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Infrastructure projects to drive Saudi sukuk surge

Infrastructure projects are expected to drive Saudi Arabia’s sukuk issuance in the years ahead as government, corporates and banks tap into the liquidity of what is still an evolving bond market that faces challenges common to other GCC countries.

According to Khalid Nasser Al Muammar, chief executive of Saudi Hollandi Capital, issuance for the infrastructure projects in Saudi Arabia will continue.

“That will be a theme for many years to come as more projects come on stream, mainly the large government projects,” he said. He cited the example of the Riyadh transportation system that is estimated to cost about $25 billion, which will demand tapping the sukuk market.

However, Al Muammar said that oil price will be a key factor in the growth of the Islamic bond market, as it does matter for everything else in this country. The economy of the country continues to rely heavily on oil.

“It is not expected to rise, but I am not sure whether it will decline,” said Al Muammar during his visit to Dubai to attend the Sukuk Congress, which was held between February 3-4. “Most of the income comes from oil. And so, if there is a significant decline in oil prices or production output [it will have an impact].”

Beginning 2010, the Sharia bond market has seen more private contractors coming in. The Saudi Bin Laden Group (SBG) has been one of the prominent contracting groups that has regularly issued from then on and it has issued five so far.

In 2008, the total sukuk issued in Saudi Arabia stood at SR (Saudi Riyal) 7.025 billion, which has since jumped to SR40.011 billion in 2013. The big leap was from 2010 to 2011, when it rose to SR25.190 billion from the previous year’s SR7.550.

On the quasi-government side, General Authority of Civil Aviation (GACA) has also been a regular issuer. It arranged finance for the construction of the airport in Jeddah by tapping the Sharia bond market and is expected to do for other infrastructure projects.

“I am sure these quasi-government entities will come into the market and tap into the liquidity that’s already there to finance their projects rather than just depend on government funding,” said al Muammar. “The same [trend] continued in 2013, with again several number of issues. We expect that trend should continue in 2014 and beyond.”

In fact, since 2012, there has been a mix of issuers and issues of different tenors. Government (GACA, Tasnee), banks (SABB, Bank Saudi Fransi, Riyad Bank, Saudi Hollandi Bank) and corporates (for e.g. the likes of SBG, Almarai, Olayan, AJIL Financial Services, Savola).

Liquidity in the sukuk market has been improving due to the increasing number of issues over the last five years. And especially by repeat issuances by the issuers, both government and corporates, the yield is expected to climb. For example, Al Muammar cited the yield of Dar Al Arkan’s, Saudi Arabia’s biggest real estate company, which has dropped as a result of repeat issuances.

With investor sentiment improving, and a wider investor base and broader acceptability of Sharia structures, sukuk issues are expected to grow and thrive, he said. The challenge of different sharia structures prevailing and scholars disagreeing is something common to the region.

“This [on Sharia structures] is something that is not yet developed as it is in Malaysia for example. There are different structures and some of the issuers and investors have different Sharia Boards and they do raise this as an issue from time to time. This remains to be a challenge.”

There are other key issues that need to be dealt with, pointed out Al Muammar. Most banks are all rated and some of the institutional issuers are also rated, but majority are unrated sukuks, which are naturally less attractive.

“For the government and quasi-government funds to invest in them is very limited. Therefore, issuers have to go beyond Saudi Arabia for the successful closure of the sukuks,” he added.

Issuance costs are higher than what they should be. Economies of scale do play a role and so, Al Muammar said, if there are more issuances in the market, it will definitely help drive the prices down.

Lack of an established yield curve is another issue. With GACA, coming into the market last year with large issues — that should act as a benchmark for within Saudi Arabia, he noted, adding that the lack of an active secondary market as elsewhere in the GCC markets is a challenge too.

The way forward to make it a more robust investment option includes several steps. Increasing awareness is one of them.

“I think one of the key things is education – we need to do our part as advisors, and also, the regulator needs to be more active, in making the investment pool aware of the sukuks,” said Al Muammar.

Encouraging cross border investment for advising a company is another. “As issuer, we are looking at regional banks to jointly work with us as placement agents in the GCC and international markets,” he added.

Finally, he suggests the introduction of a domestic regional rating guideline and criteria that would help more issuances.

HNWIs keen on sukuk exposure

There is a perception that High Net Worth Individuals (HNWIs) are lukewarm towards sukuk investment.

In Saudi Arabia, said Khalid Al Muammar, chief executive of Saudi Hollandi Capital, that’s not true. They are keen on participating, but they tend to prefer a short tenor and that is why the issue size catering to these investors is small.

“We have individuals participating between $1 and $5 million,” he said. “They prefer more sharia-compliant issues, but others don’t. But importantly, they would want tradeability. Unfortunately, at the moment, this is something that we can’t offer. These bonds are non- tradeable.”

Also, HNWIs sometimes like to see a higher risk than it is for institutional investors and some issues should be generated for that particular segment, he said.