A report from Standard & Poor’s highlights an interesting development in sukuk markets in West Africa, in a report with several other interesting points. Towards the end of the report, it highlights that the Central Bank of West African States (BCEAO) is allowing Senegal’s sukuk to be used in repo transactions with the regional central bank. This isn’t a surprising policy, as sukuk are designed to pass along the credit risk of the issuer (in this case, the Government of Senegal), and the decision helps to equalize the treatment of the sukuk with regional government’s conventional bonds.
By encouraging banks to buy the sukuk, it helps offset any liquidity disadvantage that the banks would face if they invested in sukuk instead of conventional bonds. As alluded to, the move is designed to encourage conventional banks to invest in sukuk (there is not a widely used Islamic repo product and most WAEMU countries do not yet have Islamic banks). By encouraging the conventional banks to support sukuk primary market issuance (by giving assurance of liquidity) as well as to support the development of more robust pricing data by (ensuring that the sukuk can be a source of liquidity if needed), it will enhance the pricing benchmark for sukuk.
This is necessary down the road to support corporate issuance as well as to move out on the yield curve (for longer-dated project sukuk to fund infrastructure) but initially it will be most important for subsequent sukuk pricing. The hit against sukuk for countries that don’t need to issue to support a domestic banking system (and even in these cases) is that they can be more expensive than conventional bonds. For lower-income countries, every dollar of issuance costs is important. But so is diversifying access to finance for whatever future market conditions may bring. For sukuk, this means enough issuance, with enough liquidity, to narrow the sukuk premium rapidly.