Redefining Sukuk As AnEquity Instrument, Not A Debt OneDhafer Salih AlqahtaniExecutive principalRusmal ConsultManama, King...
some of these countries, starting with Tunisia, Egypt, Libya, Morocco, Yemen, and soon Syria,thus adding new markets and a...
also preventing reputational risk in the new world order of the global financial market as well asour direct markets.1. We...
This would expand the volume of the Sukuk market while directing those surpluses to morepressing issues at the social leve...
better asset allocations by developing more innovative products in the fixed-income industry,with different tenors, return...
wealth, and equality as opposed to concentration of wealth. At the same time, the balancedgrowth of the industry will prog...
prudent and transparent Islamic financial services industry through introducing new or adapting existinginternational stan...
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Redefining sukuk as an investment instrument , not a debt one.


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  • There is no doubt that Islamic financial instruments have changed and grown over years in the way they are structured and managed. The question is are these instruments going to stand the test of time given the free market economies? Do they survive only on promoting ideologies and cultures and beliefs? Is there a way to still improve on them to make them open further doors to the world capital market as options on the international markets?

    With the changes in the financial systems stimulated by the recessions in the west (USA & Europe) we need to try and optimise on the use of such instruments which will not be affected by some of the economic variables caused by the Western economic environment of capitalism.

    I am interested to see how Islamic Asset management and Financial instruments play a role in hedging businesses during this period.

    Do they survive on the financial muscles from oil rich nations? or are they viable instruments on their own?
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Redefining sukuk as an investment instrument , not a debt one.

  1. 1. Redefining Sukuk As AnEquity Instrument, Not A Debt OneDhafer Salih AlqahtaniExecutive principalRusmal ConsultManama, Kingdom of Bahrain.dhaferq@gmail.comAs 2013 unfold and we begin to look towards a better new year, global investors are waitinganxiously for nerve-racking volatility and uncertainty in the world economy to settle at anacceptable and tolerable level, once again restoring confidence in the financial sector. In Europe,investors are hoping for a resolution to the European sovereign debt crisis that will avoidescalating and propagating the woes of the western European economy. In addition, the U.S.economy’s path to recovery has been dominated by the contrary aims of bickering politicians.Unfortunately, it all adds up to a bigger fear—that the goal of reaching workable long termsolutions to those crises on both sides of the Atlantic is not getting serious and timely attentionthus reducing the options for solutions and escalating further the global economic deterioration.Austerity measures are spreading like fire all over the globe, and their implications areprofoundly negative. And if that was not enough, ratings agencies are rushing into downgradingsovereign debts and financial institutions, adding insult to injury. The irony of this bleak pictureis the fact that sovereign debt was created specifically to solve economic problems and stimulatethe market economy. Instead, and in due course, the solution itself became the problem.Accordingly, we now have two major problems— troubled economies and bad debts—whichraises the question of whether so-called capitalism (particularly the Western version) is in denialabout what it promised to deliver through its interest-based system. We are left with over-leveraged economies and over-borrowed countries, not to mention the over distressed individualswho are struggling to make ends meet, and the situation will not get any better even aftercountries enforce their super-national lender’s austerity plans and belt-tightening measures. At thesame time, funding resources are drying out and funding has become more expensive, thusforcing governments, banks, and corporations alike to seek alternatives outside the interest-based(i.e., asset-based) system. One alternative that has received wide attention is Islamic finance andits crown jewel—Sukuk. In fact, the demand for Sukuk is outstripping the supply. And why not,in light of the unprecedented growth in the Islamic banking sector, averaging 15%–20% annuallyfor the past decade, even during the financial crisis. Most of that growth took place in the GulfCooperation Council (GCC) region and some parts of Asia that happen to be the least affected bythe financial crisis.The Islamic finance area also enjoys surplus liquidity, particularly in oil-rich countries (i.e., GCCcountries). Accordingly, in their quest for surplus liquidity, the rest of the world’s countries andfinancial institutions— facing liquidity squeezes, debt crises, holding extremely risky assets,rating downgrades, and increasing unemployment—are looking toward Islamic instruments to dobusiness. Meanwhile, with the financial crisis tremors being felt in the background, the ArabSpring revolutions swept across the Middle East and North Africa (MENA) region. Somecountries are yet to recover from the aftermath of the Arab Spring revolutions, which is continuesto harvest tyrants and install Islamists who promise to embrace democracy after decades ofdictatorship. After decades of suppression and rejection, Islamic banking is starting to flourish in
  2. 2. some of these countries, starting with Tunisia, Egypt, Libya, Morocco, Yemen, and soon Syria,thus adding new markets and a new players as well new challenges. The majority of thesecountries and their newly elected governments, however, inherited huge deficits andinfrastructures in shambles with great need for liquidity as well as huge unemployment rates.Resolving these issues in the current troubled macroeconomics times will require seriousnavigation. Logically, because Islamists hold the majorities on these newly elected governments,Sukuk will be a favorite tool to tackle these issues. Also unfolding in the gulf region, othercountries acted ahead of the unrest in the streets and forged ahead with their infrastructuredevelopment and social programs by expanding their budget spending and thus, with minimalconfrontation, met most of the demands of the protesters and the social media campaigns. Thosemeasures did stimulate the economy in the gulf region.Islamic finance and its institutions are an intricate part of this unsympathetic economic cycle andunstable political atmosphere. Hence, they are not isolated from its impacts and progressions.Accordingly, Islamic finance should take advantage of this turmoil and come forward as thesolution provider for the crisis, not just as a safe harbor for excess liquidity that seeks a betteryield. In order to do so, it will need to rapidly adapt to a myriad of ongoing changes in themarkets. Islamic finance has already demonstrated its resiliency and sustainability, so it should beable to see and capture opportunities in the crisis while reserving and defending the authenticityand genuineness of Shari’ah-based products.No dialogue or scholarly discussion about Islamic finance and banking as a whole would becomplete without addressing one of the cornerstones of Shari’ah-compliant investmentsinstruments— Sukuk. Sukuk as an instrument are less than two decades old, and recently, since2007, they have been under intensive scrutiny about whether they are workable, real Islamicfinancial instruments. The conflict between the Sukuk documents and the governing law ofShari’ah, especially cross-border Sukuk, arises from the differences between asset-backed andasset-based Sukuk. In a true Sukuk, an asset-backed one, the Sukuk holders have recourse in caseof default through the transfer of the underlying assets through a trust—this is known as an“equity Sukuk.” In so-called “complaint” or asset-based Sukuk, also known as “debt sukuk”where no true sale or real ownership take place between the originator and the issuer i.e., (trustSPV), hence sukuk units holders have recourse to originator, contrary to true sale in asset-backedsukuk, where recourse is to the Sukuk’s SPV that represents the Sukuk units holders ownership ofthe underlying assets and no recourse to originator in case of default. Such concerns as this orothers that have been raised by Shari’ah standards setting bodies (e.g., Accounting and AuditingOrganizations for Islamic Finance, or AAOIFI) are needed to further refine and tune Sukukstructures without violating the principals of risk and profit sharing on which Sukuk should bebased. The rapid growth and mounting global interest in Sukuk will bring with it new andinnovative structures designed to serve specific needs and demands, consequently giving rise tonew challenges and concerns. Unfortunately, the core issue remains unsolved and untackled, atleast by the scholars who are suppose to be the “gatekeepers”—that is, the shift toward asset-backed Sukuk instead of debt sukuk, (Asset-based sukuk), it’s a case of “substance over form”.Indicators are pointing in the right direction for a change, signaling a possible recovery on thehorizon, thus the time is ripe for the sukuk to move to the next level of its development andadvancement, as well as carving a place for true sukuk in the global financial market whilecorrecting the way sukuk are being issued, structured, and administered.With that said, and out of fear and concern for where the sukuk industry might be headed, I wouldlike to contribute and share my views and suggestions as a practitioner and a veteran of theindustry. Thus, I have few pointers on how we can possibly make sukuk more genuine andappealing (i.e., investment sukuk) while holding their creditability and conformity with shari’ah,
