Taking GCC debt capital markets to the next level

Participants in the roundtable were:

Tom Koczwara, director, debt management office, Government of Sharjah 

Thuwaini Al-Thuwaini, executive manager, investment banking group, Warba Bank 

Mike Wallace, director of corporate finance and treasury, Aldar 

Zeina Rizk, director, fixed income asset management, Arqaam Capital 

Mohieddine Kronfol, chief investment officer, global sukuk and MENA fixed income,
Franklin Templeton 

Salman Ansari, regional head, capital markets Africa and Middle East, Standard Chartered 

Sarmad Mirza, executive director, debt capital markets, MENA, Standard Chartered 

Dima Jardaneh, executive director, head, MENA economic research, Standard Chartered 

Virginia Furness, moderator, GlobalCapital

GC: Gulf borrowers have a lot to raise this year in the international debt markets. But there are headwinds: a new US president, disappointing global growth, rising US interest rates and geopolitical unrest, to name but a few of the known issues we have to face this year. Yet the capital markets are still enjoying exceptionally bullish conditions. Gulf issuers have had an excellent 2017, so far. Can it last?

Mohieddine Kronfol, Franklin Templeton: We’re in a much better situation than a year ago when oil prices were south of $30 a barrel and people weren’t confident that we would be able to implement any of the structural reform or fiscal consolidation measures being announced. 

Globally there was a very optimistic outlook for the US, but a fairly pessimistic outlook for Europe, emerging markets and the rest of the world. Today the optimistic outlook for the US may still be there but it is a little more challenged. Europe has done much better and China and the emerging markets have been doing better with the recovery in commodity prices. 

In this part of the world we’ve seen an improvement in oil prices, where the downside risk seems to have been diminished by the OPEC agreements, and governments have done a very impressive job with implementing fiscal consolidation.

I expect between $50bn-$60bn in total international issuance. Also investor demand will be there, with this window lasting for the next couple of years.

Dima Jardaneh, Standard Chartered: For Gulf issuers and their external funding needs we see two distinct routes. For Abu Dhabi, UAE, Qatar, Kuwait, funding needs may have peaked so there might be more opportunity for corporates in that space. But Oman, Bahrain and Saudi Arabia may still need to raise funding in similar amounts to last year.

Mike Wallace, Aldar: I think it’s mainly risks around how relevant the region is in terms of fixed income for investors, and that will be primarily driven by rates in the US. As soon as yields start lifting there, then the relevance of the GCC and emerging markets becomes less, and the money just flows back.

Zeina Rizk, Arqaam: The identified risks from last year, which were recession risk in Europe, China’s hard landing, US economic slowdown and oil dropping further, didn’t materialise. The two risks that actually were considered as tail and highly unlikely both materialised: Brexit and Trump. Despite that, emerging markets had a good year, and a very strong start to 2017.

If you had asked me in Q4 last year, I would have said rates can’t stay here. Yields should move higher and the curve is going to steepen. However, now there is a greater uncertainty with regards to yields’ trajectory. 

Trump came into office with the agenda to ‘make America great again’. The fact that the Healthcare Bill didn’t pass shows that he’s not as strong as markets perceived him to be, which puts a question mark on the magnitude of the fiscal plan that he’s going to be able to pass. This being said, the reflation trade is on hold for now, the risk of the 10 years blowing out is reduced; and short term rates are contained.

I think the 10 years will trade within a 2.3%-2.5% range, which is going to be supportive for the market. GCC spreads are at tight levels compared to their historical levels. However, if you compare the GCC to other markets, mainly Asia, the region still looks attractive. 

GC: Dima, how long can the good market conditions last, and what is Standard Chartered expecting in terms of rate hikes this year?

Jardaneh, Standard Chartered: We believe that the market was somewhat complacent on, or extra euphoric on, Trump policies. We have been more cautious on the impact of the Trump administration’s economic plans and we didn’t necessarily expect the fiscal stimulus to be of the size that the market was pricing. We’re expecting there to be another two hikes this year, and another two next year.

Increases in the Fed Funds rate may not translate to a meaningful pick-up in longer term yields, that is if the reflation story disappoints and inflation does not rise meaningfully in the US. At the current juncture of the US economy, there is a possibility that inflation will just really not pick up to a high extent, and so the market will become less and less euphoric and hence yields will probably be capped at much lower levels.

GC: We’ve talked about external factors impacting the region, but what about specific GCC concerns?

Kronfol, Franklin: It is relevant to make clear to policymakers that it would be a big mistake, from a systemic point of view, to continue to rely almost exclusively on trying to attract foreign funding.

