articles Ratings /ratings/en/research/articles/200112-sukuk-market-to-continue-expanding-in-2020-barring-event-risk-11303325 content esgSubNav
In This List
COMMENTS

Sukuk Market To Continue Expanding In 2020, Barring Event Risk

COMMENTS

Stress Test Highlights European Banks' Resilience To Potential Trade Escalations

COMMENTS

CreditWeek: How Could The Israel-Iran Escalation Stress Sovereigns, Banks, And Corporates?

COMMENTS

Navigating Tariffs' Credit Implications Across Asset Classes

COMMENTS

Israel-Iran Escalation Stresses Geopolitical Risk Scenarios For Regional Sovereigns And Banks


Sukuk Market To Continue Expanding In 2020, Barring Event Risk

High levels of liquidity in Indonesia, Turkey's efforts to tap all available financing sources, the return of some Gulf Cooperation Council (GCC) country issuers to the market, and good performance in Malaysia boosted sukuk issuance by 25.6% in 2019 compared with 2018. Foreign currency issuance also increased by almost 20.8% during the year, explained primarily by activity in Turkey but also issuances by Malaysian and Saudi corporates and Qatari banks. Overall in 2019, the market exceeded S&P Global Ratings' previous expectation of, at best, a stabilization in issuance. Significant positive market conditions and the unexpected performance of some issuers/countries resulted in stronger growth.

We anticipate total sukuk issuance of $160 billion-170 billion this year, including $40 billion-$45 billion of foreign currency issuance. This represents about 5% growth on the $162 billion seen in 2019. Abundant global liquidity and negative yields on more than $10 trillion of debt mean that issuers with a good credit story will find relatively easy entry to the sukuk market in 2020. Therefore, barring an abrupt turn of the economic cycle or a significant deterioration in the geopolitical environment, we think issuers from core Islamic finance markets (the GCC, Malaysia, Indonesia, and Turkey) will maintain good access to the sukuk market. We believe new fintech propositions in the Gulf are likely to open the market to small and midsize issuers. In addition, given the increasing commitment to the Principles of Responsible Investments, we think that the green sukuk market will continue to expand, aided by opportunities related to energy mix diversification in the GCC/Malaysia and investor diversification.

What's Behind The Good Performance in 2019?

Total sukuk issuance increased to $162 billion in 2019, compared with $129 billion in 2018 (see chart 1). Sukuk issuances from Malaysia, Saudi Arabia, Indonesia, Turkey, and Qatar supported the activity of the market (see chart 2).

Chart 1

image

Chart 2

image

Of particular note was the strong performance of Malaysia, explained primarily by government issuances, including the issuances related to the transfer of some Lembaga Tabung Haji (LTH) assets in the course of its restructuring to a wholly owned subsidiary of the Ministry of Finance. The International Islamic Liquidity Management Corporation, and to a lesser extent other private sector and government-related entity issuers, have also stepped up their sukuk issuance volumes in 2019 (see chart 3).

Chart 3

image

Other notable players in 2019 included the Central Bank of Indonesia, which began offering sukuk as liquidity management instruments for its financial institutions, issuing local currency denominated instruments worth about $11 billion. This meant the country's total issuance increased to $21.6 billion in 2019, compared with $15.7 billion in 2018. Saudi Arabia also supported the market with higher issuances of local currency denominated government sukuk under its unlimited program and a few private sector issuers tapping the market. In the wider Middle East, Turkey increased its volumes, with total sukuk issuance of $13.8 billion in 2019, compared with $8.4 billion in 2018. Turkish issuers have been under significant pressure in recent months given their major reliance on external debt and declining rollover ratios. This meant they actively tapped all available pockets of liquidity including the sukuk market.

In the GCC, Qatari issuers returned to the market through sovereign and bank issuances and Kuwait's central bank continued to offer sukuk as liquidity management instruments for Kuwaiti banks. In contrast, issuance volumes increased slightly in Bahrain and dropped in the United Arab Emirates (UAE). In Bahrain, the government had less need to tap capital markets because funds from the $10 billion GCC support package began to be disbursed. For the UAE, there was a marginal drop explained by corporates front-loading their issuance programs in 2018 to prepare for less supportive market conditions.

Overall, the market structure by geography remained relatively stable and concentrated in a few core Islamic finance markets with limited involvement of noncore markets or new issuers (see chart 4).

Chart 4

image

2020 Is Likely To Be Another Good Year

We think that this strong performance will likely continue in 2020 for a number of reasons including:

Global liquidity remains abundant

Although global financial conditions should remain highly accommodative next year, we don't expect additional easing by the U.S. Federal Reserve and only a marginal deposit rate cut by the European Central Bank in 2020. In addition, more than $10 trillion of debt has negative yields. Therefore, we think that issuers with a good credit story from core Islamic finance countries will continue to tap the market with relative ease. With that said, some will continue to prefer conventional instruments because they are easier to issue (see chart 5). Last year saw limited involvement from new issuers in the sukuk market. In fact, we know of several would-be issuers that decided to walk away because of sukuk's complexity compared with conventional bonds. Similarly, some issuers in noncore Islamic finance countries have yet to return to the market after their debut issuances. We continue to believe that strong support from multilaterals, through their advisory services, could help. We also think that standard setters, regulators, and fintech companies will help simplify the sukuk process for potential issuers in the future as the standardization agenda progresses.

