When writing an article, an author usually tries to connect the dots. Indeed, year 2020 created many puzzling dots. So the following two articles represent an attempt to arrange the puzzle pieces in a reasonable manner.  

Islamic Securitization pre and post COVID-19 era

Securitization is a structured product under both conventional and Islamic finance. Securitization is the process of pooling various assets into a Special Purpose Vehicle (SPV) besides financing the acquisition of these pooled assets by the issuance of securities through the SPV. Hence, Islamic finance mimics conventional in defining securitization since most financial Islamic products are based on the concept of asset backing. Another similarity is the parties’ involvement in the securitization process.

Nevertheless, there are two main differences. First, the underlying assets pool or portfolio should match the Islamic Shariaa principals or the accepted Islamic financing schemes. Second, investors should have a share of ownership in the asset pool of the new SPV. In other words, investors participate in the securitization product based on a profit and loss generation mechanism rather than an interest rate based as in conventional financing. Sukuk is considered the most common Islamic product used with securitization deals. So how did Islamic Sukuk securitization perform in 2020 especially in light of the COVID-19 outbreak? What is the contemplated outlook for Sukuk securitization in 2021?    

2020 a review

From a global perspective, Covid pandemic had a negative impact on conventional securitization deals. According to S&P global securitization report, conventional securitization new issuance in 2020 is expected to record an aggregate of USD$ 830 Billion. If compared to 2020 new issuance expectations prior the Covid, it should have recorded an amount of USD$ 1.12 Trillion. Hence, the pandemic resulted in a decline of around 26% in the global securitization market. The market of Islamic bonds or Sukuk is no different. As mentioned by Moody’s in last August, global issuance of Islamic bonds or Sukuk is expected in 2020 to record an aggregate of USD$ 170 Billion representing a drop of 5% ending a four consecutive years of annual growth. Worth mentioning that most of the Sukuk issuance in 2020 represents Sovereign Sukuk issued by governments to support its balance sheets against the pandemic impact beside the major drop in oil prices. In other words, it is not a fully securitized product if compared to the conventional concept. Furthermore, if correlating the whole Sukuk market of USD$ 170 billion to only the conventional securitization new issuance of USD$ 830 billion, Sukuk will represent around 20%. This indicates that Sukuk securitization deals will witness a further drop than 5% in 2020 despite starting the current year with a positive outlook. This is evidenced by some Islamic market news detailing securitization programs launched prior the pandemic. One example is the first asset backed USD$ 266 million Sukuk launched in Saudi Arabia last January. The Sukuk proceed was expected to acquire real estate assets in Europe with a specific focus on Germany. Since then, few Sukuk securitization deals were conducted or announced except recently. In last September, KFH- Bahrain launched an Islamic Securitization program offering local financial institutions and state owned entities an opportunity to manage their liquidity positions and balance sheets through the issuance of a series of Mudarba Sukuk. 

 2021 a preview

According to expectations, the whole market of Islamic finance during 2020 will aggregate to around USD$ 2.4 Trillion. Such declines are expected to continue during 2021. So what could Sukuk securitization expect in 2021? In liaison with international reports, the outlook is gloomy to some extent. But is there any window of opportunity? In my humble opinion, to answer this question we have to take into consideration two main pillars: LIBOR cancellation and the link of recourse concept with the issuance credit rating. Many issued Sukuk are referenced to LIBOR rate which is expected to be cancelled by end of 2021 and replaced by the Secured Overnight Rate (SOFR). Worth mentioning that SOFR rate is higher than LIBOR currently. Also, most Sukuk securitization embeds fixed cash flow streams. So what connects the two dots? Upon LIBOR cancellation, Sukuk will not be affected from the technical perspective since it is fixed and Islamic bonds are non-tradable. Nevertheless, new Sukuk issuance in 2021 referencing LIBOR might refrain investors from subscribing in the Sukuk offering. In other words, an investor will be better off with a conventional income stream referenced in SOFR than with an Islamic product tied with the fixed cancelled LIBOR. An investor could mitigate this by engaging in a series of Islamic swaps. The other main pillar is finding a Sharia compliance and legal opinion that allows embedding recourse clause on the Sukuk issuer. This is stemmed from the expectations of a global economy contraction that will impact most of sovereign and corporate credit ratings downwards.     