It is almost impossible to figure out what is going to be driving that sentiment. One day it is Brexit, then Trump. The next there could be an Asian financial crisis. Every time we go through these different taper tantrums there’s a risk. So far, we’ve been able to deal with this because the liquidity domestically has been so strong, and banks have been able to absorb a lot of this volatility and step in, buy debt and anchor these markets.

But as the market grows and develops, we need to focus on generating or building a local demand base outside of the banking system. And that means promoting inward investment, promoting local asset management, promoting insurance and pension companies.

We need to prioritise non-bank investors in these markets because when times are good people focus on the upside and the potential, and think how attractive we are. If we want the GCC bond markets to remain resilient and to attract foreign investors year in and year out, we need to have that resilience embedded structurally.

Tom Koczwara, Government of Sharjah: Governments in the GCC have not seen market development as a main objective. We may have talked about it, but we haven’t actually done it. We have used issuance as a way of raising funds to plug budget deficits and to pay for projects. That is a relatively immature way to approach government borrowing. It means that, from the perspective of higher volumes of issuance, we remain dependent on a volatile global market.

The GCC market is seen as self-contained from a global perspective, and it is so tiny. It’s just a flea on the back of the debt capital market dog. We talk about Trump and Brexit fluently but are reluctant to talk about local factors.

Even in these bumper deals, where are the biggest orders from? The GCC. The big questions for us are whether governments can find the right balance between raising funds, supporting financial markets, generating economic growth and controlling fiscal deficits.

And these conflicting or competing objectives will drive the shape of the market and the quality of sovereign credits, and therefore the rest of the market beneath that, over the next two or three years.

GC: How are you as a sovereign issuer 

trying to help to address these aims?

Koczwara, Sharjah: In some ways, we’re more like a corporate. We’re not going to be driving the market. But the advantage we have is that we’re inside the tent, so we do get to have these sorts of discussions with the bigger brothers, in terms of policy making.

We expended a lot of negotiating capital in the better times trying to push for development of local debt capital markets, local currency debt capital markets, which is one of the key steps in developing a deeper, more liquid, more predictable debt capital market in the region. 

As an issuer, I think we are very focussed on our relationship with our key investor base, which is here in the GCC.

GC: So how important is the local investor base, and how can that be harnessed to further develop the GCC markets?

Rizk, Arqaam: I agree that the local investors are as important as the internationals, but we have a chance of attracting new money, which we need. The GCC market is very much a one-way market. Everybody’s buying and no one wants to offer, or everybody’s selling and no one wants to buy. Attracting a larger investor base may normalise the market and we may start seeing proper two-way flows and a more mature market.

The growth in the regional capital markets last year was significant and the inflow of international funds increased accordingly. This leaves us with the risk that the usual backstop of the regional markets, the local bid, won’t be able to absorb all this liquidity. The flipside of this is that the Asian buyers are arguably buy and hold accounts and therefore they will not be dumping as heavily as we would expect them to.

Kronfol, Franklin: To be really significant, you need to develop the local capital markets, and you need to disintermediate the banks.

If you look at the loan market, it’s also substantial. If some share of that market could be captured, the bond market could be north of $150bn a year. Then issuers would start to be included in indices, do more 144A trades, and place more deals internationally. That’s just the dollar side. If you can mobilise the domestic market too, the whole block becomes more significant. 

I’d like to see insurance companies in the region buy our paper in size. When I look at our insurance companies buying real estate I find it worrying.

We’re beginning to get insurance companies and other large investors to want to farm out fixed income mandates. But still, it’s very small considering the potential size of capital markets, the size of GDP, or compared to the level of savings.

We need better regulation and more effort to promote financial services. A proper market is a function of different investors having different investment objectives, not about all buying or all selling. A bank looks at things differently than an insurance company, different than a private bank, different than an asset manager. That is what makes a market become more efficient.

Koczwara, Sharjah: I don’t think people have realised just how lucky we are at the moment; that we’ve just got away this huge Kuwaiti deal, and last year we had the huge Saudi deal, and so on. We are so fortunate that global market conditions allow us to do this. If the fall in the price of oil had coincided with more difficult global liquidity conditions we would have been absolutely stuffed. Our tendency is always to think that was a job well done, that there’s nothing to worry about. But that’s not the case at all, actually. We need to plan for next time we have a sudden fiscal gap, in case markets at that time are less accommodating.

Kronfol, Franklin: Yes, when this happened to us in 2009 and 2010, the GCC could barely borrow, while Egypt was able to do all their financing in the local market.

GC: Can you foresee a situation where that happens again? Markets have moved on, and the likes of Saudi Arabia have created these large liquid benchmarks. Will these help with returning access?

