Experience with sukuk financing in infrastructure-
The infrastructure investment requirement (including real estate) of the Association of Southeast Asian Nations region between 2015 and 2030 is pegged at $7 trillion. The bulk of the financing needs in the region are met from government budgets. Since many countries are facing fiscal constraints, there is a need to develop alternative sources to meet the gigantic investment requirement. This has created opportunities for issuing Islamic bonds (sukuk) to complement traditional bond financing and bank credit. The avenue is gaining prominence as an alternative source of funding for large-scale and long-term infrastructure projects. So far, most sukuk issues are by sovereigns, with Malaysia being the largest issuer.
Amid falling commodity prices and political instability in some Muslim-majority countries, new sukuk issues globally declined in 2015. This was also partly because Malaysia suspended the sales of short-term, local currency sukuk due to concerns that the bonds carry too much investment risk.
Why sukuk financing?
The sharing of risk between project sponsors and investors and the creation of tangible assets that generate revenue align well with the principles of the sharia (Islamic law) financing. Sukuk can also be combined with conventional financing options in project structures. Islamic finance is a relatively new concept, emerging only in recent decades. It is based on religious tenets that prohibit charging interest. Advocates promote it as an alternative to traditional banking, touting its cost-effectiveness and ethical values.
The asset-backed nature of Islamic finance makes the sukuk well suited for infrastructure financing. Other major reasons for sovereign sukuk issues are that they enable diversification of the investor base, ensure better governance and transparency, and promote good business practice.
Types of sukuk financing
Three main Islamic instruments have been traditionally used for infrastructure projects. Musharakah sukuk share the profits and losses of the infrastructure project between investors and issuers, while sukuk based on ijarah (rental) and murabahah (profit) are more like conventional bonds as the rental and profit rates are fixed. The ijarah structure can be used for brownfield refinancing of an existing project as its structure is similar to that of a conventional lease.
Sukuk can also be used for greenfield financing. The istisna structure allows an asset to be sold before it has been built, with the purchase price paid in instalments during the construction phase. This can be combined with an ijarah, allowing investors to receive lease prepayments, and thus a return, during the construction phase.
Malaysia as the frontrunner
Malaysia has long dominated both global and domestic sukuk issues worldwide. New data released by the International Islamic Financial Market shows that between January 2001 and December 2015, Malaysia accounted for 67.34 per cent of all global sukuk issues and 88.34 per cent of global short-term sukuk issues, with international sukuk (which accounts for about one-fifth of the market), the only area where Malaysia does not lead, lagging behind the United Arab Emirates (UAE). Most of the funding through sukuk issues goes into Malaysia’s infrastructure projects in power, ports, roads, railways, etc. One reason the country has been successful in developing its sukuk market is that it can use long-term fixed financings for these projects.
A slump in oil prices dampened growth in Malaysia due to which sukuk issues fell to a four-year low of RM 56.2 billion in 2015. However, the monetary easing by Bank Negara Malaysia, the country’s central bank, in July 2016 stimulated stronger demand for sukuk issues. Offerings of Islamic notes have climbed 69 per cent to RM 50.4 billion in 2016. Further, a slew of infrastructure-related sukuk sales have revived Malaysia’s corporate Islamic bond market.
Recently, in August 2016, Ekovest Berhad announced plans to issue Malaysia`s largest ringgit-denominated greenfield toll road project financing, worth RM 3.64 billion, for its Setiawangsa-Pantai Expressway project. The proposed issue of wakalah sukuk will be among the largest issue for a new highway construction project as well as among the highest rated AA-sukuk in 2016.
In another major sukuk financing in 2015, Malaysian telecom firm Axiata Group issued a $500 million wakalah sukuk to fund its investment in Myanmar’s tower business. Around $125 million of the bond’s proceeds will be used to fund the acquisition of a majority share in the Myanmar Tower Company (MTC) under Axiata’s wholly owned subsidiary, the Edotco Group.
Indonesia following suit
Since 2012, sukuk has become one of the sources of financing infrastructure projects in the country. Private bank Maybank’s sharia unit, Maybank Syariah, disbursed 80 per cent of its Rp 10.8 trillion ($817.25 million) loans in the first half of 2016 to the infrastructure sector. Along with bank loans, the lender – through Maybank Kim Eng – Indonesia boosted Islamic financing in Indonesia in 2015 by arranging sukuk totalling Rp 6 trillion ($454 million) issued by big companies including XL Axiata and Maybank Indonesia itself.
More recently, Indonesia joined hands with Saudi Arabia, Turkey and the Jeddah-based Islamic Development Bank to set up a new Islamic finance infrastructure bank. The four entities could contribute around $300 million each for the project, with plans to establish two regional Islamic banks based in Istanbul and Jakarta.
Obstacles in sukuk issues
A frequent obstacle to the use of sukuk for infrastructure is its complex structure. Some require the transfer of assets into special purpose vehicles, which can be problematic for political or legislative reasons when it comes to large-scale projects.
The problem of liquidity is one of the biggest constraints facing Islamic project finance. The disconnection between the short-term nature of deposits of most Islamic financial institutions and the long-term nature of investments in projects continues to pose a threat to the industry at large.
Transaction costs and the absence of the skill set provided by financial modellers and other analysts is another major obstacle to the growth of Islamic project financing. Only a few Islamic financial institutions are equipped to perform the complex tasks of project appraisal and monitoring.
Conclusion
Despite the benefits, it still appears that most ASEAN countries have failed to build large-scale sukuk markets, whether through a lack of enabling infrastructure or the fact that issuers do not come when they can rely so heavily on bank credit and budgetary support. However, Islamic finance has a growing presence in countries such as Thailand and the Philippines. Brunei, in April 2016, also expanded its financial base with the announcement of several sukuk offerings worth a total of $150 million, specially in support of businesses and large infrastructure projects. Going forward, the ASEAN region’s efforts towards greater integration, including financial integration, augur well for Islamic capital markets; cross-border investments in sukuk and Islamic funds will support a vibrant Islamic finance industry.
