London: Global sukuk issuance is expected to be slightly lower in 2022 compared to the previous year, mainly due to higher global oil prices and an anticipated rise in global interest rates. These concerns, coupled with the continued spread of the Omicron variant of COVID-19, the current negative investment sentiment, and the complexity of issuing and investing in sukuk may negatively impact the market. However, the rise in environmental, social and corporate governance (ESG) related sukuk issuance and the emergence of new issuers will boost the global sukuk universe.

Softer sukuk market in 2022

S&P Global Ratings forecasts global sukuk issuance to be between $145 billion and $150 billion in 2022. It says global issuance was $147.4 billion in 2021 and $148.4 billion in 2020. .

S&P estimates that sukuk volumes will be stable at best in 2022, and points to three main reasons: weaker and more expensive global and regional liquidity, increased complexity of issuing sukuk, and reduced funding needs in major markets. Islamic financiers, such as those in the Gulf. Cooperation Council (CCG).

“Gulf states’ financing needs are likely to be lower this year due to higher oil prices and production and tighter spending controls,” said Mohamed Damak, global head of Islamic finance. at S&P Global Ratings. “Nevertheless, some of the investments that are part of national transformation programs and economic strategies could be financed through sukuk.”

A Dubai-based Islamic Debt Capital Market (DCM) banker believes that some issuers will need to access the market regardless of oil prices: “Volume in 2022 is expected to be stronger than last year. Rising oil prices are supporting the GCC region, but businesses, financial institutions and government-related entities will continue to no longer depend on state support and will continue to access the debt market in accordance with the conventional space,” he said.

Angad Rajpal, head of fixed income at Emirates NBD (ENBD) Asset Management, said strong energy earnings and higher external balances justify significantly lower sovereign issuance from GCC issuers, particularly the UAE, the United Arab Emirates. Saudi Arabia and Qatar.

“We still expect sustained sovereign issuance from Bahrain and Oman on higher refinancing needs,” he added. “These latter issuers may even be well served to preload their issuances before higher rate hikes and potential moderation in oil prices in the second half of the year affect the optimal funding window. As for quasi-sovereigns, recurring issuers, such as Saudi Electricity, might keep the opportunity intact, but I would expect rookie issuers.

ESG linked Sukuk

ESG-related sukuk should continue to see strong activity and growth. ESG sukuk are debt instruments where Sharia-compliant sukuk align with ESG principles such as environment and sustainability. They are linked to an issuer’s ESG framework.

Issuers that have sold green or sustainable sukuk include the Islamic Development Bank, the governments of Indonesia and Malaysia, Saudi Electricity Company and Majid Al Futtaim of the United Arab Emirates. The most notable ESG-linked sukuk issuance in 2022 was the Saudi National Bank’s $750 million 2.342% 2027 sustainable sukuk in January. More is likely in the weeks and months to come.

According to HSBC Sustainable Finance & Investing Survey 2020 Middle East Survey, nearly 30% of regional investors (and 40% in Asia) say that the pandemic has reinforced their commitment to taking ESG issues into account. Similarly, 93% of corporate issuers consider ESG factors to be more important to their strategy.

In addition to governments, investors said regional private issuers are also likely to benefit from demand for Shariah-compliant ESG funding.

“Well-telegraphed names such as Utico would benefit from a strong flow-driven offering for sustainability-related instruments, although disappointing corporate governance developments with some existing issuers mean savvy institutional investors would adopt a more cautious view of their credit work and pricing assumptions,” said ENBD’s Rajpal.

Rizwan Kanji, Partner at Akin Gump, said the growing demand for Sharia-compliant ESG products is benefiting the issuer in terms of sukuk pricing. “The cost of funding will play an important role in the issuer’s thought process when considering issuing sukuk,” he said. “Similarly, given macro considerations, issuers may also consider bells and whistles to help reduce the cost of funding considerations, such as issuing ESG sukuk.”

Passed the AAOIFI 59 standard?

