FATWA
IN ISLAMIC
FINANCE
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Monthly Publication - July, 2013 Edition
SUKUK: AN INTRODUCTORY REMARK
HOW IS SUKUK DIFFERENT FROM BONDS?
Marjan Muhammad* and Beebee Salma Sairally** –
Sukuk, also known as Islamic securities or Islamic bonds,
represent one of the most significant instruments of the
Islamic capital markets. Sukuk have been extensively used
for raising government funds via sovereign sukuk issuances
as well as obtaining funds for companies through corporate
sukuk offerings. Sukuk were initially introduced as an
alternative instrument which serves the same purpose
of providing long-term financing as conventional bonds,
however, without compromising the requirements of Shariah
(Islamic law). The features of the early sukuk issuances thus
mimicked those of fixed-income instruments. Nonetheless,
over time the features of sukuk have evolved to include their
own distinctiveness while at the same time maintaining
some characteristics similar to bonds.
Bonds represent a contractual debt obligation where
the investors provide a loan to the issuer. The repayment
of bonds consists of the principal (capital) at the time
of maturity and interest in the form of periodic coupon
payments. Even in the case of zero-coupon bonds, the
investors will receive accumulated interest at the end of the
maturity period in the form of the difference in the discounted
price of the bond at the time of issuance and the face value
received by the bond holder. Since bonds have violated the
principle of interest-free loan as per the Shariah requirement,
scholars have introduced sukuk as an alternative instrument
for raising financing. As such sukuk, unlike bonds, do not
establish a lending relationship between the issuer and the
investors. Rather, sukuk utilise Shariah contracts such as
sale, lease and partnership as the underlying relationship
between the issuer and the investors to enable the latter to
enjoy returns on their investment. Figure 1 below explains the
relationship established between the bond/sukuk issuer and
holder graphically.
BOND HOLDER
(LENDER)
SUKUK ISSUER
(PURCHASER/
LESSOR/PARTNER)
CASH
BOND ISSUER
(BORROWER)
SUKUK: RELATIONSHIP
BASED ON SHARIAH
CONTRACTS UTILISED
SUKUK
CERTIFICATE
BOND: LENDING
RELATIONSHIP
CASH
The Arabic term sukuk literally means certificates.
Technically, the Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI) defines investment
sukuk as “certificates of equal value representing undivided
shares in ownership of tangible assets, usufructs and
services, assets of particular projects or special investment
activity.” The definition of Securities Commission (SC)
of Malaysia, however, is broader referring to sukuk as
“certificates of equal value which evidence undivided
ownership or investment in the assets using Shariah
principles and concepts.” It is noted that these two
definitions would have an impact on the type of assets
that qualify as the underlier for a tradable sukuk: while the
SC recognizes financial assets such as receivables as the
underlying asset, the AAOIFI does not allow such assets.
BOND
CERTIFICATE
WHAT IS SUKUK?
SUKUK HOLDER
(INVESTOR)
Figure 1: Relationship established between Bond/Sukuk Issuer and Holder
Source: Authors’ Own
* Marjan Muhammad, PhD, is Head of Research Affairs at the International Shariah Research Academy for Islamic Finance
(ISRA), Kuala Lumpur, Malaysia.
** Beebee Salma Sairally, PhD, is Research Consultant at the International Shariah Research Academy for Islamic Finance (ISRA).
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Moreover, bonds are only in the form of debt, whereas sukuk
may include debt (created from sale-based transactions) as
the underlying assets (in Malaysia only) and non-debt assets
such as tangible assets, usufructs and rights, assets of
particular projects or investment activities.
The differences between bonds and sukuk are summarized
in Table 1 below.
BONDS
SUKUK
Primary Level
Relationship
Loan
Various Shariah contracts
Return
Interest
on loan
Profit gained from sale, lease
or partnership contracts
Tradability in
Sale of debt
Secondary Market
Shariah standards at the
global level (e.g., AAOIFI)
only allow the sale of tangible
assets, some intangible assets
and interest in ventures,
whereas Malaysia allows the
sale of debt (for sale-based
sukuk) at discount.
Table 1: Comparison between Bonds and Sukuk
Source: Adapted from ISRA, 2011, p. 398
July, 2013 Edition
STRUCTURES OF SUKUK
Sukuk are commonly structured based on the underlying
Shariah contracts such as murabahah, bay’ bi thaman ajil
(BBA), salam, istisna’, ijarah, musharakah, mudarabah and
wakalah. The classification of sukuk based on the Shariah
contracts is depicted in Figure 2 below.
In addition to the above, some of the sukuk structures have
become more complex where a combination of at least two
underlying Shariah contracts has been utilized. For instance,
the Sukuk al Istithmar issued by the Islamic Development
Bank’s (IDB) Solidarity Trust Services Ltd in 2003
comprised ijarah, murabahah and istisna’ contracts; Projek
Lintasan Shah Alam Bhd in 2008 utilised ijarah, mudarabah
and ijarah mawsufa fi thimmah contracts for undertaking the
toll-road project; and the Government of Malaysia’s USD
2 billion dual-tranche Wakala Sukuk in 2011 combined
the wakalah structure with ijarah assets, receivables from
murabahah contracts and Shariah- compliant shares.
