Islamic Finance and Capital Markets: Sukuk Structure and ... · The challenge: Financial...
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Islamic Finance and Capital Markets:
Sukuk Structure and Trading
Power point and Assessments
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Acknowledgement
This textbook was developed as part of the IRTI e-Learning Program (2010), which was established and
managed by Dr. Ahmed Iskanderani and Dr. Khalifa M. Ali.
Islamic Financial and Capital Markets
Khalifa M Ali Hassanain
Table of Contents
Chapter 5 ....................................................................................................................................................... 6
Chapter Introduction .................................................................................................................................... 7
Learning Objectives ....................................................................................................................................... 7
Key Innovative Activities Shaping Financial Markets .................................................................................... 7
Financial Engineering in the Islamic Financial System .................................................................................. 8
Derivatives and the Islamic Financial Markets.............................................................................................. 8
Historical Financial Innovation in Islamic Finance ........................................................................................ 8
Scope of Financial Engineering in Islamic Finance ........................................................................................ 9
Approaches for Financial Innovation in Islamic Finance ............................................................................. 10
Challenges to Innovation in Islamic Markets .............................................................................................. 11
Chapter Summary ....................................................................................................................................... 12
Key Terms .................................................................................................................................................... 13
Chapter 6 ..................................................................................................................................................... 16
Chapter Introduction .................................................................................................................................. 17
Learning Objectives ..................................................................................................................................... 17
Sukuk as a Sharī’ah-Compliant Instrument ................................................................................................. 17
Framework for an Islamic Capital Market ................................................................................................... 18
Securitisation and Sukuk ............................................................................................................................. 19
More about Sukuk ....................................................................................................................................... 19
Advantages and Pricing of Sukuk ................................................................................................................ 19
Parties in a Sukuk Issue ............................................................................................................................... 21
Chapter Summary ....................................................................................................................................... 21
Key Terms .................................................................................................................................................... 22
Chapter 7 ..................................................................................................................................................... 23
Chapter Introduction .................................................................................................................................. 24
Learning Objectives ..................................................................................................................................... 24
Classes of Securitised Papers ...................................................................................................................... 24
The SPV ....................................................................................................................................................... 25
Risk, Contract and Cash Flow Analysis ........................................................................................................ 25
Types of Permissible Sukuk ......................................................................................................................... 26
Controversial Sukuk .................................................................................................................................... 27
Ijarah Contracts in Sukuk ............................................................................................................................ 27
Chapter Summary ....................................................................................................................................... 28
Key Terms .................................................................................................................................................... 29
Chapter 8 ..................................................................................................................................................... 30
Chapter Introduction .................................................................................................................................. 31
Learning Objectives ..................................................................................................................................... 32
Muqaradah or Mudarabah Sukuk ............................................................................................................... 32
Musharakah Sukuk ...................................................................................................................................... 33
Basics of Ijarah Sukuk .................................................................................................................................. 34
Structuring the Ijarah Sukuk ....................................................................................................................... 34
Types of Ijarah Sukuk .................................................................................................................................. 36
Aspects of Ownership, Rent and Expenses ................................................................................................. 37
Issuance and Trading of Ijarah Sukuk ......................................................................................................... 37
Basics of Salam Sukuk ................................................................................................................................. 38
Ownership and Trade in Salam Sukuk ........................................................................................................ 39
Istisna‘a Sukuk............................................................................................................................................. 39
Trade of Istisna‘a Sukuk .............................................................................................................................. 40
Murabaha Sukuk ......................................................................................................................................... 40
Use of Murabaha Sukuk .............................................................................................................................. 41
Mixed Sukuk ................................................................................................................................................ 41
Chapter Summary ....................................................................................................................................... 43
Key Terms .................................................................................................................................................... 44
Chapter 5
Chapter Introduction
Innovations in Islamic Markets.
Features of the global financial market:
It is efficient and sophisticated.
It is driven by financial engineering and innovation.
Financial markets have been evolving since the 1980s due to:
Breakdown of exchange rate mechanisms
Volatility of markets
Requirement of liquidity
Requirement for range of products
Financial deregulation
Breakthroughs in information processing and communication technology
Advancements in financial theory
Learning Objectives
At the end of this chapter, you will be able to:
Describe the three key financially innovative activities that shape markets.
Explain the criticality of financial engineering to the Islamic financial system.
Explain the consequences of the lack of derivative instruments in an Islamic financial system.
Describe how historically Islam has facilitated financial innovation.
Explain the three aspects to be considered for financial innovation in Islamic systems.
Describe the two approaches that can be used for financial innovation in Islamic financial
systems.
Describe the innovation of a synthetic currency forward contract.
Key Innovative Activities Shaping Financial Markets
Financial engineering includes:
Designing new and innovative solutions.
Developing these solutions into a new product, service or process.
Reducing funding costs and increasing returns on investments and opportunities for risk sharing.
Activities in financial engineering that shape markets:
Marketability, negotiability and transferability of financial claims
Development of derivatives market
Generation of revenues from credit and equity
Benefits of financial engineering:
Market experiments continually.
Market makes variations to instruments.
It helps improve efficiency and balance costs and returns.
Financial Engineering in the Islamic Financial System
Financial engineering is critical to:
Development of Islamic markets
Risk management in Islamic markets
Financial engineering is important because:
Islamic markets follow traditional practices.
Markets are unable to address modern requirements for liquidity, risk and portfolio management.
Islamic markets primarily offer short-term options. There is a shortage of medium- and long-term
options. The lack of secondary market has affected liquidity. Investors are unable to expand portfolios.
The challenge is to give investors more options at the lowest cost.
Derivatives and the Islamic Financial Markets
Modern financial markets depend on derivatives markets because derivatives:
Allow investors, corporations and countries to hedge themselves against financial risks.
Provide information about expected market-clearing prices, future demand and supply.
Provide transactional efficiency. Impact of absence of derivatives in Islamic markets:
A company may lose its competitive edge.
A company without active risk management will be perceived as high-risk.
The company will face financial distress.
The company will be more vulnerable during a financial crisis.
Islamic financial institutions will find it difficult to integrate with global system.
Historical Financial Innovation in Islamic Finance
Financial engineering is the restructuring of:
Returns
Price risk
Credit risk
Country risk
Most modern markets have complex instruments that are built on a basic set of instruments. Islamic
markets are built upon the same basic structures, but without the complexity required for markets
today. Financial engineering must develop modern complex instruments that are also Sharī’ah-
compliant.
