Sukuk

Sukuk (; plural of ) is the Arabic name for financial certificates, also 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.

Sukuk were developed as an alternative to conventional bonds, which are not permissible in Islam as they pay interest (prohibited or discouraged as Riba, or usury), and also may finance businesses involved in activities not permitted under sharia (gambling, alcohol, pork, etc.). Sukuk securities are structured to comply with sharia by paying profit, not interest—generally by involving a tangible asset in the investment. For example, sukuk securities may have partial ownership of a property built by the investment company (and held in a Special Purpose Vehicle), so that sukuk holders can collect the property's profit as rent (which is allowed under Islamic law). Because they represent ownership of real assets and (at least in theory) do not guarantee repayment of initial investment, sukuk resemble equity instruments, but like a bond (and unlike equity) regular payments cease upon their expiration. However, most sukuk are "asset-based" rather than "asset-backed"—their assets are not truly owned by their Special Purpose Vehicle, and their holders have recourse to the originator if there is a shortfall in payments.

According to the State of the Global Islamic Economy Report 2016/17, of the $2.004 trillion of assets being managed in a sharia compliant manner in 2014, $342 billion were sukuk, being made up of 2,354 sukuk issues.

Etymology

The Arabic term ṣakk was borrowed from Classical Persian چک (čak, “legal document, document, contract, deed of sale, bill”).

History

In the classical period of Islam, sakk (sukuk) meant any document representing a contract or conveyance of rights, obligations or monies done in conformity with Shariah. The term was used to refer to financial obligations originating from trade and other commercial activities in the Islamic pre-modern period.

According to Camille Paldi, the first sukuk transaction took place in Damascus in its Great Mosque in the 7th century AD. Muslim traders are known to have used the cheque or ṣakk system since the time of Harun al-Rashid (9th century) of the Abbasid Caliphate.

The modern Western word "cheque" appears to have been derived from "sakk" (singular of sukuk), which during the Middle Ages referred to a written agreement "to pay for goods when they were delivered" and was used to "avoid money having to be transported across dangerous terrain".

;Modern

Answering a need to provide short and medium term instruments so that balance sheets of Islamic financial institutions could be more liquid, the Fiqh academy of the OIC (Organization of Islamic Countries) legitimized the use of sukuk in February 1988. The next major sukuk issuances were by Kuala Lumpur International Airport for RM2.2 billion each in 1996 and 1997. 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.

To standardize the growing market, the AAOIF issued "Shari’ah Standard No.17" on "Investment Sukuk" in May 2003. It became effective starting 1 January 2004.

Industry

{| class="wikitable" style="float: right;"

!colspan=2|International Sukuk Issuance

|2007||$13.8 billion

|2015 || >$100 billion

|2016 || $72.9 billion

!colspan=2|<small>SOURCES: 2012 International Islamic <br>Financial Market report p. 12, <br>Forbes,</small>

As of early 2017, there were US$328 billion worth of sukuk outstanding worldwide. As of the end of 2016, there were about 146 US dollar-denominated, Islamic fixed income securities issued in the global markets, that were investment-grade, and had a duration of at least one year. These securities—which make up the Citi Sukuk Index—had an average maturity of 4.54 years, and most were issued by governments. The top four issuers by market weight—making up over 40% of the market—were: ISLAMIC DEVELOPMENT BANK, PERUSAHAAN PENERBIT SBSN INDOIII, SAUDI ELECTRICITY CO, and SOQ SUKUK A QSC. and as of 2015, there were 2,354 sukuk issues in total, including local currency denominated, non-global market sukuk, according to Thomson Reuters & Dinar Standard. As of July 2014 sukuk.com listed fifteen sukuk on the secondary market for Gulf sukuk.

Principles

Ali Arsalan Tariq states that Islamic finance—including sukuk—is based on a set of several prohibitions:

Transactions in unethical goods and services;

While a bond is a contractual debt obligation of the issuer to pay to bondholders, on

certain specified dates, interest and principal, a sukuk is a certificate giving its holders an undivided beneficial ownership in the underlying assets. Consequently, sukuk holders are entitled to share in the revenues generated by the sukuk assets as well as being entitled to share in the proceeds of the realization of the sukuk assets.

Similarities with bonds

Sukuk and bonds are sold to investors who receive a stream of payments until the date of the maturity of the sukuk or bond, at which time they get their original investment (in the case of sukuk a full payment is not guaranteed) back.
Sukuk and bonds are intended to provide investment with less risk than equities (such as shares of stock) and so are often used to "balance a portfolio" of investment instruments.
Both sukuk and bond issuers must issue a disclosure document known as a prospectus to describe the security they are selling.
To give investors an idea of how much risk is involved in particular sukuk/bonds, rating agencies rate the credit worthiness of the issuers of the sukuk/bond.
Both sukuk and bonds are initially sold by their original issuers. After that they (or some sukuk and bonds) may be bought and sold by brokers and agents, mostly on the over-the-counter (OTC) market, but are also available on some stock exchanges around the world.

