This document discusses Islamic bonds (sukuk). It begins by defining sukuk and explaining their historical origins. Sukuk are asset-backed financial certificates that represent ownership in the underlying assets. The document then discusses how sukuk are structured, focusing on the most common types - mudarabah, musharakah and ijarah sukuk. It explains the standards from AAOIFI and the process for structuring each type of sukuk. The document concludes by discussing ratings of Islamic bonds, differentiating between sovereign and corporate ratings and the methodology used.

1. Islamic Bonds - Sukuk
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2. Learning Objectives
Upon the completion of this topic, you should be able
to:
 Understand what sukuk is, its historical origin and
benefits, and the distinguishing features of sukuk
from conventional bonds
 Understand how Islamic bonds are structured, and
distinguish between different types
 Be familiar with the AAOIFI (Accounting and Auditing
Organization for Islamic Financial Institutions)
standards on Islamic bonds, and the characteristics
of investment sukuk and Shariah rulings defined by
these standards
 Differentiate between sovereign and corporate
ratings of Islamic bonds, and the methodology used
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3. What are Sukuk?
Sukuk: an Arabic term for financial certificate; it is the Islamic
equivalent of bond
Sukuk: asset-backed instruments, and tradable Shariah
compatible trust certificates
AAOIFI defines Sukuk as:
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 (AAOIFI 2008, p. 307)
The IFSB (Islamic Financial Services Board)defines Sukuk
in its Capital Adequacy Standard (IFSB-2) as ‘certificates that
represent the holder’s proportionate ownership in an
undivided part of an underlying asset where the holder
assumes all rights and obligations to such asset’
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4. What are Sukuk?
A Brief History of Sukuk
 Sak, the singular form of sukuk was used to refer to
documents or certificates representing obligations,
contracts, conveyances of rights executed in conformity
to the principles of Shariah
 The earliest usage of the sukuk receipts relates to the
method of payment of the soldiers during the Umayyad
Caliphate in the 1st century of the Islamic calendar
where soldiers were given commodity coupons in place
of cash
 During the medieval period, sak was used as the main
instrument for transferring obligations arising from
commercial transactions, thus reducing movement of
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5. What are Sukuk?
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A Brief History of Sukuk
 In the modern practice of Islamic finance, sak
is used to provide alternative funding for
financing projects through asset
securitization
 The Islamic Fiqh Academy of the Organization
of Islamic Cooperation (OIC) ruled for
legitimacy of the concept of sukuk

6. What are Sukuk?
Benefits of Sukuk
 Among the best ways of financing large
enterprises beyond the ability of a single party to
finance
 Provide an ideal means for investors seeking to
deploy streams of capital and at the same time are
able to liquidate their positions with ease should the
need arise
 Manage liquidity for banks and Islamic financial
institutions
 A means for the equitable distribution of wealth
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7. What are Sukuk?
Advantages of Sukuk include:
 Diversification of fund sources
 Secondary liquidity
 Creation and enhancement of profile on the
international market
 Infrastructural development in Muslim countries
Sizeable financing
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8. What are Sukuk?
Differences Between Sukuk and Conventional
Bonds
 Conventional bonds are contractual debt
securities, while sukuk represent the undivided
ownership of each of the sukuk holders in the
underlying asset
 Returns in conventional bonds comes in interest
(coupon) and the principal amount whereas in sukuk,
the return is in profits
 In conventional bonds, the contractual relationship
between issuer and investor is debt/credit, while it is
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9. What are Sukuk?
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Differences Between Sukuk and Conventional
Bonds
 Sukuk holders have ownership rights in the
underlying asset, while conventional bonds
merely represent a debt certificate
 Sukuk must be asset-backed, while
conventional bonds may be backed by financial
assets such as receivables, which are not
allowed in the case of sukuk

10. Structuring Islamic Bonds
Types and Structure of Islamic Bonds
 Sukuk can be of many types depending on the types
of Islamic finance products used in its structuring
 AAOIFI identified fourteen major sukuk-structured
products
 Sukuk have been classified as:
- Tradable sukuk
- Non-tradable sukuk
- Debt based sukuk
- Equity based sukuk
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11. Structuring Islamic Bonds
The Most Common Investment Sukuk
 Mudarabah Sukuk (Trust Investment Bonds)
 Musharakah Sukuk (Partnership Investment
Bonds)
 Ijarah Sukuk (Leased Asset Bonds)
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12. Structuring Islamic Bonds
The Fourteen Sukuk Structures of AAOIFI
1. Sukuk ijarah (leased assets certificates)
2. Sukuk ijarah mausufa bi dhima (forward lease
certificates)
3. Sukuk manfaa ijarah (usufruct of a lease
certificate)
4. Sukuk manfaa ijarah mausufa bi dhima
(usufruct of a forward lease certificate)
5. Sukuk milkiyat-al-khadamat (ownership of
services certificates)
6. Sukuk al-salam (forward contract certificates)
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13. Structuring Islamic Bonds
The Fourteen Sukuk Structures of AAOIFI
8. Sukuk al-murabahah (cost-plus certificates)
9. Sukuk-al-musharakah (partnership certificates)
10. Sukuk al-mudarabah (trust Investment certificates)
11. Sukuk al-wakalah (investment agency certificates)
12. Sukuk al-muzra’a (sharecropping certificates)
13. Sukuk al-musaqa (irrigation certificates)
14. Sukuk al-mugharasa (agricultural certificates)
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14. Structuring Islamic Bonds
Structuring of Islamic Bonds
 The replication of conventional bond features
excluding characteristics impinging on fundamental
principles of Shariah in commercial transactions e.g.
