Structural risks in the design of Sukuk

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Structural risks in the design of Sukuk

  1. 1. Structural risks in Sukuk designs Dr. Tariqullah Khan, Professor of Islamic Finance QFIS – Hamad bin Khalifa University CENTER FOR ISLAMIC ECONOMICS AND FINANCE Symposium on Sukuk - Shariah, Legal and Economic Issues - November 9, 2013
  2. 2. What are Sukuk? Sukuk are special types of bonds based on the: Credit risk of the issuer Ownership share of the underlying assets Exposure to market risk based on underlying contracts Simultaneous compliance with Islamic and prevailing laws
  3. 3. Yearly issuance in billion US dollars 140 Size of annual global Sukuk issues Total outstanding global Sukuk in 2013 are estimated at US$ 210 billions 120 100 80 60 40 20 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Q3 Source: Zawya Sukuk Reports
  4. 4. Sukuk demand drivers Simultaneous conformity with the Islamic and prevailing legal regimes Financial inclusion, deepening of financial markets Risk-return considerations & unique asset class Infrastructure project finance Synergy with other segments of Islamic financial services Progress in relevant financial infrastructures
  5. 5. Structural risks in the design of Sukuk is inhibiting & destabilizing What is it? How it exists? How to alleviate it?
  6. 6. Sukuk are engineered and structured products by the architectural players in conformity with the required architectural elements
  7. 7. ⃝ ⃝ ⃝ ⃝ ⃝ Who are the architectural players in designing the product? Architects – setting the principles, norms and guidelines (Shariah & legal scholars); Engineers - (product developers & arrangers) Plumbers - (other professionals) Influencers – independent scholars, Muftees, media Investors and users
  8. 8. What are the architectural elements of the product design? Universal ethical principles; Tenets of religious faith; Social norms; Best practice business and industry standards; * External regulatory guidelines * Internal operational and contractual documentation * * * *
  9. 9. Violation of architectural principles ① Shaky foundations of the wall ② Raw rocks in the wall ③ Too narrow Structural risks of a design
  10. 10. Narrow but stable Unstable but not narrow Noise among architectural players will increase vulnerability
  11. 11. Preconditions for structural/architectural stability Consensus among lead architectural players about key architectural elements
  12. 12. The noisy architectural players and structural risks in the design of Sukuk
  13. 13. Top standard setter of the industry ❶ Promise to repurchase the Sukuk assets at the initial price is not permissible “Sukuk and their Contemporary Applications” open source document 2007 by Muhammad Taqi Usmani, President of the AAOIFI Shariah Council ❷ Promise to repurchase the Ijarah Sukuk assets at the initial price is permissible AAOIFI Sukuk Resolution 2008 If the AAOIFI position was # 2, why in #1 it was completely ignored? If #1 was an important internal position paper, why it became viral on the Internet even before #2 was issued? Hence the impression – there is a disagreement between Chairman and members of the AAOIFI Shariah Board Noisy architectural players – example 1
  14. 14. OIC Fiqh Academy Re-purchase of Sukuk or their assets for a prefixed price is impermissible in the future cases of issuance Resolution No. 188 (2012) of OIC Fiqh Academy on the subject of Sukuk Top independent Academy of the industry ❶ Externally in conflict with the 2008 AAOIFI Resolution about permissibility of repurchase in case of Ijara ❷ Internally inconsistent as it makes only future cases of Sukuk with repurchase impermissible Noisy architectural players – example 2
  15. 15. Impression of the Market & - the 2 apex standard setters of the industry disagree on what is permissible and what is not
  16. 16. “Prospective Holders should note that different Shariah advisers, and Saudi courts and judicial committees, may form different opinions on identical issues and therefore prospective Holders may wish to consult their own legal and Shariah advisers to receive an opinion if they so desire.” SABIC Sukuk Prospectus Response of Sukuk issuers to the noise between architectural players by itself adds additional noise Noisy architectural players – example 3
  17. 17. Structural basis of Financial Market Products Ownership risk of the asset (price risk) Equity shares Credit risk of the issuer & interest rate risk Bonds
  18. 18. Independent Shariah scholars Asset price risk Sukuk Equity Interest rate risk Credit risk Bond Structural risk free Sukuk will be without repurchase agreement
  19. 19. Shariah Advisors of Sukuk Issuers Asset price risk Equity Interest rate risk Credit risk Sukuk Bond Structural risk free Sukuk will be with repurchase agreement
  20. 20. Repurchase at initial price is not permissible Independent team noisy arguments fragility of Repurchase at initial price is required Advisors’ team firm argument s structure
  21. 21. Lack of consensus on architectural elements Independent Shariah scholars More noise No noise Shariah Advisors The one single most important architectural element – repurchase of Sukuk assets at initial price
  22. 22. Sukuk Structural Risk – bundled nature of credit, price and return risk Consequence of disputes Return and noise risk between Shariah Price Credit scholars risk risk Sukuk Credit risk Interest rate risk Bond Asset price risk Equity
  23. 23. Can the market have this type of a product? Return risk Price risk Credit risk Bundled risks Independent Shariah Scholars – No, because it has credit risk and the rate of return risk is actually interest rate risk Shariah Advisors – No, because rating and pricing is not possible
  24. 24. Structural risk originates from the disagreements of Shariah scholars and leads to the bundling of credit, price and return risks Such a financial market product could not exist in the market by consensus of the Shariah advisors and independent Shariah scholars
  25. 25. Structural risks could cause wealth losses as well as hamper growth and depth of the Islamic capital markets
  26. 26. Avoiding structural risks is an imperative for Islamic capital market development
  27. 27. Avoiding structural risks is an imperative for the resilience and stability of Islamic capital markets
  28. 28. The key architectural players are actually Finance Ministers Central Bank Governors Sukuk Issuers and Dealers Islamic Bankers Investors “Independent” scholars
  29. 29. Looking ahead – a high powered Apex Islamic Finance Board of the above mentioned key stakeholders is needed to avoid the structural risks of the Sukuk industry
  30. 30. Announcement Please be informed that the Qatar Faculty of Islamic Economics does offer an Executive Education Program on “Sukuk and Islamic Capital Markets”
  31. 31. Thank you tkhan@qfis.edu.qa

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