gif Sukuk
Shaher Abbas, Shari’ah Advisor and Auditor for Islamic Finance Advisory and Assurance Services, United Kingdom
The Sukuk industry is growing at an unprec- edented rate. Do you expect this growth to be consistent? Although historically concentrated in the Gulf and south-east Asian countries, Islamic fi- nance has shown strong growth over the last decade in many different parts of the world. This strong growth has been generated main- ly by the significant increase in the issuance of Sukuk. Interest in this new Islamic capital market product is encouraging a wide spec- trum of countries in Europe and the far east to modify their approach towards Islamic finance, in order to accommodate Sukuk issuance. In the wake of the ‘Arab Spring’ and the recent political developments across the Arab world, which brought significant changes to almost all North African countries, the new-formed governments are now more receptive to con- sidering this potential funding instrument. The West African Economic and Monetary Union (UEMOA) is currently reviewing its legislation to allow provisions for Islamic banking and Sukuk issuance. Together with the ongoing expansion of Islamic finance in east Africa, and positive measures taken by a vast number of countries, these events point to a sustainable growth for Sukuk over the years to come.
Why is Sukuk becoming an increasingly pop- ular commodity within Islamic finance and banking? Sukuk is the backbone of the Islamic finance and banking industry. It is used as a real al- ternative to conventional financial products by most financial institutions, governments, corporate organisations (Islamic and conven- tional) and investors. Due to Sukuk’s popular- ity, the number of Islamic financial institutions and other parties interested in the industry is growing continuously. Sukuk serves various purposes for these institutions and individuals, providing access to the Islamic capital market, a tool for the management of liquidity, a new asset class for investors and a new funding channel for governments. Sukuk’s provision of direct ownership of the underlying asset, and the right to sell in case of default by the issuer, makes it more popular in the eyes of investors, who usually prefer to have optimal ownership and control over their assets.
Description Financing Category Underlying Capital Total Returns Objectives of Funding Bond Debt instrument
No underlying asset usually, unless forming part of collateral
Guaranteed
Fixed income (known/ predetermined cash flows)
Unrestricted 56 Global Islamic Finance April 2012
What does the future hold for the Islamic Su- kuk sector? The market for Sukuk is growing rapidly year- on-year, as is the demand for new issuance of Sukuk, backed with different types of assets. This growing demand will be the main engine behind future expansion of the Sukuk sector. However, the industry urgently needs to resolve issues such as the struggle between innova- tion and standardisation, and between credit risk and rating considerations, in order to un- lock the huge potential of Sukuk as a product. Many institutions and individuals have called for standardisation of the Islamic finance and banking industry. So far, AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions) and IFSB (Islamic Financial Serv- ices Board) have both done a lot of work to- wards this goal. However, the standardisation process may take a long time. This should not hinder efforts to innovate new products, which are urgently needed at this early stage of the industry’s life.
The other important issue that we need to resolve is problems with solicitors and other industry professionals’ understanding of the nature of Sukuk, and of the credit and others risks associated with this product. Most insti- tutions currently work on the assumption that Sukuk is a substitute to conventional bond products, and make their analysis and judg- ment on Sukuk as a product based on this as- sumption. Unfortunately, many Sukuk products have been developed with this issue in mind, which undermines the development process, and leads in many cases to a replication, in substance, of a conventional bond.
A lot of hard work still needs to be done in order to create better awareness among the industry practitioners, and to impress on them that Su- kuk is a wholly different asset class, requiring a different approach towards credit and legal analyses to that usually taken towards conven- tional bonds. Until new mitigation tools are de- veloped to tackle the specific risks associated with Sukuk, Sukuk’s real potential will remain overshadowed by conventional bonds, and by the performance of the conventional capital market.
How does Sukuk differ from conventional bonds? Sukuk differs from conventional bonds in both substance and form. The following table pro- vides a snapshot of the main differences be- tween the Sukuk and conventional bonds:
Sukuk
New asset class, representing undivided owner- ship of specific underlying assets
Underlying asset is compulsory, usually a tangible asset
No capital guarantee, but capital protection might be provided
No guarantee of overall returns Restricted for use in Shari’ah-compliant assets References and Further Reading
• Ayman H. Abdel-Khaleq and Pe- ter Young, Vinson & Elkins RLLP, (2008)
“Structuring and Of-
fering Sukuk Products Involving Assets in the US: Challenges and Opportunities”, pp 56. • Abozaid, A & Al-Jarhi Mabid, (2010), “Reasons for Failure of Some Sukuk Issuances”, Inter- national Fiqh Academy, IRTI & Is- lamic Economics Research Center Conference, Islamic Sukuk: Exam- ination & Reevaluation, King Ab- dul Aziz University & Westin Hotel, Jeddah, Saudi Arabia, May 24-25. • Central Bank of Malaysia Finan- cial Stability and Payment Sys- tems Report (2007), pp 56-57, website:
http://www.bnm.gov.my/ files/publication/fsps/bm/2007/ cp02_rencana_01.pdf • General Council for Islamic Banks and Financial Institution, Islamic Financial Industry News Cen- tre, website:
http://www.cibafi. org/newscenter/english/Spe- cificProductsAndServicesNews. aspx?SubC=70 (accessed on 4th February 2011) • Islamic Financial Training, “Sukuk & Islamic Capital Markets: Prod- ucts & Documentation”, website:
http://www.islamicfinancetrain-
ing.com/sukukpdnov.php • Muhammad Taqi Usmani, presi- dent of the AAOIFI Shariah Coun- cil, “ Sukuk and Their Contempo- rary Applications, website: http://
www.failaka.com/downloads/Us- mani_SukukApplications.pdf (ac- cessed on 6th February 2011) • Malaysian Debt Securities and Su- kuk Market, (2009). “A Guide for Issuer and Investor”, A joint Pub- lication by Central Bank of Malay- sia and Securities Commission Malaysia, pp 29-34.
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