Sukuk

Overview

Sukuk (Arabic: صكوك, romanized: ṣukūk; plural of Arabic: صك, romanized: ṣakk, lit. 'legal instrument, deed, cheque') is the Arabic name for financial certificates, also commonly referred to as "sharia compliant" bonds. Sukuk are defined by the AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) as "securities of equal denomination representing individual ownership interests in a portfolio of eligible existing or future assets." The Fiqh academy of the OIC legitimized the use of sukuk in February 1988. Sukuk were developed as an alternative to conventional bonds, which are not permissible in Islam as they pay interest (prohibited or discouraged as Riba, or usury), and also may finance businesses involved in activities not permitted under sharia (gambling, alcohol, pork, etc.). Sukuk securities are structured to comply with sharia by paying profit, not interest—generally by involving a tangible asset in the investment. For example, sukuk securities may have partial ownership of a property built by the investment company (and held in a Special Purpose Vehicle), so that sukuk holders can collect the property's profit as rent (which is allowed under Islamic law). Because they represent ownership of real assets and (at least in theory) do not guarantee repayment of initial investment, sukuk resemble equity instruments, but like a bond (and unlike equity) regular payments cease upon their expiration. However, most sukuk are "asset-based" rather than "asset-backed"—their assets are not truly owned by their Special Purpose Vehicle, and their holders have recourse to the originator if there is a shortfall in payments. Different types of sukuk are based on different types of Islamic contract (murabaha, ijarah, istisna, musharaka, istithmar, etc.) depending on the project the sukuk is financing. According to the State of the Global Islamic Economy Report 2016/17, of the $2.004 trillion of assets being managed in a sharia compliant manner in 2014, $342 billion were sukuk, being made up of 2,354 sukuk issues.

Etymology

The Arabic term ṣakk was borrowed from Classical Persian چک (čak, “legal document, document, contract, deed of sale, bill”).

History

In the classical period of Islam, sakk (sukuk) meant any document representing a contract or conveyance of rights, obligations or monies done in conformity with Shariah. The term was used to refer to financial obligations originating from trade and other commercial activities in the Islamic pre-modern period. According to Camille Paldi, the first sukuk transaction took place in Damascus in its Great Mosque in the 7th century AD. Muslim traders are known to have used the cheque or ṣakk system since the time of Harun al-Rashid (9th century) of the Abbasid Caliphate. The modern Western word "cheque" appears to have been derived from "sakk" (singular of sukuk), which during the Middle Ages referred to a written agreement "to pay for goods when they were delivered" and was used to "avoid money having to be transported across dangerous terrain".

Modern Answering a need to provide short and medium term instruments so that balance sheets of Islamic financial institutions could be more liquid, the Fiqh academy of the OIC (Organization of Islamic Countries) legitimized the use of sukuk in February 1988. In 1990 one of the first contemporary sukuk—worth RM125 million—was issued by Malaysia Shell MDS Sdn Bhd, on the basis of bai' bithaman ajil. The next major sukuk issuances were by Kuala Lumpur International Airport for RM2.2 billion each in 1996 and 1997. In 2000, the government of Sudan issued domestic sovereign short-term sukuk worth 77 million Sudanese pounds on the basis of musharaka. In 2001, the sukuk market went international with the issuance of the first US-dollar-denominated ijara sukuk, worth $100 million, by the Central Bank of Bahrain. Since then many sovereign and corporate sukuk issues have been offered in various jurisdictions. To standardize the growing market, the AAOIF issued "Shari’ah Standard No.17" on "Investment Sukuk" in May 2003. It became effective starting 1 January 2004. In 2025, the AAOIF proposed changes to its Shariah Standard 62 that could significantly reshape the global sukuk market, which has grown to over $1 trillion. The new framework advocates a shift from commonly used "asset-based" sukuk structures, where investors have beneficial interests but not legal ownership, to "asset-backed" models requiring full legal transfer of underlying assets. While intended to enhance Shariah compliance by distancing sukuk from conventional debt instruments, the proposed changes raise concerns about legal feasibility, investor appetite, and market fragmentation. Critics warn that inconsistent implementation across jurisdictions could introduce legal uncertainty, reduce liquidity, and deter institutional investors reliant on credit ratings. AAOIFI is expected to finalize the standard in 2025 after reviewing industry feedback.

