Corresponding author, e-mail: email@example.com. The authors thank Udaibir Das, Allison Holland, Juan Sole, and Alessandro Zanello for helpful comments and feedback.
All from the International Monetary Fund (IMF), Monetary and Capital Markets Department (MCM), 700 19th Street, NW, Washington, D.C., 20431, USA. The views expressed in this paper are those of the authors and should not be attributed to the International Monetary Fund, its Executive Board, or its management. Any errors and omissions are the sole responsibility of the authors. An earlier version of this paper formed part of an IMF Background Paper prepared for the meeting of the OECD Working Party on Government Debt Management, Islamic Government Bonds, on October 2–3, 2007. The paper is also forthcoming in International Journal of Islamic & Middle East Finance and Management, Vol. 1, No. 4 (2008).
In a musharaka, both the financier and borrowing enterprise (and possibly others) jointly contribute funds to an existing or future project, in form of capital or in kind, and ownership is shared according to each party’s financial contribution.
At the moment, several large banks in the GCC package their revenues from mortgage and commercial lending into sukuk structures, which represent the majority of outstanding murabahah sukuk globally.
In addition, hedge funds and conventional investment institutions are beginning to hold sukuk for purposes of either yield pick-up or portfolio diversification.
The five-year €100 million (US$147 million) ijara sukuk was based on a sale (to an SPV) and leaseback (to Saxony-Anhalt) of certain previously state-owned real estate assets.
It is important to recognize that shari’ah compliance is continuous process that ends at the legal maturity date of the transaction.
The requirement of a direct linkage between identifiable assets and investors under Islamic law belies the commercial principle of perfected security interest in asset-backed transactions, i.e., establishing a legal separation of assets from the bankruptcy estate of the asset originator.
Note, however, that the principle of contractual certainty is at the heart of Islamic law. In fact, uncertainties or ambiguities can lead to disputes that may render a contract void under shari’ah. Thus, issues of bankruptcy resolution, in the case of sukuk issuance, do not arise so much from contractual uncertainty as from instances when contractual rights and agreements under commercial law encroach upon the inseparability of investor returns and asset performance as required by shari’ah.
The development of synthetic sukuk structures could establish direct ownership in the underlying asset (according to sharia’ah requirements while maintaining perfected security interest and bankruptcy remoteness under the precepts of commercial law.
Presently, the shari’ah approval process is ad hoc and beset by legal uncertainty from the heterogeneous assessment of shari’ah compliance across different jurisdictions and Islamic schools of thought.
Since Islamic law itself is divided in different juristic schools of thought (madhahib), there is no consistent ruling of Islamic courts on the religious compliance of the eligibility of certain assets and transaction structures. That said, some progress has been made to establish general applicability of shari’ah standards. Malaysia was the first country to institute a registered and regulated shari’ah advisory market. The creation of a National Shari ‘ah Council at the central bank soon prompted similar efforts in Pakistan, and more recently, the UAE.
AAOIFI recognizes 14 types of sukuk. The most prominent structures are sukuk al-salam, sukuk al-ijara, sukuk al-musharaka, sukuk al-mudharaba, sukuk al-intifa ‘a, sukuk al-istisna, and sukuk al-musharaka.
The Malaysian Financial Market Association (Persatuan Kewangan Malaysia) taking efforts to create more liquidity and enhance transparency of the domestic sukuk market by sponsoring the standardization of contract and documentation standards with a view to elevate Malaysia’s aspirations of consolidate its position as a leading center of Islamic finance.
The ijara sukuk by the German State of Saxony-Anhalt underscores the apparent price benefits from shari’ah-compliant issuance. While Saxony-Anhalt raised a total of US$1.2 billion through conventional covered bonds at an average spread of 17 basis points over EURIBOR in 2004, its premier sukuk issuance priced at a spread of merely one basis point, which resulted in non-cumulative net interest savings of US$192,000 per year for the State’s Treasury.
However, the emerging controversy about the shari’ah compliance of outstanding sukuk quickly dissipated once AAOIFI proposed to “grandfather” all outstanding issues. Note, however, that AAOIFI standards would need to be first approved by national regulators to take effect.
Most of these sukuk have been sold with a borrower/creditor guarantee to repay the full notional amount at maturity, or, in the event of default or early redemption, mirror the structure and payout of a conventional bond. Such a promise (and not the option) to repay capital violates the principle of risk- and profit-sharing under Islamic law.
Recall that under shari’ah rules, issuers and investors are required to equitably share transactions-related profits or losses.