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by Rodney Wilson
Executive Summary
Conventional bills, bonds, and notes which pay interest are unacceptable from an Islamic perspective. Tradable financial instruments using Islamic structures were introduced in Pakistan in 1980 and Malaysia in 1990. The defining characteristic of sukuk is their asset backing. There remains much controversy over sukuk structures, especially amongst shariah scholars. There is growing worldwide interest in sukuk, including from the Treasury in the United Kingdom.
jurisprudence which prevails in Malaysia and Indonesia, but is not permitted in Saudi Arabia or the Gulf. Scholars of Islamic jurisprudence in the Gulf believe that debtors should know who they are indebted to, rather than having their debt obligations traded in an impersonal market.
Asset-Backed Sukuk
Given the concerns with bai al-dayn, it became clear that an alternative approach was needed to the securitization of debt instruments, and it was this that resulted in the emergence of sukuk. The defining characteristic of sukuk is that they are asset backed, which implies that when they are traded the investors are buying and selling the rights to an underlying real asset, usually a piece of real estate or a movable asset such as equipment or vehicles. It is this that makes the transaction legitimate, as under sura 2.275 in the Quran, it states that God hath permitted trade but forbidden riba. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has stated that for sukuk, to be tradable, (they) must be owned by sukuk holders, with all the rights and obligations of ownership in real assets.
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Again, it was Malaysia that took the lead in sukuk issuance, the first being for Malaysian Newsprint Industries in 2000, with an eight-year maturity. It was, however, the Malaysian governments global sukuk in June 2002 that brought international attention, this being the first ever sovereign sukuk, with maturity after five years, the sum raised being $US 600 million. State-owned land provided the asset backing, and an ijara structure was used, with the government selling the land to a special purpose vehicle (SPV) and leasing it back, and the investors in the SPV receiving a rental income as indirect owners rather than interest payments. The returns were, however, benchmarked to the London Inter-Bank Offer Rate (LIBOR), the return being LIBOR + 0.95%, which meant the sukuk had similar financial characteristics to a floating rate note. HSBC Amanah the Islamic finance affiliate of HSBC acted as arranger. Since 2002 sukuk issuance has risen remarkably, with sukuk issuance peaking at $US 46.6 billion in 2007, representing 205 issuances. The subprime crisis in asset-backed securities had a negative impact on sukuk issuance from August 2007 onward, demonstrating that Islamic finance was not immune from global financial developments. However, it mainly affected dollar-denominated issuance, as issuers who were asked to pay much more for their financing decided to postpone or abandon planned sukuk. Hence, US dollar-denominated issuance fell to just over $US 1 billion over the September 2007 to September 2008 period. Sukuk issuance in other currencies was less affected, however, with the equivalent of $US 15.4 billion issued in Malaysian ringgit over the same period, and $US 6.6 billion in UAE dirham, even though the latter currency is pegged to the dollar. The need for funds for project finance continues to propel sukuk issuance in the Gulf, with the Saudi Arabian Basic Industries Corporation, the regions leading petrochemical producer, issuing sukuk worth $US 1.3 billion in May 2008, with the sukuk being riyal-denominated and paying SAIBOR (Saudi Arabia Inter-Bank Offer Rate) plus 48 basis points over a 20-year period. AAOIFI has identified 14 types of sukuk with different risk and return characteristics. Salam sukuk, for example, are a short-term substitute for conventional bills, as they yield a fixed return, usually over a 90-day period, and are regarded as very low-risk instruments, not least because the issuers are usually sovereign governments rather than corporate clients. The major limitation of salam sukuk, however, is that they cannot be traded, unlike treasury bills, as the investors are paying in advance for the delivery of an asset in 90 days. Under shariah investors can only trade assets they own, and not those that they hope to own at a future date. With the ijara sukuk cited above there is a return risk, as payments are usually linked to LIBOR which varies, and typically the issuance is for three to five years, which increases the possibility of default risk. Ijara sukuk can, however, be traded as the investors have a title to the underlying assets. This also applies in the case of mudaraba sukuk, which in some respects are less risky than their ijara equivalents as they pay a fixed return.
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years ahead the Qatar Financial Centre may well become a major center for sukuk trading, contributing to the countrys diversification into financial services. The temporary pause in dollar-denominated sukuk issuance provides an opportunity for reviewing sukuk structures, and in this context the debate that followed Sheikh Taqi Usmanis remarks is timely. There can be no doubt that once the market in conventional asset-backed securities revives internationally, dollardenominated sukuk issuance will revive. The weakness over the 200007 period, however, was that although there was much new sukuk issuance, trading was limited, apart from in Kuala Lumpur in ringgitdenominated sukuk. The investment banks and regulators of financial centers in the Gulf, and indeed London, will have to consider how more active trading can be facilitated, as until this occurs sukuk will not fulfill their potential in providing long-term financing while maintaining investor liquidity.
More Info
Books:
Nathif, Adam, and Thomas Abdulkader. Islamic Bonds: Your Guide to Issuing, Structuring and Investing in Sukuk. London: Euromoney Books, 2004. Obaidullah, Mohammed. Securitization in Islam. In Handbook of Islamic Banking, M. Kabir Hassan and Mervyn K. Lewis (eds). Cheltenham, UK: Edward Elgar, 2007, pp. 191199.
Articles:
Cox, Stella. The role of sukuk in managing liquidity issues. New Horizon: Global Perspective on Islamic Banking and Insurance 163 (JanuaryMarch 2007): 3839. Online at: www.newhorizonislamicbanking.com/index.cfm?action=view&id=10430§ion=features Jabeen, Zohra. Sukuk as an asset securitisation instrument and its relevance for banks. Review of Islamic Economics 12:1 (2008): 5772. Samsudin, Anna Maria. Sukuk strikes the right chord. Islamic Finance Asia (August/September 2008): 1624. Online at: www.islamicfinanceasia.com (click on Archives). Wilson, Rodney. Innovation in the structuring of Islamic sukuk securities. Humanomics: The International Journal of Systems and Ethics 24:3 (2008): 170181.
Report:
Islamic Financial Services Board. Exposure draft on capital adequacy requirements for sukuk securitisations and real estate. Online at: www.ifsb.org/docs/ed_sukuk_english.pdf
Website:
Accounting and Auditing Organization for Islamic Financial Institutions: www.aaoifi.com
Notes
1 Accounting and Auditing Organization for Islamic Financial Institutions. Shariah Board Statement. Bahrain (February 13 and 14, 2008), p. 1. www.aaoifi.com/sharia-board.html 2 HM Treasury. Government Sterling Sukuk Issuance: A Consultation. London, November 2007, p. 3. Online at: www.hm-treasury.gov.uk/5703.htm To see this article on-line, please visit
http://www.qfinance.com/raising-finance-best-practice/islamic-capital-markets-the-role-of-sukuk?full
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