  3. 3. also preventing reputational risk in the new world order of the global financial market as well asour direct markets.1. We start with the most important component of any sukuk development—the Shari’ahSupervisory Board (SSB) and shari’ah scholars—“The Gatekeepers.” Their duties and mandatesshould go beyond issuing a signed and sealed fatwa for Sukuk or any product for that matter, theSSB must be fully responsible and accountable in addition to being proactive, from the conceptlevel of structuring and the Fatwa process to implementation and execution and, eventually, theattainment of maturity for the instrument or security, as well as a possible default. TheseGatekeepers should serve in this role for all related Shari’ah-complaint structures, securities, andproducts as well as Halal businesses. The Shari’ah compliance and/or audit officer shouldspearhead such crucial functions under a direct mandate from the SSB.2. All SSBs, separately or collectively, should encourage if not require asset-backed Sukuk(equity Sukuk or investment Sukuk) with clear and well-defined recourse for investors whilediscouraging asset-based Sukuk (debt Sukuk) with the objective of eventually minimizing if noteradicating debt Sukuk. Such a task is only possible and feasible through the institutionalizationof an SSB process.3. Introduce Sukuk at the retail level (distribution of wealth) by allocating sizeable tranches to theretail segment, thus expanding the trading platform of Sukuk to augment accessibility,consequently expanding the secondary markets. At the same time, this adds another attractive andviable asset class for investors (i.e., Sukuk) in addition to traditional equity and real estate.(Moreover, real estate as an asset class is illiquid in nature, and it is becoming too expensive toacquire by the regular investor, which gives all the more reason to push for Sukuk as analternative asset class that is liquid for Muslim and non-Muslim investors alike who may havelimited choices.)4. Contribute to the expansion of the secondary market by issuing larger Sukuk to address thevolume concerns, which will enhance their liquidity and marketability.5. Increase the number of long-term Sukuk (10 years), which will increase both the diversity andthe attractiveness of Sukuk, particularly for long-term investors (e.g., asset managers, sovereignwealth funds, pension funds, and takaful companies).6. Advance and encourage issuance of Sukuk for short and medium terms to expand thebreadth and depth of secondary markets as well as the numbers and diversity of Sukuk.7. Governments issuances should promote Sukuk as a saving instrument option for individuals,allowing them to participate in major issuances at the retail level by creating retail portions forprivate individuals.8. Sukuk issuance cost should be driven down, thus allowing cash-starved medium-capitalizationbusinesses to become issuers to finance expansion and growth and fulfill one of their vital rolesin the economy—jobs creation. This could come mainly through more standardization in terms ofSukuk generic structures and types by AAOIFI and other standards-setting bodies for Islamicfinance (e.g., Islamic Financial Services Board or IFSB; International Islamic Financial Market orIIFM).9. Infrastructure development and mega-project originators and issuers, both governments andquasi-governments, should utilize Sukuk for financing their needs instead of using their surpluses.
  4. 4. This would expand the volume of the Sukuk market while directing those surpluses to morepressing issues at the social level, such as education and health care.10. Explore and encourage innovative features and structures that are hybrid in nature, beyond the14 Sukuk types of AAOIF (especially, the well-known Sukuk alijarah or leasing) structure),toenhance versatility and adaptability in meeting the increasingly complex needs and situationsfaced by issuers.11. Encourage new asset classes as the underlying asset other than the traditional assets (i.e., realestate and Islamic financial institutions), such as infrastructure, railroads, airports, manufacturing,power generation, education, and health care sectors, thus widening diversity as well as the riskprofile for Sukuk. Similarly, encourage more issuances in local currencies other than the dollar.12. One of the major misconceptions in the Islamic finance industry is calling a Sukuk an“Islamic bond.” Islamic finance does not have any structure that can be called a bond. Similarly, abond as we know it is contrary to Islamic finance principals. Thus, a bond cannot be calledIslamic, and it’s not a Sukuk, as Sukuk are an investment instrument. Accordingly, there is nosuch thing as Islamic bond, and a Sukuk is not any kind of bond. Those issuances that are beingcalled Islamic bonds