Sukuk
Encyclopedia
Sukuk is the Arabic
name for financial certificates
, but commonly refers to the Islamic equivalent of bonds
. Since fixed income, interest bearing bonds are not permissible in Islam
, Sukuk securities are structured to comply with the Islamic law
and its investment principles, which prohibits the charging, or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets.
Conservative estimates by the Ten-Year Framework and Strategies suggest that over $1.2 trillion of assets are being managed according to Islamic investment principles. Such principles form part of Shari'ah, which is often understood to be ‘Islamic Law’, but it is actually broader than this in that it also encompasses the general body of spiritual and moral obligations and duties in Islam. In the Persian Gulf and Asia, Standard & Poor's
estimates that 20 per cent of banking customers would now spontaneously choose an Islamic financial product over a conventional one with a similar risk-return profile.
Sukuk financing resembles the similarly religious concept of gemach
or Jewish interest-free loans
, which subscribe to both the positive Torah
commandment
of lending money and the Torah prohibition against charging interest
on a loan. Such religiously inspired non-interest loan systems can be quite mystifying for outsiders. A good analogy is one of ethical or green investing. Here the universe of investable securities is limited by certain criteria based on moral and ethical considerations. Islamic finance is also a subset of the global market and there is nothing that prevents the conventional investor from participating in the Islamic market.
If one would rather avoid the singular word "sakk", perhaps due to its obscurity, then they can always use "Islamic bond" for the singular form, and "sukuk" for the plural. In addition to being grammatically correct, this would also help in capturing two keywords about the subject in any piece of writing, which enhances its visibility and accessibility.
, Sakk (sukuk) – which is cognate with the Europe
an 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. Empirical evidence shows that sukuk were a product extensively used during medieval Islam for the transferring of financial obligations originating from trade and other commercial activities.
The essence of sukuk, in the modern Islamic perspective, lies in the concept of asset monetization - the so called securitisation - that is achieved through the process of issuance of sukuk (taskeek). Its great potential is in transforming an asset’s future cash flow
into present cash flow. Sukuk may be issued on existing as well as specific assets that may become available at a future date.
Most commonly used Sukuk structures replicate the cash flows of conventional bonds. Such structures are listed on exchanges, commonly 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).
From a Sharia perspective, certificates of debt are not tradable (although a different view is held by many in Malaysia).
The most accepted structure, which is tradable, is thereafter the Sukuk Al Ijara. Debt certificates can be only bought before the finance occurs and then held to maturity from an Islamic perspective, which is critical on debt trading at market value regarding any difference to be like the prohibited Riba
(interest on money).
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 institution
s is that the trading and selling of debts, receivables (for anything other than par), conventional loan lending and credit card
s are not permissible.
This principle is widely understood to mean uncertainty in the contractual terms and/or the uncertainty in the existence of an underlying asset in a contract, which causes issues for Islamic scholars when considering the application of derivative
s. 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 still much discussion yet to come on this issue.
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."
HSBC estimates there is $822bn Islamic finance debt outstanding in the world.
. 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 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:
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.
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 conventional bonds show that sukuk securities are different from conventional bonds.
Arabic language
Arabic is a name applied to the descendants of the Classical Arabic language of the 6th century AD, used most prominently in the Quran, the Islamic Holy Book...
name for financial certificates
Academic certificate
An academic certificate is a document that certifies that a person has received specific education or has passed a test or series of tests.In many countries, certificate is a qualification attained in secondary education. For instance, students in the Republic of Ireland sit the Junior Certificate...
, but commonly refers to the Islamic equivalent of bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
. Since fixed income, interest bearing bonds are not permissible in Islam
Islam
Islam . The most common are and . : Arabic pronunciation varies regionally. The first vowel ranges from ~~. The second vowel ranges from ~~~...