The challenge:
Financial engineering requires a thorough knowledge of Islamic legal system and economics, finance and
banking. Islamic nations have a long history of working in accordance with the Sharī’ah. Economics and
commerce in Muslim countries have developed based on rulings and precedents set by Sharī’ah experts
in accordance with the Sharī’ah. The practice of interpreting and applying Sharī’ah through the Ijtihad
must be revived.
Scope of Financial Engineering in Islamic Finance
In Islamic markets, legitimacy of a product or service, with respect to the Sharī’ah, is critical. Every new
product, service or instrument must be approved by Sharī’ah scholars. Only products that have no
element prohibited by Sharī’ah will be granted approval. Key issues that help understand the extent to
which financial engineering can be developed are:
● Freedom of contract that economic agents have
● Building blocks of the Islamic financial system
● Risk/return profile of the instruments
Freedom of Contract
Islam does not forbid any contracts. Sharī’ah prohibits:
● Riba
● Gharar
● Qimar
● Ikrah
Traditionally, economic agents drawing up contracts would show them to Sharī’ah scholars to study
their legitimacy. Agents have the power to enter any kind of contract, provided they stay within the
Sharī’ah’s boundaries. Financial instruments and services must be seen as sets of contracts specifying
rights and duties of each party. Sharī’ah scholars verify if the rights and duties are in accordance with
the Sharī’ah.
Basic Building Blocks
It is necessary to understand the basic structures of a market. It becomes easy to build on top of these
building blocks. The main building blocks of Islamic markets are similar to the conventional financial
market. But Islamic financial system and modes of finance should be designed to be Sharī’ah-compliant
and to adhere to the Maqasid Al-Sharī’ah. However, practices by some financial institutions may cause a
deviation from these principles. This uniqueness must be understood while building complex structures
that are also Sharī’ah-compliant.
Risk/Return Profile
There is an assumption that Islamic finance is equity-driven. Non-equity contracts used in Islamic
markets are:
Trade financing
Leasing and sales
Non-equity contracts accepted by the Sharī’ah are:
● Murabahah
● Ijarah
● Salaam
Approaches for Financial Innovation in Islamic Finance
Approaches to financial engineering:
Reverse engineering
Innovative engineering
Reverse Engineering
Features of reverse engineering:
● Analysing existing market structures.
● Finding their closest substitutes in the Islamic market.
● Using the basic structures to rebuild them within the boundaries of the Sharī’ah.
Major benefit: Easy introduction and merger with conventional structures, particularly in markets
outside.
The challenge: The substitutes can be closely related to the original, but not completely Sharī’ah-
compliant. Contamination occurs due to misuse of instrument.
Innovative Engineering
Features of innovative engineering:
Identification of a menu of Islamic instruments
Designing new instruments from that menu
Giving the new instrumentation a unique risk/return profile and easy applicability
The benefit: Ready for Sharī’ah-compliance.
The challenge: Needs long-term commitment and time to evolve.
The problem: Innovative engineering requires an Islamic financial system. Most Islamic nations lack
stable economy, supervisory or regulatory laws and Sharī’ah-compliant property laws. Operational
difficulties hamper innovative engineering.
In the short term, reverse engineering will dominate.
In the medium term, reverse and innovative engineering will co-exist.
The long-term solution is to develop instruments with risk/return profiles.
Challenges to Innovation in Islamic Markets
Conventional markets have used financial engineering with good effect. It was easy for conventional
markets because:
● They already had a variety of short- and long-term options.
● There were fixed income securities.
● There were easy entry and exit norms.
● The level of technology was fairly high.
Islamic markets face a number of challenges.
Theoretical Foundation
Conventional markets have a strong theoretical foundation. Capital structure, portfolio diversification
and options pricing are well developed. It is easy to build complex structures over and above that.
Islamic markets have no theoretical foundation. Asset and risk pricing and derivatives are not well
established. Islamic markets must work on building a theoretical base. For this, they must resort to
cross-training. Sharī’ah scholars must be trained in banking and finance. Bankers and economists must
be trained in the Sharī’ah.
Investment in Infrastructure
Financial engineering requires established cells to conduct:
● Market research ● Product research ● Analytical modelling
Conventional institutions have a mechanism to collect market information, Islamic institutions don’t.
They are usually too small and lack the necessary funds and human resources. Islamic institutions must
come together to collectively pool resources and conduct research. This will help reduce costs and
create a research base.
IRTI’s Pathbreaking Initiative
Multi-year project titled Products and Financial Instruments in Islamic Fiqh
Extensively examine original Fiqh sources and develop new products for the modern Islamic financial markets
Collaboration and Cooperation
IFIs and western institutions can collaborate for developing new instruments. Western institutions have
the benefit of resources and technology. They can together develop products with varying risk/return
profiles. Western institutions can design products and IFIs can market them. IFIs can acquire the
sophistication of Western institutions while being Sharī’ah-compliant. Costs of development will be low
for IFIs.
Standardisation and Exception
Aim of financial engineering is to standardise contracts and practices. Sharī’ah scholars and bankers
must work towards standardising contracts, practices, accounting norms, supervisory practices. The
practice of invoking Dharoora, the rule of necessity, when products do not comply with the Sharī’ah,
must be supervised and any misuse checked.
Chapter Summary
You have completed the chapter, Innovations in Islamic Markets. The key points of this chapter are as follows:
Financial markets are driven by financial engineering and innovation.
The trend began in the 1980s due to:
A breakdown of exchange rate mechanisms
Volatility of markets
Requirement of liquidity
Requirement for a range of products
Financial deregulation
Information processing
Communication technology
Financial engineering means designing new products, services and processes to:
Reduce costs
Increase returns
Increase opportunities
Financial engineering impacts:
Tradability and negotiability
Development of derivatives market
Generation of revenues from credit and equity.
Islamic markets lack medium and long term options. The need of the market is derivatives. They are necessary for the Islamic market to integrate with global markets.
Financial engineering is a restructuring of:
Returns
Price risk
Credit risk
Country risk
Key issues that help understand the extent to which financial engineering can be developed are:
Freedom of contracts that agents have
Basic building blocks of the market
Risk/return profiles of instruments
Islam forbids no contract. It allows agents freedom to enter contracts that do not violate Sharī’ah.
The main building blocks of Islamic markets and Western markets are similar, but Islamic modes of finance are envisaged to be Sharī’ah -compliant and to achieve the Maqasid Al-Sharī’ah.
Islamic markets allow equity and non-equity-based instruments such as Murabahah, Ijarah and Salaam. These even offer interest-like fixed returns.
