SOVEREIGN SUKUK PRICING STRATEGIES: RISK
ASSESSMENT vs. SHARI’AH STANDARDS
This draft proposal is submitted in partial fulfillment of the requirement of the
Doctorate of Philosophy in Islamic Finance
BY
NIDAL A. ALSAYYED (0900313)
THE GLOBAL UNVERSITY IN ISLAMIC FINANCE (INCEIF)
SUPEVISORS
Dr. Ahcene lahsasna
Prof. Datuk Syed O. AlHabshi
Kuala Lumpur, January 2010
SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
‫بسم هللا الرحمن الرحيم‬
‫وبه أستعين‬
TABLE OF CONTENTS
ABSTRACT (English & Arabic) ...................................................................................................
Approval Page .........................................................................................................................
Declaration Page .....................................................................................................................
Acknowledgement...................................................................................................................
List of Tables............................................................................................................................
List of Figures ..........................................................................................................................
List of Abbreviation .................................................................................................................
CHAPTER ONE: INTRODUCTION ..............................................................................................
1.0 Introduction .........................................................................................................................................
1.1 Sukuk overview in Malaysia and Middle East ........................................................................................
1.3 Historical background ...........................................................................................................................
1.4 Objectives of the study .........................................................................................................................
1.4.1 Motivation of the study ...........................................................................................................................................
1.4.2 Contribution of the study .........................................................................................................................................
1.4.3 Organization of Chapters .........................................................................................................................................
CHAPTER TWO: LITERATURE REVIEWS ....................................................................................
2.0 Introduction .......................................................................................................................................
2.1 Basic Principles of Islamic Financial Systems ........................................................................................
2.2 The concept of Debt & Equity in Islam .................................................................................................
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
2.3 The development of sukuk in Malaysia and Middle East .......................... Error! Bookmark not defined.
2.3.1 Murabahah - based Sukuk ...................................................................................... Error! Bookmark not defined.
2.3.2 IjÉrah- based sukuk ................................................................................................. Error! Bookmark not defined.
2.3.3 Mudarabah – based sukuk ...................................................................................... Error! Bookmark not defined.
2.3.4 Salam & Istisna Sukuk ............................................................................................. Error! Bookmark not defined.
2.4 The structure of Islamic Bonds (Malaysia vs. Middle East) ....................... Error! Bookmark not defined.
2.4.1 Sale-based Financing Debt Instrument ................................................................... Error! Bookmark not defined.
2.4.2 Lease-based Financing equity-Equity Debt instruments ........................................ Error! Bookmark not defined.
2.5 Sukuk and Islamic Bonds vs. Conventional Bonds ...................................... Error! Bookmark not defined.
2.6 Unresolved Issues on Malaysian and Middle East Sukuk ............................ Error! Bookmark not defined.
2.7 Conclusion ................................................................................................ Error! Bookmark not defined.
CHAPTER THREE: SUKUK PRICING ENGINEERING MODELS ......... Error! Bookmark not defined.
3.0 Introduction ............................................................................................. Error! Bookmark not defined.
3.1 Evolution and Profiles of Sukuk Structures and Markets ............................ Error! Bookmark not defined.
3.2 Innovative Mathematical Approach and ................................................... Error! Bookmark not defined.
3.3 Conclusion ................................................................................................ Error! Bookmark not defined.
CHAPTER FOUR: THEORITICAL FRAMEWORK AND HYPOTHESIS DEVELOPMENT ............. Error!
Bookmark not defined.
4.0 Introduction ............................................................................................. Error! Bookmark not defined.
4.1 Theoretical Framework ............................................................................. Error! Bookmark not defined.
4.1.1 Legitimacy Theory ................................................................................................... Error! Bookmark not defined.
4.1.2 Social Issue Life Cycle Theory .................................................................................. Error! Bookmark not defined.
4.1.3 Hypothesis Development ........................................................................................ Error! Bookmark not defined.
4.1.4 Islamic Financial Reporting Associations (IFSB vs. AAOIFI) ..................................... Error! Bookmark not defined.
4.2 Conclusion ................................................................................................ Error! Bookmark not defined.
