Middle East sukuk pipeline muted as rates and regulatory uncertainty cast doubts over issuance
With just over a month to go before the Thanksgiving holiday brings markets to an unofficial close, hopes for a flurry of activity in the Middle East sukuk market are muted.
Experts concede that the market faces a number of challenging hurdles - from macro-economic to commodity prices to regulatory - while some bankers continue to err on the optimistic side.
The sukuk market across CEEMEA, particularly the Middle East, has enjoyed plenty of activity since the start of the year, with issuers breaking new ground in the Sharia-compliant market.
In June, Saudi Aramco – the world’s largest oil company – debuted in the sukuk market with a USD 6bn triple-trancher that raked in over USD 60bn of orders, making it the largest ever order book for a US dollar sukuk transaction.
That offering consisted of a USD 1bn 0.946% 2024 tranche, a USD 2bn 1.602% 2026 tranche and a USD 3bn 2.694% 2031 tranche.
Further down the credit spectrum, Turkey re-entered the market, raising USD 2.5bn in a five-year sukuk sale shortly after.
Just last week, the Jeddah-headquartered Islamic Development Bank raised USD 1.7bn in a sukuk sale. Similar issuance in the market this year has garnered traction from conventional and Islamic investors alike.
But the market is not without its challenges. A combination of wider market volatility with regulatory hurdles may dent volumes going forward, market participants say, with the pipeline appearing slim.
Inflationary concerns have been dominating the agenda, with US Treasury notes spiking in recent weeks, reflecting weakening investor appetite. As of Tuesday, the 10-year note was yielding 1.599%, up from 1.3% one month ago.
That has already forced bankers and issuers in the Middle East to pull deals from screens, according to bankers.
One banker confirmed that Kuwait’s Burgan Bank had planned to issue a dollar-denominated bond this month, but was forced to revise its timeline after seeing the markets go “haywire”.
“[They] had announced their meeting schedule and then right in the middle of marketing, we saw a lot of market volatility hit in the aftermath of the FOMC meeting minutes being released. The feedback from investors was that they would need to be compensated for that volatility and that the issuer would have to pay up. So the issuer was advised to hold back – they did not need the liquidity and did not want to pay a premium.”
Two bankers confirmed that Burgan Bank is still waiting for conditions to improve before re-entering the market.
External volatility weakens appetite
The uncertainty surrounding the future of the Chinese property market has also led to a dent in investor appetite for emerging market credit. This month, both Fantasia Holdings and Sinic Holdings defaulted on interest payments, following Evergrande’s missed bond payments late last month.
That has not only put a strain on sukuk but also conventional issuance from the Middle East.
“Asia tends to be a pretty decent component of Middle East trades – their distribution could be anywhere from 15%-30%,” the first banker added. “That investor group has been badly impacted because of Evergrande. On the other hand, we are seeing EM investors across the board try to unwind their positions because they are seeing stress points in the system. That has put pressure on the entire curve.”
Bashar Al Natoor, global head of Islamic finance at Fitch Ratings conceded that despite the bulk of buyers on sukuk trades consisting of the Middle East and Asia-based Sharia-compliant investor base, the market is not “insulated” from external forces.
“Islamic finance is not immune to problems in the international investor environment. The appetite of international investors plays just as much of a role in the sukuk market as it does in the conventional market – it is not cocooned.”
“There is slower movement in the sukuk pipeline, which has been influenced partially by what is going on with the Federal Reserve and emerging markets more generally. The key issue is uncertainty: there are significant maturities that need to be refinanced and there is a strong diversification push, but uncertainty around investor appetite is holding the market back.”
A second banker conceded that the recent shift in market conditions had deterred issuers across the Middle East, in both the conventional and Islamic space.
“The pipeline is continuing to slowly build up, including issuers with the intention to execute this side rather than next,” the banker said. “But from a market perspective, the picture is mixed – everyone is focused on inflation, there are concerns about commodity prices and the impact on issuers in our region. No-one is subscribed to the “transitory inflation” theory anymore. It seems that the Fed will definitely taper."
"If you add in the fact that investor returns this year have not been particularly strong relative to other asset classes, you will see that the market may still be open – but not every issuer has access. Not every issuer wants to take what the market wants to offer.”
Market volatility aside, the recent introduction of new regulation around Islamic finance in the UAE has struck another blow to issuance, market experts say.
The UAE’s Higher Sharia Authority this year introduced new regulations to comply with AAOIFI – the Accounting and Auditing Organization for Islamic Financial Institutions – standards. Those regulatory changes have made issuance more complex for smaller, non-sovereign borrowers that have less manpower and experience than more seasoned sukuk issuers.
“The sukuk market has had a good year in terms of issuance, but it has had its hiccups,” said Al Natoor at Fitch Ratings. “Firstly, the AAOIFI implementation, which issuers in the UAE are trying to implement in their bonds, is having a toll on the time it takes to structure a transaction. It has made the process more complex, which has put a break on some issuance – some issuers have instead decided to go down the conventional path. This is a bigger issue for the smaller corporate issuers.”
Commodity recovery dents fundraising needs
With oil prices back above USD 80 per barrel – at an all-year high – the necessity for sovereigns to fill their funding gaps with liquidity from the sukuk and conventional markets has decreased.
As of Tuesday afternoon, Brent crude oil was trading at USD 85 per barrel.
If that recovery continues, market participants say, the issuance market will take a hit. Experts estimate that Saudi Arabia’s 2021 fiscal breakeven oil price for 2021 is around USD 75 per barrel, while the UAE’s is lower at around USD 60 per barrel, meaning that a sustained oil price of USD 80 would push external borrowing down the agenda.
Nevertheless, market participants remain optimistic that there will be some, albeit slow, sukuk action in coming weeks.
“There is somewhat of a sukuk pipeline – if markets improve, we could see a transaction as early as next week,” said a second banker.
Fitch’s Al Natoor added however that, "there is still a push to diversify funding via the Islamic investor base, especially for oil importers across the Middle East. Even for oil exporters, diversification is a big focus, so there could still be issuance even though their funding gap is smaller.”
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