From the Shariah perspective, there is no preference of one
contract over the other. However, the issuer normally chooses
the type of Shariah contract based on some factors such as
economic objectives, the availability of underlying assets, the
level of debt of the company, the credit rating of the issuer,
the legal framework in the jurisdiction and the tax implication
of a structure (ISRA, 2011).
SUKUK BASED
ON SHARIAH
CONTRACT
SALE
BASED
LEASE
BASED
EQUITY
BASED
AGENCY
BASED
BBA
IJARAH
MUSHARAKAH
MURABAHAH
IJARAH
MUNTAHIYA
BI TAMLIK
MUDARABAH
SALAM
IJARAH
MAWSUFAH
FI DHIMMAH
WAKALAH
Figure 2: Sukuk Structures based on the Underlying Shariah Contracts
Source: Adapted from the Securities Commission Malaysia (2009)
ISTISNA’
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Sukuk have also been classified based on the following
technical and commercial features: (i) type of issuer such as
sovereign and corporate (ii) underlying asset such as assetbased, asset-backed and asset-light; (iii) convertibility such
as convertible and exchangeable sukuk; and (iv) others such
as subordinated and stapled sukuk.
GROWTH AND DEVELOPMENT OF THE
SUKUK MARKET
The sukuk market has grown considerably since the
pioneering issue by Shell MDS Malaysia in 1990, which
was of a modest size of RM 125 million (USD 30 million)
using the bay’ bi thaman ajil (BBA) concept. Post-1990,
the sukuk market developed modestly after 2000 with a
total of 3 sukuk issuances at the corporate level worth
USD 336 million. After a slump in 2008, a positive market
trend is notable thereafter. In fact, the market appears to
have reached its peak in 2012 with over USD 81 billion
of new sukuk issuances—representing an increase of over
66 percent compared to 2011. The market for 2013 looks
poised to remain equally healthy with new sukuk issuances
already exceeding USD 48 billion in the first-half of 2013.
Going forward, market opportunity remains bright as global
demand for sukuk continues to grow, well exceeding its
supply. According to estimates by Ernst & Young’s Global
Islamic Banking Center of Excellence, it is forecasted that
global sukuk demand will rise to USD 900 billion by 2017
from the estimated USD 300 billion in 2013. Figure 3
shows the growth in the new sukuk issuances during the
period 1995 to mid-2013.
July, 2013 Edition
and representing, in size, over USD 48 billion of new sukuk
issuances in 2012 and over USD 29 billion in the first-half
of 2013. Saudi Arabia and United Arab Emirates follow
thereafter, representing 9% of the global sukuk market each.
The country-wise distribution of sukuk issuances is depicted
in Figure 4.
With regard to the Shariah contracts used in the structuring
of sukuk, according to Figure 5 on the next page, it is
noted that at the global level the ijarah and musharakah
structures have been among the most popular, followed by
the murabahah contract. In the beginning years of the sukuk
market development, there were a number of sukuk al-ijarah
issuances—since its preponderance to mimick conventional
bonds with fixed periodic rental payments. However, from
2004-2008 sukuk al-musharakah issuances increased
until negative criticisms were raised against equity-based
sukuk by Sheikh Taqi Usmani in 2007. Sukuk al-musharakah
issuances thereafter slumped considerably and were taken
over by sukuk al-ijarah between the period 2009 to mid2013. Issuances using the musharakah contract appear
to have again recovered in 2012, reaching a peak of USD
16.9 billion compared to sukuk al-ijarah, which stood at
above USD 19 billion
.
SUKUK ISSUANCE (1995-2013)
In terms of issuances by country, Malaysia remains the
world’s largest sukuk market, garnering 61% of the total
market space between the period 1995-2013
Figure 4: Sukuk issuances by country
Source: Bloomberg
Biillons (USD)
ISSUANCE: TOTAL ANNUAL GROWTH
Figure 3: Total Annual Growth in Sukuk Issuances
Source: Bloomberg
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July, 2013 Edition
CONTRACT PERFORMANCE
Figure 5: Sukuk issuances based on Shariah contracts
Source: Bloomberg
CRITICISMS RAISED AGAINST SUKUK
At AAOIFI’s annual event in Bahrain in November 2007,
Sheikh Taqi Usmani, Chairman of the Shariah Board of
AAOIFI raised three main criticisms against sukuk relating
to the following issues: (i) sukuk holders not having real
ownership interest in the underlying assets; (ii) the regular
distributions to sukuk holders not being based on actual
performance of the underlying assets; and (iii) guarantee of
the return on capital via the use of purchase undertakings.
