as North Sea production rose, the market continued to shift towards Brent as benchmark in terms of contracts outstanding on the exchanges.

Natural GasThe surge of gas prices through the month owed once again predominantly to a helpful weather pattern. The Henry Hub index rose 15%, with US natural gas breaking through $4 mBtu, as low temperatures extended wintry conditions into the spring, remaining near freezing in New York and Chicago, for instance. Inventory draw-downs surpassed expectations over several weeks, and stocks were claimed from storage. In the UK a pipeline outage added to price pressure, with some concern aris-ing even of national supplies running out.

GoldGold was already on the defensive coming into March, having lost safe-haven appeal with the increasing rotation into equities and other risk assets. The scale of redemptions in ETF funds was a further sign of the tide having turned. In mid-month, however, prices perked up upon the highest monthly increase in US inflation for over three years, as well as some pick-up in demand from India and China in response to the previous dip. The market softened again, though, with the impression that the mix of news on economic growth and contained inflation were depriving the precious metal of key sup-portive momentum.


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Copper/Base MetalsThe unconvincing nature of global recovery, and its sepa-ration from the surge in stock markets, was well expressed by the continuing downshift in copper, and base metals generally. Stocks more than doubled in the first quarter in London Metals Exchange warehouses, and speculative short positions climbed during March to record highs. The Cyprus bailout fiasco noticeably damaged fragile senti-ment. Prices have tracked trends in PMI (manufacturing) indices, and particularly the decline in Chinese imports, exaggerated by the reversal of overstocking. Expected global demand slumped against a backdrop of ample stocks relative to current and pending usage.

Sugar/AgriculturalsEarly March saw a temporary lift in sugar prices owing to delayed deliveries at ports in Brazil, the world’s largest producer and exporter. However, the story for the re-mainder of the month was one of sharp decline, reflecting a price war and competition for market share amid fall-ing revenue. Farmers in Brazil increased plantings so mills would operate at full utilization, while the second dominant source, Thailand, raised output from its enhanced capac-ity. Traders anticipated that ample supplies would come on the international market also from India and Mexico. A weaker Brazilian real, prompting higher local sales, also encouraged funds to take short positions.

Edible Oils

Conditions were uneven in vegetable oils through the month, with no particularly strong sense of direction, and participants awaiting further guidance from pending indus-try data. US soybean stocks were reported at sufficiently high levels to put pressure on the competition from palm oil too, with firm exports and stockpiles in Malaysia, but there was technical reaction from chart levels once the market was deemed oversold.

Sources: Financial Times, OPEC, Bloomberg, Reuters


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Soybean Oil

Evolution of highly traded commodities in March 2013. MTM Change and Percentage Volatilities. US $ and US c indicate United States Dol-lar and United States cent repsectively. bbl = billion barrels, MMBTU = Million British Thermal Unists, MT = Metric Tonne, LB = Pound and Bsh=Bushel. Prices represent the price of the respective commodity at 29/3/2013. Source: Datastream

GCC

The market lost some degree of confidence in the GCC in March, caught by the apparent curtailment of the long uptrend there had been emanating from US Treasuries, and their subsequent turn into reverse. CDS spreads widened more markedly. Whereas stronger economic news in the States served to underpin perceptions of the US as a safer haven for all investment classes again, the Gulf’s belonging to emerging or frontier categories meant that the spell had been broken. A modest sell-off occurred, restrained by the essentially firmer financial condi-tions prevailing in the region itself, besides technical, chart support. The depressive conditions in the euro-zone also capped the rise in yields. In fact, regional market watchers say local fixed-income prices may still be overcooked, reflecting paper having been chased up too far. New issuance has still drawn high levels of interest and momentum, but that prompt on the primary side led again to underperformance in secondary trading.

Egypt / MENA

The downtrend denoted at global level was exagger-ated in the Mena space with Egypt’s financial dete-rioration, although its central bank denied any sig-nificant, further draining of reserves in March, since a decline of about two-thirds in the two years since the January 2011 revolution. Moody’s downgraded the sovereign rating during the month. A sharp decline in imported food and fuel led to shortages that ag-gravated the already strained situation in the country, which remains devoted to securing a multi-billion loan from the IMF that should trigger other financial handouts. That deal was said to have been delayed to mid-year, and investors will have perceived a circularity in the need with the circumstances on the ground, in terms of political instability and social unrest, that would give the supranational institution any comfort in expecting its conditions to be applied. Consequently, yields on international instruments that had been drifting in the region of 7% at end-February had spiked out to 9% by end-March.


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1.6

1.65

1.7

1.75

1.8

1.85

1.9

Yie

ld t

o M

atu

rity

(%

)

275.5

276

276.5

277

277.5

278

278.5Malaysia Bond Yields & Prices

Bo

nd

Ind

ex

Bonds and CDS markets

Malaysia / Far East

Movements in Asian bonds showed a conspicuous parallel with other emerging markets in respond-ing to the fallout from the US benchmark, that’s to say a moderate retreat. That move was tempered, however, by lingering confidence, aided by research reports suggesting that whereas yields themselves are unlikely to drop back to levels recently seen, the

Credit Default Swap Markets

Sovereign Bond Markets

Evolution of Bond Markets in March 2013 relative to the previous month. The table reports the price index on which the MTM Change is calculated (month-to-month) and the Yield of sovereign bond maturities typically between 6 months and 25 years. Data as at 29/3/2013.

