The sukuk market will likely a see significant reduction in issuance volumes in 2020 as lower oil prices and the novel coronavirus hurt key sectors in core Islamic finance countries, S&P Global Ratings said on Monday.
Most government issuers in core Islamic finance countries may turn to conventional bonds rather than sukuk, because sukuk issuance is more complex and there is increasing risk-aversion among investors, S&P said.
The volumes of the global issuance of sukuk have nose-dived 32 per cent in the first quarter of this year against Q1 2019, and a further decline is expected in Q2 2020 as several countries implement measures to control the spread of COVID19.
The sukuk market is expected to recover in the third quarter of 2020 but the analysts at the S&P Global Ratings are of the view that the volumes of sukuk issuance in H2 of 2020 won’t be sufficient to compensate for the decline in the H1 2020.
S&P expected 2020 sukuk issuance to total $100 billion at best, down almost 40% from 2019, on the back of muted economic performance in the market’s core countries as they take measures to combat the spread of the coronavirus.
Several countries have taken measures to “unlock banking sector liquidity”, the ratings agency said, making potential issuers turn to banks rather than the sukuk market.
“We observed an increase in the share of foreign currency issuance in the first quarter, however. This is primarily due to the sharp increase in sukuk issuance in foreign currency in Saudi Arabia, while in other markets it remained stable or declined,” S&P said. “We understand such issuances stemmed from the proactive sourcing of funds by the Islamic Development Bank and Riyadh Bank before the market turbulence began.”
The central banks of countries with strong presence of Islamic finance have few reasons to issue sukuk in 2020 because the apex banks have opened liquidity taps through the banking sector and there is limited need for local currency liquidity management through Islamic bonds, said the note.
Last year, central banks accounted for 17.5 percent of total sukuk issuance. S&P said it expects credit risk to increase sharply.
“Among other things, we might see much higher default rates among sukuk issuers, especially those with low credit quality or business plans that depend on supportive economies and market conditions,” it said. “We expect defaults and the implications for investors will bring the debate on standardization of legal documents back to the forefront.”
S&P Global Ratings identified two major trends for sukuk in 2020 – defaults and slowdown of the innovative sukuk issuance. Given the shocks to the economic environment and rapid change in market conditions, the advisory firm expects credit risk to increase sharply.
Sukuk issuers will wait for the best window of opportunity to tap the market this year if they have no alternative, such as loans or conventional bonds.
“The momentum in using blockchain for sukuk and issuing green sukuk will likely slow this year,” S&P added, two areas it still expects will play a significant role in opening up the sukuk market when conditions improve.
S&P said the crisis could even lead to developments such as: “Social sukuk or a new breed of instruments, for example, one on which the rate of return would decline if the issuer fulfills certain social objectives, such as supporting the healthcare system or helping companies affected by COVID-19 so they don’t need to lay off staff.”
Source Zawya