One of the biggest challenges for sukuk issuers and investors continues to be the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) Standard 59 on the sale of debt. This has been particularly difficult in the United Arab Emirates, where the central bank’s Supreme Sharia Authority (HSA) has been stricter in applying AAOIFI standards to all Islamic sukuk issuers and lenders in the country.

The standard poses a specific challenge to issuers with hybrid sukuk structures in which 51% of sukuk assets must be tangible and 49% may be non-tangible to be Sharia compliant. Prior to stricter legal enforcement by HSA, an issuer had to have a minimum ratio of 51% tangible assets and a maximum of 49% intangible assets only at issue. However, a stricter application requires that the tangibility ratio be maintained at 51% for the life of the sukuk.

S&P’s Mohamed Damak said there are three main market risks stemming from AAOIFI Standard 59. The first is residual asset risk: “For some structures, risk increases as a partial loss event – ​​in addition to a total loss event – ​​becomes relevant,” he said. “Indeed, in a transaction with multiple assets, if one or more are destroyed, the tangibility ratio could be broken.”

He said the second risk is placing investors in a potential liquidation or default situation. “Standard 59 affects language relating to the indemnity generally offered by the sukuk sponsor as an independent entity in the event of a breach of one of its contractual obligations. This could equate sukuk creditors with subordinate creditors,” he added.

The third risk is a growing liquidity risk for issuers and investors: “Standard 59 creates new potential scenarios for early dissolution of sukuk,” Damak said. “If the issuer does not have enough unencumbered assets on its balance sheet, there could be acceleration and redemption of sukuk before maturity.”

Damak said these challenges increase the risk of non-payment for investors and increase the cost of sukuk compared to conventional debt. “Some issuers select other funding initiatives than the sukuk market because of the complexities involved,” he said.

Nevertheless, most market participants are confident that issuers and investors have found the way forward.

“The AAOIFI 59 standard, which initially in early 2021 posed some challenges to sukuk structuring, has now been broadly addressed by stakeholders and the market and we have seen a significant volume of compliant issuances. AAOIFI in the second half of 2021,” said Kanji of Akin Gump.

Islamic banker DCM in Dubai broadly agreed and said the heart of the industry is coming out of it. “Of the transmitters we speak with, they are adapting their programs to accommodate the changes required,” he said. “What we do notice though is that it [Standard 59 requirements] poses a challenge when trying to attract new issuers or investors to this market.

Kanji said non-Emirati issuers who wish to target UAE investors or have UAE arrangers will need to ensure that the sukuk structure and documents comply with AAOIFI and HSA requirements.

“For repeat issuers, this may mean that it is not just a process of using previously used documents, but investing time to ensure that documents are changed to reflect the AAOIFI and HSA requirements,” he said.

Pipeline of mixed issuers

Outside of major Islamic financial markets like the GCC, Malaysia, Indonesia, Pakistan and Turkey, the pipeline for other sukuk issuers is mixed.

Among the most anticipated rookie sukuk issuers is the Egyptian government. The Arab world’s most populous nation is expected to sell up to $2 billion in Sharia-compliant sukuk in the first half of this year.

“Egypt is expanding the pool of high yield issuers in which sukuk investment managers can invest,” said a UAE-based bond portfolio manager.

Uzbekistan continues to work with the United Nations Development Program (UNDP) and the Islamic Development Bank through the Islamic Corporation for Private Sector Development (ICD) on a possible green sukuk issuance.

Elsewhere, new sukuk markets like Bangladesh are expected to see more domestic sukuk issuance this year.

Other issuers likely to exploit their local markets include South Africa. The country has previously declared its intention to sell a rand-denominated sukuk in FY21/22, although a deal has yet to materialize.

In an emailed statement to Salaam Gateway, a spokesperson for the South African National Treasury said: “The process of issuing national sukuk has begun. Once the process is finalized, the information will be communicated.

In March 2021, Salaam Gateway reported that the National Treasury was working with Rand Merchant Bank and Standard Bank on the planned issuance of Islamic debt in local currency. South Africa sold its first-ever sukuk, an international issue denominated in US dollars in 2014. The deal was $500 million of ijara sukuk over 5.75 years with a profit rate of 3.90%.

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