The sukuk market is the most publicised segment of the Islamic finance industry, yet significant development is still required and its compatibility with infrastructure financing could be a major spur to push sukuk into the mainstream.
The sukuk market
In 2016, the global sukuk market rebounded following three consecutive years of decline. In fact, global sukuk issuance grew 13.2 per cent during that 12-month period compared to 2015, reaching US$74.8 billion in total. In addition, there was a significant shift in the composition of sukuk issuers in 2016, with corporate issuers dominating the market (see fig. 1), compared to the historical norm in which issuance has been driven by sovereigns. Corporate issuers produced a volume of US$47.3 billion in 2016, accounting for a 63.2 per cent share of global sukuk issuance.
The primary sukuk market has been forecast to gain momentum throughout 2017, backed predominantly by corporate issuances in Malaysia, as well as sovereigns within Gulf Cooperation Council (GCC) countries and the Middle East and North Africa (MENA) region.
With approximately 17 per cent of total global Sharia-compliant assets in the form of sukuk, coupled with a growing number of markets working to build the necessary frameworks for issuance to take place, the future development of the asset class, which offers important opportunities for more diversified financing, looks bright. However, the challenges to sukuk development are not insignificant and must be addressed if its potential is to be fully realised.
Due to the obvious imbalance between the scope of this Focus piece and the complexity of the sukuk landscape, it is pertinent to highlight one important potential growth driver, which also exemplifies some of the major challenges affecting sukuk development in general and the growth of the Islamic finance industry as a whole. That growth driver is infrastructure development.
Building sukuk growth
Infrastructure development is an important global growth driver and numerous analyses posit infrastructure spending requirements in the coming years. Significant funds are already invested in global infrastructure around the world, but supranational organisations, such as the Organisation for Economic Co-operation and Development (OECD) and the International Monetary Fund have published reports pointing to large infrastructure gaps in both developing and developed nations. The OECD has cited a figure of US$70 trillion for ports, roads, power and communications until 2030 and the World Bank estimates that US$1 to US$1.5 trillion per year, on top of current spending, will be needed until 2020 in order to meet growth targets in emerging and developing economies alone.
This reality presents interesting opportunities for sukuk development. As sukuk structures must be linked to tangible assets, it provides a natural funding match for infrastructure projects, which offer the kind of long-term stable cash flows required for this type of transaction. Additionally, the risk-sharing aspect of sukuk further cements the relationship, with sukuk providing the necessary flexibility to deal with the uncertainty of projects.
The infrastructure gap has increased, directly or indirectly, due to reverberations from the 2008 Financial Crisis. Commercial banks have become less inclined to finance large infrastructure as they nurse damaged balance sheets and the Third Basel Accord (Basel III) has made long-term financing less attractive for traditional providers.
Thus, the responsibility for infrastructure finance is being relocated to the bond markets and the huge increase in visibility of global sukuk has demarcated the funding tool as an attractive and, importantly, eminently feasible alternative to conventional debt financing.
There are obvious opportunities within the countries that are leading the Islamic finance push. Malaysia has already demonstrated a successful track record for appropriately structured sukuk for infrastructure upgrades and market actors are citing large projects in the pipeline, such as the Mass Rapid Transit development, as growth drivers. Meanwhile, the GCC countries are continuing with significant infrastructure spending plans affected by sustained low oil prices, resulting in a surge in issuance to meet planned expenditure.
Yet, it is perhaps in the oil-importing and developing economies in Caucasus and Central Asia (CCA) and MENA countries where sukuk will prove to be the most useful mechanism for bridging the infrastructure gap. Supranational entities and several Islamic finance thought leaders suggest that closing this gap would help address the limited growth prospects and unemployment challenges in these regions in the short term, while building an improved growth platform over the medium term.
In most cases, the required assertive infrastructure programme cannot be fully funded because state resources are insufficient and borrowing from domestic markets is becoming decidedly more difficult. Project-based infrastructure sukuk is, therefore, likely to be a vital tool in advancing an economic development agenda. Furthermore, many countries in the two regions have significant Muslim populations which will expedite the uptake of Islamic financing.
