Sukuk

What Is a Sukuk?

A sukuk is an Islamic financial certificate, like a bond in Western finance, that consents to Islamic strict law commonly known as Sharia. Since the traditional Western interest-paying bond structure isn't permissible, the issuer of a sukuk basically sells an investor group a certificate, and afterward utilizes the proceeds to purchase an asset that the investor group has direct partial ownership interest in. The issuer must likewise make a contractual guarantee to buy back the bond sometime not too far off at par value.

Grasping Sukuk

With the rise of Islamic finance, sukuk have become very well known starting around 2000, when the principal such products were issued in Malaysia. Bahrain went with the same pattern in 2001. Fast forward to current times, and sukuk are utilized by Islamic corporations and state-run organizations the same around the globe, taking up a rising share of the global fixed-income market.

Islamic law prohibits what's known as "riba," or what we comprehend as "interest" in the West. Hence, traditional, Western debt instruments can't be utilized as feasible investment vehicles or ways of raising capital for a business. To bypass this, sukuk were made to interface the returns and cash flows of debt financing to a specific asset being purchased, successfully distributing the benefits of that asset. This permits investors to work around the preclusion framed under Sharia nevertheless receive the benefits of debt financing. In any case, due to the way that sukuk are structured, financing must be raised for identifiable assets.

Subsequently, sukuk address aggregate and undivided shares of ownership in an unmistakable asset as it connects with a specific project or a specific investment activity. An investor in a sukuk, thusly, doesn't possess a debt obligation owed by the bond issuer, however rather claims a piece of the asset that is linked to the investment. This means that sukuk holders, in contrast to bond holders, receive a portion of the earnings generated by the associated asset.

Sukuk versus Traditional Bonds

Sukuk and conventional bonds truly do share comparable attributes, yet additionally have important key differences:

Similarities

Both provide investors with payment streams.
Bonds and sukuk are issued to investors and may be used to raise capital for a firm.
Both are considered to be safer investments than equities.
Sukuk investors receive profit generated by the underlying asset on a periodic basis while bond investors receive periodic interest payments.

Key Differences

Sukuk involves asset ownership while bonds are debt obligations.
If the asset backing a sukuk appreciates then the sukuk can appreciate whereas bond yield is strictly due to its interest rate.
Assets that back sukuk are halal whereas bonds are often riba and may finance non sharia compliant businesses or fuel speculation.
Sukuk valuation is based on the value of the assets backing them while a bonds price is largely determined by its credit rating.

## Sukuk Example: Trust Certificates

The most common type of a sukuk comes as a trust certificate. These certificates are likewise administered by Western law, in any case, the structure of this type of sukuk is more nuanced. The organization raising funds initially makes an offshore special purpose vehicle (SPV). The SPV then, at that point, issues trust certificates to qualified investors and puts the proceeds of the investments toward a funding agreement with the responsible organization. In return, the investors earn a portion of the profits linked to the asset.

Sukuk structured as trust certificates are just applicable on the off chance that the SPV can be made in an offshore jurisdiction that permits such trusts. This is sometimes impractical. In the event that a SPV and trust certificates can't be made, a sukuk can be structured as an alternative common law structure. In this scenario, an asset-leasing company is made in the country of beginning, actually purchasing the asset and leasing it back to the organization needing financing.

Features

Sukuk includes a direct asset ownership interest, while bonds are indirect interest-bearing debt obligations.
Both sukuk and bonds furnish investors with payment streams, but income derived from a sukuk can't be speculative which would make it no longer halal.
A sukuk is a sharia-consistent bond-like instruments utilized in Islamic finance.