Differences from bonds

Ownership: Sukuk should indicate partial ownership of an asset. Bonds indicate a debt obligation.
Compliance: The assets that back sukuk should be compliant with Shariah. Bonds need only comply with the laws of country/locality they are issued in. The sale of bonds is the sale of debt. Bond investors are guaranteed the return of their initial investment/principal. In practice some sukuk are issued with repurchase guarantees.

Definitions, structure and characteristics

;Definitions

The AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions, the body which issues standards on accounting, auditing, governance, ethical, and Shari'a standards) defines sukuk as "securities of equal denomination representing individual ownership interests in a portfolio of eligible existing or future assets," or "'certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity'."

The Islamic Financial Services Board defines sukuk as: <blockquote>certificates with each sakk representing a proportional undivided ownership right in tangible assets, or a pool of predominantly tangible assets, or a business venture. These assets may be in a specific project or investment activity in accordance with Sharia rules and principles.</blockquote>

The Securities Commission of Malaysia defined sukuk as a document or certificate which represents the value of an asset. While a conventional bond is a promise to repay a loan, sukuk constitute partial ownership in a debt, asset, project, business or investment.

debt (sukuk murabaha). These sukuk are not common because their payments to investors represent debt and are therefore not tradable or negotiable according to sharia. (If diluted with other non-murahaha sukuk in a mixed portfolio they may be traded).
asset (sukuk al ijarah). These are essentially rental or lease contracts, or conventional lease-revenue bonds. With these sukuk, the borrower's tangible asset is 'sold' to the financier and then 'leased' back to the borrowers. The borrowers then make regular payments back to the financiers from the income stream generated by the asset. and have been described (by Faleel Jamaldeen) as well known because of there simplicity, tradability and ability to provide a fixed flow of income. Sukuk al-salam are (at least usually) used to support a company's short term liquidity requirements.
project (Sukuk al istisna). These sukuk are complex and cannot be traded in the secondary market or sold to a third party for less than its face value.
business (sukuk al musharaka). These sukuk holders are also the owners of the originator issuing the sukuk and participate in the decision-making. These sukuk can be traded in the secondary market.
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 Bank or Clearstream Banking SA. 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 ijarah, by the issuer. In the meantime rent is paid, which is often benchmarked to an interest rate (LIBOR is the most common though its use is criticized by some Sharia scholars).

The most accepted structure, which is tradable, is the sukuk al ijarah. 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).

Issuing and payment process

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

The originator—a business firm requiring capital—creates a special purpose vehicle (SPV), an independent entity and structures. The SPV protects the sukuk assets from creditors if the originator has financial troubles. It specifies what asset or activity the sukuk will support, how large the issuance of sukuk will be, their face amounts, interest rates, and maturity date. SPVs are often located in "tax-efficient jurisdictions" such as Bahrain, Luxembourg or the Cayman Islands.
The SPV issues the sukuk offering it for sale to investors with an agreement spelling out the relationship between obligator and sukuk holders (depending on the type of sukuk this can be lessor and lessee, partner, etc.).
With the money from the sale of sukuk certificates, the SPV passes the offering to the originator who makes the sharia compliant asset purchase, lease, joint venture, etc. (again depending on the type of sukuk).
The SPV purchases assets (such as land, building, machinery, etc.) from the originator.
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, the 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.

Example

thumb|right|500px| Structure of a $100 million sukuk issued by the Tabreed Financing Corporation in March 2004

An example of a sukuk was a $100 million security used to finance the construction and delivery of cooling plants in Abu Dhabi. This sukuk had an istisna'a and ijarah structure and was issued by the Tabreed Financing Corporation (or National Central Cooling Company PJSC) in March 2004.

Tabreed created an SPV (incorporated in the Cayman Islands), which sold certificates of sukuk bonds.
With the proceeds of this sale it bought some partially completed central cooling plants ("assets" held in trust for the sukuk).
"Complex financial products and corporate structures" in some countries/jurisdictions because "regulatory and supervisory frameworks" do not "address the unique risks of the industry". Consequently, what is needed is "increased regulatory clarity and harmonization, better cooperation between Islamic and conventional financial standard-setters, and further improvement of supervisory tools".

;Defaults

In three years during and following the 2008 financial crisis—2008, 2009, 2010—there were at least 21 substantial sukuk defaults,

and several large near defaults such as that of Dubai World, which was saved by a $10 billion loan from Abu Dhabi 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 the $650 million Golden Belt 1 sukuk. Standard & Poor's cut the rating of that sukuk "owing to the non-availability of vital information".

;Protection from originator's default

Fitch Ratings, one of the three major bond rating agencies for the US, has indicated doubts about the "validity" of transfer of assets from the originator in sukuk in the "event of an insolvency of the originator" and attempts by creditors to seize the assets. "Fitch has not reviewed any transaction to date that would satisfy these requirements."