are only debt instruments that are being forced to be Shari’ah-complaintwhile mimicking many features of the conventional bond—so, calling those issuances “Islamicbonds” is not far from the truth, even though there is no such thing as an Islamic bond. Butcalling them Sukuk is major distortion to the substance and a misrepresentation of the form ofSukuk as a major Islamic investment product that derives its uniqueness and functionality fromthe equity side. Sukuk is an investment instrument, in which the Sukuk units represent a partialownership of the underlying assets, with direct claim to those assets and profits in distribution orliquidation.13. Significantly improve the disclosure and transparency of Sukuk structures and unit holderrights and obligations to the underlying assets, including the case of default, market risk, pricing,fees, charges, and uses of the funds. Similarly, risk and return prevailing conditions with theiressential dynamics should be embedded in the transparency and disclosure process, bothquantitative and qualitative.14. Educational institutions that cover Islamic finance and economics in their degree programs,but who have been invisible until now while claiming they have Islamic finance research centers,should go beyond their curriculum guidelines and textbooks for Islamic finance andconstructively challenge, analyze, and criticize the industry practices and products throughresearch and development. Their findings, criticisms, recommendations, and analyses should bemade public, sharing it with the concerned regulators, standards-setting bodies, and Islamicfinancial institutions.15. Islamic finance standard-setting bodies (e.g., AAOIFI, IFSB) should move beyond theirpresent mandate by being vocal in enforcing their regulations and raising the red f lags publiclywhenever needed and by introducing newer regulations and guidelines. At the same time, theymust be proactive in terms of being ahead of the industry’s needs and requirements.Considering these pointers and recommendations, which largely address the creation of a vibrantsecondary investment Sukuk market as well as accessibility, will enhance growth and reinforceconfidence in Sukuk and attract a sizeable share of the liquidity surplus by opening a newwindow for private individuals’ savings, an area that yet to be developed. By the same token,following these recommendations will give more choices and flexibility to asset managers for
  5. 5. better asset allocations by developing more innovative products in the fixed-income industry,with different tenors, returns, and risk profiles involving investment Sukuk. This will bring moreinvestors to structured Sukuk funds, in particular, which have been battling to gain market sharein the mutual and fixed-income funds sector. They have encountered difficulties in attractinginvestors due to the lack of breadth and depth caused by the shortage in diversity and volume inthe Sukuk issuance as well as the low variety of sectors in relation to the underlying assets inSukuk issuance, and a lack of variety in the currencies mix. Fortunately, Sukuk funds can be nowre-energized on the basis of the Sukuk issuances record for 2011, 2012 and its high prospects for2013 and beyond.On the issuance side, governments through central banks will have a stable instrument to managethe money supply as well as the fiscal and monetary budget. In the larger picture, governments ofIslamic countries should also foster the growth of Shari’ah-compliant products by utilizingIslamic finance instruments (i.e., investment Sukuk) to finance major infrastructuredevelopments, power grids, bridges, transportation projects, housing, and mining projects. At thesame time, the government issuances will enable citizens at the individual level (retail segment)to become Sukuk unit holders (wealth distribution) with clear recourse to the underlying assets,thus investing in financing those projects through those Sukuk while getting reasonable returns ontheir participation alongside having the comfort from knowing that they are investing in genuineSukuk. In addition, those citizens will feel pride in knowing that they are owners of a megaproject in their country for their benefit. Allowing individual participation in Sukuk willeventually create products for preserving wealth and encouraging savings for citizens, whilegradually developing a vibrant secondary market and slowly moving away from concentration ofwealth.The unprecedented growth of the Sukuk has raised many red f lags and requires all of the partiesinvolved to step back and take the time to evaluate, analyze, and examine its merits and virtues,its impact on the industry as a whole—in particular, its integrity, reputation, creditability, and itsauthenticity. It’s the responsibility of all of us practitioners, lawyers, and regulators, with aparticular focus on scholars; this responsibility and accountability should go beyond the race tointroduce