LONDON: Is the coronavirus (COVID-19) pandemic forcing innovation in the Islamic capital market, especially in social and sustainable Sukuk issuance? The second half of 2020 may just see the green shoots of such innovation as governments all over the world scurry to come up with emergency financing packages either to mitigate the health and economic impact of the virus outbreak or to fund socio-economic recovery from the first wave of infections.

The Islamic Development Bank (IsDB), the multilateral development bank (MDB) of the OIC (Organisation of Islamic Cooperation) countries with its headquarters in Jeddah, a few days ago issued the first Sukuk in the world specifically ring-fenced to mitigate the health and economic impact of the global coronavirus outbreak and aid the recovery from the pandemic.

The IsDB successfully closed its second Sukuk issuance in 2020 with the aim of consolidating its financing “to tackle the aftermath of the COVID-19 pandemic in its Member Countries”. The bank issued a debut US$1.5 billion Sustainability Sukuk on June 19, 2020, which has a five-year tenor.

The proceeds from the maiden sustainability issuance, according to the IsDB, will be exclusively deployed towards social projects under the Bank’s Sustainable Finance Framework (SFF), with a focus on ‘access to essential services’ and ‘SME financing and employment generation’ categories under the umbrellas of the UN’s Sustainable Development Goal (SDG-3) relating to Good Health and Well-Being’ and ‘SDG-8 relating to Decent Work and Economic Growth’ for its 57 Member Countries, to assist them in tackling the aftermath of the COVID-19 pandemic.

The project categories are identified as per the guidelines standards set by the International Capital Market Association (ICMA) under its Sustainability Bond Guidelines (2018) and Social Bond Principles (2018).

UN Sustainable Development Goals

In September 2015, countries throughout the world, spearheaded by the United Nations, signed up to a new agenda for comprehensive and sustainable human development called Sustainable Development Goals (SDGs) – The 2030 Agenda. The 2030 Agenda aspires to achieve 17 high SDGs and 169 specific targets, encompassing the social, economic and environmental dimensions of development.

These aspirations for human dignity, and ‘to leave no one behind’, says Dr Bandar Hajjar, President of the IsDB Group, is fully in line with the principles and objectives of the IsDB. “The Bank,” added Dr Hajjar, “is committed to prioritising the UN Sustainable Development Goals in accordance with the specific development needs of its Member Countries. As part of these ambitions, IsDB aims to boost its commitment towards sustainability through the potential issuance of Sukuk to finance sustainable investments. The issuance of Sukuk under this Sustainable Finance Framework will enable the Bank to diversify its sources of funding, while enhancing IsDB's sustainability profile as well as helping the Bank to continue to deliver environmentally sustainable growth in a socially responsible and transparent manner.”

The IsDB’s latest foray into the Sukuk market comes at a time when Malaysia too is considering a similar offering. In fact, Prime Minister Tan Sri Muhyiddin Yassin announced on June 5 that the Ministry of Finance will tap the Islamic debt market in the third quarter of this year through a RM500-million ‘Sukuk Prihatin’ – a ‘People’s Sukuk – from the people to the people’ - the proceeds of which would be similarly ring-fenced to fund, among others, micro enterprises and research grants for infectious diseases.

"Proceeds from the Sukuk issuance will be utilised for specific development programmes such as connectivity of schools (especially in rural areas), funding for micro enterprises (focused on the women entrepreneurs) and research grants for infectious diseases. The issuance of the Islamic debt instrument is to enable the Rakyat to join the government in supporting post-recovery measures of the COVID-19 pandemic," Muhyiddin said when announcing the short-term Economy Recovery Plan (ERP). The Sukuk would be an adjunct to the Prihatin Rakyat Economic Stimulus Package 2020 announced by the government in March and other COVID-19 mitigation packages such as the National Economic Recovery Plan (PENJANA), totaling RM295 billion.

The social financial programme, according to the Ministry of Finance, is in the form of initial capital for micro entrepreneurs through zakat and matched with micro financing at affordable rates. The Prihatin Rakyat package provides RM4.5 billion additional funds including RM3 billion to the Special Relief Fund (SRF) for SMEs with reduced interest rate/profit rate from 3.75% to 3.5%; increase in the size of funding by RM1 billion to RM6.8 billion under the All Economic Sector Facility; a RM500 million fund under the Micro Credit Scheme with an interest rate/profit rate of 2% without collateral; a guarantee facility of RM5 billion and an increase guarantee coverage from 70% to 80% by Syarikat Jaminan Pembiayaan Perniagaan (SJPP).