Koczwara, Sharjah: If oil goes back to $90, Saudi perhaps won’t issue again.

Kronfol, Franklin: There’s limited credibility to the idea of Saudi maintaining a dialogue with fixed income investors. It’s like them talking about wanting to be leaders of Islamic finance when they still haven’t closed a single sovereign sukuk until now. The market’s grown to $400bn, and I’m yet to see the Saudi government be proactive in structuring and issuing Sharia-compliant securities.

Jardaneh, Standard Chartered: But I sense there might be a shift in Saudi from thinking of the capital markets as just a means of filling a fiscal gap to looking at a more holistic approach.

Rizk, Arqaam: Exactly, the GCC sovereigns issued because they needed to, not because they want to develop and support the capital markets. As such, if the situation gets better, the capital markets will not be a priority anymore and we will go back to the situation of discontinued GCC sovereign curves.

Kronfol, Franklin: Yes… but up until a year ago, it was never really fixed income securities that were envisaged. A seed has been planted but I still feel like, across most of the region, we have a strong equity culture with a limited focus on debt markets. The development is driven by the private sector, by banks, by issuers, by a few companies. But you don’t feel that there’s a policy response there. 

We need a holistic policy framework that encourages the development of non-bank financial services and bond markets.

GC: OK, let’s look at a specific example. Thuwaini, what drove Kuwait to issue this year?

Thuwaini Al-Thuwaini, Warba: When you dig deep enough, you see that there is no real necessity [to fund]. Despite all we hear about fiscal deficits, leverage, for countries of comparable ratings, they’re still way below the median when it comes to the debt-to-GDP ratio. 

Using Kuwait for example. Did it really have a fiscal deficit? What it reports is oil price versus an assumed fiscal break-even budget oil price per barrel, which they assumed at $45 per barrel. 

The KIA has assets of around $600bn-$650bn. You have the Future Generations Fund, which is speculated to be around $380bn. You have the General Reserve Fund at $250bn. So you’re talking about a country with over $1tr in assets outside of oil.

So, why did Kuwait end up issuing? Does it really have a problem? No. It went with the flow and the trend being followed by the other GCC members. And it feared that non-conformity would negatively impact the local market, specifically, local Kuwaiti issuers trying to access the international debt capital market, without having a benchmark to guide pricing. Outside of Oman and Bahrain there isn’t a necessity to fund fiscal deficits by the other GCC members. 

Even Saudi, you don’t know what the actual requirements are. I think Saudi has taken a political decision that it wants to be more independent, to be less reliant on US policies, and on foreign policy. I’m highly sceptical that Saudi’s decision to tap the debt capital markets is driven by fiscal deficits as much as it is driven by the aspiration to position itself to be more independent of its long-standing Western allies.

Rizk, Arqaam: Kuwait is the exception, I think. It is the only GCC sovereign that issues because it can, not because it needs to.

GC: How can you encourage non-bank investors in the region to participate?

Kronfol, Franklin: The banks may be providing all the necessary capital, but if you look at private credit, or SMEs, there is a massive funding gap there. It’s $70bn-$150bn, depending on estimates. You should encourage that sort of funding because it drives employment and economic growth. 

Governments try to get banks to plug that gap but they end up mispricing it, and not doing so well. They’re not really geared towards it. If you want to promote the private sector, you need to specialise in lending to private credit. There is a consequence to relying on the status quo. 

The banks could be a stabilising influence when they’re doing well. But when they’re not doing very well, they can, and have in the past, become a liability.

Koczwara, Sharjah: The driving force needs to be at an even higher level. It’s the tension between the closed economy, the kind of model that says ‘we’ve got all the money; we’ve got all the oil; we own all the banks therefore we’re fine’, versus the more open economy like Dubai. Dubai is the pioneer of the open GCC economy. 

Which one is more successful in delivering economic and social development for its inhabitants? Most people will say Dubai is ahead. So the most successful model is the open model, which depends on attracting capital, talent and permitting competitiveness. 

Rizk, Arqaam: But that makes you more vulnerable to external shocks; which is not necessarily negative when see from a higher risk, higher return perspective.

Koczwara, Sharjah: Day-to-day it makes you more open to external bumps in the road, but long term, it allows you to build diversity and resilience. The biggest shock we’re going to face is when people stop wanting to buy oil.

It feels that the UAE is the only country that can lead this. We need to promote openness to capital flows; encouraging competitiveness in the banking sector; encouraging the development of a proper insurance sector, which is not cross-subsidised by real estate.

As policymakers, we need to think in both the good and the bad times, how do I focus on that long term goal of developing a more open and diverse economy? You see some good examples of that. Clearly, Saudi is trying to take the bull by the horns and setting up a planning ministry.

