Sukuk in focus The necessity for global common practices Deloitte Islamic Finance Insights Series Leading by engaging
Sukuk in focus | The necessity for global common practices
Contents
04 05 06 07 Foreword from Deloitte Foreword from ISRA Acknowledgments Executive summary
09 10 12 17 Introduction: Strategic Shariah governance and Practice and market Regulatory capabilities and practice approach sustainability institutions market development
40 41 Sustainability in focus Thinking further ahead: Practice and policy considerations
03 Sukuk in focus | The necessity for global common practices
Foreword from Deloitte
Dear Islamic finance practitioners, For Islamic finance practitioners, this will require re-thinking and re-modelling of For nearly two decades, many financial their governance frameworks and regulators and investment institutions business operating channels. Most around the world have been committed importantly, practitioners need to harness to strengthening practices in Islamic their Islamic finance corporate culture capital markets, and leverage standards and embrace a ‘back to basics’ approach for Sukuk as a key investment asset class. and adhere to designing products and Embedded within this has been an services in line with the ‘equity-base’ equally strong commitment from industry differentiator to fund real economy standards setters and other business projects. supporting institutions (BSIs) to address practice differences and inconsistency. Clearly, this can be streamlined in the first place, with Maqasid Al Shariah, which It is with great pleasure that we produce reflects values and practices of social and Dr. Hatim El Tahir, FCISI this report, and put forward our thoughts economic inclusion and sustainable Director, Islamic Finance Group on a number of business practices community development. Needless to say, Leader, Deloitte ME IFKC relevant to the Sukuk markets this goal can be achieved more efficiently Deloitte & Touche (M.E.) development in Asia, the Middle East and by adopting, for instance, the United Europe. Nations’ (UN) Sustainable Development Goals (SDGs), the Principles of The themes, topics and practice reviews Responsible Investment (PRIs), and social and analysis of selected key markets have impact and green Sukuk, to name a few. been researched in collaboration with ISRA, leveraging our specialist skills and This report is produced under the sector expertise, engaging leading Deloitte Islamic finance series “Leading by industry institutions and prominent Engaging”, produced by the Deloitte thought leaders to reflect on these Middle East (ME) Islamic Finance challenges and opportunities. Knowledge Center (IFKC).
One driving theme is the global We hope that you enjoy reading it and do discussion around impact investment and not hesitate to get in touch should you responsible finance triggered by several need any more information. industry initiatives. The extent of adopting these investment guidelines by Islamic finance need is to be assessed and aligned to global capital markets, leveraging on Sukuk as a catalyst for investment projects in several economies.
04 Sukuk in focus | The necessity for global common practices
Foreword from ISRA
For a Sukuk market to thrive, a conducive Besides, more efforts are required in environment that would support active the aspect of standardization of legal Sukuk issuance, promote corporate documentation for various Sukuk governance, ensure fair, transparent and structures. This standardization will help efficient markets, and safeguard investor in providing simplified documents, which protection is vital. These principles are in will lower Sukuk issuance costs―a key line with international best practices factor pushing issuers and investors promoted by capital market standard- towards conventional bonds. There is a setting bodies such as IOSCO. As core ‘Sukuk standardization’ standard (IIFM Sukuk markets move towards aligning Standard 12) currently being envisaged by their practices to these international IIFM. This will certainly prove beneficial for standards―usually adopted by leading Sukuk to gain further traction. financial centers ―Sukuk will gain firmer ground in attracting the wealth of global This report, developed with the investors. collaboration between ISRA and Deloitte Professor Mohamad Akram Laldin ME, is an attempt at highlighting the Executive Director The adoption of best practices will also go necessity for the adoption of global International Shari’ah Research a long way in boosting market confidence common practices in Sukuk markets. I Academy for Islamic Finance (ISRA) and thus eliminating trust deficit issues, hope the content will be beneficial to all especially after the recent disputes in stakeholders of the Islamic finance some Sukuk issues. Indeed, these industry. disputes have further highlighted the need for the institutionalization of a I would like to seize this opportunity to proper Shariah governance framework to thank all those who provided support to ensure end-to-end compliance of Sukuk produce this report. Special thanks go to to the Shariah principles starting from the the team at Deloitte Middle East and ISRA structuring stage until the time of for their hard work and efforts. redemption. Last but not least, I would like to show The setting up of international Islamic appreciation to the subject matter standard-setting bodies such as the IFSB, experts and industry practitioners of the AAOIFI and IIFM has to some extent two workshops held in Kuala Lumpur and promoted greater harmonization in terms Bahrain as well as the respondents of the of regulation and supervision, Shariah online survey who shared their ideas and standards, and standardization of Islamic thoughts on the practices of Sukuk financial products and contracts, markets. respectively. However, given adoption of these standards is only voluntary, thus far To all readers, I wish them an insightful they have been adopted by a few and rewarding read. jurisdictions.
05 Sukuk in focus | The necessity for global common practices
Acknowledgments
Deloitte Middle East and ISRA are grateful Project contributors to acknowledge the support of a number Deloitte Middle East team of institutions and their contributions • Dr. Hatim El Tahir, Director towards the making of this report. We • Sajida Ali, Business Consultant salute their courage and spirit to work with us in addressing industry issues, ISRA team which we aim to share with all industry • Associate Professor Dr. Said stakeholders worldwide. Bouheraoua, Director of Research Development and Innovation A special word of thanks and appreciation Department, ISRA is due to three individuals who have • Professor Ashraf Md. Hashim, CEO, ISRA tirelessly continued to support ‘Deloitte Consultancy Sdn. Bhd Sukuk market dialogue’ and generously • Hissam Kamal Hassan, Research Fellow, provided time for our events and ISRA conferences, despite their busy work • Dr. Salma Sairally, Research Consultant, schedules. ISRA • Dr. Marjan Muhammad, Head, Research • Stella Cox, CBE, Managing Director, Quality Assurance Office, ISRA DDCAP Group • Tallat Hussain, Environmental Counsel, Industry experts White & Case • Dr. Hurriyah El Islamy, Executive Board • Peter Casey, Advisor to the IFSB and the Member, Badan Pengelola Keuangan UAE Securities and Commodities Haji, Member of Advisory Council on Authority (SCA) Islamic Finance, Astana International Financial Centre While the report has benefited greatly • Daud Vicary Abdullah, CEO, DVA from their contributions, the views Consulting Sdn. Bhd. expressed herein are solely those of the • Khalid Howladar, Managing Director and authors and do not necessarily reflect the Founder, Acreditus views of Deloitte and ISRA. • Stuart Hutton, CIO, Simply Ethical • Mufti Hassaan Kaleem, Shariah Scholar
Industry supporters
06 Sukuk in focus | The necessity for global common practices
Executive summary
This report discusses the drive to Shariah governance promote efforts to enhance the Shariah governance functionality of Islamic capital markets and sustainability Maqasid Al Shariah & sustainability amidst the increasingly fragmented Priority sectors & SDGs alignment Islamic financial marketplace. In doing so, we believe, the Sukuk market ought to Sukuk structures & investors preference have better common practices globally as Practice and market a prerequisite for building effective Islamic institutions Practice & Shariah challenges capital markets. Development by standard-setting bodies
We structured our analysis around three Asia broad considerations: the element of Regulatory capabilities enhancing Shariah governance with noble and market development • Malaysia • Indonesia objectives of the Shariah linked to those • Pakistan of the global sustainable goals, the strategic role of industry institutions to Middle East harness good practices, and current • GCC countries regulatory and policy support initiatives in Europe key markets selected for this study. • United Kingdom • Luxembourg In our view, this approach will not only • Turkey help enhance the functionality of Islamic Regulatory support capital markets but also integrate Sukuk Thinking further ahead: practices more effectively with global Practice & policy Niche, specialized Sukuk investment and financial markets. considerations Serving priority sectors To reflect on global investment practices, we have invited industry experts to share their perspectives on processes and • Daud Vicary Abdullah continues the • Stuart Hutton continues with the principles of sustainable investment that industry analysis and practice in the UK analysis and offers complementary will harness the case for global common and Luxembourg. He highlights the views on the value proposition of practice of the Sukuk markets. extent of development and depth of developing an alternative Sukuk experience, particularly in the aspects of marketplace, featuring responsible • Dr. Hurriyah El Islamy provides an business, legal, tax and Shariah issues. investment and structures that are overview on the development of His chronological analysis did not emphasizing on delivery of transparent regulatory capabilities in Indonesia, include the evolution of Islamic finance, flow of funds for positive green and emphasizing the government policy government support policies, recent social return. support and opportunities presented by initiatives and challenges presented by several new initiatives and issuances. the rise of Fintech, the Brexit impact, However, for most of the analysis, we • Mufti Hassaan Kaleem describes the and green finance. emphasize on the importance of aligning Sukuk market landscape in Pakistan and • Khalid Howladar offers a critical analysis Maqasid Al Shariah in developing a new discusses the different government on regulatory support needed to drive governance and practice framework that measures taken to create an enabling Sukuk standards, which he arguably is able to accommodate emerging environment for Islamic finance and views as being key to boosting growth principles of responsible investment, Sukuk in funding some current projects. and liquidity. He concludes with a note green finance and sustainable He also introduces the possible of advice that “the best way to move development goals. development and introduction of forward is to empower investors Shariah-compliant alternatives for T-Bills, through transparency, governance and using the Pakistan Mercantile Exchange education”. Commodity Trading Platform.
07 Sukuk in focus | The necessity for global common practices
Research framework & methodology Secondly, we launched an online survey in We have structured our industry report the Summer of 2017 to obtain against three functions of Sukuk market stakeholders’ perspective and gain further development and twelve clusters of insight. Participants included industry practice considerations, as illustrated in professionals such as regulators, policy the diagram on the right. makers, Shariah scholars, compliance managers and other knowledgeable To achieve our set goals and objectives, industry leaders. Figure 1 illustrates the we followed a maturity assessment breakdown of geographical participation. approach, supported with a series of industry discussions and engagement processes to examine the above functions 1 Deloitte & ISRA Roundtable one: March 2017 , Malaysia and clusters of practical issues and ensure a wide participation of practitioners and policy makers in the key markets identified. 2 Deloitte & ISRA Roundtable two: November 2017 , Bahrain
Following this assessment, Deloitte and ISRA identified the main elements of practices in the Sukuk markets and 3 Practitioners’ online survey designed a set of questions for practitioners to address. First, we organized two stakeholder workshops at two international industry hubs with 70+ 4 Thought leaders perspectives total participants including industry leaders, subject matter experts and regulators. The prime objective was to 5 Industry whitepaper engage practitioners, investment bankers, regulators and scholars in a focused dialogue. Workshop one was facilitated in Kuala Lumpur, Malaysia and workshop two in Manama, the Kingdom of Bahrain.
Figure 1: Participating respondents by geography
53% 23% 16% 8% Asia MENA Africa Rest of the world
08 Sukuk in focus | The necessity for global common practices
Introduction: Strategic practice approach
Rapidly advancing technologies, To achieve this challenging goal, it may be It may be time to take a increasing socioeconomic pressures, and effective to consider the streamlining of infrastructure investments are opening Sukuk issuance practices with closer look at how Sukuk, doors to disruptive innovation in Islamic international investment guidelines being already somewhat capital markets. It has been nearly two already in place. To assess how this decades since the first Sukuk on the proposition can be achieved, and support internationally accepted global finance scene, yet it remains its merit, the following discussion will and tested, may continue popular. However, corporates have been address the core elements of the global to spur growth in local slow to tap into this niche market and common practices in Sukuk markets. Such investment bankers equally have been an approach will not only help enhance economies, through short to innovate Islamic debt capital the commercial competitiveness of Sukuk practice convergence to market instruments which are simple (i.e. as an international investment asset but not overly complex structures with also transform the way its market reduce issuance frictions. enforceability uncertainty) and have integrates with the global capital grown in size, at 19.5% as of 2017, of total marketplace and serves the social and global assets (IFSB’s Financial Stability economic needs of Muslim societies. Report, 2018). This practice improvement approach on The drive to formulate global common operations, reporting and investment practices for Sukuk and the wider Islamic considerations, in our view, potentially capital market will require stakeholder strengthens Sukuk market efficiency, collaboration to align regulatory and increasing its viability and impact on associated standards and practices. Muslim economies and attracting Furthermore, industry growth is evidently international investor demand. Three core facing performance headwinds as a result elements have been addressed in the of macroeconomic conditions in several following sections: markets around the world. As a result, the • Shariah governance and sustainability Sukuk market landscape looks set to • Practice and market institutions become increasingly divergent and • Regulatory capabilities and market segmented. Hence, it may be time to take development a closer look at how Sukuk, being already somewhat internationally accepted and tested, may continue to spur growth in local economies, through practice convergence to reduce issuance frictions.
