Diversification of Islamic Financial Instruments
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Challenges to Sukuk Markets
The Sukuk markets though developing at a fast pace historically have slowed down, and the
trend seems to have persisted for the last two years. Surveys and inquiries into the apparent
challenges the Sukuk markets face in both primary and secondary markets. Summary of those
challenges and issues is highlighted below.
 Limited Sukuk supply main driver for lack of liquidity and tradability. The reason for
this arises out of the shortage in the supply of Sukuk in the market. Mainly because of
the general hold till maturity strategy of investors. Generally, Islamic financial
institutions invest more heavily in Sukuk compared to other non-Shariah-compliant
investors, as the former are limited to Shariah-compliant investments.
From the sell side perspective, the issue of liquidity arises out of insufficient depth of
bids in the Sukuk market. This can be attributed to the significant drop in Sukuk
issuances since 2014. It has risen out of the suspension of short-term issuances in
Malaysia and the drop in sovereign issuances from GCC countries that have recently
shown a preference for conventional bonds.
The shortage of supply also emanates from the asset based nature of Sukuk. Sukuk
issuers need to have underlying Shariah-compliant assets to structure Sukuk and,
therefore, the size of issuance is somewhat limited, whereas conventional issuers can
access the market more easily.
 Market preference of long-term Sukuk: As a recent survey by Thomson Reuters
suggested that investors and issuers have a stronger preference for long term Sukuk.
The survey suggested that preference is for 3-5 years’ tenor followed by longer 5-10
years’ tenor Sukuk in the market players. The shift to longer tenors for investors
indicates that they are willing to accept the risks associated with longer tenors.
 Legal regimes: Different legal regimes put Sukuk at a disadvantage as compared with
conventional bonds. The issuance of Sukuk often requires the issuing entity to create a
Special Purpose Vehicle (SPV) and transfer the assets underlying the Sukuk to such
SPV. Additional taxes and stamp duties may be incurred as a result. Muslim majority
countries have generally introduced laws to bring Sukuk and bonds at same level, but
more global laws need to be brought in.
Investment exposure to Sukuk offers diversification benefits, as well as generally being an
instrument used for long term holding strategy. This grants an additional layer of insulation
against volatility relative to conventional fixed incomes.
With additional information and enhanced knowledge, investors are becoming more
comfortable with Sukuk investing. There are clear signs that the Sukuk market is maturing and
spurring a growing interest in gaining investment exposure to the asset class. Sukuk
investments and the reversal in the global Sukuk issuances presents diversification benefits for
investors who have until now only invested in the traditional fixed income space. It has the
ability to enlarge the total fixed income investment universe to offering international
diversification with credit quality and Shariah-compliant financial sector exposure.