The first criticism pertained to asset-based sukuk where
there is no legal sale of the underlying assets and as such
no real transfer of ownership of the assets to sukuk holders
from the originating company. Legal documentation in assetbased sukuk indicates that the sukuk holders do not have an
interest in the underlying asset, which conflicts with Shariah
principles that require sukuk investors to have rights over
the sukuk assets.
The other two criticisms focused mainly on the structural
features of the sukuk al musharakah, sukuk al murabahah
and sukuk al wakalah structures—the so-called equitybased sukuk. The criticisms highlighted the use of Shariahcompliant funding to make up for any shortfalls in actual
profit below the stipulated percentage to sukuk holders; the
payment of any excess profit realized beyond the expected
profit percentage as incentive fees to the manager; and
the use of purchase undertakings to guarantee the sukuk
holders’ principal such that it is expected that the issuer
will buy back the underlying asset at the expiration date of
the sukuk or in the event of default at face value regardless
of their true value on that day. Such practices convert the
equity-based sukuk to debt-based structures whereby the
sukuk are redeemed at par value at the maturity date and
sukuk holders are paid a guaranteed periodic return on
capital throughout the duration of the sukuk.
I. S
UKUK HOLDERS’ OWNERSHIP
OF ENTERPRISE ASSETS
II. R
EGULAR DISTRIBUTIONS TO
SUKUK HOLDERS NOT BASED
ON ACTUAL PERFORMANCE OF
UNDERLYING ASSETS
SHEIKH TAQI
USMANI’S MAIN
CONCERNS
III. “GUARANTEE” THE RETURN
OF CAPITAL VIA PURCHASE
UNDERTAKING
Figure 6: Sheikh Taqi Usmani’s Criticisms against Sukuk
Source: Authors’ Own
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SHARIAH RESOLUTIONS TO ADDRESS
SHARIAH CONCERNS
As a response to the various Shariah concerns, the AAOIFI
issued additional guidelines on sukuk structures in February
2008, stating that the following are prohibited in equitybased sukuk: (i) the use of Shariah-compliant financing to
smooth out periodic income distribution amounts to sukuk
holders; and (ii) the use of purchase undertakings in order
to guarantee the return of the principal amount to sukuk
holders at its par value. The AAOIFI Resolution, on the other
hand, does not prohibit the use of purchase undertakings
in sukuk al ijarah, if the lessee is not an investment partner,
mudharib or agent. Moreover, the AAOIFI Resolution stated
that the use of a reserve account to cover shortfalls is
permitted and so is distribution on account, so long as the
latter is subject to reconciliation prior to a final distribution.
The recent resolution of the International Islamic Fiqh
Academy (IFA), a branch of the Organization of Islamic
Cooperation (OIC), in its 20th session (2012) also iterated,
similar to the resolution of the AAOIFI (2008), the nonpermissibility of purchasing equity-based sukuk at their
nominal value or at a predetermined price, which leads to
the capital of sukuk holders being ensured; and of providing
loans to sukuk holders when actual sukuk revenue is less
than expected, although it allows for recourse to reserve
accounts to redress potential shortfalls.
July, 2013 Edition
The IFA also placed emphasis on the fact that sukuk should
establish genuine ownership of the underlying assets, in
line with both the Shariah and conventional law, along with
enabling its attendant legal effects, such as the power of
disposal of the assets and bearing the liability associated
with ownership.
CONCLUSION
While the development of sukuk originated from the idea of
finding an alternative to interest-bearing bonds, today with
the rising Shariah concerns about the sukuk structures,
emphasis is being placed by fiqh councils to ensure that
sukuk structuring aligns closely with the principles of the
Shariah. The aim is to demarcate clearly the differences
between sukuk and conventional bonds in terms of the
structure, design, utilisation of proceeds and overall
objective of supporting genuine activities and economic
development. This certainly adds confidence to the sukuk
market and will contribute to the further growth of the overall
Islamic finance industry.
For more information, please mail nimap@bloomberg.net.
Regarding sukuk al ijarah, the IFA prohibited the current
structure of asset-based sukuk al ijarah as it is a form of
inah (sell and buy-back arrangement). The IFA pronounced
the impermissibility of selling an asset on a cash basis on
the condition that the seller leases the asset via a lease
ending in ownership, whereby the total rental payments
and repurchase price [paid by the sukuk issuer] would be
more than the cash price [paid by the sukuk holders]. Such
stipulation is impermissible, regardless of whether it is
mentioned explicitly or implicitly, because this would be a
form of the prohibited inah, and therefore, sukuk cannot be
issued using this structure.
Disclaimer: The views and analysis expressed herein result from an independent review by researchers at the International Shariah Research Academy
for Islamic Finance (“ISRA”), based on information provided by Bloomberg Finance L.P. and its affiliates (“Bloomberg”). Bloomberg believes the
information used herein came from reliable sources, but do not guarantee its accuracy. No information or opinion expressed herein constitutes a
solicitation of the purchase or sale of securities or commodities. While every care is taken in the preparation of this publication, no responsibility can
be accepted by ISRA or Bloomberg for any errors.
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