09 Sukuk in focus | The necessity for global common practices
Shariah governance and sustainability
Setting the context for priority and should be reflected in investment these investment guidelines within its sectors objectives, proceeds, structure Sukuk structure. It is widely acknowledged that the primary issue. These fundamental objectives have objective of Islamic law is the realization translated into contemporary social While a reasonably large number of of its benefit to mankind by preserving needs i.e. ‘ social priority sectors’, conventional bonds have adopted these and protecting five fundamental addressing the socioeconomic needs of sustainable and green initiatives, we have objectives of Shariah (Maqasid Al Shariah): the Muslim-majority economies or the recently seen growing interest in green religion (Deen), life (Nafs), lineage (Nasl), economies of the Organization of Islamic Sukuk and industry institutions adopting intellect (Aql) and property/wealth (Mal). Cooperation (OIC). these global SRI principles.
The ultimate objective of Shariah is to Recent developments in international This trend, in our view, can potentially protect the well-being of people and investment shows that both issuers and accelerate Sukuk issuances and broaden nature, which lies in the safeguarding of investors are keen and supportive of the investor-base globally. Key to this is these five fundamental objectives (refer to adopting the global sustainable and designing strategies within priority sectors Table 1) through the promotion of social responsible investment (SRI) principles and blending the types of SDGs and other justice. These objectives have great developed by several initiatives. One investment practices and standards as resemblance to the United Nations’ important aspect of making Sukuk more shown in Table 1 below. Sustainable Development Goals (SDGs) attractive to these investors is to adapt
Table 1: The priority sectors: Maqasid Al Shariah alignment to Sustainable Development Goals (SDGs)
h d a i i s r Property Intellect Life Religion Family/Lineage a a q h (Mal) (Aql) (Nafs) (Deen) (Nasl) S a
l M A
y s t r Sustainable i o
r Housing and t
o Infrastructure Education environment and Healthcare c i
r food security e s
P energy resources
s l a o G
t n e m p ) o s l G e v D e S ( D
e l b a n i a t s u S
Source: Deloitte Research and Analysis
10 Sukuk in focus | The necessity for global common practices
Responsible investment and Islamic Table 2: Differences between responsible investment and Islamic finance finance
The increasing discussion over the Responsible investments Islamic finance concept of responsible investment has General investment Holistic approach that aims to include Value-based approach that has mainly attracted wider attention amongst approach any Environmental, Social and focused on exclusionary screens on investors globally. Clearly, Islamic finance Governance (ESG) information that specific social and economic grounds. has some resemblances as well as could be material to investment differences and Table 2 lists these performance. differences. Nevertheless, Islamic Active ownership Strong emphasis on being active No widespread practice of investment practitioners have debated owners and to engage with companies engagement or active ownership. the need for alignment between both to on ESG issues (including proxy voting). articulate globally accepted investment Avoiding Not widely considered. Sophisticated approach to analyzing products. investments financial structures of corporate in highly leveraged entities to understand cash flows and However, responsible investment have companies avoid investments in companies with excessive leverage. been featured with three key differentiating points as follows: Impact Not widely considered, but there is a Shariah scholars have typically • Strong emphasis on aligning finance growing focus on environmental and assessed the compliance of financial social impacts of investments products from a structural and legal with social good. (including contributions to the SDGs). perspective – the focus is not on actual • Seek to increase the contribution of the impact or real economy outcomes. finance sector to the real economy. • Pursue a more resilient financial system Source: Principles for Responsible Investments (PRI) void of unsustainable system risk.
Back to basics and the rationale for Figure 2: Embracing common practices through a sustainable Shariah-based framework common practices The trend towards common global SDGs practices for Sukuk poses two types of Sustainable Development SRI ESG challenges to Islamic finance: Goals • Strategic governance framework: Sustainability Development of a new Shariah-based SRI principles t Socially SDGs r PRI approach aimed towards improving o g S Responsibile p o h p s v a u n e r governance practices embedding the o r i Investing s i n a s t a h s u n fundamentals of al-Shariah and aligned t e i c n t e i s ESG s A sustainable Maqasid with global sustainable and investment n Environmental, Faith u i Shariah-based Property Al Shariah principles. Figure 2 draws the lines of B Social & framework how these principles can be streamlined Governance with the objectives of Shariah to design products and services, including Sukuk. • Compliance and operational PRI Market practices Principles for Intellect considerations: Inconsistent legislation Life Responsible and reporting practices in different Investment Lineage markets and jurisdictions pose challenges and operational risks to
investors and issuers. Social cohesion Economic inclusion Education Healthcare However, embracing a sustainable Housing Energy & resources Shariah-based framework to fund projects in key priority sectors can enhance the Food security Infrastructure Sukuk market and increase its convergence to global capital markets. In Islamic Capital Markets essence, this will help boost the drive to Structures and instruments global common practice. Sukuk
Source: Deloitte Research and Analysis
11 Sukuk in focus | The necessity for global common practices
Practice and market institutions
In this section, we highlight some of the • 13% and 8% believe that Hybrid Sukuk Figure 5: In your opinion, which Sukuk main views shared by participants from and asset-light Sukuk are widely used structure is more likely to attract investors from the following two types? our online survey conducted in summer as well. 2017. Whilst the focus was on Shariah- • Recently, Saudi Aramco has used the related functional and operational issues, Hybrid Sukuk structure for issuing a we also offered participants an domestic offer of riyal-denominated opportunity to express views through an Sukuk. open-ended question to address other Figure 4: To what extent do you agree practice and investment challenges with the notion that the Sukuk market 74% relating to Sukuk structures, investment requires more innovative structures to and regulatory development. cater for the capital needs of corporates and lack of assets (‘Ayn)? We follow this analysis with contributions Asset-backed structure where 3% from selected industry experts to share 3% Sukuk holders have ownership 3% rights over the underlying assets. their respective views on the topical issues addressed in this report and how best we can align thinking around a global common practice for the Sukuk market.
Sukuk structures and investors’ preference
Figure 3: What is the most widely used Sukuk structure in your country/jurisdiction? 35% 26% 56%
8%
Asset-based structure where 13% Strongly agree Agree Sukuk holders rank side by side Disagree Strongly disagree with unsecured creditors. Do not know
• Generally, the Sukuk market has • A majority of 74% of participants believe developed numerous structures that asset-backed structures are more including perpetual Sukuk and attractive to investors than asset-based 22% convertible Sukuk. 57% structures. • As markets grow, it appears there is • This is attributed to that the fact that demand for more innovation as seen by Sukuk holders have legal ownership with respondents. Asset-based Sukuk right to dispose the assets and they • 56% of respondents strongly agree that Asset-backed Sukuk have recourse to the asset in case of the Sukuk market requires more Hybrid Sukuk defaults. Light asset Sukuk innovation while 35% of respondents • Investors always seek more security and agree to the need for innovation. prefer to have some of form of • 57% of respondents agree that the assurance regarding ownership rights asset-based Sukuk structure is widely over the underlying assets. used in their countries while 22% of the • Nonetheless, asset-based Sukuk respondents view the asset-backed structures are widely used despite their Sukuk as the common structure. disadvantages over asset-backed notes.
12 Sukuk in focus | The necessity for global common practices
Practice and Shariah challenges from opting for an asset-backed Our survey respondents A better understanding of Shariah structure whereas 19% believe the compliance concerns can help improve problem stems from legal restrictions indicate that there are operational and functional processes and in asset ownership. various reasons that significantly reduce risks and costs associated with that. To assess these Figure 7: The use of asset-light Sukuk, in might impede Sukuk the absence of tangible assets (‘Ayn), has issues, we designed a set of questions to given rise to a number of Shariah issuers and investors obtain more clarity from industry concerns such as tradability. To what from opting for an asset- practitioners. extent do you agree with this statement? backed Sukuk structure Figure 6: In your opinion, what are the 9% key reasons that impede Sukuk and the most prominent 2% issuers/investors from opting for an 38% reasons include a true asset-backed Sukuk structure? Please 9% select your top three answers. transfer of ownership,
5% legal restrictions, and the
22% lack of suitable 19% underlying assets.
42%
11% Strongly agree Agree 16% Disagree Strongly disagree Do not know 9% 10% 8% • Tradability of Sukuk remains an True transfer of ownership unresolved issue and different views Shariah concerns Bankruptcy remoteness and enforceability have emerged, particularly to the fact Tax neutrality and other incentives that there is an absence of tangible Complexity and cost of structuring assets in the case of the asset-light Lack of suitable underlying assets Sukuk. Legal restrictions in asset ownership • 42% of respondents agree that the use Other (please specify) of asset-light Sukuk, in the absence of tangible assets, has given rise to a • Our survey respondents indicate that number of Shariah concerns such as there are various reasons that might tradability. impede Sukuk issuers and investors • 2% strongly disagree with this statement from opting for an asset-backed Sukuk and 9% disagree to an extent. structure and the most prominent reasons include a true transfer of ownership, legal restrictions, and the lack of suitable underlying assets. • 22% believe the issue of true transfer of ownership is the main reason that hinders Sukuk issuers and investors
13 Sukuk in focus | The necessity for global common practices
Figure 9: The AAOIFI is required to Central to the Sukuk investment provide more clarity and guidance on the repurchase of assets at maturity whether at par value, original sale price, market structure is the element of value or fair value. To what extent do you repurchasing the asset at maturity agree with this statement?
5% and the majority of our respondents 5% believe that more clarity and guidance 6% 43% is required.
Figure 8: In asset-based Sukuk, the right of disposal of the underlying asset continues to pose serious Shariah concerns. To what extent do you agree 41% with this statement?
3% Strongly agree Agree 9% Disagree Strongly disagree 41% Do not know
• Central to the Sukuk investment structure is the element of repurchasing the asset at maturity and the majority of our respondents believe that more clarity and guidance is required. • 43% strongly agree that the AAOIFI is 47% required to provide more clarity and guidance on the repurchase of assets at maturity whether at par value, original Strongly agree Agree sale price, market value or fair value. Disagree Strongly disagree Do not know However, 5% of respondents strongly disagree with the statement. • The disposability of the underlying assets in asset-based Sukuk continues to cause challenges. • 41% strongly agree that the right of disposal of the underlying asset continues to pose serious Shariah concerns. • 9% disagree with the above statement and do not think of the disposal of underlying assets as an issue.
14 Sukuk in focus | The necessity for global common practices
Figure 10 : The IIRA’s Fiduciary ratings Table 3: Key recent development by Standard-Setting Bodies (SSBs) concept is ‘welcome news’ to the industry and should be widely accepted as good practice to strengthen Shariah The IFSB launched, for consultation IFSB-19, Guiding Principles on governance and investor confidence. To an Exposure Draft (ED-21): Disclosure Requirements for what extent do you agree with this Core Principles for Islamic Finance Islamic Capital Market Products statement? Regulation (Islamic Capital (Sukuk and Islamic Collective Market Segment) Investment Schemes) 17% The main objective of ED-21 is to IFSB-19 outlines disclosure 32% provide a set of core principles for the requirements for Sukuk and ICIS,
B regulation and supervision of the covering the main stages of disclosure, S F
I Islamic capital market (ICM), taking into i.e. initial, ongoing (periodic and 2% consideration the specificities of Islamic immediate) and point-of-sale disclosure. 5% finance, while complementing the In addition, the document provides existing international standards, guidance on the disclosure principally International Organization of requirements for private offerings, Securities Commissions’ (IOSCO) government and multilateral issuances, objectives. and cross-border issuances with regard to Sukuk.
