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The “conventional wisdom” of indicative sukuk pricing

The “conventional wisdom” of indicative sukuk pricing

By Mohammed KHNIFER | February 10, 2020

One of the most known misconception among prospective issuers (in the emerging & frontier markets) that sukuk pricing differs from bonds. Well, it is not! Debt Capital Market Bankers use the same conventional wisdom for pricing of bonds. Knowing the indicative pricing is the most decisive factor for reluctant issuers who weigh the other option of using loans or bonds. 

Know-how

Depending on the initial term length (tenor), a relative benchmark would be used for the Sukuk pricing. The size of the spread is denominated in basis points (bps) and it varies according to the risk of the borrower. The relative value of indicative pricing is driven by the following:

  • The issuer’s own Sukuk/bonds outstanding
  • The issuer’s credit default swaps
  • Peer group analysis

If there is a lack of benchmark for a sovereign in terms of its own bonds, peer bonds could be used as a proxy to arrive at final pricing. Remember that “pricing is an art”. Hence, there could be other methodologies that will deliver almost the same results for the indicative pricing. 

In certain trades, there will be marginal/no difference in pricing between a Sukuk and a conventional bond for the issuer

Distribution and the demand

By capitalizing on demand / supply gap, cost of funding can be lowered for the issuer. Sukuk supply/demand imbalance may offset new-issue premium. Sukuk attracts both conventional & Non Interest demand across different investor classes. Some 50% of the sovereign Sukuk issues are subscribed by conventional bond investors. The addition of Islamic investors in the funding pool will create price tension between these two distinct investor types leading to better price discovery. All investor classes (Islamic, regional & international) are important to create price tension.

Ratings

Credit Rating Agencies assess the relative credit risk of debt securities, borrowing entities (issuers of debt), and the creditworthiness of governments and their securities. Obtaining such rating will facilitates the marketability of the sukuk. From a credit perspective, Sukuk represent the same credit risk as that of the underlying obligor (“borrower”)


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