What Is Sukuk, Types Of Sukuk, And Characteristics Of Sukuk

Sukuk definition:

The sukuk concept is based on the premise that any Islamic financing contract representing ownership of a tangible asset can be bought or sold, and hence can be structured in the form of tradable securities.

A sukuk represents:

An undivided proportionate beneficial ownership interest in an asset or portfolio.

The corresponding right to the Islamically acceptable income streams generated by the asset or portfolio.

A sukuk is similar to a conventional bond in most respects – such as trading, listing, and rating – but is structured in a Shariah-compliant manner. The sukuk structure has several advantages, one of which is that it provides access to a growing Islamic liquidity pool in addition to the conventional investor base.

Different Types of Sukuk:

A sukuk can be structured in a number of ways, depending on its underlying assets and business purpose. Some of the generic sukuk structures used for international sovereign and corporate structures are:

(a) Ijara sukuk

Concept: Certificates of equal value based on sale & leaseback of an asset.

Examples: International sovereign issues: Malaysia, Qatar, Pakistan, DCA   Domestic issues: Bahrain, Malaysia

(b) Musharaka sukuk

Concept: Based on the concept of partnership, with the aim of using the mobilised funds to establish a new project or develop an existing project, so that the certificate holders become the owners of the project or the assets as per their respective shares.

Examples: Emirates Airlines

© Sale of co-ownership of Ijara contracts

Concept: Ijara contracts between the bank & the customer, shown on the bank’s books.

Examples: Dubai Islamic Bank sukuk

Key characteristics of sukuk:

Issuer – Typically a Special Purpose Vehicle (SPV) that issues sukuk certificates on the back of a Shariah-compliant asset/contract with the obligor. The investors purchase sukuk certificates to fund the issuer, who passes the funds to the obligor. This is unlike a conventional bond issue, where the obligor is also the issuer. However, in both instances, the recourse of investors is ultimately to the obligor.

Obligor – The beneficiary of the funds or the entity which is raising the funds through the sukuk. Typically, investors take ultimate credit risk on the obligor for both coupon and principal repayments, as with a conventional bond.

Profits versus interest – Because interest is not allowed under Shariah principles, contracts are structured so that the investor has a share in the profits generated from the use of the underlying asset/financial contract. These are distributed as regular ‘profit’ or ‘coupon’ payments on the sukuk on predetermined dates (comparable to regular coupon servicing in conventional bonds).

Ratings – The certificates issued by the SPV can be rated by recognised rating agencies. Typically, for a straight unsecured senior sukuk, the rating of the sukuk issue is same as the rating of the obligor, since the ultimate credit is the obligor. Hence, ratings are usually on par with those of conventional bonds.

Clearing – Through Euroclear, Clearstream, or any such mechanism, as with conventional bonds.

Listing – As with conventional bonds, sukuk certificates can be listed on most major stock exchanges.

Governing law – Sukuk certificates are typically governed by UK law for eurobond issues, or by local laws for local-currency issues (as with conventional bonds).

Trustee – In a eurobond, a trustee may be appointed to represent the interests of the bondholders. In a sukuk structure, this role is often effected by a delegate (an independent third party).

Basis of profit payment – Sukuk certificates can be either on a fixed-rate or floating-rate basis and priced against a benchmark such as USD LIBOR, EURIBOR.

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