44% AAOIFI’s new and revised accounting UAE Adoption of AAOIFI standards: standards on Sukuk According to the recent pronouncement, Strongly agree Agree 1. Exposure draft: FAS 34 - Financial all full-fledged Islamic banks, Islamic
Disagree Strongly disagree I Reporting for Sukuk Holders windows of conventional banks, and F I 2. Exposure draft: FAS 29 – Sukuk Do not know O finance companies offering Shariah A Issuance
A compliant products and services in the 3. Exposure draft: FAS 25 - Investment UAE are required to comply with the • Ratings of Sukuk remain at the forefront in Sukuk, Shares and Similar AAOIFI standards with effect from 01 of investment in Sukuk and all credible Instruments September 2018. rating agencies now have developed different analysis models for Sukuk.
• A unique fiduciary rating approach was IIRA to operate as a licensed credit rating agency in the Sultanate of Oman: A
R The IIRA has been authorized as a credit rating agency in Oman according to the I
developed by the IIRA and our survey I communication by the Capital Market Authority (CMA) of Sultanate of Oman with IIRA. respondents have strong supportive views on this concept. • Three quarters of the survey’s
IIFM Standard No. 12: Sukuk standardization (to commence soon):
participants view the concept as a good M
F As per IIFM, consultation process on the Sukuk standardization project will involve the I practice to strengthen Shariah I development of specific guidelines and standard documentation on Ijarah Sukuk. governance and investor confidence.
Table 3 illustrates some recent practice Source: Compiled by Deloitte Research and Analysis initiatives led by industry Standard-Setting Bodies (SSBs) to improve practices relating to Sukuk investment, issuance, standardization and compliance.
15 Sukuk in focus | The necessity for global common practices
These important practice considerations, Figure 11 : AAOIFI’s new and revised accounting standards on Sukuk in our view, strengthen the case for global common practices in Sukuk markets to AAOIFI’s new and revised accounting standards on Sukuk enhance regulatory strategy capabilities for the larger debt and capital markets and streamline fragmented markets.
Moreover, the AAOIFI has been engaging Exposure draft: FAS 34 - Exposure draft: FAS 29 - Exposure draft: FAS 25 - industry stakeholders in a process of Financial reporting for Sukuk issuance Investment in Sukuk, reviewing its standards, which includes Sukuk holders shares and similar instruments revised accounting standards on Sukuk
FAS 29: Sukuk Issuance and FAS 34: The objective of this standard The objective of this standard The objective of this standard Financial reporting for Sukuk Holders (EDs is to set out principles for the is to establish the principles is to prescribe the accounting classification, recognition, issued, being finalized) along with revision of accounting and financial and financial reporting measurement, presentation of FAS 25: Investment in Sukuk, Shares reporting for assets and guidance for the accounting and disclosure of investment business underlying the treatment and classification and Similar Instruments. A summary of in Sukuk, shares and other Sukuk to ensure transparent with regard to the Sukuk these developments is shown in Figure 11. similar instruments made by and fair reporting to all issuance, in the books of the Islamic financial institutions. relevant stakeholders Islamic financial institutions It is also worth noting that the Islamic particularly Sukuk-holders. or other institutions issuing International Rating Agency (IIRA) has Sukuk (the institution). developed a unique approach to rate and assess risk related to sovereign Sukuk, which needs to be widely communicated, improved if required, and used.
Improve Enhance level of Financial discipline Long run transparency Shariah compliance confidence Sovereign rating by IIRA The six basic categories used by IIRA in analyzing sovereign Sukuk: Source: AAOIFI Standards • Politics and policy continuity • The Economy–Structure and Growth Prospects • Budgetary and Fiscal Policy • Monetary Policy and Flexibility • The External Accounts • Internal and External Debt
16 Sukuk in focus | The necessity for global common practices
Regulatory capabilities and market development Asia Sukuk markets – Malaysia: A trajectory growth of Sukuk markets
By Dr. Salma Sairally, Research Consultant, ISRA
Since Malaysia’s first corporate Sukuk seeks to elevate the country to Based on the Securities Commission issue by Shell MDS Malaysia Sdn Bhd in developed-nation status by 2020. The Malaysia’s Securities Commision (SC) data, 1990, the country has evolved into one of decision to include Islamic finance as a the size of the ICM as a percentage of the world’s most advanced and largest policy tool in GoM’s economic agenda has Malaysia’s capital market has already markets for Sukuk origination and been the driving force behind the surpassed 60% as at May 2018. Growth of investment. According to the MIFC, as at country’s successful development of its the ICM has been supported by an active end-April 2018, Malaysia accounts for overall Islamic capital market (ICM), corporate Sukuk market as well as regular 51.7% of global Sukuk outstanding including the Sukuk market. issuance of sovereign Sukuk to fund GoM compared to other jurisdictions such as expenditure. Saudi Arabia (19.1%), the UAE (8.1%), Indonesia (7.5%), Qatar (4.1%) and others Figure 12 : Malaysia's conventional vs. Sukuk issuances (2008 to end- June 2018) (9.5%). The healthy and sustainable pipeline of Sukuk issuance that the 43% 140 45% 43% 43% 46% country enjoys, from both the public and 120 31% private sectors, is backed by a strong 100 34% 47%
n 46% 49%
o 80 value proposition for Sukuk, placing it at a i l
l 29% 36% i 60 comparative advantage over conventional B
M 40
bonds. R 20 0 Malaysia’s strategic vision 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 June June Malaysia’s leadership position in the 2017 2018 Sukuk market is not a haphazard Sovereign conventional issuance Sovereign Sukuk issuance occurrence. It is a result of the collective and coordinated efforts of the 63% Government of Malaysia (GoM), the 200 68% regulators as well as market players to 51% 62% 150 spur national economic growth through n 58% 59%
o 43% i
l 49% 54% 60% l 62% 67% the strategic development of the financial i 100 B services industry, including Islamic M finance. The financial services industry is R 50 one of the 12 national key economic areas (NKEAs) under the Economic 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 June June Transformation Programme (ETP), which 2017 2018 Quasi + Corporate conventional issuance Quasi + Corporate Sukuk issuance
Source: BPAM, RAM
17 Sukuk in focus | The necessity for global common practices
The facilitative The progressive expansion of the ICM is The prominence of corporate Sukuk also an outcome of the strategic vision issuances is a result of GoM’s efforts to infrastructure put in embedded in the SC’s Capital Market promote the private sector as an engine place has led to several Master Plans (CMP), i.e. CMP (2001-2010) of economic growth. To this end, a and CMP2 (2011-2020). These blueprints number of fiscal stimuli has been financial engineering mapped out the long-term development accorded in the form of income tax efforts to emanate in of the Malaysian capital market into a deduction, real property gains tax Sukuk structures. This well-regulated international ICM center exemptions and stamp duty exemptions which fosters ‘growth with governance’. to set the level playing field between has spearheaded Sukuk and bonds. Malaysia’s strong Domestic Sukuk market evolution Over the years, in support of its aspiration In addition, tax incentives have been reputation as a center to promote Malaysia as an international introduced such as tax deductions to the for Sukuk innovation. ICM, the GoM has progressively increased issuer on Sukuk issuance expenses for its Sukuk vis-à-vis bond issuances. In total, Ijarah Sukuk and Wakalah sukuk that Sukuk represent 52% of Malaysia’s bond comprise a mixed portfolio of assets. In market as at June 2018 and sovereign general, this fiscal incentive adds to the Sukuk, as shown in Figure 12, represent attractiveness of Sukuk vis-à-vis bonds. It 49% of total government securities, has further promoted the issuance of compared to only 29% as at end-2008. ‘asset-light’ Sukuk structures which have Meanwhile, the share of corporate Sukuk increased in popularity in light of the issuances, including quasi Sukuk, has difficulty of finding suitable tangible increased from 43% to 67% over the unencumbered assets to serve as same period. One of the advantages of underlying assets for the Sukuk structure. the GoM’s active participation in the The use of the Wakalah structure, for Sukuk market is that it has helped to set example, enables the issuer to utilize the necessary benchmark yield curve for certain assets such as Shariah-compliant corporate issuances. shares, vouchers representing entitlement to a specified number of Malaysia features among the world’s most travel units on public transportation active corporate Sukuk market with services as well as Murabahah and Istisna’ issuances across various sectors (e.g. receivables to form part of the portfolio of financial services, infrastructure and assets (such as in the case of the GoM utilities, transportation, property and real Wakalah Global Sukuk 2016). estate). Thanks to high demands from cornerstone institutional investors such The GoM has liberalized the mandatory as Employee Provident Funds (Kumpulan credit rating for bonds and Sukuk Wang Simpanan Pekerja), Hajj Funds issuance starting from 01 January 2017. (Tabung Haji), Retirement Fund (Kumpulan Such removal is deemed as a positive Wang Persaraan) and many others. response to the growing demand for Institutional investor base in Malaysia is higher-yielding securities in the global considered the most well-developed in economy. It also aims to encourage OIC countries. domestic credit rating agencies to upgrade their services and take a more regional or global approach to their business.
18 Sukuk in focus | The necessity for global common practices
Sukuk innovation Figure 13 : Malaysia’s strong reputation as a centre for Sukuk innovation The facilitative infrastructure put in place has led to several financial engineering 1990 First corporate sukuk - Shell Malaysia Shd Bhd efforts to emanate in Sukuk structures. This has spearheaded Malaysia’s strong reputation as a center for Sukuk innovation. Pioneering structural 2001 First quasi-sovereign global Sukuk - Kumpulan Guthrie enhancements have, for instance, evolved for tax efficiency reasons, to improve Shariah compliance, to resolve issues 2002 First rated global sovereign asset-based Ijarah Sukuk - Government of Malaysia about encumbered Shariah-compliant assets, or to support higher credit ratings.
Figure 13 depicts Malaysia’s trailblazing 2006 First exchangeable Sukuk - Khazanah Nasional Berhad position with many ‘firsts’ in terms of Sukuk structures.
