View from practice: Stock market reaction to sukuk credit rating changes in Malaysia

• Date: 01 September 2019
• Author: Shamsher Mohamad,Zulkarnain Muhamad Sori,Mahmoud Al Homsi
• DOI: http://doi.org/10.1002/tie.22066
• Published date: 01 September 2019

VIEW FROM PRACTICE

View from practice: Stock market reaction to sukuk credit

rating changes in Malaysia

Zulkarnain Muhamad Sori

1

| Shamsher Mohamad

1

| Mahmoud Al Homsi

2

1

INCEIF, Lorong Universiti A, Kuala Lumpur,

Malaysia

2

Research Department, CIBAFI, Manama,

Kingdom of Bahrain

Correspondence

Zulkarnain Muhamad Sori, INCEIF, Lorong

Universiti A, 59100 Kuala Lumpur, Malaysia.

Email: zulkarnain@inceif.org

Funding information

MOHE-UM-INCEIF, Grant/Award Number:

RPIF05-16INCEIF

Abstract

Documented evidence on conventional bond markets shows negative market reac-

tion to bond credit rating downgrade and no reaction to credit rating upgrade.

Despite the fact that sukuk issuances make up more than 58.8% of the value of out-

standing bonds in the country and Malaysia issues at least half of the world's sukuk

and is widely recognized as a leader in the sukuk space, there is no documented evi-

dence on the stock market reaction to sukuk credit rating changes. This study ana-

lyzed the wealth effect of sukuk credit rating changes in Malaysia using 16 sukuk

upgrades and 20 sukuk downgrades for the period 2000–2014. The evidence shows

negative market reaction to downgrades and positive significant reaction to sukuk

rating upgrade. This symmetrical market reaction to sukuk credit rating changes

implies the market was indifferent between bonds and sukuk from the credit rating

perspective. This finding supports the notion that the credit rating agencies are

Shariah-neutral when rating these capital market instruments.

KEYWORDS

credit ratings, Islamic finance, market reaction, sukuk, wealth effect

1|INTRODUCTION

Credit rating agencies (CRAs) play a vital role in the capital market by

verifying the creditworthiness of the issuing firm. The rating agencies

usually conduct a fundamental analysis to estimate the chances of

default by the issuer that is signaled through different credit rating

grades to indicate the different chances of default. For example, a

high rating, indicated by AAA grade, implies excellent creditworthi-

ness, or a very small probability of default. Conversely, a D rating

grade implies the sukuk has poor creditworthiness with a very high

probability that the issuing firm will default. The objective of these

rating grades is to signal to the market on the quality of the sukuk

issuance so as they can make objective assessment of the risk in their

investment decisions. As the rating agencies are expected to have

better access to information about the issuer regarding expected

future cash flows, market competitiveness, management quality, and

governance, such information provides greater transparency regarding

the changing risk profile of the firm's investments and enhances the

CRAs’role in ascertaining the potential creditworthiness of the firm.

Better potential is indicated by upgrading of credit rating and poor

potential is signaled by downgrading of the instrument. The level of

the changes (up or down) in the credit rating grades indicates the

extent of changes in the rating.

Credit rating for bonds and sukuk is not only done at listings but

also after listing as it is a mandatory requirement to continually assess

the financial viability of the issuer on a periodic basis (usually annu-

ally). The objective of the continuous assessment is to keep investors

updated about any adverse change in the creditworthiness of the issu-

ing firm. This article addresses the wealth effect of credit rating

changes of listed sukuk. For conventional bonds, the creditors are

interested to get back their principle investment and the interest,

which becomes a strong motivation to assess the issuer’s creditwor-

thiness so to be able to service its financial obligations. Any decline in

the issuer’s financial capability will be reflected in a rating downgrade,

and an improvement will be reflected in an upgrade.

DOI: 10.1002/tie.22066

Thunderbird Int. Bus. Rev. 2019;61:659–667. wileyonlinelibrary.com/journal/tie © 2019 Wiley Periodicals, Inc. 659