Sukuk Islamic Bonds

Summary

In this engaging conversation, Mr. Hussam provides an insightful explanation of sukuk, a form of Islamic finance, in response to queries from a committee. He discusses the advantages of sukuk, including its competitive pricing and liquidity, and compares it with bonds. The discussion delves into the history, types, and mechanisms of sukuk, including asset-based and debt-based variants, as well as the operational processes such as issuance, subscription, and redemption. The session also covers sukuk’s Sharia-compliant features, trading rules, and the potential role of sukuk in financing large projects or government initiatives.

Takeaways

• 😀 Sukuk are asset-linked certificates representing undivided ownership shares in underlying assets or services.
• 😀 Sukuk can be an alternative to bonds, offering advantages such as tapping into international markets and liquidity in secondary markets.
• 😀 Sukuk can be issued through a Special Purpose Vehicle (SPV), ensuring that assets are protected even if the parent company faces bankruptcy.
• 😀 The two main types of Sukuk are asset-based (linked to performance of the asset) and debt-based (linked to the credit risk of the originator).
• 😀 Sukuk were introduced in modern times over the last four decades and have gained global recognition, with specific legislations even in non-Muslim countries.
• 😀 Sukuk assets must meet five criteria: they need to be qualified, quantified, valuable, beneficial, and revenue-generating.
• 😀 The operational aspects of Sukuk include issuance, subscription, and redemption, where investors receive periodic income based on their holdings.
• 😀 Sukuk redemption involves the SPV purchasing back the underlying assets at maturity and distributing the proceeds to the investors in proportion to their holdings.
• 😀 Sukuk are tradable in secondary markets, but they must have at least one-third of their assets in tangible form to comply with Sharia law.
• 😀 If a Sukuk’s return is insufficient, the originator can raise funds through Sharia-compliant financing to cover the shortfall, which is repaid by the Sukuk holders at maturity.

Q & A

What is the main difference between sukuk and bonds?

Bonds are debt instruments that generate a fixed interest return over a set period, whereas sukuk are asset-linked certificates, meaning the income or profit for the holder comes from the underlying asset of the sukuk. Sukuk represents undivided ownership in assets or services.

Why would a company prefer sukuk to raise funds over other financing methods?

There are two main advantages: First, sukuk allow access to international markets, enabling companies to attract global investors. Second, sukuk is a liquid instrument, meaning investors can trade it in secondary markets anytime.

What are the two main types of sukuk?

The two main types of sukuk are asset-based sukuk, where the asset remains under the ownership of the investor throughout the maturity period, and debt-based sukuk, where the asset does not remain with the investor, and the return is linked to the credit risk of the originator.

What role does a Special Purpose Vehicle (SPV) play in the issuance of sukuk?

An SPV is established to acquire and finance specific assets. It is typically a subsidiary company designed to hold the assets and issue sukuk to investors. The SPV is legally protected, meaning even if the parent company goes bankrupt, the obligations of the sukuk remain secure.

What are the requirements for the assets used in sukuk?

The assets must meet five key criteria: they must be qualified, quantifiable, valuable, beneficial, and revenue-generating.

What are the three main operational features of sukuk?

The three main operational features of sukuk are issuance, subscription, and redemption. The SPV issues the sukuk, investors subscribe by providing the principal amount, and at maturity, the sukuk is redeemed by the issuer buying back the underlying assets.

Can sukuk be traded in secondary markets?

Yes, sukuk can be traded in secondary markets after the subscription period ends. However, for the sukuk to be sharia-compliant, at least one-third of the sukuk's assets must be in tangible form.

What happens when a sukuk matures?

Upon maturity, the sukuk holders surrender their sukuk certificates to the SPV, and the issuer buys back the underlying assets. The purchase price is then distributed to the investors in proportion to the number of sukuk they hold.

What are the different mechanisms of sukuk?

One example is Sukuk Al-Ijara, where the government raises funds by issuing sukuk, and the SPV uses the proceeds to purchase assets, leasing them back to the government in return for periodic rental payments. These payments are distributed to investors. Another mechanism involves investing in government business plans under mudaraba or wakala.

How is a shortfall in periodic returns treated in sukuk?

If there is a shortfall in the periodic returns of sukuk, the originator can raise additional sharia-compliant financing to fulfill the obligation, and the sukuk holders repay this on the sukuk's maturity.