2011 First Wakalah global Sukuk - Government of Malaysia Latest market trends One of the recent market developments pertains to the introduction of retail Sukuk which seeks to make Sukuk 2015 First SRI Sukuk for education - Khazanah Nasional Berhad accessible to individual investors and increase retail participation in the market. In September 2012, the SC launched the 2017 First corporate green Sukuk - Tadau Energy Shd Bhd Retail Bonds and Sukuk Framework to enable retail Sukuk to be issued and traded in Malaysia. The retail Sukuk Source: ISRA market was introduced in phases to allow time to retail investors to gain with the rising convergence of Islamic understanding and familiarity with finance with various streams of ethical investing and trading in Sukuk. The first finance such as environmental, social and Malaysian retail Sukuk issued under the governance (ESG), sustainable/impact/ framework was in 2013 by DanaInfra green investments, the United Nations Nasional Berhad to meet the capital Principles for Responsible Investment expenditure and operation expense (UN-PRI) and value-based intermediation under one of the country’s biggest (VBI, an ongoing initiative of the Malaysian infrastructure projects, notably the Klang Central Bank). Altogether, these initiatives Valley mass rapid transit (MRT) line. aim to accomplish the UN Sustainable Subscriptions were in multiples of Development Goals (SDGs) which seek to RM1,000 (about US$232) making the transform the world by targeting several investment affordable to Malaysian socio-economic development issues by citizens. 2030. The second tranche of the Khazanah Nasional Berhad SRI Sukuk in Another latest trend in the market is the July 2017―which aligns with the UN SDG issuance of Sustainable and Responsible of improving accessibility to quality Investment (SRI) Sukuk the first SRI Sukuk education―contained a retail issued for the purpose of financing component, allowing individual education was by Khazanah Nasional Malaysians to invest in a good cause. Berhad in June 2015 under the SC’s SRI Sukuk Framework (2014). SRI Sukuk align
19 Sukuk in focus | The necessity for global common practices
Table 4: Tax incentives for retail and SRI Sukuk To promote both retail and SRI Sukuk, the GoM has incentivized issuers with the Recipient Incentive Reference legislation following income tax deductions, as stipulated in Table 4. Issuer of retail Sukuk Tax deduction on additional Income Tax (Deduction for expenses incurred on the Expenditure on Issuance of With the growing concern for the issuance of: Retail Debenture and Retail • retail Sukuk structured pursuant Sukuk) Rules 2016. environment and its preservation, to the principle of Murabahah or Malaysia has also been leading the green bay’ bithaman ajil (based on the SRI Shariah-compliant financing stream. It concept of Tawarruq), Mudharabah, Musharakah, has launched several green SRI Sukuk, as Istisna’ or any Shariah principle described in Table 5. Again, issuers of other than the principle green SRI Sukuk have benefitted from mentioned below, ample GoM support. In addition to tax • retail Sukuk structured pursuant to the principle of Ijarah, or incentives introduced to attract green Wakalah comprising a mixed issuers, the SC established a Green SRI component of asset and debt, Sukuk Grant Scheme for an amount of approved or authorized by the RM6 million. The scheme incentivizes SC from the year of assessment 2016 until the year of issuers to seek green certification by assessment 2018. offsetting external review costs of up to 90% subject to a maximum of RM300,000 Issuer of Sustainable Tax deduction for the expenditure Income Tax (Deduction for (about US$69,767) per issuance. The and Responsible incurred on the issuance or Expenditure on Issuance or Investment (SRI) Sukuk offering of SRI Sukuk approved or Offering of Sustainable and grant is open to both domestic and authorized by, or lodged with, the Responsible Investment foreign companies for Sukuk issued in SC for the year of assessment 2016 Sukuk) Rules 2017 Malaysia in any currency up to December until the year of assessment 2020. 2020. In addition, grant recipients enjoy The tax deduction is applicable to income tax exemption. SRI Sukuk in which %90 of the proceeds raised from the issuance The future of green Sukuk is certainly or offering of the SRI Sukuk are promising in Malaysia. As the used solely for the purpose of funding SRI projects as specified in President/CEO of Cagamas at the IFN Asia the guidelines by the SC. Forum 2018 said, this is in light of the GoM’s aspiration to position the country Source: Securities Commission Malaysia as the home for SRI and to support Malaysia’s Green Technology Master Plan which targets the country as a green technology hub by 2030.
20 Sukuk in focus | The necessity for global common practices
Table 5: Malaysia’s Green SRI Sukuk (as at June 2018) Way forward Tadau Energy Issued the first corporate green SRI Sukuk in Malaysia in Sdn Bhd July 2017 totalling RM250 million (about US$58 million) Over the years, Malaysia has been for financing a 50-megawatt solar power plant. successful in diversifying its investor- and issuer-base as well as increasing its cost competitiveness vis-à-vis other Sukuk markets. Quantum Solar Park Malaysia Issued the world's largest green SRI Sukuk in October 2017 Malaysia has been a frontrunner in Sdn Bhd worth RM1 billion (about US$233 million) to finance the construction of three large-scale solar photovoltaic plants various arenas in the Sukuk market, in the states of Kedah, Melaka and Terengganu, Malaysia. including the development of an active Islamic money market, the issuance of innovative Sukuk structures and the launch of green PNB Merdeka Ventures Issued a green SRI Sukuk in December 2017 totalling RM2 Sdn Bhd billion (about US$466 million) to finance the construction SRI Sukuk, among others. The latter of the Merdeka 118PNB Tower project which contains has specifically strengthened workplace safety, green and sustainability features. Malaysia’s position as a forerunner for Islamic sustainable finance. The current challenge is for the country Sinar Kamiri Issued a green SRI Sukuk in January 2018 totalling RM245 to preserve its leadership position Sdn. Bhd million (about US$57 million) to undertake the development through greater penetration of of a photovoltaic facility. retail investors and more awareness of green SRI Sukuk. The prospects of aligning Sukuk with sustainable initiatives, which are in line with UiTM Solar Power Issued a green SRI Sukuk in April 2018 totalling RM240 upholding the objectives of the Sdn Bhd million (about US$56 million) to fund a large scale renewable Shariah (Maqasid Al Shariah) and energy project. meeting the UN SDGs, may represent the key catalyst for Malaysia to further expand its Sukuk market. The launch of the Source: ISRA Bond and Sukuk Information Exchange (BIX Malaysia) in 2017―a Over the years, Malaysia has been centralized and comprehensive information platform on issuers, successful in diversifying its investor- credit risk and pricing―is envisaged to facilitate more retail participation and issuer-base as well as increasing its in the Sukuk market and contribute towards transparency in both cost competitiveness vis-à-vis other primary and secondary markets. Continuous support from both the Sukuk markets. Malaysia has been a government and the regulator is significant to increasing the value frontrunner in various arenas in the proposition of Sukuk as an undeniable competitive financing Sukuk market, including the tool to issuers for sustainable development projects. development of an active Islamic money market.
21 Sukuk in focus | The necessity for global common practices
Asia Sukuk markets – Sukuk in Indonesia: Development, challenges and opportunities
By Dr. Hurriyah El Islamy, Executive Board Member, Badan Pengelola Keuangan Haji
Despite the slow growth of Islamic finance The development billion making Indonesia the largest in Indonesia, Sukuk is gaining momentum. Since 2008 up to 12 July 2018, the sovereign Sukuk issuer ahead of Saudi The government of Indonesia first issued government has issued sovereign Sukuk Arabia, the UAE, Malaysia, Turkey, Qatar sovereign Sukuk in 2008. The objectives totaling to Rp906.1 trillion of which and Bahrain whose international were, among others, to provide an Rp615.0 trillion is outstanding. sovereign Sukuk issuance stand at US$9, alternative source of funding for the US$8.2, US$7, US$6.25, US$6.23 and Government, to offer Shariah compliant Outstanding Indonesian Sovereign US$5.2 billion respectively. investment instruments and to promote Sukuk Islamic finance. Sovereign Sukuk, known Furthermore, since 2009 the government Indonesia is the first country in the world as SBSN being the short form for Surat of Indonesia has issued sovereign Sukuk to have issued green global sovereign Berharga Shariah Negara, also serves as in foreign currency (namely US$). As of Sukuk. This year, as a manifestation of the the benchmark for corporate Sukuk today, the total sovereign Sukuk in foreign government’s commitment towards issuance. currency that has been issued by the tackling environmental issues such as government of Indonesia is US$16.15 climate change, carbon emissions and
Figure 14 : Outstanding Indonesian Sovereign Sukuk
300 700 615.00 600 250
500 200
400 150 300
100 200
50 100
- - 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
IFR 4.70 5.98 12.13 16.74 17.14 16.59 16.59 11.24 11.24 10.07 10.07
SR - 5.56 13.59 20.93 28.99 35.92 47.91 56.26 72.79 67.50 53.97
SNI - 6.11 5.84 14.96 25.47 50.58 62.20 96.57 127.64 169.35 223.00
SDHI - 2.69 12.78 23.78 35.78 31.53 33.20 36.70 36.70 36.70 34.20
SPNS - - - 1.32 0.20 8.63 10.74 9.02 7.70 19.64 26.43
PBS - - - - 16.71 26.03 35.48 82.72 153.98 245.78 264.80
SPNS-NT ------5.08 - - -
ST ------2.59 2.52 2.52
Total (Rhs) 4.70 20.33 44.34 77.73 124.28 169.29 206.10 297.58 412.63 551.56 615.00
Source: Ministry of Finance, Indonesia.
22 Sukuk in focus | The necessity for global common practices
other environmental problems, the Figure 15 : International (foreign currency) Sovereign Sukuk issuance government issued green global sovereign Sukuk totaling US$1.25 billion. Indonesia 16,150
This has not only become the first green Saudi Arabia 9,000 global sovereign Sukuk issuance, it was Emirates of Dubai 8,219 also the largest global Sukuk ever issued outside the GCC region. Indonesia has Malaysia 7,000 also become the largest international Turkey 6,256 Sukuk issuer in the world for having Qatar 6,231 issued the total of US$16.15 billion Sukuk Bahrain 5,238 in less than a decade after its first Sukuk Pakistan 5,044 issuance. Figure 16 below shows the growth of Indonesian sovereign Sukuk Oman 3,149 issuance. Hongkong 3,000
Emirates of Ras Al... 2,625 The challenges Emirates of Sharjah 2,250 The absence of a supporting legal framework was a hurdle that discouraged South Africa 500 the issuance of Sukuk. The ISRA-Deloitte -1,000 2,000 5,000 8,000 11,000 14,000 17,000 survey which was conducted for the Million US$ purpose of this study confirmed that 41.41% of respondents strongly agreed Source: Ministry of Finance, Indonesia. that lack of suitable underlying assets and legal restrictions in asset ownership have for Sukuk has not been well established caused practical difficulties to issue Sukuk thus making even tradable Sukuk and the other 49.49% of respondents practically illiquid. Fourth, except for a agreed to an extent. This is a common small coupon margin offered by sovereign challenge that applies globally. In the case Sukuk, there has been no other financial of Indonesia the matter has been rectified incentive offered to make Sukuk more with respect to sovereign Sukuk issuances appealing to investors. Nonetheless, the (Law Number 19 of 2008 on Sovereign coupon margin fails to attract investors as Sukuk) but not for corporate Sukuk the offered margin does not warrant issuances. Secondly, despite the large locking one’s position for the entire term number of sovereign Sukuk issuances, of the certificate, which is likely the case with the recent representing the largest with the Sukuk market in Indonesia. one thus far, the Sukuk market in Further, there has been no tax incentive Indonesia is somewhat small in for the issuer nor the investor for dealing comparison to bonds as total Sukuk with Sukuk which otherwise could outstanding represents merely 18% of motivate players to choose Sukuk over total bonds. Third, the secondary market bonds.
23 Sukuk in focus | The necessity for global common practices
Figure 16 : The growth of Indonesian Sovereign Sukuk issuance
July 12, 2018 147.89
2017 192.49 2016 179.90 2015 118.51 2014 75.54 2013 53.18 2012 57.09
2011 33.31 2010 26.97
2009 16.55 2008 4.70
- 25 50 75 100 125 150 175 200
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 July 12, 2018
IFR 4.70 1.28 6.15 4.61 0.40 ------
PBS - - - - 16.71 9.32 9.45 46.25 91.89 91.80 67.74
SDHI - 2.69 12.78 11.00 15.34 - 12.86 4.50 1.00 2.00 -
SNI - 7.03 - 9.04 9.64 17.24 17.75 26.42 33.41 39.97 41.38
SPNS - - - 1.32 1.38 11.65 16.17 14.30 16.99 44.69 30.33
SPNSNT ------5.08 2.54 - -
SR - 5.56 8.03 7.34 13.61 14.97 19.32 21.97 31.50 14.04 8.44
ST ------2.59 - -
Total 4.70 16.55 26.97 33.31 57.09 53.18 75.54 118.51 179.90 192.49 147.89
Source: Ministry of Finance, Indonesia.
