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German Legal Expertise in the Middle East since 1981

Sukuk Markets, Challenges & Opportunities

Heinrich Köllisch

Author: Heinrich Köllisch

Guiding Principle
An account of the World Bank and Saudi-CMA organized Conference on Islamic Securities (Sukuk). On December 6, 2016 the World Bank and the Saudi Capital Market Authority (CMA) organized a conference on Sukuk Markets in Riyadh, Saudi Arabia. Attended by ministers, bankers, prominent scholars and members of concerned international organizations, latest developments and future perspectives with regard to Islamic Securities (sukuk) were discussed. M&P had the privilege to be present at this event and would like to give some first-hand information about backgrounds, dynamics and trends in this area of Islamic banking and finance.

A. Backgrund for a Sukuk-Conference in Riyadh

Visions in the Gulf area are a common phenomenon for a number of years. Amongst the recent ones is the Vision 2030 of King Salman in Saudi-Arabia. Despite the fact, that these visions mainly promote future ideas of the country, in frequent cases they are driven by an assessment of the current situation of the country. For many years, oil revenues have enabled the Saudi Economy to be sustained by a money abundant public sector, paying ongoing expenses and projects “cash on the table” at once. These times seem to be over. A continuously growing and very young population (More than a quarter of the population is below 14 years old.[1]), as well as low oil prices seem to be amongst the factors to not open a perspective for persistently soaring incomes of the country.

On the other hand, the population of Saudi Arabia has consistent needs for employment, education infrastructure, health etc. All of these investments to be made will have to be financed in the future.

Due to its very own Islamic nature, the kingdom first turns to Islamic perspectives, when trying to finance its outlined needs. Thus, Sukuk seems to be a promising perspective and the Kingdom tries to foster developments in this area from intellectual and economic perspective. In this context it does not seem out of the ordinary, that the Saudi CMA and the World Bank lined up to organize a large scale conference in Riyadh in December 2016 to discuss the issue of Sukuk from various perspectives such as scholars, banks and financial institutions as well as government entities and lawyers. In order to stay updated on these developments, M&P Riyadh Office was present at this conference.

B. Sukuk

In order to assess the topic of Sukuk a short overview on the background of Sukuk shall be given. Apart from a definition and some historic cornerstones in the development of this instrument, relevant institutions shall be presented, forms and feat of Sukuk shall be outlined, relevant markets shall be mentioned and challenges and relevant issues to be tackled shall be sketched.

   I. Meaning, History and Definition of Sukuk

The Arabic Word ṣukūk (سكوك) is a plural of the word ṣakk (سكّ) and its meaning in English is a debenture, or written acknowledgement of a debt of money or property, or of some other thing and a written statement of a commercial transaction, purchase or sale, transfer, bargaining, a contract, or the like, a sealed, or signed and scaled, statement of a judicial decision; a judicial record; or the record of a judge, in which his sentence is written and a written order for the payment of subsistence-money, or of a stipend, salary, pension, or allowance; which some persons used to sell, but the selling of which is forbidden.[2]

In short and simple: a translation the word ṣakk is a certificate. Moreover, the same word is the origin of the modern word cheque as we use it today.

Historically the word ṣakk can be found in Islamic legal literature as early as in the book al-Muwaṭṭa’ (الموطأ) of the prominent Islamic legal scholar Mālik b. Anas (مالك بن أنس) (d. A.D. 795)[3], who writes:

“It was related from from Malik that he had heard that ṣukūk were given to people in the time of Marwān b. al-Ḥakam for the produce of food at al-Jār. People bought and sold the ṣukūk among themselves before they took delivery of the goods. Zayd b. Thābit and one of the Companions of the Messenger of God, may Allah bless him and grant him peace, went to Marwān b. al-Ḥakam and said, ‘Marwān! Do you make usury ḥ̣alal?’ He said, ‘I seek refuge with God! What is that?’ He said, ‘These ṣukūk which people buy and sell before they take delivery of the goods.’ Marwān therefore sent a guard to follow them and to take them from people’s hands and return them to their owners.”[4]

The expression ṣukūk as used by Mālik bears many of the traits we use for contemporary Sukuk as well, yet it should be considered, that modern day Sukuk underwent a considerable development until they were established as the financial instrument, we know today.

Milestones in the development of the modern Sukuk were the Resoulution No. 30 (3/4) of the International Islamic Fiqh Academy (IIFA)[5], which outlined major cornerstones of Sukuk, followed by Standard No. 17 of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), which entered into being beginning from November 2001.[6]

One of the most common definitions for Sukuk as a specific technical term in modern contexts comes from the AAOIFI standards and reads 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’.

