income market, such as in Malaysia, where both conventional and sukuk securities are issued by the government. Conventional government debt securities are simple to price and normally treated as risk-free assets in their respective jurisdictions. They are also usually issued regularly and frequently for a wide range of maturities and in large sizes that allow periodic price updates in primary markets and a conducive environment for liquidity in secondary markets.

Alternative price references may be used, depending on the context of a particular market, but shortcomings are found. Alternative price references may appear as desirable cost-effective solutions when government issuance is unnecessary (e.g., in a surplus economy<sup>25</sup> or where a government deficit is completely funded through other vehicles, such as multilateral or bilateral lending). Potential substitutes include, among other options, quasi-sovereign debt, asset-backed securities such as mortgage bonds, municipal bonds, and central bank bills. These instruments, however, suffer limitations in different degrees in comparison with government bonds due to relatively smaller amounts of frequency of issuance, higher credit risk, discontinuity of maturity across the several segments of the yield curve, and lack of liquidity. Other references such as a dollar curve (in countries using a fixed peg such as in the GCC) or swap curves are also potential substitutes, but they also face limitations.<sup>26</sup> Policies to develop reference curves are thus dependent on the choice of instruments used as price benchmarks. In the case of government instruments, building a reliable curve requires a comprehensive policy to develop the government securities market, including efficient, regular, and predictable issuance of short-, medium-, and long-term benchmark instruments, and the introduction of supporting arrangements to stimulate liquidity such as a primary dealer system and a marketmaking program. For reference curves based on alternative instruments, the agenda would consist of policies that could alleviate the limitations discussed above, especially with regard to the fragmentation and lack of liquidity that most alternative methods entail.

# **_Primary Markets_**

A robust primary market with the presence of a broad pool of issuers requires building an enabling environment in which sukuk would be on a level playing field with other instruments. As with conventional instruments, such as corporate bonds, offering mechanisms should not be unduly onerous in terms of disclosure requirement, approval procedures, duration, and costs.<sup>27</sup> Tax treatment and investment regulations applied to different products and followed by key segments of 25Several economies (including OECD countries in the early 1990s, Norway, and Singapore) have examined the pros and cons of starting or continuing to issue debt during surplus times. The overwhelming decision was to issue debt for reasons that varied from country to country, such as to stimulate the development of the capital markets or to avoid reentry costs if existing markets were to be eliminated and the government needed funding in the future.

26Development of interest rate swap curves usually follows an already existing government bond curve or a robust money market reference rate from which a derivatives curve is created. A dollar curve is an attractive proposition in countries with credible fixed peg regimes because it is very liquid and covers a wide spectrum of maturities. However, dollar curves pose risk for sustainable development of these markets because they may lead to (1) excessive exposure by issuers and investors to potential shifts in the foreign exchange regime, limiting the room for maneuver by the central bank, and (2) imperfect price formation for securities denominated in the local currency, because international price references may not reflect country-specific aspects driving the cost of capital in the domestic market.

27See IMF, WB, EBRD, and OECD (2013).

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