The opportunities day as Muslims continue to pay the initial The issuance of sovereign Sukuk, hajj fee contribution to reserve the Now that there are institutional particularly the SDHI, has continued to entitlement to perform hajj (pilgrimage). players participating more actively increase to meet the demand for The Government Regulations number five in investment business transactions investment of a fund accumulated from of 2018 dictates that during the first three including Sukuk, it is expected that pilgrimage fees. Similar trend applies to years after the Agency establishment, not overall Sukuk growth in Indonesia other types of sovereign Sukuk too. The less than half of the fund is to be invested will accelerate. As a sovereign growth was due to the increase of while the rest is placed with local Islamic agency BPKH is in the position to demand from both the institutional as banks (including Islamic windows). work together with ministries and well as individual investors. Motivated by such requirement, BPKH has other government agencies and to been actively dealing with the Ministry of discuss and agree on transactions The emergence of a new market player, Finance and other market players to have and/or approaches that will Badan Pengelola Keuangan Haji (BPKH), Sukuk issued and within a few months, it improve market practice. Initiatives the Indonesian pilgrims fund has already placed Rp4 trillion in are taken that in effect will remove management agency has started to sovereign Sukuk and purchased further some factors that remain as impact the Islamic finance industry. A Rp1.7 trillion in addition to about Rp38 impediments in Shariah compliant market maker in the making, BPKH has trillion sovereign Sukuk mostly in the form investment transactions. While such cash (including Sukuk) under its of SDHI it inherited from the Ministry of action may be motivated by the management totaling to Rp113trillion (as Religious Affairs. objectives BPKH has to fulfill, it is at 30 June 2018). The size increases each expected that the Islamic finance industry as a whole will benefit from such change.
24 Sukuk in focus | The necessity for global common practices
Asia Sukuk markets – Sukuk market Government sector issuances have development in Pakistan dominated the Sukuk By Mufti Hassaan Kaleem, Shariah Scholar market, with approximately PKR 865 Sukuk has become an essential part of In 2016, a total of 9 domestic Sukuk the Islamic financial system. In line with were also issued with a total value billion (US$7.089 billion) the global trend, the Sukuk Market has of approximately PKR 320 billion being issued directly by been consistently gaining ground in (US$3 billion). Of these, around PKR 195 Pakistan’s growing Islamic finance billion (US$1.860 billion) were the Government of industry. There has been a concerted Government Ijarah Sukuk and PKR 100 Pakistan and around PKR push by regulatory authorities in Pakistan billion were issued by public-sector 150 billion (US$1.229 to promote the Islamic finance industry entities (primarily the PKR 100 billion on a sustainable basis. Regular Sukuk (US$954 million) Neelum Jhelum Sukuk). billion) by public sector issuance has been a key element of this New corporate Sukuk issuances stood at entities. Over the same strategy as Sukuk make a number of around PKR 26 billion (US$248.115 options available to Islamic financial million). period, corporate Sukuk institutions for effective liquidity issuances are around management. In the recent past, notable Sukuk within the corporate sector include the PKR 22 PKR 170 billion Pakistan joined the global Sukuk market billion (US$217 million) issue by K-Electric (US$1.393 billion). with issuance of its first international in 2014-15, the PKR 10.5 billion sovereign Sukuk of US$600 million in (US$100 million) issue by Fatima Fertilizer 2005 and first domestic Sukuk a year in 2016, the PKR 7 billion (US$66.800 later. Since then four international Sukuk million) issue by Meezan Bank in 2016 amounting to US$3.6 billion and 107 and the PKR 5 billion (US$48 million) issue domestic Sukuk amounting to Rupees (Rs) by Engro Fertilizer in 2016. Banks such as 1,204.28 billion (US$9.869 billion) have Al Baraka, Meezan and Dubai Islamic Bank been issued. have issued Sukuk to bolster their Tier 2 capital to comply with Basel III capital Government sector issuances have adequacy requirements. dominated the Sukuk market, with approximately PKR 865 billion (US$7.089 In comparison with global issuances, the billion) being issued directly by the overall volume and size of the domestic Government of Pakistan and around PKR Sukuk market in Pakistan is relatively 150 billion (US$1.229 billion) by public small; the Pakistani Sukuk market was sector entities. Over the same period, approximately 4% of global Sukuk corporate Sukuk issuances are around issuances in 2016, which stood at US$75 PKR 170 billion (US$1.393 billion). The billion. Malaysia, the global Sukuk market Government of Pakistan tapped the leader, issued Sukuk worth approximately international capital markets thrice during US$35 billion in 2016, accounting for over this time, initially in 2005 with a US$600 45% of the Sukuk issued globally that million Sukuk, followed by two issuances year. Indonesia and the UAE were the of US$1 billion each in 2014 and 2016. second highest issuers with issuances of approximately US$7 billion each.
25 Sukuk in focus | The necessity for global common practices
Regulatory development In 2017, this percentage has substantially The principal laws governing the issuance dropped to around 22% of Islamic Pakistan’s infrastructure needs for of Sukuk in Pakistan are: banking deposits, creating a widening gap development projects covering 1. Companies Act 2017 (the “Companies which is alarming, as it may affect the China Pakistan Economic Corridor Act”). overall growth trajectory of Islamic (CPEC) and other projects, can be 2. Trust Act 1882. banking in the country. The GoP entered achieved with the issuance of 3. Companies (Asset Backed the domestic Sukuk market, with the Sukuk. The Government of Pakistan Securitization) Rules 1999 (the issuance of PKR 6.5 billion (US$108 has dominated the total volume of “Securitization Rules”). million), in 2006, a year after it issued its Sukuk issued in the country, in 4. Debt Securities Trustee Regulations first international sovereign Sukuk of order to ensure the sustainable 2012. US$600 million. With three international growth of Islamic banking and 5. Sukuk (Privately Placed) Regulations and 19 local issues, the GoP has issued finance in the country, sovereign 2017 (the “Sukuk Regulations”). 22 Sovereign Sukuk in total till date. Out Sukuk need to be issued on a more of 19 domestic issues, 16 issues carried a frequent basis. The Securities and Exchange Commission variable rental rate, whereas the last 3 of Pakistan (SECP) had earlier issued the domestic issues carried a fixed rental rate. In this regard, regular structures for “Sukuk Regulations 2015” (the “2015 The following Sukuk is the latest issue in medium term Sukuk and other Sukuk Regulations”), which have now been the series of fixed rental rate Sukuk. innovative structures may be replaced by the Sukuk Regulations. In July explored. Additionally, the option of 2013, the State Bank of Pakistan (SBP) Sukuk structures introducing Shariah compliant issued guidelines for the adoption of the The Sukuk market in Pakistan is now alternatives for T-Bills using AAOIFI Shariah Standard No. 17 on maturing. Sukuk have confirmed their Pakistan Mercantile Exchange investment Sukuk (the “SBP Directive”). In viability as an alternative means to Commodity Trading Platform, which addition, the Government amended the mobilize medium to long-term savings would provide necessary depth and Income Tax Ordinance 2001, in 2016 to and investments from a huge investor breadth to Pakistan’s Islamic give Sukuk tax neutrality in comparison base. Different Sukuk structures have finance industry should be with other corporate debt instruments been emerging over the years but most of explored. such as Term Finance Certificates (TFCs). the Sukuk issuances to date have been Sukuk al-Ijarah. Other types of Sukuk like Growth trends Salam, Musharaka and Wakalah are also One of the major challenges that playing a role for the government in major Pakistan’s Islamic banking industry is projects like motorways, bridges, railways, facing is excess liquidity on the back of its power plants, among others. As the growing deposit base, which constitutes universe of investors becomes more around 14% of total banking deposits in diverse, so too will their appetites, and the country. Whereas, if we look at with these there will be issuances beyond Government borrowing/funding from the currently prevalent structures like conventional means and Islamic avenues, Wakalah bil Istithmaar based structure then the ratio is 95.5% and 4.5% used in Dawood Hercules Sukuk and respectively. If we further focus on Islamic Power Holding Sukuk or Hybrid Sukuk banking deposits versus Government of based on Ijarah and Wakalah or Ijarah and Pakistan (GoP) Sukuk, then in 2011, the Salam/Istisna’ etc. outstanding Sukuk were around 56% of Islamic banking deposits.
26 Sukuk in focus | The necessity for global common practices
The Middle East: GCC Sukuk market
The GCC’s debt capital market continued As can be seen in Figure 17, the Kingdom Domestic currency issues to be dominated by bond and Sukuk of Saudi Arabia (KSA) is the largest issuer issuance, and Sukuk has become a key accounting for 29% of issuances, followed in SAR, AED, BHD and financing driver for infrastructure projects by Bahrain which has continued to be a OMR have been similarly in the GCC and elsewhere in the wider leading regional issuer of Sukuk. Sukuk MENA region. Both sovereign and Istithmar structure was the main type by used to support liquidity, corporate issues have surged in the first the Saudi sovereign Sukuk issuance. In market pricing and half of the year compared with the same addition, Ijarah, Wakala and the Hybrid investors’ requirements period in 2017. have been used for the corporate issuances. The US dollar is the main in the respective markets Conventional issuances represent denomination currency for most issues. of the GCC. US$50.17 billion (80.19%) of the total GCC However, domestic currency issues in bond and Sukuk markets during H1 2018. SAR, AED, BHD and OMR have been Meanwhile, Sukuk issuances were similarly used to support liquidity, market Figure 17 : Key leading GCC Sukuk US$12.39 billion representing 19.81% of pricing and investors’ requirements in the issuance by country (Jan 2018 -July 2018) the total market in H1 2018. This is respective markets of the GCC. We have
30.84% lower compared to US$17.93 seen tenure varying from 7-10 years 24% billion raised in H1 2017, as reported by except for Al Rayan Bank’s Sukuk issued 29% the Kuwait Financial Centre “Markaz”, in its which has been denominated in GBP for recent research report titled GCC Bonds 34 years, marking a new horizon on Sukuk & Sukuk Market Survey, July 2018. issues. The anchor issue is seen as a new development in corporate Sukuk, as it The report stated that the aggregate tapped into the real estate mortgage- primary issuance of bonds and Sukuk by backed assets space. Finally, almost all the GCC entities, including Central Banks Sukuk issues were rated and listed in local 19% Local Issuances, GCC Sovereign and and international exchanges (dual listing 28% Corporate Issuances, totaled US$95.25 in some issues), to meet investor’s billion in H1 2018, a 9.64% increase from appetites and requirements. the total amount raised in H1 2017. Qatar Saudi Arabia Bahrain Oman led the GCC issuances in terms of total UAE Qatar value raised. Source: Deloitte Research and Analysis
To reflect on this growth in the first half of the year, we have listed some of the key Sukuk issues, highlighting the sectors they served, yield, tenure and structures used in Tables 6 and 7. These issues were divided in parts in Q1 and Q2.
