Sukuk: Where to from here?
You can read our previous article Sukuk: The Shari’ah compliant response to government bonds if you’d like a bit more insight into the structure of sukuk
Sukuk has undergone immense innovation over the past few years. It is no longer a relatively obscure financial product. It is traded on major exchanges, issued by Muslim-minority countries, part of prominent portfolios and issued as green variants. Given the development of sukuk, we cannot but ask: where to from here?
Oil
The Russia-Ukraine war has sent the oil price soaring. Oil prices have been consistently trading well above $ 100 Dollars per barrel. While a high oil price is bad news for consumers, it bodes well for oil producing nations, who are likely to face fewer fiscal constraints. The GCC are some of the main issuers of sukuk, therefore, we may see a correlation between oil prices and sukuk issuances. Sukuk issuance will likely fall as government deficits narrow amid higher oil prices, lower pandemic-related spending and accelerating economic growth in core sukuk-issuing countries according to Moody’s. Mohamed Damak from S&P Global Ratings has expressed similar sentiments.
The African awakening
Egypt is the second largest economy on the African continent. Unfortunately, over the last few years it has consistently maintained a debt to GDP ratio well above 80 %, peaking in 2017 with a debt to GDP ratio of 103 %. In June 2021, the Egyptian House of Representatives approved a draft Sovereign Sukuk law. This is an attempt by the Egyptians to diversify financing sources. Egypt is on track to issue it’s first sovereign sukuk by the end of the year.
South African currently has a R 355.7 billion rand budget deficit, with the debt-service costs expected to increase year on year. For many years there have been reports of South Africa issuing a rand-dominated sukuk. In the 2022 Budget Review, the National Treasury of the Republic of South Africa reiterated that a Rand-dominated sukuk remains part of the funding strategy which aims to “develop South Africa’s capital market and ensure a diversified portfolio of instruments.” If the Rand-dominated sukuk is issued it would provide impetus for South African State-Owned Enterprises such as Eskom to issue their own sukuk.
Similar diversification strategies are gaining momentum in other African countries as well. These include Tunisia, Algeria and Maldives.
From LIBOR to SOFR
On 20 April 2021 the Islamic Development Bank issued its first ever Secured Overnight Financing Rate (SOFR)-linked Sukuk in the global capital markets. The SOFR will be the new global benchmark rate, replacing the London Interbank Offered Rate (LIBOR) that is being phased out by June 2023. The SOFR is a broad measure of the cost of borrowing cash overnight collateralized by US Treasury securities. SOFR is different from LIBOR in that it's based on actual observed transactions in the U.S. Treasury market while LIBOR used estimations of borrowing rates.
Going forward, we will be seeing SOFR linked sukuk much more often. The change isn’t envisaged to have a significant impact on sukuk offerings. According to a report by Fitch Ratings, the transition only creates challenges for a “small portion of the sukuk market”. A sukuk survey by Refinitiv had similar findings with only 8.8 % of respondents of the opinion that the change to SOFR will either present a challenge for the sukuk market or reduce issuance.
There are many other components that may influence the nature and issuance of sukuk in the future. Many of these may be technological. The development of financial technology which allows for automation, lower costs and faster transactions will undoubtedly influence the future of blockchain. However, despite all our predictions we can’t lose sight of the fact that ultimately, the future is only known to God.
You can also read our previous article on Green and sustainability sukuk for more information on green and sustainability sukuk