Sukuk: Sinking Oil Floats Islamic Bond Issues

Hit by the double curse of falling oil p­­rices and rising interest rates, global issuance of sukuk— shariah-compliant Islamic bonds—slowed sharply in the final quarter of 2014, failing to reach the record high that financial markets had expected and leaving investors wondering about the outlook for the instruments in the coming year.

But many investors say that sukuk have yet to reach their full potential and that 2015 could see strong growth in issuance, with one fund manager predicting that looming public deficits in the Middle East region could support more issuances in the coming months.

Sukuk have been one of the fastest growing segments of Islamic finance since the first international issuance by the Islamic Development Bank in 2003. Compliant with Islamic law, which forbids usury, sukuk give investors rights to a future stream of revenue. They are defined by the Accounting and Auditing Organization for Islamic Financial Institutions as “certificates of equal value representing undivided shares in the ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity.” “Sukuk” is the plural of “sakk,” which means the ownership an individual has after posting their seal on a deed or legal instrument.

According to the Islamic Finance Information Service, which has a database on the sukuk market going back to 1990, the volume in the fourth quarter, as of December, was $21 billion, the lowest since the second quarter of 2012. For the year, sukuk issuances are expected to total about $117 billion, less than 2013’s $125.5 billion and well below 2012’s record $149 billion.

“Sukuk are not immune to what happens in the rest of the market. Lower oil prices have affected the other markets, such as equity or other bonds, and sukuk are not isolated from the capital market trend, including government spending and oil prices,” said Bashar Al Natoor, Islamic finance specialist at Fitch Ratings in Dubai. “All in all, 2014 was an excellent year in the first two quarters, and then it was less good in the second part of the year for the declining oil prices, but that it is not unique to the sukuk market. Sukuk is an instrument that is here to stay, and it is not going to disappear. It will grow and achieve its potential.”

With the price of oil down more than 40% since July, several countries in the Middle East, including Saudi Arabia and its neighbors in the Gulf Cooperation Council, could soon run into public deficits as oil money partially dries up. This should support the issuance of more sukuk. “I think 2015 will be a stronger year than this year was,” said Abdul Kadir Hussain, CEO of Dubai-based Mashreq Capital, which has $1.4 billion in assets under management. “There will be less liquidity in the market, but the [United Arab Emirates] government will want to continue to assign the infrastructure and the domestic programs, so potentially running into deficit. To me this points to a situation where there will be more need for public market debt, and that will come in the form of sukuk.”