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Sukuk (Arabic: صكوك‎, plural of صك Sakk, “legal instrument, deed, check”) is the Arabic name for financial certificates, but commonly refers to the Islamic equivalent of bonds. Since fixed income, interest bearing bonds are not permissible in Islam, Sukuk securities are structured to comply with the Islamic law and its investment principles, which prohibits the charging, or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets.

According to Global Islamic Finance Report 2012 Global Islamic Finance Report, $1.34 trillion of assets are being managed according to Islamic investment principles. Such principles form part of Shari’ah, which is often understood to be ‘Islamic Law’, but it is actually broader than this in that it also encompasses the general body of spiritual and moral obligations and duties in Islam. In the Persian Gulf region and Asia, Standard & Poor’s estimates that 20 per cent of banking customers would now spontaneously choose an Islamic financial product over a conventional one with a similar risk-return profile.[citation needed]

Such religiously inspired non-interest loan systems can be quite mystifying for outsiders. A good analogy is one of ethical or green investing. Here the universe of investable securities is limited by certain criteria based on moral and ethical considerations. Islamic finance is also a subset of the global market and there is little to prevent the conventional investor from participating in the Islamic market.

[edit] TerminologyThe use of the word “sukuks” when referring to Islamic bonds in the plural is incorrect, because “sukuk” is actually a plural word. The correct forms are: “sakk” (singular) and “sukuk” (plural). A good analogy is adding an S letter to an already plural word like “children”; obviously this would be incorrect.

If one wishes to avoid using the singular word “sakk”, perhaps due to its obscurity, an option is to use “Islamic bond” for the singular form, and “sukuk” for the plural. In addition to being grammatically correct, this would also help in capturing two keywords about the subject in any piece of writing, which enhances its visibility and accessibility.

[edit] HistoryIn classical period Islam, Sakk (sukuk)—which is cognate with the European root “cheque” from Sanskrit ‘(چک) pronounced check’—meant any document representing a contract or conveyance of rights, obligations or monies done in conformity with the Shariah. Empirical evidence shows that sukuk were a product extensively used during medieval Islam for the transferring of financial obligations originating from trade and other commercial activities.

The essence of sukuk, in the modern Islamic perspective, lies in the concept of asset monetization—the so called securitisation—that is achieved through the process of issuance of sukuk (taskeek). Its great potential is in transforming an asset’s future cash flow into present cash flow. Sukuk may be issued on existing as well as specific assets that may become available at a future date.

[edit] PrincipleSukuk can be structured alongside different techniques. While a conventional bond is a promise to repay a loan, Sukuk constitute partial ownership in a debt (Sukuk Murabaha), asset (Sukuk Al Ijara), project (Sukuk Al Istisna), business (Sukuk Al Musharaka), or investment (Sukuk Al Istithmar).

Most commonly used Sukuk structures replicate the cash flows of conventional bonds. Such structures are listed on exchanges, commonly Luxembourg Stock Exchange and London Stock Exchange in Europe, and made tradable through conventional organisations like Euroclear or Clearstream. A key technique to achieve capital protection without amounting to a loan is a binding promise to repurchase certain assets, e.g. in the case of Sukuk Al Ijara, by the issuer. In the meantime a rent is being paid, which is often benchmarked to an interest rate like LIBOR (which is disliked by Sharia Scholars).

From a Sharia perspective, certificates of debt are not tradable (although a different view is held by many in Malaysia).

The most accepted structure, which is tradable, is thereafter the Sukuk Al Ijara. Debt certificates can be only bought before the finance occurs and then held to maturity from an Islamic perspective, which is critical on debt trading at market value regarding any difference to be like the prohibited Riba (interest on money).

As Shari’ah considers money to be a measuring tool for value and not an asset in itself, it requires that one should not receive income from money (or anything that has the genus of money) alone. This generation of money from money (simplistically, interest) is “Riba”, and is forbidden. The implication for Islamic financial institutions is that the trading and selling of debts, receivables (for anything other than par), conventional loan lending and credit cards are not permissible.

