Sukuk

Sukuk (Arabic: صكوك‎‎, plural of صك Sakk, "legal instrument, deed, check") is the Arabic name for financial certificates, but commonly referred to as "sharia compliant" bonds. Sukuk are defined by the AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) as "securities of equal denomination representing individual ownership interests in a portfolio of eligible existing or future assets." The Fiqh academy of the OIC legitimized the use of sukuk in February 1988 Since fixed-income, interest-bearing bonds are not permissible in Sharia or Islamic law, Sukuk securities are structured to comply by not paying interest. This is generally done by involving a tangible asset in the investment. For example, by giving partial ownership of a property built by the investment company to the bond owner who collect the profit as rent, which is allowed under Islamic law. Upon expiration of the Sukuk, the rent payments cease.

HSBC estimates that as of 2009 there was $822bn Islamic finance debt outstanding in the world. According to the 2014 Global Islamic Finance Report, $1.813 trillion of assets are being managed in a sharia compliant manner.

In common usage outside of Arabic-speaking countries, the word "sukuk" is often used both as singular as well as plural. (In proper Arabic, "sukuk" is plural, "sakk" is singular.) Use of the word "sukuks" when referring to more than one Islamic bond is incorrect.

History

In the classical period of Islam, Sakk (sukuk)—which is cognate with the European root "cheque" from Persian '(چک) pronounced check'—meant any document representing a contract or conveyance of rights, obligations or monies done in conformity with the Shariah. Sukuk were extensively used during medieval Islam for the transferring of financial obligations originating from trade and other commercial activities.

The first sukuk—worth RM125 million—were issued in Malaysia by Shell MDS, on the basis of bai' bithaman ajil, according to an 2012 International Islamic Financial Market report. In 2000, the government of Sudan issued domestic sovereign short-term sukuk worth 77 million Sudanese pounds on the basis of musharaka. In 2001, the sukuk market went international with the issuance of the first US-dollar-denominated ijara sukuk, worth $100 million by the Central Bank of Bahrain. Since then many sovereign and corporate sukuk issues have been offered in various jurisdictions.

In 2004, Euromoney published the first book exclusively on sukuk investments, Islamic Bonds: Your Issuing, Structuring and Investing in Sukuk. It was co-authored by the Islamic banking specialist Nathif Jama Adam.

Principle

As Shari’ah considers money to be a measuring tool for value and not an asset in itself, it requires that one should not receive income from money (or anything that has the genus of money) alone. This generation of money from money (simplistically, interest) is "Riba", and is forbidden. The implication for Islamic financial institutions is that the trading and selling of debts, receivables (for anything other than par), conventional loan lending, and credit cards are not permissible.

This principle is widely understood to mean uncertainty in the contractual terms and/or uncertainty in the existence of an underlying asset in a contract, which causes issues for Islamic scholars when considering the application of derivatives. Sharia also incorporates the concept of maslahah or "public benefit", denoting that if something is overwhelmingly in the public good, it may yet be transacted – and so hedging or mitigation of avoidable business risks, may fall into this category, but there is disagreement on this issue.

From a Sharia perspective, certificates of debt are not tradable (although a different view is held by many in Malaysia).

Structure and characteristics

Sukuk are structured in several different ways. While a conventional bond is a promise to repay a loan, Sukuk constitute partial ownership in a debt (Sukuk Murabaha), asset (Sukuk Al Ijara), project (Sukuk Al Istisna), business (Sukuk Al Musharaka), or investment (Sukuk Al Istithmar).

The most commonly used Sukuk structures replicate the cash flows of conventional bonds. Such structures are listed on exchanges, commonly the Luxembourg Stock Exchange and London Stock Exchange in Europe, and made tradable through conventional organisations like Euroclear or Clearstream. A key technique to achieve capital protection without amounting to a loan is a binding promise to repurchase certain assets; e.g. in the case of Sukuk Al Ijara, by the issuer. In the meantime a rent is being paid, which is often benchmarked to an interest rate like LIBOR (which is disliked by Sharia Scholars).

The most accepted structure, which is tradable, is thereafter the Sukuk Al Ijara. Debt certificates can only be bought before the finance occurs and then held to maturity, from an Islamic perspective. This is critical for debt trading at market value without incurring the prohibited Riba (interest on money).