Many of the same arguments apply to Sub-Saharan Africa, which has long been lauded as a new frontier for Islamic finance and, particularly, infrastructure sukuk. Nevertheless, as with other emerging economies, this region has faced significant barriers in terms of legal frameworks and capital market development. However, Togo was a recent African sovereign issuer in 2016, and Kenya, Niger and Nigeria have been preparing similar moves to finance infrastructure needs. Additionally, in East Africa, Uganda has amended its laws to permit Islamic banking products and therefore allow the establishment of full-fledged Islamic banks or Islamic banking windows.
As stated, infrastructure sukuk is just one potential driver in a very complex sukuk landscape, yet the potential benefits in developing this particular segment have significant implications for the growth of the asset class in general and Islamic finance as a whole.
Primarily, an economic development agenda underpinned by infrastructure sukuk has enormous capacity to draw global investors into the fold. The G20 group of major nations has already included a discussion on sukuk as an infrastructure financing tool on its annual agenda, and the issue will be pushed by the group’s Muslim-majority countries.
Moreover, the Asian Infrastructure Investment Bank proposed by the government of China, which has already adopted Islamic finance structures in other areas, could be another significant avenue of growth, as a number of the founding members are Muslim countries that have issued, or have plans to issue, sovereign sukuk.
Additionally, as has been posited by Michael Bennett of the World Bank, trends in the global financial markets may be converging to highlight infrastructure sukuk as a viable form of finance for green or environmentally sustainable investing. As outlined above, capital market investors are taking on the infrastructure funding mantel. Consequently, those interested in green investment may be attracted by, among other factors, the opportunity to invest in projects with pre-determined criteria in line with their values, and a greater degree of certainty with regard to where their money is going. With the shift towards renewable energy in the MENA region offering significant opportunities, green sukuk is only a matter of timing rather than a question of feasibility.
Furthermore, infrastructure sukuk has played an important role in generating the scale necessary to entice institutional investors and sovereign wealth funds that, thus far, have been unable to contribute significantly to the development of Islamic finance due to shallow Islamic capital markets. This will be further magnified by the shift in infrastructure funding to the bond markets, as a result of Basel III.
The wider implications of these developments are that they will serve to increase the acceptance of sukuk by global investors and could provide the conclusive push into the mainstream. Moreover, the instrument not only has the potential to contribute to key industry challenges, such as scale and Islamic capital market development, but also to bridge another important gap between the conventional and Islamic financial worlds.
For sukuk to meet its potential, a robust domestic market infrastructure must be developed and access to international markets facilitated using a holistic approach. Islamic finance jurisdictions can achieve this by taking advantage of a number of factors. Among these are the vast knowledge and experience available through international development agencies and technical assistance providers that have previously fostered conventional domestic bond markets. Such market actors are, therefore, able to assist in deploying well-established frameworks, assess constraints and build an agenda of reforms to support policymakers foster the ecosystem required for growth. It is under the banner of development and social responsibility that global institutions can increase their mandate to push the sukuk, and in turn the Islamic finance agenda.
The growth of infrastructure sukuk will also increase the cross-border reach of sukuk markets and could further advance the adoption of commonly acceptable structures, a significant factor that, historically, has retarded sukuk growth. Concomitant efforts must also be made to promote securitisation, tradable structures, a deepening of secondary and money markets and centralised Sharia boards. Again, it is striking how important these developments are for Islamic finance industry growth as a whole.
Along similar lines, the expansion of infrastructure sukuk has the capacity to create additional geographical diversification and, importantly, build on the growing number of sovereign issuances from Europe, Africa and Asia, providing stimulation for issuances from non-sovereign entities. This would engender a greater range of risk profiles and more opportunities for diversification, appealing to a wider pool of investors and positively affecting liquidity concerns.
Infrastructure sukuk is on the cusp of significant growth; it is the right instrument at the right time for Islamic finance and for the world. Moreover, the developmental challenges this financing tool faces are the same as those hindering the broader growth of Islamic finance. Thus, the critical point is that the growth of infrastructure sukuk will bolster both development and expansion across the entire industry.