CONTROVERSY - ARE EXISTING SUKUKS SHARIAH COMPLIANT?

Wow, the statement itself is full of controversy – well, let me tell you what actually happened.

There was an article initially carried by Bloomberg, a financial news agency, specifically attributed the fall-off in sukuk last year due to a fatwa issued in early 2008 by the Bahrain-based Accounting & Auditing Association for Islamic Financial Institutions (AAOIFI) essentially deeming the majority of issuance thus far non-shariah-compliant and setting out a stricter series of principles necessary for religious acceptability.

AAOIFI’s doubts first hit the headlines in late 2007 when the body’s influential scholar and chairman Sheikh Mohammed Taqi Usmani told a conference that some 85% of outstanding sukuk failed the shariah-compliance test on the basis that they were asset-based rather than asset-backed - with the issuer undertaking to pay back the face value of the bond on maturity and without the buyers truly owning the underlying asset - mimicking a conventional bond through a guaranteed return and a lack of the profit and loss-sharing required under Islamic financial tenets.

A more detailed pronouncement was published by the AAOIFI board in February, the first point of which covered this area, stating that ownership of the relevant assets were required to be legally transferred to the sukuk-holders. The fatwa ruled unacceptable the extension of “loans” from the borrower to the investors to make up for any shortfall in the return on the assets - in effect offering an assured rate of return - while barring guarantees to repurchase the bonds for a nominal value at maturity, except in the case of the ijara, or leaseback, structure.

AAOIFI also called for closer scrutiny by shariah boards of the documentation detail of particular issues, rather than accepting the nominal structure at face value - a development that has for some time been advocated more broadly among conservatives in the Islamic banking community, complaining that overstretched or inexperienced scholars are frequently misled by issuers and their financial advisers over the true shariah-compliance of a transaction’s contractual framework.

The statement ended with an explicit exhortation for a return to basic principles: “The (AAOIFI) shariah board advises Islamic financial institutions to reduce their involvement in debt-related operations and to increase true partnerships based on profit and loss-sharing in order to achieve the objectives of shariah.”