Sovereign borrowing still eludes the Islamic bond, or sukuk, market, leaving investors hungry for a benchmark issue to reinvigorate trading after the credit crunch. Where issuance from euro zone and emerging market borrowers in 2010 has been fast and furious, with emerging market borrowers alone issuing over $50 billion (Dh183.6bn), there have been no sovereign sukuk issues at all.
Only one international sukuk has been issued so far this year, a $450 million Islamic bond for Saudi property developer Dar Al Arkan.
The mounting of domestic regulatory hurdles for issuers and improved liquidity could bring sovereigns to the sukuk market from around the third quarter. But for now thin trading, the extra premium which borrowers have to pay to attract investors into this relatively small and specialist market, question marks over sovereign guarantees and regulatory conundrums have deterred borrowers. "There is genuine need for issuance," said Muneer Khan, partner and head of Islamic finance at law firm Simmons & Simmons in Dubai. "Government-related issuances and good credit corporate issuances can often open the gates for further corporates," he said.
A sukuk is similar to a bond but complies with Islamic law, which prohibits the charging or payment of interest.
The typical path for any debt market is that the initial borrowers are sovereigns, seen as relatively risk-free, followed by state-owned entities, and then by corporate borrowers who will offer a higher yield.
"If sovereigns get deals away at a certain level, corporates should trade 30-40-50 basis points above," said a London-based Islamic finance specialist.
But without sovereign deals, it is hard for corporates to follow.
The Philippines last week shelved plans for a debut sukuk issue, citing legal hurdles. Indonesia, which has previously issued in the sukuk market, has no plans to issue again before September. Gulf borrowers such as Bahrain and Dubai have also previously issued sukuk. But trading is weak after the restructuring of Dubai World debt, which includes Islamic debt, and other defaults in a market once boasting a zero default rate.
Sukuk prices are generally trading below par and the market is highly illiquid, market participants say, even as benchmark emerging sovereign debt spreads are trading at their tightest over US Treasuries in nearly two years.
Global sukuk issuance is likely to range between $15-17bn in 2010, down from $19bn last year, a recent Reuters poll shows. Currently even those forecasts look ambitious – in 2009, nearly all sukuk issues were made by states and quasi-sovereign entities.
"The sukuk market has been doubly affected by the downturn and the situation in the Middle East, so people are not pushing ahead – it's not an easy market for a first-time borrower," said Farmida Bi, partner at law firm Norton Rose in London.
European sovereigns have failed to issue any sukuk at all.
The UK was at the forefront of plans for sukuk issuance, and has the legal framework in place. But its original plans coincided with the outbreak of the global financial crisis, and the country has since saddled itself with huge amounts of debt.
"The reality is that the UK government has to fund a £178bn (Dh977bn) deficit," said the Islamic finance specialist.
"To come to the market with a $500m to $1bn sukuk is not the highest on their priority list."
France was also hoping to issue a sukuk but has become bogged down in legal changes, and market participants say sukuk issuance in countries such as Turkey remains some way off.
However, there are a few signs of light.
Investors are awaiting a restructuring any day of $26bn in Dubai World debt.
"The more positive news that comes for resolutions, the better," said Khan. "It can't hinder further issuances, but it could help."
Sovereigns such as Jordan and Kazakhstan have said they want to issue sukuk for the first time, although there is no set timing.
And as markets around the world recover, led by emerging debt which is seeing strong demand, sukuk could yet attract investors.
According to a Gulf regional banker at a major investment bank: "The sukuk market is a natural follower of the debt capital markets and we're starting to see more activity there. There is liquidity in the bond market."
- The writers are Reuters columnists. The views expressed are their own