Malaysia’s strong liquidity position

Finance Minister Tengku Datuk Seri Zafrul Abdul Aziz confirmed on June 13 that Putrajaya would borrow up to RM35 billion from the local financial market to finance initiatives under the Prihatin Rakyat and PENJANA packages. Given Malaysia’s strong liquidity position with current exposure to foreign borrowings only RM13 billion, raising funds from the domestic market not only makes sense but would be a major boost to the domestic capital market, which of course is dominated by the Islamic capital market (ICM).

According to the latest annual report of the Securities Commission, in 2019 the size of overall capital market totalled RM3,202.11 billion, of which the ICM accounted for RM2,035.59 billion or 63.57%. At end-January 2020, the size of the ICM held firm at RM2,001.77 billion or 63.46% of the overall capital market. The resilience of the ICM is underlined by its steady growth trajectory over the last few years from RM1,133.83 billion (or 59.19% market share) in 2017 to RM1,036.52 billion (or 60.55% of market share) in 2018 to its 2019 growth.

Malaysia has an active local sovereign Sukuk and bond issuance programme for reserve, liquidity management and interbank money market transactions – both Syariah-compliant and conventional. These comprise mainly Malaysian Government Securities (MGS), Malaysian Government Investment Issues (MGII) and Mudarabah Certificates. It would be revealing to see what portion of the RM35 billion the government seeks to raise locally would indeed be through Syariah-compliant issuances. If the issuances tilt towards Islamic debt securities given their competitiveness in pricing and uptake and the fact that the ICM already constitutes a majority market share, then it could be a major boost to the Malaysian Sukuk market, which has over the last few years been overtaken by the Saudi Sukuk market as the largest in the world. If not, Malaysia may see its reputation as a major Sukuk market dented (albeit slightly) indulging instead in the rhetoric of aspiration.

Neighbouring Indonesia, perhaps, went one step further issuing a three-tranche US$2.5 billion Sukuk on June 17 in the international market. According to the Directorate General of Budget Financing & Risk Management at the Indonesian Ministry of Finance, the US$2.5 billion Sukuk Wakala comprises a US$750 million 5-year tranche, a US$1 billion 10-year tranche and a US$750 million 30-year tranche.

The Sukuk were issued by Perusahaan Penerbit SBSN Indonesia III, a legal entity established by the government solely for the purpose of issuing government Sukuk. The Sukuk certificates assigned a rating of Baa2 by Moody’s Investor Service, BBB by S&P Global Ratings Services and BBB by Fitch Ratings, were priced on 16 June 2020 at par with a yield of 2.3% on the five-year tranche, 2.8% on the 10-year tranche and 3.8% on the 30-year tranche.

“This transaction took advantage of an opportunistic window within a period of heightened volatility in the global capital markets and received positive response from global and domestic investors with an order size of US$16.66 billion or oversubscription of close to 6.7x above the government’s target of US$2.5 billion issuance,” said the Ministry of Finance.

The relevance and importance of the Sukuk is that Jakarta claims that “it continues to show its commitment, leadership and contribution for sustainable financing by dedicating the five-year tranche as a Green Sukuk for climate change financing. The five-year tranche Green Sukuk is the third global Green Sukuk outside the retail Green Sukuk issued at the end of 2019. The transaction is in line with the government’s financial objectives including financing its fiscal expenditures to handle the impact of the COVID-19 pandemic as well as strengthening Indonesia’s position in the global Syariah market and supporting the development of Syariah financing in the Asian region. It remains unclear though whether the entire issuance will be used in COVID-19 mitigation and sustainable projects.

Public finance borrowing srategies

To put the importance and attraction of Sukuk as COVID-19 mitigation financing in a global Sukuk market context, several governments have regularly issued domestic Sukuk since the beginning of 2020 till now as part of their public finance borrowing strategies especially in response to the COVID-19 disruption and other major events including the slump in world oil and gas prices and production and the general downturn in the global economy. These include Saudi Arabia, Turkey, Bahrain, Nigeria and Indonesia.

Saudi Arabia, for instance, in the first five months of 2020, according to the National Debt Management Center of the Ministry of Finance, issued consecutive monthly Saudi riyal-denominated Sukuk issuances, raising a total SR38,088.5 million (US$10,134.94 million) in the process.

The Ministry’s 2020 Calendar of Local Sukuk Issuances envisages 12 consecutive monthly issuances of Saudi-riyal denominated sovereign Sukuk. No other jurisdiction is committed to such a dedicated and deep domestic Sukuk issuance regime.

