Sukuk-backed sukuk test industry’s appetite for complexity

Interbank lending programmes that securitise sukuk are testing the Islamic finance industry’s ability to digest complex financial products.

Some firms are starting to combine sukuk, using portfolios of long-term issues to back short-term certificates. This lets them create liquidity programmes that address a major weakness of the Islamic finance industry: a persistent shortage of money market instruments needed by Islamic banks to manage their short-term funds.

Such is the approach used by Liquidity Management Centre (LMC), a Bahrain-based wholesale Islamic bank.

“The programme is very simple: we have an SPV (special purpose vehicle) where we book all the sukuk. The SPV is fully backed by sukuk of different tenors and rates,” said Ahmed Abbas, LMC’s chief executive.

The rising number of sukuk issuers globally is making it easier to manage the programme, and LMC plans to double its size in a year’s time from about $120 million now, Abbas added.

“As we speak, we are reviewing our offering circular. We will have more options in terms of tenors, rates and liquidity.”

He added, “As we see more issuers come to the market, the programme can grow. This helps in geographical distribution, the number of issuers – it helps on many levels.”

A similar format is to be used by the Malaysia-based International Islamic Liquidity Management Corp (IILM), which plans to launch a Luxembourg-domiciled programme of its own.

“All of the assets will be either sovereign, sovereign-linked or supranational assets,” said Eric Gretch, senior director at Standard and Poor’s, which rates the programme.

“Basically you have long-term sukuk assets backing short-term certificates, all of which will be sharia-compliant.”

The IILM programme was originally to launch by the end of this month; that timetable is now expected to slip because more time is needed to resolve regulatory aspects, according to a source familiar with the programme. But the IILM scheme could encourage others to consider its approach.

“We expect other similar programmes to come to market in attempts to replicate this unique structure,” Gretch said.

LAYERS

If these programmes gain traction they could open the door to additional layers of securitisation, not only in Islamic finance’s core markets in the Middle East and Southeast Asia, but perhaps further afield.

For example, Nigeria is only just starting to develop Islamic finance; its cocoa-producing Osun State plans to issue the first sukuk in the country, a 10 billion naira ($62 million), seven-year issue, by the end of July.

But the Nigerian central bank issued guidelines in December for asset-backed securities that would use IILM certificates as collateral – essentially creating three layers of sukuk.

LMC plans to develop a product secured by its own short-term sukuk programme through a murabaha structure, a common cost-plus sale transaction, Abbas said.

But the nature of Islamic finance raises potential obstacles to such complexity. Boards of scholars at the issuing institution must certify the sharia-compatibility of not only the programme itself, but of all the sukuk backing it.

Scholars at each investing institution are supposed to do the same thing – increasing costs and time required with each layer of the product. Since sharia standards are not uniform across countries and investing institutions, the issuer may have to take into account an increasingly complex set of demands as its investor base expands.

The complexity of ensuring approvals for a range of sovereign sukuk that will back the IILM’s programme appears to be one reason behind delays to its launch. The IILM was established in 2010 and took over two years to even agree on a plan for its programme.

Some issuers may seek to minimise the approval problem by placing their products with a relatively small group of like-minded institutions, often from the same geographical area.

The LMC programme, launched in 2004, was initially used mainly by its own shareholders and related parties, although its client base has expanded since then, Abbas said.

LMC’s four shareholders, each with a 25 percent stake, are Bahrain Islamic Bank, Dubai Islamic Bank, the Jeddah-based Islamic Development Bank (IDB) and Liquidity Management House, a unit of Kuwait Finance House .

However, the types of sukuk in which the LMC programme can invest has gradually expanded and now includes selected Malaysian and Indonesian issuers, Abbas said.

The IILM has not revealed its choice of sukuk to back its programme, but recent issuers of sukuk include IILM shareholders such as the AAA-rated IDB and Qatar’s central bank.

(REUTERS)
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