Islamic bond issuance will pick up as green sukuk bloom

When he used to go on global roadshows couple of years ago to meet international investors, Dr Zamir Iqbal, Vice President Finance & CFO at the Islamic Development Bank (IsDB), recalls “we had to explain who we are, then explain what a sukuk is. We have been issuing sukuk for 20 years; but many investors still don’t know about it.”  

Fast forward to 2024: the Islamic finance market, which includes sukuk (Islamic bonds), is valued at more than USD4 trillion. The sukuk market alone is poised to reach the USD1 trillion mark by 2026. In the full year 2024, ratings agency Standard & Poor’s (S&P) projects total sukuk issuance to be between USD160 billion and USD170 billion. 

Following a slowdown in the third quarter, observers reckon that sukuk issuance will pick up again in the fourth quarter of the year, driven by refinancing needs and market expectations of additional interest rate cuts by the Federal Reserve. “We saw issuance in June, then the market held out for the fourth quarter, expecting further easing from the US Federal Reserves,” explained Rami Falah, Head of Islamic Banking (Najmah), BNP Paribas Middle East & Africa.  

Taking advantage of a positive backdrop following the successful US dollar transactions from several sovereign and supranational issuers in September and October, IsDB issued a USD1.25 billion five-year Reg S sukuk on 8 October, with the support of BNP Paribas as one of the lead managers.

Developing the sukuk market 

In recent times of uncertainty and market volatility, sukuk became a safe haven for investors given that a majority of sukuk were issued by highly rated sovereign and quasi-sovereign issuers from the Gulf. As a result, interest in the Islamic bond market grew further and international investors became familiar with sukuk. 

Speaking at the recent BNP Paribas Global Official Institutions Conference (GOIC), Dr Iqbal shared that since the Covid-19 pandemic, he noticed a significant change during his roadshows: “Investors knew about Islamic finance and what sukuk are. ‘You don’t need to explain,’ they would say.” 

This change is reflected in the investor allocations for new bond issuances: “Conventional investors constitute the majority of the order books,” Falah observed. 

As sukuk attracted more interest from global investors, issuance on the international market picked up pace, new types of sukuk structures such as perpetual and those with call options came to the market and maturities extended. “The profile of issuers grew in the Gulf countries and Asia alike, more financial institutions and corporates joined sovereigns to issue sukuk and tenors extended in some instances to 30 years, even if the sweet spot remains in the five- to 10-year maturities,” noted Falah. 

Asia remained the largest issuers of sukuk in 2023, followed by the Gulf Cooperation Council countries, with a majority of issuers being sovereigns, accounting for well over 50% of the total sukuk issued. The Indonesian government continues to be a regular sukuk issuer, and the issuance of a debut sovereign sukuk by the government of Philippines also contributed to the growth from the region. Corporate Asian issuers have not really tapped the international sukuk market because “the underlying needs for funding for Corporates have been mainly in local currencies,” explained Faozie Shahari, Head of Islamic Banking, APAC at BNP Paribas.

For the IsDB whose mandate includes “developing the Islamic capital market throughout the world, the question became ‘how do we expand the menu of options within the sukuk market?” said Dr Iqbal.  

A blooming green sukuk market  

With climate action very high on its agenda, developing a green sukuk market seemed a natural progression. IsDB created its Sustainable Finance Framework in 2019 and issued its first Euro green sukuk in 2019. “When we were on the roadshow, investor appetite was high given the value proposition of green and sustainable development,” Dr Iqbal recalls, which gave further impetus to IsDB to subsequently issue its first sustainability sukuk (USD1.5 billion in June 2020) and its largest size ever of USD2.5 billion as its second sustainability sukuk in March 2021.  

Reinforcing its role as a market leader, IsDB, along with the International Capital Market Association (ICMA) and the London Stock Exchange, also developed a full-fledged guidance on Green, Social and Sustainability (GSS) Sukuk principles. The initiative was announced at COP28 which was held in the UAE in November 2023. With the last two COPs and this year’s COP taking place in member countries of IsDB, climate has been very high on its agenda.  

“During our Golden Jubilee event this April we launched the Guidance on Green Social and Sustainability Sukuk along with ICMA and LSE. We believe that it will pave the way for standardisation for many other countries, sovereigns, MDBs, and corporates, enabling them to issue GSS sukuk,” noted Dr Iqbal. 

According to Fitch, global outstanding ESG sukuk rose 41% year-on-year to reach USD43 billion in the first half of this year, and outstanding ESG sukuk represent a sizeable 12.9% of global outstanding sukuk.  

“Green sukuk issuance is a key development, led by sovereign issuers and the Islamic Development Bank which have their issuance programmes,” observed Falah, adding: “We are increasingly seeing various issuers from sovereigns to corporate, supras to government related entities (GREs) and financial institutions, and it is expected to see more new issuers coming to the market in the future.” 

Headwinds ahead 

Falah notes that there are regulatory and legal challenges ahead and the need to develop a framework by potential issuers. “The cost/return benefit is another challenge to issue ESG sukuk for new issuers.” That said, with government initiatives for economy transition as well as investor demand, Falah estimates that ESG is where sukuk will grow. 

In a recent report, S&P remained cautiously optimistic for 2024, uncertain afterward due to a new draft Shariah Standard 62 from the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) which will require, among other changes, that ownership and risks of underlying assets be transferred to sukuk holders. The ratings agency observes that “sovereigns may be unwilling to transfer their assets since it could be perceived as a disguised privatisation [and] corporates may be reluctant to lose control of their assets, considering the move could markedly increase their cost of funding or deprive them from the future appreciation of these assets.” 

That said, it’s still early days: updated AAOIFI Sukuk standards, “might be challenging for the development and growth of the sukuk market, but we need to wait and see the implementation of the new standards and its impact on Sukuk as the market has absorbed such shocks in the past and probably will do the same this time,” concluded Falah.