The characteristics that distinguish sukuk from other Islamic instruments of other investment vehicles and which have contributed to its widespread prevalence are:

• Based on the principle of participation in profit and loss: The appropriate posts underlying principle of Sukuk issuance in terms of the relationship between the participants is to participate in the profit and loss regardless of the investment formula in place, which gives the owner a share of the profit, not the proportion of predefined nominal value, and the share of bondholders of the profits from the project or activity which is funded by a percentage determines when hiring, Fmakouha captured from participating in the agreement as set out in the prospectus, and bear Grmha by owned by each of them, according to the base of profits and losses sharing.
• Documents issued on behalf of the owner of categories of equal value: issued instruments categories of equal value because they represent the common shares in the assets of a particular project or activity of a special investment, so as to facilitate the buying and trading of these instruments, and it looks like an instrument of Islamic stock issued denominations equal and represents a common share in the net assets of the company to contribute, as he meets with the conventional bonds, which are issued denominations equal.
• Issued and traded in accordance with the terms and conditions of Shariah: allocate the proceeds of instruments to invest in projects in accordance with the provisions of the Islamic Sharia, as it is based on a contract basis and legitimacy according to Islamic modes of finance and speculation Kalmharkat and other controls governing the issuance and circulation.

Represents a common share in the ownership of assets or benefits or services to be provided, and do not represent our source for bondholders.

Issuing process

Step-by-step process of issuing a sukuk based on an asset:

• A business firm requiring capital (the originator) creates a special purpose vehicle (SPV), an independent entity.
• The SPV purchases assets (such as land, building, machinery) from the originator.
• The SPV converts the value of the assets into securities (sukuk) which it issues and sells to investors.
• The sale proceeds are paid to the originator/debtor as the price of the assets.
• The SPV, acting as a trustee on behalf of the sukuk-holders, arranges to lease the assets back to the originator who pays the sukuk-holders the lease income.
• The originator buys back the asset from the SPV at a nominal price on termination of the lease.

In this type of sukuk, fixed interest of a conventional bond is replaced by fixed lease income. Islamic economist Muhammad Akram Khan complains that sukuk are "different from conventional finance in form and formalities rather than substance", and "may even be more expensive" for the income provided than a conventional bond.

Challenges

International Sukuk Issuance
2007	$13.8 billion
2008	$2.14 billion
2009	$7.47 billion
2010	$5.35 billion
SOURCE: 2012 International Islamic Financial Market report p. 12

A 2012 International Islamic Financial Market report notes a decline in international sukuk issuance from 2007 ($13.8 billion) to 2010 ($5.35 billion). According to one source (Askari, Iqbal and Mirakhor) it was mainly due to the shortcomings of Islamic finance relating to liquidity. Others (Taqi Uthmani, chair of the AAOIFIF's Shariah Board, and Salman Ali), have questioned the shariah compliance of sukuk. (see below)

Defaults

As of 2009, there were a number of cases where the sukuk had defaulted or were in serious trouble. In May 2009, Investment Dar of Kuwait defaulted on $100 million sukuk. Saad Group set up a committee to restructure $650 million Golden Belt 1 sukuk. Standard & Poor's cut the rating of that sukuk "owning to the non-availability of vital information". East Cameron Partners ECP issued a multiple-award-winning sukuk in 2006 but filed for bankruptcy in October 2008, prompting a legal dispute about the creditors' right to $167.67 million in sukuk assets. S&P downgraded the sukuk of Dubai Islamic bank and Sharjah Islamic Bank. According to one estimate, the credit crunch in the global Financial crisis of 2007–08 could result in defaults of 5-8% of the sukuk.

According to Ibrahim Warde as of 2010,

What is till unclear is what happens to sukuk when they fail -- an issue that has not been tested in court. In Malaysia, some sukuk issues have junk status, and two other sukuk are already in default: the Easter Cameron Gas company in the United States and Investment Dar of Kuwait. One of the unresolved questions is whether sukuk holders should stand in the line of creditors or in the line of the owners of underlying assets."

According to Rodney Wilson, when sukuk payments are delayed or fail, "the means of redress are potentially more complex than for conventional notes and bonds". In particular "under Shari’ah leniency towards debtors is favoured", which inevitably raises moral hazard problems.

Secondary market

Sukuk securities tend to be bought and held and, as a result, little of the securities enter the secondary market (allowing them to be traded). Furthermore, only public Sukuk are able to enter this market, as they are listed on stock exchanges.

