Fitch Ratings-London-02 April 2015: The G20 group of nations' decision to examine the use of sukuk to finance infrastructure investment could eventually spur a big increase in the size of the market, Fitch Ratings says. But several significant challenges would need to be overcome first, most importantly finding a legal structure that would be acceptable to governments, investors and the sukuk's Sharia boards.

Infrastructure projects could eventually be a key source of sukuk issuance due to their asset based or asset-backed nature. But so far infrastructure sukuk have generally been relatively small and locally funded. Traditionally, infrastructure development has been financed and carried out by government or government linked bodies, or in some regions with private sector involvement through infrastructure project financing.

One of the main uncertainties is whether sovereign issuers will be willing to directly pledge infrastructure assets to sukuk investors or accept the most common structure, known as Ijarah sukuk. In this structure the originator sells the asset to a special purpose vehicle that issues the sukuk. The originator then leases the asset back from the SPV and agrees to buy it back at a future date.

Using Ijarah sukuk could make arranging deals simpler and easier and potentially make them more attractive to investors, particularly as the structure is fairly compatible with traditional project finance. However, sovereigns may not be willing to adopt such structures if they may risk losing control of the asset or if they do not have the necessary regulation and legislation allowing them to do so. This would result in more work to find an acceptable legal structure or the introduction of new regulations.

We believe alternative structures could be found, but it would take longer to achieve and could see slower take-up, especially as innovative structures would have to be approved by a Sharia board, which assesses compliance with sharia law. Currently, differences of opinions among Sharia scholars can occur even within a single jurisdiction.

These challenges will probably lead to a longer time-frame and higher costs than more established forms of infrastructure funding, at least until a standardised framework is established. But we believe several important trends will provide the necessary impetus for the development of infrastructure sukuk. These include growing government support for Islamic finance, increasing acceptance of sukuk and large investment and financing requirement in the GCC (Gulf Cooperation Council), Turkey, Asia and other emerging markets projects.

A transparent framework that investors, issuers and scholars are all comfortable with and which makes clear the rights of all the stakeholders should help attract the significantly wider investor base that would be needed for major infrastructure projects.

As well as the G20's initiative, other bodies are also taking steps that could help. These include the Islamic Development Bank's and the Asian Development Bank's reported efforts to provide technical assistance and credit guarantees to member countries that want to fund infrastructure projects and the International Monetary Fund's creation of a working group to build expertise in sukuk.

Contact:
Bashar Al Natoor
Global Head of Islamic Finance
+971 4 424 1242
Al Thuraya Tower 1
Office 1805
Dubai Media City
Simon Kennedy
Director
Fitch Wire
+44 20 3530 1387

Media Relations: Francoise Alos, Paris, Tel: +33 1 44 29 91 22, Email: francoise.alos@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com.

© Press Release 2015