Since the establishment of the Steering Committee for the Development of Islamic Finance in September 2013, various steps have been taken to facilitate the Islamic finance industry.

To name a few of these steps, the State Bank of Pakistan (SBP), taking a stock of its initiatives, had launched its strategic vision for the industry in 2014; the rules for Sukuk issuance were launched this year; and interest has been sought for establishing a centre for Islamic finance.

With large banks aggressively stepping into the market, the Islamic banking portfolio is successfully expanding. And recently, the central bank reported that Islamic banks have taken the lead from conventional banks in housing finance.

Despite these efforts, the market for Sukuks, however, remains shallow and illiquid. Regular Sukuk issuance of various maturities is much needed for effective liquidity management of Islamic banks. They provide depth to the market as well as establish a yield curve that serves as a benchmark for corporate Sukuks.

With Rs233bn worth of Sukuks maturing in November, Islamic banks will be in need for fresh issuances to the tune of Rs500bn to maintain the 19pc statutory liquidity requirement (SLR). If no fresh Sukuks are offered, the funds placed in the Islamic bonds for compliance with the SLR would decline to 6.5pc.

As reported in the print media, the conventional SLR-eligible securities outstanding are Rs4.8tr, which are 59pc of the total conventional bank deposits. Meanwhile, there are Rs326bn worth of outstanding Sukuks, which are less than 29pc of the total Islamic banking deposits by May.

Given that the regulatory framework is the same for both conventional and Islamic banks, this creates an additional capital adequacy pressure on Islamic banks, as the SLR-eligible securities are capital charge exempt.

To meet the above challenges, one Rs100bn Sukuk is in the pipeline, expected to be arranged by Wapda for the Neelum-Jhelum hydropower project. The government may consider re-issuing the Ijara Sukuk on the Jinnah International Airport as well. However, experts say it would still leave a gap of Rs150-200bn to meet the industry’s liquidity needs.

With Rs233bn worth of Sukuks maturing in November, Islamic banks will be in need for fresh issuances to the tune of Rs500bn to maintain the 19pc statutory liquidity requirement

Meanwhile, the corporate Sukuk market is fairly active, with K-Electric and Engro taking the lead. Globally, although sovereigns and supra-national bodies take the fair share of issuances, the aviation and banking industries are forthcoming with Sukuk issues. One of the reasons for banks is the eligibility of certain Sukuk as capital for compliance with Basel III rules. The local banking industry may look into this option for improving the gaps in meeting the capital requirements.

Furthermore, the legal and regulatory framework must be amended to take into account the specificities of Islamic finance, given that Sukuks are ownership certificates and not debt instruments issued via wholly owned special purpose vehicles (SPV). Their accounting and statistical treatment should reflect their status as such.

Of the milestones yet to be achieved, the amendment of tax laws enabling legitimate ownership of physical assets by SPVs is awaiting their turn. SPVs are subject to transfer and stamp duty taxes under current laws.

Beyond regulatory reforms, the onus is on the industry to simplify and facilitate access to participatory finance for inclusive economic development.

Globally, Sukuk issuances have declined after a scintillating decade-long growth. Global Sukuk issuance had grown exponentially from $45bn in 2010 to $118.7bln in 2014.

But the S&P has revised its 2015 Sukuk forecast from $100-110bn to $50-60bn. The first half of the year saw a correction due to a major plunge in issuances from Bank Negara Malaysia (BNM) and the continued slump in oil prices. BNM, which alone issued Sukuks worth $45bn in 2014, has shifted its focus to other liquidity management instruments, thereby reducing its supply of Sukuks. And while there has been a slight decline in issuances from the oil-producing countries, the entry of non-traditional participants has kept Sukuks in the news.

Going forward, with multilateral support coming its way — the G20 pledging to get involved in Sukuks; the IDB’s proposal for launching the Islamic Infrastructure Investment Bank in 2016 with $1bn capital; and the IDB canvassing Islamic finance options with the Asian Infrastructure Investment Bank — the Sukuk market is set to grow in the long run.

However, the momentum demands the resolution of issues faced in various jurisdictions and the elimination of opportunity for international regulatory arbitrage.

The writer is a faculty member at the department of accounting and finance at IoBM.

sarwat.ahson@iobm.edu.pk

Published in Dawn, Economic & Business ,July 13th, 2015

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