27 Sukuk in focus | The necessity for global common practices
Table 6: GCC Key Sukuk issuance Q2 (Apr 2018 – Jul 2018)
Profit Date of Issuer Type of Sectors/ Use Issuance Issuance Tenor Sukuk Sukuk Name Structure rate Exchanges issuance name issuance of Proceeds currency size year rating (yield) Jul-18 Kingdom of Saudi Sovereign Sukuk Government/ SAR 403,000,000 3.80% 10 NA Tadawul Saudi Arabia Government Istithmar Budget Financing Stock SAR Sukuk Exchange
Jul-18 Kingdom of Saudi Sovereign Sukuk Government/ SAR 962,000,000 3.62% 7 NA Tadawul Saudi Arabia Government Istithmar Budget Financing Stock SAR Sukuk Exchange
Jul-18 Kingdom of Saudi Sovereign Sukuk Government/ SAR 2,100,000,000 3.50% 5 NA Tadawul Saudi Arabia Government Istithmar Budget Financing Stock SAR Sukuk Exchange
May-18 Qatar QIB Corporate Wakala/ Banking/Financials USD 120,000,000 1.900% 5 Fitch: A- Dublin Islamic Bank Sukuk Ltd Mudaraba + USD Securities Libor 3 Market Months
May-18 Kuwait KFH Sukuk Corporate Hybrid: Banking/Financials USD 3,000,000,000 NA NA Moody’s: NA Finance Company SPC Wakala/ (P)A 1 House Limited Murabaha senior unsecured long-term rating
Apr-18 Bidaya Bidaya Home Corporate NA Real Estate/ SAR 250,000,000 3.75% 2 NA NA Home Finance Sukuk Financials Finance - Series 1 Apr-18 Kingdom of Saudi Sovereign Sukuk Government/ SAR 1,125,000,000 3.75% 10 NA Tadawul Saudi Arabia Government Istithmar Budget Financing Stock SAR Sukuk Exchange
Apr-18 Kingdom of Saudi Sovereign Sukuk Government/ SAR 1,500,000,000 3.50% 7 NA Tadawul Saudi Arabia Government Istithmar Budget Financing Stock SAR Sukuk Exchange
Apr-18 Kingdom of Saudi Sovereign Sukuk Government/ SAR 9,425,000,000 3.40% 5 NA Tadawul Saudi Arabia Government Istithmar Budget Financing Stock SAR Sukuk Exchange
Apr-18 Noor Sukuk Noor Sukuk Corporate Wakala Banking/Financials USD 500,000,000 4.47% 5 A- (Fitch) Nasdaq Company Ltd Company Ltd Dubai Trust Certificates 2023
Apr-18 Sharjah SIB Sukuk Corporate Ijarah Banking/Financials USD 500,000,000 4.23% 5 Moodys: Irish Stock Islamic Bank Company III A3 Exchange, Limited Trust Nasdaq Certificates Dubai 2023
Apr-18 DAMAC Alpha Star Corporate Ijarah Real Estate USD 4,000,000,000 6.63% 5 S&P BB Nasdaq Real estate Holding V Management/ Dubai Development Limited Financials (Damac)Sukuk
Apr-18 CBB on CBB Sovereign Ijarah/ Government/ USD 1,000,000,000 6.88% 7 B+ stable Irish Stock behalf of the International Murabaha Budget Financing (S&P), B 1 Exchange Government Sukuk negative of the Company 7 (Moody's), Kingdom S.P.C. BB- stable of Bahrain (Fitch)
Source: Compiled by Deloitte Research and Analysis
28 Sukuk in focus | The necessity for global common practices
Table 7: GCC Key Sukuk issuance Q1 (Jan 2018 – Mar 2018)
Profit Date of Issuer Type of Sectors/ Use Issuance Issuance Tenor Sukuk Sukuk Name Structure rate Exchanges issuance name issuance of Proceeds currency size year rating (yield) Mar-18 Emirates Zahidi Limited Corporate NA Transportation/ USD 600,000,000 4.50% 10 NA Nasdaq Airlines Trust Financing of aircraft Dubai Certificates and working capital due 2028 requirements
Mar-18 Dar Al Arkan Dar Al-Arkan Corporate Ijarah Real Estate USD 500,000,000 6.88% 5 Moody's: Nasdaq Real Estate Sukuk Management/ B1 Dubai, Irish Development Company Ltd Financials Stock Exchange
Mar-18 IDB Group IDB Trust Corporate Wakala Support the USD 1,250,000,000 3.10% 5 S&P, Bursa Services economic & social Moody’s Malaysia, Limited advancement goals and London in line with Shariah Fitch: Stock principles AAA Exchange, Nasdaq Dubai
Mar-18 Emirates of Sharjah Sukuk Sovereign Hybrid Banking/Financials USD 1,000,000,000 4.23% 10 Moodys: Irish Stock Sharjah Program A3 Exchange, Limited Trust Nasdaq Certificates Dubai/DFM 2028
Mar-18 First Abu First Abu Corporate Wakala Banking/Financials USD 650,000,000 3.63% 5 NA London Dhabi Bank Dhabi Bank Stock Sukuk Exchange Company Limited
Feb-18 Qatar QIB Sukuk Ltd Corporate Wakala Banking/Financials USD 49,500,000 NA 5 NA Irish Stock Islamic Bank (Qatar Islamic Exchange Bank)
Feb-18 Al Rayan Tolkien Corporate Hybrid Banking/Financials GBP 250,000,000 LIBOR 34 Moody's Irish Stock Bank Funding Sukuk plus /S&P: Exchange, NO.1 PLC 80bps AAA London Stock Exchange
Feb-18 Albaraka Turk Albaraka Turk Corporate Mudaraba Banking/Financials USD 205,000,000 10.00% Perpetual - Irish Stock Participation Perpetual Exchange Bank Sukuk
Feb-18 Golden Golden Sukuk Corporate Wakala Create reputable OMR 50,000,000 6.50% 5 BBB+ by Muscat Group Series 1 branded hotels to Capital Securities enhance tourism Intelligen Market sector & will create ce Rating more employment Limited opportunities for the Omani youths
29
B
Sukuk in focus | The necessity for global common practices
Profit Date of Issuer Type of Sectors/ Use Issuance Issuance Tenor Sukuk Sukuk Name Structure rate Exchanges issuance name issuance of Proceeds currency size year rating (yield) Feb-18 Dubai DIB Sukuk Corporate Ijarah Banking/Financials USD 1,000,000,000 3.63% 5 NA Irish stock Islamic Bank Limited exchange ,Nasdaq Dubai /DFM
Jan-18 Kingdom of Saudi Sovereign Sukuk Government/ SAR 3,775,000,000 3.45% 7 NA Tadawul Saudi Arabia Government Istithmar Budget Financing Stock SAR Sukuk Exchange
Jan-18 Kingdom of Saudi Sovereign Sukuk Government/ SAR 2,050,000,000 3.85% 10 NA Tadawul Saudi Arabia Government Istithmar Budget Financing Stock SAR Sukuk Exchange
Jan-18 CBB on Government Sovereign Ijarah Government/ BHD 100,000,000 4.80% 3 NA Bahrain behalf of the Islamic Lease Budget Financing Bourse Government (Ijarah) Sukuk of the Kingdom of Bahrain Jan-18 Sharjah Sharjah Corporate NA Banking/Financials AED 2,668,050,000 NA 10 NA NA Islamic Bank Islamic Bank Sukuk
Source: Compiled by Deloitte Research and Analysis
Recent regulatory Regulatory and policy responses interest that may arise from members of Recent regulatory development in the the Shariah Supervisory Committee; and development in the GCC GCC appears to show efforts towards the method of resolving disputes related appears to show efforts developing Islamic capital markets and to the Islamic financial paper. This applies lies on engagement with the private to any issuer looking to offer Sukuk in the towards developing sector to fund capital investment projects. UAE – both local and foreign – as well as Islamic capital markets This can be seen by several initiatives and domestic issuers intending to tap the and lies on engagement governmental support for building an international market. effective debt capital market in many with the private sector to parts of the GCC. Essentially, the aim is to Other requirements included that “Fatwa fund capital investment reduce reliance on governments to carry issued for any Sukuk must detail the out infrastructure projects, given the process of how the Shariah Scholars projects. recent budgetary constraints due to oil reached the Shariah opinion, and to price falls among other reasons. support the pronouncement with legal evidence and disclosures.” This is In the UAE , in the wake of practice particularly viewed as an improved development and challenges, the Shariah governance practice to protect Securities and Commodities Authority both Sukuk issuers and investors. (SCA), recently issued a resolution stipulating a set of rules and guidance to Another important aspect of adopting issuers of Islamic securities. Emphasis has common practice is the resolution of the been placed on practice enhancement Higher Shariah Authority at Central Bank and the need to disclose mechanisms of of UAE, to adopt AAOIFI Shariah resolving disputes, such as reallocation of Standards and making the AAOIFI Shariah resources, and how to dispose of them or standards mandatory for all institutions their revenues in the event the Sukuk or offering Islamic financial services (IIFSs). issuer no longer complied with the provisions of Islamic law; conflict of
30 Sukuk in focus | The necessity for global common practices
Indeed, the proposed Nasdaq Dubai: aiming at mature that the Nasdaq Dubai plans to allow end of the Sukuk journey individuals to invest in Sukuk market new rule changes will • Sukuk issuers often see securities by 2019. This highlights a new phase boost products listing as key to liquidity, access to of development in the Sukuk market more investors and greater visibility leading to more mature end where innovation pace to design to global institutional investors. small investors will have the and articulate products However, improvements in listing opportunity to tap into the market with new risk and return requirements, trading, performance and boost growth. benchmarking and increased profile. number of international centers of Can the Individual Investors help exchanges have helped growth of the boost Sukuk Growth? Sukuk market globally. Nasdaq Dubai • Indeed, the proposed new rule has developed into a leading regional changes will boost products and international exchange for innovation pace to design and global Sukuk listing and emerged as articulate products with new risk and a catalyst platform for developing return profile. In turn, this will help effective Islamic debt and capital broaden the investors base as it will market. Other international Sukuk attract a new set of investors from listing centers include; London, the region and international. The Luxembourg, Dublin and Bursa new products can also help to Malaysia. absorb much of the small idle • While regional Sukuk listing is savings, held by small investors. A growing considerably, the Exchange new suite of investment solutions has steadily improved listing rules, can be designed to fund priority product offerings, technology and social sectors. performance-related measures to • The new Sukuk designed for keep pace with global market individuals investors will create a growth. new category of investors which will • One important feature developed by require a whole set of ecosystem the Exchange is the development of development and leveraging on a suite of Sukuk indices to provide emerged innovative technology Sukuk investors with timely investment platforms performance benchmarks on price • Likewise, the Exchange will and liquidity aspects. These indices strategically need to adopt new have a main index and sub indices regulatory, operational and designed for investment grade functional measures to Sukuk, sovereign, corporate, financial accommodate for the new type of and GCC-wide index. investors. • Another development was announced, as we write this report,
31 Sukuk in focus | The necessity for global common practices
It is worth noting that the In the Kingdom of Saudi Arabia , similar as a good debt note to diversify their new regulatory developments were investment portfolio and Sukuk has CMA and the Saudi Stock introduced by the Kingdom’s Capital become a key investment note amongst Exchange (Tadawul) have Market Authority (CMA) to develop the mainstream international investors. Sukuk and debt capital market in the made a number of country. Key to this is the ‘Rules of In Kuwait , generally the Sukuk market is regulatory changes in Offering Securities and Continuing limited in scale and size and is recent months, ahead of Obligations’, which aims to regulate the constrained by limited policy support. offering of securities in Saudi Arabia. It However, the Capital Markets Authority the anchor Aramco’s IPO. includes the conditions of the offer of (CMA) of Kuwait issued new regulations This includes a relaxation securities, identifies the requirements of on Sukuk in November 2015 and a set of listing and offering, and the conditions policy guidance to spur growth of the of regulatory qualification and requirements of capital changes. Sukuk market and investors’ interest to requirements for tap the asset class as a catalyst for The CMA anticipates that the offer of investment projects’ financing in the institutional foreign securities and continuing obligations rules country. investors. and the listing rules will contribute in many aspects, including greater flexibility In a similar move, the Boursa Kuwait of the public offering, development of made several initiatives to improve new types of offerings, enhancement to reporting and transparency mechanisms the requirements of some types of for listed securities. The new online offerings, and increased flexibility for the system is believed to help improve price requirements of continuing obligations, discovery and contribute in providing noted Mohammed Elkuwaiz, Chairman, liquidity, enabling special trades, and CMA. improving the settlement and clearing mechanism. It is worth noting that the CMA and the Saudi Stock Exchange (Tadawul) have In the Sultanate of Oman , the Capital made a number of regulatory changes in Market Authority, Sultanate of Oman recent months, ahead of the anchor (CMA) has since 2016, issued a set of Aramco’s IPO. This includes a relaxation of rules and guidance to govern Sukuk regulatory qualification requirements for issuance. The ‘Sukuk Regulation’ is institutional foreign investors. developed to complement the existing bond regulatory framework, which is In the Kingdom of Bahrain , early this currently in place in the Commercial summer, it successfully priced a Rule Companies Law and Executive Regulation 144A/RegS international US$1 billion of the Capital Market Law. This new 6.875% Oct-2025 Sukuk offering, reported Sukuk Regulation provided clarity and the Central Bank of Bahrain. This issue transparency to the market players, while comes at a time when growth rates show providing protection to investors in a a surge and demand for capital to fund Sukuk transaction. projects equally spurred. In Qatar , Sukuk issuance has become This issue is significant for three reasons. increasingly important as a corporate and First, it has strengthened confidence in government debt instrument. In a recent Bahrain’s debt management credibility Bond and Sukuk survey, it was revealed and its prudential government policies to that the GCC Sovereign and Corporate manage its funding needs. Second, it Issuances, totaled US$95.25 billion in H1 reinforces the role of sovereign Sukuk as 2018, a 9.64% increase from the total a catalyst financing asset class for GCC amount raised in H1 2017. Qatar led the states and other emerging markets. Third, GCC issuances in terms of total value global investors increasingly view Sukuk raised, reported Markaz.