, Sukuk securities are structured to comply with the Islamic law
Sharia
Sharia law, is the moral code and religious law of Islam. Sharia is derived from two primary sources of Islamic law: the precepts set forth in the Quran, and the example set by the Islamic prophet Muhammad in the Sunnah. Fiqh jurisprudence interprets and extends the application of sharia to...
and its investment principles, which prohibits the charging, or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets.
Conservative estimates by the Ten-Year Framework and Strategies suggest that over $1.2 trillion of assets are being managed according to Islamic investment principles. Such principles form part of Shari'ah, which is often understood to be ‘Islamic Law’, but it is actually broader than this in that it also encompasses the general body of spiritual and moral obligations and duties in Islam. In the Persian Gulf and Asia, Standard & Poor's
Standard & Poor's
Standard & Poor's is a United States-based financial services company. It is a division of The McGraw-Hill Companies that publishes financial research and analysis on stocks and bonds. It is well known for its stock-market indices, the US-based S&P 500, the Australian S&P/ASX 200, the Canadian...
estimates that 20 per cent of banking customers would now spontaneously choose an Islamic financial product over a conventional one with a similar risk-return profile.
Sukuk financing resembles the similarly religious concept of gemach
Gemach
Gemach is a Jewish free-loan fund which subscribes to both the positive Torah commandment of lending money and the Torah prohibition against charging interest on a loan. Unlike bank loans, gemach loans are interest-free, and are often set up with easy repayment terms.Gemachs operate in most Jewish...
or Jewish interest-free loans
Israel Free Loan Association
The Israel Free Loan Association is the largest free loan association in the world, having lent out nearly $150 million in the last two decades. This non-profit organization offers interest-free loans to citizens of Israel only. It is supported primarily by private donations and grants...
, which subscribe to both the positive Torah
Torah
Torah- A scroll containing the first five books of the BibleThe Torah , is name given by Jews to the first five books of the bible—Genesis , Exodus , Leviticus , Numbers and Deuteronomy Torah- A scroll containing the first five books of the BibleThe Torah , is name given by Jews to the first five...
commandment
Mitzvah
The primary meaning of the Hebrew word refers to precepts and commandments as commanded by God...
of lending money and the Torah prohibition against charging interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
on a loan. Such religiously inspired non-interest loan systems can be quite mystifying for outsiders. A good analogy is one of ethical or green investing. Here the universe of investable securities is limited by certain criteria based on moral and ethical considerations. Islamic finance is also a subset of the global market and there is nothing that prevents the conventional investor from participating in the Islamic market.
Terminology
The use of the word "sukuks" when referring to Islamic bonds in the plural is incorrect, because "sukuk" is actually a plural word. The correct forms are: "sakk" (singular) and "sukuk" (plural). A good analogy is adding an S letter to an already plural word like "children"; obviously this would be incorrect.If one would rather avoid the singular word "sakk", perhaps due to its obscurity, then they can always use "Islamic bond" for the singular form, and "sukuk" for the plural. In addition to being grammatically correct, this would also help in capturing two keywords about the subject in any piece of writing, which enhances its visibility and accessibility.
History
In classical period IslamIslam
Islam . The most common are and . : Arabic pronunciation varies regionally. The first vowel ranges from ~~. The second vowel ranges from ~~~...
, Sakk (sukuk) – which is cognate with the Europe
Europe
Europe is, by convention, one of the world's seven continents. Comprising the westernmost peninsula of Eurasia, Europe is generally 'divided' from Asia to its east by the watershed divides of the Ural and Caucasus Mountains, the Ural River, the Caspian and Black Seas, and the waterways connecting...
an root "cheque
Cheque
A cheque is a document/instrument See the negotiable cow—itself a fictional story—for discussions of cheques written on unusual surfaces. that orders a payment of money from a bank account...
" from Persian '(چک) pronounced check' - meant any document representing a contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
or conveyance of rights, obligations or monies done in conformity with the Shariah. Empirical evidence shows that sukuk were a product extensively used during medieval Islam for the transferring of financial obligations originating from trade and other commercial activities.
