What is Islamic Sukuk?
Bonds are fixed income securities that promise the holder a specified set of payments. A bond investor has lent money to the bond issuer. In return, the issuer of the bond promises to pay interest and repay the principal on maturity.
Islamic Sukuk is a form of debt financing structured under the rules of Shariah. Sukuk are term finance certificates (TFC) of equal value representing undivided shares in ownership of assets of a particular project or special investment activity.
Difference between Sukuk and Conventional Bonds
The basic difference between conventional bonds and Sukuk lies in the way they are structured and floated. In the conventional system of bond issue and trading, the element of ‘interest’ is at the centre of all transactions. Sukuk, on the other hand, are structured in such a way that the issue is asset backed and is based on “an exchange of approved asset for some financial consideration” that allows the investors to earn lawful profits from transactions. The underlying asset, contract, and payment mechanism of the Sukuk while being commercially viable, has to be aligned with the requirements of the Shariah.
Types of Sukuk
Thus, the issuance of Sukuk requires an exchange of a Shariah compliant underlying asset for a financial consideration through the application of various Islamic commercial contracts, such as the Mudarabah, Musharakah, Ijarah, Istisna’, Salam, and Murabahah. The equity-based nature of Mudarabah and Musharakah Sukuk exposes investors to the risks connected with the performance of the project for which the financing is raised. In contrast, issuance of Sukuk on principles of Ijarah and Murabahah yields deterministic receivable and hence result in predictable and somewhat fixed returns for the prospective investors.
Mechanism of Ijarah Sukuk
The Ijarah Sukuk is one of the most popular concepts among issuers of global Islamic Sukuk. The structure of Ijarah Sukuk can be understood from this example. If a corporation requires, for example, USD50 million for the purchase of land, real asset, equipment, aircraft, etc., it can issue Ijarah Sukuk equalling that amount in small denominations, say USD10,000 each. The firm then either purchases the asset on behalf of the Sukuk holders (investors or certificate holders) or transfers the ownership of the already acquired asset to Sukuk holders by establishing a Special Purpose Vehicle (SPV), which owns the underlying assets. The investors or Sukuk holders, own the shares of this SPV. The asset is then leased back to the firm and the lease proceeds from the asset are distributed to the Sukuk holders as dividend. The returns on the Sukuk certificates, or shares of the SPV, could be either fixed or floating. The expected returns (pre-determined rental payments) are fixed and can be treated as predictable like the coupon payments of a conventional bond.
Ijarah Sukuk can be issued through a financial intermediary, a bank, a brokerage house or directly by the users of the lease asset. A third party can also guarantee rental payments, and since the yield is predetermined and the underlying assets are not liquid but tangible and secured, the Ijarah certificate can be freely traded in the secondary markets at par, premium or discount.
Note: The prevalent system of Islamic banking the world over is truly not the ultimate and ideal solution. It is only a step towards creating an interest free environment to provide Muslims with an option. Much needs to be achieved keeping in view the injunctions of Quran and Sunnah.