Sharia-Compliant Bonds, Also Known as Sukuk or Islamic Bonds, on The Rise Thanks to Malaysia, Gulf States and Africa

Islamic finance, which includes a proscription against borrowers paying interest to lenders, will grow internationally to more than $100 billion this year, after a difficult 2013. 

The issuance of sukuk, or shariah-compliant bonds, will likely exceed $100 billion this year thanks to general economic growth, demand from the Middle East and high development potential in Africa.

A report released Tuesday from Standard & Poor’s explains that issuance of sukuk will exceed $100 billion in 2014.

“The long-term prospects for the sukuk industry remain promising as regulators continue to build and strengthen their frameworks to minimize barriers in the market and deepen liquidity,” the report reads.

Technically, a sukuk is a kind of asset-backed security, not a debt instrument.

“Sukuk securities adhere to Islamic laws, sometimes referred to as shariah principles, which prohibit the charging or payment of interest,” according to the Islamic Development Bank. 

Sukuk, an Arabic word that is the plural form of “suk,” differ from an ordinary bond in that it grants the investor a share of the asset, cash flows and risk. 

The certificates represent undivided shares in ownership of tangible assets, usufruct or particular projects or special investment activities.

Since 2002, more than $500 billion worth of sukuk have been issued around the world, according to S&P.

Malaysia is one of the biggest lenders. The country had a difficult economic year in 2013. Like many emerging markets, its economy struggled after the U.S. Federal Reserve announced a plan to taper its quantitative easing program.

But S&P analysts are optimistic about Malaysian growth this year, which in turn is good for sukuk issuances.

“As Malaysia follows its policy of supporting private-sector investment, we believe nonsovereign issuance could accelerate in 2014- 2015, continuing the trend witnessed at the global level,” the report reads.

Globally, nonsovereign issuances rose by 20 percent last year, while sovereign ones decreased by 26 percent.

While countries in the Gulf Cooperation Council -- an economic union of countries bordering the Persian Gulf -- are the second-highest destination. Meanwhile, there is a growing sukuk market in Africa, that some experts say can be a major source of funding for much-needed infrastructure development projects.

Demand from GCC corporate and infrastructure issuers grew by 17 percent in 2013 to reach $28.2 billion. In the Gulf region, Saudi banks issued 42.3 percent of all regional sukuk, totaling $1.5 billion, while banks in the UAE represented 57.7 percent of all regional issuance.

“We see good economic prospects in major Gulf countries, which should translate into lending and balance-sheet growth opportunities for the banks,” reads the reporting, adding that “local currency sukuk issuance across GCC states may continue to be used as a means of developing the local capital markets,” the report reads, with the caveat that a drop in oil prices or increase in “geopolitical tensions” could affect the region’s economy and impact issuance.

Hydrocarbon exporters with large infrastructure needs such as Qatar and the UAE will see issuances rise thanks to a “robust” economy in 2014.

Growth and demand for sukuk in Africa will also drive growth. A few countries that started issuing in 2013 are likely the beginning of a trend.

In October, a state in Nigeria issued a sharia-compliant bond: a seven-year instrument that raised about $62 million from domestic pension funds and international investors, and paid 14.75 percent in nominal terms (about 6.75 in “real” terms thanks to an 8 percent inflation rate, and received an A rating from a local agency.

Senegal has also announced plans to issue a $200 million sukuk in the first quarter of this year.

One of the benefits of sukuk is that it gives the governments access to a new investor base, and help build reserves when issued to foreign investors.

 “We believe that for investors looking to buy Islamic bonds outside of traditional markets like Asia and the GCC region, Africa may soon offer a fresh alternative,” reads the report.

In November, South African officials told Reuters that the country is making arrangements to debut Islamic bonds in the first quarter of 2014.

In October, the Financial Times reported that Morocco, Tunisia, and Kenya were also laying groundwork to begin issuing the funds. The central bank of Nigeria holds shares in the International Islamic Liquidity Management Corp.

It’s good for African countries because it can be cheaper to borrow because of high demand from the Middle East.

 “Islamic finance requires a clear link with real economic activity and transactions have to relate to a tangible, identifiable asset, which comes in handy in the case of infrastructure financing,” wrote Amadou Sy, a Brookings fellow and an expert on banking in Africa, in a recent blog post.

He cited Malaysia as an example of a country that used Islamic securities to grow its bond market – now the third largest in Asia.

Of course the products appeal to the growing Muslim population in Africa, but “the challenge, however, is to set up the conditions for Islamic financial products to be attractive to all investors,” Sy wrote.