26 June 2013

Africa: Looking to Sukuk

Led by Morocco, a handful of African nations plan to issue Islamic bonds to finance infrastructure, build reserves and diversify their investor base

After Zambia’s successful maiden eurobond issue last year, 2013 has looked like the year for Africa to join the emerging market debt rush.

But it is not just Western capital markets those countries are looking to. An increasing number of African nations are making provisions to issue sukuk, the Islamic equivalent of bonds, as they seek to finance their vast infrastructure requirements and diversify their investor base.

Sukuk are Islamic financial certificates that represent undivided shares in the ownership of tangible assets, often providing the first inroad for countries into Sharia-compliant funding. Still a relatively young financial instrument, global sukuk markets are growing fast, with issuance increasing by 64 percent last year to reach $138bn, according to Standard & Poor’s, the rating agency.

Issuers have generally stemmed from Islamic countries in southeast Asia and the Gulf Cooperation Council, and so far in Africa only the Gambia and Sudan (both not rated) regularly launch short-term domestic notes.

But in the last two years, sub-Saharan sovereigns including South Africa, Nigeria, Senegal and Mauritania have all announced their intention to come to the market with Islamic bonds.

Most are seeking to diversify their investor base as they find new ways to fund development, Islamic finance experts say. “Primarily, most of the countries in Africa are interested to issue sukuk to tap the growing Islamic liquidity pool which has become a significant part of the overall investment pool, especially in the capital surplus countries of the Middle East, and to establish a benchmark for their corporates and quasi-sovereign entities to tap this market,” explains Ahsan Ali, global head of Islamic origination at Standard Chartered Bank. “Also, a sovereign sukuk would help to support and grow the domestic Islamic finance markets in their own countries.”

Sukuk can be an important tool in meeting external financing needs and building reserves - particularly in the Arab states of North Africa - S&P adds in a report entitled Will African Sovereigns Turn To Islamic Finance To Fund Growth?

“Some northern African countries are facing increasing fiscal and current account deficits, which may suggest their governments could look to increase and diversify their funding base,” the report states.

“What’s more, following the Arab Spring, Islamist parties have dominated parliamentary elections in countries such as Egypt, Morocco, and Tunisia, and this has put the development of Islamic finance on their governments’ agendas.”

It is these countries that are heading up the list of African nations looking to make their first sukuk sales. Egypt’s administration has recently presented a law allowing sovereign sukuk issuance, which would help to finance the country’s high fiscal and current account deficits, while Tunisia’s 2013 budget law expects to finance the fiscal deficit partly through sukuk issuance.

Watching Morocco

But the fastest mover appears to be Morocco, which first became interested in sukuk after a moderate Islamist party won a majority in the 2011 parliamentary elections, according to Fayçal Jamali of the Al-Khawarizmi Group, an Islamic finance consultancy.

“Also as a result of worsening economic conditions in Europe, which is Morocco’s traditional trading partner, the country wants to diversify its funding instruments and attract Middle Eastern investors,” he says.

The North African country is finalising the publication of a new securitisation law that will allow the state and companies to issue sukuk, and preparations for a corporate and a sovereign bond are already underway, according to Islamic finance experts.

The country’s securitisation law was enacted in 2002 and amended in 2010 to broaden the range of eligible assets and allow institutions other than banks to use securitisation. At the end of last year, the government sent parliament an amendment to that law paving the way for sukuk, as part of a broader financial reform aimed at developing the role of securitisation in funding the economy, says Nouaman Al Aissami, head of the credit division at Morocco’s ministry of economy and finance. The law was adopted in January and will come into effect after it is published in the country’s official gazette, which is expected to happen in the coming months once some related regulations are finalised.

One Moroccan “large corporate” has already planned a $500m sukuk, currently on standby until the enactment of the law, according to Mr Jamali. A sovereign sukuk is also in preparation, he says. Nine out of 10 institutions surveyed by the Moroccan financial market authority (CDVM) last year said they would be interested in issuing sukuk if the law allowed.

The country’s political stability and above investment grade rating should draw interest from foreign investors. S&P assigns a foreign currency rating of BBB- to Morocco, its lowest investment grade. Of potential sukuk-issuing nations in Africa, only South Africa has a higher sovereign rating, according to S&P.