It shall be the definition relied upon in the context of this article.

  II. Relevant institutions

As already mentioned under the previous heading two major institutions play a vital role in the definition and description of Sukuk: The IIFA and the AAOIFI.

The IIFA is a body set up in the framework of the Organisation of Islamic Cooperation (OIC) formerly known as Organisation of the Islamic Conference. The OIC is an International Governmental Organisation with 57 member states (Art. 3 Para 1 OIC Charter)[7] (including Palestine). The IIFA itself is an academic branch apparatus of the OIC with own legal personality (Art. 2 IIFA Charter), amongst its tasks is to strive collectively for new fiqh solutions (ijtihād [اجتهاد]) to contemporary life and its problems in complete independence (Art. 3 IIFA Charter).

The AAOIFI is a privately founded non-profit organisation that was founded on a conference in Algiers 1990 and is registered in Bahrain since 1991.[8] It is closely related to Islamic financial institutions and has the objective to set and harmonize standards in the Islamic Finance community.[9] Therefore, it issues standards in English and Arabic in order to set common rules amongst its members and for the respective markets. These AAOIFI standards often provide a common and commonly understood reference frame in the field of Islamic banking and finance. This is also due to a great number of prominent sharīʿa scholars to be found on the sharīʿa board of AAOIFI, who draft these frames and try to find a common, yet practical denominator for modern financial products.

In addition to these two main institutions, a number of other players are involved in the field of Sukuk such as Governments as legislators as well as obligors, banks and other financial institutions and finally yet importantly a number of academic institutions that provide the necessary research and background from legal, sharīʿa and economic sides.

III. Forms and Features

After defining Sukuk and mentioning the institutional framework thereof, a closer look at the structure of the Sukuk itself shall be given and different Types of Sukuk shall be outlined in general.

     1. Basic and General Structure

In accordance with the given definition, certificates of equal value representing undivided shares have to be issued. This process happens for all Sukuk in a very similar way: The Obligor establishes a separate entity, the so called Special Purpose Vehicle (sharikat dhāt gharaḍ khāṣṣ [شركة ذات غرض خاص]) which then will issue the Sukuk and will operate the transaction in its name.

       a) The Obligor

The obligor is the initial entity wanting to raise funds for a certain transaction by means of the Sukuk. In theory, it can be any kind of entity. In practice, these are mostly states or public institutions, private financial institutions or (large) companies.

       b) The SPV

In order to issue the Sukuk the SPV (Special Purpose Vehicle sharikat dhāt gharaḍ khāṣṣ [شركة ذات غرض خاص]) is founded. It is a separate legal entity.

The SPV itself issues the Sukuk to the investors in return for their invested capital.

Additionally all relevant assets for the transaction are transferred from the Obligor to the SPV.

SPVs in theory can take a number of legal forms such as corporations, limited partnerships, endowments or frequently declared an English law trusts, being declared over the capital and assets[10]. In addition, a combination of the aforementioned seems to be imaginable (e.g. an independent company with limited liability declaring a trust).

The setup of the SPV has a number of reasons. In many cases, only certain types of (legal) persons can hold certain types of rights. E.g. in many jurisdictions the ownership of real property is limited to national only and cannot be held by foreigners. Likewise, tax issues can be a major factor in these contexts. In this respect, it might be worthy to note, that a number of jurisdictions exempted Sukuk structures from certain default tax legislation such as the UK and Hong Kong[11] and some legislations do not tax in general. These taxation issues are regularly mentioned amongst the core reasons of Malaysia’s success in Sukuk issues (holding accountable for over 60% of the Sukuk issued globally).[12] Thirdly, the SPV structures provide for an independence of the Sukuk issuer from the Obligor.

       c) The Transaction

The transaction or transactions done by the SPV has to be in accordance with the principles of Islamic finance.

In general, this includes that sharīʿa prohibitions on transaction in particular the one of ribā are respected and that the objects of the transaction conforms to sharīʿa requirements such as the prohibition of gharar or the prohibition of sale of unclean (e.g. pork or alcohol) or unusable goods.