Evolution of CDS Spreads in March 2013 relative to the previ-ous month. The index reported here represents the average ba-sis points (bp) of a 5-year CDS for protection against sovereign bonds. Data as at 29/3/2013. MTM Change refers to the change relative to the previous month.


1.75

1.8

1.85

1.9

1.95

2

2.05

2.1

Yie

ld t

o M

atu

rity

(%

)

151

152

153

154

155

156US Bond Yields & Prices

Bo

nd

In

de

x

scope for currency appreciation makes Asian bond markets distinctly attractive still for the medium term. The suggestion is that they now represent strategic exposure rather than a risk categorization on an international basis. Market deepening and favourable supply and demand dynamics created an ongoing cushion of support for investor senti-ment, though a drift could be seen to shorter dura-tions and longer exchange positioning, given that US T-bonds had probably turned a big corner.

Global Benchmarks

Volatility was more in evidence in key markets, where mixed economic news kept the underpin-nings to bond instruments in limbo. Improved per-formance in the US economy had a double-edged effect, indicating that Treasury yields should be rising, while investors could justify taking a stake in an outperforming economy on the global stage. A safe-haven effect could be seen as well in German bunds, considering the continued fracturing of Euro-pean solidity, for which the Cyprus fiasco provided clear evidence. Economic data out of Europe also favoured core bonds, with retreats in industrial pro-duction and purchasing managers’ indexes, with rising unemployment. Peripheral eurozone bonds suffered, itself aggravating the financial difficulties faced in the midst of austerity-oriented policy set-tings. In the US rate moves were contained, nearly flat across the curve.

Sources: GIC, Invest AD, HSBC, Reuters, Bloomberg

Islamic Bonds (Sukuk)

Lack of activity prevailed in Gulf secondary sukuk trading during March, with the key comparison of conventional benchmark bonds having found some kind of neutrality from the signs of economic rebound in the US.

The downward pressure from the possibility that a resumption of growth might keep the Fed out of the market, while leading to higher yields, was conceiv-ably offset by confidence in ongoing central bank support in the face of any such threat, besides weak-ness evident in other regions of the world, especially Europe.

In other words, there was no obvious conviction as to a sense of direction, and investors stayed sidelined, depriving the market of liquidity, in line with remarks by fund managers identifying that factor as constrain-ing the market’s evolution, with the need for encour-agement by relevant authorities.

Attention within the GCC was focused instead on activity in the primary sphere, where Emirates Airlines, Bank Asya and Saudi Electricity came forward with new issues. In the last case a $1bn 30-year offering was delivered, a pioneering development.

In 2013 so far, it has become apparent, however, that Malaysia is dominating global sales of sukuk, a trend highlighted in a recent report by Standard & Poor’s, further elaborated in this edition of the bulletin (see special feature). Issuance in ringitt could account for in excess of 70% of issuance worldwide this year, the agency has suggested.

In recent weeks the Malaysian market has in fact been anxious ahead of elections to be held by mid-year, as reflected in an increase in the cost of insuring against sovereign default by the use of credit default swaps. Still, confidence remains among economists and ana-lysts convinced of the country’s financial and regula-tory proposition, as well as issuers, including from the Gulf, interested in diversifying sources of funding.

Sources: Rasmala, Bloomberg, Zawya, Gulf News


2.65

2.7

2.75

2.8

2.85

2.9

2.95

3

Yie

ld t

o M

atu

rity

(%

)

99.5

100

100.5

101HSBC−NASDAQ Dubai Sukuk Index (SKBI)

Cle

an

Pri

ce

Sukuk is the Arabic name for financial certificates, but commonly refers to the Islamic equivalent of bonds. Since fixed income, interest bearing bonds are not permissible in Islam, Sukuk securities

are structured to comply with the Islamic law and its investment principles, which

prohibits the charging, or paying of interest. Financial assets that comply with the Islamic law can be classified in ac-

cordance with their tradability and non-tradability in the secondary markets.

Source: HSBC Nasdaq Dubai


3.55

3.6

3.65

3.7

3.75

3.8

Yie

ld t

o M

atu

rity

(%

)

106

106.5

107

107.5

108

108.5Middle−East Conventional Bond Index (MEBI)

Cle

an

Pri

ce

Source: HSBC Nasdaq Dubai

Accountancy Issues Rules and Regulations

Saudi Arabia quits industry body

A prominent matter this month has been that of Saudi Arabia leaving the International Islamic Liquid-ity Management Corp (IILM) which is preparing to launch its first, long-delayed sukuk since inception in 2010. The IILM is an entity backed by central banks located mainly in Asia and the Middle East, which aids Islamic banks in managing their liquidity as well as facilitating liquidity across the sector’s instruments. The central banks of Qatar and Malaysia bought out Saudi Arabia’s share. IILM did not give a reason for this exit. Issuance of the first sukuk has been de-layed twice, as the organization has faced a major challenge in ensuring compliance with laws in all its twelve member countries, situated across Asia and the Middle East.

