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It has been reported that Hong Kong's bill to facilitate the issuance of sukuk, or Islamic bonds, is expected to be ready early next year but initially at least, it may attract little interest among issuers.

In March, the government asked for industry feedback on the subject and this month, it said it aimed to introduce a bill in early 2013.

A draft bill could take three months to prepare and then be passed quickly into law provided there is no controversy, said Marcellus Wong, co-chairman of the taxation policy committee at the Taxation Institute of Hong Kong, an association of tax professionals.

But the appetite from local firms to tap the sukuk market does not appear to be as strong as it was when the idea of issuing sukuk in Hong Kong was first considered seriously.

"It is good to have the framework in place but market interest has gone. The consultation was expected a few years back; the market is not that buoyant now," Wong said. "It is already a few years late."

Previously, arrangers hoped that the main issuers of sukuk in Hong Kong would be mainland Chinese companies seeking to tap large pools of Islamic funds from southeast Asia and the Gulf.

Hong Kong's market for yuan bonds has been growing rapidly; last year it saw over 100 billion yuan ($16 billion) of issuance from 81 issuers, three times the volume of 2010, according to the Hong Kong Monetary Authority.

But recent trends within the market have not been favourable for yuan sukuk, analysts said. For one thing, the yuan stopped appreciating against the U.S. dollar in the first eight months of this year and although appreciation has resumed in the last few weeks, the market now sees greater risk of two-way movements in the Chinese currency.

This has reduced the potential appeal of yuan-denominated sukuk to investors, making any deals more expensive for issuers, the analysts said.

"Issuing sukuk is not a priority for Chinese corporates at this moment," said Ivan Chung, vice president and senior credit officer at Moody's Investors Service in Hong Kong.

"Last year, it was almost purely a currency play with lots of short-tenor, small-amount, low-yield bonds. While the change in market dynamics has prompted currency-play investors to leave the market, issuers will be more inclined to launch longer-tenor bond with larger amounts, and thus more eager to attract a larger scope of investors.

"Sukuk is more appealing to a niche investor base, which they (issuers) will likely consider after establishing the larger international institutional investor base."

For potential Hong Kong issuers of sukuk, the territory's real estate sector would probably be the main source of assets to back the Islamic bonds.

But returns on such assets have declined, making sukuk based on them less attractive. In September, monthly investment yields in Hong Kong's real estate market reached their lowest levels since data began in 1999, according to data from the government's Rating and Valuation Department.


Davide Barzilai, banking partner and Asia Pacific head of Islamic Finance at Norton Rose in Hong Kong, said of expected sukuk issuance in the territory: "I think it will only be a small number - this is never going to be a major market."

A first-mover will be needed to show how the laws work in practice, before most companies consider an issue, Barzilai noted. "It will have to stand the test from a real deal."

The idea of a Hong Kong sukuk has been raised as far back as 2008, when the territory's Airport Authority considered selling an Islamic bond of up to $1 billion, but that issue has not materialised.

"We have no further updates on both our financing plan and on the subject of sukuk financing," a spokesperson for the authority told Reuters.

The most important aspect of Hong Kong's sukuk bill will be to clarify the tax status of sukuk. Islamic bonds can face heavy taxation because they involve multiple transfers of the assets backing them; bankers hope the bill will remove this obstacle.

Amirali Nasir, chairman of the Islamic finance working group at the Hong Kong Law Association, said he expected the law to be passed within 2013.

He noted that the government had accepted the industry's recommendation to add the wakala (agency) sukuk structure to four other types of sukuk covered by the bill, in order to broaden issuers' options.

By the time the law is passed, however, many issuers and investors may have become used to issuing in other markets than Hong Kong - particularly Malaysia.

In October, Hong Kong-headquartered Noble Group, a global trader and supply-chain manager, opted to issue a three-year, 300 million ringgit wakala sukuk in Malaysia.

In September, Malaysia's mobile phone operator Axiata Group issued a two-year, 1 billion yuan sukuk, listed on the Malaysian and Singapore stock exchanges. Last year, Malaysia's sovereign wealth fund Khazanah issued a three-year, 500 million yuan sukuk, listed on the Malaysian and Labuan exchanges.

Most interest in issuing yuan sukuk does not now come from Hong Kong or Chinese companies, but from Malaysian companies, said Hassan Ali Shah, special assistant to the chairman at Okasan International (Asia), a Hong Kong-based brokerage.

In April, Hong Kong signed a tax treaty with Malaysia clarifying investors' tax liabilities, which has made it easier for Hong Kong investors to buy sukuk issued in Malaysia.

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