Al-Thuwaini, Warba: The regulator has a lot of responsibility in driving a deeper debt market, but for some reason they are not. One thing that always puzzled me is that you don’t have to reinvent the wheel here. Look at Malaysia. It did not focus on international money for its development. Yes, attracting FDI was a factor. But because it was a ringgit economy, it focused on developing a local debt capital market to help it withstand any international shocks, which can adversely impact its local economy. I don’t think even the UAE has accomplished this yet.

The first serious step in establishing a robust debt capital market is that we establish a local rating agency which caters to the nuances of the local industries because you can’t compare the rating of our companies to, say, blue chip companies in the US, Europe or Japan.

Salman Ansari, Standard Chartered: While encouraging non-bank investors is a critical next step, to date regional issuers have managed to successfully place primary issuances with relative ease. Looking at last year, when the region saw challenges associated with the oil price crunch, some market participants questioned whether GCC issuers would easily be able to raise funding at price-efficient levels. Yet if you look at the 150-plus deals that were completed last year across both public benchmark and private placement transactions, the market did not see a single failed deal. 

GC: So clearly there needs to be a change at government level, but what about corporates, are bank loans still a more attractive funding option? 

Wallace, Aldar: The first observation I made, having moved over here from the UK a couple of years ago, was that we can borrow from our banks far more cheaply than we can on the debt capital markets. At least 50% of our debt is from bank loans, which we can get out to 10 years, so if I can get that, I’ll take it. Bank debt is more flexible. It’s cheaper to arrange. I can work on the relationship side of things. I don’t have distant investors who maybe aren’t so flexible or accommodating to change. But everything I know from back home says this is wrong, this isn’t how efficient capital markets should be working. But, as a corporate, you know, you’d take it all day because I can’t change it. But it can be risky and more volatile.

Kronfol, Franklin: I don’t think you’d be extended the same privileges if you were an independent corporate. 

Al-Thuwaini, Warba: I think you really hit it on the head there. The difference is that there is a scarcity of quality credit in the private sector. And those that are of quality usually are long-standing merchant families, or quasi-government entities with some support from the government sector.

If we go to one of our clients and say: ‘well, instead of giving you a 10 year facility, we’ll take you to the debt capital markets’ that’s business I’ve lost for the next 10 years from this corporate, because what I’m doing essentially is not using my balance sheet and that is very challenging for us to replace. So, if I turn over my balance sheet, I’m going to have a big problem maintaining my business. Most banks that continually aspire to grow their balance sheets find it challenging to replace bankable credit.

Wallace, Aldar: The irony is that the people who are buying my notes are the same people providing the loans, the banks.

Ansari, Standard Chartered: Undoubtedly there is a dichotomy between what the international debt markets will offer versus lending rates available locally. In particular, high yield issuers who look at the possibility of approaching the international debt markets with yields at high single digits will often find their local bank partners offering them mid-single digit loan pricing. This is a key reason why we have not seen any meaningful growth across the high yield sector in the region. The availability of cheap lending rates is even more prevalent at the higher end of the rating scale. This is a key reason why the region’s DCM volumes remain dominated by sovereign and bank issuers, while corporate volume averages between 10%-15%.

GC: So if there isn’t a pricing benefit, how can you encourage issuers to turn to the capital markets?

Rizk, Arqaam: You’re right on the differential and that the banks are the go-to for lending, but the first step is for sovereigns to have a curve, to set a benchmark for the corporates. The next step should come from the regulators. They should incentivise corporates to turn to the capital markets when funding is needed. A head of treasury won’t choose to raise funds in the capital markets for the general improvement of the markets. He would only do so if it makes economic sense for him and so far, banks are being more competitive and that is where the regulator should have a role. Step four is to encourage the construction of indices and ETFs.

Kronfol, Franklin: If you just left it to market forces or the private sector you can’t compete with the banks when they’re so big, and they have entrenched relationships, and government backing, with an interventionist policy. It’s almost impossible to circumvent and that’s why there’s no consolidation.

We in the GCC have a history of using government funds to kick-start industries, whether it’s airlines, or telecoms, or logistics. I think the same should be done, especially with pension funds; especially with insurance companies. Those would play a big role in trying to create those domestic pools of capital that can then compete with the banks and provide different types of funding. Sharia-compliant finance is a very good innovation to be leveraged as well.

Ansari, Standard Chartered: But we are seeing some very positive developments, particularly versus the last two years. We’ve seen the GCC sovereigns building curves, which can be easily leveraged by other GCC issuers. We have also seen non-traditional investor participants becoming more active, such as the US base on the back of the sharp rise in 144A issuances. The Asian investor base has also been a large contributor to the growth of volumes. But sustaining this proactive attitude towards the international debt markets is critical to giving international investors confidence that this is not a one-off approach, and if oil prices rise then local GCC issuances will shut down. 

