Sukuk (literally: “certificates”) is an Arabic word, nowadays referring to a financial certificate which complies with Shariah (Islamic law) to act as an Islamic bond (Qamar, A 2007; Sukuk 2007). In the classical period of Islam, sukuk simply referred to any document that represented a conveyance or a contract of rights, moneys or obligations conducted in conformity with Islamic law. Thus, sukuk acted as a popular product in the medieval Islamic period for the transference of monetary obligations that originated from commercial activities or trade.
Sukuk remains popular in modern times, too.
Nowadays the popularity of sukuk lies in the concept of securitization or asset monetization, which is achieved by the issuance of this financial instrument. The sukuk holds power to transform the future cash flow of an asset into current cash flow. This financial instrument may be issued on specific assets as well as existing assets that could be made available in the future. What is more, the entire world seems to have embraced the sukuk at present, with the sukuk market expected to grow exponentially in the current year (Sukuk).
Generally, Sukuk can be considered analogous to asset-backed securities which provides an investor with ownership in an underlying asset or a pool of underlying assets along with the cash flows and risks commensurate with such an ownership.
The foremost condition for the issuance of Sukuk is the existence of tangible underlying assets on the balance sheet of the issuing entity, which is the basic distinguishing feature between a Sukuk and a conventional bond/security.
Contrary to the position in case of a conventional bond which is a contractual debt obligation entitling the holder to receive interest and principles on specified dates, a Sukuk holder has a proportionate share in the revenues generated by the Sukuk assets as well as in the proceeds of the realization of the underlying assets.
The workflow of a Sukuk transaction is based on the conventional securitization process which entails setting up of a special purpose vehicle (SPV) to acquire the intended assets and to issue claims on those assets. A Sukuk transaction can be structured in a number of different ways, depending upon the type of underlying assets and the specific financing needs of the issuing entity. The transaction may be based upon any one of the permissible Islamic financing modes, such as Ijara (leasing), Musharaka (profit-loss sharing), Salam (forward sale) and Murabaha (deferred payment) etc.
Whichever mode of financing is employed, the returns on Sukuk certificate are tied with the income generated through the underlying asset in the transaction. Like conventional bonds, these certificates can be negotiated and traded freely in the market; however their tradability is strictly contingent upon the nature of the underlying asset during the term of Sukuk, since the sale and purchase of debt or liquid assets (cash or receivables) is not permissible under Shari’ah (Qamar, A).
In order to be a legitimate financial instrument in the Muslim world, the sukuk must be Shariah-compliant. The Shariah or Islamic law prohibits usury or interest, which is any compensation charged on a contract of loan, or in the rescheduling of debts. “Excessive uncertainty,” as in gambling, is also strictly prohibited under Islamic law – based on the Holy Qur’an (Tariq, AA 2004). Furthermore, Islam prohibits investments as well as the selling of services that are unethical in nature, e.g. pornography (Tariq, AA).
As Shariah-compliant, “asset-backed, stable income, tradable” trust certificates, the sukuk may be issued by any entity with assets on its balance sheet, be it the government, a corporate body, a financial institution, the monetary authority, a bank, or any other entity that wishes to mobilize its financial resources (Tariq, AA). Yet another condition for the sukuk to be Shariah-compatible is that the asset pool that is identified for the issuance of sukuk certificates must not be wholly comprised of “debts from Islamic financial contracts,” which are a class of their own and founded in Islamic trade laws (Tariq, AA).
There are fourteen types of sukuk approved and standardized by the Accounting and Auditing Organization of Islamic Financial Institutions, based in Bahrain (Gassner, MS 2005; Macknight, J). The “Pure Ijarah Sukuk” certificates are among the most common (Tariq, AA). For these certificates to be issued, the issuer must first identify “stand-alone assets” on balance sheets (Tariq, AA). The assets that these sukuk could be issued on may be plots of land that are meant to be leased, or leased aircrafts, ships and other equipment. On such sukuk, the “rental rates of returns” could be fixed as well as floating (Tariq, AA).
The federal state of Saxony-Anhalt in Germany has issued the Pure Ijarah Sukuk worth U.S. $100 million in the past few years. Because Saxony-Anhalt was among the newer states of the country after reunification, and its debts were guaranteed by the entire federation of Germany, the Pure Ijarah Sukuk was given a rating of AA- by Standard & Poor’s and AAA by Fitch. The Kuwait Finance House became the Co-Lead Manager for the bond, while Citigroup took up the role of Lead Manager. Still, the Shariah Board of Citi Islamic Investment Bank had to certify the sukuk from the point of view of Islamic law (Gassner, MS).
The fundamental transactions required by the sukuk were a particular number of specific buildings that were owned by Ministry of Finance. The master lease got sold for one hundred years to a Special Purpose Vehicle. The Special Purpose Vehicle rented the master lease back to the Ministry of Finance for five years. Because German laws had not completely evolved with reference to securitization and related taxes, it was Netherlands that came forward to register the Special Purpose Vehicle.