Approaches to financial engineering:
Reverse Engineering - involves analysis of existing market structures and rebuilding them into new
Innovative engineering - involves identification of Islamic instruments from which new ones can be created
Challenges to financial engineering before Islamic markets:
The absence of a theoretical base
The need to train Sharī’ah experts in banking and bankers in Sharī’ah
The need for collaboration of IFIs and Western institutions to develop a knowledge base and standardise practices across markets
IRTI’s multi-year project called “Products and Financial Instruments in Islamic Fiqh” aims to extract new Islamic finance products from the original Fiqh sources, refine them and make applicable to modern finance and banking.
Key Terms
Dharoora Gharar Ijtihad
Ijarah Ikrah Istisna‘a
Maisir or Qimar Murabahah Ribâ Sharī’ah
Chapter 6
Chapter Introduction
Securitisation in Islamic Finance. Islamic banking and finance has gained momentum particularly in the
areas of Sukuk and securitisation. Shirkah-based instruments are in use since 1980s; Sukuk have been
issued only since 1992. Since 2002, Sukuk issues by both corporate entities and sovereign nations have
grown in value from a few hundred million dollars to several billion dollars. The underlying contracts
include Ijarah, Mudarabah, Musharakah, Istisna‘a and a mix of some of these.
Pioneering Example: The $400mn Islamic Development Bank- Solidarity Trust Services Sukuk issue in
2003
Estimates for Sukuk market size in 2015 (IRTI-IFSB Ten-Year Framework for Islamic Financial Services
Development):
15% annual growth rate= $1.41 trillion
10% annual growth rate=$1.25 trillion
Sukuk is preferred as an alternative source of funding for sovereigns and corporate bodies.
Sukuk provides a substitute to conventional fixed income securities issued for funding large
developmental and capital expenditures of big entities.
Sukuk facilitates Islamic Financial Institutions (IFIs) and investors to successfully manage
liquidity.
Learning Objectives
On completing this chapter, you will be able to:
Describe Sukuk as a Sharī’ah-compliant instrument in an Islamic financial structure.
Describe the features of the capital market comprising debt, equity and Sukuk markets.
Explain securitisation and Sukuk in Islamic finance.
Distinguish between Sukuk and conventional securitisation.
Describe the advantages and pricing of Sukuk.
Describe the key players in various issues of Sukuk.
Sukuk as a Sharī’ah-Compliant Instrument
It was believed that only an equity market finances long-term projects in an Islamic finance framework. According to Sharī’ah, debts can be sold only when their trading is subject to Hawalah. Emergence of Ijarah Sukuk and Sukuk implies that some features and benefits of a debt market are possible in an Islamic financial structure. A Sharī’ah-compliant investment certificate should not represent interest-bearing debt as a dominant part of the underlying assets. As the Sukuk issued on the basis of Shirkah and Ijarah signify the ownership of assets by Sukuk holders, it can be traded in the secondary market at the price determined by the market forces. Sukuk can provide the facilities of a normal debt market. Alternatives of conventional bonds can be developed through securitisation of assets.
Instruments formed through securitisation of assets represent the proportionate ownership of the holders in the assets.
Two types of return from Sukuk:
• Variable-return Sukuk (VRS)
• Fixed-return Sukuk (FRS)
Framework for an Islamic Capital Market
Key components of an Islamic capital market are:
• Sharī’ah-compliant stocks.
• Islamic funds.
• Islamic investment certificates.
Debt market involves Ribâ and Gharar and is not an active part of the Islamic financial market. In Hawalah, debts can only be assigned to others on a par value without transferring the risk of default. Stock market investment is subject to many conditions.
The conditions for trading stocks are covered in detail in Chapter 2 of this course, Advanced Islamic Instruments and Markets. An Islamic capital market can be developed by:
• Issuing more Sukuk
• Introducing Islamic Depository Receipts (IDRs).
• Replacing debt financing
• Securitisation
• Fund management
Sukuk signify the common undivided shares in the ownership of underlying assets. Sukuk holders share the return and bear the loss in proportion to their share in investment.
Sharī’ah-compliant Sukuk result in:
• Enhanced supply of risk-based capital with reduced risk.
• Balanced return rate structure based on economic activities backed by real assets.
An IDR involves trading of stocks of Islamic companies in countries other than their origin. Importance of IDRs:
• Convergence of Islamic capital markets
• Alternative to cross-listing
• Provision of better regulatory environment
• Generation of funds for developing Muslim countries
• Standardisation of Sharī’ah compliance across jurisdictions
• Growth of Islamic capital markets
The originator of the underlying asset, an investor and the custodian bank engage in IDR.
Advantages of IDRs for the originators:
• Facilitates the expansion of the investor base
• Enables low cost of funds in extremely liquid markets
• Provides better securities by trading in more organized markets
Advantages of IDRs for the investors:
• Provides diversification of portfolio in other markets
• Requires IFIs to have Sharī’ah-compliant stocks
• Enables greater returns for IFIs
• Facilitates liquidity management for IFIs
Securitisation and Sukuk
Securitisation is a process of pooling/repackaging the non-marketable and illiquid assets into tradable certificates of investment. It changes the role of the originator from an accumulator to a distributor. In securitisation, ownership of the underlying assets is transferred to a large number of investors in the form of Sukuk. Sukuk is issued on the basis of assets booked by IFIs or by purchasing the assets with proceeds of a variety of Sukuk created as per Shirkah principle. The contractual rights of Sukuk reveal the mutual ownership and benefits of the securitised assets for individual Sukuk investors. Sukuk holders receive the revenue generated and capital appreciation of the assets. A Special Purpose Vehicle (SPV) or Special Purpose Mudarabah (SPM) manage assets on behalf of Sukuk holders and issue investment certificates.
More about Sukuk
According to Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), investment Sukuk is a certificate representing undivided shares in the ownership of tangible assets, usufruct and services or in the ownership of assets of the any particular projects or activity. A share implies the ownership of a company as a whole for an indefinite period. Sukuk represent specified assets and are issued for a certain period ranging from three months to ten years. Unlike bonds, Sukuk hold the returns based on the cash flow originating from the assets. Sukuk do not encourage Ribâ, Gharar and the activities prohibited by Sharī’ah.
Advantages and Pricing of Sukuk
Securitisation involves:
Evaluating, isolating and allocating specific risks.
Assessing taxation, accounting and legal implications.
Designing appropriate credit enhancement structures.
Pricing the residual risk for pricing the units of securitized assets or pools.
Benefits of securitisation for the investors:
Offers premium over equivalent related plain securities
Provides better stability than vanilla papers
Associates focused risks with securities
Allows portfolio diversification
Enables customised cash flow structures
Provides flexible range of maturities
Offers skilled risk assessment
Benefits of securitisation for the originator:
Offers incentives to develop a transparent fund approval process
Encourages efficient collection procedures
Provides a competent mechanism to control approval and collection process
New form of securities:
Assist the development of capital markets.