prohibition of riba and gharar
 The process of modelling and structuring Islamic
bonds requires basic knowledge of major Islamic
finance products e.g. mudarabah, musharakah,
ijarah, murabaha, wakalah
 Islamic finance experts developed, modeled and
structured finance products through Islamic financial
engineering
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15. Structuring Islamic Bonds
Mudarabah Sukuk (Trust Investment Bonds)
 Investment sukuk representing ownership of units of equal
value in the Mudarabah equity
 Registered in the names of the sukuk holders on the basis
of undivided ownership of shares in the Mudarabah equity
 Usually structured as an agreement between the rabb al-
mal who provides the capital and the entrepreneur which
may be an investment company or a Special Purpose
Vehicle (SPV)
 Returns shared in accordance with the percentage of share
ownership of each sukuk holder
 Losses are borne by financiers but necessary measures
mitigate risks (through the process of securitization)
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16. Structuring Islamic Bonds
Basic Features of Mudarabah Sukuk (MS)
As articulated in the Resolution of the Islamic Fiqh
Academy of the OIC in its fourth session in 1988
 Mudarabah Sukuk (MS) represent common
ownership and entitle holders to share in specific
projects against which the MS have been issued
 Contract based on the official notice of the issue
or the prospectus, which must provide all
information required by Shariah for a Qirad contract
 The MS holder is given the right to transfer the
ownership by selling the sukuk in the securities
market at his/her discretion
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17. Structuring Islamic Bonds
Basic Features of Mudarabah Sukuk (MS)
The sale of MS must follow the rules listed below:
1. If mudarabah capital is in money, the trading of
MS will be like the exchange of money for money
and it must satisfy the rules of Bai‘ al Sarf
2. If the mudarabah capital is in debt, it must be
based on principles of debt trading in Islamic
jurisprudence
3. If capital is a combination of cash, receivables,
goods, real assets and benefits, trade must be
based on the market price evolved by mutual
consent
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18. Structuring Islamic Bonds
Basic Features of Mudarabah Sukuk (MS)
4. The manager/SPV who receives the funds collected from
the subscribers to MS can also invest his/her own funds
5. Neither prospectus nor MS should contain a guarantee,
from the issuer or the manager of the fund, for the capital
or a fixed profit, or a profit based on any percentage of
the capital
Accordingly:
i. the prospectus, or the MS issued pursuant to it, may not
stipulate payment of a specific amount to the MS holder
ii. profit is to be divided, as determined by applying the
rules of Shariah
iii. the profit and loss account of the project must be
published and disseminated to MS holders
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19. Structuring Islamic Bonds
Basic Features of Mudarabah Sukuk (MS)
6. It is permissible to create reserves for
contingencies, such as loss of capital, by deducting
from the profit a certain percentage in each
accounting period
7. The prospectus may also contain a promise made
by a third party, to donate a specific sum, without
any counter benefit, to meet losses in a given
project, provided such commitment is independent
of the Mudarabah contract
(The Resolution of the Islamic Fiqh Academy of the OIC in its fourth session
in 1988)
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20. Structuring Islamic Bonds
Structure of
Mudarabah
Sukuk
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21. Structuring Islamic Bonds
Steps Involved in the Structure of Mudarabah
Sukuk
 A company which needs liquidity establishes an
SPV
 The SPV issues sukuk certificates to investors/sukuk
subscribers
 Cash generated used as capital in Mudarabah
contract between SPV and an organisation
appointed to manage the business
 The Mudarabah business is carried out and profits
are periodically distributed among the two major
parties: the company and the SPV
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22. Structuring Islamic Bonds
Musharakah Sukuk
 Musharakah Sukuk are investment bonds which
represent the ownership of the partnership equity
 Musharakah Sukuk can be used for the mobilization of
funds for new project, develop an existing project or
finance a huge business activity based on joint venture
contracts
 The Musharakah certificate given to all sukuk holders
represent their proportion of ownership in the assets of
the project being undertaken
 The Musharakah certificates are treated as negotiable
instruments which are tradable in the secondary market;
they can be bought and sold in the capital markets
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23. Structuring Islamic Bonds
Musharakah Sukuk
 The structure of a Musharakah Sukuk is based on
the joint venture partnership
 Profit is shared according to an agreed
predetermined ratio
 Any loss is shared according to the individual
contribution of the parties/sukuk holders involved
 Every subscriber is entitled to participate in the
management of the business if he or she wishes
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24. Structuring Islamic Bonds
A
Musharakah
Sukuk
Structure
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25. Structuring Islamic Bonds
Ijarah Sukuk