32 Sukuk in focus | The necessity for global common practices
Europe: UK and Luxembourg Sukuk markets By Daud Vicary Abdullah, Managing Director, DVA Consulting Sdn. Bhd. *
As a non-Muslim country, the United Kingdom (UK) has long been at the The Bank of England has been active forefront as a center for Islamic finance activity since the mid 1970’s. More than in developing a Shariah compliant 20 banks located in the UK offer Islamic financial services or products, 5 currently, liquidity facility with availability beyond are fully Shariah compliant. Many foreign banks access Islamic finance through the Islamic banks to possible include London markets or their London based teams for specific initiatives such as Islamic mortgage firms, Takaful treasury funding, trade finance, property finance and agency desks for corporate companies and Islamic leasing financing. ICD Thomson Reuters Islamic Finance Development Report gives the UK companies. an index of 16.2, which is the highest ranking of any non-majority Muslim setting body for Islamic financial Islamic leasing companies. In addition, a country. London has the leading share of institutions. In October 2010, the Central priority in the UK has always been to trading in many financial markets and has Bank of Luxembourg was one of 14 ensure the equivalence of Islamic finance a proven platform for Islamic capital founding members of the International with the conventional markets, market development. International Sukuk Islamic Liquidity Management Company particularly in the area of tax treatment. In issuances totaled nine in 2017, (IILM Co). The idea behind this institution terms of recent capital markets issuance representing 20.5% of all Sukuk issuances is to create and issue short-term Shariah by UK firms, perhaps the most in Europe for last year. The London Stock compliant financial instruments that will outstanding example was the STG MBS Exchange is a key global venue for the facilitate effective cross-border Islamic Sukuk issued by Al Rayan Bank in issuance of Sukuk. To date close to US$50 liquidity management. February 2018 for GBP 250 million, which billion has been raised through over 60 was oversubscribed by 155% and was issues. As can be seen from the two paragraphs designed to ensure that it was above, both the UK and Luxembourg have recognizable as High-Quality Liquid Assets Similarly, the Luxembourg market has been proactive market leaders in the (HQLA) and as a securitization under been an early adopter of Islamic finance. development of Islamic finance in Europe, Central Registry Depository (CRD) For example, Europe’s first Islamic and are rightly thought to be dynamic definitions. financial institution was licensed in leaders in the global market. However, no Luxembourg and carried out operations market center can rest on its laurels and In terms of policy and actions as a result from 1978 to the 1990’s. In 1983, needs to be active in developing new or related to Brexit there is nothing Luxembourg was the first European strategies to sustain momentum in the specific to report. Most UK practitioners country to host a Takaful company. In future. see no diminishment in the UK’s expertise 2002, Luxembourg’s stock market was the in Islamic finance coming as a result of first in Europe to list a Sukuk. In 2009, In the UK, the Bank of England has been BREXIT. Indeed, some experts are saying Luxembourg’s central bank was the first active in developing a Shariah compliant that UK’s experience may well be European entity to become a member of liquidity facility with availability beyond enhanced through greater engagement the Islamic Financial Services Board (IFSB), Islamic banks to possibly include Islamic through FinTech and impact and green the prudential/supervisory standard- mortgage firms, Takaful companies and investment. What is also encouraging is
*With grateful thanks to Stella Cox CBE, MD of DDCAP, Shakeeb Saqlain, CEO of IslamicMarkets.com and Marco Lichtfous, Partner Deloitte Luxembourg for their valuable input.
33 Sukuk in focus | The necessity for global common practices
the development of a new generation of Luxembourg’s stock Also encouraging in both UK and competent and business savvy young Luxembourg is the aspiration, Shariah scholars in the UK market, who market was the first in among certain private sector firms, have a great awareness on the 17 UN Europe to list a Sukuk. for the development of green SDG’s and their alignment with the overall Islamic Finance. These initiatives, objectives on the Maqasid Al Shariah, this In 2009, Luxembourg’s like those related to Islamic Fintech, growing awareness and maturity will only central bank was the are being driven by private sector serve the UK well on the global stage of first European entity to engagement through the likes of the future. Harnessing, in a more holistic The City UK (TCUK) and Luxembourg way, the expertise of responsible business become a member of for Finance. Government is and the Shariah, will provide the basis for the Islamic Financial participating informally, but a richer and more innovative Sukuk organizations, such as TCUK, are market. Services Board (IFSB), the invaluable in bridging private and prudential/supervisory public sector aspirations, drawing In Turkey, since 2010, the Capital Markets standard-setting body for together the dialogue and lobbying. Board (CMB) introduced regulation to Both the UK and Luxembourg support Sukuk issuance in the country. Islamic financial markets for Islamic Finance have The Communique provided guidance institutions. developed and learned well over regulating the principles and rules the last 30 years or so. The extent of regarding board registration, issuance, development and depth of and sale of Ijarah certificates, and the experience, particularly in the establishment and activities of asset lease aspects of business, legal, tax and companies. In 2012 and 2013, through a Shariah issues, should stand them series of regulations issued by the in good stead as the world faces the Istanbul Stock Exchange (Borsa Istanbul), challenges and opportunities public and private lease certificates were presented as the result of accepted among eligible instruments that developments in FinTech and the could be traded in the Debt Securities increasing realization that business Market, and market conventions were has to be more and more focused regulated. In 2013, following the on sustainability and recognize the enactment of a new Capital Markets Law, benefits of responsible finance. The the Capital Markets Authority widened the Sukuk industry is facing a number definition of lease certificates, allowing of global challenges. However, the contracts to be based on ownership, contributions of both the UK and management, trade, and partnership. Luxembourg will go a long way to ensuring that Sukuk will be at the A key development to support Sukuk forefront of driving a sustainable issuance was made by the amendments industry transformation. The future to several tax laws relating to stamp duty, can be bright, but there is much to corporate tax, and value-added tax do and not a moment to lose. related to Sukuk and the transfer of assets to asset leasing companies. Several other initiatives associate Islamic finance and Sukuk in particular with investment in real economy sectors such as renewable energy, and wider UN’s SDGs. See case study on page 35.
34 Sukuk in focus | The necessity for global common practices
Case study: GIFIIP’s green Sukuk initiative
• In its efforts to align investment strategies with the UN’s SDGs, the Istanbul International Center for Private Sector in Development (IICPSD), under the Global Islamic Finance and Impact Investing Platform (GIFIIP) hosted stakeholders from public and private sector to build greater understanding of the role of Islamic finance in clean energy projects in Turkey. • The meeting was organized as the first stakeholder consultation meeting for green Sukuk initiative launched under GIFIIP. The initiative aims at three main goals: (i) facilitating access to finance for renewable energy projects in developing countries, particularly in the MENA region and OIC countries, (ii) providing financial solutions to environmental issues and (iii) expanding the role of Islamic finance in achieving the SDGs. • Green Sukuk initiative will be piloted in Turkey and then replicated in OIC countries starting with the countries in the MENA region. The initiative has registered keen interest from investors. In Turkey, two domestic and one international green Sukuk issuances are currently under discussion, as an outcome of GIFIIP’S green Sukuk initiative. • Representatives from Republic of Turkey Ministry of Energy and Natural Resources, Capital Markets Board of Turkey and Republic of Turkey Prime Ministry under secretariat of Treasury participated in the meeting besides private sector representatives. The meeting focused on discussions on both the current landscape of Turkey’s green Sukuk market and future opportunities. The meeting offered a unique opportunity to discuss challenges and opportunities regarding the green Sukuk market in Turkey and to identify potential solutions.
Green Sukuk initiative will be piloted in Turkey and then replicated in OIC countries starting with the countries in the MENA region. The initiative has registered keen interest from investors.
35 Sukuk in focus | The necessity for global common practices
Regulatory support needed to drive Sukuk standards to boost growth and liquidity
By Khalid Howladar, Managing Director and Founder, Acreditus
The topic of Sukuk standards is an desired ‘bond’ hence complex and important but sometimes divisive one in sometimes-expensive legal engineering is Islamic capital markets and is a constant applied to replicate the bond. This source of debate between many key compromise is to reflect the perceived industry stakeholders. needs of a market that is still very immature and developing. Importantly, it While many esteemed industry bodies like should be noted that some Sukuk issues the Accounting and Auditing Organization have the ‘symptom’ of the underlying for Islamic Financial Institutions (AAOIFI) structural/complexity issues. and the International Islamic Financial Market (IIFM) have worked or are working on standards, widespread market The varying Sukuk structures observed adoption remains limited given they are still in development and sometimes do (Wakalah, Ijarah, Mudarabah, not fit the objectives of the market’s key stakeholders – the investors and issuers. Murabahah, Musharakah and hybrids
The Sukuk market still remains of the above) do not intrinsically have fragmented and Shariah-compliance driven structural complexity can expose the same risk, return profile as the investors to unnecessary legal risks and investment frictions that simply do not desired ‘bond’ hence complex and apply to conventional instruments, hence subduing global growth prospects and sometimes-expensive legal engineering liquidity. Unfortunately, despite these problems being highlighted by recent is applied. industry challenges - little of substance has changed. Even though the English Regulatory promotion of standards can (governing law) courts ruled in favor of the have multiple beneficial effects for an investors, they have ultimately suffered a industry that struggles to harmonize given material loss due to these risks – not a the varying incentives and agendas of the good outcome for the industry. stakeholders involved. Private sector issuers in the dominant ‘unsecured’ Sukuk The underlying issues stem from the market could benefit from reduced inherent tension between the underlying complexity and standards with lower equity, risk/profit sharing and asset costs, thus leading to higher issuance financing principles of Islam and the volumes, transparency and liquidity. current investor and issuer demand for a debt-like instrument. The varying Sukuk Ultimately, of all the parties, it is those structures observed (Wakalah, Ijarah, with the ‘money’, who decide the success Mudarabah, Murabahah, Musharakah and or failure of any market - including Sukuk. hybrids of the above) do not intrinsically Aside from the above benefits, active have the same risk, return profile as the regulatory endorsement of ‘pragmatic’
36 Sukuk in focus | The necessity for global common practices
versus ‘idealistic’ standards would boost Regulators also need to ensure a holistic Development of the confidence for international investors and view and have clear goals before setting help the sector mature. Standards would policy – sometimes these goals can even sector is a key goal of reduce the time and resources needed conflict and these too must be managed most governments of for newcomers and smaller investors to carefully. National Shariah Boards are key assess the risk of such investments and for market confidence, improving market Muslim majority hence increase the number of liquidity and reducing costs for issuers countries and thus far, participants – boosting trading and and investors. Their endorsement of they have proven much investment. market standards would support transparent and healthy growth. more effective in driving Standards across the different growth than the private jurisdictions (a desirable but still The most quoted negative of unrealistic ideal) would allow greater and standardization for the market is reduced sector can achieve alone. more resilient capital flows and variety and innovation. However, the investment opportunities between the chosen standards should address the active countries, creating a much larger needs of the nearly US$450 billion mostly market and attracting more investors and unsecured public market. This will not issuers to the Sukuk market – kick-starting meet the needs of all issuers and it may a virtuous circle. not be the most orthodox or conservative structure. The author proposes that For some market parties (such as lawyers, having market standards for these fatwa providers, and bankers) common ‘unsecured’ instruments would standardization is a mixed blessing. On not constrain ‘innovation’. the one hand - such parties can benefit economically from the complexity of such transactions with the prospect of esoteric Indeed, all those who are not happy and individual (potentially higher) fees per with the standards can still transact transaction. On the other hand - such with each other. Nothing stops complexity consumes precious resources transactions outside the standard, and human capital. Such parties could but one can be assured the also benefit from the higher volumes (and regulator-endorsed structures with more frequent fees) that a more their lower costs and better legal standardized market could create. certainty will find favor with investors who will decide the shape Development of the sector is a key goal of of the market with their money. In most governments of Muslim majority all market related activities, the best countries and thus far, they have proven way to move forward is to empower much more effective in driving growth investors through transparency, than the private sector can achieve alone. governance and education – having Public agencies are responsible for standards supports all three of exercising authority over the Sukuk capital these objectives that are important markets in a regulatory or supervisory to build a growing Sukuk market capacity. They provide administrative laws, that all issuers and investors can regulations, transparency, supervision, have confidence in. disclosures and oversight for the benefit of all parties but typically focus on protecting investors.
