The Development of Sukuk
Of growing importance, particularly in the last decade, has been the development of sukuk (Islamic bonds). Sukuk arose as a natural response to the remarkable growth of Islamic financial services and allowed Islamic banks, companies, and sovereigns to raise shariah-compliant funds through the market. It is this development in fact which has led to the growth of an Islamic capital market, though trade in shares of Islamic banks, takaful companies (or companies whose activities comply with shariah) is always feasible.
According to the Accounting and Auditing Organization for Islamic Financial Institutions' (AAIOFI) definition of investment sukuk (Shariah Standard 17), there are 14 possible forms that these can take. However, sukuk development meant approval of securitization within Islamic finance. Within the shariah framework the scope of assets that can be pooled, designated, and packaged for securitization is comparatively limited. The ijara contract has been widely accepted by fuqaha (Muslim jurists) for securitization, since sukuk will rightly be backed by physical assets and financial rights over usufruct. Contracts such as murabaha, istisna, or salam cannot be securitized because they are debt arrangements. According to shariah, debt-based contracts cannot be traded in secondary markets, If this is done it would typically mean trade in money and involvement in riba. Yet, the decision of the Organization of the Islamic Conference’s Fiqh Academy (Number 5, Fourth Annual Plenary Session, Jeddah, 1988) opened the door for assets in the form of money or debt (for instance, istisna and murabaha) to be exceptionally securitized if mixed in “minor proportion” with physical assets (ijara).
Under shariah principles of interest prohibition and profit/loss sharing, no guarantee can be given in respect of either regular payment to sukuk holders or redemption of the sukuk’s face value. This goes against conventional market practices. Payments to sukuk holders should be made from the actual or realized cash flow of the investment that is based on the assets in the underlying pool. However, guarantees of performance, collateralization attached to sukuk, and their rating by conventional standards (Fitch or Standard & Poor’s) imply the existence of mechanisms that secure a regular known flow of income to sukuk and redemption of their full face value. For example, in the Islamic Development Bank (IDB) sukuk issue of US$400 million in 2003, returns were calculated on a fixed-rate basis of 3.635% per annum until their full redemption in 2008. The same principle applies to all the sukuk issued by sovereigns, and Salman Syed Ali (2005) observes that “rents payable to sukuk holders are not necessarily generated from the use of sukuk assets but from general revenues and other earnings of the state enterprise.”
All this throws doubt on the genuine submission of sukuk to the principle of profit/loss sharing. Besides, the exception made for possible securitization of murabaha and istisna assets in “minor proportion” with ijara assets has been widely extended. As in the case of IDB’s US$400 million sukuk of 2003, the “minor proportion” of murabaha and istisna assets reached 49% of total tangible assets. More serious in this case is that under exceptional circumstances the composition of ijara assets can fall temporarily under 51%, but not to a minimum of 25%, of the total pool of assets!
In practice, therefore, the gap between Islamic sukuk and conventional bonds has narrowed considerably. In future issues, sukuk should stick strictly to shariah rules if they are not to be confused in the markets with conventional bonds.
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