Chart 5

image

Innovation is coming

Last year saw the launch of a new platform for sukuk issuance and management using data technology blockchain. We think that if adopted by the market, this platform could boost GCC issuance volumes over time, since it significantly simplifies sukuk issuance processes. The platform relies on a set of standardized legal documentation for sukuk structure. The issuer can just plug in its underlying assets and start building its investor book with a few clicks. The overall transaction is managed using blockchain, which helps improve transparency and traceability. This platform can open the market to a new class of issuers that were until now excluded because of the costs or the complexity of the process. More importantly, this shows that standardization of legal documents and Sharia rulings is actually achievable. The speed of adoption by issuers, investors, and other stakeholders will determine to what extent this platform could disrupt the market.

Standard setters and regulators now understand the necessity of pushing for more standardization

Standardized legal documents and Sharia interpretation could help the market expand by making the process easier and more cost effective for issuers. We expect standard setters and regulators will continue to push this agenda after one standard setter came close to disrupting the market in 2019 with proposals disconnected from current practices. A more inclusive process would help achieve greater standardization and minimize the risk of disruption.

The green sukuk market will continue to expand

We expect green sukuk issuance to increase in 2020 as more investors commit to responsible investment and the structures and benefits become more apparent. Several core Islamic finance countries have committed to diversifying their energy mix with a significant contribution from green energy generation. Moreover, as GCC countries begin their transition toward less carbon-intensive economies, green projects are set to flourish. Some of these projects will likely be funded via the sukuk market. We have yet to see whether the green sukuk route translates into any pricing advantage. Indeed, for the time being the benefit is reportedly limited. However, going green can attract new investors, according to anecdotal evidence from green sukuk issuers.

Downside Risks Remain Outside Our Base Case For Now

What if the cycle unexpectedly turns?

A major shift in the global economy could affect some core Islamic finance markets. The most obvious channel would be through lower oil prices. We maintain our oil price assumption at $60 for 2020. A lower price would mean higher financing needs for GCC governments, which would then need to choose between conventional or sukuk instruments. However, based on previous experience, the conventional bond route seems to be the preferred option. Similarly, a higher oil price would likely mean lower financing needs and issuance volumes for GCC governments.

Geopolitical risk is still an important factor

Event risk has rapidly escalated in the Gulf region following recent developments between Iran and the U.S. For now, these do not alter our base-case assumption that any military action by either side will not lead to a fully fledged direct military confrontation. We continue to believe that any escalation will remain contained given that a direct conflict would be economically, socially, and politically destabilizing for the entire region, including U.S.-Gulf allies. We consider that a potential intensification of proxy conflicts will further undermine confidence and investment in the region. If a protracted and wider conflict emerges, assuming export routes remain functional, the fiscal benefit of potentially higher oil prices for Gulf sovereigns will likely be offset by the adverse effect on capital outflows and weaker economic growth, in our view. In case of a significant increase in tensions, investors could shift their attention to more stable regions. This would prompt an increase in funding costs, a lower appetite for regional instruments, or major foreign funding outflows.

Related Research

  • Rising Sovereign Event Risk In The Gulf Is Testing Our Base Case Of "No Direct Military Conflict", Jan. 6, 2020
  • The Sukuk Market Starts 2019 Well, But Activity Might Taper Off, June 16, 2019
  • GCC Banks 2020 Industry Outlook: Stable Credit Fundamentals Clouded By Event Risks, Oct. 9, 2019
  • A Sharp Increase In Geopolitical Risk Could See GCC Banks Require Sovereign Support, July 8, 2019
  • Islamic Finance And ESG: The Missing 'S', May 20, 2019
  • Islamic Finance 2019-2020: One Industry, Three Accelerators, June 24, 2019
  • AAOIFI's Proposed Standards For Governance Of Sukuk Might Open The Door To Unforeseen Risks, Jan. 21, 2019

This report does not constitute a rating action.

Primary Credit Analyst:Mohamed Damak, Dubai (971) 4-372-7153;
mohamed.damak@spglobal.com
Secondary Contact:Dhruv Roy, London (44) 20-7176-6709;
dhruv.roy@spglobal.com
Additional Contact:Financial Institutions Ratings Europe;
FIG_Europe@spglobal.com

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: research_request@spglobal.com.


 

Create a free account to unlock the article.

Gain access to exclusive research, events and more.

Already have an account?    Sign in