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Sukuk perceptions & forecast study 2017: Poised for growth

The decline in new issuances slows in 2016

Sukuk issuance remained subdued in 2016 after reaching an all-time high by value in 2012 and by number of issuances in 2013. However, despite continuing challenges including low oil prices and the attraction of conventional bonds for potential issuers, the decline in new issuances in 2016 is on pace to be lower than that of 2015, while the total value of outstanding sukuk continued to grow. 

Issuers shift toward quasi-sovereign entities, international currencies

Although the value of new issuances declined by 18% year-on-year in the first nine months of 2016 to US$39.82 billion, the market welcomed new issuers Ivory Coast at the end of 2015 and Togo this year and maintained issuances from 13 different jurisdictions. By comparison, new issuances fell 51% in a similar time period last year, as compared to 2014. Malaysia remains the biggest domestic sukuk market with US$23.14 billion in new issuances, followed by the UAE with US$3.95 billion and Saudi Arabia with US$3.20 billion.
 
Graph of global sukuk issuance historical trend from 1996 to year to date (Q3 2016)

Along with this slowing decline in issuances, the sukuk market has also witnessed a shift in some of its attributes. The proportion of sukuk denominated in domestic currencies has fallen to 56% of all new issuances, compared to 86% in 2012. Moreover, the share of quasi-sovereign entities as issuers of sukuk has increased from 23% to 31% year-on-year. Financial services remain the largest private sector in the market by far, issuing US$14.2 billion in sukuk, while no other single sector issued more than $3 billion in total in the first nine months of 2016

Many of these shifts are attributable to the lasting effect of Bank Negara Malaysia’s decision to stop issuing short-term sukuk in 2015 in exchange for targeted Islamic T-bills reserved for the liquidity management of Malaysian Islamic banks, as well as the expansion of state budget deficits in GCC countries because of lower export revenues resulting from low oil prices. Rather than turning to sukuk as some analysts had presumed, these sovereigns have preferred issuing conventional bonds based on their relative simplicity and low costs.

Supply still falls short of demand in the global perspective

Large institutions hold the majority of sukuk issued worldwide until their maturity. The majority of investors in our survey, therefore, believe that improving the secondary market for sukuk is key to attracting issuers and lowering costs, but this requires a boost to the limited supply, posing a cyclical trap. Moreover, smaller corporations face less investor appetite than sovereigns for their sukuk, as well as high relative costs associated with arranging and rating small issuances. However, these shortages are both reducing the demand for a high credit rating, and moving preferences from short to longer-term tenors.

In spite of these shortages, the largest segment of our survey respondents indicated they were willing to invest between 5% and 25% of their portfolios in sukuk, with a further 44% willing to invest more than 25%. Investors are eager for new issuances from promising emerging sukuk markets such as the United States, Australia, and Hong Kong.

The outlook for 2017

2016 provided a fair share of economic and political shocks, although the core countries of the Islamic finance industry have largely come to terms with persistent low oil prices, while the full scope of expected global interest rate hikes failed to materialize. While the “Brexit” process has the potential for short-term economic disruption as the UK renegotiates relationships with its trading partners, it could turn to sukuk to address new financing shortfalls resulting from a loss of EU budgetary funding during this transition.

The pipeline of announced and rumored sukuk as of September 2016 totals US$22 billion, down from US$32 billion a year prior. However, qualitative factors have promising signs for the recovery and expansion of the sukuk market in the coming year. Since the lifting of UN sanctions on Iran in January 2016, its government is preparing to attract international investors to a potentially increased volume of sukuk. Oman, Nigeria, and Kenya have recently issued new sukuk regulations, while the latter two and Niger are all planning to issue their first sovereign sukuk in the near future.