Islamic Conferences Group 2007 London Sukuk Summit 20 – 21 June 2007 The Royal Horseguards Hotel, Whitehall Increasing the Secondary Market for Sukuk Speaker:

Islamic Conferences GroupIslamic Conferences Group

2007 London Sukuk Summit2007 London Sukuk Summit

20 – 21 June 200720 – 21 June 2007The Royal Horseguards Hotel, WhitehallThe Royal Horseguards Hotel, Whitehall

Increasing the Secondary Market for SukukIncreasing the Secondary Market for Sukuk

Speaker: Stella Cox, Managing DirectorSpeaker: Stella Cox, Managing Director

DDCAP LimitedDDCAP Limited

During this presentation we will:

• Evaluate current status of the Islamic Capital Market

• Consider the development of the secondary market

• Where are the priorities?

• Where do opportunities lie?

• Summary


IntroductionIntroduction

Islamic Financial Marketplace – Sources of FundsIslamic Financial Marketplace – Sources of Funds

• 1.3 billion Muslims (20% of population)• Fastest growing and one of the most active religions • Islamic financial assets estimated at USD 700bn*

(* source – Standard Chartered Bank 2006)

More than two thirds of Islamic funds are from the Middle East

SE Asian Islamic Marketplace experienced rapid expansion 2006

Islamic banks have EU footprint through UK


Equity Equity

• GCC equity markets were amongst the fastest growing in the world by both value and volume in 2005, but sharp decline in Q1 2006

• Equity held in Islamic portfolios at end of 2005 est. US$ 20 billion *1

• Approx. 100 GCC companies planned IPO’s in 2006 but only a fraction floated

• 60-70% of GCC market stock comply with generally accepted screening criteria + 30% of international stocks, total accessible market value c. US$ 9 trillion

BondsBonds• Rapidly expanding GCC conventional and Islamic bond (sukuk) market• Sukuk were first recognised as a Sharia’a compliant instrument in Malaysia c. 2000• Total issues to December 2006 c. US$ 54 billion*2 of which

•US$ 33bn Malaysian domestic •US$ 14bn international corporate•US$ 7bn sovereign

• Sovereign issues have not shown significant growth, but corporate issues grew 150% in 2005 and over 400% in 2006

(source: *1: IFC Bahrain / *2: Islamic Banker / IFIS)

Islamic Capital Markets – 2006/2007Islamic Capital Markets – 2006/2007


Sukuk Issuance 2000 - 2007Sukuk Issuance 2000 - 2007

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

USD Billion

MalaysiaDomestic

Corporate(ex.Malaysia)

Sovereign

(sources – i) Bloomberg – 2007 issues / ii) IFIS – International issues / iii) Securities Commission – Malaysia Domestic)

2007• US$ 5.33bn international, corporate Sukuk announced or issued Jan – June 2007

• Sovereign issues awaited;• May - UK government announces preliminary intention• June - DIFC (US$ 1.25bn – international), Malaysia (MYR 3bn - domestic)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

USD Billion

i) as at December 2006 ii) International issues completed / announced January - June 2007


Sukuk Issuance 2000 - 2007Sukuk Issuance 2000 - 2007

02,0004,0006,0008,000

10,00012,00014,00016,00018,000

USD

Bn

UAE

Saud

i Ara

bia

Kuwait

Bahr

ain

UK

Qatar

Indo

nesia US

A

Malay

sia I n

t'l

Brun

ei

International Corporate Sukuk (ex. Malaysia Domestic) Volume by country - to June 2007

• Issues by Islamic Development Bank and Saxony Anhalt classified as ‘sovereign’

• DIFC Sukuk Centre US$1.25bn – largest single sovereign issue to date

• UAE leads corporate issues by volume with US$ 14bn

• Of this, Dubai Ports issued US$ 3.5bn and Nakheel US$ 3.52bn (in 2006)

• Aldar issued US$2.53bn, Dubai Islamic Bank US$1bn, Emirates Islamic Bank US$350mn (in 2007)

• Saudi Corporate issues include Saad US$650mn and Daar US$600mn (in 2007)

0400800

1,2001,6002,0002,4002,800

USD

Bn

Malay

sia I n

t'l

Bahr

ain

UAE

IDB

Pakistan

Qatar

Brun

ei

Germ

any

Total Sovereign Issues (+IDB) by country - to June 2007

(sources – i) Bloomberg – 2007 issues / ii) IFIS – International issues / iii) Securities Commission – Malaysia Domestic)


Why Sukuk?Why Sukuk?


