Saudi Arabia’s recent $9 billion debut global sukuk bond issue may help the Middle East to hold onto its crown as the Islamic world’s premier investment destination, but governments in the region could do a lot more to underpin market development, say asset management executives.

As AsianInvestor’s annual list of the 50 biggest Islamic fund managers shows, Malaysia is now only $1.87 billion behind Saudi Arabia in terms of sharia-compliant assets under management, as reported on Monday. While Malaysia’s share of sharia-compliant assets under management grew last year, Saudi Arabia’s fell.

In 2016 Malaysia took an important step closer to the top of the rankings when its flagship state pension scheme, the Employees Provident Fund, established a sharia-compliant portfolio, to be run on a segregated basis from the main portfolio. And Kwap, the country’s civil service retirement fund, announced in mid-year that it planned to make its entire portfolio sharia-compliant.

Yet there is no sign that Middle Eastern countries will be making similar moves any time soon. What’s more, portfolio managers have previously noted that many of the region’s government pension plans are under-funded.

Eric Swats, Dubai-based head of asset management at investment bank Rasmala, told AsianInvestor: “It would make a lot of sense if beneficiaries of these government pension schemes had a box they could tick, enabling a portion of their pension assets to be managed on a sharia-compliant basis.”

Sukuk support?

It would also help if more Middle Eastern countries were to issue sukuk bonds. Doing so would not only provide tangible evidence of their commitment to sharia funding, but would also act as benchmarks for other issuers from their countries. However, Saudi Arabia did go some way to rectifying this just before Easter when it raised $9 billion from a dual tranche five- and 10-year issue.

At a stroke, the Kingdom doubled global dollar-denominated sukuk issuance to $19.5 billion in the year to the end of April, according to Malaysian bank RHB.  As a result, 2017 issuance is now almost on a par with 2016’s $21.74 billion total.

But other Middle Eastern sovereigns have yet to follow Saudi Arabia’s lead, even though they also have budget deficits they want to bridge with bond financing.

Swats noted: “The main issue is their desire to target investors from outside the region and [tap] the broadest investor base possible, so unsurprisingly they’ve been targeting conventional rather than sukuk debt issuance.”

Gulf Co-operation Council countries raised just over $140 billion from conventional debt issuance in 2016, but slightly below $20 billion from local and dollar-denominated sukuk, according to rating agency Standard & Poor’s.

S&P said the situation was unlikely to change much in 2017 as there has been “little progress reducing the complexity of sukuk issuance”.

Focus on governance

However, the agency did say that an increasing focus on sharia governance could spur growth. 

In late 2016, the Islamic Finance Services Board asked market participants for their views on ways to enhance disclosure standards and help bridge the gap between the Middle Eastern and Malaysian Islamic finance models – which has long been an issue for this industry.

It highlighted one proposal to implement global standards, coupled with an external sharia audit. While this might appear difficult to achieve, said the IFSB, it “might help the industry reach the desired level of standardisation in sharia interpretation”.

Sandeep Singh, Franklin Templeton’s former Malaysia head, believes this would go a long way to taking the industry to the next level.

“The sukuk story is quite unique,” said Singh, who is now head of central/eastern Europe, the Middle East and Africa for the US fund house. “Global issuance has increased and it not only offers good diversity for a portfolio but also lower correlation to other asset classes.”

Other positive steps are also being taken.

Sukuk has also been moving into mainstream portfolios after leading index providers started to include it in their benchmarks. Last October, for example, JP Morgan made sharia-compliant notes eligible for its EMBI Global Diversified and JACI indices. A year earlier, Barclays had added Malaysia’s local-currency sovereign sharia-compliant debt into its Global Aggregate and emerging market local-currency government indices.

Meanwhile, equity investors are taking advantage of investment opportunities from the introduction of real estate investment trusts (Reits) in October last year, said Zaheeruddin Khalid, chief investment officer at Jadwa Investment in Riyadh.

Jadwa has just completed a 660 million riyal ($176 million) issue with a 5.2% yield backed by properties in Saudi Arabia’s two holy cities, Mecca and Medina. The transaction has effectively doubled the size of the market in the country, where only asset managers are allowed to issue Reits. Khalid said a further 10 issues are in the pipeline.