Industry

As of early 2017, there were US$328 billion worth of sukuk outstanding worldwide. As of the end of 2016, there were about 146 US dollar-denominated, Islamic fixed income securities issued in the global markets, that were investment-grade, and had a duration of at least one year. These securities—which make up the Citi Sukuk Index—had an average maturity of 4.54 years, and most were issued by governments. The top four issuers by market weight—making up over 40% of the market—were: ISLAMIC DEVELOPMENT BANK, PERUSAHAAN PENERBIT SBSN INDOIII, SAUDI ELECTRICITY CO, and SOQ SUKUK A QSC. About 3/4 of the sukuk market is domestic, not international. Most sukuk are not investment grade however, and as of 2015, there were 2,354 sukuk issues in total, including local currency denominated, non-global market sukuk, according to Thomson Reuters & Dinar Standard. According to the Malaysian International Islamic Financial Centre, as of 2013 the biggest issuers of sukuk were governments (65.6%), and the second largest were power and utility companies (13.6%).

Secondary market

Sukuk securities tend to be bought and held. As a result, few securities enter the secondary market to be traded. Furthermore, only public sukuk are able to enter this market, as they are listed on stock exchanges. The secondary market, though still developing, remains a niche segment with virtually all of the trading done at the institutional level. The size of the secondary market remains unknown, though LMC Bahrain states they traded $55.5 million of sukuk in 2007. As of July 2014 sukuk.com listed fifteen sukuk on the secondary market for Gulf sukuk.

Principles

Ali Arsalan Tariq states that Islamic finance—including sukuk—is based on a set of several prohibitions:

Transactions in unethical goods and services; Earning returns from a loan contract (riba/interest); Compensation-based restructuring of debts; Excessive uncertainty in contracts (gharar); Gambling and chance-based games (qimar); Trading in debt contracts at discount, and; Forward foreign exchange transactions. As Shari’ah considers money to be a measuring tool for value and not an asset in itself, it requires that one should not receive income from money (or anything that has the genus of money) alone, as this (simplistically, interest) is "riba", and forbidden. From a Sharia perspective, certificates of debt are not tradable except at their par value (although a different view is held by many in Malaysia). While a bond is a contractual debt obligation of the issuer to pay to bondholders, on certain specified dates, interest and principal, a sukuk is a certificate giving its holders an undivided beneficial ownership in the underlying assets. Consequently, sukuk holders are entitled to share in the revenues generated by the sukuk assets as well as being entitled to share in the proceeds of the realization of the sukuk assets.

Similarities with bonds

Sukuk and bonds are sold to investors who receive a stream of payments until the date of the maturity of the sukuk or bond, at which time they get their original investment (in the case of sukuk a full payment is not guaranteed) back. Sukuk and bonds are intended to provide investment with less risk than equities (such as shares of stock) and so are often used to "balance a portfolio" of investment instruments. Both sukuk and bond issuers must issue a disclosure document known as a prospectus to describe the security they are selling. To give investors an idea of how much risk is involved in particular sukuk/bonds, rating agencies rate the credit worthiness of the issuers of the sukuk/bond. Both sukuk and bonds are initially sold by their original issuers. After that they (or some sukuk and bonds) may be bought and sold by brokers and agents, mostly on the over-the-counter (OTC) market, but are also available on some stock exchanges around the world.

