UK Post-Brexit International Sukuk

08/04/2021 02:04 PM
Opinions on topical issues from thought leaders, columnists and editors.
By :
Mushtak Parker

LONDON: Malaysia’s top two banking majors, Maybank and CIMB, are part of an international consortium of banks appointed a week or so ago by The UK Debt Management Office (DMO) on behalf of HM Treasury to arrange the country’s second sovereign Sukuk in the international market.

Indeed, the Treasury took the market by surprise by fast-tracking the Sukuk issuance two days ago with the result that the UK returned to the international Sukuk market after an absence of seven years when it issued a UK£500 million benchmark Sukuk Al Ijara (leasing Sukuk) with five-year maturity on 25 March 2021. The transaction, the settlement date of which is April 1, says HM Treasury saw “strong demand from investors in the Middle East, Asia and the UK.” The robust demand saw the issuance value increase to UK£500 million.

The DMO, on behalf of HM Treasury, on 22 March 2021 announced its intension “to issue the UK’s second sovereign Sukuk in the coming weeks, subject to market conditions,” and appointed HSBC as the Structuring Advisor and mandated the latter together with Standard Chartered Bank, Dubai Islamic Bank and Emirates NBD Capital – both from the UAE – and CIMB Investment Bank from Malaysia as Joint Lead Managers to the transaction. In addition, the DMO appointed Bank ABC from Bahrain, Dukhan Bank (formerly Barwa Bank from Qatar), KFH Capital from Kuwait and Malaysia’s largest bank in terms of assets, Maybank, as Co-Lead Managers.

Most proactive Islamic finance regions

The fact that the DMO appointed a demographically wide syndicate of banks to arrange the offering suggests that the Treasury was keen to ensure participation from the two most proactive Islamic finance regions – the Gulf Cooperation Council (GCC) area and SE Asia, especially Malaysia.

The pricing of the Sukuk certificates, which mature on 22 July 2026, has been flat – at a profit rate (yield equivalent) on the Sukuk set at 0.333% - flat to the yield on the 1.5% conventional gilts due July 2026. This second issuance, according to the Treasury, “attracted high-quality global demand, with orders totalling in excess of UK£625 million and was sold to a broad range of high-quality institutional investors around the world.”

UK Chancellor of the Exchequer Rishi Sunak, whose task it is to navigate UK Inc.’s public finances through the post-COVID economic recovery and in the aftermath of Brexit, maintained that “we’ve set out ambitious plans to make the UK the most open and dynamic financial centre in the world. By launching our second sovereign Sukuk, we’re cementing the UK’s position as the leading global hub for Islamic finance outside of the Islamic world. Strong investor demand for this Sukuk meant we achieved a good price for the taxpayer and will help us develop our relationships with Islamic economies around the world.”

The issuance was well received by bankers and the investor community. “The UK has long since presented an attractive investment destination for investors from the GCC, South East Asia including Malaysia and other regions overseas who have regularly and increasingly utilised Syariah-compliant financial structures to invest in a diverse range of UK assets. I am hopeful that the second sovereign Sukuk will underpin further expansion and development of the UK Islamic finance market, both domestically and in terms of our international outreach,” explains Stella Cox, MD of DDCAP Group, one of the leading intermediation platforms serving the Islamic finance sector.

As with the first issue, added HM Treasury, the second sovereign Sukuk will use the Al-Ijara structure which is in widespread use in the market. It will be underpinned by rental income from a number of central government office properties which are owned by the UK Government. The certificates will be listed on the London Stock Exchange.” Sukuk, according to The Treasury are financial certificates, equivalent to bonds, which comply with the principles of Islamic finance. An Al-Ijara structure uses assets (in this case government properties) to generate a regular income stream that is used to pay investors an agreed rate of return, in lieu of interest payments which are not consistent with Shariah principles.

The UK issued its maiden sovereign Sukuk in 2014, making it the first country outside the Islamic world to issue sovereign Sukuk and cementing its position as a centre for Islamic finance. “This second Sukuk offering is more than double the size of the first issuance (UK£200 million), increasing the supply of high-quality Syariah-compliant, liquid assets to the market and supporting the development of Islamic finance products in the UK,” added the Treasury.

Psychological impact

When a major global economy such as the UK gets involved in the Islamic debt issuance market, then global investors ranging from the California Pension Fund to offshore US accounts and investors in the Middle East, Malaysia, Singapore and Hong Kong are attracted like a moth to a candle. It is not the actual transaction that is at play, but the psychological impact of a sovereign issuer from a non-traditional non-Islamic country accessing Sukuk as a public debt instrument.

The issuance, however, should raise neither unrealistic expectations nor euphoria of a dramatic breakthrough in the UK and by extension the EU Sukuk issuance market.

When the UK debuted its first sovereign Sukuk in 2014, it paved the way for Luxembourg, Hong Kong and South Africa to follow suit with their maiden international issuances. But whether in a much-changed world since 2014 there is any potential correlation between the second UK Sukuk and other potential non-traditional issuers remains a moot point.