CHAPTER FIVE: RESEARCH METHODOLOGY ................................ Error! Bookmark not defined.
5.1 Introduction 5.2 Data Collection ............................................................... Error! Bookmark not defined.
5.2.1 Contents Analysis
5.2.2 Disclosure Index 5.2.3 Questionnaire (Mail Survey) ... Error! Bookmark not defined.
5.3 Sample Selection 5.4 Conclusion ............................................................... Error! Bookmark not defined.
CHAPTER SIX: FINDING AND ANLYSIS.......................................... Error! Bookmark not defined.
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
6.1 Introduction ............................................................................................. Error! Bookmark not defined.
CHAPTER SEVEN: CONCLUSION................................................... Error! Bookmark not defined.
7.1 Introduction 7.2 Conclusion for Research Results and Findings 7.3 Limitation of the Study 7.4
Research Outlook Error! Bookmark not defined.
BIBLIOGRAPHY ........................................................................... Error! Bookmark not defined.
APPENDIX: Sample Questionnaire .............................................. Error! Bookmark not defined.
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
In the name of Allah, the Beneficent, the Merciful
ABSTRACT
The purpose of this dissertation is to provide an analysis of different sovereign and corporate sukuk structures
from a financial and economical perspective. This examination includes murabahah, mudarabah, and ijÉrahbased sukuk, while the former offering a fixed return, and the latter, the most popular form of sukuk, and a
variable return. The potential for other more novel sukuk structures based on mushÉrakah partnership contracts
is also investigated, and sukuk pricing issues are explored using alternative benchmarks to London Inter-bank
Offer Rate.
I aim to conduct a hybrid contemporary research project utilizing Islamic Financial Engineering tools to modern
sovereign sukuk structures; outside the conventional law of mu’amalat and under the guidance of the Qur’an
and Sunnah. The project seeks to expand the knowledge, clear misconceptions, provide guidance, help decision
makers standardize shari’ah parameters and practices in the issuance of sovereign sukuk, and bridge the relevant
gap in Islamic capital market, instruments, pricing policies, strategies, and risk transfer- among scholars, jurists,
practitioners, and financial institutions in the Middle East and Malaysia. The central feature of this research is
to offer a different interpretation and design models of the source material of the Shari’ah towards a vital,
important, and viable economic sukuk pricing & structures in today’s Islamic Finance.
KEY WORDS: Islamic Financial Price Engineering, MushÉrakah- based sukuk, ijÉrah-based sukuk,
Malaysia, Middle East, Conventional Law of Mu’amalat (The shari’ah perspective on commercial transactions),
AAOIFI1, IFSB2, IjtihÉd, and Alternative Benchmarks to LIBOR
1
2
Accounting and Auditing Organization for Islamic Financial Institutions
The Islamic Financial Services Board (IFSB)
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
INTRODUCTION AND LITERATURE REVIEW
The unprecedented advances in information technology & communications and the diverted approach to
Intensive Knowledge Economics had left its fingerprints on the financing instruments and methodologies for
governments, financial institutions and corporations; which had depended on the imitative (traditional“taqlidi”) banking and finance approach for a very long time. In today’s market which was accompanied with
not only the evolvement of multinational corporations3, mutual funds, treasury stocks, Credit Cards, CDs;
Financial markets, commodity markets, and precious metals markets; but also with the newly developed tools,
instruments, and formulas of multi-applied transactions conducted in those markets.
The most important of those instruments penetrated the Islamic financial markets are sukuk; which continue to
remain the topic that researchers can never keep up with its diversified and multi facet aspect. In spite of the
fact; that many had referred to sukuk in the context of conventional bonds, debt securities, non shari’ah
compliant sukuk4, innovations in sukuk structure will continue to be the motive force in real expansion of the
Islamic Financial Industry.
To bring new and significantly different products to the market; will require the introduction of a new
production technique, the opening up of new market5 The industry products have become commodities
and increasingly both less profitable and more expensive to sell. Islamic Financial services industry will
have to reinvent itself if it is to continue to prosper in the 21st century.
I am not referring only to those corporations with Foreign Direct Investment; but also to those “DAC” corporations (based in USA,
Japan, UK, France, and German).
4
Sheik Taqi Usmani declared early in the first quarter of 2008 that bulk of the sukuk issued in the market defied Islamic norms
(Usmani, M. Taqi: An Introduction to Islamic Finance, Idaratul Ma’arif, Karachi, Pakistan).
5
Peter Drucker(1999), Economist, Drucker on Financial Services, Innovate or die
3
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
Innovative sukuk structures pricing strategies are new models; which needed to be formulated In light of
the operative procedure of Islamic Capital markets.6 Sukuk design and pricing structures are conducted
by trained professionals in a highly centralized and controlled market. In addition the contract
specifications and its related procedures are such that the prospects of uncertainty and risk-taking
(gharar) are virtually eliminated. Adequate understanding of the mechanisms of sukuk pricing and
profiles and the relevant market procedures since only then will be able to determine the nature of the
issues before us in each case and specify the purpose of our inquiry and its hypotheses7.
The commercial reality of the market can be judged from an Islamic law view point without negatively
influencing the public interest and under the spirit of shari’ah The shari’ah provides us with the
necessary tools (maslahah being one of them) to reach an acceptable formula for both practitioners and
in line with the public interest.
STATEMENT OF THE RESEARCH PROBLEM
Islamic finance as an emerging form of financial intermediation would require tremendous investment in