Differences from bonds

Ownership: Sukuk should indicate partial ownership of an asset. Bonds indicate a debt obligation. Compliance: The assets that back sukuk should be compliant with Shariah. Bonds need only comply with the laws of country/locality they are issued in. Pricing: The face value of a sukuk is priced according to the value of the assets backing them. Bond pricing is based on credit rating, i.e. the issuer's credit worthiness. Rewards and risks: Sukuk can increase in value when the underlying assets increase in value. Returns from bonds correspond to fixed interest. (Because most bonds' interest rates are fixed, most increase in value when the market interest rates fall.) Sales: When you sell sukuk, you are selling ownership in the assets backing them. (In instances where the certificate represents a debt to the holder, the certificate will not be tradable on the secondary market and instead should be held until maturity.) The sale of bonds is the sale of debt. Principal: Sukuk investors (in theory) share the risk of the underlying asset and may not get all their initial investment (the face value of the sukuk) back. (The value payable to the holder on maturity should be the current market value of the assets or enterprise and not the principal originally invested, according to Taqi Usamani.) Bond investors are guaranteed the return of their initial investment/principal. In practice some sukuk are issued with repurchase guarantees. Conventional bonds are issued with underwriters. Sukuk underwriters do not usually conduct the issuance and may not be required. Special Purpose Vehicles are used as the trustee/issuer of the sukuk.

Definitions, structure and characteristics

Definitions The AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions, the body which issues standards on accounting, auditing, governance, ethical, and Shari'a standards) defines sukuk as "securities of equal denomination representing individual ownership interests in a portfolio of eligible existing or future assets," or "'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 investment activity'."

The Islamic Financial Services Board defines sukuk as: certificates with each sakk representing a proportional undivided ownership right in tangible assets, or a pool of predominantly tangible assets, or a business venture. These assets may be in a specific project or investment activity in accordance with Sharia rules and principles. The Securities Commission of Malaysia defined sukuk as a document or certificate which represents the value of an asset.

Need Sharia forbids both the trading of short-term debt instruments except at face value, and the drawing upon the established interbank money markets (both being seen as involving interest and excessive uncertainty (gharar)). As a consequence, prior to the development of the sukuk market, the balance sheets of Islamic financial institutions tended to be highly illiquid and lacking in short and medium term investment opportunities for their current assets.

Structure and characteristics Sukuk are structured in several different ways. (The AAOIFI has laid down 14 different types of sukuk.) While a conventional bond is a promise to repay a loan, sukuk constitute partial ownership in a debt, asset, project, business or investment.

debt (sukuk murabaha). These sukuk are not common because their payments to investors represent debt and are therefore not tradable or negotiable according to sharia. (If diluted with other non-murahaha sukuk in a mixed portfolio they may be traded). asset (sukuk al ijarah). These are essentially rental or lease contracts, or conventional lease-revenue bonds. With these sukuk, the borrower's tangible asset is 'sold' to the financier and then 'leased' back to the borrowers. The borrowers then make regular payments back to the financiers from the income stream generated by the asset. They are the most common type of sukuk (as of 2015), and have been described (by Faleel Jamaldeen) as well known because of there simplicity, tradability and ability to provide a fixed flow of income. asset at a future date (sukuk al-salam). In this sukuk the SPV does not buy an asset but agrees to buy one at a future date in exchange for advance payments. The asset is then sold in the future for its cost plus a profit by an agent. On (or before) the date agreed to in the contract, the seller delivers the asset to the agent, who sells the asset and passes the proceeds (minus expenses/fees) on to the SPV, which distributes the proceeds to the sukuk holders. Sukuk al-salam are (at least usually) used to support a company's short term liquidity requirements. Holders receive payment not with a regular flow of income, but at maturity—similar to a zero-coupon bond. An example of this kind of sukuk is the 91-day CBB Sukuk Al-Salam issued by Central Bank of Bahrain. project (Sukuk al istisna). These sukuk are complex and cannot be traded in the secondary market or sold to a third party for less than its face value. business (sukuk al musharaka). These sukuk holders are also the owners of the originator issuing the sukuk and participate in the decision-making. These sukuk can be traded in the secondary market. or investment (sukuk al istithmar). The most commonly used sukuk structures replicate the cash flows of conventional bonds. Such structures are listed on exchanges, commonly the Luxembourg Stock Exchange and London Stock Exchange in Europe, and made tradable through conventional organisations like Euroclear Bank or Clearstream Banking SA. A key technique to achieve capital protection without amounting to a loan is a binding promise to repurchase certain assets; e.g. in the case of sukuk al ijarah, by the issuer. In the meantime rent is paid, which is often benchmarked to an interest rate (LIBOR is the most common though its use is criticized by some Sharia scholars). The most accepted structure, which is tradable, is the sukuk al ijarah. Debt certificates can only be bought before the finance occurs and then held to maturity, from an Islamic perspective. This is critical for debt trading at market value without incurring the prohibited riba (interest on money).