Ribā (ربا)in short means exchange of certain types of goods (gold, silver or essential food items) either with a difference of quantity in them (ribā al-faḍl) or with a postponement in time (ribā an-nasī’a).[13]

Gharar  (غرر)in a literary translation of the word would be “hazard” or “jeopardy”. This concept is connected to the idea that the good and price of a sharīʿa sales contract have to be defined and known (maʿrūf) as well as capable to be delivered (maqdūr ʿalā taslīmi-hī).[14]

As the Islamic sharīʿa more or less contains a numerus clausus of established treaties, the AAOIFI in turn also outlined 14 types of Sukuk in its Standards based on the respective Islamic transaction.

     1. Different Types of Sukuk

In accordance with the aforementioned, the most common categorisation of Sukuk is modelled alongside the treaties of the pursued transaction. One of the most commonly spread labelling of Sukuk is the Separation into asset based and debt based Sukuk.

       a) Asset Based Sukuk

In general, an asset based Sukuk is one, where the underlying assets are present during the whole time of the Sukuk. Examples here fore are ijāra Sukuk as well as wakala and Sukuk.

A simple ijāra Sukuk is a construction, where the SPV purchases an asset and leases it out to the Obligor. This can also take the shape of a sale-and-lease-back construction. In many cases, the Obligor also buys the underlying asset at the end of the lease period in a separate undertaking. The ijāra contract is one of the standard contracts of Islamic jurisprudence (fiqh) (فقه) . In core, it is an exchange of money for the benefits or usufructs of an object. In accordance with different legal school of Islamic fiqh (madhahib, sg. madhhab) definition and terminology may vary in detail. A standard ḥanafī definition for an ijāra would be e.g.: a contract that will give the ownership of known and intended benefits of the leased object in exchange for a compensation.[15] The malikī madhhab would sometimes even differentiate in terminology and call only the lease of manpower as ijāra, where it would call the lease of an object kira’ instead.[16] A common definition here could be: A contract that provides for the ownership of the benefits of a legally allowed object for a known period of time in exchange for a compensation which is not of the drawn benefits.[17]

A wakala construction would be a construction, where the SPV would have the gathered assets managed by the Obligor as its agent in exchange for a certain pre-determined fee, the SPV would pay to the Obligor as its agent.

A muḍāraba construction would be similar, but would be seen as a company founded by the two shareholders: the SPV and the Obligor. Whereas the SPV would contribute shares in capital, the contribution of the Obligor would be in expertise, management and effort, which it would undertake for the common project. In return profits would be shared and losses only be borne by the contributor of capital (the SPV). In comparison to the wakala arrangement outlined above, in a muḍāraba construction the Obligor would not receive a sum determined in advance, but would rather participate in the profits generated by the company.

       b) Debt Based Sukuk

A debt based Sukuk is one, where the backing commodities are handed over to the Obligor with the permission to further transfer it to a third party to obtain cash. Therefore, where the asset based Sukuk derives its profits from the performance of the underlying asset, the debt based sukuk derives its profit from the substance of the underlying asset. The prominent examples for such a Sukuk would be a murabaḥa, salam or istiṣna’ Sukuk.

A muḍāraba Sukuk would be based on a concept, where the SPV would purchase an object for and in accordance with the specifications made by the Obligor for his use or further sale. The purchase price paid by the Obligor to the SPV will usually exceed the price initially paid by the SPV. It can be paid in installments or at one time, but in this way the SPV will generate profit, once it will finally pay out to the certificate holders. Very similar to the concept of muḍāraba would be the idea of mushāraka. Here the contributions of every party do not have to be different, but can be of the same kind (money, goods, work).

In an opposite way, a salam structure would be used. The word salam should not be confused with the frequently used word salām (meaning peace and being used in greetings). Salam rather means handover or transfer. One of the main features of a salam is the idea, that the purchased good in a sales treaty is being transferred to a new owner at a later stage, whereas the purchase price is paid at once. In the context of modern European laws such as the German Law with its principle of separation and abstraction between the purchase treaty and the transfer of ownership, this seem nothing extraordinary. However, sharīʿa works according to the consensual principle, where the purchase treaty itself transfers the legal ownership of goods and price. Therefore, in a way a salam is an infringement to this principle, as the ownership of the purchased good is transferred only with delay. The exact opposite of a salam would be a bayʿ bi-thaman ājil, where the goods would be subject to transfer of ownership at once and the purchase price would be paid at a later stage.

An istiṣnā’ structure would work in a very similar way to a salam, but focusses rather on the idea of contract to produce a work such as a German Werkvertrag or an Italian contratto d’opera. What resembles the structures of the salam before, is that in an istiṣnā’ structure the contractual object does not exist in the ownership of the party obliged to deliver it. It is rather still to be produced by exactly this party and this obligation of the party to produce the work itself (or by subcontractors) is also the main difference between an istiṣnā’ and a salam, the latter one placing no emphasis on the source of the transferred object.