Attract conservative buyers.
Draw international capital.
Facilitate efficient sharing of risks.
Securitised papers are traded at a premium above similar vanilla corporate papers. The premium
depends on the following:
Active secondary market
Complexity of transaction
Comfort level of investors
Demand of investors
Parties in a Sukuk Issue
Key parties in Sukuk transactions:
Originator of Sukuk: Sells the assets to SPV and uses the funds; usually IFIs, governments or
corporations
SPV or issuer: Purchases assets from the originator and issues Sukuk to fund the purchase price
Investment bank: Manages and directs book-making services for Sukuk for a predetermined fee;
usually operate as syndicates
Subscribers of Sukuk: Buy securities issued by the SPV; central banks, IFIs and individuals are
subscribers
Key parties in general securitisation process:
Obligor
Lead manager
Servicer
Cash administrator
Credit enhancement provider
Credit rating agency
Legal and tax counsel
Auditor
Custodian/ R&T agents
Chapter Summary
You have completed the chapter, Securitisation in Islamic Finance. The key points of this chapter are as follows:
Sukuk is preferred as an alternative source of funding, especially for sovereigns and corporate bodies.
IRTI-IFSB Ten-Year Framework for Islamic Financial Services Development estimates Sukuk market to be between $ 1.25 and $ 1.4 trillion by 2015.
A Sharī’ah-compliant investment certificate should not represent interest-bearing debt as a dominant part of the underlying assets.
Key components of an Islamic capital market are Sharī’ah-compliant stocks, Islamic funds and Islamic investment certificates.
Debt market, which deals in debentures and bonds, usually involves Ribâ and Gharar and, hence, it cannot be a part of Islamic financial market.
Stocks of the joint stock company are traded in equity market, which is also known as stock market.
IDR involves trading of stocks in countries other than their origin. Sharī’ah-compliant stocks and other instruments are traded in IDRs.
According to AAOIFI, investment Sukuk is a certificate representing undivided shares in the ownership of tangible assets, usufruct and services or in the ownership of assets of the any particular projects or activity.
Securitisation is a process of pooling/repackaging the non-marketable and illiquid assets into tradable certificates of investment.
Sukuk is similar to conventional securitisation. However, Sukuk does not encourage Ribâ, Gharar and the activities prohibited by Sharī’ah.
Key parties involved in Sukuk transactions are the originator of Sukuk, SPV, investment banks and subscribers of Sukuk.
Sukuk in the form of new securities: Assist the development of capital markets. Attract conservative buyers. Draw international capital. Facilitate the efficient sharing of risks.
Key Terms
Hawalah Ijarah Ijarah Sukuk
Mudarabah Mudarabah Sukuk
Musharakah Musharakah Sukuk
Murabahah Ribâ Salam or Bai’ al-Salam
Sharī’ah
Sukuk
Chapter 7
Chapter Introduction
Structure of a Sukuk. Sukuk refers to an instrument in which the ownership of the underlying assets is
transferred to a large number of investors.
Major classes of securitised papers:
Pool-based securitisation
Future flow securitisation
The lead bankers undertake minute risk analysis, contract analysis and cash flow analysis with respect to
several aspects of an issue. In the Islamic world, Sukuk first became popular in the 1990s. However, the
use of Bai’ al-Dayn and Bai’ al-Inah contracts in these were deemed to be against the Sharī’ah principles.
Since then, Sukuk have been widely accepted in Islamic financial markets around the world.
Before we proceed, note that you can learn about various other aspects of Sukuk in various chapters of
this course:
Chapter 6: Securitisation in Islamic Finance
Chapter 8: Categories of Sukuk
Chapter 9: Tradability, Structures and Potential of Sukuk
Learning Objectives
On completing this chapter, you will be able to:
Describe various classes of securitised papers in a Sukuk issue.
Describe the characteristics of the Special Purpose Vehicle (SPV) in terms of managing securities
issues.
Explain the importance of performing risk, cash flow and contract analysis.
Describe the types of investment certificates permitted by the AAOIFI.
Explain the controversies that arose from the application of different concepts of Sukuk issues
and trading in Sukuk.
Describe the features of Ijarah contracts in Sukuk.
Classes of Securitised Papers
Let’s look at the two types of securitised papers in a Sukuk issue.
Pool-based Securitisation
The following are the classes of Pool-based securitisation:
Mortgage-backed securitisation
Collateralised debt obligations (CDO)/Collateralised loan obligations (CLO)
Lease rentals securitisation
Future Flow Securitisation (FFS)
Future flow securitisation is the securitisation of receivables to be generated in future. Some of the
asset classes include:
Road toll securitisation
Telecom receivable securitisation
Credit card receivable securitisation
The SPV
Purpose of an SPV
A Special Purpose Vehicle (SPV) is a separate legal entity that manages the securities issues. An SPV:
Is efficient with regards to both capital usage and tax.
Requires legal costs to establish and manage it.
Characteristics of a typical SPV:
Bankruptcy remoteness
Thin capitalisation
It is important to ensure that:
The sale to the SPV is true.
The asset is correctly separated from the first owner.
When the ownership is transferred to the SPV, the discretion of the original owner ends. It cannot be
reversed even if the original owner is declared insolvent. The legal structure of an SPV is based on its
regulatory and legal environment.
Payment Structure of an SPV
Alternative payment structures adopted by SPV are:
Pass-through structure
Pay-through structure
SPVs reinvest the funds and pay investors according to a predetermined schedule. SPVs also serve as
“conduits” for multiple issuances.
Risk, Contract and Cash Flow Analysis
The lead bankers perform the following analyses on various aspects with respect to securitisation issues.
Risk Analysis
The lead bankers undertake minute analysis of:
1. Credit and bankruptcy risk
2. Performance risk 3. Asset/collateral risk 4. Payment risk 5. Return rate risk 6. Exchange rate risk 7. Liquidity risk 8. Risk of loss of money 9. Prepayment risk
10. Reinvestment risk in pay-through structures 11. Legal/ Regulatory/ Tax related risk
Securitisation mitigates risks with respect to various factors and it differs from an originator’s and an
investor’s perspective.
The Sukuk holders or the issuers adopt some methods to manage and mitigate risks. They are as follows:
1. Create a Takaful fund with contributions from certificate holders. 2. Take a cover from Islamic Takaful companies and pay the contributions from the income or
donations. 3. Keep aside a certain amount of profit to reduce the fluctuations of the distributable profit.