Issuing and payment process

The step-by-step process of issuing a sukuk based on an asset is:

The originator—a business firm requiring capital—creates a special purpose vehicle (SPV), an independent entity and structures. The SPV protects the sukuk assets from creditors if the originator has financial troubles. It specifies what asset or activity the sukuk will support, how large the issuance of sukuk will be, their face amounts, interest rates, and maturity date. SPVs are often located in "tax-efficient jurisdictions" such as Bahrain, Luxembourg or the Cayman Islands. The SPV issues the sukuk offering it for sale to investors with an agreement spelling out the relationship between obligator and sukuk holders (depending on the type of sukuk this can be lessor and lessee, partner, etc.). With the money from the sale of sukuk certificates, the SPV passes the offering to the originator who makes the sharia compliant asset purchase, lease, joint venture, etc. (again depending on the type of sukuk). The SPV purchases assets (such as land, building, machinery, etc.) from the originator. The sale proceeds are paid to the originator/debtor as the price of the assets. The SPV, acting as a trustee on behalf of the sukuk holders, arranges to lease the assets back to the originator, who pays the sukuk holders the lease income. The originator buys back the asset from the SPV at a nominal price on termination of the lease. In this type of sukuk, the fixed interest of a conventional bond is replaced by fixed lease income. Islamic economist Muhammad Akram Khan complains that sukuk are "different from conventional finance in form and formalities rather than substance", and "may even be more expensive" for the income provided than a conventional bond.

Example

An example of a sukuk was a $100 million security used to finance the construction and delivery of cooling plants in Abu Dhabi. This sukuk had an istisna'a and ijarah structure and was issued by the Tabreed Financing Corporation (or National Central Cooling Company PJSC) in March 2004.

Tabreed created an SPV (incorporated in the Cayman Islands), which sold certificates of sukuk bonds. With the proceeds of this sale it bought some partially completed central cooling plants ("assets" held in trust for the sukuk). (1) The SPV leased the trust assets to the Tabreed; (2) which made rental payments to the SPV; (3) which passed the payments on to sukuk holders (4). When the sukuk matured the trust assets were bought back from the SPV and the sukuk holders got their principal back. If some "dissolution event" (e.g. destruction of the leased property) had interrupted the payment of rent this would have prompted "the continuation of payments in the form of repurchase price". This reduces the risk structure of the sukuk to that (or near that) of conventional bonds, which permits the sukuk to earn the same or close to the same credit ratings that conventional bonds earn. Consequently, they are able to be sold at an interest rate lower than they might be otherwise, although their transactions costs are higher than conventional bonds because of the creation of SPVs, as well as payment of various jurists' and legal fees for structuring the bond issuance.

Challenges

According to a 2015 IMF report, the supply of sukuk "falls short of demand" and, with some exceptions, "issuance takes place without a comprehensive strategy to develop the domestic market".

Sukuk are seen as well-suited for infrastructure financing because of their risk-sharing property could also help fill financing gaps. National authorities should, therefore, focus on developing the necessary infrastructure, including promoting true securitization and enhanced clarity over investors' rights, and on stepping up regular sovereign issuance to provide a benchmark for the private sector. Increased sovereign issuance should be underpinned by sound public financial management. "Key challenges" to the Islamic finance industry as a whole—including sukuk—as of 2016 include (according to the State of the Global Islamic Economy Report, 2015/16 and the IMF):

