Banking on sukuks in a crisis.

The global financial crisis has taken the wind out of the sails of the equities market. More than that, it has hurt lending badly. But it has breathed fresh air into the bond market - be it Islamic or conventional.

Seizing the opportunity, Abu Dhabi, Dubai and Qatar all have issued billions of dollars worth of conventional bonds in recent months.

Bahrain went a step further and issued a $750 million sovereign sukuk that attracted an order book of about $4 billion with strong demand from the Middle East. (Islamic bonds, or sukuk, are underpinned by physical assets whose returns are used to pay bond-holders, to account for Islam's prohibition of interest.)

Are these isolated instances of Gulf governments trying to increase their liquidity?

They are not. Regional governments are co-coordinating efforts to develop secondary bond trading. In the past creditors tended to hold the few bonds that were issued to maturity. The new government issuance will help develop a yield curve, which will make for more efficient pricing and give corporate issuers a benchmark to price against.

Also, it is a push by the region to further develop their debt markets and shift the pressure of bank lending to fund the mega-projects that have come to characterise the region.

The high-cost and long-term nature of these ventures, which include new economic cities, refineries and airport expansions, requires longer-term financing that has been increasingly difficult to secure as the global recession has tightened credit markets and sapped liquidity.

After the sukuk, Bahrain now hopes that firms will follow the government lead. Aldar, one of the largest Emirati property developers, has reportedly retained advisers to consider issuing bonds.

"One of the major reasons behind this issue was to establish a yield curve benchmark for longer-term Islamic securities," says Sheikh Salman bin Isa Al Khalifa, executive director, banking operations, CBB.

"This is a testament to Bahrain's strong credit and the confidence which international markets place on the kingdom's financial sector," says Sheikh Salman.

The five-year sukuk was priced at the low end of expectations at 340 basis points over US Treasuries. The central bank says the bonds enjoy a solidly investment grade rating of 'A' by ratings agencies Fitch and Standard & Poor's.

"They've quickly realised when they saw the responses coming through they could increase the issue, the only constraint was in terms of assets," says Mohammed Dawood, head of debt capital markets at HSBC Amanah, one of the lead arrangers of the issue.

Some 55 per cent of the issue went to Middle Eastern investors, with Europe accounting for 26 per cent and Asia for 15 per cent of the investor base of almost 200 accounts, Dawood says.

He says there would have been more than enough demand from the Middle East to cover the whole issue.

"Previous issues would be placed internationally and bid up by local investors who received lower allocations. This Bahraini issue is a departure from that strategy to achieve tighter pricing," says Mohieddine Kronfol, managing director at Dubai-based asset management company Algebra Capital.

The strong demand for the sukuk is likely to encourage corporates eager to return to the market which has been lying idle for months after the global liquidity freeze hit the region late last year.

"That should be a promising sign for corporates to trade off their sovereigns for a premium relative to quality of credit," says Nader Al-Salim, a banker at Citigroup's Islamic banking operations.

The London Stock Exchange has welcomed the Bahrain sukuk. This is the first sukuk to be listed in Europe this year and highlights London's standing as a key global venue for Islamic finance.

What next? Kuwait and Saudi Arabia would be next in line to issue sukuks. Saudi Electricity plans to issue sukuk that could be worth about 5 billion riyals ($1.33 billion). Saudi Arabia also launched its new market for both conventional bonds and sukuk to offer firms new sources of funding amid tight credit conditions.

But, despite all the euphoria the fact remains that sukuks are more often illiquid.

According to a 2007 study by economists from the International Monetary Fund, sukuk have delivered lower returns to investors than conventional bonds and are more often illiquid, meaning they are hard to buy and sell in the secondary market.

It remains to the issuing governments to coordinate their efforts to develop a robust secondary market for sukuks so that bond-holders are not pushed to a corner because of illiquidity.

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