The secondary market whilst developing remains a niche segment with virtually all of the trading done at the institution level. The size of the secondary market remains unknown, though LMC Bahrain state they traded $55.5 million of Sukuk in 2007. The European Islamic Investment Bank (EIIB) in an interview published on Sukuk.net stated "Secondary market trading volume has contracted significantly in the first half of 2008 when compared to 2007 where Sukuk with a nominal value of approximately $0.5bn was traded."

"Sukuk bonds" are designed to get around religious laws banning the payment of interest for money lending. But one of the most volatile debts in the Dubai World standstill is a $3.5bn Islamic bond due to be repaid in December.

HSBC estimates there is $822bn Islamic finance debt outstanding in the world.

Countries using Sukuk

Bahrain

Bahrain is a major issuer of sukuk.

Egypt

On 8 May 2013, the Egyptian President approved a law allowing the government to issue sukuk, however as of May 2013 the relevant regulations have not been specified.

Gambia

In 2007, Gambia replaced Sudan as one of the ten countries issuing sukuk. It has one of the lowest amount of sukuk issuance, with $12.6 mil as of 2008.

Iran

Further information: Banking in Iran § Sukuk

Although the first use of Islamic financial instruments in Iran goes back to 1994 with the issuance of Musharakah sukuk by Tehran Municipality to finance Navab project, the enactment of Iran securities market law, and new instruments and financial institutions development law was done respectively in 2005 and 2010 to pave the way for the appliance of such instruments to develop financial system of the country. The first Ijarah sukuk was issued in Iranian Capital Market in January 2011 for financing Mahan Air company with the value of 291,500 million Rials. From April to December 2011, financing through Ijarah sukuk in capital market was reached to 3,673,750 million Rials.

Malaysia

Malaysia is one of the few countries that makes it mandatory for sukuk and other debt papers to be rated. RAM Rating Services Bhd CEO Foo Su Yin says the total issuance of sukuk corporate bonds in 2012 was RM 71.7 billion while conventional bonds totalled RM48.3 billion. As at 2011, Malaysia was the highest global sukuk issuer by issuing 69 percent of world's total issuances.

Kazakhstan

In June 2012, Kazakhstan finalized its debut sukuk which will be issued by the Development Bank of Kazakhstan (DBK) in the Malaysian market. The DBK, which is 100% owned by the government of Kazakhstan, is working with HSBC and Royal Bank of Scotland (RBS) to manage the ringgit-denominated issuance which is effectively a quasi-sovereign offering. The issuance will be listed on the Kazakhstan Stock Exchange, which has developed the infrastructure to list Islamic financial products such as Ijara and Musharaka Sukuk and investment funds.

Qatar

Qatar authorities and government related companies are looking into funding for its infrastructure projects by issuing Sukuk. In 2011 Qatar issued 11 percent of global Sukuk.

Singapore

Singapore was the first non-Muslim majority country to issue a Sovereign Sukuk in 2009. Called the MAS Sukuk domestically, it is issued via a wholly owned subsidiary of the Monetary Authority of Singapore - Singapore Sukuk Pte Ltd. The Singapore MAS Sukuk is treated similarly to the conventional Singapore Government Securities ("SGS")in aspects such as compliance with liquidity requirements.

Since then there have been several Sukuk issuances in Singapore by local and foreign issuers. Singapore City Development Limited issued the first Ijara Sukuk in 2009, and Khazanah Shd Bhd issued a SGD1.5bn Sukuk in 2010 to finance its acquisition of parkway holdings. In 2013, there were 2 new Sukuk Programmes arranged for Singapore listed companies - Swiber Holdings & Vallianz Holdings, with the former issuing a SGD150mn 5 year sukuk in Aug 2013.

Somalia

The Somalia Stock Exchange (SSE) is the national bourse of Somalia. In August 2012, the SSE signed a Memorandum of Understanding to assist it in technical development. The agreement includes identifying appropriate expertise and support. Sharia compliant sukuk bonds and halal equities are also envisioned as part of the deal as the nascent stock market develops.

Turkey

Turkey issued its debut sukuk in October 2012. The October 2012 issuance was a double issuance, with one being in US Dollars (issued on 10 October 2012 for $1.5B), and one being in Turkish Lira (issued on 2 October 2012 for 1.62LRY). According to data from Sukuk.com, the US Dollars issuance was oversubscribed and was initially planned to be for $1B, but because of strong demand from the Middle East it was increased to $1.5B.

Turkey returned to the Sukuk market in October 2013 with a $1.25B issuance.

