What are Islamic sukuk and how do they differ from conventional bonds?
Sukuk is the plural for the word suk, which means a certificate. Investment sukuk are certificates of equal value representing undivided shares in the ownership of an invested asset.
A sukuk takes place when a set of investors pool in their wealth to invest in accordance with the Sharia principles to earn halal (the term means permissible by Islamic principles) profit, which is then distributed pro-rata among the investors.
Unlike bonds, the sukuk holders have the pro-rata undivided ownership rights over the sukuk asset/s.
There are various types of Sharia-compliant sukuk, and the risk paradigm and tradability of each of them is based on the nominate Sharia contract the transaction has been structured around. It is important to understand that the sukuk in itself is not a Sharia contract or structure but merely a means to seek funds from the investors against issuing certificates to them. The funds are then utilised in accordance with the objectives laid out in the offering circular (also called prospectus).
Following are some of the most commonly used Sukuk structures:
Sukuk Al Ijara (Leasing Sukuk) is an agreement reached between the investors and the obligor (party needing funds) whereby the investors purchase the obligor’s asset by paying cash and lease the same asset to the obligor for a defined lease term. The obligor (as lessee) pays the lease rent to the Sukuk investors on a periodic basis during the lease term for using the asset, and purchases the asset on maturity of the lease term by making the bullet payment. Sukuk investors receive periodic lease rent during the lease term and are redeemed at the end of it.
Sukuk Mudaraba (Fund Management Sukuk) is when the Sukuk investors enter into a Mudaraba agreement for an agreed period with the obligor and provide the entire Mudaraba capital to it.
The Mudaraba capital is invested by the obligor as per the pre-agreed Sharia-compliant business plan with projection of expected profit submitted by the obligor, which is considered an integral part of the Mudaraba contract. The actual profit is distributed between the investors and obligor during the tenure of Mudaraba as per a pre-agreed distribution ratio.
Upon completion of the Mudaraba tenure, the Mudaraba is liquidated and the capital is returned to Sukuk investors.
Sukuk Musharaka (Partnership/ Joint Venture Sukuk) is a Musharaka agreement where both obligor and sukuk investors contribute capital. The capital contribution by the obligor could be in kind as well, such as a plot of land on which a residential tower needs to be built with cash contribution by the sukuk investors. The Musharaka capital (such as land plus cash) is invested by the obligor as per the Musharaka feasibility study for and on behalf of the Musharaka partners and the profit is distributed as per the pre-agreed ratio between partners.
The Musharaka is liquidated upon completion of the agreed term and the capital is returned by the obligor to the sukuk investors normally by purchasing the sukuk investors’ share of the Musharaka asset.
In a Sukuk Wakala (Investment Agency Sukuk), the sukuk investors provide the entire sukuk amount to the obligor as Wakala capital (now acting as the wakeel or the investment agent) with the instruction to invest it in a Sharia-compliant way for a defined period with the return up to a certain expected threshold.
Malta is ideally placed to tap this accessible liquidity by issuing its landmark sovereign sukuk
The wakeel invests the Wakala sukuk capital accordingly and manages the investment till maturity and provides the sukuk investors with the return expected by the investors and redeem them up on maturity.
The wakeel is not entitled to any right on the profit generated by the Wakala investment however, but sukuk investors may grant the wakeel certain incentive out of the Wakala profit.
A Hybrid Sukuk (Musharaka and Ijara) hybrid structure entails joining hands by the Sukuk investors and obligor as partners under Musharaka whereby upon completion of the project, the Sukuk investors lease their part of the asset to the obligor on an operational or financial lease basis.
In case of an operational lease, the obligor purchases the Sukuk investors’ share in the asset whereas under financial lease, the Sukuk investors are gradually redeemed.
Since the sukuk represent the pro-rated ownership of their holders in the leased asset, and not the debt as in case of conventional bond, there is no Sharia reservation on their being fully tradeable. As such, the Ijara Sukuk can be bought and sold freely in the secondary market, like the shares of a joint stock company.
In such situation, the new purchaser replaces the seller in the pro-rated ownership of the leased asset and all the rights and obligations of the seller are passed on to the new buyer. The selling price of the Sukuk in the secondary market is based on its demand and supply.
Sukuk transactions that result in debt, such as Murabaha, Salam and Istisna, are not tradable since Sharia does not permit sale and purchase of debt. The Mudaraba, Musharaka and Wakala sukuk are tradable since they represent the investment in a project or asset which does not result in a debt.
The UK, Hong Kong, South Africa and Luxembourg have already entered the Islamic capital market by issuing sovereign sukuk. These are non-Islamic countries, which indicates significant change in the perception of the sukuk, besides increasing depth and larger sizes of the issues.
Other countries including Australia, the Philippines, South Korea and Russia have shown moderate to high interest in attempting the Sukuk issuance in the near future.
Facing the North African countries on one side and Europe on the other, besides being a stable European jurisdiction with low foreign debt, Malta is ideally placed to tap this accessible liquidity by issuing its landmark sovereign sukuk.
The sukuk proceeds can be diverted towards country’s various developmental needs which do not raise any Sharia issues, such as roads, bridges, renewable energy, hospitals, technology parks and residential real estate.
While the structure of the Ijara sukuk may be utilised to generate immediate liquidity requirement, the hybrid structure may be ideal for greenfield projects.
The Malta Institute of Management is organising an economic forum on recent trends and developments in Islamic finance on Friday at Xara Lodge, l/o Rabat.
Sohail Zubairi is the CEO of Dar Al Sharia.