The launch of Europe’s first sukuk ETF by HSBC Asset Management earlier this month highlights the growing demand for Shariah-compliant investing, however, what is a sukuk and where is the demand coming from?
Often referred to as an ‘Islamic bond’, sukuk were first issued in the early 2000s to circumvent the interest-paying bond structure which is prohibited under Shariah law.
Like bonds, sukuk provides investors with regular income, unlike bonds, this income is derived from the profit of the underlying asset instead of the interest rate linked to the bond.
Sukuk are often used by Islamic corporations and sovereigns to raise capital without issuing an interest-bearing product such as bonds.
They require issuers to sell a ‘trust certificate’ to investors and use the proceeds to purchase an asset linked to a specific investment activity.
To do this, an issuer will be required to set up a special purpose vehicle in an offshore jurisdiction, which will then issue the certificate to investors. The funds will then be invested via a funding agreement with the issuer.
The issuer will be contractually obliged to buy the bond back on a set future date at market value.
Olga de Tapia, global head of ETF and indexing sales at HSBC AM, said the reason behind its launch was to give faith-based investors an option to invest in a market where fixed income is once again looking attractive and to provide them with better access to the market on the same terms as conventional investors.
“There is nothing on the passive side [in Europe] that replicates a sukuk market and for the last year we have been launching many Islamic ETF building blocks for investors,” she said.
Demand has been rising steadily for sukuk in recent years with global issuance topping $765.3bn in 2022, 7.6% higher than the previous year, according to Fitch Ratings.
Despite this, de Tapia said it was primarily UK investor demand that drove it to launch HBKU.
“It became apparent over the past three years that the UK market started to be really relevant [for Shariah investing], with assets growing significantly,” de Tapia said.
“The UK has the most assets and investment products in Europe and in addition, there has been a rise in Islamic fintech providers such as Wahed.”
Alongside robo-advisers such as Wahed, which HSBC AM has a distribution partnership with, de Tapia said pension funds have been the key driver of growth over the past three years.
“Pension funds in the UK are starting to offer the Shariah defaults within their self-select schemes to meet inclusion and diversity criteria, which is why we are seeing investment in the area.”
She added the firm’s Islamic index equity fund, which has been around for over two decades, has gathered the majority of its $2.6bn assets under management in the past three years.
In the past investors have questioned the liquidity of sukuk, which Tapia said is improving every year with more issuers coming to market.
“Previously, issuances have been short-dated but we are seeing more sukuk which are longer dated and larger in size,” she said.
“It is a market that is growing and we expect more countries to issue and more [fund] vehicles to launch, meaning liquidity will improve.”
Listing on the London Stock Exchange with a total expense ratio (TER) of 0.70%, the HSBC Global Sukuk UCITS ETF (HBKU) is an ETF share class of an existing index fund that launched in January.
Tracking the FTSE IdealRatings Investment Grade index, it offers exposure to 64 sukuk – often referred to as ‘Islamic bonds’ – across sovereigns and investment grade corporates globally.
Countries eligible for inclusion in the index but be at least BBB-rated and include Saudia Arabia, United Arab Emirates, Indonesia, Malaysia and Qatar.
“There are other countries that issue sukuk but they are not investment grade,” de Tapia added.
The index incorporates over 150 Shariah standards and is subject to oversight by a team of scholars to ensure they are Shariah-compliant. It will also look to meet the standards of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI).
De Tapia said: “We like the approach taken by FTSE IdealRatings, which is quite strict in terms of screening sukuk issuers in and out to ensure they are aligned to our Shariah philosophy.”