UK Issued Shariah-Compliant Bond, Others to Follow

In late June, as many participants and the media focused on the fallout from UK Prime Minister Cameron's defeat in trying to objections to Juncker's nomination for EC President, the UK became the first western country to issue a bond structured in way that was compliant with Islamic law (shariah).  

The bond was five year in duration.  The size of the issue was small at GBP200 mln.  Demand was strong.  It was over-subscribed 11-fold.  

Under shariah law, as it is presently being interpreted, interest cannot be paid or received.  The UK bond is structured in a way that investors earn an earnings stream that emanates from the government's rental income from three properties.  This particular structure is called an "ijara".  The profit rate corresponds to the yield of the government's 5-year gilt at the time of the bond sale (2.036%).  

Reports suggest that UK investors picked up a third of the issue, while Middle East and Asian accounts bought the remainder.  There are six Islamic banks in the UK.  According to Dealogic, since 2013 there have only been 4 triple A sukuk (shariah compliant financial instruments).  There were by the Islamic Development Bank in Saudi Arabia and the fourth being Malaysia's public sector. 

Other countries, including South Africa, Hong Kong and Luxembourg are reportedly considering issuing shariah-compliant instruments.  While the UK issuance was driven by its desire to continue being a key financial center, which also drives its interest in being an offshore center for yuan, others may simply seek to diversify its investor base.  

Nearly eight years ago, I recommended that the US Treasury consider issuing a bond structured in a way that would appeal to shariah compliant investors.    I submitted it first to the Wall Street Journal, which rejected it before you could say "using market mechanisms to achieve political and economic goals".  Fortunately, the Financial Times thought it was a sufficiently interesting proposal that they publish it here.