• Up to 80% of the assets of Islamic banks have historically been allocated to non-tradable short-term investments, such as Morabaha

• Created inappropriate concentrations, adversely impacted yields and portfolio/balance sheet diversification

• Also, inefficient for supporting reciprocal liquidity requirements

• Islamic banks remain hungry for risk (asset diversification and instruments better suited to liquidity management purposes)

High returnHigh return

Low return Low return

Shorter termShorter term Longer termLonger term

PRIVATEEQUITY

EQUITIES

Property FinanceIJARA / MORABAHA

Medium Term IjaraNote Issue

SUKUK

IJARA

Structured TradeMORABAHA

Working CapitalFinance

SALAM / ISTISNA

SecuredCommodityMORABAHA

Short TermSUKUK

Islamic Asset Islamic Asset Allocation MatrixAllocation Matrix

65%+ OF65%+ OFGLOBALGLOBALMARKETMARKET

65%+ OF65%+ OFGLOBALGLOBALMARKETMARKET

INTERBANK LIQUIDITY

MANAGEMENT


Development of Secondary TradingDevelopment of Secondary Trading


• Development of Sukuk secondary trading is viewed as essential to inject liquidity

• To date this has been slow to happen

• Most Sukuk have been purchased to hold

• Investors have no incentive to trade because:-

• There is sufficient depth of quality new issues

• Historically Islamic sovereign issues have offered enhanced yields

• Simply a lack of more attractive assets to replace existing holdings

• Information flows are limited

• Standard or consistent market practice:

• product origination – market standards

• trade contracts – standard documents

• pricing – benchmarks, ratings

• settlement – crossborder, secure payment mechanisms

• Authoritative regulation, market best practice

• Established, tested legal infrastructure

• Confidence – issuers, investors, participants, intermediaries

• Efficient processes and systems

• Liquidity through volume and market utilisation

Capital Market Infrastructure Requirements:Capital Market Infrastructure Requirements:


• Global bond market is very diverse

• Primary issues are by auction, tender and direct placement

• Secondary market turnover is significant (UK secondary bond market turnover c. £9bn per day)

• Investors/holders are constantly adjusting holding to reflect

• their liquidity management requirement

• credit rating

• future interest rate expectation

• envisaged economic changes

• Most trading occurs OTC through electronic trading and many bond markets are decentralised

• Banks act as market makers, there are primary dealers who act as principal and inter-dealer brokers acting as institutional participants

The Secondary Bond Market – a conventional The Secondary Bond Market – a conventional comparisoncomparison


• A well functioning primary market for government securities underpins government liquidity needs

• Most Islamic sovereign issues have been “landmark” – need more frequent tranches i.e. Bahrain, Malaysia domestic

• Primary volume building and structures conducive to trading

• Creating the secondary market foundation is key

• Market standard documentation

• International clearing through conventional systems?

• Focus on use of a Central Counterparty to ensure good order

• Professional market bodies to ensure order and market best practice

The Islamic secondary market requirementThe Islamic secondary market requirement


• Sukuk are traded over a number of different manual and automated systems

• Malaysia managed over 0.5 million secondary bond trades OTC in 2006 without the benefit of an electronic system but technology can support efficiency and cost reduction

• Settlement varies although the international, listed Sukuk are settled through Euroclear and Clearstream, which develops market confidence

• Otherwise, average time to process a Sukuk trade from deal to settlement is more than a day

Development of Clearing and Settlement for Secondary Development of Clearing and Settlement for Secondary TradingTrading


Motivating Secondary TradingMotivating Secondary Trading


• High global demand from all sector investors for Islamic capital market products, underpinning market liquidity

• Structures need to be appropriate (i.e. Ijara – Musharaka – Next?)

• Issuance and trading costs need to be comparable to conventional (associated structuring costs, processing and settlement)

• Market intermediaries are required to assist distribution – dealers, brokers, interdealer brokers

• Information flows must continue to improve – rating, pricing, benchmark

• Education is needed – of issuers, investors and intermediaries

• How do they participate?

• Role for a professional market body – IIFM (ISDA, ICMA)

• Markets and investors are becoming more sophisticated using cash as strategic liquidity management tool

• Islamic banks liquidity management needs should remain the driving force

• However, conventional bank liquidity needs will feature • Basle I caused Sukuk to be a capital intensive asset for banks• Basle II provisions in 2007 are expected to improve this

• Market needs continual issuance, supported by Sovereigns, rather than ‘landmarks’

• Greater volume of fixed rate issues will introduce new, longer-term investors such as pension funds, with criteria on changes to market forecast, credit and yield

• Exchangeable/convertible structures in GCC securities are presently in demand as investors perceive only upside potential following equity market downturn

• Recent listing on London Stock Exchange has introduced another new investor category - Hedge Funds i.e. traders with a different investment perspective

Summary Summary


Contact DetailsContact Details

Stella Cox – Managing DirectorStella Cox – Managing DirectorEmail: Email: [email protected]

Lawrence Oliver – DirectorLawrence Oliver – DirectorEmail: Email: [email protected]

15 Grosvenor Gardens15 Grosvenor GardensLondon London

SW1W 0BDSW1W 0BD

Telephone: +44 207 663 5460 / 1Telephone: +44 207 663 5460 / 1Fax: +44 207 663 5462Fax: +44 207 663 5462

ICAP/DDCAP Sukuk info: (Bloomberg: ICSU <GO>)ICAP/DDCAP Sukuk info: (Bloomberg: ICSU <GO>)

Documents

Islamic Conferences Group 2007 London Sukuk Summit 20 – 21 June 2007 The Royal Horseguards Hotel, Whitehall Increasing the Secondary Market for Sukuk Speaker: