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Mufti Saad Ali Chippa

Definition of Sukuk

Sukuk is the plural of “Sak”, which means: “document or certificate”. During the period of Marwan Bin Huqam, the certificate issued to people to get rations from the Treasury were called “Sukuk”. But, the modern meaning of Sukuk is different. In contemporary Islamic finance terms, Sukuk means:

“Securities of equal denomination representing individual ownership interests in a portfolio of eligible existing or future assets”

(Source: AAOIFI)

Investments in Sukuk assets is represented by the certificates, i.e. Sukuk. Some people also call them Islamic bonds, but this is not correct, because the difference between bonds and Sukuk is that bonds are only debt documents, while Sukuk are proof of ownership of a proportional share in some identified asset.

Also, in Sukuk, the return of Sukuk holders depends on the income from the assets that the Sukuk represents, but in bonds the return is fixed, whether or not the issuer makes a profit or a loss. Similarly, there is a difference between common shares and Sukuk. That is, shares are issued for a fixed term, for example three or five years, and shares are for an indefinite term.

Origin and Development of Sukuk

The Council of Islamic Ideology in Pakistan in its famous interest-free banking report in 1980 proposed financial instruments based on the principle of profit and loss sharing to raise capital for a specific period, which would replace debentures. The name of the alternative instrument was also suggested in the report, i.e. “Participation Term Certificate”.

In 1984, according to this proposal of the Council, the term share certificates were also introduced. Although due to some reasons, these certificates could not be used for long and were replaced by term finance certificates, but we can refer to them as the first attempt to issue Sukuk, because the concept of modern Sukuk is derived from these foundations on which Participation Term Certificates were based.

Malaysia issued its first global sovereign Sukuk in 2002, with an amount of $600 million. Later in 2003, Islamic Development Bank Jeddah also issued a Sukuk. After that, a lot of activity was seen in the area of Sukuk issuance.

However, in 2008, Maulana Mufti Muhammad Taqi Usmani, as the president of AAOFI’s Majlis Shari’ah, declared the majority of Sukuk issued in the Middle East and Malaysia worth billions of dollars as illegitimate. Resultantly, there was a slight decrease in the process of Sukuk issuance, but this process has not stopped, rather it is still going on.

In 2009, Sukuk worth more than Rs 30 billion were issued in Pakistan. Similarly, the Indonesian government had also issued Sukuk to cover its budget deficit and to raise funds. Around the same time, one of the world’s largest Sukuk was issued by the United Arab Emirates’ property Developer Nakheel, which was worth $3.5 billion dollars.

According to a report published by the International Monetary Fund (IMF), Sukuk is one of the most popular instrument among international financial products. Considering the popularity of Sukuk, many non-Muslim countries are also considering issuing Sukuk. Hong Kong, Singapore, United Kingdom, Luxembourg and other countries had issued Sukuk in past. The American Corporation General Electric became the first company in non-Muslim majority region to issue Sukuk.

Types of Sukuk

There are many types of Sukuk, such as:

  • Musharakah Sukuk
  • Mudarabah Sukuk
  • Ijarah Sukuk
  • Istisna Sukuk
  • Salam Sukuk
  • Wakalah Sukuk

Some of them are explained below:

Musharakah Sukuk

These refer to shares in projects or activities, which are run on a partnership basis. For example, a company has a huge project and it requires a huge amount of money to complete it. Suppose there is a requirement of Rs 10 billion which cannot be provided by a single company or a few individuals.

Now the company issues Rs 10 billion worth of certificates, which are called Musharakah Sukuk and the people who buy these certificates are called shareholders in this project.

Then, the project is no longer the property of a single company, but becomes the property of several people and the profit or income arising from it will be distributed among all the Sukuk holders according to their pre-agreed share in the income of the asset. If there is a loss, everyone owning the share of assets in the project will participate in this too. When the Sukuk period is over, the company will buy these Sukuk and become the sole owner again.

Mudarabah Sukuk

These are certificates which represent that the holder has invested a certain amount of money on the basis of Mudarabah. These Sukuk are either issued by companies that want to raise capital on the basis of Mudarabah, or they are issued by financial institutions.