The nation can also count on a vibrant domestic investor community. The volume of assets managed by Moroccan mutual funds amounted to Dh241bn ($28bn) in 2012, more than a quarter of the country’s GDP, according to data from the Association des Sociétés de Gestion et Fonds d’Investissement Marocains (ASFIM) - the professional association of Moroccan OPCVM (mutual funds) managers.

Rim El Honsali, general manager at ASFIM, says that Moroccan OPCVM are interested in investing in sukuk. “The introduction of sukuks will allow the creation of a new asset class and will offer an opportunity of asset diversification for the OPCVM,” she believes.

“Sukuk are essential to assure the development of Islamic finance in Morocco, and with their introduction the country has the means to access a non-negligible amount of international financing,” she adds.

The development of the Moroccan sukuk market, however, will depend on further efforts by the government to promote sound economic policies, says Mr Jamali of the Al-Khawarizmi Group. “The principle of sukuk is to finance the real economy,” he says, “so the government will need to identify the right projects to refinance.”

Regional hubs

In terms of other countries to watch, the timelines are hazier. Senegal - another predominantly Muslim nation - is trying to position itself as a hub for Islamic finance in west Africa. As a politically stable economy with GDP in excess of $14bn, the country would be likely to draw interest from international investors - but it postponed plans to issue sukuk last year and still needs to adjust its policies to be able to sell debt that complies with Islam’s ban on interest.

Neil Miller, global head of Islamic finance at the law firm Linklaters, points to some of the difficulties confronting such nations as they try to create the right regulatory frameworks: “Politicians will glibly announce that they are going to issue sukuk, but they don’t realise how complicated it is to create a capital market for Islamic instruments with the legislation and regulation that surrounds that process. You have to get the law in place, get the investors and regulators educated.

In some cases neither the country nor the institutions that are going to issue have a rating, so that must be considered. It’s a complex process,” he says.

“For all of that, you could be talking about a couple of years before those countries can come to the market.”

Other countries already have the rules in place but face more political obstacles. Nigeria - Africa’s most populous country, of which roughly 50 percent is Muslim - is vying for the position as regional hub for Islamic finance, and has been talking about issuing a sovereign sukuk since 2011. “We think the sukuk market is something that Nigeria should tap into,” the country’s central bank governor Lamido Sanusi tells This is Africa. “Developing an Islamic finance market is a very good advantage, and certainly if any African country should be the hub of Islamic finance it should be Nigeria, just based on the size of its population.”

As to dates, Mr Sanusi is less willing to be drawn: “We have been ready in terms of the regulation and the technical work a long time ago, but it’s a political decision,” he explains.

Meanwhile, South Africa, the continent’s biggest economy, stated its plan to issue a debut Islamic sovereign bond last year and also has rules in place to do so. Unlike Nigeria, Senegal, or its North African counterparts, less than 2 percent of South Africa’s 52 million population is Muslim. If it follows through on its pledge, it will become the first non-Muslim country to come to the Islamic market with a sovereign issue.

While the country may not need to build a retail Islamic finance sector, its interest is in creating a more attractive investment destination for Middle Eastern and southeast Asian capital.

“The investor base for global sukuk issued by African sovereigns could be investors looking for Sharia-compliant assets, for instance from the Middle East. Hydrocarbon-based economies in the Middle East typically have high saving rates,” says Chris Esters, a primary credit analyst at S&P’s and co-author of the group’s Africa Islamic finance report.

“Although such sovereign sukuk might also attract some interest in domestic African markets, often African capital markets would be too shallow, and saving rates too low, to buy more substantial amounts of sukuk issuance.”

The international appetite for these African sukuk should be there, says Standard Chartered’s Mr Ali: “We would expect strong investor support as the economies of Africa continue on a growth trajectory with improving credit fundamentals.”

Clearly, some time will elapse between announcement and issuance of sukuk, but Morocco could get the ball rolling this year. As trade and investment links to the Middle East and Asia grow, expect more African sovereigns and sovereign-related entities to come to the market.

“Islamic finance is starting to flourish in capital markets and other product areas, but it’s complicated to get underway in places across Africa if you either don’t have a securities law or you don’t have the rating,” Linklaters’ Mr Miller explains. “With that in mind, I think that we’ll see a lot more preparation done during this year and 2014 and 2015 will more likely be the years for African issues.”

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