London’s prime motivation, says Bashar Al-Natoor, Global Head of Islamic Finance at Fitch Ratings, is driven by factors specific to the UK. “It is about maintaining and reinforcing the UK’s status as the premier Western hub for Islamic finance and its Islamic finance ecosystem where many Islamic market participants access international markets. It is also about creating a level playing field for the industry in the UK, thus adding to the Islamic finance ecosystem there,” he maintains.

The post-Brexit dispensation and the UK government’s policy of Global Britain seeking to sign trade and investment cooperation and opportunities, especially in exports and investment flows to and from member countries of the Islamic Development Bank (IsDB), has identified a potential contribution the Islamic finance industry can play in achieving these new goals.

Islamic finance including Sukuk has moved beyond the earlier facilitation under the UK’s cross-party financial inclusion policy. Although there is now much more activity in retail, SME and capital market sectors, the development of the Islamic Capital Market (ICM) and the market per se has been frustratingly slow.

While the UK has spectacularly leveraged its advantages in the global Islamic finance industry abroad, especially its pole position by far in legal services in Islamic transactions, this has not impacted much in the domestic market. It’s a question of lack of market depth and critical mass. The UK will not be a major market in in this respect. After all, the UK is home to five standalone authorised Islamic banks with assets of only about GBP5.5 billion, more than a dozen conventional banks offering Shariah compliant services, a host of investment firms, and a thriving legal and intermediation advisory sector.

UK’s second sovereign Sukuk issuance

So, what is the significance of the UK’s second sovereign Sukuk issuance in the international market? According to Bashar Al-Natoor, Global Head of Islamic Finance at Fitch Ratings,

“the UK has played a central role in growing its global footprint in Islamic finance over the past several years and plays a central role in the international Islamic finance market. The UK’s position in Islamic finance is driven by three main factors: The London Stock Exchange’s role as a key global venue for sukuk listing; London’s position as a global financial hub where many Islamic market participants access international markets; and the importance of UK-based legal services due to the use of English law for the majority of international sukuk and financing agreements.

“Brexit could create an interesting footrace over time with other western markets likely to expand their footprint in the sector. Ireland and Luxembourg in particular are interesting to watch in this field.”

From a debt issuance point of view, the Treasury and Bank of England (BoE) could have opted for a conventional bond or gilts. Given that UK interest rates are almost at zero per cent, they can easily continue to raise funds cheaply from the conventional markets. Implicit in the DMO’s mandate is to raise funds that “are value-for-money to the UK taxpayer”.

The reality is that Sukuk as a public debt fund-raising tool does not feature in the calculation of the DMO. It does however factor into successive UK governments’ strategy, with cross-party support, to facilitate Islamic finance under its financial inclusion policy. This has now moved beyond the vanilla products and services such as Shariah-compliant retail accounts, savings products, mortgages, and even pensions.

The UK Department of Education, for instance, has long been exploring the issue of Syariah-complaint student loans for tertiary education, the development of the Islamic Fintech market, in which the UK is becoming a market leader, and the launch of short-term liquidity management for Islamic financial institutions and Islamic Banking Windows or units of conventional institutions – which are all happening or imminent.

The strength of the UK’s Islamic finance policy is underlined by a supportive cross-party approach in the House of Commons which ensures continuity in the event of a change of prime minister or government party in office or indeed a chancellor of the exchequer. Indeed, Chancellor of the Exchequer, Rishi Sunak, an ex-Goldman Sachs banker, embodies this ministerial continuity having served as Chief Secretary to the Treasury to his predecessor Sajid Javid, who played a pivotal role in enhancing the UK’s Islamic finance proposition.

“The UK’s Islamic finance sector,” confirmed a senior UK Treasury spokesperson, “is a fundamental part of our economy and its significance to UK financial services is always growing; therefore, it will certainly make up a key part of our (post-COVID-19) economic recovery.”

The changing national and global market dynamics including Brexit and the pending UK-EU trade deal; the continuing economic impact of the COVID-19 pandemic and the export-led recovery; promoting the concept of Global Britain which encourages greater exporting to new markets thus creating a growing need for finance and support from UK Export Finance (UKEF) the country’s ECA; contributing to achieving the various UN SDGs, and even competition from other non-traditional markets in issuing Sukuk including Luxembourg, South Africa, Ireland, Hong Kong and Kenya are now all in play.

In 2020, for instance, the Islamic Finance Council UK (UKIFC), in partnership with the UK Government, convened the inaugural Islamic Finance & UN Sustainable Development Goals (SDGs) Taskforce through a virtual meeting bringing together over 40 global Islamic finance leaders. The meeting explored the role Islamic finance can play in addressing the US$2.5 trillion SDGs funding gap as part of the post-Covid-19 economic recovery. With assets expected to reach US$3.8 trillion in 2022, Islamic finance is one of the fastest growing sectors in the global financial industry. Achieving the 17 Sustainable Development Goals (SDGs) agreed in the UN’s 2030 Agenda for Sustainable Development will take over US$5 trillion per year investment with the current financing gap standing at around US$2.5 trillion per year.

