International SUKUK issuance bounced back in May and June, after the primary market shut down due to coronavirus-driven volatility, Fitch Ratings says - Photo: Privacy

JAKARTA (TheInsiderStories) – International SUKUK issuance bounced back in May and June, after the primary market shut down due to coronavirus-driven volatility, Fitch Ratings says. The agency expect supply to rise as issuers diversify their funding bases, continuing a trend of innovation in sustainable, green and hybrid SUKUK seen in first half (1H) 2020.

The growth of Taiwan’ Formosa SUKUK market is also helping to expand the investor base. It said, SUKUK issuance with a maturity of more than 18 months from the Gulf Cooperation Council (GCC) region, Malaysia, Indonesia, Turkey and Pakistan reached US$12 billion in 2Q 2020, a 42 percent increase on the previous three months. The volume of outstanding Fitch-rated SUKUK reached $114.5 billion at end-2Q 2020.

The global rater said, the sharp slowdown in SUKUK issuance in March and April reflected wider financial market volatility as the pandemic took hold around the world. This had a larger impact on the SUKUK market than on the conventional bonds market, as the former is very concentrated, much smaller and less liquid.

Fitch has looked at 22 comparable SUKUK and conventional bonds from eight issuers, mostly GCC sovereigns plus Malaysia, Indonesia and Turkey. Historically and during normal market conditions, the pricing of comparable SUKUK and conventional bonds are strongly correlated. The average spreads between them were low at 11bp in the two years to 5 March, 2020.

However, from mid-March, emerging markets experienced increased capital outflows, while coronavirus-related lockdowns were implemented in the GCC. During March and April, investors looking to liquidate their SUKUK positions sold at steeper discounts than when comparable conventional bonds were sold, with average spreads widening very sharply to nearly 250bp by 18 March.

Additionally, banks in the United Arab Emirates, Saudi Arabia and other GCC countries, which are size-able SUKUK investors, faced heightened liquidity needs, as highlighted by the expanding spreads between local Interbank Offered Rates and Libor. However, after regulators implemented measures to unlock banking sector liquidity, SUKUK and bonds’ spreads and pricing correlation began to normalize.

Measures have included lowering reserve ratio requirements for banks, cutting policy interest rates, and tax cuts. Subsequently the primary markets opened for both SUKUK issuance and conventional bond issuance in the same jurisdictions, which rose by two-thirds between 1Q20 and 2Q20. Since April, many new sukuk have been oversubscribed multiple times as US and European investors search for higher yielding investments in emerging markets, including key sukuk-issuing jurisdictions.

“We expect SUKUK supply to rise further in 2020. Sovereign supply should continue as oil prices remain low and fiscal policy responses to the pandemic are implemented. Issuance by financial institutions and corporates is likely to increase as they diversify their funding sources and take advantage of low funding costs,” concluded by Fitch.

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