Legal Frameworks, Standards Remain Key to Long-Term Development of Sukuk, Says Fitch

The inclusion of sukuk in major bond indexes would be a significant boost for the product, but initiatives to harmonize standards, structures and legal frameworks and improve transparency remain key to its long-term development, Fitch Ratings says.

Reuters reported on Friday that JP Morgan would include eight sovereign and corporate sukuk in various bond indexes from 31 October this year, citing a research report that the bank had sent to its clients.

If confirmed, index inclusion should raise the profile of sukuk and support inflows from international institutional investors, including index tracking funds. This in turn may encourage issuers to supply index-eligible sukuk (criteria for inclusion include a credit rating and a liquidity assessment, according to Reuters) and support secondary market liquidity.

Nevertheless, Fitch believes the sukuk market's growth rate will be determined by two factors.

Firstly, product-specific initiatives around regulation and standardization of sukuk issuance, which have been noteable in some jurisdictions, but have not always been harmonized across jurisdictions; and secondly, the broader attempts to deepen the investor base and improve transparency in the relevant national and regional debt capital markets.

Citing an example, Fitch says the implementation of the Islamic Financial Services Act 2013 in Malaysia has clarified regulatory issues, and the central bank launched Islamic T-bills early this year, adding to a range of liquidity management tools for Islamic banks.

Kuwait's Capital Markets Authority announced a broad sukuk framework in November 2015, and the central bank in the UAE has proposed creating a Higher Sharia Authority to provide unified supervision and guidelines on Islamic finance-related matters.

“Such initiatives, combined with efforts to improve corporate governance, financial reporting and enforceability in jurisdictions where Islamic finance is most widespread, support our expectation that sukuk issuance will increase gradually over the long-term as more countries create supportive frameworks,” says Fitch.

Fitch had recently noted that sukuk issuance from key markets in 1H16 rose 11% from a year earlier to USD21.74bn, representing 30% of total issuance. But Abu Dhabi and Qatar both issued conventional sovereign bonds in 2Q16, demonstrating that this remains the surest route to tap international institutional investors.

“Overall, our expectation is for 2016 sukuk issuance to at least match 2015 issuance of around USD32bn,” notes Fitch.

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