The demand for sukuk by corporate and infrastructure issuers in the Gulf is likely to continue growing at a double-digit pace in the year or two ahead, despite weakness globally, said a report.

The support for the market is coming from refinancing requirements, a huge need to finance infrastructure projects, the pullback in bank lending, and supportive governments, though investor uncertainty continues to hold back even stronger growth, according to Standard & Poor's Ratings Services.

One of the main factors that continued to support Gulf corporate and sukuk issuance during the period and especially in the first half was low yields on average, because many GCC issues are denominated in US dollars and are therefore sensitive to changes in Fed policy, it stated.

The other factors included some improvement in the perceived credit quality of sukuk, arising from better economic conditions and higher oil prices, the continued need for infrastructure finance, and calls by GCC governments (in particular Dubai) for greater Islamic issuance by corporate and infrastructure entities.

The issuance in the GCC region grew a solid 11 per cent in the year to September 24, 2013, to reach $14.8 billion. By contrast, volumes decreased about 25 per cent in the period in the world's biggest country of issuance, Malaysia, dulling global performance, the S&P report said.

The prospects for that country next year largely depend on the direction of interest rates, but S&P foresees at least stable volumes.

"Malaysian volumes for full-year 2013 could fall short of 2012 levels, however, on the back of one of the market's slowest periods in third quarter. The first half of the year already saw a 53.5 per cent drop in corporate issuance from first-half of 2012," it stated.

"Yet, since the US Federal Reserve Bank announced that it would delay the tapering of quantitative easing, yields dropped and we are seeing an uptick in investor interest in sukuk that companies are proposing to launch - in the GCC as well as Malaysia," said S&P in its report.

In Malaysia, government issuance accounts for about 65 per cent of volumes, complemented by issuance from the power, utilities, manufacturing, and financial services sectors.

S&P said the Gulf sukuks were issued at compellingly low prices in the first half by infrastructure entities such as Saudi Electricity Company (SEC) and Dubai Electricity and Water Authority (Dewa), compared to historical pricing for these entities at similar tenors.

These large issuances favoured denomination in US dollars to attract international investors, and the SEC issue broke a record in tenor with its 30-year maturity, illustrating that the market is broadening and innovating. In the past, maturities have typically been no longer than about seven years for this asset class.

After Dubai's ruler early in the year announced plans for the emirate to be the world's eminent sukuk hub, several government-related entities went to market including Dewa, said the S&P report.

Then in the third quarter, following the Fed's announcement of a possible tapering, issuance for GCC corporate and infrastructure sukuk began to decline, mirroring the falloff in conventional bond issuance. As a result, sukuk yields spiked more than 1 percentage point.

Granted, the third quarter has seen a lull in activity in the GCC in the past couple of years due to summer and religious festivities when the markets generally tend to be less active. When the Fed indicated that it would delay tapering, yields started to tighten again, and declined by about 30 basis points to about 4.2 per cent on average over the month to October 25, according to the GCC Corporates (GSKC) HSBC Sukuk Index.

Certain issuers have returned to the market (notably in Saudi Arabia) such as the General Authority for Civil Aviation (GACA), with a SR15.2 billion issue. Al Marai Company also issued Islamic bonds, and others such as ACWA Power have announced plans for sukuk by the end of the year.

In November, the Saudi real estate entity Dar Al Arkan tapped the market with a $300 million, three-year issuance, and the board of the country's Capital Market Authority approved Saudi Electricity's sukuk offering, whose size the company will determine at a later time.

The drivers for sukuk in the coming years in the GCC are likely to be refinancing requirements, the vast government programs for building out the infrastructure, and tighter global and local regulation of banks that could dampen their issuance, said the top ratings agency in its report.

Infrastructure plans include much-needed investment in power and water, expansion related to events like the FIFA World Cup in Qatar in 2022, and corporates aiming to diversify their sources of funding with the aim of supporting the development of Islamic finance in the region.
 
In the tougher regulatory environment, issuers are likely to turn to alternative sources of funding in the capital markets, with corporate and infrastructure entities in the Gulf favoring sukuk, the report added.-TradeArabia News Service