Sukuk

What is Sukuk?

Sukuk (plural of sakk, which is the Arabic word for certificate) is defined as certificates representing a proportional and undivided ownership right in tangible assets, a pool of predominantly tangible assets, or a business venture. These assets must be in a specific project or in investment activities that comply with shari’ah rules and principles. it is the Islamic equivalent of securities or bonds in the conventional system.

Difference between Sukuk and Bond

Bonds are certificates of debt owed by the issuer, whereas sukuk are instruments that represent a proportionate and undivided ownership right over the asset in which the funds are being invested.

  • Sukuk can only be issued for specific shari’ah-compliant purposes and shari’ah-compliant assets, whereas bonds can be issued for general unspecified purposes
  • Sukuk are based on the real underlying asset; therefore, the income must be related to the purpose for which the funding is used.
  • In the case of sukuk, investors have ownership claims on the specific assets or the underlying business venture, whereas in bonds they have general creditors’ claim on the issuer.
  • It cannot be traded in the secondary market unless the underlying assets represented by the certificate comprise the majority of real assets and financial rights.

Structures of Sukuk

Asset-backed structure

It nvolves the physical ownership rights in the underlying assets or in the form of usufruct of such assets. This structure needs to meet the requirements set by a recognized external credit assessment institution (ECAI) for being an asset-backed structure. This structure exposes the sukuk holders to losses in case of the impairment of the assets.

Asset-based structure

According to this structure, the issuer purchases the assets and then leases them on behalf of the investors, using the funds received from the issued sukuk notes. In most cases, this structure takes the form of a sale-lease to the originator and backed by the issuer, with a binding purchase undertaking from the originator on the asset at maturity. The credit risk in this structure lies within the originator subject to any shari’ah-compliant credit enhancement by the issuer. The payment schedule of the repurchase undertaking and the capability of the originator to make the schedule payment to the issuer has weight in determining the credit rating by the ECSI. In case of default, in this type of structure, the holders need to have a right of recourse to the originator because the ownership rights over the underlying asset may not reliably result in an effective right of possession. Because the income of the asset is paid through the issuer to the investors, this type of structure is in some cases referred to as pay-through.

Pass-through asset-based structure

In this structure, a separate issuing entity purchases the underlying assets from the originator and packages them into a pool and acts as the issuer of the sukuk. This issuer requires the originator to provide recourse for the asset to the sukuk holder. In case of default by the originator, the issuer guarantees repayment by providing shari’ah-compliant credit enhancement.

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