Source: The Arabian Business News, April 7th

Saudi’s Sedco Capital plans sukuk funds

Jeddah-based investment firm Sedco Capital is aiming to expand its range of Islamic funds to more than fifteen by this year-end. The plan adds mo-mentum to the Gulf’s Islamic funds industry, which was obviously affected by the global financial crisis but is now attracting regional firms such as Qatar’s QInvest. The main objective is to create a range of asset classes, introducing products in commodities, real estate and private equities.

GOLCER finds this to be an initiative that would improve financial market sentiment and change investor attitudes in Saudi Arabia.

Source: Reuters, April 3rd

Kingdom Tower at night in Riyadh, Saudi Arabia

http://uk.reuters.com/sectors/industries/overview?industryCode=128&lc=int_mb_1001

Perspective

Very much helped by the inherent strength of the Gulf region in its oil-buoyed finances, and the welcom-ing currency play of the Asian emerging markets, the growth of sukuk as a market instrument has become a cornerstone of current investment-oriented discus-sions in Islamic finance.

Both the GCC and Malaysia especially are bringing also a determined pursuit of the institutional frame-work necessary to entice both issuers and investors into the fray, though the tendency for primary activity to dominate over secondary is somehow a familiar characteristic in markets literally emerging.

Meanwhile, those following the fortunes of the Islamic finance sector are bound to come across the succession of stories of countries turning to sukuk to both tap into and diversify prospective funding.

In this edition of the bulletin we have reported on the implicit clash between the short-term reverse in Islamic bond markets, by association with the turn-around in US Treasuries since the new year, and the medium- and long-term prospects offered by a market with such convincing structural drivers.

Naturally, this topical evolution draws attention from serious analysts, and this month we have been fortu-nate enough to host refreshed reporting by Standard & Poor’s of their recent research documenting these trends. Further to which, only last week the consul-tancy Arabia Monitor put out its findings in watching the sukuk market’s progression.

Its report noted the decline overall of global issuance so far this year, though actually higher in the Gulf. Figures for Malaysia have been down by about a third, pending elections due next month. A pick-up can be expected there later in the year, given the relative appeal of that country’s announced infra-structure programme, provided sufficient calm is

retained and this exemplar of the Asian growth story resumes its cheery tale.

Of particular interest to investors, though, would be the consultancy’s observation that sukuk, in the GCC space at least, have outperformed conventional bonds, using data from HSBC/Nasdaq.

With sideways trading the approximate outcome in fixed-income of the year to date, the Gulf’s sukuk index was up 1.3%, compared to the conventional counterpart’s 0.9%. The turmoil of the Mena region’s Arab Spring, and the flight-to-quality phenomenon witnessed on-and-off through the global financial crisis, have not noticeably upset the stability of sukuk trading.

Moreover, though briefly expressed here, examining the relative value opportunities in Mena sovereign sukuk compared to similarly-rated sovereign bonds, Arabia Monitor deduced that, from the holder’s perspective, the spread characteristics are “virtually identical”, implying an investable opportunity when market discrepancies occur.

Such analytical insights suggest that not only does su-kuk development appear to be coming an established norm in the global financial architecture, with a firmly upward trajectory, but that these instruments are offer-ing a comparability in investment terms underpinning their acceptability and performance.

At this point, the issue for observers becomes whether this process develops towards the flowering and frui-tion that the market’s supporters hope, or whether bumps in the road may introduce unexpected jolts and impediments. On those matters this publication will hope to keep vigil and report.

Talking the book is increasingly talk about sukuk, and fairly so

by Andrew Shouler

Research TeamGerry Steele

[email protected]

Vasileios [email protected]

Marwa El [email protected]

Marwan IzzeldinDirector

[email protected]

DISCLAIMER

This report was prepared by Gulf One Lancaster Centre for Economic Research (GOLCER) and is of a general nature and is not intended to provide specific advice on any matter, nor is it intended to be comprehensive or to address the circumstances of any particular individual or entity. This material is based on current public information that we consider reliable at the time of publication, but it does not provide tailored investment advice or recommendations. It has been prepared without regard to the financial circumstances and objectives of persons and/or organisations who receive it. The GOLCER and/or its members shall not be liable for any losses or damages incurred or suffered in connection with this report including, without limitation, any direct, indirect, incidental, special, or consequential damages. The views expressed in this report do not necessarily represent the views of Gulf One or Lancaster University. Redistribution, reprinting or sale of this report without the prior consent of GOLCER is strictly forbidden.

Andrew ShoulerEditor

[email protected]

islamic finance bulletin april 2013

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