The development of the local market is also very important. At the moment, we only have one major investor – the region’s banks. Even with over 300 transactions in the last two years, we’ve been very reliant on domestic liquidity, which still represents 50%-60% of most GCC order books. More importantly, these books have been anchored by a small range of anchor investors, which are the mega-banks of the region, and international investors have come to rely on this. While a core focus must be to expand the non-bank investor base, I do think this may be subsided by the fact that Asia is coming in and driving a lot of these deals. But we need to get away from the over-reliance on this domestic liquidity.

GC: How important is the Asian bid for the GCC?

Ansari, Standard Chartered: On average over the last two years, Asian investor participation in GCC deals has more than doubled. Some of this growth comes from the continued relative value differential seen between similarly rated issuers from the GCC versus Asia. This increased interest from the Asian market is opening up interesting avenues — of late we have even seen, for example, select Taiwanese investors looking more closely at sukuk formats — a welcome investment in the region.

GC: Where are the pockets of demand coming from, apart from Taiwan? 

Ansari, Standard Chartered: We have seen a healthy pick-up in interest from markets such as Korea, Singapore, Hong Kong and Malaysia. New markets like Thailand have also been showing increased interest, with participation in both public and private formats. 

Asian interest has been so strong that many ‘myths’ that existed in the market are now proving false — for example, the myth that Asian investors only look at rated products. If you look at the most recent transactions — including those that are unrated — Asian distribution has increased twofold versus the last five year average. Asian investors are looking actively at this region and historically what we perceived as no-go areas for them — such as unrated credits — are of strong interest now. You’re seeing those boundaries being pushed. 

In addition, we’re seeing new pockets of non-deal roadshow locations being explored by GCC issuers. Historically, issuers only targeted deal-related roadshows, going to Hong Kong, Singapore and London, and pricing the deal in London. Now you’re seeing issuers travel on a non-deal roadshow basis to keep investors educated on their credit story, while also targeting new markets like Taipei or Seoul. A lot of regional borrowers have gone to Taipei and Korea of late. This is adding to the diversification element of transactions. 

GC: Are you looking, Tom, at the Asian market? 

Koczwara, Sharjah: Yes, we’d look at some of the market-specific products, whether it’s Formosa or Panda bonds, or others. Some of these options are attractive in some ways, less attractive in others. They’re not straightforward. There’s a relatively high degree of execution risk. 

When we market a standard or sukuk issue, or through the private placement market, or indeed the loan market, we have seen some of these Chinese banks in particular being, I was going to say proactive — probably more than that — pushy even. 

They work a bit behind the scenes so you don’t get a sense of how active they are. They don’t really have a general banking platform, but they’re coming and writing some huge cheques. They are the biggest banks in the world in terms of balance sheets and they can make a big difference to this market and put pressure on the traditional big ticket lenders in the GCC. 

On the one hand, for Chinese lenders, there can be a restriction, which is they need a Chinese angle to get things signed off back home. On the other hand, they are keen to do deals and to build their book. As a result, the people on the ground here are flexible in terms of what that Chinese angle can be. 

GC: Turning to practical examples of market access, what about our issuers’ funding plans for the year?

Koczwara, Sharjah: We’ve got financing requirements of around Dh3.5bn ($1bn) which I expect to be made up of one or two large transactions of multiple hundreds of millions of dollars, plus two or three smaller transactions. For the large transactions, we’ll look at different options. So we have people marketing quite innovative markets that we should go and issue into. In addition we’d consider a repeat of our previous debt capital market sukuk issuance, which we’ve done twice before.

For the smaller transactions, either we’ll look for our traditional bilateral banking relationships or at private placement opportunities that normally come from proactive investors. That’s for the government itself. Then we also have 19 government-owned entities that we manage the financing for. There, we’ve got a big focus on export credit agencies and guaranteed or direct funding from foreign governments for exporting countries. We see that as the most attractive source of low cost long term finance, and it’s a big growth area for us. We just closed our first export credit deal in January, and we’ve got six or seven which we’re working on. More generally, across the GRE sector, we’re consolidating. I think we will end the year with less GRE debt on a net basis than we started the year.  

