DUBAI -- Islamic bonds, or sukuk, have long been popular with investors in the Middle East. Now they are being discovered in Europe and the United States. When the Dubai government issued a $500 million, 10-year sovereign Islamic bond, last month, 38 percent of it was snapped up by Western investors, according to research by Standard & Poor's.
"European problems helped fuel demand for alternative products like sukuk in emerging markets, which is why we're seeing a strong wave of interest coming in from Western investors lately," said Mohammed Dawood, managing director of debt capital markets for HSBC's Islamic banking division.
As economies in European and other advanced countries struggle, a growing pool of investors is considering alternative investments in emerging markets. Sukuk are possible vehicles for investing in Gulf Arab countries and some Asian countries.
Islamic principles forbid paying interest, so Islamic bonds are designed to provide investors with profits through other mechanisms like capital gains. Sukuk rules also forbid investing in activities that involve gambling, alcohol, or pork-related industries.
The sukuk market has improved but it still has its problems. The market is thin compared to gigantic western bond markets. Also the standardization of the religious compliance aspects of these securities needs work, analysts say.
"The Gulf's Islamic bond market still needs more depth with private sector issuers and a wider spread of maturities at the sovereign level to support a domestic yield curve," said Khalid Howladar, an Islamic finance analyst at Moody's Investors Service.
Malaysia is the dominant sukuk market, handling 74 percent of the $135 billion Islamic bond issuance in 2012. Still, last year saw more sukuk being issued than conventional bonds in Gulf Cooperation Council countries eager for a larger share of the market.
While Malaysia continues to dominate the sukuk market with 74 percent to new issues last year, 2012 also saw sukuk outpacing conventional bonds in the Gulf Cooperation Council countries -- Saudi Arabia, Kuwait, Bahrain, Oman, Qatar and the United Arab Emirates. They are eager for a larger share of the $135 billion Islamic bond market.
New sukuk from the Middle East and North Africa came to $26.3 billion in 2012, a 34.4 percent jump from the year before, driven by heightened activity in Saudi Arabia, according to research from Kuwait Finance House.
Saudi Arabia alone accounted for $10.5 billion of these instruments -- nearly three times the amount the year before. This included the kingdom's first sovereign sukuk last May, worth 15 billion Saudi Riyals, or about $4 billion.
Large issues by the Dubai government and some of the biggest Saudi companies in the last two months have led analysts to predict that this year could be the busiest for the Gulf region's Islamic bond market since the financial markets crisis in 2008.
HSBC expects Gulf sukuk volumes to hit a record of $35 billion this year, up 33 percent from 2012, in line with the Kuwait Finance House research projecting a 30 percent increase in sukuk issuance worldwide.
The low interest rate environment and global investors' preference for bond markets explains the booming sukuk market, said Paul-Henri Pruvost, a credit analyst at Standard & Poor's.
"The developing global Islamic asset management industry is also creating further demand for sukuk," he added.
Opportunistic countries are taking advantage of investor demand to raise cheap money. Qatar, which likes to enhance the financial power of its natural gas exports with debt, made a $4 billion sale last year. State borrowing accounted for an estimated $115 billion in 2012, about 85 percent of all Islamic bonds.
"What drives sovereign issuances is the same as any business -- if they see an opportunity to get a good amount of money from the market at an attractive rate, they will turn to the market to raise funds," said Ahsan Ali, global head of Standard Chartered Bank's Islamic banking division, based in Dubai.
"Corporate entities will begin to access the market, as well," he added.
Analysts say that the Dubai government's cost of borrowing, judging by its January sukuk yielding about 3.9 percent, has fallen 40 percent from last year.
The Dubai Electricity and Water Authority, is now preparing a $1 billion issue -- its first since October 2012 when it raised $2 billion through the market.
With a low interest rate environment favoring borrowers, analysts say they expect several countries to tap the Islamic bonds market for the first time, as a new avenue of financing for large-scale infrastructure projects, including airports and roads.
These new issuers could include Egypt, Kuwait, Oman and Tunisia, Mr. Dawood, of HSBC, and other analysts said.
"We're seeing that there's a big push to develop capital markets in this part of the world, to increase the investor pool and encourage more issuers," said Mr. Dawood. "Places like Kuwait and Oman opening up the sukuk market contributes to that development.
Saudi Arabia, which was a major issuer of Islamic bonds last year, "is poised to become one of the largest Islamic markets in the world," he added.world
This article originally appeared in The New York Times.