Asset-based vs asset-backed In an asset-based sukuk structure, the overriding reliance of investors is on the credit strength of the obligor rather than the underlying assets. Advantages and disadvantages of sukuk For a corporate or a sovereign, some key advantages of tapping the sukuk market include: There is a potential marketing benefit for issuers active in Islamic markets, should they be seeking investments in those markets.
The investor base represented by Islamic compliant investors is still largely untapped and there has traditionally been significant unmet demand for products such as sukuk.
There is potential for crossover into other niche financial markets, such as the broader ethical investment market, that may provide a reputational benefit. Some disadvantages of the sukuk market include: As the key element for attracting investors is the credit standing of the obligor, it may be difficult to tap this market for corporates or sovereigns with an inadequate credit rating.
A sukuk whose underlying funding arrangement is based on ijara will necessarily require the obligor to have at its disposal suitable halal income-producing assets on which to base the transaction. In addition, unless the correct mechanics are included within the documentation, the substitution of similar assets into and out of the structure would be impossible. Unlike the conventional bond market, the standardisation of documents for sukuk issuance has been slow to develop and this can have adverse cost implications.
From transaction to transaction, to the extent that the structure used for the sukuk departs from the typical structures already well recognised in the market, the involvement of the sharia scholars is necessarily required. This can add some additional cost and an element of unpredictability to the transaction structuring process. As sharia scholars have differing views as to how compliant the structures are, there is no absolute unified and settled body of opinion on these issues.
The tax treatment of sukuk may be dissimilar to conventional bonds in certain jurisdictions. Sukuk are backed by tangible assets, rather than by debt. Sukuk ownership indicates ownership of an asset that has value.
Although, a bond may also indicate this, the real definition of a bond simply indicates a debt obligation. At its root, the relationship between the issuer of a bond and the consumer is very different from the relationship between the issuer of sukuk and the purchaser of sukuk. In the case of a bond, the consumer is acting as the loaner and the bond issuer as a loan recipient.
In this case, the loan has a fixed interest, therefore being Riba. In sukuk, the purchaser is purchasing an asset that has value rather than participating in an implicit loan agreement. Another important difference between bonds and sukuk is that the assets involved in sukuk certificates comply with all laws of Islam.
The consumer of sukuk is assured that the value of the certificate corresponds to assets that are in the public good and not related to activities or products that are against Islam.
Although some may argue that the differences between sukuk and bonds are merely technicalities, these differences matter to Muslims.
In fact, the practice of profiting from money alone, at the expense of productivity and real people has been one of the drivers for many of the economic problems that have plagued the world in the last decade. Interest and artificial inflation of prices based on debt rather than on real value is the main reason why bubbles form, burst, and then lead to recessions and depressions.
Although the above differences appear to be technical, they make a difference in the Islamic community. The main advantage that a Sukuk has is that the value of the Sukuk increases in relationship to the asset. If the value of the asset rises so does the value of the Sukuk. This is not the case with bonds.
The market accepts this rating process as reasonable and it has been widely accepted by regulators and Sharia supervisors. Yet rating a Sukuk security based on the existing criteria for the bond market is questionable. Sukuk have unique features that are not amenable to bond-type rating.
There is good reason to believe that widespread practices in the rating industry, though largely accepted at this stage of market development, needs to be modified.
There has been a tremendous growth in the Sukuk market in the last decade. Investors are not only from the Middle East, Southeast Asia but all around the world to diversify the holdings beyond the traditional assets. Initially the issuances were in Malaysia. Recently other countries with Muslim population like Turkey, Indonesia, and Pakistan have also become regular to issue Sukuk. For a Sukuk transaction to be successful the first and foremost essential is that it should be compliant with Sharia laws.
Now this becomes a challenge in countries governed by a legal system which is independent of Sharia. This is true not only in case of Muslim minority countries but also in the case of Muslim majority countries governed by secular laws which cannot explicitly make reference to religion. The legislative framework of these countries do not mention Sharia principles nor do they provide any guarantee to investors on compliance with the Islamic doctrine.
The instruments are indirectly defined in the legislation without openly naming them. The role of getting opinion from Islamic scholars is left to managers of financial institutions who act as intermediaries on a per transaction basis. A similar reminder is issued in the offering of Luxembourg securities SA stating that any dispute would be subject to court proceedings under laws of i Luxembourg ii England and Wales.
Indonesia differs from the above as Sukuk law explicitly requires the minister to request an opinion fatwa on Sharia compliance from the Ulema Council of Indonesia Majelis Ulama Indonesia with the purpose of giving assurance to the investors that investment will not violate Sharia principles.
Here it is important to note that validity of legal documents differs by jurisdiction. Extra attention must be given to the drafting of primary and secondary legislation in countries where Sharia principles are not allowed or encouraged. Otherwise the very purpose of Sukuk is defeated. Therefore, a close coordination between relevant authorities is required in the review of the existing legislation, with a view to identify deficiencies and to devise remedies.
To conclude both Sukuk and conventional bonds successfully solve the same common financial problem which is raising capital for entities, being corporations or governments. However, there are various fundamental differences between the two.
The conventional bonds are structured on the basis of debt while Sukuk are equity based instruments. Ultimately it is up to the bondholder to decide which method of financing he would prefer and if he would want to invest as per the religious sanctioned systems.
There are a large number of affluent and religious Muslim investors all around the globe seeking an opportunity to receive a decent return on investments and at the same time be in compliance with religion. Stocks: When a company issues stock, it is selling partial ownership in exchange for cash. Stocks are issued by companies only, whereas Sukuk and Bonds are issued by both companies and governmental entities.
Sukuk and Bond prices are considered less volatile compared to equities, while the return on equities could potentially be higher than that of Sukuk and bonds. Sukuk and Bond holders have the priority of repayment in the event of company liquidation or bankruptcy. While Bonds are financial certificates through which investors lend money to the issuer, indicating an obligation for repayment at maturity. Bondholders receive regular interest payments, while Sukuk holders receive a share of the profit generated by the underlying asset.
What are Sukuk and Bonds used for?
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