Contract Analysis
Contract analysis mainly focuses on the following with the purpose of knowing the ability to fulfill the
rights and obligations:
1. Rights and obligations 2. Performance requirements 3. Termination 4. Events of default and consequences of defaults 5. Study of transaction documentation
Cash Flow Analysis
Cash flow analysis is performed to:
Identify key variables and expected patterns of the underlying cash flows under various scenarios.
Determine the rating of the issue.
Types of Permissible Sukuk
The AAOIFI, in its Sharī’ah standard for Investment Sukuk, has put forth eight types of investment
certificates or Sukuk.
Most important Sukuk are:
Shirkah
Ijarah
Salam
Istisna‘a.
As per the basic rules of Sharī’ah,
On one side, investment Sukuk have to be structured according to Shirkah but can be designated as Ijarah Sukuk, Salam Sukuk and Istisna‘a Sukuk.
On the other side, they must use participatory or fixed return modes/instruments.
Rates of return on Sukuk will be:
Variable
Quasi-fixed
However, any third party guarantee can make the Sukuk fixed-return certificates of investment.
Controversial Sukuk
Sukuk issues are based on the concept of Ijarah, whereas few are based on Shirkah, Salam or pooled
assets. Sukuk issues are criticised due to the involvement of controversial contracts like Bai’ al-‘Inah, Bai’
al-Dayn and other non-Sharī’ah compliant traits. Most jurists do not accept these although the debt
represented by Sukuk is supported by the underlying assets. But some of the traditional Muslim jurists
and contemporary Sharī’ah scholars agree on the point that Bai’ al-Dayn with discount is not allowed
according to the Sharī’ah. Some scholars have allowed this kind of sale based on the ruling of the Shafi‘e
school. They do not consider the fact that the Shafi’e jurists allowed it only in a case where a debt was
sold at its par value. The OIC Islamic Fiqh Council of all Islamic countries approved the prohibition of Bai‘
al Dayn.
Bai’ al-Dayn and Bai’ al-Inah contracts are covered in detail in Chapter 8, Controversial Financing & Fee-
based Products, of the course, Islamic Financial System.
Ijarah Contracts in Sukuk
Sale and Lease-Back Technique
The sale and lease-back technique involves the purchase of an asset from a party that can again be
leased to the same party. The experts in Sharī’ah principles allow its use. The sale and lease-back
technique does not create any Sharī’ah-related problem with respect to Sukuk issue on the basis of
Ijarah. The use of sale and lease-back technique in case of consumer durables is not considered
desirable by many Sharī’ah scholars and practitioners, except when the client wants to avoid interest-
based financing and there is no other way out.
View of Sharī’ah Scholars on the Use of Sale and Lease-back Technique
1. Sufficient time should pass before the lessee repurchases the asset.
2. This period creates the chance of a change in the value and structure of the asset being sold and leased back.
3. The client should purchase back the asset at least one year after the sale to avoid an interest-based transaction.
Concerns in Ijarah Sukuk
Ijarah has a great flexibility and potential for Sukuk issue. Some of the aspects of Ijarah Sukuk that need
to be considered before issuing are:
Ijarah Sukuk issues are pointers to different Sharī’ah-related problems.
Sukuk holders have to jointly bear the risks of an asset’s price and the ownership-related costs and share its rent by leasing it to any user.
Returns could be quasi-fixed and not absolutely fixed or unmodified when pegged to any benchmark.
The issue of Ijarah Sukuk carries systemic risk of non-Sharī’ah-compliance. Note however that Sukuk
originating from Sudan, Bahrain and other Middle Eastern countries are based on Shirkah, Ijarah, Salam,
Istisna‘a, Istisna‘a-cum-Ijarah or a pool of mixed assets. These Sukuk issues are acceptable to almost all
of the Islamic scholars and banking experts.
Chapter Summary
You have completed the chapter, Structure of a Sukuk. The key points of this chapter are as follows:
Sukuk refers to an instrument in which the ownership of the underlying assets is transferred to a large number of investors.
The major classes of securitised papers include pool-based securitisation and future flow securitisation.
An SPV is a separate legal entity that manages the securities issues.
An SPV is both capital and tax efficient. However, there are legal costs in establishing and managing an SPV.
Some of the alternative payment structures are Pass-through and Pay-through structures.
The lead bankers perform the following analysis on various aspects with respect to securitisation issues.
The most important Sukuk or investment certificates with sizeable potential are Shirkah, Ijarah, Salam and Istisna‘a.
Thus, the rates of return on Sukuk will be either variable or quasi-fixed.
Sukuk issues are based on the concept of Ijarah, where as few are based on Shirkah, Salam or pooled assets.
Sukuk issues are criticised due to the involvement of controversial contracts like Bai’ al-‘Inah, Bai’ al-Dayn and other non-Sharī’ah compliant traits.
The sale and lease-back technique involves the purchase of an asset from a party that can again be leased to the same party. The experts in Sharī’ah principles allow its use.
Key Terms
Bai’ al’-Inah Bai’ al-Dayn Ijarah Ijarah Sukuk
Istisna‘a Mudarabah Mudarabah Sukuk
Musharakah Musharakah Sukuk
Murabahah Ribâ Takaful
Tabarru
Salam or Bai’ al-Salam
Sharī’ah
Shirkah
Sukuk
Chapter 8
Chapter Introduction
Categories of Sukuk.
Sukuk can be categorised into six types:
Muqaradah or Mudarabah Sukuk
Musharakah Sukuk
Ijarah Sukuk
Salam Sukuk
Istisna‘a Sukuk
Murabaha Sukuk
Muqaradah or Mudarabah Sukuk
Muqaradah or Mudarabah Sukuk are certificates that represent projects or activities managed on the
basis of Mudarabah principle. The purpose of Muqaradah or Mudarabah Sukuk issue is to enhance
public participation in investment activities in any economy.
Musharakah Sukuk
Musharakah Sukuk serve as the mode of security for projects involving huge amounts. As redeemable
certificates, Musharakah Sukuk are issued for:
Rehabilitation or employment.
Purchase of automobiles for their commercial use.
Establishment of high-standard clinics, hospitals, factories, trading centres, endowments, etc.
Ijarah Sukuk
Ijarah Sukuk or certificates serve as an evidence for the purchase of proportion of asset that a lessor
wishes to recover the cost of purchase to get liquidity or for the purpose of profit even after executing
the Ijarah contract.
Salam Sukuk
In a Salam Sukuk, an advance payment is made for goods that would be delivered in future. A Salam
buyer can onward sell the Salam commodity using a parallel contract. The specifications of the two
contracts and delivery dates may conform to each other.
Istisna‘a Sukuk
Istisna‘a Sukuk is a contractual agreement for manufacturing goods, allowing advance payment for
future delivery of goods or allowing future payment and future delivery of goods, as per the contract.
