Sukuk represents undivided shares in the ownership of tangible assets relating to particular projects or special investment activity.
However, Sukuk securities comply with Islamic commercial jurisprudence and its investment principles which prohibit the charging or paying of interest. Since its establishment in Bahrain on 27 Marchit has been supported by institutional members members from 40 countries, so far including central banks, Islamic financial institutions, and other participants from the international Islamic banking and finance industry worldwide.
Sheikh Taqi Usmani chairman of the AAOIFI Shariah board published a paper2 which was circulated towards the end of in which he commented that most of the Sukuk in the market those using a musharaka or mudaraba structure are not in line with the principles of Shariah. Mudaraba sukuk are investment Sukuk which represent the ownership of units of equal value in the equity of the mudaraba.
The Sukukholders provide the capital for the Shariah compliant investment activity that is undertaken by the investment agent. The investment agent is paid an agreed fee out of any profits derived from the business activity.
Musharaka Sukuk are investment Sukuk that represent ownership of musharaka equity. The musharaka agreement is a form of joint venture agreement between the issuer and usually the originator to engage in a Shariah compliant investment activity in accordance with a business plan that is appended to the musharaka agreement.
Any profits received from the musharaka arrangements are distributed between the issuer and the originator as agreed. Mudaraba and musharaka Sukuk gained popularity over the last couple of years because they allowed Sukuk to be issued without being wholly reliant on the existence of underlying tangible assets as in the case of Ijara-based Sukuk in order to generate a return for the Sukukholders.
Sheikh Taqi Usmani stated that the mudaraba and the musharaka sukuk were in breach of the principles of Shariah because they provide the issuer with a purchase undertaking to buy back the underlying assets from the issuer at face value on the expiry date of the Sukuk or in the event of a default.
In other words, the credit on the Sukuk was based on the credit worthiness of the provider of the purchase undertaking and not the assets underlying the Sukuk. The guidance in the AAOIFI Statement stipulates that the purchase undertaking should not be based on an exercise price which is calculated by reference to the face value of the Sukuk at the maturity date or upon the earlier dissolution of a Sukuk.
Instead, any such undertaking may be based on the net asset value, market value, cash equivalent value or any price agreed upon at the time of purchase. The Sukuk manager can only guarantee to repay the capital to Sukukholders at face value in cases of negligence or violation.
Sukukholders in a mudaraba or musharaka-based structure need to understand that the Sukukholder must have some risk in these structures.
Shariah principles encourage the sharing of risk and profit. Generally, under most mudaraba and musharaka sukuk, the provider of the purchase undertaking is also the investment agent. The role of the investment agent under a mudaraba sukuk is ultimately to use his or her best efforts to make a profit for the Sukukholders, for which the investment agent is entitled to be paid an agreed proportion of the profit.
It is not the role of the investment agent to guarantee the capital repayment of the Sukuk in the form of a purchase undertaking or otherwise. Similarly, the nature of a musharaka partnership is that the partners agree to maintain the assets of the joint venture on a trust basis.
Except therefore in the case of wilful default, negligence or breach of contract, it is not permissible to stipulate that a partner under a musharaka agreement will guarantee the capital of another partner in the same contract.
According to the AAOIFI standards and our discussions with scholars, purchase undertakings under which the exercise price is calculated by reference to the face value of the underlying assets are permissible under Ijarah sukuk. The lease payments from the originator to the SPV are used to pay the Sukukholders their periodic distributions.
It is permissible for the originator to undertake to purchase the tangible asset at face value on the maturity date. The Sukukholders still bear the risk of total loss of the asset. If the asset is destroyed in some way the originator in accordance with Shariah will not be under an obligation to buy the asset.
Sanctity of contracts is a very important concept in Islamic jurisprudence. However, anecdotal evidence from clients suggests that Sukuk using musharaka or mudaraba structures may be suffering from reduced liquidity in the secondary market. The tension that exists in the market is between, on the one hand, those arrangers, originators and issuers who seek the certainty of fixed income returns and, on the other hand, the Shariah principles that require mudaraba and musharaka-based financing to operate in accordance with profit and loss principles.
Footnote Sukuk and their Contemporary Applications. This means that Sukukholders will be taking a risk with regards to the potential depreciation of trust assets if they rely on a purchase undertaking from the originator to purchase the assets at market value.
The risk on the assets is in addition to the credit performance and risk on the originator which investors have traditionally taken.
There is currently an increasing amount of lateral thinking in this area within the Islamic finance industry in order to address this issue.
There is likely to be a move towards calculating the periodic distributions on the basis of principal and profit repayments during the term of the Sukuk. This will avoid the need for the originator to repurchase the assets at market value on the maturity date of the Sukuk. We can see an example of this approach under the terms and conditions of the Villamar Sukuk issued in May 3 in which the cashflows generated from the trust assets using a musharaka structure are used for the purposes of gradually redeeming the Sukuk on periodic distribution dates.
A similar approach is taken in the Sorouh securitisation issued in August 4, in which the certificates amortise using a mudaraba structure. We may also see a move towards: It is anticipated that there will be a number of innovative structures that emerge as a result of the AAOIFI Statement guidance which will encourage practitioners in the industry to think creatively.
However, there may be limits on that creativity and if the attempt is merely to devise another fixed income instrument devoid of profit and loss sharing characteristics it is unlikely to succeed. In many respects, it will not just be the legal character that has to adapt but also the risk and reward expectations of the participants in the market.
Issued by Sun Finance Limited. Further information If you have any questions or would like to discuss the issues raised in this paper further, please contact:Introduction of Sukuk - Islamic Business and Finance - Study Notes, Study notes for Islamic Finance and Banking Systems. structured trade finance and real estate.
Sukuk Introduction • A ‘Sukuk’ bond is essentially an ‘interest-free’ variant of a conventional bond that is structured to comply By definition, all Islamic Finance.
Sukuk are defined by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) as: ‘certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special.
In the case ofsukuk issued to finance trade, this profit is fixed in advance. In case of the sukuk issued to finance other activities, the profit varies according to market conditions. In the case of bonds, however, funds are raised in the form of interest bearing loans (Richard , pp.
1). Sukuk (Arabic: صكوك ṣukūk, plural of صك ṣakk, "legal instrument, deed, cheque") is the Arabic name for financial certificates, also commonly referred to as "sharia compliant" vetconnexx.com are defined by the AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) as "securities of equal denomination representing individual .
According to Islamic Invest Guide, a Sukuk is an asset based security that provides a relatively fixed constant flow of income without violating the Islamic laws on interest. Sukuk has developed as one of the most significant mechanisms for raising finance in the international capital markets through Islamically acceptable structures. Multinational corporations, sovereign bodies, state corporations and financial institutions use international sukuk issuance as an alternative to syndicated financing. Sukuk: Definition & Types I: Defining Sukuk The emergence of Sukuk has been one of the most significant developments in Islamic capital markets in recent years. structure, a form of trade finance (murabaha) and a joint-venture equity investment (musharaka).
Sukuk has developed as one of the most significant mechanisms for raising finance in the international capital markets through Islamically acceptable structures. Multinational corporations, sovereign bodies, state corporations and financial institutions use international sukuk issuance as an alternative to syndicated financing.
According to vetconnexx.com a Sukuk is an Islamic financial certificate, similar to a bond in Western finance. Sukuk are securities that comply with the Islamic law and its investment principles, which prohibits the charging or paying of interest.