S&P warns high costs may curtail sukuk growth

High financing costs may curtail the future growth of sukuk in the Gulf, according to a report by Standard & Poor’s Ratings Services.

Investor enthusiasm for the Islamic bonds may be discouraged by the high cost of structuring and issuing sukuk, accounting fees, a real estate downturn, low hydrocarbon prices and their predominantly local investor appeal, the agency said in a report on Tuesday.

"In our experience, the costs of structuring and issuing sukuk remain high relative to conventional bank loans and bond issuance," said S&P’s credit analyst Karim Nassif.

Uncertainty surrounding the perceived risks associated with the instruments, a lack of standard structures and perceived differences in approach to sharia compliance, along with a relative lack of liquidity in the secondary market may also affect investor appetite, he said.

After years of rapid growth, project and infrastructure sukuk issuance in the Gulf has stalled, the report said.

Total sukuk issuance fell 56 percent to $14.9bn in 2008 compared with the previous year.

However, the report said the GCC will be the focus of most infrastructure and project finance sukuk activity in the short to medium term. 

It said sukuk-based financing remained the most attractive means of raising funding for medium and long-term capital costs for GCC issuers.

The Saudi Electricity Company and Dubai Electricity and Water Authority (DEWA) issued sukuk in late 2007 and during 2008 to fund capital expansion in Saudi and Dubai respectively, it said.

Algebra Capital, a Dubai-based asset management firm, gave the sukuk market a show of support on Tuesday.

The Middle East North Africa sukuk market represented around a third of the total global sukuk market, and would continue to see strong issuance growth as most countries in the region continue to run fiscal deficits which needed to be financed, Ziad Makkawi, founder and CEO of Algebra Capital, said at the International Islamic Finance Forum in Dubai.

Makkawi said he expected that over the next 10 years there would continue to be a convergence in regulatory as well as product know how between the conventional and sharia markets.

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