     3. The Investment and its Return

With regard to the investor, also the issue of investment and return on investment should be touched. This includes the first sale of Sukuk in the primary market, further tradability in the secondary market and finally the return on investment upon maturity of the Sukuk.

       a) Primary Market

The Primary Market would be the one tapped, when the Sukuk is emitted.

In many cases, the primary market will be the securities market of the respective country. In Saudi Arabia thus, the issuance of Sukuk in the securities Market is governed by the Capital Market Law and the respective Regulations issued based on it by the Capital Market Authority (CMA). Hence, a public offer would have to take place in accordance with the Offers of Securities Regulations. In accordance with Art. 8 of the aforementioned Regulations it would in turn be subject to a prior listing in accordance with the Listing Rules issued by the CMA.

As definitions and conditions may vary from country to country and jurisdiction to jurisdiction. Legal shapes and situations of Sukuk are always subject to the applicable jurisdiction and its rules. One of the factors e.g. made responsible for the success of Sukuk in Malaysia is the obligatory rating by a Rating Agency also for this kind of Securities.

The prospectuses issued for Sukuk in Saudi-Arabia for example contain short Biographies of the responsible sharīʿa scholars. This underlines, that Sukuk must not only fulfill all requirements of an ordinary security from financial audit and legal side, but undergoes an additional check from its Islamic or sharīʿa side.

       b) Periodic Distribution

Sukuk is an asset linked certificate rather than a classical bond, which is based on a fixed interest return over an agreed period. Thus, Sukuk generate periodic income on a usually quarterly, half-yearly or annual basis, but the payout is linked to the performance of the underlying asset, which generates profit. After subtraction of the costs and expenses, these profits will be distributed to the Sukuk holders, as they have an undivided share in the underlying assets.

It is this periodic income that provides for a surplus on the invested capital. However, here also one of the main differences from interest becomes visible: Though paid periodically as interest, the distributed amount is not fixed as in an interest construction regardless of how the underlying assets perform. In a Sukuk structure, the risk and chance of the entrepreneur is forwarded in a large degree to the investor. In turn, this makes the investor more aware of risks as it causes the responsible entrepreneur to avoid these risks towards the shareholders.

       c) Secondary Market

As many securities, Sukuk will often be designed to be traded in the secondary market as well. This has the main advantage that investors can liquidate their Sukuk at any time, without being bound to the payment originating from the periodic distribution or to wait until redemption upon maturity.

On the other hand, a number of sharīʿa requirements have to be met for a Sukuk to be approved as tradable in the secondary market. Again, the issue of ribā comes into play in this context. It will be seen as ribā al-faḍl, when the Sukuk traded for money will only contain the invested capital and no tangible assets. Thus, scholars require a certain percentage of the Sukuk’s capital to be in the form of tangible assets rather than money, which is regarded as equivalent to a precious material by closely to all scholars. A number of different thresholds are named, when it comes to this point, but a frequently found figure is that of 1/3 of the capital to be present in tangible assets. Another major issue frequently discussed amongst sharīʿa scholars with regard to tradability in the secondary market is that one of debt based Sukuk, because what is traded here is not a tangible asset, but rather an undertaking to pay at some point in the future. Thus, frequently debt based Sukuk structures are not traded in the secondary market.

       d) Maturity

Once the Sukuk has reached maturity stage, the principal invested will be liquidated and paid back to the investors. In many cases the Obligor will repurchase the underlying asset and the sale price will be distributed amongst the Sukuk holders. This is of course the case mainly for asset based Sukuk, where the asset remains present.

Yet for some Sukuk the repurchase of the asset imposes a number of problems from a sharīʿa perspective. One of the most prominent examples is a mudaraba Sukuk. Here sharīʿa scholars see a difficulty, if the mudarib, (the Obligor) undertakes to repurchase the underlying assets at a pre agreed value prior to maturity of the Sukuk. The same type of Sukuk poses the problem of providing liquidity facilities form the Obligor. Here also problems with conformity to sharīʿa might be seen.

   II. Issues to be tackled

Modern Sukuk can look back onto a successful yet short history in comparison to other securities. The sharīʿa conformity of the transaction or transactions seems largely assured. A clear indicator therefore is the standardisation of these transactions by the AAOIFI.

