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New S&P criteria draw line between sukuk issuers, sponsors

[KUALA LUMPUR] Credit rating agency Standard & Poor's said it had updated its criteria for Islamic bonds to distinguish more clearly between issuers of sukuk and sponsors of them.

Sukuk tend to be more complex than conventional bonds because they use structures designed to avoid interest payments. They often involve special-purpose vehicles (SPVs) which issue the paper and lend the proceeds on to the ultimate entity raising money, which is known as the sponsor.

S&P's new criteria describe the conditions under which it would rate sukuk at the same level as the sponsor's rating. For example, sukuk will be rated on a par with the sponsor's senior unsecured rating if they provide contractual commitments by the sponsor to make payments that ultimately cover periodic distribution and principal amounts.

The agency said it did not expect the new criteria to lead to upgrades or downgrades of the sukuk which it rates, but it might withdraw a rating if terms and conditions did not meet the criteria. It estimated this might happen for fewer than 5 per cent of rated sukuk.

Sukuk defaults are rare, but the revised criteria could help address market uncertainty about the contractual obligations of the various parties. Such uncertainty can affect sukuk pricings, particularly for issuers with ratings below investment grade.

For situations in which a sponsor is performing on its own obligations while sukuk payments by an SPV are not full or timely, S&P said such temporary deferrals would not be classified as defaults as long as the agency expected payment within one year.

S&P predicted global sukuk issuance would exceed $100 billion this year, after reaching US$116.4 billion in 2014 and US$111.3 billion in 2013, supported by still-positive economic outlooks in the Gulf region and Malaysia.

The market will benefit from new sovereign issuers and the implementation of Basel III global banking standards, which are encouraging banks to boost their capital, S&P said. But it warned that episodes of turbulence could cause issuance volumes to fall this year. "The first will likely come from the current trend in oil prices, which have dropped precipitously over the past few months," the agency said in a research note. "The second episode of turbulence may come from the expected increase in US Fed interest rates, which is likely to reduce global liquidity."