UK Completes its Sukuk – a Statement of Intent

Euromoney, July 2014

The UK sovereign has completed its first sukuk, with considerably more fanfare than scale: the deal raised just £200 million of five-year funds. But the modest scale was intentional – the total orders topped £2.3 billion – and the issue was much more about a statement of intent than any need for funds.

So what did we learn from the sukuk? Most obviously, that paper from a non-Islamic sovereign can attract considerable demand, though that was not really in doubt. Despite carrying a profit rate (like a yield) of just 2.036%, identical to the equivalent yield for gilts of the same maturity, it was more than 11 times oversubscribed.

HM Treasury declines to state the precise distribution, but it appears to have met targets of diversity in both geography and investor type. Robert Stheeman, chief executive of the UK’s Debt Management Office, tells Euromoney the Treasury “wanted to ensure a diversified spread of investors, and we achieved this.” He says there was a “broad distribution” of sales across the UK, the Middle East and Asia, and that private banks, central banks, official institutions and fund managers were represented. It is understood that sovereign wealth funds were among the buyers.

One person close to the deal says that UK Islamic banks received around a third of total allocation, which is likely to be out of step with the proportion of the order book they represented, and this brings us to one of the sub-plots of the landmark sukuk: the role of Britain’s home-grown Islamic finance institutions.

When HM Treasury announced on June 12 that the joint lead managers, alongside structuring advisor HSBC, would be Qatar’s Barwa Bank, Malaysia’s CIMB, Standard Chartered and the National Bank of Abu Dhabi, there was deep disappointment among Britain’s Islamic banks, who had hoped for a role. “Naturally we are disappointed that no UK Islamic bank has been selected as an arranger as this would be a further opportunity to champion the UK Islamic finance market,” Humphrey Percy, CEO of the Bank of London and the Middle East, said shortly before the deal priced. Nevertheless, he pledged to support it, though he declined to tell Euromoney how much the bank was eventually allocated. “BLME will be participating in the issue on behalf of our clients and for our own liquidity management purposes.”

That makes sense, because the UK’s banks have surely grasped that the significance of this deal is what might follow it, and in that respect, further opportunities should arise for them. “It is hoped that the successful issuance of a UK government sukuk will demonstrate to large UK corporates that sukuk is a viable and competitive method of fund-raising, and directly comparable in pricing terms to the conventional bond market,” Percy says.

He makes an important point here: a close level of pricing to conventional funding was vital if this is to be an attractive benchmark, and it is perhaps for this reason, and also with a sense of good marketing, that a hefty roadshow was assembled for such a small deal, covering Asia, the Middle East and London. When the order book opened on June 25, indicative price guidance was a spread of 0 to 2 basis points above the reference gilt, and by 10.30am that guidance had been tightened to flat to gilts (that is, zero basis points). Incidentally, don’t expect much discussion of the aftermarket performance, for this is an issue that is hardly going to trade at all. “Due to the size of this issue and the demand, most investors will buy and hold their allocation,” Percy says. “It is unlikely there will be much liquidity in the secondary market.”

For his part, Stheeman defends the choice of leads and feels the success of the deal shows the right approach was taken. “HM Treasury took the decisions on the basis of clear and explicit criteria, with a specific focus on the strategic fit and complementarity of the team, intended to maximise the investor reach of the transaction,” he says. “The diversity of the distribution across the UK, Middle East and Asia vindicated this approach.”

Stheeman says the deal “sends a clear message that the UK is committed to becoming the western hub of Islamic finance, and we look to this pioneering move by the government to encourage new private sector issuers to follow in our wake.” And this is the point: it’s the following wind that is truly essential, and the reason the UK found it important to be the first non-Islamic sovereign to issue. Luxembourg will likely be next.

There was no technical ingenuity here: an ijara structure, the most common for sovereign sukuk, underpinned by three central government properties. And that’s appropriate, for this was not a moment to try to be structurally clever, but instead to point out that the UK cares about this market at all. Now, the fun part: seeing if anyone follows the sovereign. Because this is a deal that should be judged not by its own success in pricing or distribution, but by the catalytic force it demonstrates among other issuers.