Loans for raising: Islamic finance

Could sharia-compliant bonds be the answer to funding the world’s growing infrastructure needs? Vision finds out

McKinsey & Company, the consultants, last year estimated that US$57tn of investment in infrastructure will be needed between 2013 and 2030 in order to keep up with projected growth in the global economy. One important solution could lie in a relatively new but thriving niche of finance: Islamic bonds. These instruments, usually known as sukuk, are deftly structured by Muslim scholars, specialist lawyers and bankers to replicate the fixed interest rates of conventional bonds.

Sukuk sprung out of the modern Islamic finance industry. Globally, the industry is now worth well in excess of US$1tn; the sukuk market represents a young, small but rapidly growing subset of that.

So far there have been 10 sukuk worth US$6.1bn listed on Nasdaq Dubai, making the exchange the world’s third largest for sukuk by value and underscoring Dubai’s growing credentials in the Islamic finance industry

Last year, the market swelled to US$274bn, according to Moody’s Investors Service. Issuance dipped due to turbulence caused by the US Federal Reserve’s plans to gradually trim its monetary stimulus programme, but the global sukuk market has grown at a compounded annual growth rate of 38 per cent since 2002 and few expect that to slow markedly.

Meanwhile, the appetite for using sukuk to fund infrastructure projects is already in evidence. In 2012, for example, the number of new infrastructure-based sukuk issuances amounted to US$27.8bn, representing growth of 140 per cent on the previous year.

To date, there have been 10 sukuk, valued at US$6.1bn, listed on Nasdaq Dubai, making the exchange the world’s third largest for sukuk by value and under-scoring the emirate’s growing credentials in Islamic finance.

Hamed Ali, Chief Executive of Nasdaq Dubai, says the bourse “is playing a growing role in Dubai’s drive to become the global centre of the Islamic economy. We look forward to listing many more sukuk from regional and international companies as Islamic financing expands further in popularity among issuers and investors.”

Abdul Kadir Hussain, Chief Executive Officer of Mashreq Capital, a Dubai-based investment bank and asset manager, agrees. “It is still a growing asset class, and the fundamentals are pretty strong,” he says.

Khalid Howladar, a senior analyst at Moody’s, notes how international investors – who have no compunctions against interest – are also embracing sukuk, providing yet more opportunities for the asset class.

“All things being equal, most conventional investors are quite comfortable with sukuk now and are keen to take some Gulf credit exposure. While a conventional bond would exclude the Islamic investors, sukuk still taps both liquidity pools. This is helping the market grow,” Howladar says.

Islamic finance and infrastructure are a natural fit, with Islam stipulating that finance should serve the “real economy” rather than be mere speculation.That means sharia scholars – who are versed in both Muslim jurisprudence and conventional finance, and serve as the industry’s regulators – require all Islamic financial transactions to be backed by an underlying asset. The return of the underlying asset, whether leases from a residential building or the electricity generated by a power plant, is what allows sukuk to pay a fixed income stream.

“Infrastructure investments are easy to structure in a sharia-compliant way, and if it helps develop something socially useful, it’s even better,” says Muddassir Siddiqui, a sharia scholar at AAOIFI, an international standards body for Islamic finance.

In what can be seen as a sign of the market’s increasing sophistication, sukuk need not necessarily be backed by a physical asset in the strict sense. Dubai’s Emirates Airline last year issued a US$1bn sukuk backed by future seat proceeds. Although the Emirates sukuk was not backed by a traditional asset such as land and leases, sharia scholars accept that intangible revenue streams originating from something like passenger seats – or airport concessions – are in the spirit of Islamic finance, which encourages risk-sharing between borrower and lender.

Dubai’s Emirates Airline issued a US$1bn sukuk last year
 

Still, while countries and companies may issue sukuk to pay for infrastructure investments, few actually back the Islamic bonds with the project in question. Conventional project finance – the mainstay way to fund big developments across the world – normally takes the shape of very long-term loans where the returns are tied to the underlying project, when it is completed. Yet most buyers of sukuk are Islamic banks. They may be awash with deposits, but tend to shy away from long-term sukuk that could feature the risk of construction delays, preferring more conventional structures that are guaranteed by the borrower itself, not the project being sponsored.

“Considered from a sharia perspective, infrastructure investments are ideal,” says Howladar. “It’s a physical asset that can underpin the financing structure, with a tangible, useful purpose. But we haven’t seen much – if any – real infrastructure sukuk. We’ve seen governments or companies fund projects directly on their balance sheet, but not any Islamic project finance bonds.”