HOW DID SUKUK FARE IN 2008 ?

The Global Sukuk Report 2008 by Global Investment House cited that the amount raised by sukuk, or Islamic bonds, totalled $15.1 billion US Dollars last year, compared with $33.1 billion in 2007. At the same time however, the number of sukuk issued worldwide increased from 129 to 165 in 2008.

The impact of the global financial downturn has only recently begun to be felt in the Gulf region. Consequently, the Global Investment House report recorded that the majority of sukuk were issued in the first three quarters of 2008, with only 26 sukuk issued in the final three months - an indication of the correlation with the impact of the global economic slowdown on the region.

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At the same time, the market for sukuk issuance, and Islamic finance instruments in the Gulf was noted to be growing. The Gulf Cooperation Council (GCC) was the largest issuer of sukuk last year, followed by Malaysia.

"The Islamic bond market is still concentrated in the GCC region and Malaysia, in terms of dollar amount. GCC countries accounted for 55.5 per cent of the dollar amount issued, while Malaysia accounted for 36.3 per cent," according to the report's findings.

The market share for sovereign issued sukuk is also increasing, with 73 sovereign sukuk issued in 2008, compared to 32 in 2007, an indication of the growing importance of the debt instrument to raise government funds.

Over half of Gulf states are already issuing sovereign sukuk, with the UAE leading the way.

In 2008, the UAE was the second largest market for sukuk raising, with Dh19.5 billion raised from 10 issues.

This was marginally behind Malaysia, which raised Dh20 billion. The only other country to have raised over $1 billion from sukuk was Saudi Arabia, out of a total of ten states which issued sukuk last year.

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.”

SUKUK

I was reading a book on Corporate Finance just now and suddenly I remembered about sukuk. However, not many of us know how it works, therefore, I decided to give a brief introduction of sukuk.

Sukuk is the Arabic name for a financial certificate but can be seen as an Islamic equivalent of bond. However, fixed income, interest bearing bonds are not permissible in Islam, hence Sukuk are securities that comply with the Islamic law and its investment principles, which prohibits the charging, or paying of interest.

Shariah requires that financing should only be raised for trading in, or construction of, specific and identifiable assets. Trading in indebtedness is prohibited and so the issuance of conventional bonds would not be Shariah compliant. Thus all Sukuk returns and cashflows will be linked to assets purchased or those generated from an asset once constructed and not simply be income that is interest based. For borrowers to raise compliant financing they will need to utilise assets in the structure (which could be equity in a ‘tangible’ company). It’s worth noting that Equity financing is Shariah compliant and fits well with the risk/return precepts of Islam.

The Problem with Interest or Riba

As Shariah considers money to be a measuring tool for value and not an asset in itself, it requires that one should not be able to receive income from money (or anything that has the genus of money) alone. This generation of money from money (simplistically interest) is Riba, and is forbidden. The implications for Islamic financial institutions is that the trading/selling of debts, receivables (for anything other than par), conventional loan lending and credit cards are not permissible.

The Problem of Uncertainty or Gharar

This principle is widely understood to mean uncertainty in the contractual terms and/or the uncertainty in the existence of an underlying asset in a contract and this causes issues for Islamic scholars when considering the application of derivatives. Shariah also incorporates the concept of Maslahah or Public benefit, denoting that, if something is overwhelmingly in the public good, it may yet be transacted and so hedging or mitigation of avoidable business risks, may fall into this category but there is still much discussion yet to come.

Controversy

Sukuks are widely regarded as controversial due to their perceived purpose of evading the restrictions on Riba. Conservative scholars do not believe that this is effective, citing the fact that a Sukuk effectively requires payment for the time-value of money. This can be regarded as the fundamental test of interest.

If you are interested to know more about sukuk, you may find that the article below is very helpful and informative :

1. Sukuk Structures