Sukuk (Ar. “certificates” or “written documents”) are the Islamic equivalent of Western bonds. Since conventional debt instruments that rely on payment of interest are prohibited by Islam, Western investors willing to invest in the Middle East need to be aware of sukuk.
Sukuk are used in a number Islamic (e.g., Bahrain, Turkey, and the UAE) and non-Islamic (e.g., the UK and Singapore) countries. A report issued by the International Islamic Financial Market (IIFM), an organization responsible for standardization of Islamic financial contracts, states that in 2015 the global sukuk issuance’s amounted to USD 60 billion.
How does sukuk work?
Sukuk are used to finance specific projects. A buyer of sukuk receives (i) partial ownership of tangible or intangible assets and (ii) a percentage of the profits generated from those assets. Sukuk can be bought by both domestic and foreign investors. Sukuk are issued mainly by governmental and corporate bodies.
Similarities and differences between bonds and sukuk
Sukuk and bonds have the following common features: (1) both sukuk and bonds can be turned into cash by selling them on the secondary market; (2) both financial instruments can be rated; and (3) investors can choose between many types of sukuk and bonds. However, there are five major differences between sukuk and bonds.
- Bonds indicate a debt obligation, whereas sukuk certify ownership of assets.
- Assets backing bonds may relate to products and services that are prohibited by Islam (e.g., alcohol, pork, and pornography), whereas sukuk cannot be used for backing assets which do not comply with Sharia principles.
- Bonds are priced on the basis of credit ratings, whereas the price of sukuk is defined on the basis of the value of the assets purchased through investment in sukuk.
- Profits from bonds are derived from fixed interest, whereas profits from sukuk come from profits generated from sukuk-funded investments.
- The sale of bonds results in selling a debt, whereas selling sukuk means selling ownership of assets.
Types of sukuk
There are six most common types of sukuk:
- Sukuk based on equity partnership (Ar. “sukuk al mudaraba”) in which sukuk holders function as “silent partners”, i.e., they do not participate in the management of the sukuk-funded project.
- Deferred payment/Cost plus sukuk (Ar. “sukuk al murabaha”) in which the issuer of sukuk can use sukuk holder’s capital for buying an asset and selling it on plus-profit-margin basis.
- Deferred delivery purchase sukuk (Ar. “sukuk al-salam”) in which the funds of the sukuk holder are used for purchasing assets in the future.
- Lease-based sukuk (Ar. “sukuk al-ijara”) in which the sukuk holder is entitled to derive income from leased assets.
- Joint venture sukuk (Ar. “sukuk al musharaka”) in which the sukuk holder actively participates in the management of a joint venture in which he has ownership rights.
- Islamic project bond (Ar. “sukuk al istisna”) in which the sukuk holder funds the future delivery of constructed or manufactured assets.