The recent rise in foreign currency-denominated sukuk issuance was mainly due to features specific to certain core Islamic finance markets. In Saudi Arabia, for example, reduced banking system liquidity and lower oil prices meant a decline in sovereign local currency sukuk but higher foreign currency-denominated issuances.

Why it matters:   The mixed activity levels highlight the sukuk market's geographic concentration. To attract interest from non-core jurisdictions, the industry may need to rethink the issuance process and harmonize its Sharia standards.

What we think and why:   We still believe total sukuk issuance will likely be lower this year than in 2022 or 2021, even though we anticipate additional foreign currency activity in the market. That said, we see continued growth of sustainability-linked sukuk, albeit from a low base, amid rising awareness of environmental, social, and governance considerations among issuers. In the medium term, the sukuk market is set to benefit from increased automation and digitalization. It remains to be seen whether the launch of Islamic Coin, expected later this year, will contribute to this trend.

A Mixed Picture In 2023

In the first half of this year, total issuance was down by 17.5% to $83.2 billion compared with $100.7 billion in the same period last year (see chart 1). We continue to expect muted issuance activity overall. We have revised upward our estimate of sukuk issuance to $174.1 billion from $155.8 billion in 2022 by better capturing the volume of local currency-denominated issuances. However, issuance volumes are still lower than in 2021.

Chart 1

The volume of local currency issuance is down.   Year on year, the market saw a drop of almost 25% in the first half of 2023, primarily due to lower issuance by the Saudi Arabian government. We think liquidity constraints in the Saudi banking system in the first half of the year was the main reason for this, since it implies subdued local demand. We saw a marginal decline in the UAE and also in Turkey, where we think this related more to the environment amid the legislative and presidential election. In the UAE, we note that the federal authorities issued their first local currency-denominated sukuk during the period. We expect to see more such issuance in the next few years as the UAE authorities continue efforts to develop the local capital market (see chart 2).

Chart 2

However, the volume of foreign currency-denominated sukuk is up.   Despite less supportive market conditions, we saw foreign currency-denominated sukuk increase by about 9% in the first half of this year. This stemmed from sovereign and government-related entities, as well as from banks tapping the sukuk market to ease liquidity pressure in Saudi Arabia. We also saw a couple of new issuers reach the finish line. Egypt tapped the sukuk market for the first time (see chart 3), in a transaction that was priced in a similar manner to conventional bonds. U.S.-based Air Lease Corp. also tapped the market during this period, using some of its leased aircrafts as underlying assets. We expect to see more traction in the foreign currency sukuk market in the second half of 2023. Many issuers in the Gulf are on the lookout for opportunities the market may have to offer. They are also seeking to benefit from the current rates situation, under the assumption that central banks are not yet done with inflation and further rate hikes may be on the horizon. Interestingly, we saw limited activity in Turkey, Indonesia, and Malaysia.

Chart 3

We think the overall volume of issuance will remain muted in the second half of 2023.   For the full year, issuance volumes will be higher than our initial forecast of $150 billion; we now expect the market to see $160 billion-$170 billion of new sukuk for 2023. A rampup of local currency issuance in Saudi Arabia could change this picture, however, particularly because we expect oil prices to be lower for the remainder of the year. This points to one of the weaknesses of the global sukuk industry: its concentration by geography. To attract more interest from other jurisdictions, the industry can leverage opportunities offered by technology while rethinking the process of issuance and harmonizing Sharia standards related to sukuk.

Technology Can Disrupt The Market In A Positive Way

As we stated earlier this year, we believe digital sukuk could provide a quicker and cheaper way for issuers to tap Islamic finance markets, due to the limited number of intermediaries involved (see chart 4). Other benefits may include enhanced transaction security, traceability, and integrity, which could further strengthen compliance with Sharia. However, this assumes the availability of reliable technology, readiness of legal frameworks to accommodate these instruments, and standard legal documents that can be used as a template. Sharia standards and their harmonization across geographies are also critical factors of success.

Chart 4

Reducing the time, cost, and minimum issuance volume requirement in this way could open up the sukuk market to more issuers. Investors in digital sukuk will continue to bear traditional risks, including credit market and liquidity risk. They will also face higher operational risks related to technology stability and cyber attacks, and need a means to transact digitally, for example, a stable Islamic coin or central bank digital currency. It remains to be seen whether the expected launch of the first Sharia-compliant cryptocurrency, Islamic Coin, the native currency of the Haqq Network, will contribute to this trend.

We also note that regulatory uncertainty remains high and resides in the fragile equilibrium between retaining sukuk's core fixed-income instrument characteristics and Sharia scholars' objective of more profit-and-loss sharing. In our view, if sukuk instruments lose their fixed-income characteristics, while adding significant risks compared to bonds, they will become a less attractive option, reducing the market's prospects.

Sustainability Sukuk Are Becoming More Prevalent

Despite the natural alignment of Islamic finance and sustainable finance, sustainability-linked sukuk issuance remains limited, albeit expanding rapidly (see chart 5). The total volume of sustainability-linked sukuk increased by around 50% in the first half of 2023 compared with 2022. We expect to see higher volumes as issuers meet investor demands and core Islamic finance countries seek to reduce their carbon footprints. The upcoming COP28 in the UAE is expected to shed more light on the opportunities offered by Islamic finance and sukuk to finance initiatives related to the climate transition.

Chart 5

Many core Islamic finance countries are implementing strategies to put their economies on a path toward net-zero greenhouse gas emissions, which could imply future growth for green sukuk issuance. We expect to see much more activity in this space as issuers attract global investors' attention and regulators start offering incentives. For example, the UAE's Securities and Commodities Authority announced in June 2023 an exemption from registration fees for companies that list their sustainability-linked bonds or sukuk in the local market during 2023.

The social aspect of Islamic finance is less visible, but is also relevant as the economic impact of various political and geopolitical shocks continues to hit populations in some countries. The Islamic Development Bank and the International Committee for Red Cross are reportedly looking at the possibility of using humanitarian sukuk to help deal with crises in their member countries. Overall, we expect the contribution of sustainability-linked sukuk to continue increasing over the next few years.

Related Research

• S&P Global Ratings Lowers Hydrocarbon Price Assumptions On Moderate Demand, June 22, 2023
• Credit FAQ: Can GCC Banks Weather Funding Risks? June 5, 2023
• Islamic Finance 2023-2024: Growth Beyond Core Markets Remains Elusive, May 1, 2023
• Digital Bonds: The Disruption Is Underway, Feb. 27, 2023
• Global Sukuk's Slump To Slow But Not Stop In 2023, Jan. 16, 2023