As demand for Islamic project financing grows, concerns remain over whether Islamic banks have the necessary capital bases to fund larger projects
Globally, Islamic banking assets are said to be growing twice as fast as conventional banking assets and are expected to reach US$1.1 trillion (Dhs 4.04 trillion) in 2012, up over 30% from 2010. Despite continuing tensions across the Middle East and North Africa, key regions for this niche industry, Islamic finance continues to make headlines.
One area of particular significance is the project finance market, where the Middle East region has seen strong levels of activity over the last three years as regional economies emerge from the shadows of the global credit crunch. Saudi Arabia continues to dominate, but significant re-building and new infrastructure demands across the North African countries as they emerge from the Arab Spring will undoubtedly attract the further deployment of Islamic funds.
Although the demand for Islamic project financing continues to grow, there does remain some concern over whether Islamic banks have the necessary capital bases to fund the requirements of the larger projects on their own. Indeed, the trend seems to be for Islamic tranches to be integrated within a much wider ‘multi-sourced’ financing arrangement where the competing demands of conventional banks, export credit agencies and/or multilaterals also come into play.
This inevitably gives rise to some interesting discussions around inter-creditor arrangements which aim to ensure that all of the funders come into the deal on an equal footing – on a pari passu and pro rata basis.
Also – because one of the key goals of project finance is to transfer risk to the parties who can manage it best – insurance coverage and financial derivative products are often relied upon quite heavily to mitigate certain key risks that are inherent within a project.
This means that there are certain aspects to a typical project finance deal which may present compliance issues for an Islamic investor and the scholars who are asked to approve such investment structures. This is particularly evident amongst some of the more conservative Islamic banks, who will now look for Takaful and other Islamic product solutions as the ‘first choice’ to cover-off these kind of risks wherever possible.
However, the record shows – particularly in Saudi Arabia – that all of these concerns can be overcome. It is expected that the proportion of project financings which include an Islamic tranche will continue to grow. Furthermore, recent trends suggest that the number of project financings which have multiple Islamic tranches to them – including of particular note, project sukuk – will also increase.
This blending of Islamic finance with other sources of financing offers a genuine means of deepening the capital pool that would otherwise be available to these kind of projects.
Whilst the use of sukuk in project financings has been fairly limited to-date, it is expected that an increasing number of projects will look to raise capital, in whole or in part, through the global debt capital markets in the form of a sukuk issuance. The Satorp refinery sukuk and the forthcoming Sadara petrochems sukuk go to show that there is appetite amongst investors for these kind of instruments and that the use of a sukuk structure can be modelled into a multi-sourced project financing structure.
Growing international demand for sukuk, coupled with an investor base which – in comparison to banks – is much less restricted in both number and limits on the amounts which can be invested, make the use of sukuk an ideal alternative to bank debt. It is easy to see why project financing has looked to move in this direction.
The future for Islamic finance looks very promising. With the backdrop of the continuing Eurozone crisis, as well as the demand for rebuilding the North African economies following on from the Arab Spring, Islamic finance – particularly Islamic project finance – looks set to play a key role and will hopefully continue on its impressive growth trajectory for a number of years to come.