The essence of sukuk, in the modern Islamic perspective, lies in the concept of asset monetization - the so called securitisation - that is achieved through the process of issuance of sukuk (taskeek). Its great potential is in transforming an asset’s future cash flow
Cash flow
Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.Cash flow...
into present cash flow. Sukuk may be issued on existing as well as specific assets that may become available at a future date.
Principle
Sukuk can be structured alongside different techniques. While a conventional bond is a promise to repay a loan, Sukuk constitutes partial ownership in a debt (Sukuk Murabaha), asset (Sukuk Al Ijara), project (Sukuk Al Istisna), business (Sukuk Al Musharaka), or investment (Sukuk Al Istithmar).Most commonly used Sukuk structures replicate the cash flows of conventional bonds. Such structures are listed on exchanges, commonly Luxembourg Stock Exchange
Luxembourg Stock Exchange
The Luxembourg Stock Exchange is a stock exchange based in Luxembourg City, in southern Luxembourg.The Exchange is located on avenue de la Porte-Neuve,...
and London Stock Exchange
London Stock Exchange
The London Stock Exchange is a stock exchange located in the City of London within the United Kingdom. , the Exchange had a market capitalisation of US$3.7495 trillion, making it the fourth-largest stock exchange in the world by this measurement...
in Europe, and made tradable through conventional organisations like Euroclear
Euroclear
Euroclear is a user owned and governed Brussels, Belgium based financial services company that specializes in the settlement of securities transactions as well as the safekeeping and asset servicing of these securities. It was founded in 1968 as part of J.P...
or Clearstream
Clearstream
Clearstream Banking S.A. is the clearing and settlement division of Deutsche Börse, based in Luxembourg and Frankfurt. Clearstream was created in January 2000 through the merger of Cedel International and Deutsche Börse Clearing...
. 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).
From a Sharia perspective, certificates of debt are not tradable (although a different view is held by many in Malaysia).
The most accepted structure, which is tradable, is thereafter the Sukuk Al Ijara. Debt certificates can be only bought before the finance occurs and then held to maturity from an Islamic perspective, which is critical on debt trading at market value regarding any difference to be like the prohibited Riba
Riba
Riba means one of the senses of "usury" . Riba is forbidden in Islamic economic jurisprudence fiqh and considered as a major sin...
(interest on money).
As Shari’ah considers money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
to be a measuring tool for value and not an asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
in itself, it requires that one should not receive income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
from money (or anything that has the genus
Genus
In biology, a genus is a low-level taxonomic rank used in the biological classification of living and fossil organisms, which is an example of definition by genus and differentia...
of money) alone. This generation of money from money (simplistically, interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
) is "Riba", and is forbidden. The implication for Islamic financial institution
Financial institution
In financial economics, a financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries...
s is that the trading and selling of debts, receivables (for anything other than par), conventional loan lending and credit card
Credit card
A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services...
s are not permissible.
This principle is widely understood to mean uncertainty in the contractual terms and/or the uncertainty in the existence of an underlying asset in a contract, which causes issues for Islamic scholars when considering the application of derivative
Derivative (finance)
A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...
s. 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
Hedge (finance)
A hedge is an investment position intended to offset potential losses that may be incurred by a companion investment.A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of...
or mitigation of avoidable business risks, may fall into this category, but there is still much discussion yet to come on this issue.
Sukuk 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.
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 Sakk (Islamic bond) effectively requires payment for the time-value of moneyTime value of money
The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time. The time value of money is the central concept in finance theory....
. This can be regarded as the fundamental test of interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
. 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 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
Muhammad Taqi Usmani
Muhammad Taqi Usmani is a Hanafi Islamic scholar from Pakistan who was born in 1943. He served as a judge on the Federal Shariat Court of Pakistan from 1981 to 1982 and the Shari'a Appellate Bench of the Supreme Court of Pakistan from 1982 to 2002. He is an expert in the fields of Islamic...
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.
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 conventional bonds show that sukuk securities are different from conventional bonds.