Conclusion

By definition, Islamic finance entails the conventional securitization concept in most of its products. It has a real window of opportunity if stipulated on slim market dynamics by turning it around to its favor. 

This article was first published in Islamic Finance News (IFN) Annual Guide 2021 on December 22nd , 2020. https://www.islamicfinancenews.com/islamic-securitization-pre-and-post-covid-19-era.html

Islamic leasing: An intrinsic Antidote to Stimulate Economic Recovery.

Until recent years, Islamic leasing has enjoyed a competitive edge over its conventional counterpart.  This is stemmed from two key features embedded in the Ijarah product. First is the application of fixed interest rates during the whole facility period. This is considered a synthetic hedging against interest rate fluctuations. Second is the implementation of Shariah principals allowing Islamic banks to own the leased asset. As a result, Islamic banks have generated lucrative profits by attracting conventional clients and ultimately attaining a larger market share. Consequently, conventional banks introduced fixed and floating interest rate leasing, forcing Islamic banks to introduce floating Ijarah in order not to lose their market share. Also, some conventional banks launched leasing subsidiaries granting them security access on the leased asset through tri-party agreements. So, did Islamic banks lose its intrinsic advantage over the conventional? To answer this question, we need to know how Ijarah performed  in 2020. What is the contemplated outlook in 2021?        

Review of 2020

According to IFSB Services Industry Stability report issued in July 2020, the GCC captured the largest share of global Islamic banking assets at 45.4%. Nevertheless, and as a result of the pandemic and low oil prices, 2020 had a negative impact on GCC conventional and Islamic banks as depicted in Diagram 1. For the first time since 2013, the asset growth of both conventional and Islamic banks are equivalent at an almost 2% rate. To curb the weak growth, central banks launched several stimulus packages. This boosted Ijarah based product associated mainly with Sovereign Sukuk. For example, Indonesia issued Ijarah-based retail Sukuk for around US$342 million to finance the country’s economic recovery allowing retail investors to participate through online channels utilizing Islamic fintech.

As per PWC 2020 Middle East Working Capital study, around US$ 36.5 Billion in excess working capital is currently trapped on the balance sheets of Middle East companies. Weaker credit policy controls slowing collection rate, shifting demand patterns and rigid supply chain are all factors contributing to liquidity challenges and inventory buildup for most companies in the Middle East especially the SME’s. Such an economic situation could explain the purpose of the Sustainability Sukuk issued by ISDB. In June 2020, the ISDB issued a US$1.5 billion sustainability Sukuk offering to curb the negative impact of COVID-19. Around 53% of the issuance proceeds will be allocated to the MENA region with a special focus on SME’s in an attempt to ease the liquidity squeeze faced by many companies in the region.

Preview of 2021

2021 could be a promising year for the Ijarah product to act as a key solution for some of 2020’s economic turbulences or concerns. According to S&P Islamic Finance Outlook 2021, deteriorating banking asset quality will be the main challenge facing banks in the GCC in 2021. This shouldn’t be a problem for Islamic banks since most of its products including Ijarah are asset-backed facilities.

Another promising opportunity for Ijarah product is to integrate it into environmental, social and governance (ESG) offerings such as ISDB sustainability and green Sukuk issuance. Associating such issuance with a fixed Ijarah product could act as a catalyst to boost Islamic finance market. Availing funds with fixed interest rate to SME’s would accelerate economic recovery.

The same idea is also applicable to any other green Sukuk issuance. In addition, the timing of implementing new accounting treatment and standards for Ijarah to match international accounting standards could ease the pandemic negative impact on many clients’ financial statements.  

Another lucrative horizons for Ijarah market is to entice global sovereign funds to issue Sukuk Ijarah as a main source of raising required funds. Such institutional investors hold massive real estate assets that are generating fixed income stream. Based on the prevailing interest rate in the global markets, sovereign funds could easily bundle specific generating assets with a Sukuk issuance that ultimately creates a lucrative spread. Such assets could include health care projects and / or Shariah complaint tourism projects. These two sectors are expected to be on the rise during 2021.

Conclusion

Once a profitable edge for Islamic banks, fixed rate Ijarah could be the same factor necessary for creating an intrinsic antidote. With regards to Islamic fintech, banks could further enhance their deposit liabilities cost of fund catering for the fixed rate asset assumption. Even better, launching Islamic digital banks or what is known by “phygital” banks could tap new horizons in both retail and commercial products.