Sukuk gif
and bonds, and the legal status of each. The difference between Sukuk and bonds can be most easily seen by defining each term; Bonds are securities in the form of a debt that will be paid back before a certain date, termed the date of maturity, in addition to interest (on this debt). In short, a bond is a debt security in which borrowed money is re- paid along with interest at a fixed rate. Sukuk as well known by now are financial fixed in- come certificates that are permissible within the provisions of Islamic Shariah law as they are raised on trading in, or construction of, specific and identifiable assets (rather than being interest based like bonds).
We can therefore see the basic difference between bonds and Sukuk. Bonds are a proof of debt, whereas Sukuk are a proof of ownership. Bonds also include a fixed rate of interest regardless of loss or gain, while the income from Sukuk is related to the original legal contract that governs the relationship between the Sukuk provider and the cus- tomer (owner of the Sukuk). Bonds expire at their pre-agreed value, whereas Sukuk expire at either their market value, a pre-arranged figure (agreed upon by the two parties) or a fair value.
As a result the Islamic Fiqh Academy issued Resolution 60 (6/11) concerning bonds and it states the following:
The Council of the Islamic Fiqh Academy, in its sixth session held in Jeddah, Kingdom of Saudi Arabia from 14-20 March 1990 studied the papers and recommendations presented and conclusions reached in the seminar held in Rabat [Morocco] between 20-24 1989 on the subject of ‘Financial Markets’ in coopera- tion between the Islamic Fiqh Academy and the Islamic Research and Training Institute of the Islamic Development Bank and hosted by the Ministry of Endowment and Islamic Af- fairs of the Kingdom of Morocco. A bond is a certificate by which the issuer undertakes the liability of paying its face value to the bearer on its maturity along with an agreed interest relating to its value or to a pre-determined profit, either in lump-sum or as a discount or in the form of prizes to be distributed on the basis of ballot resolves.
The most prominent characteristics of con- ventional bonds (interest based) may be sum- marised as follows:
1. Conventional bonds do not represent ownership on the part of the bond holders in the commercial or industrial enterprises for which the bonds were issued. Rather, they document the interest-bearing debt owed to the holders of the bonds by the issuer, the owner of the enterprise. 2. Regular interest payments are made to the bond holders. The amount of interest is determined as a percentage of the capital and not as a percentage of actual profits.
Sometimes the interest is fixed, while often- times in bonds with longer tenures the rate of interest is allowed to float. 3. Conventional bonds guarantee the return of principal when redeemed at maturity, re- gardless of whether the enterprise was profit- able or otherwise. The issuer of such conven- tional bonds is not required to return more than the principal and the agreed amount of interest. Whatever profits may have been earned by the enterprise, accrue entirely and exclusively to the issuer. So the bond holders have no right to seek a share in the profits beyond the interest. On the contrary, these characteristics are not to be found in Islamic Sukuk, at least not directly. Even so, the is- suers of Islamic Sukuk today have attempted to distinguish their Sukuk, however indirectly, with many of these same characteristics. For this reason they have developed a variety of mechanisms of Sukuk, like, Murabaha, Mudaraba, Musharaka, Ijarah and Istisna certificates. 4. The bonds which represent an undertaking to pay its amount along with an interest re- lated to its face value or to a pre-determined profit are prohibited in Shariah. Their issu- ance, their purchase, and their negotiation are all prohibited because they are interest- bearing loans, no matter whether their issu- ing authority belongs to the private sector or is a public entity related to the state. The change in the nomenclature, such as call- ing the bonds “certificate” or “investment securities” or “saving certificates” or calling the interest “profit” or “income” or “service charge” or “commission” has no effect on the aforesaid ruling. 5. The “zero coupons bonds” are also prohib- ited because they are loans sold at a price inferior to their face value, and the owners of such bonds benefit from the difference in their prices which is considered a discount on the bonds. 6. Similarly, “prize bonds” are also prohibited because they are loans in which a liability to pay a pre-determined profit or an additional amount is undertaken in favor of their bear- ers as a whole, or in favor of an undermined number of persons out of them. Moreover, these bonds have a resemblance with gam- bling (“Qimar”). 7. The interest bearing bonds can be substi- tuted by the bonds and certificates issued on the basis of the contract of “Mudharabah” (Profit and loss sharing) meant for a particu- lar project or a particular enterprise, wherein no pre-determined profit or interest shall be paid to the bearers, but they shall be entitled to get a proportional share in the profit of the project in relation to the proportion of their respective investments. This profit cannot be given to them unless it has been actually yielded.
The following table 1 summaries the compari- sons between the conventional bonds and Is- lamic Sukuk.
The Quandary of Substance over Form in
Sukuk: The current global crisis has allowed the Islamic Finance industry some time for re- flection, and as such, when considering the future of the Sukuk market, we explore in detail the issue of substance over form. Su- kuk structures are being tested for the first time by originator insolvency and proposed restructurings. In these more difficult periods it is important that all investors understand that very few existing Sukuk have asset own- ership or security –the majority are unse- cured. Asset-backed Sukuk or Islamic secu- ritisations generally perform very differently from asset–based under stress.
Most Islamic market participants are aware that Sukuk, sometimes known as Islamic bonds, should grant the investor a share of an asset or business venture along with the cash flows and risk commensurate with such ownership. However, while this is indeed the Shariah ideal’, most current structures have more in common with conventional fixed in- come or ‘debt’ instruments from a risk/return perspective. The recent highly successful In- donesian sovereign Sukuk ($650 million) shows there is still heavy demand for these unsecured, asset ‘based’ structures, although the recent bonds of Qatar and Abu Dhabi were not Sukuk. The assets in the structure are commonly for Shariah compliance only, and ultimately have little or no bearing on the risk or performance of the Sukuk. Investors should note that, while all conventional as- set-backed securities (ABS) are not Sukuk, a true asset-backed Sukuk is accessible to the whole universe of global ABS investors, and not just to the much smaller Shariah compli- ant investor base.
The disparity between the ‘ideal’ and the ‘re- ality’ of Sukuk was highlighted by AAOIFI in February 2008, when it published six princi- ples regarding Sukuk structures (refer to An- nexure I) and initially noted that around 85 percent of existing Sukuk were not in com- pliance with these principles. Subsequently, many sources attributed the market decline to these statements. In reality, the decline in Sukuk market volume in 2008 probably had also to do with the prevailing global credit market conditions (it was a very difficult time to raise funds, whether conventional or Islam- ic) rather than to any direct reaction to the AAOIFI statements.
As we strive to strip away the sometimes ex- cessive structural and legal complexity and confusion surrounding Sukuk products, get- ting to the real ‘substance’ of the Sukuk with- out being distracted by the ‘form’. This focus on the substance of the risk and return is helpful when trying to assess a product’s com- pliance with a given set of Shariah principles or views. While terms such as Mudarabah, Musharaka and Ijarah are widely applied, the actual legal structure behind the ‘name’ and
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