another debt Sukuk while blinded by the fees to be earned from those issuances to themarket, as that debt Sukuk undoubtedly will backfire on the industry. In short, debt Sukuk is an“accident is waiting to happen,” thus let us prevent it from happening and be vigilant of such atrend.The rush of many sovereign and conventional financial institutions, investment and commercialbanks, as well as international regulators, to Sukuk issuance is mainly driven by the dryingfountain and high cost of conventional debt. They are also lured by the surplus liquidity in theArabian Gulf region and some parts of Asia; this was demonstrated most recently by theannouncement that South Africa, Japan, Hong Kong, Ireland, Kazakhstan, Bermuda, France,China, India, and Australia, among others, are joining the issuers league, or contemplating theidea. This coincides with the fact that a large sum of the gulf region’s liquidity is starved and inmost cases constrained to Shari’ah-compliant instruments and securities. Such a new paradigm ofdebt demand and supply—jointly with the wrong intentions and purposes (camouflaged greed orneeds)—can be a recipe for disaster. Thus, although the sprouting interest motives and aims inSukuk should be welcomed, it must also be challenged and scrutinized, especially by theGatekeepers (i.e., Shari’ah scholars) as well the standards setting bodies (e.g., AAOIFI, IFSB),until the establishment of a universal regulatory body to supervise and scrutinize Sukuk toguarantee the conformity and adherence to Shari’ah guidelines at all times. This scrutiny andsupervision will prevent any threats to the authenticity and integrity of Sukuk and the Islamicfinance alike, while serving the essence of Islamic economy in term of fairness, distribution of
  6. 6. wealth, and equality as opposed to concentration of wealth. At the same time, the balancedgrowth of the industry will progress without any major setbacks while carrying out best practicein terms of transparency and governance.A PPENDIXGLOSSARYAccounting and Auditing Organization for Islamic Financial Institutions. AAOIFI is an Islamicinternational, autonomous, non-profit corporate body that prepares accounting, auditing, governance,ethics, and Shari’ah standards for Islamic financial institutions and the industry. Professional qualificationprograms (notably CIPA, the Shari’ah Adviser and Auditor or “CSAA,” and the corporate complianceprogram) are presented by AAOIFI in its efforts to enhance the industry’s human resources base andgovernance structures. AAOIFI was established as an independent international organization in accordancewith the Agreement of Association, this was signed by Islamic financial institutions on February 26, 1990,in Algiers. It was registered on March 27, 1991, in the Kingdom of Bahrain. AAOIFI is supported byinstitutional members (200 members from 45 countries, so far) including central banks, Islamic financialinstitutions, and other participants from the international Islamic banking and financeindustry, worldwide. ( Under Islamic teachings, in Arabic “fatwa” is a religious opinion concerning Islamic law issued byan Islamic scholar in Arabic, an “alim” or “ulama” for plural. Ulama is a body of recognized Muslimclergy who have completed several years of training, research, and study of Islamic sciences.GCC. The Arabian Gulf Cooperation Council was established on May 25, 1981. The GCC is a political andeconomic union of the Arab states bordering the Arabian Gulf and constituting the Arabian Peninsula,namely Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates. The unified economicagreement between the countries of the Gulf Cooperation Council was signed on November 11, 1981, inAbu Dhabi. These countries are often referred to as the GCC States. ( Islamic Financial Market. IIFM is the global standardization body for the Islamic capital andmoney market segment of the Islamic financial services industry (IFSI). Its primary focus lies in thestandardization of Islamic financial products, documentation, and related processes. IIFM was foundedwith the collective efforts of the Central Bank of Bahrain, Bank Indonesia, Central Bank of Sudan, LabuanFinancial Services Authority (Malaysia), Autoriti Monetari Brunei Darussalam, and the IslamicDevelopment Bank-IDB (Saudi Arabia). IIFM is supported by its permanent member State Bank ofPakistan. Dubai International Financial Centre Authority (DIFCA), ABC Islamic Bank, Bank IslamMalaysia Berhad, Crédit Agricole CIB, European Islamic Investment Bank, Kuwait Finance House,National Bank of Kuwait, Standard Chartered Saadiq. ( Economic System. An economic system that identifies and promotes an economic order thatconforms to Islamic scripture and traditions that evolved around creating a real economy that is ethical andsocially responsible, where money is always in circulation and equitable while sharing risk and reward,with an interest-free financial system as guided