S&P believes that a period of rising oil prices, coupled with higher production and tighter spending controls, will result in fewer funding needs for some of the major Islamic finance countries.
Between a tight labor market, accelerating inflation numbers in recent months and increasingly firm indications from the US Federal Reserve, the S&P report predicts three rate hikes in 2022, with the first expected in May.
This would trigger a similar hike in interest rates by the Gulf Cooperation Council (GCC) central banks given their currency’s peg to the US dollar.
In addition to these broader trends, the sukuk market saw a period of dislocation in 2021 due to the implementation of Standard 59 of the Organization of Accounting and Auditing for Islamic Financial Institutions (AAOIFI).
In the United Arab Emirates (UAE), for example, the volume of sukuk emissions decreased by 64%, partly due to the additional complexity introduced by this standard. Although legal solutions were implemented, the change negatively impacted the appetite of issuers and investors for issuing sukuk.
This, combined with the above factors, leads to the forecast that the volume of sukuk issues will stabilize at around $ 145-150 billion in 2022.
However, on a positive note, the report identifies opportunities created by the energy transition in major Islamic finance countries, greater environmental, social and governance (ESG) awareness of regional broadcasters, and greater automation across the board. the future growth of the sukuk market.
Sukuk issuance will stabilize at a maximum in 2022
In 2021, total sukuk issuance reached $ 147.4 billion compared to $ 148.4 billion in 2020 (see chart 1).
The increase in volumes in 2020 compared to our previous publication stems from the evolution of exchange rates and the increase in emissions in Pakistan and Indonesia compared to what was previously reported. Last year, the market benefited from increased issuance from the Saudi private and public sector.
Oman is also back on the market after conventional issuance in 2020, and Malaysia and Turkey recorded higher sukuk volumes. On the other hand, issue volumes decreased significantly in the United Arab Emirates. The report believes this is partly due to the implementation of the AAOIFI 59.
Issues of foreign currency-denominated sukuk increased by 10% in 2021 (see Figure 3). S&P attributes the growth to jumbo issues in Saudi Arabia and continued growth in issues in Malaysia, Indonesia and, to a lesser extent, Turkey, thanks to favorable market conditions and ample liquidity.
The issuance of capital increase instruments by some GCC banks seeking these same favorable conditions also provided an impetus. Conversely, Qatar, Bahrain and the United Arab Emirates recorded the largest declines in issuance volumes denominated in foreign currencies.
In 2022, the report predicts that the following factors will translate into stable emission volumes:
Liquidity will be rarer and more expensive. In a tense labor market, with inflation data accelerating in recent months and increasingly firm forecasts by the US Federal Reserve, three rate hikes are therefore expected in 2022, the first of which is expected in May. GCC central banks are likely to follow such a move to preserve their currency’s peg to the US dollar. This means that global and regional liquidity will become more expensive.
Some of the major Islamic finance countries will have lower funding needs. S&P assumes higher oil prices from pandemic lows, which, combined with higher oil production and tighter spending controls, will result in lower or static funding needs for some of the world’s major countries. That said, S&P believes that the implementation of economic transformation projects such as Saudi Vision 2030 will result in opportunities for issuing sukuk.
Greater complexity will discourage the appetite of issuers and investors.
The implementation of AAOIFI 59 will continue to impact the volume of problems, although legal solutions have been implemented. Higher residual asset risks for investors and challenges with the availability of unencumbered assets on issuers’ balance sheets are likely to lead to a lower propensity to sukuk.
Standard 59 applies not only to issuers domiciled in jurisdictions that have adopted the AAOIFI standards, but also to those targeting investors in those jurisdictions.
So far, 20 jurisdictions have partially or fully adopted the AAOIFI Sharia standards, as has the Islamic Development Bank (IDB). Most of them are key players in the Islamic finance sector, although it is worth noting that some major players in Islamic finance do not make the list.
The evolution of the pandemic could also be a source of risk for the sukuk market. S&P Global Ratings believes the omicron variant is a clear reminder that the COVID-19 pandemic is far from over. Uncertainty still surrounds its transmissibility, severity and the effectiveness of existing vaccines against it.
Early evidence points to faster transmissibility, leading many countries to reset social distancing measures and restrictions on international travel. In the coming weeks, further trials and tests are expected to demonstrate the extent of the danger it poses to enable a more informed credit risk assessment.
“In our view, the emergence of the omicron variant demonstrates once again that more coordinated and determined efforts are needed to vaccinate the global population in order to prevent the emergence of new, more dangerous variants,” the report said.
Increased awareness of ESGs could lead to a gradual increase in issuance volumes
Over the past year, S&P has seen some sustainable sukuk issues. The Islamic Development Bank has issued a $ 2.5 billion sukuk and revealed that the proceeds will be used to finance green (10%) and social (90%) development projects.
Malaysia also issued a $ 1.3 billion sukuk, including a $ 800 million sustainability tranche, which was over-subscribed 6.4 times.
The proceeds would be used to finance social and green projects in line with the United Nations Sustainable Development Goals. Additionally, Indonesia issued a $ 750 million green tranche as part of its $ 3 billion issue in 2021, and in January 2022 the Saudi National Bank issued a sustainable $ 750 million sukuk.
Green sukuk is another area where opportunities would be high given the energy transition in many Islamic finance countries and the ambitions of some in the field of electric vehicles.
These types of instruments can attract investors, given the growing awareness of ESGs in the region. However, S&P believes that green sukuk will only gradually contribute to market growth as it remains more complex and time-consuming than conventional tools.
Digital sukuk could lead to a smoother emission process
Digital sukuks could provide a faster and cheaper way to take advantage of Islamic financial markets due to the limited number of intermediaries involved.
Benefits may also include increased security, traceability and transaction integrity, which could further strengthen Shariah compliance. However, this presupposes the availability of reliable technology and the preparation of legal frameworks to accommodate these tools.
It also assumes the presence of standard legal documents that can be used as a template for issuing sukuk. S&P notes in its report that the international Islamic financial market has already issued standard legal documents for ijara and mudaraba Tier 1 sukuk.
Reducing time, cost and minimum issue volume requirements could open up the sukuk market to a wider range of issuers. Investors in digital sukuk will continue to bear traditional risks (including credit market and liquidity risk). They will also be exposed to higher operational risks stemming from technological stability and cyber risks.
- Total sukuk issuance stabilized at $ 147.4 billion last year from $ 148.4 billion in 2020, but foreign currency-denominated issuance increased 10%.
- Declining global liquidity and growing complexity surrounding regulatory standards are likely to dampen sukuk issuance in 2022, assuming any adverse disruptions related to COVID-19 in major Islamic finance countries remain under control.
- S&P also expects lower funding needs in some key Islamic finance countries.
- Therefore, S&P expects a total issuance of approximately $ 145 billion to $ 150 billion in 2022.