What has been left rather untouched by sharīʿa scholars to the present days are the SPV. It will become with a certain probability a next focus of attention. SPVs are used in many financial transactions and have been taken over by Islamic finance closely one on one from conventional finance structures. In many cases, structures of modern company law or English law trusts are utilized for Sukuk transactions. It seems to bear a little irony e.g. that the English law trust structures frequently used in Sukuk contexts actually originate in the time of the crusades, to protect a crusader’s assets. Therefor this might be an argument for many Muslim customers to endorse more sharīʿa-based structures for the SPV.

C. The Conference

The conference organized by the World Bank and the Saudi-CMA focused on the development of Sukuk in general and in the Saudi context in particular. In several panels, current issues were discussed and a wide audience of local and international institution showed their presence. Aside bankers, brokers and financial analysts a number of representatives of international financial institutions such as the World Bank and the AAOIFI were present and presenting. Government representatives as the Minister of Housing underlined the Importance of financing and Islamic ways of it in the framework of future policies of the Kingdom. What was clearly outspoken was the ambition of the Kingdom of Saudi Arabia to become the leading country internationally with regard to Sukuk. In this regard, the current leadership of Malaysia was inevitably challenged. Of course a number of legal scholars were also present (but as it appeared only Saudi) and a large number of sharīʿa scholars contributed to the success of the conference.

D. Assessment

As one of the few non-Saudi lawyers present, it had been an outstanding opportunity for M&P to get in contact with the Sukuk scene in the Kingdom of Saudi Arabia and beyond. Looking at the mentioned challenges for many oil-revenue-based Arabic countries it was an ideal opportunity to be informed about future trends with regard to financing and capital markets. It was obvious to see, that financing will become a future issue, when doing business in the Gulf region. With regard to the Kingdom of Saudi-Arabia, the distinct Islamic identity, the country continues to express also in the Vision 2030, raises the interest in Islamic forms of financing. The country also can provide a good number of intellectual resources to tackle this issue. Even sharīʿa scholars present at the conference presented themselves in language and argumentation to be very familiar with the world of international finance and seemed to be well aware of problems issues and ambitions in this field of economy.

On the other hand, competition in this field is very apparent. The Development of the Dubai Islamic Economy Development Centre since 2013 and its underlining slogan of “Dubai the Capital of Islamic Economy” challenges openly the aspired lead in Saudi Arabia.

In consequence, the issue of Islamic financing and funding and the issue of Sukuk right at its core will be of major importance throughout the region in the near future.

[1]     Cf.. The World Bank: Data, (viewed Feb. 12, 2017).

[2]     Cf. Lane, Edward William; An Arabic-English Lexicon; London 1872, Vol. 4, p. 1709

[3]     Cf. EI², Vol. 6, p. 262.

[4]     Mālik b. Anas; al-Muwaṭṭa‘: as related by Yaḥya b. Yaḥya al-Laythī; ed. by Bashar ʿAwād Maʿrūf; 2nd Edition 1997, Vol. 2, p 168.

[5]     Cf. (Mar. 05.2107)

[6]     Cf. AAOIFI Standard 17AR  p. 300.

[7] (Mar. 05, 2017)

[8] (Mar. 05, 2017)

[9]     Cf. (Mar. 05, 2017)

[10]    Cf. Linklaters; Shari’a-compliant Securities (Sukuk); 2012, p 7,9

[11]    Cf. Latham & Watkins LLP; The Sukuk Handbook: A Guide to Structuring Sukuk; 2016, p. 4.

[12]    Cf. Latham & Watkins LLP; The Sukuk Handbook: A Guide to Structuring Sukuk; 2016, p. 4.

[13]    Cf. Al-Jazīrī, ʿAbd ar-Raḥmān; al-Fiqh ʿalā al-madhāhib al-arba; Beirut 2015, Vol. 2, p. 137 ff.

[14]    Cf. Ibn Juzay, Abū al-Qāsim Muḥammad; al-Qawānīn al-fiqhīya; Kuwait 2010, p 392, 404 ff.

[15]    Cf. Al-Jazīrī, ʿAbd ar-Raḥmān; al-Fiqh ʿalā al-madhāhib al-arba; Beirut 2015, Vol. 3, p. 51.

[16]    Cf. Al-Jazīrī, ʿAbd ar-Raḥmān; al-Fiqh ʿalā al-madhāhib al-arba; Beirut 2015, Vol. 3, p. 52.

[17]    Cf. Al-Jazīrī, ʿAbd ar-Raḥmān; al-Fiqh ʿalā al-madhāhib al-arba; Beirut 2015, Vol. 3, p. 52.

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