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Don’t expect rush to follow Lux sukuk

Luxembourg’s debut in the sukuk market last week was a great advert for the asset class and rounded off a run of ground-breaking deals from new borrowers. But despite bankers reporting interest from other European sovereigns in the aftermath – and suggestions the Grand Duchy itself will return next year – it is unlikely that its western neighbours will follow soon.

Luxembourg got a decent result with its debut, pricing the €200m five year deal to yield just 0.436%, or minus 2bp versus mid-swaps. While that was a premium to what it would pay on a new conventional bond, it wasn’t a big one – and one banker away from the deal suggested the small size was the main reason for this, rather than the sukuk structure.

Although the €500m book size for Luxemburg’s sukuk was much smaller than the £2.3bn seen for the comparably sized £200m UK debut in June, the underlying sterling rate on that deal meant a juicier 2.036% profit rate for buyers and Luxembourg does not – yet – have any home-grown Islamic banks to buy its paper (the UK has six). But Luxembourg did manage to sell 61% of the sukuk to Middle East accounts – who don’t like to invest in foreign currencies other than dollars.

Overall then, this can be seen as a vote of confidence for highly rated European sovereign borrowers who might be looking to issue sukuk. The problem is that there aren’t any others.

Luxembourg’s reasons for issuing sukuk may have been slightly different to the UK’s, but it definitely had them. Both deals were about burnishing a financial centre’s Islamic credentials. The UK wanted to create suitable highly rated paper for its Islamic banks to hold in their liquid asset buffers and to attract inward investment from sovereign wealth funds in the Gulf and South East Asia. Luxembourg wanted to advertise itself as a listing jurisdiction for Middle East / SEA funds as well as bonds and sukuk.

But both borrowers had issuing a sukuk on their agendas for several years before they did one. No other European country can seriously make that claim and syndicate officials reckon that it would take two or three years for any that had a change of heart to go from concept to fruition, much in the manner of South Africa’s sukuk. Hong Kong stands out for having put its deal together in only 12 months, but it had advertised its desire to issue sukuk for years before that.

Germany has shown little interest and while France gestured in the direction of a sukuk issue a few years ago, market participants say the country has gone backwards on this front rather than progressed, with little incentive to make another push. The form of Napoleonic civil law operating in France was found to be much less accommodating to sukuk structure than Luxembourg’s, and there is little chance of this being changed.

Eastern European countries might have more incentive to come to market, but for funding reasons rather than strategic advertising. Africa is the other obvious area of the CEEMEA region to look at, but African sovereigns will be taking their cues from South Africa rather than Luxembourg, the UK and Hong Kong.

Goldman Sachs’s recent sukuk is also seen as a door-opener for conventional / western banks to follow. Many of them are said to have been studying this possibility for years and just waiting for someone braver than themselves to test the market. But even though banks could come much quicker than sovereigns, the best guess would be some time next year.

Luxembourg has done well and should be applauded for the work it has put in to get its deal over the line. And it has shown that Western European debt offices have every reason to put in calls to Islamic finance bankers. But if you’re looking for the follow-up deals from Luxembourg, look anywhere but here.

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