Under Dutch laws, the sukuk was a competitive financial instrument, especially with regards to the municipality tax that could not apply to a conventional bond. The sukuk holders received a variable rent that was benchmarked to the European Interbank Offered Rate over five years. Following repayment, the Ministry of Finance could decide to employ the Special Purpose Vehicle a second time for a brand new issue of the sukuk (Gassner, MS).
The Pure Ijarah Sukuk is, of course, not the only globalized sukuk in our times. In hybrid or “pooled sukuk,” Ijarah or leasing contracts may be combined with Murabaha or “conditional sale” contracts in addition to Istisna or conditional contracts that are made on the sales of items that are yet to be manufactured (Tariq, AA). This form of sukuk is issued on an asset pool that must comprise at least fifty one percent of Ijarah assets. Moreover, the returns on the Murabaha as well as Istisna certificates must be fixed and pre-determined rates (Tariq, AA).
In Malaysia, a certain Murabaha based sukuk named bithaman Al Ajil is most popular, but not so in the Middle East. This form of sukuk has been considered controversial by the Islamic finance industry because it results in debt and cannot be traded at face value as debt. According to the Middle Eastern scholars of Islam, this sukuk could cross the boundaries of Islam into usury or interest. Hence, the Islamic finance industry would not list the bithaman Al Ajil on any stock exchange in the globe. Because this sukuk has no secondary market, Malaysia might have to apply the “tradable Ijarah” form of sukuk so as to allow for secondary market trading around the globe, and also to render the sukuk acceptable in the Middle Eastern sukuk markets (Gassner, MS).
Despite the rejection of the Malaysian sukuk by the majority of Muslim sukuk markets, the International Finance Corporation of the International Monetary Fund has shown interest in the bithaman Al Ajil structure, which essentially refers to deferred payment. The International Finance Corporation issued the Wawasan Bond worth U.S. $132 million on the structure of the Malaysian sukuk. The salient feature of the transaction was a sales contract that resulted in debt rather than a lease. The Joint Lead Managers for the sukuk purchased the issuer’s assets at U.S. $132 million, before they sold the self same assets back at a “deferred sales price plus profit (Gassner, MS).”
The Istisna based sukuk has been widely used to raise finances for real estate development (Gassner, MS). Regardless of its type, however, the fact remains that the entire financial world is presently enthralled by the exotic concept of the sukuk. According to the Banking Technology Magazine: “A niche product until recently, issuance of the global sukuk, an asset-backed, Shariah-compliant trust certificate or Islamic bond, will top $100 billion by the end of the decade, up from some $70 billion at the end of 2006 (Macknight, J).”
The market for sukuk has been experiencing an unparalleled growth for the past five years, with issues worth U.S. $11 billion made by the Gulf region alone. However, the first sukuk issued and sold in global markets came from Malaysia. It was in 2002 that the Malaysian government introduced the sukuk to the whole world (Qamar, A).
The sudden growth of the global sukuk market is said to be fueled by the overall explosion of the Islamic financial market. Shariah-compatible assets around the world are said to total approximately U.S. $500 billion. There has been a ten percent per year increase in the growth of these assets over the past decade. Standard & Poor’s has predicted that Islamic finance would continue expanding, both in terms of geography and product offerings. Besides, Shariah-compliant financial instruments are predicted by Standard & Poor’s to compete with the products of conventional banks around the globe (Macknight, J).
Dow Jones and Citi have recently launched their very own sukuk index, known as the Dow Jones Citigroup Sukuk Index, which happens to be the first international Islamic bond index. In order to be included in the index, a sukuk has to be Shariah-compatible and also comply with the Accounting and Auditing Organization for Islamic Financial Institutions. HSBC, Barclays Bank, Deutsche Bank, and various other international banks are similarly very interested in the sukuk market nowadays. BNP Paribas has managed to complete the second largest issue of bonds in Saudi Arabia on behalf of the Saad Trading Contracting and Financial Services Company. As the only managing underwriter for the U.S. $650 million bond issue for five years, BNP Paribas conformed to the sukuk format. What is more, this transaction happened to be the first issue of sukuk for a private business in Saudi Arabia (Macknight, J).
In response to the excitement over the global sukuk, Europe and America have opened a few Islamic financial institutions. Certain Western countries have also changed regulation in recent years to accommodate the increasing interest in Islamic financial instruments. London has joined the ranks of important financial centers that specifically handle Islamic financial transactions. According to Standard & Poor’s, London is nowadays the only non-Muslim rival to Dubai, Bahrain, and Kuala Lumpur. As a matter of fact, the UK government is reported to have expressed its commitment to the sukuk market through the 2007 budget. The government introduced “new measures for sukuk, enabling them to be issued, held and traded in the same way as corporate bonds (Macknight, J).”
Indeed, the success of the sukuk appears unhindered. In the Western mind, this financial instrument – growing popular by the day – is following a structure that is similar to that of revenue bonds. In order to pay profits on sukuk, the streams of revenue from toll roads, utilities, power plants, airports, oil facilities, seaports and new buildings are being utilized. Presently, most sukuk issues are simply bought and then held. Although there is no vibrant secondary market, and the actual issuance of the sukuk is more difficult than that of conventional bonds due to the necessity of interpreting Shariah, the sukuk continues to perform brilliantly (Macknight, J).