RAWALPINDI, Aug 7: International Monetary Fund (IMF) has noted rapid growth of the Islamic finance sector in recent years, saying that a surge has been witnessed in the issuance of Islamic capital market securities (sukuk) by corporate and public sector entities, amid greater demand for alternative investments.

In a policy paper, discussing the ‘Islamic Bond Issuance’, IMF says as the sukuk market continues to develop, new challenges and opportunities for debt managers arise as structured finance instruments are receiving increasing attention owing largely to enabling capital market regulations and financial innovation, amid an establishing greater inclusiveness of Shariah compliance.

The paper says the sovereign sukuk are likely to gain popularity as more governments in both Muslim and non-Muslim countries explore options to diversity their traditional debt portfolios.

The latest examples of this trend are efforts in the UK, Japan and Thailand to establish a sukuk issuance programme

and Indonesia’s bill on Islamic debt financing, which will enable the government to fund large parts of its budget deficit by

issuing sukuk.

Of all the rapidly growing Islamic capital market securities, none are gaining popularity as much as sukuk. The Islamic finance industry has grown by about 15 per cent on average over the last three years in response to a profusion of investment products, which has been fuelled by an increasing demand for investments that comply with Islamic law.

Currently, more than 800 billion dollars are lodged in Islamic banks, mutual funds, insurance schemes (takaful), and Islamic branches of conventional banks.

The most popular form of Islamic finance is commonly referred to as sukuk, which are wholesale, asset-based capital market securities.

Recent years have witnessed a surge in the issuance of sukuk by corporates and public sector entities, amid growing demand for alternative investments.

The sovereign sukuk market has witnessed considerable institutional and geographical diversity since the first sovereign issue in 2002.

Malaysia, Qatar, Bahrain, and Pakistan are the most prolific national issuers. Also quasi-sovereign entities, international financial institutions (IFIs), such as Islamic Development Bank, World Bank, and its private sector arm, International Finance Corporation, publicly-listed corporates, privately-owned companies and religious councils, such as the Singapore Islamic Religious Council (MUIS), have issued sukuk.

The report says the primary sukuk market is dominated by corporates, which have accounted for over 86 per cent of total historic issuance through end-2007.

Corporate issuance - both public and private - has expanded rapidly, doubling both between 2004-05 (from 5.7 billion dollars to 11.3 billion dollars) and 2005-06 (from 11.3 billion dollars to 24.8 billion dollars) to reach almost 32 billion dollars in 2007. The largest proportion of corporate sukuk was issued in the financial services sector, accounting for 31 per cent of total volume, followed by real estate, with 25 per cent and utilities with 12 per cent.

While Asia, specifically Malaysia, accounted for the bulk of all issues in 2004 (close to 90 per cent), issuance activity in the GCC has picked up rapidly and now accounts for more than 43 per cent of all issues (by number).

Despite limited funding needs of many sovereigns in the GCC, sovereign issues have also been growing strongly, more than quadrupling to about 4.8 billion dollars in 2007, motivated by the objective of developing local capital markets. Yet despite growing market maturity, supply remains concentrated, with the top five lead managers accounting for almost 40 per cent of global sukuk issuance in 2007.

While sukuk continues to evolve, a select few still dominate the market. Musharaka contracts continued to be the largest sukuk issued in 2007, accounting for more than 12 billion dollars of issuance, although lease-based transactions are the most common.Other Islamic finance contracts, such as murabaha, where the financier provides funds at a premium in return for the temporary transfer of a contractual asset for a specified period of time, ‘istasna’ or ‘salam’ only play a minor role.

Growing demand for convertible sukuk also demonstrates strong demand for structures with an opportunity to benefit from the recent gains in local equity markets.

The IMF report says although the current level of sukuk issuance remains a fraction of the global issuance of conventional bonds and asset-backed securities (ABS), the market for sukuk has been growing rapidly despite the global financial crisis triggered by the collapse of the US subprime market.

At the end of 2007, outstanding sukuk globally exceeded $90 billion. Gross issuance of Islamic structured securities has quadrupled over the past two years, rising from $7.2 billion in 2004 to close to $39 billion by the end of 2007.