Wallace, Aldar: Our next priority is looking at our December 2018 sukuk, which is $750m. So we’re thinking about how we deal with that. We’re also looking at our capital structure. We are a pure play developer on one side, and an asset manager on the other. And the capital structures for those businesses are very different. But because we are one entity, we need to maintain an investment grade rating. And I’m pleased to say we’ve been upgraded over the last 12 months. But it means that one business compromises the other. And so we’re thinking about how we manage that. In that context, refinancing a sukuk is not simple. We are thinking about whether we can create some sort of structure that allows us to efficiently issue the sukuk in the right sort of format, in the right entity with the right structure for investors. 

The sukuk/conventional debate is an interesting one. As a real estate company, we have assets. But it’s not necessarily as simple as that. We have land that we need to develop — so we need flexibility and freedom around that. Sukuk has the provisions of being flexible in moving things around, but it’s not necessarily an easy process. We have operating assets, so maybe we could look at those instead. But we need to work out if they are fully sharia-compliant in all areas. Hotels, as an example, may not be. 

We need to make sure that whatever structure we go into is as simple, efficient and flexible as possible and that if there is a meaningful pricing difference of being in a sukuk then you need to consider that sukuk maturity profiles are different to conventional profiles. So we factor in all this before deciding which route to go down. 

GC: Is refinancing risk in the region a problem?

Wallace, Aldar: The $750m sukuk is half of our debt at the moment. But we’re not highly geared so I’m not concerned about the financing. 

Koczwara, Sharjah: You are quite typical of issuers in the region. There are a lot in the sovereign and corporate sectors who do nothing, do nothing, do nothing, do a huge issuance, do nothing, do nothing, do nothing. 

Wallace, Aldar: But it goes back to the bank capital markets question. Half of my current debt is with the banks, which I wouldn’t normally do, by which I mean I wouldn’t normally structure my long term debt with 50% in bank debt. I’d have an RCF with a bunch of banks, and then the rest would be capital markets and then I wouldn’t have the maturity cliff I’m facing now.

Koczwara, Sharjah: I’m sure there are a hundred solutions to it but this is one of these risks that is created by the state of the market, essentially.

Wallace, Aldar: We did a 10 year last year with one local bank, which was really pushing them. They did it at pricing levels that were probably inside those available from the capital markets. But that’s the problem. The banks are feeding companies like Aldar because it’s easy to do so. As a bank, you don’t need to do all the work you’re going to have to do for small and medium size businesses and it’s less risky. You can just give the money to Aldar.

Sarmad Mirza, Standard Chartered: It certainly is little surprise in the debt capital markets sphere how the longer maturities have become the strong preference of investors. One thing we hear from every investor is the need for more yield.

In addition, one of the themes we have been trying to drive in our capital markets platform in the past couple of years is to try and encourage the middle tier names to come to the private placement market. However, even now, when we go to bank investors, who are the key players in the regional private placement market, they still express concerns around the unrated nature of an issuer, or that they’re single-B or double-B rated credit, or the sector that the issuer is in. The investors often question if it is really worth doing the work for a smaller sized, unrated or high yield deal.

Wallace, Aldar: The efficiency of the market needs to change. Because if one goes to the capital markets and can issue sukuk and bonds 50bp within what you [the banks] can lend me, then you’ll be forced to look at that market because you won’t be able to lend to me. 

GC: With such large sovereign funding needs, is there a risk of crowding out smaller issuers in the region?

Koczwara, Sharjah: A slightly more mature approach would be good. But the second point I was going to make is one of my most painful experiences in the government of Sharjah, one we discussed already, was the transparency journey. The other one is convincing my organisation to do less business with our local banks and forcing them to work with the private sector in Sharjah. 

It’s so easy for us to rely on our local banks. Funding is available the next morning and we can put our feet up for the rest of the month. But if we step back, they will be forced to lend more to the local SMEs and, indeed, larger corporates. This is the lifeblood of our economy: we’re the most private sector-driven part of the UAE. And you find that some of the banks tend to be very volatile in their appetite when lending to this sector. They come in when times are good and then suddenly, they step back and close all of the SME accounts in the UAE overnight. We need our local banks to be supporting the private sector. But it’s incredibly painful to get people to think that way. 

Kronfol, Franklin: That’s exactly how you could encourage the banks to do more plain vanilla banking. If you or the government or GREs were all told that X% of your funding needs to come from international markets. 

GC: Mike, how would this work in practice for you as a borrower?

Wallace, Aldar: I agree that a regulator needs to promote and emphasise this but if you start setting hard thresholds of what you can do, I’m not sure that gets you there. 

To your earlier points about having institutions like insurance companies and pension funds bringing capital: that will make the capital markets more efficient, better priced and more competitive to the banking sector, so that they’re forced to look at different avenues. 

I’m going to struggle and you’re going to struggle to go to our boards and say, ‘no, we’ve got to take money from this more expensive group over here because it’s better for the rest of the economy’. They’re just not going to do it. 