Istisna‘a Sukuk helps finance the construction of:
Houses
Plant
Bridges
Roads
Highways
Murabaha Sukuk
In a Murabaha Sukuk, the purchaser on credit signs a paper to document his indebtedness towards the
seller. This paper signifies a debt receivable by the seller. The paper can be transferred to third party
only at par value and the transfer should adhere to the rules of Hawalah.
Note that various structural aspects of Sukuk are described in the following chapters of this course:
Chapter 6, Securitisation in Islamic Finance
Chapter 7: Structure of Sukuk
Chapter 9: Tradability, Structure and Potential of Sukuk
Learning Objectives
On completing this chapter, you will be able to:
Describe Muqaradah Sukuk as a mode of enhancing public participation in investment activities
in any economy.
Describe Musharakah Sukuk as a mode of facilitating proportionate ownership of assets used for
big projects.
Describe Ijarah Sukuk as a mode of mobilising funds for long-term infrastructure projects.
Explain how Ijarah Sukuk can help solve liquidity management problems.
Explain the five types of Sukuk that can be issued on the concept of Ijarah.
Describe the structure and issues with regard to trading and potential of Salam Sukuk.
Describe the level of ownership and trading in Salam Sukuk.
Describe the features of Istiana’a Sukuk and their development.
Describe the rules of trading and conditions for selling Istisna‘a certificates in the market.
Explain how Murabaha Sukuk can be used for the purchase and sale of assets in the market.
Describe the salient features of mixed portfolio securities and the key benefits of issuing them.
Muqaradah or Mudarabah Sukuk
Nature of Muqaradah or Mudarabah Sukuk:
Mudarabah Sukuk is issued by Mudarib.
The subscribers are the owners of the capital.
Realised funds are the Mudarabah capital.
Assets of Mudarabah are owned by the certificate holders.
Profit or loss is shared by the owners of the capital.
Salient Features of Muqaradah or Mudarabah Sukuk:
In terms of the Resolution of the Islamic Fiqh Council of the OIC (fourth session, 1988),
the following are the salient features of Mudarabah Sukuk (MS) or certificates:
1. MS represent common ownership and entitle their holders to a share.
2. The contract must provide all compatible information required by the Sharī’ah for a Qirād contract.
3. The MS holder can transfer the ownership by selling the Sukuk in the securities market by following certain rules:
If capital is in the form of money, trading of MS will be done by interchanging of money that satisfy the rules of Bai‘al-Sarf.
If capital is in the form of debt, trade must be based on the principles of debt trading in Islamic jurisprudence.
If capital is in the form of a combination of cash, receivables, goods, real assets and benefits, trade must be based on the market price evolved by mutual consent.
4. The manager or Special Purpose Vehicle (SPV) can obtain profit by investing his own funds in addition to his share in the profit as Mudarib.
5. MS or prospectus should not contain a guarantee from the issuer or the manager of the fund.
6. Reserves for contingencies such as loss of capital can be created by deducting a certain percentage in each accounting period from the profit.
7. The prospectus can contain a promise made by a third party in terms of legal entity or financial status.
Note: The third party should be totally unrelated to the parties involved in the contract. Islamic financial institutions can offer MS to the investors who would subscribe and participate in the investment transactions.
Musharakah Sukuk
Nature of Musharakah Sukuk:
The Musharakah Sukuk are issued to every subscriber of the project.
The Sukuk have equal value for mobilising funds to be used on the basis of partnership.
The Sukuk holders are the owners of the relevant project or the asset. Similarity Between Musharakah and Mudarabah Sukuk:
Basic Sharī’ah rules apply to both Musharakah Sukuk and Mudarabah Sukuk apart from the fact that the intermediary party involved will be a partner of the Musharakah certificate holders. Secondary Market for Musharakah Sukuk:
Musharakah can be treated as negotiable instruments.
Musharakah/Mudarabah can be bought and sold in the secondary market provided the portfolio comprises non-liquid assets of more than 50%.
The combination of liquid and non-liquid assets can be sold and purchased for an amount greater than the amount of liquid assets in the pool.
The profit is shared according to an agreed ratio, while the loss is shared on a pro rata basis.
Uses of Musharakah Sukuk:
Musharakah Sukuk are used to mobilise short-term deposits for the development of long-term projects
or for investment in general financial activities or specific projects.
The proceeds of the Sukuk can be used: To buy and lease certain equipment.
For the construction of projects and factories.
For the expansion of projects.
For working capital finance.
The Musharakah structure is considered more equitable and safer for the investors than the Mudarabah
structure. Musharakah Sukuk holders will have added comfort and security due to the manager’s
participation in the Musharakah capital.
Musharakah Sukuk Issues in Islamic Countries:
On Musharakah basis, a number of assets of the following institutions have been identified for the purpose of securitisation in Sudan:
Ministry of finance
Bank of Sudan
Bank of Khartoum
Nilain Bank
Other public entities
Since 1998, central bank Musharakah certificates (CMCs) and government Musharakah certificates (GMCs) have been issued for investors. The CMCs are sold or bought by the central bank through auctions.
Basics of Ijarah Sukuk
The Concept of Ijarah:
Mobilise funds for the development of long-term infrastructure projects.
Offer Sukuk to a large number of institutional and individual investors.
Create a secondary market instrument for financiers on the basis of Ijarah.
Representation of Ijarah Sukuk for the Investor:
Ownership of the pro rata undivided parts of the asset.
Ownership of well-defined and known assets.
Structuring the Ijarah Sukuk
Securitisation of Ijarah Sukuk can:
Solve liquidity management problems.
Finance the public sector needs.
Note: Assets used by governments need not generate income.
Ijarah funds can be raised by purchasing and leasing assets through Sukuk issues.
Note: Mudarabah Sukuk can also be used to raise funds through services and leases apart from selling goods.
Rental Mechanisms in Ijarah Sukuk
For first term of lease, rental must be specified in clear terms. For the future renewable terms, it could
be constant, increasing or decreasing.
Note: Mufti Muhammad Taqi Usmani (2000a) explains that even though benchmarking with any interest rate as reference is not desirable, it is permitted as long as all the Sharî‘ah requirements are satisfied.
Types of Ijarah Sukuk
The following types of Sukuk can be issued based on the concept of Ijarah:
Sukuk of ownership in leased assets
Sukuk of ownership of usufruct of assets Sukuk of Ownership in Leased Assets
These certificates are issued for the leased asset or for the asset to be leased (by promise) either
By the owner of the asset (or)
By the owner’s financial agent The subscribers are buyers of the asset. The certificate holders become owners of the asset.
