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A unit of the Jeddah-based Islamic Development Bank, a multilateral lending institution, has launched an insurance product designed to boost the credit ratings of sukuk (Islamic bonds) for sovereign issuers.
The Islamic Corporation for the Insurance of Investment & Export Credit (ICIEC), rated Aa3 by Moody's, hopes its insurance policy can help issuers tap into strong investor demand for investment-grade sukuk.
"Ideally the sukuk will have the rating of ICIEC - it is designed to enhance the rating of the issuer/obligor and then have a pricing and placement impact," Bessem Soua, head of structured finance business at ICIEC, told Reuters.
ICIEC declined to name specific countries with which it would work but it will approach those that have shown an interest in issuing sukuk in the past. Established in 1994, ICIEC has 40 member countries, including 13 in Africa and eight in Asia.
"The focus will be more on those that have signalled plans to issue sukuk - we will work with those countries that have already prepared the groundwork," Soua said.
ICIEC will test the insurance product during a two-year pilot period, initially focusing on ijara sukuk, where one party leases equipment, buildings or other facilities to a client for an agreed rental price.
"We are targeting ijara sukuk at the outset. After the pilot phase we will assess our experience and market response, and then we will determine which other types of sukuk can be covered by ICIEC."
The expectation is that ICIEC could insure $300 million in the first year and $600 million in the year after, although the figures are not binding, said Soua. "For larger issuance, we would seek reinsurance or insuring a tranche of the issue."
The policy offers ICIEC member countries a risk management tool based on the risk-sharing concept of takaful (Islamic insurance), an approach that could serve as a model for other risk management products in the industry.
Governments would buy the product in order to enhance their credit profiles; they would contribute to a common pool of funds that would be used to indemnify investors in their sukuk in cases of default.
Soua said the product was fundamentally different from credit default swaps (CDS), which are commonly used in conventional finance; in those, investors pay a premium to buy cover against default risk, and the instruments can be traded.
"CDS is a credit derivative contract based on speculation. It is not sharia compliant," he said. "Credit insurance provides an indemnity against the losses actually suffered by the policy holder on an underlying asset. By contrast a CDS provides an equal payout to all holders."
Although takaful is well-established in life and general insurance, the Islamic finance industry has rarely used the concept to manage other financial risks, instead favouring synthetic tools such as Islamic swaps and options.
The maximum tenor for the ICIEC insurance is 15 years; in exceptional cases the cover could be extended to 20 years. ICIEC would insure up to 95 percent of the risk of a sukuk, with pricing determined on a case-by-case basis, Soua said.
"We are currently developing the pricing mechanism for sukuk insurance which would depend on different things including the issuers, tenors, size, etc.," he added.
"In terms of pricing, we are trying to make it attractive for both investors and issuers and also in line with insurance industry practice."