Sukuk: Key Concepts and Applications

Aug 5, 2024

Lecture Notes on Sukuk: Islamic Bonds

Definition of Sukuk

  • Sukuk: Represents proportionate ownership in an asset or a pool of identified assets.
  • Trading of Murabaha and Salam Sukuk is not permissible.
  • Also referred to as Islamic investment certificates.

Key Advantages of Sukuk

  • New source of funds for Islamic borrowers at attractive rates.
  • Vital for developing deeper and more liquid Islamic capital markets.
  • Taps into cash surplus in Islamic financial institutions.

Benefits and Features of Sukuk

  • Capital Gains: Accumulated when bond prices rise as variable market indices fall.
  • Asset-backed Investments: Linked with tangible assets and real sector activities.
  • Credit Quality: Rated by international agencies to assess risk and return parameters.
  • Regular Income: Characterized by periodic income streams.
  • Liquidity: Existence of a secondary market provides liquidity.

Applications of Sukuk

  • Issued for:
    • Government projects (Ijara-based Sukuk).
    • Corporate bodies and financial institutions.
  • Public Involvement: Gives a sense of ownership in government projects.

Legitimacy of Sukuk

  • Must consist primarily of physical assets; small portion can be cash/debts.
  • Islamic Bonds: Do not involve interest or gambling; represent ownership.

Understanding Conventional Bonds vs. Sukuk

  • Coupon Bond: Pays specified amount at maturity.
  • Discount Bond: Bought at a discount; pays once at expiry.
  • Convertible Bond: Right to convert to common shares.
  • High Yield/Junk Bond: Issued by companies with speculative grade or below ratings.

Types of Sukuk and Their Applications

  • Ijara-based Sukuk: Certificates of ownership of leased assets.
  • Diminishing Musharaka-based Sukuk: Ownership in assets based on diminishing partnership.
  • Zero Coupon Sukuk: Not readily tradable due to lack of assets.

Issuance of Islamic Bonds

Stages of Issuance

  1. Securitization: Creation of underlying assets.
  2. Bond Issuance: Debt certificates sold to investors.
  3. Trading of Debt Certificates: Secondary market trading.

Investment Sukuk Types

  • Certificates of Ownership for various assets/services.
  • Musharaka: Proportionate ownership in musharaka assets.

Structuring Types of Sukuk

  • Requires exchange of assets through Sharia-compliant contracts such as Mudharabah, Musharaka, Ijara, and Murabaha.

Case Study: Ijara-based Sukuk

  • Example of ABC Limited purchasing a plant via Sukuk:
    • Establish Special Purpose Vehicle (SPV).
    • Issue bonds; collect funds.
    • Lease asset to the company; distribute lease proceeds to investors.

Diminishing Musharaka Sukuk Structure

  • Involves agreements between investors and issuers for joint asset ownership.
  • Payment agreements for periodic rental payments.

Salam Sukuk

  • Advance payment for future delivery of goods.
  • Example: Government selling crude oil after advance payment.

Other Types of Islamic Sukuk

  • Musara: Sharecropping certificates.
  • Mugara: Agricultural certificates.
  • Mussaka: Irrigation certificates.

Hybrid Structures

  • Combining multiple Islamic modes for a single Sukuk issuance.