Sukuk of Ownership of Usufruct of Existing Assets
These certificates are issued for the existing asset either:
By the owner of usufruct of an existing asset (or)
By his financial agent.
The mobilised funds from subscription are the purchase price of the usufructs. The certificate holders
become owners of the usufruct along with the risks and rewards. When the assets are sub-leased, the
certificate will represent the rent receivables. The issuer is allowed to redeem the tangible assets either
at the market price or as agreed upon at the time of purchase.
Sukuk of Ownership of Usufructs to be Made Available in the Future
These certificates are issued for the assets to be leased. The rental is recovered from the subscription
income. The holders of the certificates are the owners of the usufruct of the future assets. The
subscribers are the buyers of usufructs and will have both the risks and rewards. It is not valid to sub-
lease or trade or made available the asset prior to identification.
Sukuk of Ownership of Services of a Specified Supplier
These certificates are issued:
To provide or sell services through a specified supplier.
To obtain the value in the form of subscription income. The holders of the Sukuk become owners of the services.
Sukuk of Ownership of Services to be Made Available in the Future
These certificates are issued:
To provide or sell services through a non-existing supplier.
To obtain the value in the form of subscription income. The holders of the Sukuk become owners of the services.
Aspects of Ownership, Rent and Expenses
Clarity on Sharing of Expenses and Rent:
The asset to be leased and the amount of rent should be known to the parties involved in an Ijarah
contract. Ijarah Sukuk can be issued on an asset or a building that is yet to be constructed.
Shared Ownership and Accrued Rent:
Lessor can sell the leased asset.
Lessor and lessee can dispose of their share in the asset to the new owner.
Holder will assume the rights and obligations of the owner.
Holder will have the right to enjoy part of the rent.
Holder will suffer the loss due to destruction to the assets.
Ijarah Sukuk should represent ownership for the both profit and loss.
Sharing of Expenses and Rent:
Capital and basic expenses of asset are the responsibility of the owner.
Maintenance expenses are to be borne by the lessee.
If the asset is destroyed without any fault or negligence of the lessee, the loss has to be borne
by the Sukuk holders (lessor).
The rental should consist of:
Payment to the lessor.
“On account” payment to be held by the lessee for any costs relating to the ownership of the
asset.
Issuance and Trading of Ijarah Sukuk
Procedure for Issuing Ijarah Sukuk:
Creation of an SPV to purchase and lease assets
Roles of SPV:
Serves as a manager.
Makes payment for purchasing the asset.
Collects rental payments from lessee and distributes it among Sukuk holders.
Rental Payment:
The lessee makes periodic rental payments to the SPV as stipulated by the lessor in advance with the
possibility of small variation.
Trading in Secondary Market:
After the transfer of ownership to the holders, Ijarah Sukuk can:
Be negotiated and traded freely in the market.
Serve as an instrument easily convertible into cash.
Represent only real assets and not the monetary capital.
The holders become owners of the assets and the issuer can:
Redeem the Sukuk of ownership of leased assets.
Trade the Sukuk of ownership of usufruct of ascertained assets.
Tradeability of Sukuk is covered in greater detail in Chapter 9 of this course, Tradability, Structures and
Potential of Sukuk.
Basics of Salam Sukuk
In a Salam contract, money is paid in advance for goods that would be delivered in future. According to
AAOIFI Standard, a Salam buyer can onward sell the Salam commodity using a parallel contract.
Specifications of the two contracts may conform to each other. Contracts should be independently
enforceable. Salam Sukuk are certificates of equal value issued to raise funds equal to the price of the
commodity, but paid in advance in the Salam contract.
Salam Sukuk is:
Issued by the seller of the Salam commodity.
Subscribed to buyers who eventually become the owners of the commodity.
In Parallel Salam, the holder of Salam Sukuk is entitled to the Salam commodity or the selling price of
the commodity at the time of delivery. Usually, investment banks may act as arrangers, i.e. sell the right
to take delivery of the commodity at a future date.
Advantages of a Salam Contract
The seller of Salam contract can enhance his cash flow in advance.
The buyer has the advantage of lower Salam price.
In June 2001, the Bahrain Monetary Authority (BMA) developed Salam-based securities with LIBOR-
related three-month tenures used for maintaining Statutory Liquidity Ratio (SLR) by Islamic banks.
How the Contract Works
1. Bahrain government sells a specified amount of aluminium to Bahrain Islamic Bank (BIB) at a
future date.
2. BIB appoints the government as its agent.
3. Agent promotes aluminium at the time of delivery at a price which provides returns to the
security holders.
Such short-term Sukuk can be developed based on the commodities being traded, like crude oil and
cotton.
Ownership and Trade in Salam Sukuk
The secondary market trading of Salam Sukuk is prohibited because the Sukuk certificate represents a
share in the Salam debt and speculators who are not interested in the final delivery may seek to profit
from Parallel Salam transactions. This issue should be analysed when the original buyer resells the
commodity purchased under Salam before taking possession. This problem becomes acute when the
buyer maintains an inventory, forcing the bank to sell the items from their own stock without specifying
units. A change in price of tangible goods during the delivery period gives rise to business risk, which
justifies the change in the expected return through the sale. Salam contracts are exempted from the
rule of not selling goods without owning them, if the contracts are written to avoid excessive Gharar in
transactions.
Trading is permitted only if:
The owner of the commodity to be delivered is the purchaser of Sukuk.
The price of Sukuk is decided by the market depending upon the demand and supply of the
underlying commodity.
Istisna‘a Sukuk
Istisna‘a is a contractual agreement for future delivery of manufacturing goods that allows advance or
future payment. An Istisna‘a contract helps to finance construction of different projects. A Parallel
Istisna‘a contract with subcontractors enables Islamic banks to undertake construction of any project
and sell it for a deferred price, but outsource the actual construction to the subcontractor. Upon
delivery of goods, the ownership of the constructed item is transferred to the purchaser against the
deferred sale price. The price covers the construction costs and profits, which would include the cost of
locking funds during the repayment period.
Istisna‘a Sukuk:
Are certificates of equal value issued for mobilizing funds required for producing goods.
Document the deferred price that needs to be paid.
Are issued by the manufacturer (seller).
Are held by the subscribers who are the buyers of the goods.
Trade of Istisna‘a Sukuk
Rules for Trading Istisna‘a Sukuk
Istisna‘a certificates can be traded/redeemed:
If the funds are transformed into assets owned by the certificate holders through business or
trade.
If the funds are immediately offered as a price in a Parallel Istisna‘a contract.
If the manufactured item is handed over to the purchaser.
