On 26 July, the Saudi Arabian Ministry of Finance debt management office announced the completion of its first Sukuk issuance under the primary dealers programme. The programme had previously been established for the distribution of local government Sukuk securities.
“This issuance, which totalled around SAR 3.5 billion, the equivalent of $925 million, is positive for the development of Islamic debt capital markets in Saudi Arabia because it broadens the investor base for government Sukuk securities in the primary market and supports liquidity in the secondary market,” said Jonathan Parrod, Associate Analyst at Moody’s Investor Service.
The Saudi government has been a regular issuer of Islamic bonds since the Ministry of Finance established a Saudi riyal-denominated Sukuk programme last year. More than $20 billion of riyal-denominated Sukuk have been issued since July 2017, according to Moody’s.
“However, this issuance is the first under the newly launched primary-dealer scheme and more than 20 investors from participating financial institutions and asset managers submitted bids through an electronic platform for both their own books and on behalf of investors. Previously, the Saudi Government typically relied on banks and institutional investors' subscriptions to complete its tap issuances.
In the new primary-dealer system, the Saudi debt management office appointed five local banks to act as primary dealers for local government securities, namely National Commercial Bank, Samba Financial Group, Saudi British Bank, Bank Al-Jazira and Alinma Bank,” said Parrod.
Under this agreement, the appointed primary dealers purchase Sukuk sold at auction directly from the government, and later place these securities in the secondary market for final investors, acting as market makers for government securities.
“We expect the primary-dealers scheme will develop the local government Sukuk market, and more generally, debt capital markets in Saudi Arabia, which is one objective in the government’s Financial Sector Development Program under Vision 2030, its national plan to reform the economy. We expect the primary dealers will also help the government build stable demand for Sukuk securities and foster a broader and more diversified investor base by facilitating public access to sovereign debt. In addition, primary dealers acting as market makers will play a key role in stimulating the secondary market trading activity and liquidity, ensuring efficient pricing of government securities on an ongoing basis. In April 2018, the Saudi Capital Market Authority, the government’s financial regulatory authority, announced the Saudi stock exchange listing of riyal-denominated government debt
instruments, including both Sukuk and bonds totalling more than SAR200 billion ($50 billion), in an effort to enhance the ease of trading these instruments in the secondary market,” said Parrod.
Saudi Arabia has been the largest issuer of Sukuk by value among Gulf Cooperation Council countries since 2017, raising around $9.5 billion of Sukuk during the first seven months of 2018, and accounting for almost 55 per cent of the region’s total Sukuk issuance in that period.
It has not been the private sector that has driven issuance, however The government has largely driven issuance, accounting for around 85 per cent of the Sukuk supply in the country since the beginning of the year, while corporate Sukuk activity has remained limited to a handful of issuers.
“Going forward, we expect more issues and listings of government Sukuk, which, along with the introduction of the primary-dealers scheme, will help develop the secondary market and build a benchmark yield curve for local corporate issuers,” said Parrod.
Investors are still quite interested in Sukuk, according to private banking giant UBS.
"Our clients are expressing increasing interest in Middle Eastern assets as economic reforms and other factors open up local markets to international investors. Our coverage of key instruments such as equities, bonds, and Sukuk has steadily expanded to reflect demand, and will likely continue to do so in the years ahead,” said Michael Bolliger, Head of Emerging Market Asset Allocation, UBS Global Wealth Management Chief Investment Office.
Investors are not the only ones in the Islamic economy that are benefiting from Saudi Arabia’s 2018 moves. Accoridng to Fitch Ratings, Saudi Arabia’s rising interest rates will be a big boon to banks.
“The offsetting impact of higher funding costs will be less for Islamic banks than conventional banks - which will also get a boost - because they have a higher proportion of non-profit bearing deposits,” said Bashar Al Natoor, head of Islamic Finance for Fitch.
Saudi Arabia's central bank raised the official repo rate from 2 per cent at end-2017 to 2.25 per cent in March and 2.5 per cent in June.
“We expect banking sector earnings to increase in 2018, although financing growth is likely to remain muted. We also expect Saudi banks' capital buffers to remain strong and sufficient to absorb a potential mild deterioration in asset quality. Islamic banks continue to outperform conventional banks, helped by lower funding costs and a higher proportion of retail financing. Islamic banks, like conventional banks, have benefitted from improved liquidity conditions. Last year, the Ministry of Finance established a Saudi riyal-denominated Sukuk programme, which has been issuing regularly. This is a positive development to help Islamic banks manage their liquidity,” said Natoor.
Saudi Arabia has the largest Islamic banks' financing base (78 per cent) of any country that allows commercial banks to operate alongside Islamic banks. Four of Saudi Arabia's 13 licenced commercial banks are fully Shari'ah compliant, while the other nine provide a mix of Shari'ah-compliant and conventional banking products and services. All banks are regulated by the Saudi Arabian Monetary Authority with the same disclosure requirements.
“Saudi banks are predominantly deposit funded, with deposits representing about 90 per cent of funding at Islamic banks and about 94 per cent at conventional banks at end-2017. The largest bank, National Commercial Bank, considered an Islamic bank in our ratio calculations, has the most diversified funding profile of the Saudi banks we rate,” said Al Natoor.
“Islamic banks are well capitalised, with an average Fitch Core Capital ratio of 18.6 per cent at end-2017. This was 70bp above conventional peers due to lower risk weightings on retail banking assets and lower off-balance-sheet activities. Capital ratios have increased in recent years due to lower financing growth and improved profitability,” he continued.
Saudi Arabia’s emerging market status, set to kick in at the beginning of 2019, should continue the good news for the Islamic finance space in Saudi Arabia.