GC: Thuwaini, what was your experience of issuing the sukuk recently? Would you do it again? 

Al-Thuwaini, Warba: Our options were limited. We’re a bank that was in a unique position. We’re a newly created bank. Our licence was granted as part of an initiative of the government to promote the financial sector with shares issued in the form of a grant to Kuwaiti nationals. It was also one way for the government to redistribute the country’s wealth to its citizens.

The first few years were set-up costs. So we accumulated some negative reserves, negative retained earnings. By the time we wanted to issue, we couldn’t by law, because we had to recover the accumulated losses before issuing capital again. We couldn’t raise equity capital. We witnessed new bylaws issued by the capital markets authority in late 2015, allowing sukuk issuances. If it wasn’t for this positive regulatory development, I don’t think you’d have seen Boubyan issue, thereafter AUB, and then us as the third bank. 

The primary reason for the success of the issuances, despite the overload of challenges, was demand and supply. Demand for sukuk in the market far surpassed supply, coupled with the perception of quality credit and the chunky yield the issue promised.

We achieved our target, which was to pick up on the momentum of the debt regulatory changes, the lack of supply in Islamic debt instruments, and third, our unique challenges of raising additional capital with accumulated losses incurred due to set-up costs. 

This gives other issuers the courage to go ahead and issue. The next stage is: how do you take that outside the banking sector? Because the banking sector has an advantage as it’s an extension of the sovereign credit. That doesn’t usually translate to corporates. So this will remain a challenge. 

GC: Do you see more innovation in terms of products on offer this year?

Ansari, Standard Chartered: This goes back to the trend of international investors taking a much more active look at the GCC market, particularly Asian and US investors. This has resulted in both a sharp rise in Asian participation on traditional US dollar issuances, as well as GCC issuers targeting Asian liquidity directly. The Formosa market out of Taiwan for example has been particularly active for GCC borrowers. Last year, QNB successfully tapped the Formosa market and both NBAD and ADCB have followed suit this year

GC: Let’s look more closely at sukuk — growth of the market has been slow. How can development be accelerated?

Kronfol, Franklin: It is a growing market. Islamic finance remains robust and the source of that demand is really strong at the retail level. Everywhere you see Islamic banks operating, they’re capturing market share, they’re gathering deposits, and so these treasuries are always looking for paper. If it’s investment grade, and it’s in that comfortable 10 or five year tenor, it will be bought.  

Al-Thuwaini, Warba: Sukuk issuances significantly help Islamic banks because when you look at the new banking regulations, Basel III standards and all that, where you have stricter liquidity standards to abide by, conventional banks have a lot more flexibility.

Whenever the bank deposits decrease, conventional banks can still tap high quality liquid assets such as bonds to fill that gap. The Islamic banks have fewer tools at their disposal to meet Basel III liquidity ratios. All they have, currently, are deposits and some sukuk and some products that they can replace with retail deposits. The fact that Saudi Arabia and others are bringing high quality sukuk to market gives Islamic banks more flexibility to manage their liquidity ratios. It will have a greater impact on the development of Islamic banks, in particular.

Rizk, Arqaam: The proof of the market growing is that more exotic issuers are considering issuing sukuk; the likes of Ecuador, for example. The finance minister came to the region for a non-deal roadshow to sense the appetite of GCC investors for such an issue. We definitely would.

The problem with sukuk is the lack of structure standardisation: one Sharia board can approve a structure as compliant while another can reject the same. This makes issuing and structuring a sukuk a lengthier process with higher closing risk and arguably more expensive. Standardisation of structure would make it easier for issuers to consider sukuks and therefore have new names issuing.

The regulator needs to step into the sukuk markets too to encourage market development. Yes, it may take longer to structure a sukuk. Yes, it may be more expensive. Yes, it’s harder to keep in contact with your investors. But, longer term, having diversified sources of funding and investor bases would help in difficult times.

Kronfol, Franklin: I don’t think aiming for standardisation is a necessarily good objective because it may come at the expense of innovation and new structures. The market can establish its own standards and comfort with different structures.

Mirza, Standard Chartered: Three years back, issuers would bring a five year instrument, and Singapore would buy some, and Malaysia. Now we see Hong Kong as a regular stop on deal roadshows, with HK investors buying actively. Across Europe, the format has become a mainstay of local investors and European demand is as strong as for any bond issuance. 

Even across select pockets in Asia which have traditionally shied away from sukuk, like Taiwan, onshore investors are taking a closer look and starting to nudge the regulators to start thinking about the format more seriously. 