research and development to promote innovation. Of importance is to develop a broader range of Islamic
financial market instruments that include instruments with equity ownership features, Islamic assetbacked securities, inclusion of permissible forms of credit enhancements as well as Shari’ah-compliant
risk mitigating instruments. The development of an Islamic Bonds (Sukuk) market for hedging is
required for market-making activities to support the development of secondary markets. Malaysia has
recently established a Shari’ah Scholar’s fund to fund such research and development efforts. The fund
also aims to promote greater engagement among the international Shari’ah scholars and thus provide a
6
7
Ali Abd Al-Qadir (2006), Encyclopedia of Islamic Banks
Mohammad H. Kamali (2002), Islamic Commercial Law: An analysis of futures and Options
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
platform for deliberation on the Shari’ah compatibility of newly developed Islamic financial instruments
and markets.
The increasing complexity in the way that debt is created and distributed in the financial system raises
important implications for financial stability. The “originate and distribute” strategy that has been
adopted by some institutions warrants addressing more comprehensively the full range of risks to which
the banks are exposed. This includes the liquidity, equity, foreign exchange, profit, and moral hazard
risks in banking institutions. Credit risk exposures have also taken on more complicated forms,
including counterparty risks on derivatives and foreign exchange transactions. The valuation of such
financial transactions and instruments are also often difficult to measure particularly under distressed
market conditions. In addition, the correlations between credit and market risk, both within and across
national borders, have become more complex. Of concern has also been lack of adequate information on
debt concentrations in the system partly due to the increasingly elaborate ways in which debt is passed
on from originating institutions to different investors. The propensity to under price credit risk,
especially under conditions of excess liquidity, has also increased concerns over underwriting standards.
The consequent sharp pricing corrections would in turn have the potential to result in broader economic
disruptions.
We cannot simply accept the argument of some contemporary scholars referring to high percentage of
sukuk applications as they closely resemble conventional debt instruments without scrutinizing and
investigating this matter in all relevant aspects. Sukuk can be structured and applied to contribute a
major role in the expansion and development of the economic structure of any country.
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
Moreover; we cannot neglect the massive total notional value, the huge use of leverage involved with
sovereign sukuk structures and that early indications of the investment portfolio structural problem show
up quicker in the sukuk markets.
JUSTIFICATION OF THE STUDY
Flow charts are used to illustrate different innovative structural models, pricing strategies, financial transfers
and the rights and obligations of sukuk investors as well as the beneficiaries of the funding as indicated by
Shari’ah standards of AAOFI & IFSB. Historical data have been used to assess whether the payments flows are
more stable in the case of sovereign sukuk where the returns are based on gross domestic product (GDP) growth
rather than interest.
HYPOTHSIS OF THE RESARCH
The conventional debt instrument (Interest, usury, or RibÉ) and gharar in sukuk is evidently a pervasive concept
that permeates the whole spectrum of contracts and transactions in Islamic law. It is also a broad concept in that
it comprises uncertainty and risk-taking as well as excessive speculation, gambling and ignorance of the
material aspects of contracts. The basic tools of evaluation and analysis that Islamic law has provided are
comprehensive enough to relate to all these concerns and especially to the overriding one, namely to ensure,
fairness and prevent excessive uncertainty and abuse in commercial transactions and contracts.
To determine the correct procedure for the resolution of ikhtilaf in Muslim societies today, one should refer to
the Constitutions and laws of the countries concerned. Resolutions of difference s must be made in a maslahah
oriented manner in the interests of the people and by accommodating their views. Once a selection has been
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
made by the ruling authorities, everyone must comply with it and disagreements must be laid to rest. Of course,
there is no single formula for resolving ikhtilaf. Often the shari’ah, or the applied law of a country, provide only
genera l guidelines and leave specific decisions to be made by the experts or those in charge of community
affairs.
Islamic legal theory on financial transactions; that have similar aspects to the application of financial derivatives
, sources and principles, and how they were applied by different schools and scholars to derive religious
verdicts. I will – Insha’Allah- 'streamline' Islamic law through a number of Sunni schools, various conceptions
of shari'ah, and modern attempts at law reform through dynamic scholarship and ijtihad (independent
judgment). Upon completion we should be able to explain the developments process in Islamic legal thought
within our socio historical contexts, and identify key debates among Muslim scholars using modern case
studies.
RESEARCH METHODOLOGY AND SOURCE OF DATA
A hybrid research method is used (quantitative and qualitative) that will employ many tools among of which a
specially designed questionnaire (English & Translated to Arabic in some cases) to collect data from major
players (hundreds of copies) in this industry (Malaysia and Middle East). Such questionnaire will consist of
multiple choice questions based on the hypothesis as well as a blank spaces to get the practitioner open
responses.
Moreover; the other methodology that will be used is case-study where triangulation of the data is required to
confirm results (Yin 2003). The following methods will be used for collecting primary and secondary data:
Primary Data
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Secondary Data
SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
Focus group discussions:
Documents
from

