The Hong Kong Monetary Authority sold its first-ever sharia-compliant bond, known as a “sukuk,” last week. The $1 billion deal is part of the city’s plans to woo investors and issuers in the $2 trillion Islamic finance industry, and compete with London and Dubai for a fast-growing pool of capital.
Sukuks are investment products that rely on payments from an underlying asset, like real estate, rather than paying back a loan with interest like a traditional corporate or government bond, because the Koran forbids usury.
The deal was a success, drawing $4.7 billion in orders. What’s especially interesting is who bought in. The deal attracted “a diverse group of conventional and Islamic investors” totaling 120 institutions in all. Hong Kong didn’t break that down by specific names, but it did by geography.
Asian investors purchased 47% of the deal. That pool is likely to include both Islamic and non-Islamic investors, Waina Leong, an analyst with Kuwait Finance House told Quartz. And it is safe to assume that “almost all” of the US and European investors, who bought 17% of the deal, are not Muslim, Leong said.
Given the potential returns, it’s no surprise that even investors who aren’t obligated to follow the Koran’s ban on usury could be interested in the Hong Kong sukuk issuance: the five-year security priced at a return of 2.005%, which is more than 30 basis points above the 1.7% return on five-year US Treasury notes.
Because of interest from Muslim and non-Muslim investors, outstanding global sukuk issuance has skyrocketed in the past decade, hitting $286 billion at the end of the first half of 2014, according to research from Kuwait Finance House:
The growth in demand is moving sukuks from a niche category to a viable alternative investment, KFH said in its 2014 half-year report. This year’s issuance so far has been dominated by Malaysian issuers, with 63% of the market, followed by Saudi Arabia with 13.7%, according to KFH. Malaysian bonds in particular are attracting “agnostic” investors including hedge funds and fixed income managers who don’t necessarily follow sharia, and who bought up 42% of Malaysian Export-Import Bank’s (Mexim) $300 million five-year sukuk in February, Finance Asia reported.
The Hong Kong government is just the latest non-Islamic issuer to jump into the mix. Earlier this year, the British government did a landmark £200 million ($325 million) deal, becoming the first country outside the Islamic world to issue one of these bonds. Deals in the pipeline in the second half of the year include Société Générale, the South African government, and Bank of Tokyo-Mitsubishi.
Despite sukuks’ rapid growth, they remain a far from mainstream asset, and one limited mostly to sophisticated investors because of an often complicated structure. The UK government’s sukuk, for example, earns profits from rent payments from two government-owned buildings, but even a simplified diagram of how it works is hardly straightforward:
They’re also much less liquid than traditional forms of government or corporate bonds, because the secondary market is much smaller. But for investors looking to buy and hold, they’re looking more attractive all the time.