 Ayub (2007, pp. 400-401) defines ijarah sukuk as “the
securities representing ownership of well-defined and
known assets tied up to a lease contract, rental of which is
the return payable to the sukuk holders”
 The contract of ijarah has been:
- Structured and transformed as a competitive bond in
the secondary market
- Structured to allow the mobilisation of funds for
development of long term infrastructure projects via the
issuance of ijarah sukuk
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26. Structuring Islamic Bonds
Different Variations Ijarah Sukuk
1. Sukuk of ownership in leased asset
 It is issued with the sole aim of selling the asset to
the sukuk holders through the transfer of title
 The sukuk holders jointly own the asset through
undivided ownership and are entitled to profits and
losses accordingly
 This form of ijarah sukuk can be used for the
purchase of a new asset
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27. Structuring Islamic Bonds
2.Sukuk of ownership of usufructs of assets:
 It is issued to conferring the right of usufruct in the sukuk
holders where they become joint owners
 The sukuk holders only become owners of usufruct
(manfa’a) of the assets since the owners of asset have
leased its usufruct to the sukuk holders
 Sukuk holders can also sublease the usufruct of the
asset to a third party
3. Sukuk of ownership of services:
 Issued to subscribers to confer the ownership in such
services to the sukuk holders
 The sukuk holders may also sublease such services to a
third party
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28. Structuring Islamic Bonds
Ijarah Sukuk
Transactio
n
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29. AAOIFI Standards for Islamic
Bonds
Characteristics of Investment Sukuk
 Certificates represent the rights and obligations of
the owner
 Common share in the ownership of the underlying
asset
 Shariah compliance
 Trading of investment sukuk and the rights they
represent
 Return and losses are commonly shared by
certificate holders
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30. Rating of Islamic Bonds
Ratings of Islamic Bonds
 Bond credit rating is the assessment of the credit
worthiness of a corporation’s debt issues or
government bonds. The designated grades range
from ‘AAA’ which is considered as the highest grade
to ‘C’
 Credit rating allows potential investors to make
informed decisions before subscribing to debt
securities.
 There are over 50 rating agencies that have been
established across the world. The leading global
rating agencies include, Moody’s, Standard & Poor’s,
and Fitch Rating of Islamic Bonds
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31. Rating of Islamic Bonds
Ratings of Islamic Bonds
 Different countries have their own rating agencies, such
as Malaysia, India, Bangladesh, and Sri Lanka
 The two popular classifications of bonds while rating their
quality are:
- ‘investment grade bonds’
-‘junk bonds’
 The Islamic International Rating Agency (IIRA) which
was established by the IDB began operations in 2005
and has since been striving to ensure quality in the
Islamic finance industry
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32. Rating of Islamic Bonds
Types of Islamic Bonds Ratings
Islamic bonds can be rated on two bases:
- Sovereign
- Corporate
First: Sovereign Ratings
 Sovereign credit rating is the credit rating of a
sovereign entity such as a national government
 The risk level of the regulatory, political, economic
and legal atmosphere comprises a crucial factor in
sovereign credit ratings
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33. Rating of Islamic Bonds
In the country risk rating, Euro money Country Risks
consider the following factors in the ranking of
countries by risk:
- Political risk
- Economic performance/projections
- Structural assessment
- Debt indicators
- Credit Ratings
- Access to bank finance
- Access to capital markets
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34. Rating of Islamic Bonds
IIRA Ratings
The six basic categories used by IIRA in analysing
sovereign sukuk and the likelihood of any default on
debt obligations at maturity are:
- Politics and Policy Continuity
- The Economy–Structure and Growth Prospects
- Budgetary and Fiscal Policy
- Monetary Policy and Flexibility
- The External Accounts
- Internal and External Debt
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35. Rating of Islamic Bonds
First Page
of IIRA
Sovereign
Ratings of
Turkey in
2008
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36. Rating of Islamic Bonds
Types of Islamic Bonds Ratings
 Corporate credit rating is a credit worthiness rating in form
of financial indicator to potential investors of debt
securities such as sukuk
 Corporate credit ratings play a significant role in the
economy of a country and, more importantly, it promotes
stability and sustainability in the financial industry
 The level of risk surrounding a business entity determines
the confidence prospective investors will have in it
 Corporate entities must adopt best practices (reducing
their risk level, demonstrating ability to meet financial
obligations)
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37. Rating of Islamic Bonds
 In the Islamic financial markets, corporate ratings
involve:
- Bond/sukuk ratings
- Bank’s financial strength ratings
- Shariah quality ratings
- Corporate governance ratings
- Real estate ratings etc.
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