The Government of Malaysia sold the world's first 30-year sovereign sukuk and, in the process, shrugged off domestic woes to establish a long-dated benchmark Islamic curve for other sovereigns to follow.

The 30-year was part of a two-tranche offering of US$1.5bn in Islamic 144A/Reg S bonds to the international markets at a time when 1MDB's M$41.9bn debt woes threaten to derail the government's bid to rein in its fiscal and budget deficits.

Political battles between reigning Prime Minister Najib Razak and former PM Mahathir Mohamad further clouded the situation. The public tension between the two not only undermined the apparent unity of the UMNO ruling party, but also forced Najib to deny publicly accusations of any involvement in a murder of a Mongolian model.

This was political noise that some 450 global investors uniformly dismissed when contributing to a cracking US$9bn order book for the sukuk.

The deal was well distributed among the various investor groups and geographically as well, with the US investors crowding into the 30-year tranche with a 29% share. Malaysia has not sold bonds since 2011 and its scarcity value was a hit even among Middle Eastern investors who usually do not invest in tenors of more than seven years. These investors bought 24% of the 10-year bonds, a share hardly seen in deals originating outside the Middle East/North African region, said a sovereign bond trader.

Malaysia stayed disciplined and kept to its initially targeted issue size of US$1.5bn split between the US$1bn 10-year note and the US$500m 30-year note. Investors rewarded that discipline, when the bonds traded up at the open.

The 2025s, priced to yield 115bp over US Treasuries, rallied to 112bp/109bp and the 2045s, priced at 170bp, traded at 164bp/161bp.

The issue also set a landmark pricing level for other sovereigns. The sovereign priced inside the outstanding conventional bonds of quasi-sovereign Petronas. This is seen as an outstanding feat as Islamic bonds often price wider than conventional paper and the fact that Petronas is rated a notch higher than the sovereign.

Petronas' 2025s and 2045s, sold on March 11 at yields of 150bp and 190bp, were quoted at 126bp and 175bp as the sovereign offering was announced. It meant the government sukuk came 11bp and 5bp inside the notes of the national oil company. Petronas' bonds pulled in about 2bp tighter immediately after the sovereign sukuk was priced.

The response underlines investor confidence in the long-term financial and political health of Malaysia and showed little impact from an expected Fitch downgrade of the sovereign's rating to the BBB band this quarter.

Fitch had indicated in March that there was a more than 50% chance that the sovereign would be downgraded from A-. That sent the credit default swap, a measure of the cost to insure against the country's default, up to more than 135bp, but that cost has now fallen to around 120bp.

Nevertheless, Fitch remains on track to downgrade Malaysia.

"The rating triggers for Malaysia include slippage relative to the government's fiscal targets and the lack of progress on structural budgetary reform, emergence of sustained twin fiscal and external deficits," said Sagarika Chandra, Fitch's associate director for Asia-Pacific sovereigns.

In contrast, Moody's and S&P have maintained their respective A3 and A- ratings on the sovereign. Moody's has a positive outlook on the rating, pointing to the government's commitment to reduce deficits, the macroeconomic stability, the depth of the domestic capital market and the debt predominantly denominated in the local currency.

Market participants gave credit to the sovereign team for its ability to dispel the 1MDB-related concerns during the global roadshows.

An investor added that the clear indication that the sukuk proceeds would be used to refinance an existing Islamic bond of US$1.25bn due in June, gave him and other investors full reassurance, though speculation was rife that the government could use proceeds to meet 1MDB debt obligations.

Investors raised the question of the state-owned 1MDB's debt during the meetings. Of 1MDB's total debt of M$41.9bn, M$5.8bn is backed with an explicit government guarantee with another M$11bn backed with a government letter of comfort.

Moody's said at end-March that it did not expect the liabilities to migrate to the federal government's balance sheet, but a M$950m line of credit extended to 1MDB earlier this year could undermine the government's fiscal consolidation strength.