For example, a bank has lent Rs 50 million to a party for three years on Mudarabah and now it wants to get this money back, so that it can meet other needs. So, it can issue certificates of equivalent value of that amount.

Those investors who buy these certificates will share in the profits from this Mudarabah enterprise. When the period expires, the bank will repurchase the Sukuk.

Ijarah Sukuk

This is the most important type of Sukuk. It applies to contracts that represent the ownership of leased assets and a proportionate share in their usufruct. The Sukuk holders share in the rent earned from these assets in proportion to their shares. The difference between Musharakah and Ijarah Sukuk is that in the former, the profit from the partnership is distributed and in the latter, the rent received from the asset is distributed.

In Ijarah Sukuk, sometimes the owner of the asset directly issues the Sukuk and sometimes through a financial agent. This financial agent is an entity set up for this particular purpose, hence it is called a Special Purpose Vehicle (SPV).

Governing Principles of Sukuk

In order to understand which principles must be followed in the issuance of Sukuk, it is necessary to determine their jurisprudential status, so that the rulings are mentioned keeping this in mind.

The details we have explained above are sufficient to prove that the mutual relationship of the Sukuk holders is based on a partnership, because unless the relationship of partnership is established, neither the profit on these Sukuk will be assessed nor will it be valid to buy and sell them at more or less than their face value. It is because in that case, they will represent debt documents with no legitimate profit or loss possibly on holding and transferring them.

If price is different, then the exchange will become usurious and hence, it will be Shari’ah non-compliant.

When it is established that the relationship between the issuer and the holders of Sukuk is based on the concept of partnership of limited duration, then they should be seen in the context of partnership rulings.

In Islamic jurisprudence, the rules of partnership are explained with great clarity. Their description will be out of place here, but the following issues must be kept in mind.

The basic principle of partnership is that all parties will share in the profit and loss. Such a partnership is not permissible in which a party shares in the profit, but does not accept the responsibility for the loss. Sukuk holders are shareholders in these assets, so they must also bear losses in proportion to their shares.

A partnership is not permissible in which one party is required to pay the other party a fixed profit in relation to the principal amount. For example, if it has been said that 12% profit will be given on these Sukuk anyway, then this would be invalid because of entering into the definition of interest.

However, it is necessary to determine at the beginning of the partnership that how the profit will be divided among the participants. So, such Sukuk is not permissible in which profit is determined or expressed as a percentage of the invested money.

At the end of a partnership, liquidation is required, which is to sell all the assets of the partnership and convert them into cash, and from the proceeds, deduct the liquidation costs and outstanding debts. Then, the remaining amount should be distributed among all the shareholders in proportion to their shares.

The rationale is that partnership assets are jointly owned by all the partners, so at the end of the partnership period, distribution must be made among all the partners in proportion to their shares. If the value of the assets is insufficient to repay the original capital, then each partner should be given a share in proportion to his capital.

It has also been explained earlier that no party to a partnership can promise to purchase the assets of the partnership at face value, as this would mean giving a guarantee to a partner. If it has been stated that capital investment by a partner will be compulsorily returned, then this is against the principles of partnership. Any repurchase of assets agreement has to be separate.

Nonetheless, Ijarah Sukuk are also issued on the concept of limited term partnership. So it is imperative that when the Sukuk period is over, the asset is sold and the proceeds are distributed among the holders of the Sukuk proportionately.

Shari’ah Status of Sukuk

Sukuk is an alternative means of obtaining capital under Islamic law, in the same way that interest-bearing bonds or various certificates are issued for long-term borrowing. Similarly, Sukuk is issued to manage capital requirements in a legitimate manner. Sukuk issued are documentary evidence of ownership in the business and assets of the issuing entity rather than representing loans.

Some Pitfalls to Avoid in Sukuk Issuance and Management

When we examine the prevailing Sukuk in the light of the above principles, the following cautionary notes shall be kept in mind:

1.       If Sukuk holders only receive profit or rent and do not share in losses (if incurred), then this is against Shari’ah principle.

2.       If a fixed percentage of return is given on the invested capital which comes under the category of interest, then this is not permissible. 3.       If the issuer provides guarantee of invested capital by agreeing to necessarily repurchase the invested capital at the original amount, then this is not permissible. Any repurchase agreement has to be independent of the original investment agreement.

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