Recommended Best Practices for Issuance of Gulf Cooperation Council Local Currency Government Bonds and Sukuk

A number of GCC governments directly issue conventional and Sharia-compliant securities and others are considering doing so. Issuance may be undertaken for reasons that include satisfying fiscal requirements, managing banking system liquidity and developing domestic financial markets. If issuance programs are carefully designed and implemented they can result in creation of risk free yield curves that are crucial for the pricing of risk over time thereby contributing invaluably to the deepening of financial markets.

While there is no one-size-fits all strategy for local government debt markets that can be implemented concurrently in all GCC states, adoption of certain key practices can help the states achieve their objectives. GCMA supports the implementation of consistent practices across the GCC markets wherever practicable. Consistent regional practice will lead to lower cost and greater market efficiency in individual markets. GCMA is prepared to assist national authorities in implementation of markets including through additional detailed guidance.

Therefore, GCMA respectfully submits these recommended best practices.

Establish clear legal and regulatory framework

An overall legal framework should provide explicit and well-defined authority to borrow regularly and within limits; commit the government to meeting its payment obligations; establish the instruments and processes for their issuance; govern the rights and responsibilities of those that purchase and trade in government securities; disclosure and transparency over the terms of the instruments; and include appropriate regulation of market participants. For states issuing Sharia compliant instruments, such framework should provide definitions and authorizations to enable regular issuance of sukuk, including provisions dealing with special purpose vehicles, use of state assets for transaction purpose and exemptions from tax and stamp duty for the transfer and substitution of such assets.

Professional Debt Management Function

GCMA recommends the creation of professionally staffed debt management offices responsible for developing debt management policies, creating borrowing strategies, designing the framework of the government debt market and managing risk. Debt managers should work closely with concerned official bodies such as central banks and obtain input from market participants and service providers. The initial placement of such debt management function may depend on the readiness of institutions, but is generally recommended to be within the fiscal authority, i.e. ministry of finance.

Provide access to a range of investor types

Local banks need government issued instruments to help manage their liquidity as well as for compliance with regulatory norms, namely Basel III. However, as governments should avoid crowding out lending to the private sector, it is important also to diversify. Consideration should be given to allowing participation by international institutional investors. These investors can bolster demand and enliven the secondary market, thus preventing the “one way traffic” characteristic of markets where banks are the predominant holders. GCMA recommends that local non-bank institutions such as pension funds have direct or indirect access to government instruments. Participation by individual investors should be considered for markets that have achieved some depth.

Issue Standard Instruments

Instruments should be standardized and simple making them easy to value, pledge, buy and sell. Governments issuing Sukuk are recommended to have standing authority to issue a range of Sukuk structures in order to reflect availability of underlying assets. Sukuk should be issued with defined underlying assets so that their trading can be deemed permissible by Sharia’ scholars.

Market Pricing

It is vital that securities are issued through a market-oriented price discovery process. We recommend that the primary means of allocation be use of competitively bid auctions open directly to banks and through them, to a wider universe of investors. Auctions should be conducted according to published term sheets and standardized conditions of issuance.

Safekeeping

Government instruments should be safe-held by a central bank, local central securities depository (“CSD”), if one exists, or on an international CSD accessible to local banks. The depository should handle both the cash and securities legs of transactions and should be capable of Delivery versus Payment (“DvP”), meaning that the payment and transfer of ownership of the securities should be simultaneous and irrevocable.

Listing on an Exchange

Government instruments do not necessarily need to be listed on an exchange. Issuers may choose to benefit from exchange rules to provide added confidence or to help diversify the investor base.

Consistent Issuance Policy

Issuers are recommended to develop and communicate issuance calendars, with regular issues of bonds and Sukuk of varying maturities and of sufficient size. Issuance plans can change during the course of the calendar period. Such changes should be communicated as early as practicable.

Phased Approach

For new issuers, we recommend that issuance programs be implemented beginning with shorter-term bills and notes and with gradual extension to medium (3, 5 and 10-year) and then longer maturities. With a market-based process firmly established, banks and other investors can absorb longer tenors more successfully.

Secondary Market

It is recommended that wholesale market participants should be allowed to choose how they execute trades. Options can include bilateral transactions performed over-the counter (“OTC”), (including through inter-dealer brokers) or through an exchange or an approved electronic platform.

Dealer Systems

Based on local circumstances, authorities should consider establishing frameworks that provide privileges to institutions that meet eligibility criteria and commit to participate regularly in the primary market as well to quote firm “bid” and “ask” prices to other such institutions. (“market making”).