Similarly, the Turkish Ministry of Treasury & Finance, on the other hand, has also been very active in May with several auctions comprising domestic issuances of fixed rent rate lease certificates; gold-backed lease certificates; and issuances of Euro-denominated and US dollar-denominated lease certificates. In total the Treasury raised TL11,810.13 million in two domestic Sukuk auctions in May, in addition to two foreign currency denominated auctions - one which raised €232.754 million and another which raised US$666.403 million, thus bringing the total US dollar equivalent for the month to US$2,676.453 million.

Similarly, the Treasury also issued Gold-backed lease certificates in May collecting 2,465,610 grams of gold (1000/1000 purity) from institutional investors for issuance of an aggregate 2,465,610 gold lease certificates (at a nominal value).

Even the UK Treasury and the South African National Treasury have confirmed to me that they are working on issuing an international sterling-denominated Sukuk and a domestic rand-denominated issuance respectively. In the case of the UK, arranging banks and legal advisors have already been appointed. Proceeds from the issuances should they materialise will be used inter alia towards mitigating the effects of COVID-19. However, these issuances, unlike the latest IsDB offering, are not necessarily ring-fenced for COVID-19 mitigation purposes per se.

The US$1.5-billion IsDB Sustainable Sukuk issuance complements the US$2.3 billion Strategic Preparedness & Response Programme (SPRP), a Covid-19 mitigation financing lifeline to its member countries which the IsDB launched in March. Indeed, the IsDB Group, of all the multilateral development banks including the IMF/World Bank Group, was one of the first MDBs to react to the coronavirus outbreak with an initial financial rescue package. The IsDB’s response to COVID-19 is pillared on the 3Rs – Respond, Restore and Restart – framework in its Member Countries.

The IsDB’s maiden sustainability offering is also the first ever AAA-rated Sustainability Sukuk in the global capital markets. “This is a flagship transaction in the development of social capital markets being the first Sukuk specifically allocated to the fight against COVID-19. It is a testament to IsDB’s efforts in providing assistance to its member countries through its 3Rs approach. The success of this transaction in terms of pricing, size and strong investor interest opens doors for other Sukuk issuers who may consider ESG-linked transactions,” explained Tanguy Claquin, Head of Sustainable Banking at Credit Agricole CIB, one of the mandated lead managers and bookrunners to the transaction.

Tapping international markets

The IsDB is one of the most proactive and prolific issuers of AAA-rated international Sukuk. This latest sustainability Sukuk is the second issuance by the Bank in 2020. In February it successfully priced its single largest Sukuk issuance ever, raising US$2 billion in 5-year Trust Certificates in the process. There are signs that the IsDB is tapping the international markets more often than previously. By June 2020, the Bank had already equaled its total 2019 issuances volume comprising three Sukuk offerings totaling US$3 billion and €1 billion respectively, with its first two issuances totaling US$3.5 billion.

The Bank is also increasing its sustainable and Green finance profile and credentials in line with the provisions of its Sustainable Finance Framework (SFF). Last November, for instance, it issued its debut €1 billion Green Sukuk based on the Framework.

The IsDB has secured a Second Party Opinion for its SFF from Norway-based CICERO (The Centre for International Climate Research) with a shading of Medium Green, under which its debut €1 billion EuroSukuk was issued last November. The IsDB has identified an eligible assets portfolio of US$5.4 billion of which US$3.6 billion are social assets including US$560 million in health-related projects plus US$62.7 million in SME financing.

“Under this Sustainable Finance Framework,” explained Dr Zamir Iqbal, Vice President (Finance) and CFO of IsDB, “the Bank intends to allocate an amount equivalent to the proceeds raised through this Sustainability Sukuk to the financing and/or refinancing, of new and/or existing Eligible Social Projects which includes access to finance for micro, small and medium enterprises and expanding access to free/subsidised healthcare across member countries.”

The Sustainable Sukuk was issued by IDB Trust Services Limited incorporated in Jersey under the IsDB’s US$25 billion Trust Certificate Issuance Programme launched in September 2019 but amended in June 2020. Leveraging its Aaa/AAA/AAA by Moody’s Investors Services, Standard & Poor’s (S&P) and Fitch Ratings (all with a stable outlook), the IsDB successfully priced the debut Sustainable Sukuk - 5-year Trust Certificates - at par with a profit rate of 0.908% to be payable on a semi-annual basis.

The pricing is very tight indicating strong demand for the papers in an environment starved of AAA-rated sovereign debt papers. This compared to the US$2 billion Sukuk in February which was priced at par at with a profit rate of 1.809% payable on a semi-annual basis, which according to the Bank was the lowest pricing for its papers since 2016.