According to Ibrahim Warde, as of 2010,

<blockquote>What is still 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 Eastern 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.</blockquote>

In reviewing cases of sukuk defaults and bankruptcies, Muddassir Siddiqui complained that: <blockquote>Through reading many cases that have so far been litigated in courts around the world, I have found that in almost all cases, the courts have struggled to reconcile the substance and form of the contract. Was it a sale, lease, construction or partnership contract or a financing arrangement between the parties?</blockquote>

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.

;Discrediting Sharia compliance

There have been at least two cases of companies seeking to restructure their debt (i.e. pay creditors less), claiming that debt they had issued was not in compliance with sharia. The issue has been called "one of the greatest challenges that the Islamic finance industry has faced in recent times", but the idea that the case is "a blow to Islamic finance" has also been dismissed as "poppycock". and imitating conventional bonds. Sheik Taqi Usmani, stated that as many as 85 percent of sukuk sold to date may not comply with all the precepts of Shariah. In a paper entitled "Sukuk and their Contemporary Applications" released in November 2007, Usmani identified the following three key structuring elements that differentiate sukuk from conventional bonds: Usmani's estimate that 85% of all sukuk in issuance were not Shariah-compliant was based on the existence of guaranteed returns and/or repurchase obligations from the issuer—a violation of shariah.

Following Usmani's criticisms the global sukuk market shrunk from US$50 billion in 2007 to approximately $14.9 billion in 2008, although how much of this was due to his criticisms or the 2008 financial crisis is a matter of debate.

The Financial Times has described this as an "ongoing" debate over "form versus substance" in Islamic finance, identifying two kinds of sukuk—"asset-backed" sukuk and the more numerous, less strict, allegedly non-compliant "asset based" sukuk. In an "asset-backed" sukuk there is "a true sale between the originator and the special purpose vehicle (SPV) that issues the sukuk and sukuk holders do not have recourse to the originator". Asset prices may vary over time. In contrast "asset-based" sukuk do give their holders recourse to the originator, and so more closely resemble conventional bonds.</blockquote>

He also complains that despite claims that sukuk—unlike conventional bonds—share the risk of their underlying asset and may increase or decrease in value, in sukuk such as the Tabreed sukuk mentioned above, steady payment of "rent" is written into the sukuk contract, giving them a risk structure "essentially" the same as conventional bonds.

Another observer, Salman Ali, found that many sukuk structures "do not conform to the Shariah".

In 2011, Safari conducted various statistical and econometrics tests to check the argument that sukuk securities are merely the same as conventional bonds. 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. In 2011 Goldman Sachs abandoned a $2 billion sukuk programme it had registered with the Irish Stock Exchange, after some analysts stated that its sukuk "might violate Islamic bans on interest payments and monetary speculation" (in 2014 it successfully drew about $1.5 billion in orders for the five-year sukuk).

Countries using sukuk

Bahrain

Bahrain is a major issuer of sukuk.

Bangladesh

In August 2020, Bangladesh Bank took initiatives to implement sukuk with the help of national private Islamic banks.

Brunei

Starting in 2006 the government of Brunei began to issue short-term sukuk al-ijarah securities. As of 2017 it has issued B$9.605 billion worth.

Egypt

On 8 May 2013, Egyptian President Muhammad Morsi approved a law allowing the government to issue sukuk. However as of May 2013 the relevant regulations have not been specified and this law has been replaced by amending some new articles in the capital market law and its executive regulations. As of 2016 the Egyptian government stated it would use "innovative financial tools for the implementation of government projects", such as sukuk.

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.

Indonesia

According to islamicfinance.com, at the end of 2013 outstanding stock in Indonesia's sukuk market was US$12.3 billion, with growth driven by the government sector.

Iran

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 Iranian rials.

Malaysia

More than half of sukuk issued worldwide are denominated in Malaysian ringgit, with the United States dollar coming second. 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.

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 ijarah, musharaka sukuk and investment funds.

Kyrgyzstan

Kyrgyzstan introduced sukuk into its securities law in 2016, but the first sukuk (a privately placed mudarabah sukuk) was only issued in 2023, followed by a number of issues of sukuk al-wakalah bi al-istithmar, an investment agency certificate. Kyrgyzstan’s government set a goal to make the Kyrgyz Republic an Islamic finance hub.

Kuwait

Pakistan

Pakistan issued a sukuk of $1 billion to fund a trade deficit with a yield of 5%.

Philippines

The Securities and Exchange Commission has issued guidelines regarding the issuance, registration and disclosure of sukuk through SEC Memorandum Circular No. 12 in early 2026. The Philippine government made its first sukuk bonds sale in December 2023, raising .

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. In September 2017, the government sold further domestic sukuk worth 7 billion riyals (US$1.9 billion) and another 4.77 billion riyals (US$1.27 billion) were sold in December. These combined five-year sukuks priced at 2.75%, seven-year ones at 3.25%, and a ten-year tranche at 3.45%. 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 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 Flydubai. The UAE has also attracted Western investment in the form of GE, which sold a 5-year, $500 million sukuk in 2009, and investment banker Goldman Sachs, which became the first conventional U.S. bank to issue sukuk in 2014.

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 the middle of 2015. It issued its first sukuk, a 5-year $1 billion ijarah 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%.