Practitioners

Practicing lawyers

fact sheets;
Focus group discussions, with

brochures,
participants ranging from 7-10

agreements, and
per group. This is to ask

others.
banks/financial
institutions:
questions on the type of Islamic Documents with diagrams that explain the
derivatives being used in their structure of these sukuk will also be used to
practice.
Practitioners
support the interviews and focus group
from
following discussions.
banks/financial institutions:
KFH
KFH
Mabank Investments Bank
Mabank Investments Bank
Bank Islam
Bank Islam
CIMB Investment Bank
CIMB Investment Bank
Deutsche Bank
Deutsche Bank
Canyon
Canyon
Research Questions Answered:
Research Questions Answered:
1. What sukuk structures are currently
1. What sukuk structures
are currently being
used in Islamic banking
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being used in Islamic banking and
finance?
2009
SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
and finance?
2. What are these sukuk used for?
2. What are these sukuk
3. How are these sukuk used?
used for?
3. How are these sukuk
used?
Online
forums/discussion Online Databases/Archives:
groups through internet:

IBF net,

linked-in.

Journals articles;

Newspaper articles;
Questions posed in these forums
to
find
out
on
Islamic Research Questions Answered:
derivatives.
Research Questions Answered:
1. What derivative instruments are
currently being used in Islamic
1. What sukuk structures
banking and finance?
are currently being
used in Islamic banking
and finance?
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2. What are these instruments used for?
2009
SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
3. How are these instruments used?
2. What are these sukuk
used for?
3. How are these sukuk
used?
Interviews:
INCEIF digital Library, IIUM Library ,

face to face;
UM,

through the phone, and
Databases/Archives:

email.

National
-
Sunnah/Hadeeths
-
Ijma
Shari’ah parameters.
Shari’ah
Sheikh Nizam Yaqubi
Dr. Ali Daghi
–
Ibn
Mundhir
advisors and scholars on the
Advisors/scholars:
Online
Fiqh Sources – Al-Qur’an
Interviews will be with Shari’ah
Proposed
Library,
Qiyas – Usul- al-
fiqh

