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Luxembourg bond plan to test Islamic finance depth

sukuk structureLuxembourg is poised to test demand for Islamic bonds as the issuer of the lowest-yielding sovereign sukuk on record plans to become a regular borrower.

The country has been “encouraged” by investor feedback and the market’s readiness and will begin working on its next sukuk today, Finance Minister Pierre Gramegna said. Luxembourg, one of the smallest economies in the 28-member European Union, sold 200 million euros ($254 million) of five-year Islamic bonds in September priced two basis points below midswaps. That compared with 10 basis points above the swaps for notes of similarly rated Islamic Development Bank.

The market for bonds that adhere to Islam’s ban on interest is growing 17 percent a year and may be valued at $2.67 trillion by 2017, according to PricewaterhouseCoopers LLP. The U.K.’s debut sovereign Islamic bond issue — the first from a non-Muslim nation — received orders worth more than 10 times the amount it sought, while Luxembourg’s sukuk was two times oversubscribed. South Africa got at least $2.2 billion in demand for a $500 million issue, and Hong Kong’s $1 billion debut sukuk was almost five times oversubscribed.

“Luxembourg’s sukuk isn’t for everyone, least of all those looking for yields,” Apostolos Bantis, a credit analyst at Commerzbank AG, said by phone from Dubai yesterday. “The reason why it’s so tight is because there are still Islamic investors that are looking for very conservative assets.”

Luxembourg’s sukuk yielded 0.47 percent yesterday compared with 1.5 percent for the U.K. notes, 1.8 percent for Hong Kong’s and 3.8 percent for South Africa’s. Islamic bond sales this year are 13 percent higher than in the same period of 2013, data compiled by Bloomberg show.

“We’re still in an initial phase,” Gramegna said in an interview in Dubai yesterday, adding that he doesn’t anticipate a ceiling to investor appetite for sovereign sukuk. “I don’t feel a limit for the time being.”

Luxembourg is rated AAA at Moody’s Investors Service and Standard & Poor’s, the highest investment-grade ranking. With a population of just over half a million landlocked between Germany and France, the country has reinvented itself as a business and finance hub, softening the blow as traditional industries decline.

The country’s economic growth will accelerate to 2.9 percent this year from 2 percent in 2013, according to government forecasts. Still, given the low yield, the Luxembourg sukuk doesn’t offer a lot of value to long-term investors, according to Al Mal Capital PSC.

“We look for long-term investments, so the pricing is really important to us,” Tariq Qaqish, the head of asset management at Dubai-based Al Mal, said by phone from Dubai yesterday. “A sukuk like Luxembourg’s, which is priced so tightly, is more attractive to traders who want to gain a few basis points here and there.”-Bloomberg