37 Sukuk in focus | The necessity for global common practices
Sukuk: A sustainable industry transformation, development of the alternative Sukuk market place
By Stuart Hutton, CIO, Simply Ethical
Over the past couple of decades, we have seen the Sukuk market slowly develop as With the fast development of solutions a secure alternative to the conventional unsecured bond. By secure, it is the to achieve the United Nations 17 backing of an asset or its reflection of the real economy that has created an Sustainable Development Goals, a shift understanding that Sukuk and similar investment vehicles have an important in both personal investment objectives role to play in the future of borrowing money. and that of where best to invest
In fact, in the recent survey by Deloitte institutional funds, is influencing a and ISRA, it was evident that the asset- backed/based version of this instrument focus on a more green and social is the dominant player in the market (78.8%). We are seeing heightened impact agenda. interest in a more hybrid solution, offering easier access, but the fact that more than that of where best to invest institutional 95% of interest in Sukuk comes from the funds, is influencing a focus on a more Asian, MENA, Africa regions, explains also green and social impact agenda. Combine why this broader perspective is still this with the notion that the Sukuk market lacking depth. requires more innovative structures, we are seeing potentially what a culture shift What is frustrating for many is that towards an exciting new area of how despite the crippling effect of the credit maybe everyone will lend their money in crisis ten years ago, the Sukuk has not the future. taken the opportunity to compete with the far larger and well-developed The green agenda has been strongly conventional global debt market. With highlighted as a fast-growing area, with default rates during this last decade lower the need to shift from a carbon-based than was expected to be, partly due to energy system to that of a clean governments intervention in the money renewable source. Like any shift of this markets, there has not been the shift nature, it is the infrastructure backing and towards these alternatives. delivering on this that requires financial support. The natural opportunity for However, is this all about to change? investors has been to see this as a With the fast development of solutions to diversification away from potentially failing achieve the United Nations 17 industries or at least shifting the funds to Sustainable Development Goals, a shift in where they see it will be needed in the both personal investment objectives and future.
38 Sukuk in focus | The necessity for global common practices
One step even further into the unknown It is about the education is lending to achieve positive social impact If we start to link how the high-level where this is needed. The significant focus on how we achieve the amongst professional difference here being that the outcomes of more sustainable investors and institutions. performance of the investment is not goals, and the impact individual financially gauged, but one of pre-agreed investments have, as an industry, It is about harmonization impact on an issue, for example related to the financial markets have probably of the approach to the health, education, or environment. the most significant role in use of Sukuk to offer a The Social Impact Bond is truly in its achieving this. This means that the infancy, with very limited scope and instruments it uses now and simpler route to market. commitment. As a part of the global debt develops for the future should market, it does not even measure. include Sukuk like structures, However, when you look at recent focusing on delivery of transparent innovative ideas on how this works and flow of funds for positive green and delivers, it is easy to understand why the social return. financial markets are finally seeing how both “doing good & receiving good” do Of course, we do not live in an ideal exist at the same time. No longer do you world, and given the financial necessarily need to forgo some financial impacts of the last 100 years, it is return in an almost philanthropic way to easy to talk down the potential achieve both. rewards. However, if innovation and collaboration, for example in use of In May of this year, the Holy See Press technology like Blockchain, can Office of the Vatican released thoughts on combine with the traditional roots this, expressing that economic and of responsible investing, as offered financial issues draw our attention to the by Islamic Finance, there is no growing influence of the markets on the excuse. material well-being of most of humankind. This has been mirrored by many other So, what may be the answer? articles and speakers focusing on how for Well, it is about the education example the role of Waqf and Zakat in amongst professional investors and Islamic finance used for the alleviation of institutions. It is about poverty and promoting social welfare is harmonization of the approach to not being sufficiently effective. the use of Sukuk to offer a simpler route to market. It is about understanding the new type of investor that the ‘millennials’ will offer, as we see the transfer of wealth to the next generation. It is this, aligning with the desire and demand for alternative investments that will offer greater flows into the green and social impact marketplace, and if allowed, into Sukuk.
39 Sukuk in focus | The necessity for global common practices
Sustainability in focus Development of green and sustainable Sukuk investment principles and the need for multi-stakeholder collaboration
A series of multi-stakeholder industry recognised organisations and initiatives. To this end, SAIFI is seeking support from dialogues, led by Deloitte and supported Amongst current workstreams and topics, key industry institutions and also policy by key leading industry institutions and Islamic investment and finance that is both support in key markets including the UK, seasoned industry practitioners, have been sustainable and has positive social impact Europe, the Middle East and Asia. SAIFI’s exploring the potential for developing is high on the agenda. initial focus is on environmental globally recognised, common principles for sustainability and, if sufficient progress can the further development of the Sukuk To drive the themes, thoughts and insights be made in this area, further work on market into green and sustainable discussed in this Report, and following the social impact investing may follow. practices. This could become a catalyst for related thought leadership Roundtable accelerating the building of the long- that took place in London in 2017, a multi- Figure 18 below shows some of the sought full eco-system of the Islamic stakeholder group of industry experts organizations and initiatives relevant to the capital markets. joined to collaborate on the development global development of responsible and of green and sustainable Islamic capital sustainable financing practices and reflects Deloitte’s Sukuk market dialogue has market principles. The main objective of how their output might link directly, or historically had a broad agenda. Its focus the Sustainable and Islamic Finance through collaboration, to Islamic financial currently includes the promotion and Initiative (SAIFI) is to bring together Sukuk sector development, including the Sukuk streamlining of practices within the global practices with global green investment market, and sustainable and responsible Sukuk market by embracing input and principles and promote international best investments that are green and / or have thought leadership from internationally practices in Islamic capital markets globally. positive social impact.
Figure 18 : Transforming the ecosystem of Sukuk investment market
Multi-stakeholders collaboration Social Priority Sectors (SPSs)
Leading sustainable Best practices Multi-stakeholders Investing responsibly to fund infrastructure and investment developed by industry group support best practices
Rail & road Affordable transportation housing
Education Agriculture facilities & Industry Industry production services standard setters institutions and and regulators expert practitioners
Healthcare services Renewable energy Water sanitation
40 Sukuk in focus | The necessity for global common practices
Thinking further ahead: Practice and policy considerations
The strategic considerations prompted by • Lagging behind in adopting global Aligning investment the necessity of global common practices investment practices and principles for Sukuk markets and the analysis discussed in this report such as the structure innovations provided, should be followed and GBPs, PRI’s, SDGs, ESG and green with Maqasid Al Shariah revisited by industry stakeholders to take finance. into the implementation phase. We to finance priority sectors believe that industry executives, policy Policy support will drive greater – identified in this report makers and practitioners should consider harmonization on leading investment – will help achieve the bringing this debate internally in their practices and will strengthen Sukuk respective organizations, focusing on the acceptability as a leading investment values of Islamic finance strategic Shariah governance, operational asset class with its unique risk and return of social inclusion. and technological implications towards profile. building globally accepted practices for Niche, specialized Sukuk Sukuk. Other policy considerations were also New innovative investment structures identified across market practices such as the one highlighted by the case Nevertheless, we have identified three considered in this study: study relating to renewable energy in main challenge areas related to the Turkey, will create targeted products and growth in Sukuk market that will require Streamlined regulatory support services and attract new investors. multi-stakeholder collaboration to be Emerging global investment initiatives and addressed effectively: technologies provide new ways to Serving priority sectors • New Sukuk structures are creating improve regulatory consistencies between Aligning investment structure innovations significant regulatory and Shariah key Islamic financial markets (Asia, Middle with Maqasid Al Shariah to finance priority challenges and acceptance by market East and Europe). Signing to these sectors – identified in this report – will leaders. investment initiatives will help boost help achieve the values of Islamic finance • FinTech products and services may give regulatory convergence in a way or of social inclusion. rise to competition and cost of raising another. capital in mid and long-term notes. Thinking further ahead, the drive for global common practices in Sukuk
A global common practice in Sukuk markets can be viewed as a nexus for building an effective markets will become the base for building Islamic Capital Market which will serve priority sectors identified in this report. effective and efficient Islamic capital markets which can in turn integrate more effectively to global capital markets.
Leading role: lead from the front to create an ecosystem for global common practices: a nexus thrive
Directional role: Provide direction, guidelines, policies and enforcement support to the Islamic Capital Market.
41 Sukuk in focus | The necessity for global common practices
Key contacts
Joe El Fadl Khaled Hilmi Akbar Ahmed Nauman Ahmed Partner Partner Partner Partner Regional FSI Leader FSI Consulting Clients & Industries Leader Tel +966 1 3 887 3739 Tel: +961 1 364 700 Tel +971 4 376 8888 Tel+971 4 376 8888 [email protected] [email protected] [email protected] [email protected]
Bhavin Shah Aejaz Ahmed Dr. Hatim El Tahir Partner Partner Director Financial Advisory Risk Advisory Tel +973 17 214490 Tel + 971 4 5064853 Tel + 96612828400 [email protected] [email protected] [email protected]
Thought leadership reports
Islamic Finance: Responsible Corporate Sukuk: Scalable and Investment: New Building the sustainable funding thinking for ecosystem to finance source for social financing renewable sustainable infrastructure energy infrastructure
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Deloitte & Touche (M.E.) (DME) would be pleased to advise readers on how to apply the principles set out in this publication to their specific circumstances. Deloitte & Touche (M.E.) accepts no duty of care or liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication.
DME is a licensed member firm of Deloitte Touche Tohmatsu Limited (DTTL) and is a leading professional services firm established in the Middle East region with uninterrupted presence since 1926. DME’s presence in the Middle East region is established through its affiliated independent legal entities, which are licensed to operate and to provide services under the applicable laws and regulations of the relevant country. DME’s affiliates and related entities cannot oblige each other and/or DME, and when providing services, each affiliate and related entity engages directly and independently with its own clients and shall only be liable for its own acts or omissions and not those of any other affiliate.
DME provides audit and assurance, tax, consulting, financial advisory and risk advisory services through 25 offices in 14 countries with more than 3,300 partners, directors and staff. It is a Tier 1 Tax advisor in the GCC region since 2010 (according to the International Tax Review World Tax Rankings). It has also received numerous awards in the last few years, which include best Advisory and Consultancy Firm of the Year 2016 in the CFO Middle East awards, best employer in the Middle East, the Middle East Training & Development Excellence Award by the Institute of Chartered Accountants in England and Wales (ICAEW), as well as the best CSR integrated organization.
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