Islamic Capital Markets: Understanding Sukuk

Introduction

Sukuk, commonly known as Islamic bonds, have become synonymous with Islamic finance in recent years. The first modern sukuk was issued in 1990 by Malaysia Shell MDS Sdn Bhd worth RM 120 million. This was followed by the first US$ 150 million international sukuk by another Malaysian company called Kumpulan Guthrie Berhad in 2001 and a USD 600 million sukuk by the Malaysian government in 2002. Today, the total sukuk outstanding globally have reached almost US$ 350 billion. The global sukuk market has witnessed double digit annual growth over the last decade and a half, and continues to grow at an impressive pace as a shariah compliant alternative to traditional bonds. Despite significant growth, sukuk still represent a small proportion of global debt markets (the size of the global bond markets is estimated to be close to US$ 100 trillion).

The year 2016 saw aggregate new sukuk issuances of around USD 75 billion, registering a small growth from the previous year despite difficult economic conditions in some of its core markets.

There have been several large sovereign issuances in 2017, including from Saudi Arabia (USD 9 billion), Indonesia (USD 3 billion) and Oman (USD 2 billion). Pakistan also recently tapped the international market and managed to raise USD 1 billion at 5.625%, a significant discount to its simultaneous USD 1.5 billion Eurobond which was priced at 6.875%.

Sukuk Defined

The question is often asked whether sukuk are the Islamic equivalent of a conventional bond? From a strict shariah perspective, the answer is clearly no, given there is no such thing as an Islamic bond due to the Islamic prohibition on interest (riba). A bond represents an obligation of the issuer / borrower to repay a certain sum of money on maturityalong with periodic coupon or interest payments. Islam does not permit interest and therefore, a sukuk in that sense is not a bond.

However, in terms of economic effect, the answer is probably yes. Sukuk, as described in AAOIFI's shariah standard 17 are "certificates of equal value which represent an interest in an underlying tangible asset, usufruct or service or (in the ownership of) the asset of particular project or special investment activity". In theory, the repayment of a sukuk is linked to the return generated by the asset, project or investment activity underpinning the sukuk certificate. Accordingly, whereas an investor takes a credit risk on the issuer's creditworthiness under a...