Following the successful pricing, Dr Hajjar maintained that the “debut Sustainability Sukuk is a major fillip for the Bank in its pursuit of tackling the aftermath of the pandemic. The funds raised will contribute towards critical interventions in our Member Countries in these unprecedented times and I would like to thank the Member Countries and the Sukuk investors for their confidence and unwavering trust in IsDB and its mission. With the success of this transaction, I also call upon the Islamic finance industry to promote Sustainable and Social Sukuk as alternate asset classes that have the potential to counter the multi-fold impact of the COVID-19 coronavirus.”

Earlier in June the IsDB had mandated a consortium of banks comprising Citi; Credit Agricole CIB; Emirates NBD; GIB Capital; HSBC; Islamic Corporation for the Development of the Private Sector (ICD), the private sector fund of the IsDB Group; NATIXIS; Société Générale CIB and Standard Chartered Bank to act as the Joint Lead Managers and Joint Bookrunners for the transaction. Kuwait International Bank acted as the co-manager.

The book-building exercise started on June 17. The initial price thoughts, according to the Bank, were set at Mid Swap (MS) plus 70 basis points (bps). Following a strong demand from investors, the deal was eventually priced at MS plus 55 bps, tightening by 15 bps, with an overall profit rate of 0.908%. This is the lowest profit rate ever that the Bank has achieved for a US dollar public Sukuk.

In terms of the final allocation, said the IsDB, the distribution was well diversified with 53% allocated to Middle East & North Africa, 37% to Asia, 8% to Europe, and 2% to others including US Offshore Accounts. Overall, the deal witnessed strong participation from real money accounts and official institutions, a testament of IsDB’s credit strength, as 79% was allocated to central banks and official institutions, 16% to bank treasuries and 5% to fund managers and private banks.

Strong credit and financial position

“The attractive pricing achieved in a global market environment which is cautiously opening up,” explained Dr. Zamir Iqbal, “once again validates the IsDB’s strong credit and financial position, reaffirmed by its AAA ratings. Coupled with its commitment to tackling the aftermath of COVID-19, it made a compelling story for investors to participate in the orderbook, especially SRI investors. With the debut Sustainability Sukuk, we are delighted to have achieved another milestone in expanding the range of products we offer, and we are proud of supporting the Bank’s COVID-19 response efforts.

“Once again, investors across the board have reaffirmed their faith in our development and sustainability mandate and AAA-rated paper which provides best-in-class risk-adjusted returns. We will work to ensure that this lower cost of funding will contribute towards extending better financing terms to our Member Countries for supporting their critical and emergent needs during this pandemic. “

Similarly, Dr Gado, the IsDB Treasurer, was encouraged by the investor demand, diversification and perception of IsDB credit risk and financial strength. With this breakthrough deal, the IsDB, he added would continue to achieving its funding objectives as demonstrated by the size and the lowest overall pricing for a public USD Sukuk ever. “Investor perception of our Sukuk has greatly improved since the last public trade in February and we will continue to work on it further when we return to the markets later in the year. The investor diversification we achieved shows that the IsDB sustainable finance story is gaining stronger traction in new markets and we hope to maintain this momentum for future issuances,” he said.

The Trust Certificates are in the process of being listed on the Irish Stock Exchange whose trading arm is Euronext Dublin, NASDAQ Dubai and Bursa Malaysia (under the Exempt Regime).

IsDB Trust Certificates are guaranteed by the IsDB as Obligor. The IsDB Board of Governors, which comprise the Ministers of Finance/Economy of its 57 member countries, is keen for the MDB to fully leverage its ‘AAA’ rating status assigned by the three major international rating agencies for 15 consecutive years, and its “Zero-Risk Weighted” rating assigned by the Bank for International Settlements (BIS) in Basle and the European Banking Authority (EBA) for multilaterals, in its resource mobilisation strategy.

In May, Fitch Ratings affirmed IsDB’s Long-Term Issuer Default Rating (IDR) at 'AAA' with a Stable Outlook and the trust certificates issued by IDB Trust Services Ltd also at 'AAA'. The rating according to Fitch, “is driven by the intrinsic credit quality of the bank with solvency and liquidity both assessed at 'aaa'. Despite negative pressures on asset quality and capitalisation as a result of the global COVID-19 pandemic, Fitch expects the overall impact on the bank's credit profile to remain limited.”

The IsDB’s shareholders have endorsed a significant increase to the bank's paid-in capital that would enable the bank to meet the growing financing needs of member countries while bolstering its capitalisation further. The final approval for the capital increase is scheduled later this year in the Board of Governors meeting in Jeddah, which was postponed from its original date on April 3-4 as a result of the COVID-19 outbreak.

-- BERNAMA

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