by Shari’ah law through Islamic economic jurisprudence.Islamic financial institution. An IFI is a bank or investment house or financing entity or takaful (co-operative insurance) or re-takaful that fully adheres and conforms to Shari’ah rules and guidelines asstipulated and enforced by the firm’s Shari’ah supervisory board (SSB) as well as its articles ofincorporation.Islamic Financial Services Board. The IFSB is based in Kuala Lumpur, Malaysia, and was officiallyinaugurated on November 3, 2002, and started operations on March 10, 2003. It serves as an internationalstandards-setting body of regulatory and supervisory agencies that have vested interest in ensuring thesoundness and stability of the Islamic financial services industry, which is defined broadly to includebanking, capital market, and insurance. In advancing this mission, the IFSB promotes the development of a
  7. 7. prudent and transparent Islamic financial services industry through introducing new or adapting existinginternational standards consistent with Shari’ah principles and recommending them for adoption. The IFSBalso conducts research and coordinates initiatives on industry-related issues, as well as organizingroundtables, seminars, and conferences for regulators and industry stakeholders. IFSB works complementthe Basel Committee on Banking Supervision, International Organization of Securities Commissions, andthe International Association of Insurance Supervisors. IFSB has 191 member; 54 are regulatory andsupervisory authorities, 7 international inter-governmental organizations, and 130 market players,professional firms, and industry associations operating in 43jurisdictions. ( Middle East and North AfricaShari’ah (Islamic Law). A set of rules and guidelines derived from two primary sources of Shari’ah. First,the divine revelations set forth in the Qur’an (the holy book of Muslims and the main religious text);second, the Hadith, the sayings and example set by the Islamic Prophet Muhammad in the Sunnah (Arabicword that means habit or usual practice; the Muslim usage of this term refers to the sayings and livinghabits of the prophet Muhammad). Fiqh (“jurisprudence”) interprets and extends the application ofShari’ah to questions not directly addressed in the primary sources by including secondary sources. Thesesecondary sources usually include Ijma (the consensus of the religious scholars) and analogy from theQur’an and Sunnah through Qiyas (the analogical reasoning). In relation to this article, the Islamic law forinvestment and finance calls for all financial transactions to be free of interest/usury (riba), speculation(maisir), uncertainty (gharar), while sharing risk beside profit and loss sharing, and to not invest inbusinesses that provide goods or services considered forbidden and prohibited (haram). Prohibited businessactivities can relate to food (production and sales of alcoholic beverages, including pubs and restaurants;pork products; tobacco), gambling (casinos; online gambling; betting; lottery schemes), adult oriented(video; magazines; on-line material; strip clubs), dubious or immoral, and illicit trades (online dating;prostitution; drugs), weapons production and manufacturing, insurance, and reinsurance. In general,Shari’ah is not dissimilar to socially responsible investing (SRI); also, because speculation and gambling isforbidden in any form, derivatives, forwards, options, and futures can be considered prohibited. Otherforbidden practices include short selling, margin, day, and scalping trading.Shari’ah Supervisory Board. An SSB is an executive body of few Islamic scholars (ulama) retained under amandate by Islamic financial institutions to ensure compliance and adherence to Shari’ah as well issuefatwa for the products and transactions within Islamic financial institutions.Sukuk. Arabic, plural of sakk, means “legal instrument, deed, check,” and is the Arabic name for Shari’ah-compliant financial certificates. It is often mistakenly referred to as the Islamic equivalent of bonds, whichit is not. Sukuk is similar to an obligation backed by asset securities but is not in any way a bond, because itis not based on debt with interest. It can be regarded as a commercial paper/certificate that gives theinvestor a share of ownership in the underlying asset or a pool of assets. The issuer must identify theasset(s) to be sold to investors by transferring it to undivided beneficial ownership in the underlyingasset(s). Investors enjoy the usufruct of the assets in proportion to their investment and bear the credit riskof the issuer. Sukuk are traded and rated financial instruments. The AAOIFI defines Sukuk as, “Certificatesof equal value representing after closing subscription, receipt of the value of the certificates and putting itto use as planned, common title to shares and rights in tangible assets, usufructs and services, or equity of agiven project or equity of a special investment activity.”