United Arab Emirates

As of January 2015, NASDAQ Dubai has listed 18 sukuk valued at a total $24 billion. The latest of these is Fly Dubai.

United Kingdom

On 25 June 2014, HM Treasury became the first country outside of the Islamic world to issue a Sukuk. This £200 million issue was 11.5 times oversubscribed and was priced at the same level as the equivalent UK Gilts (UK government bonds) at 2.036% pa. The Sukuk was linked to the rental income of UK government property.

Hong Kong

Hong Kong has issued two sovereign Sukuk as of middle of 2015. It issued its first issuance consisting of a 5-year $1 billion Ijara Sukuk in September 2014 offering a profit rate of 2.005%. It issued its second sovereign Sukuk in June 2015 also for $1 billion with a 5-year maturity which used an innovative Wakala structure offering a profit rate of 1.894%.

Controversy

Sukuk are widely regarded as controversial due to their perceived purpose of evading the restrictions on Riba. Conservative scholars do not believe that this is effective, citing the fact that a Sukuk effectively requires payment for the time-value of money. This can be regarded as the fundamental test of interest. Sukuk offer investors fixed return on their investments which is also similar in appearance to interest in that the investor's return is not necessarily dependent on the risks of that particular venture. However, banks that issue Sukuk contend that Sukuk investors are investing in assets—not currency. The return on such assets takes the form of rent, and is evenly spread over the rental period. The productivity of the asset forms the basis of the fixed income stream and the return on investment. Given that there is an asset underlying the value of the certificate, there may be, depending on the value of the asset, more security for the investors involved, accounting for the additional appeal of Sukuk as a method of financing for investors.

Certain common structuring elements for Sukuk were criticised by Sheik Muhammad Taqi Usmani President of the Shariah Council of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) in a paper entitled "Sukuk and their Contemporary Applications" released in November 2007. Sheik Usmani identified the following three key structuring elements that differentiate Sukuk from conventional bonds:

• Sukuk must represent ownership shares in assets or commercial or industrial enterprises that bring profits or revenues
• Payments to Sukuk-holders should be the share of profits (after costs) of the assets or enterprise
• The value payable to the Sukuk-holder on maturity should be the current market value of the assets or enterprise and not the principal originally invested.

Sheik Usmani stated that by complex mechanisms Sukuk had taken on the same characteristics as conventional interest-bearing bonds, as they do not return to investors more than a fixed percentage of the principal, based on interest rates, while guaranteeing the return of investors' principal at maturity. Sheik Usmani estimated that 85% of all Sukuk in issuance were not Shariah-compliant due to the existence of guaranteed returns and/or repurchase obligations from the issuer.

Following Sheik Usmani's criticisms the global Sukuk market shrunk from US$50bn in 2007 to approximately $14.9bn in 2008, although how much of this was due to his criticisms or the Global Financial Crisis is a matter of debate.

Another observer, Salman Ali, found that many of the sukuk structures "do not conform to the Shariah". According to Ali, while most of the sukuk make an effort to remain "within Shariah bounds", they "replicate conventional debt instruments". They often combine more than one contract, "which individually may be Shariah-compliant" but when combined "may defeat the objective of the shariah". Furthermore, the sukuk rate of return is often "tied" to the Libor (London interbank offered rate) or EUROBOR (euro interbank offered rate) interest rate "rather than to the underlying business" that the sukuk is financing. This makes the sukuk "so similar to conventional debt instruments that it is difficult to tell one from the other". This is perhaps why rating agencies such as Standard & Poors and Moody's apply the same methodology for rating sukuk as for conventional debt instruments.

In 2011, Safari conducted various statistical and econometrics tests to check the argument that sukuk securities are merely the same as conventional bond. However, his results on the comparison of yield to maturity of sukuk and that of conventional bonds show that sukuk securities are different from conventional bonds. In response to this argument, it was pointed out that yield to maturity reflects the interplay of supply and demand which may be affected by a financial product's packaging and target market rather than just the substance of the product alone.

Another author, Salman Ali, observes that many of the sukuk structures do not conform to the Shariah.

See also

• Gemach
• Islamic financing

External links

• Managing Financial Risks of Sukuk Structures
• Sukuk Islamic Financial Instruments
• Risks of Sukuk structures: Implications for resource mobilization
• Euromoney Encyclopedia Islamic Finance Khorshid
• Al-Sukuk.com - Sukuks explained
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