Urgent Need for Developing Sukuk Market in China

by Wilson Yeung - Partner, WMD Advisory  

Recently, raising funds through Sukuk in Malaysia has been gaining attraction among Chinese enterprises. During the last two weeks of July 2017, Chinese enterprises are seen raising funds through Sukuk in Malaysia, which has positioned itself as Islamic funds hub.

China-owned Edra Power Holdings' solar energy unit Tadau Energy announced it had issued up to RM250M (USD58M) Sustainable Responsible Investment Sukuk, the first green Sukuk issued in Malaysia.

Two weeks prior to the above issuance, Chinese Beijing Enterprises Water Group's subsidiary BEWG Malaysia made its debut in the Malaysian Sukuk market by issuing RM400M (USD93M) Islamic medium term notes, the first-ever ringgit denominated Sukuk on water infrastructure by a Chinese State-owned enterprise.

Back to Dec, 2015, Chinese property developer Country Garden has become the first mainland corporate issuer of Sukuk, opted to issue them in Malaysia rather than in Hong Kong, where it is listed, whereby raising fund of RM1.5B (USD350M) based on Shariah principle of Murabahah.

Taking the above together, it is obvious that there is an urgent need for China to develop its Sukuk market rather than letting its own enterprises to issue Sukuk in other jurisdictions, which may not be the best interest of Chinese government and Chinese enterprises in the long run.  In this article, the underlying reasons and suggestions on developing Sukuk market in China will be provided.

The urgent need of developing Sukuk in China

1. Meeting the need of raising funds for real economy in China

To expedite the process of urbanization in China, the local municipals need significant amount of funds for establishing their infrastructures and public goods.  Sukuk normally bases on properties or infrastructure facilities as collaterals, particularly it is widely adopted in the infrastructure projects in the Mid-West region of China such as Ningxia and Xinjiang, etc.  Sukuk can be able to act as the new fund raising channel and tool for the local infrastructure project constructions.

2. Satisfying the need of raising funds for SMEs in China

Nowadays in China, the issuance of debt is usually based on the guarantee of the issuers in accordance with their credibility’s and assets, which makes SMEs difficult to raise fund by issuing debt as they normally couldn't reach the issuance benchmark requirements.  In China, the fund raising issue of SMEs has not been solved for long years.  Unlike conventional bond, Sukuk focuses on the reliability and profitability of the project assets.  It usually not very focuses on the credibility of the issuer itself.  As such, if SMEs is going to issue Sukuk, they can use the beneficial ownership of the project as collateral, such that it lets the investors to share the responsibility of operations together, thereby attracting them to get themselves more involved.  To this end, it is believed that the issuance of Sukuk can be able to solve the problem of raising funds by the SMEs in China.

3. Providing new investment channels for investors in China

In China, conventional bonds are usually issued in inter-bank market, its volume of issue and transaction occupies over 90% of the entire debt market.  Besides, the types of bonds in China are very limited and imbalanced,  there is always an urgent need to flourish the types of bonds, thereby providing investors, especially small to medium sized investors, more comprehensive and suitable investment channels.  Sukuk focuses on infrastructure project investments, normally associated with less fluctuation and risks, and the relatively safe and stable profit growth given Shariah compliant investments, it is favorable for offering a new channel for investors in China.

4. Catalysing “One Belt One Road” and Internationalization of RMB

By carrying out “One Belt One Road” initiatives and developing Sukuk market in China, it is believed that the internationalization of RMB as well as regional collaborations can be largely enhanced.  The majority of the participating countries of “One Belt One Road” are Muslim countries, and by looking at the capital market development of these countries in recent years, Sukuk has played a critical role and strengthened their economic development.  First, the implementation of “One Belt One Road” initiatives cannot be done without the operation of capital markets, and by developing Sukuk, it will act as the impetus for boosting the capital market in China.  Second, “One Belt One Road” infrastructure projects, as long as they are Shariah compliant, can issue Sukuk for project financing purpose, which can further strengthen the financial feasibility of the projects. Further, China can also make the best use of this golden opportunity to develop its RMB clearing operation in OIC countries, thereby gradually getting rid of the influence and pressure on Chinese economy given by USD and Euro.

Suggestions on developing Sukuk in China 

Currently, China hasn't developed Sukuk market yet, and therefore the issuance of Sukuk, including its legislations or technical operations, etc., are needed to develop gradually.

1. Opening up policies and rules, using free trade zones to conduct pilot scheme

In 2013, Hong Kong has already amended its profits tax and stamp duty rules in order to transform itself as an Islamic finance centre that can be able to providing a level-playing field for conventional bonds and Sukuk issuances.  In China, similar things should be done in view to do the best of its preparatory work in terms of regulatory and legal framework for future Sukuk issuances.  For regulatory purpose, Islamic contracts that possess risk sharing nature should be included under the regulatory framework of China's SEC. Moreover, China can also make reference with BASEL III and AAOIFI in order to ensure the relevant standards are in place, thereby bringing effective regulatory mechanism and smooth operations.  Meanwhile, China can also carry out its pilot scheme using Qianhai or Pudong free trade zone in order to test its cross-border bond transaction platform, especially formulating some systematic solutions to cater for those “One Belt One Road” enterprises and projects.  Last but not the least, China should also eager in promoting and educating investors regarding Islamic finance and Sukuk as well as their investment procedures and associated risk.

2. Standardizing the treatment of Sukuk issuance

Sukuk normally bases on the beneficial ownership of the projects as collateral.  However, there are vast differences between projects, and thus disadvantageous for standardization,  and the majority of Sukuk are usually suitable for OTC.  On the other hand, small to medium sized investors often find themselves difficult in participating in OTC.  To solve this problem, China can learn from Malaysia's first retail bond ETBS and explore deeply on how China can proceed with cross-border Sukuk transactions.  The main points in developing Sukuk are:- i) the guarantee of the bond, probably governmental guarantee is the optimal option at the initial stage, and at the same time, needs to clearly explain the usage of the funds, in order to ensure the completeness, timeliness and accuracy of the disclosures; ii) the standardization of Sukuk issuance should always have the objective to provide convenience to investors, in particular, small to medium sized investors, in view to attract investors from a wider scope.

The author is partner at WMD Advisory, based in Hong Kong.