Sources from the
bibliography/references of Dr. & Dr.
These sources of fiqh will support the
interviews with the scholars, on the Shari’ah
Research Question Answered:
1. What are the Shari’ah
parameters that have to
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parameters.
2009
SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
be adhered to and
2009
Research Question Answered:
complied with to enable
them to be used in
1. What are the Shari’ah parameters
Islamic banking and
that have to be adhered to and
finance?
complied with to enable them to be
used in Islamic banking and finance?
POPULATION AND SAMPLE
While Fiqh, especially worship (Ibadat) type, prescriptions are permanent in nature and for all individuals,
economic and financial descriptions may change from time to time and from society to another. This research
argues that the methods of reasoning for reaching an Ijtihad ruling in Islamic financial are not necessarily
identical. While Fiqh has a well developed methodology in the form of Usul al-fiqh, Islamic financial
engineering for innovative sukuk structures are in its search for finding whether it is shari’ah permissible or not
should rely on a methodology that suits its social and descriptive nature.
RESEARCH INSTRUMENT (s)
Under Construction
ADMINISTRATION OF THE INSTRUMENT (s)
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
The instruments will be administered by the researcher, Shari’ah scholars, research supervisors, as well as some
research assistants. Methods of data interpretation includes but not limited: -Regression, and multiple regression
analysis of the data collected.
SCOPE OF THE STUDY
Little has been written previously on the use of mushÉrakah partnership contracts for sukuk, and pricing issues
have not hitherto been systematically investigated.
The study is expected to cover the period from 2000 to 2010 (for data analysis) and till date for literacy review.
Also the study will cover major Middle East countries (Saudi Arabia, Bahrain, United Arab Emirates, Jordan,
and Qatar) and Malaysia.
LIMITATION OF THE STUDY
The data analyses were restricted to four countries, but this could be extended. Alternative pricing benchmarks
were suggested for sovereign sukuk but not for corporate sukuk.
In each of the foregoing it is clear that there are diverse opinions, enough dynamism and latitude within the
Shari’ah to reform and/or reinterpret the Fiqh rules to be better reflective of modern transactions, circumstances,
and cultural outlook. Where the methodology and legal principles are not sufficient, the sanctity attached to
contractual obligations, including treaties in the Shari’ah; make it possible to reform conventional mu’amalat
law. At the same time there are some concepts such as usury, insurance, and speculative contracts, which will
be much more difficult, if not impossible, to overcome if the conventional Shari’ah mu’amalat law are adhered
to.
THEORITICAL FRAME WORK
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
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Under Construction
EXPECTED RESULTS, CONCLUSIONS AND OUTCOMES
Possible results will include the investigation to (but not limited to):
1. Investigate Special Purpose Vehicles as a prerequisite for the successful issuance and management of
sukuk. The use of GDP-based pricing benchmarks would have resulted in greater payments stability for
sovereign debt in Middle East, but not for Malaysia.
2. Recommend that Ministries of Finance and Central Banks of Muslim countries should review their debt
financing policies and explore the potential of sovereign sukuk
3. Provide and highlight an overview of the key regulatory institutions and industry associations in Islamic
Finance today and focus on areas that merit increased attention.
4. The growth of Islamic Finance sector is impacted by increased involvement of western regulators; as
well as credit rating agencies; existing of sound accounting procedures, and increased protection of
stakeholders of Islamic Financial Institutions.
5. Elaborate the experience of Malaysia in developing sukuk market and the methods that have been
BIBLIOGRAPHY8 (Sample out of 113 Articles & Books)
[1]
Abbas, A. (2005), “Helping to build an Islamic Capital Market”, Banker Middle East, 1 October, pp.
15-17
[2]
Wilson, Rodney (2008), “Innovation in the Structuring of Islamic sukuk Securities”, Humanomics, Vol.
24, No. 3, pp. 170-181. Emerald Group Publishing Limited.
8
I have gathered all available relevant articles, papers, lectures, and book’s titles relevant to the subject of my proposal.
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SOVEREIGN SUKUK PRICING STRATEGIES: RISK ASSESSMENT vs. SHARI’AH STANDARDS
2009
[3]
Aseambankers (2005), “Capitalizing on Opportunities in the Sukuk Industry”, Aseambankers, Kuala
Lumpur, pp. 1-5
[4]
Aquil, B. (2005), “Tracking the progress of Sukuk”, Islamic Banking and Finance Magazine, 14
October, pp. 6-7.
[5]
Bahrain Monetary Agency (now Central Bank of Bahrain) (2002), Islamic Banking and Finance in the
Kingdom of Bahrain, Bahrain Monetary Agency, Manama, pp. 72-75
[6]
Dommisse, A. and Kazi, W. (2005), “Securitization and Shari’ah Law”, Banker Middle East, 1 July,
pp. 7-8
[7]
Eastern Oracle (2005), “Malaysia’s PT Orient to issue Sukuk MushÉrakah for Indonesian Port”, IFIS
Islamic Finance Weekly, 3 October, p.2.
[8]
New Millennium Publishing (2005), “First Airline Sukuk Lead-Managed by Dubai Islamic Bank”,
IFIS Islamic Finance Weekly, 14 October, P.6
[9]
McNamara, P. (2005), “How to Sell Sukuk”, Banker Middle East, 1 August, pp. 4-5.
[10]
Alexakis, Christos (2009), “Islamic Finance: regulatory framework - Challenges lying ahead”,
International Journal of Islamic and Middle Eastern Finance and Management”, Vol. 2 No. 2, pp. 90104, Emerald Group Publishing Limited
[11]
Chapra, M.U., and Khan, T. (2000),” Regulation and Supervision of Islamic Banks’, Occasional Paper
No. 3, Islamic Development Bank/Islamic Research and Training Institute, Jeddah.
[12]
Alvi, Ijlal (2008), “Capacity Building Needs for Issuing Sovereign Sukuk”, Quarterly Newsletter,
August, p.3, Dow Jones Islamic Market Indexes.
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