Special relationship

Malaysia too has for long a ‘special relationship’ with the UK in promoting Islamic finance, especially during the tenure of Tan Sri Dr Zeti Akhtar Aziz as Governor of Bank Negara Malaysia (BNM). TheCityUK, the body which promotes the City of London financial services to the world, and Bank Negara Malaysia, used to organise the regular joint Malaysia-UK Islamic Finance Forum in London and Kuala Lumpur to share expertise and consider opportunities to utilise Islamic Finance solutions to raise capital and invest with a focus on infrastructure and real estate projects.

The UK government even set up an Islamic Finance Task Force and the Global Islamic Finance and Investment Group (GIFIG) in 2014 in the wake of its debut Sukuk in that year, comprising financial regulators and bank chief executives from the OIC countries to this end. A few years later these talking shops have failed to make any substantive inroads. The UK government’s drawn-out obsession with dealing with Brexit and the ensuing coronavirus pandemic naturally diverted attention to these pressing issues.

The UK became the first Western country to issue a Five-Year Sukuk Ijara in June 2014, raising GBP200 million in the process. The transaction paid a profit rate of 2.036% in line with the yield on gilts of similar maturity. The issuance was 10 times oversubscribed with the order book exceeding £2 billion. That debut Sukuk was arranged by a syndicate comprising Barwa Bank from Qatar, CIMB Islamic from Malaysia, HSBC, National Bank of Abu Dhabi (First Abu Dhabi Bank) and Standard Chartered Bank, thus covering all the major centres of global Islamic finance activity.

Demand for this second Sukuk is expected to be robust including from the five UK-authorised Islamic banks awaiting the imminent roll out by the BoE of its pioneering Alternative Liquidity Facility (ALF) to help these banks in the UK manage their short-term liquidity management requirements and capital buffers under the Basle capital and liquidity regimes on a Syariah-compliant basis.

“The Alternative Liquidity Facility (ALF) will be open for business from the first quarter of 2021. The new facility will provide UK Islamic banks (and indeed any other UK banks with formal restrictions on engaging in interest-based activity) with greater flexibility in meeting High Quality Liquid Assets (HQLA) requirements, enabling them to hold a reserves-like asset in a non-interest-based environment,” confirmed Andrew Hauser, Executive Director, Markets at the Bank of England (BoE).

Hauser explained at a recent Islamic finance forum in London that “the ALF will be structured as a Wakalah or fund-based facility: a commonly used model in Islamic finance. In simple terms, that means that participant deposits will be backed by a fund of assets, the return from which, net of hedging and operational costs, will be passed back to depositors in lieu of interest.”

First-mover advantages

The UK has important first-mover advantages over other non-traditional Islamic finance markets. “The major Islamic finance players,” reminds Fitch’s Al Natoor, “are all English speaking, so language is no barrier. The UK-based legal services dominate given that almost all the international transactions, Sukuk offerings, Murabaha syndications etc are governed by English law. The London Stock Exchange also plays an important role as a key global venue for Sukuk listing. These are difficult to take from the UK.”

The debut Sukuk in 2014 was supposed to pave the way for a spate of UK corporate issuances. Apart from a two or three small Sukuk issuances including by Gatehouse Bank, Sukuk has been conspicuous in its absence from UK project finance and urban regeneration, the two areas to which it is best suited.

“That is a concern,” maintains Bashar Al Natoor. “You need to look at three things, issuers, investors and the ecosystem. You need to have issuers who are willing to issue Sukuk. You need to have investors that are willing to invest in that Sukuk. On top of that you need to have the right ecosystem especially the regulatory system that allows you to issue Sukuk.” To him, the UK’s Sukuk strategy is underpinned by its underlying Islamic finance strategy.

But as Andrew Hauser of the BoE reminded the Wakalah Alternative Liquidity Facility “is a real step forward, but it’s only one step. Through continued engagement and focused effort, together we can build a more innovative, diverse and inclusive marketplace: one which really can meet the needs of every part of our society. Some worry that COVID might slow the pace of growth in Islamic finance, as economic activity declines, and market participants revert to more conventional tools to meet the daunting financing needs of the crisis. That needn’t be so – because key aspects of Islamic finance make it particularly well suited to financing the post-Covid recovery.”

In fact, in this respect and in the context of Brexit and Global Britain, UK International Trade Secretary Liz Truss in a letter to UKEF Chief Executive Louis Taylor in March, reiterated the government’s strategic priorities. These include Export-led Recovery, Clean Growth for a Green Industrial Revolution, Climate Risk Disclosures, The Union and Levelling Up to include support not only for large exporters but also SMEs exporting, and advancing the Global Britain concept.

“Our new free trade ambassadors will encourage greater exporting to new markets and will create a growing need for finance and support from UKEF. The UKEF will work with UK exporters who will want to capitalise on the opportunities these new markets will bring. This year, UKEF will increase its international network and recruit International Export Finance Executives into Malaysia, the Philippines, Qatar, Egypt, Morocco, and the US,” she said.


Mushtak Parker is a London-based independent economist and writer.

(The views expressed in this article are those of the author and do not reflect the official policy or position of BERNAMA)