Time for the sukuk to seize its chance

With traditional debt markets still in disarray, it's theoretically a good time for sukuks to foster issuance outside the Middle East and Asia.

Issuance of sukuk or Islamic bonds is growing impressively. In 2007, the market was twice its 2006 size. At about $6 billion each, the two largest sukuks of 2007 were almost twice the size of the biggest deal of 2006, which at the time was the largest Islamic bond ever. The sukuk market has increased more than tenfold since the beginning of the decade.

However, sukuk issuance has overwhelmingly been restricted to two hubs of the Islamic finance market: Malaysia and the six countries of the Gulf Cooperation Council. None of the 50 biggest sukuks of 2007 came from outside these two zones.

Participants in the Islamic finance market are excited about the prospect of the UK Treasury issuing a sukuk in 2008. They hope it will provide a flagship for others to follow. With such markets as central Asia, Pakistan and India also turning to Islamic finance more and more, they say the industry is becoming truly global.

The UK will not be the first developed-market issuer to raise money through a sukuk. In 2004, the German state of Saxony-Anhalt issued a sukuk worth [Euro]100 million ($123 million). Yet those who were expecting the deal to kick off a string of developed-market Islamic activity were disappointed. Since 2004, sukuk issuance from north America, Japan, and western Europe has essentially been restricted to a $165 million deal by US gas company East Cameron in 2006 (although the Malaysian subsidiaries of various G7 corporations have also issued).

Raising money using Shariah-compliant instruments is difficult for some western issuers because many investors are often relatively unfamiliar with the prospective borrower, and used to higher, emerging-market yields. Also, sukuks are fundamentally different to standard bonds, requiring unfamiliar and sometimes more complicated and time-consuming documentation.

Saxony-Anhalt was perhaps a little ahead of its time.

But as the credit crisis increases conventional market pricing, more western issuers might be convinced of the advantages of giving Islamic investors a chance. US oil and gas company Harvest is already considering issuing a sukuk. The Japan Bank for International Cooperation has signed a memorandum of understanding with the Malaysian central bank on Islamic finance.

Yet even if the credit crisis does result in a higher proportion of Islamic issuance, there is still the chance that G7 sukuks could dry up if and when the west's lending enthusiasm returns. Sukuks might then have to wait for another, more severe credit drought to become a more established competitor.

Increasingly prominent disagreement over standards of Shariah compliance is generating scepticism even in the core countries of Islamic finance.

This is happening at a bad time. If these disagreements compromise the industry's chances of exploiting the credit crisis, Islamic finance will remain confined to the Gulf and south Asia.