This article examines the following:
Understanding the particular appeal sukuk has to investors.
Notable defaults and near-defaults of sukuk and the effects on the market.
Case study: Nakheel sukuk—a lesson to learn for Islamic finance.
Issues of enforceability in light of sukuk defaults.
Jurisdictional response to legal issues surrounding sukuk.
According to the Kuala Lumpur-based Islamic Financial Services Board, a standards body for the Islamic finance industry, the Islamic finance industry is a roughly US$1 trillion asset that may almost triple to US$2.8 trillion by 2015. Arguably, sukuk is the catalyst that has put the Islamic finance industry on the global capital market map. Despite being the flagship product of the burgeoning Islamic finance industry, the sukuk market has not been immune to the economic downturn. Marketed often as a safer alternative than conventional bonds, the subsequent near and actual sukuk defaults have raised questions about sukuk-holders’ rights, how they will be treated, and what sukuk entails. A closer examination is required of the structural deficiencies of some sukuk structures that may result in nullifying the recourse of investors and the enforceability of sukuk contracts. Based on the above, we discuss bankruptcy resolution and investor protection in sukuk markets.
Sukuk by Any Other Name
Although a rose by any other name may well be a rose, a sukuk by any other name is not a sukuk. A commonly held description of sukuk, both within and outside the Islamic space, is one of an Islamic bond. Although many sukuk structures are designed to replicate the economic function of conventional bonds, their legal structures are different. “Any references to sukuk as being Islamic bonds are oxymoronic and misleading to investors who may believe they have certain bond-like remedies that, ultimately, may not be enforceable in some Islamic jurisdictions.”1 The Accounting and Auditing Organization for Islamic Financial Institutions’ (AAOIFI) shariah Standard no. 17 on investment sukuk carefully distinguishes sukuk from equity, notes, and bonds. It emphasizes that sukuk are not debts of the issuer; they are fractional or proportional interests in underlying assets, usufructs, services, projects, or investment activities. Sukuk may not be issued on a pool of receivables. Nevertheless, the importation of provisions and conventional contractual risk transfer covenants into the overall sukuk structure is the primary link between sukuk and bonds.
Given the standardized nature of conventional bond transaction in terms of (a) the relative rights and remedies of the parties, (b) the terms of many financial and commercial risk allocations, and (c) the legal documentation, one begins to understand the rationale for embedding the conventional provisions and covenant within sukuk structures. Shariah-compliant transactions of this type have not yet obtained an equivalent degree of standardization or concomitant certainty, consistency, predictability, or transparency, especially as to enforcement of the shariah, hence the importance of the work of the International Islamic Financial Market (IIFM) in its development of standardized Islamic financial transaction agreements. As long as the Islamic finance industry continues to play catch-up in term of contractual standardization, the sukuk investor may be left with cosmetically comforting structured Islamic notes that may lack the same legal safeguards and risk profile as the conventional bond to which they are often compared. Therefore, there is all the more reason to understand the sukuk structures, and in the event of default to know what, if any, recourse an investor would have under those structures.
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