Prohibition of Ribâ permits the sale of the debt certificates to a third party at any price other than their
face value. Big entities sell certain goods to IFIs on a deferred payment basis and issue Istisna‘a Sukuk
according to the date of payment. In exchange, the certificate holder may acquire the goods for a
deferred price and dispose them off in any way. The certificate holder acquires the goods at a price
higher than the spot price. The holder then relinquishes to the seller the differential price he obtained
above the construction cost of the project.
Murabaha Sukuk
Bank’s credit sale transaction that gives rise to a monetary right or obligation cannot be the basis of a
negotiable instrument. Hence, securitisation of Murabaha receivables to create negotiable Sukuk is not
possible. It is permissible to trade relevant certificates if the commodity has been purchased by a trader
but not sold to a different party.
Reason:
In a Murabaha transaction, the purchaser signs a paper that:
Proves indebtedness towards the seller.
Signifies a debt receivable by the seller.
Can be transferred only at par value.
Can be assigned only at face value.
Mixed Sukuk
A mixed portfolio having many transactions may issue negotiable certificates provided the asset pool
comprises more than 50% of Ijarah or other fixed assets. However, Hanafi scholars permit trading even
if the non-liquid assets are more than 10% of its total worth.
Use of Murabaha Sukuk
Purchase of goods by the public sector involves use of Murabaha Sukuk. Government may pay for very
expensive goods in installments. Over the period of installments, the seller recovers cost and makes
profit. Number of installments =number of certificates issued
Each certificate with a maturity date:
Represents the seller’s property right.
Can be transferred provided the amount of claim does not change.
Collection rights can be transferred to another party by the seller or the original certificate holder if
there is a default in payment that equals the face value of the certificate minus the collection cost at the
transferee’s end. An organisation with access to Murabaha funds can also issue Murabaha Sukuk. The
proceeds are used for sale of pre-specified and general assets on the basis of Murabaha, which provides
Murabaha Sukuk holders with partially-fixed return. Arcapita Bank B.S.C (Bahrain) issued five-year
multicurrency Murabaha-backed Sukuk with a five-year bullet maturity in 2005. The proceeds of the
Sukuk are used to trade the assets through Murabaha transactions. As Murabaha generates fixed
return, to avoid Ribâ, Sukuk holders are offered returns equivalent to three-month LIBOR plus 175 basis
points (bps). The SPV has full recourse to Arcapita. Hence, Sukuk is a freely transferable instrument
based on the mechanism approved by Arcapita’s Sharī’ah supervisory board. Presumably, SPV will
maintain inventory or fixed assets and make its Sukuk negotiable.
Mixed Sukuk
Mixed Sukuk consists of a pool of Musharakah, Ijarah, Murabaha, Istisna‘a, and Ju‘alah contracts. These
contracts may be securitised by the banks. Depending on the chosen mix of the contracts, the return
and risk of securities arises. Salam contracts cannot be included in mixed Sukuk since trade in Salam
Sukuk is prohibited.
Mixed portfolio Sukuk:
They are issued using a tool, which converts non-marketable and illiquid assets to negotiable
instruments holding a secondary market.
These are particularly suitable for investment banks and development financial institutions
(DFIs).
Solidarity Trust Sukuk
$400 million mixed Sukuk issued by the Islamic Development Bank (IDB) in 2003
Characteristics
As a trustee, Solidarity Trust Services (STS) issued fixed-rate trust certificates.
Certificate represents undivided beneficial ownership in trust assets.
Certificate helps buy a mix of Ijarah, Murabaha and Istisna‘a contracts.
Over 50% of the assets would comprise Ijarah assets. If the proportion fell below 25%:
o Dissolution would occur.
o IDB was required to buy trustee-owned assets.
o The certificate holder would receive periodic returns.
Redemption and Payout
Certificates are redeemed at their principal value.
Certificates are redeemed considering the return accumulation period, if an early dissolution
occurs.
Principal amounts of Sukuk are reinvested in Ijarah and Musharakah contracts to form a part of
Sukuk assets.
Guarantees
IDB guarantees the payment in respect of assets owed by the trustee, referring to the schedule
of payments.
The payment guarantees the amount payable by the obligors of the underlying transactions in
respect of the assets.
IDB meets any shortfall due to any loss in returns of the Sukuk assets.
IDB provides the STS with an interest-free facility to ensure timely payment on the trust
certificates.
IDB purchases the Sukuk assets earlier than the maturity or dissolution date. The trust
distributes the proceeds among the certificate holders.
Chapter Summary
You have completed the chapter, Categories of Sukuk. The key points of this chapter are as follows:
The six categories of Sukuk are Muqaradah or Mudarabah Sukuk, Musharakah Sukuk, Ijarah Sukuk, Salam Sukuk, Istisna‘a Sukuk and Murabaha Sukuk.
Muqaradah or Mudarabah Sukuk are issued to enhance public participation in investment activities.
Musharakah Sukuk are issued by or to the corporate sector or to individuals for their rehabilitation or employment, for the purchase of automobiles.
The concept of Ijarah can be used for mobilising funds for the development of long-term infrastructure projects.
Ijarah Sukuk can be used to solve liquidity management problems and finance public sector in developing countries.
Procedure for the issuance of Ijarah Sukuk to the investors involves the creation of an SPV to purchase the assets.
In a Salam contract, money is paid in advance for goods that would be delivered in future.
Salam Sukuk are certificates of equal value issued to raise funds equal to the price of the commodity, but paid in advance in the Salam contract.
The secondary market trading of Salam Sukuk is prohibited because the Sukuk certificate represents a share in the Salam debt and speculators who are not interested in the final delivery may seek to profit from Parallel Salam transactions
Istisna‘a is a contractual agreement for future delivery of manufacturing goods that allows advance or future payment.
Istisna‘a Sukuk are certificates of equal value issued for mobilizing funds required for producing goods.
Istisna‘a certificates can be traded or redeemed if the funds are transformed into assets owned by the certificate holders through business or trade.
Purchase of goods by the public sector involves use of Murabaha Sukuk.
An organisation with access to Murabaha funds can also issue Murabaha Sukuk.
Mixed Sukuk consists of a pool of Musharakah, Ijarah, Murabaha, Salam, Istisna‘a, and Ju‘alah contracts.
Key Terms
Bai’ al’-Inah Bai’ al-Dayn Ijarah Ijarah Sukuk
Istisna‘a Istisna‘a Sukuk
Mudarabah Mudarabah Sukuk
Musharakah Musharakah Sukuk Murabahah Ribâ Salam or Bai’ al-Salam
Salam Sukuk
Sharī’ah
Shirkah
Sukuk