This principle is widely understood to mean uncertainty in the contractual terms and/or the uncertainty in the existence of an underlying asset in a contract, which causes issues for Islamic scholars when considering the application of derivatives. Sharia also incorporates the concept of maslahah or “public benefit”, denoting that if something is overwhelmingly in the public good, it may yet be transacted – and so hedging or mitigation of avoidable business risks, may fall into this category, but there is still much discussion yet to come on this issue.

[edit] Sukuk Secondary MarketSukuk securities tend to be bought and held and, as a result, little of the securities enter the secondary market (allowing them to be traded). Furthermore, only public Sukuk are able to enter this market, as they are listed on stock exchanges.

The secondary market whilst developing remains a niche segment with virtually all of the trading done at the institution level. The size of the secondary market remains unknown, though LMC Bahrain state they traded $55.5 million of Sukuk in 2007.[1] The European Islamic Investment Bank (EIIB) in an interview published on Sukuk.net stated “Secondary market trading volume has contracted significantly in the first half of 2008 when compared to 2007 where Sukuk with a nominal value of approximately $0.5bn was traded.”[2]

“Sukuk bonds” are designed to get around religious laws banning the payment of interest for money lending. But one of the most volatile debts in the Dubai World standstill is a $3.5bn Islamic bond due to be repaid in December.

HSBC estimates there is $822bn Islamic finance debt outstanding in the world.[3]

[edit] Countries using Sukuk[edit] KazakhstanIn June 2012, Kazakhstan finalized its debut sukuk which will be issued by the Development Bank of Kazakhstan (DBK) in the Malaysian market. The DBK, which is 100% owned by the government of Kazakhstan, is working with HSBC and Royal Bank of Scotland (RBS) to manage the ringgit-denominated issuance which is effectively a quasi-sovereign offering. The issuance will be listed on the Kazakhstan Stock Exchange, which has developed the infrastructure to list Islamic financial products such as Ijara and Musharaka Sukuk and investment funds.[4]

[edit] ControversySukuk are widely regarded as controversial due to their perceived purpose of evading the restrictions on Riba. Conservative scholars do not believe that this is effective, citing the fact that a Sakk (Islamic bond) effectively requires payment for the time-value of money. This can be regarded as the fundamental test of interest. Sukuk offer investors fixed return on their investments which is also similar in appearance to interest in that the investor’s return is not necessarily dependent on the risks of that particular venture. However, banks that issue Sukuk are investing in assets—not currency. The return on such assets takes the form of rent, and is evenly spread over the rental period. The productivity of the asset forms the basis of the fixed income stream and the return on investment. Given that there is an asset underlying the value of the certificate, there may be, depending on the value of the asset, more security for the investors involved, accounting for the additional appeal of Sukuk as a method of financing for investors.

Certain common structuring elements for Sukuk were criticised by Sheik Muhammad Taqi Usmani President of the Shariah Council of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) in a paper entitled “Sukuk and their Contemporary Applications” released in November 2007.[5] Sheik Usmani identified the following three key structuring elements that differentiate Sukuk from conventional bonds[6]:

Sukuk must represent ownership shares in assets or commercial or industrial enterprises that bring profits or revenues
Payments to Sukuk-holders should be the share of profits (after costs) of the assets or enterprise
The value payable to the Sukuk-holder on maturity should be the current market value of the assets or enterprise and not the principal originally invested.
Sheik Usmani stated that by complex mechanisms Sukuk had taken on the same characteristics as conventional interest-bearing bonds, as they do not return to investors more than a fixed percentage of the principal, based on interest rates, while guaranteeing the return of investors’ principal at maturity.[7] Sheik Usmani estimated that 85% of all Sukuk in issuance were not Shariah-compliant due to the existence of guaranteed returns and/or repurchase obligations from the issuer.

Following Sheik Usmani’s criticisms the global Sukuk market shrunk from US$50bn in 2007 to approximately $14.9bn in 2008,[8] although how much of this was due to his criticisms[9] or the Global Financial Crisis is a matter of debate.[10]

In 2011, Safari[11] conducted various statistical and econometrics tests to check the argument that sukuk securities are merely the same as conventional bond. However, his results on the comparison of yield to maturity of sukuk and that of conventional bonds show that sukuk securities are different from conventional bonds.