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Tuesday 05, June 2018 by Jessica Combes

Examining Saudi Arabia's Sukuk developments

 

Mohammed Khnifer, Debt Capital Markets (DCM) Banker at Supranational Banking Institution, writes exclusively for Islamic Business & Finance about KSA's big moves

WHAT QE INVESTORS SHOULD CONSIDER REGARDING THE $54.5 BILLION IN GOVERNMENT DEBT OF SAUDI ARABIA 

Back in early April 2018, Saudi Arabia’s securities regulator announced that it had approved the listing of local currency government Sukuk & bonds on the Saudi Stock Exchange. The week after saw over SAR 204.4 billion ($54.5 billion) of riyal government debt being traded in the local exchange. it’s a landmark move, because we’re talking about $54.5 billion coming to the market in one go.

It will enable, for the first time, qualified and approved foreign investors to purchase that debt at floating, fixed, bond, Sukuk, as well as with different tenors. This will give emerging market debt investors access to this untapped local debt which has been closed off for several years. Local debt is becoming a trend in emerging markets and many investors plan to increase or increase their exposure to local currency debt. This especially to the fact that the SAR is pegged to the USD, so there so it is stabilised.

While listing will help develop active yield curve, I caution that it will take time. This assumption that there will be active trading, I doubt initially, because no market makers and primary dealers have been assigned yet, once these steps are taken, we should see an active tradability, which will be positive as it will enable to corporates to have local and active reference benchmark. On the local level there is huge publicity and retail investors are excited and wondering if they could purchase the debt, unfortunately they won’t be able to do that, because the bonds are expensive.

Each Sukuk unit will cost around SAR 1 million. The listing and tradability of local currency bonds and Sukuk with fixed rate could also create the culture of pricing corporate bonds through fixed rate and not floating rate. The majority of DCM deals are priced at floating rate, probably because the investor base are banks and they are dictating what sort of rate they are looking for, which will be in their favour when the local reference rate (SAIBOR) moves up.

This in turn is negative for the corporate sector because it will eat into their profits. The listing will create awareness of the fixed rate, the pricing of bonds, and Sukuk. These potential issuers will also have a local and active benchmark when it comes to fair price and this will raise awareness of credit rating. Overall this will have positive impact on the local debt market in Saudi Arabia and the wider EM space.

THE MYSTERY OF THE FLOATING RATE OF SAUDI CORPORATE SUKUK ISSUANCE
For an unknown reason, Saudi issuers have overrelied on the floating rate when it comes to pricing riyal denominated Sukuk. We are not taking about short-term tenor here, rather medium-term. It is a unique feature that differentiates its local debt capital market from any part of the world. I would estimate 95 per cent of total Sukuk issues in Saudi Arabia are linked to Saibor.

Saudi companies who follow this pricing practise for fixed income securities expose themselves to interest rate fluctuations, which can have a detrimental effect on pricing. This practice is in the interests of investors, not issuers, but companies in Saudi, I presume, do not have enough technical experience to know better.

There is also an over-reliance on the hybrid structure by Saudi issuers, which is acceptable to local investors. However, exporting this structure with US dollar issuance could be a problem. Since Saudi Arabia issued its debut Sukuk in 2016, no other issuer has followed suit. The market has not accepted this complex structure yet, and it is attaching a premium to pricing.

My biggest concern is when the Saudi issuers try to tap the dollar market this year using the hybrid, it will expose them to a potential premium. Lastly, we need to find a way to cut the costs of issuance expenses and standardise Sukuk documentation in the local market.