The other thing I find interesting is that everyone who is buying sukuk knows well that the issuance will likely price 10bp-15bp inside the issuer’s conventional bond curve, and yet investors seem eager to take a sukuk over a bond. Maybe it’s a sense that the sukuk is going to have a wider investor base and there are more exit options for investors in the secondary market if needed. 

GC: Do you feel the same way Dino, just take a sukuk whenever it comes?

Kronfol, Franklin: Well, yes, but with the same caveat. The primary source of demand for sukuk is Islamic banks. And the treasurers of banks are the same everywhere — they want five year fixed, investment grade, etc. So for the development of the sukuk market, we need these non-bank investors, the pension funds, us, insurance companies, to have that diversity. 

It’s very important for the development of the sukuk market. You want it to be authentically Sharia-compliant, you want it to have more risk sharing. For these different risk sharing structures to occur, you need longer term money, private banking money, asset managers. The banks will make the sukuk look very much like a bond. And then people will ask, what’s the point? This thing looks the same, it’s just an expensive way of doing it. Whereas if you have more risk sharing, more equity-like characteristics, that helps the development of the sukuk market. That will distinguish sukuk and make people that much more interested in making an allocation, regardless of where we are in the business cycle. 

Rizk, Arqaam: But desperate times call for desperate measures. Taiwanese and Hong Kong pensioners are in need of yields, given how tight their markets are. They need to diversify across regions and GCC is the most logical choice given the comparable high credit rating.

Standardising sukuk would help the market by making it easier for investors to understand. 

GC: What is the pricing dynamic between sukuk and conventional bonds?

Kronfol, Franklin: Including sukuk in JP Morgan indices was a big step. Sukuk are, without a doubt, becoming more mainstream, more widely accepted. 

Rizk, Arqaam: Agreed, which also led the gap between conventional and sukuk spreads to narrow. Earlier this year, we got instances where bonds and sukuks traded flat, the likes of Majid Al Futtaim 2024 conventionals and 2025 sukuk, Qatar 2022 conventionals and 2023 sukuk. The conventional spreads tightened to their similar sukuk levels. This was driven by Asian demand that was more into conventionals because of simpler, more straightforward structures.

GC: What other barriers do you see to the development of the sukuk market?

Mirza, Standard Chartered: One of the things that needs to be, and will be, addressed soon is the adoption of the sukuk format in the US market. I’m confident that many of the GCC sovereigns would’ve very happily taken a sukuk for all their jumbo trades recently if the US was a very active participant in the format. But with the US being a question mark, it is understandable that large issuers would side-step sukuk to ensure that US investors continue to play in a big way on jumbo deals. 

The minute you unlock that, you will have this massive opening of the sukuk market. That said, the momentum is shifting and we are seeing global sovereigns increasingly bring 144A format sukuk with increasing adoption.

GC: How will the forthcoming Saudi and Oman sukuk impact the market? Perhaps they will bring in more US investors that bought into the Saudi sovereign issue?

Kronfol, Franklin: It’s an important development. It will change the make-up of the index for an investment grade issuer. Definitely Asian demand will be enormous. For the local market here we’re already at the stage where sukuk are so widely accepted that it doesn’t really make a difference in the GCC. It’s an important milestone for the development of the industry, just like we were saying it’s good for Kuwait to issue. Now we have all six GCC sovereigns with issues outstanding. We’ve never really been there before. 

GC: Are the GCC’s currency pegs here to stay?

Jardaneh, Standard Chartered: Our in-house view is that the pegs will be maintained over the medium term. The policy adjustment to the oil price shock has been through the fiscal channel, which makes sense from an economics standpoint for the time being. The pegs are the mainstay of the GCC economies, and play an important role as nominal anchors. So it would be difficult for the governments to figure out an alternative. The move needs to be towards more flexibility at a later stage when the GCC economies have achieved a higher degree of diversification. But for that, there needs to be building of institutional capacity at central banks.

Kronfol, Franklin: And without local markets, how are you going to set interest rates?

Jardaneh, Standard Chartered: There has to be better liquidity management, better forecasting of liquidity needs to be able to set interest rates and deepening of capital markets to strengthen monetary transmission channels. You’ll need to be able to set a nominal anchor, which is something that cannot be done now. But just doing, let’s say, a re-peg to a new level does not solve a problem. More exchange rate flexibility would be needed to enhance the policy toolkit sustainably.

Kronfol, Franklin: Bahrain’s reserve position and their finances are arguably inconsistent with having a dollar peg, which will come under pressure at some point. We suspect that they will find a big deposit by Saudi Arabia into their central bank or they will figure out a way to make sure that the external deficits are addressed. But it does need to be addressed, if you want to remain credible and continue to access bond markets independently.