DUBAI, May 31 (Reuters) - The adoption by the United Arab
Emirates of certain sharia-compliance standards has slowed the
issuance of Islamic bonds from the Gulf, adding to a chronic
supply-demand imbalance, market sources said.
Dubai, one of the UAE's seven emirates, has long aimed to
establish itself as a major global centre for issuance of sukuk,
or Islamic bonds, that constitute the backbone of the $2.2
trillion global Islamic finance industry. UAE investors are also
key players in the global sukuk market.
But compliance standards adopted by UAE central bank body
the Higher Sharia Authority, and confusion around them, are
preventing local banks from buying some sukuk, prompting
investors to request clearer rules as the UAE's flow of new
issuance ebbs, market sources said.
"The market is going through a teething period as it seeks
clarity on how to find ways to comply with the regulations,"
said Bashar Al Natoor, global head of Islamic finance at Fitch
The Higher Sharia Authority (HSA) adopted the sharia
standards of the Bahrain-based Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI), the
standard-setting body for the Islamic financial industry, in
2018. However, issuance programmes created prior to that were
exempt from the new rules, sources said, meaning the effect has
taken some time to become apparent.
Investors also said disagreement among scholars at UAE
institutions over whether Saudi Arabia's National Commercial
Bank's AT1 sukuk issuance in January was AAOIFI-compliant, and
thus adhered to HSA regulations, had rattled potential buyers.
A key issue is around AAOIFI requirements for certain debt
instruments' "tangibility ratio", which relates to the assets
that need to be used as collateral for sukuk to remain
sharia-compliant until maturity.
"All this is causing a logjam in issuance and in my view is
becoming an existential threat to the long-term viability of the
market," Abdul Kadir Hussain, head of fixed income asset
management at Arqaam Capital, wrote in a note.
"Standardisation remains an elusive dream," he added.
Dollar sukuk issuance from the UAE so far this year totals
just $1 billion, compared with $6.35 billion through all of 2020
and $7.9 billion in 2019, according to Refinitiv data.
Despite expectations of an acceleration in global issuance
in 2021, there was less than $2 billion in hard currency sukuk
sold in the first quarter of this year, versus $7 billion in the
same period of 2020, according to Hussain.
This has led to sukuk risk being mispriced, he and others
said, as Islamic investors scramble for the few issues on offer,
especially AAOIFI-compliant ones.
In March, Arabian Centres sold $650 million in sukuk at
5.625% in a non-compliant deal and drew just $1.35 billion in
demand, while Bahrain's National Oil and Gas Holding Company
(NOGA Holding), which has a lower credit score, raised $600
million in eight-year sukuk. Those sukuk, which conform to
AAOIFI standards, were sold at 5.25% and attracted more than $2
billion in orders.
The HSA has been holding discussions with investors to
address standardisation issues this year, two market sources
The central bank did not respond to requests for comment.
Sukuk, which seek to replicate conventional bonds without
the use of interest payments, can be complex and time-consuming
to structure, and difficult for investors to understand.
AAOIFI's standards in some structures require the
tangibility ratio to be 51% throughout the sukuk's tenor,
meaning assets worth more than half the issuance value are used
Investors say this limits the ability of issuers to leverage
up, making it more likely for them to issue conventional bonds,
and further dent sukuk supply.
S&P analyst Mohamed Damak said if an asset doesn't perform
as expected it can hit the sukuk's tangibility ratio.
"Because of that the sukuk has to be accelerated - and (if)
the corporate doesn't have the cash on its balance sheet to pay
it back - then it's a risk for the investors," he said.
"So this is why it's causing a little bit of a headache for
issuers in the UAE."
(Reporting by Yousef Saba and Davide Barbuscia; Editing by