"Low levels" of awareness and understanding of Islamic finance products and services among the public, leading them to not buy. A "scarcity of Shariah-compliant monetary policy instruments" and a lack of understanding of "the monetary transmission mechanism". "Complex financial products and corporate structures" in some countries/jurisdictions because "regulatory and supervisory frameworks" do not "address the unique risks of the industry". Consequently, what is needed is "increased regulatory clarity and harmonization, better cooperation between Islamic and conventional financial standard-setters, and further improvement of supervisory tools". "Underdeveloped" safety nets and resolution frameworks. In many places these include complete Islamic deposit insurance systems where premiums are invested in Shariah-compliant assets, or Shariah-compliant "lenders-of-last-resort". Regulators who "do not always have the capacity (or willingness) to ensure Shariah compliance." Defaults In three years during and following the 2008 financial crisis—2008, 2009, 2010—there were at least 21 substantial sukuk defaults, and several large near defaults such as that of Dubai World, which was saved by a $10 billion loan from Abu Dhabi As of 2009, there were a number of cases where the sukuk had defaulted or were in serious trouble. In May 2009, Investment Dar of Kuwait defaulted on $100 million sukuk. Saad Group set up a committee to restructure the $650 million Golden Belt 1 sukuk. Standard & Poor's cut the rating of that sukuk "owing to the non-availability of vital information". Another source (Mushtak Parker) claims there "have been a mere three or four" sukuk defaults—the East Cameron sukuk in Louisiana (a dispute relating to the profit-sharing arrangement of the instrument); the Investment Dar sukuk (to do with "cash flow problems of the company and its subsidiaries, albeit it had a side dispute with an investor, Blom Bank relating to the shariah aspects of the contracts"); and the "notorious" Saad/Al Gosaibi sukuk default ("more a market failure and an internecine dispute between the two Saudi partners").

Protection from originator's default Fitch Ratings, one of the three major bond rating agencies for the US, has indicated doubts about the "validity" of transfer of assets from the originator in sukuk in the "event of an insolvency of the originator" and attempts by creditors to seize the assets. "Fitch has not reviewed any transaction to date that would satisfy these requirements." Underscoring Fitch's concern was the bankruptcy of East Cameron Partners ECP, which issued a multiple-award-winning sukuk in 2006 but filed for bankruptcy in October 2008, prompting a legal dispute about the creditors' right to $167.67 million in sukuk assets. (The final decision of the case "did not clearly resolve this issue".) Another major rating agency, S&P, downgraded the sukuk of Dubai Islamic Bank and Sharjah Islamic Bank. According to Ibrahim Warde, as of 2010,

What is still unclear is what happens to sukuk when they fail—an issue that has not been tested in court. In Malaysia, some sukuk issues have junk status, and two other sukuk are already in default: the Eastern Cameron Gas company in the United States and Investment Dar of Kuwait. One of the unresolved questions is whether sukuk holders should stand in the line of creditors or in the line of the owners of underlying assets. In reviewing cases of sukuk defaults and bankruptcies, Muddassir Siddiqui complained that: Through reading many cases that have so far been litigated in courts around the world, I have found that in almost all cases, the courts have struggled to reconcile the substance and form of the contract. Was it a sale, lease, construction or partnership contract or a financing arrangement between the parties? According to Rodney Wilson, when sukuk payments are delayed or fail, "the means of redress are potentially more complex than for conventional notes and bonds". In particular "under Shari’ah leniency towards debtors is favoured", which inevitably raises moral hazard problems.

Discrediting Sharia compliance There have been at least two cases of companies seeking to restructure their debt (i.e. pay creditors less), claiming that debt they had issued was not in compliance with sharia. In a 2009 court filing Investment Dar, a Kuwaiti company, claimed a transaction "was taking deposits at interest". In June 2017, the independent gas company Dana Gas PJSC declared two of its sukuk—with a total worth of $700 million—no longer sharia compliant, and offered to exchange the sukuk with new ones which would pay "less than half of the current profit rates and without a conversion feature". The sukuk were issued in 2013 and due to mature on 30 October 2017. Dana refused to make payments on them, alleging that "changes in Islamic finance over recent years have made the bonds unlawful in the UAE". A month earlier, Dana had announced plans to restructure the debt, stating it needed to "focus on short to medium-term cash preservation." Sukuk holders, represented by fund manager BlackRock and Deutsche Bank, have been arguing against Dana in a London High Court. In October 2017, a court in the emirate of Sharjah in the UAE—where Dana had filed for protection—postponed a ruling on the sukuk. The issue has been called "one of the greatest challenges that the Islamic finance industry has faced in recent times", but the idea that the case is "a blow to Islamic finance" has also been dismissed as "poppycock".