Trading differentials of comparable bonds and sukuk — those issued by the same companies — have been squeezed to almost zero for some MENA names. That differential was as much as 20bp-25bp at its peak in 2012.
The reasons for the narrowing are not clear, but likely stem from increased volatility in emerging markets since May and a slowdown of Middle East flows. In such conditions, prices result more from mark-to-market than traded levels.
So parity may be short-lived. But in the United Arab Emirates there is often only 5bp between sukuk and bonds, leaving less pricing advantage for borrowers to issue Islamic notes. Qatar sukuk holds its edge but in some areas, such as Turkey, trading is even tighter on conventional bonds.
This has led some bankers to warn that non-Islamic names may fall away from sukuk this year, rather than shoulder the extra structuring costs involved. If the market is to meet recent levels, they say, it will have to rely on purely Islamic issuers and novelty names such as South Africa, the United Kingdom and Luxembourg.
But it is a myth that sukuk are prohibitively expensive for borrowers to issue. Even if the differential was zero (and some syndicate officials claim the average to be more like 10bp) the additional costs of structuring sukuk over bonds are minimal for the borrower — just $15,000 to $100,000, according to an Islamic banking source.
Most would pay less than $30,000, say syndicate officials. And in the context of a $500m to $1bn ticket, that isn’t huge.
Of course, the structuring process can take arrangers more time and effort than conventional bonds, which might be why bankers emphasise the additional costs.
But the extra outlay is also greatly compensated by borrowers being able to open their deal up to Islamic as well as conventional investors — an advantage that provides stability in trading as well as comfort in investor diversity, if not a pricing advantage at the moment at the point of issue.
Another myth that bankers lay on heavily as a reason sukuk issuance may stutter this year is that sukuk are less liquid than conventional bonds. Investors demand liquidity in a time of crisis and issuers are keen to build out liquid curves. But bids and offers on MENA sukuk are as good as conventional offerings, say investors — it’s just that neither is an especially liquid market. The tradability of both is more about specific regions and borrowers.
An obvious answer presents itself: borrowers able to do both bonds and sukuk (and you need Shariah compliant assets) should do both. Majid Al Futtaim showed the efficacy of this strategy in 2012 — using sukuk to issue inside its conventional curve, then using momentum to price a conventional bond inside the sukuk.
While nothing will save sukuk volumes from a hefty sell-off in emerging market bonds this year, should it happen, it will have little to do with competition between the asset classes.