Sukuk
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Sukuk is the Arabic name for a financial certificate but can be seen as an Islamic equivalent of bond. However fixed income, interest bearing bonds are not permissable in Islam, hence Sukuk are securities that 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.
Conservative estimates suggest that over $500 bn of assets are 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.
The principles that are most relevant to Sukuk certificates are..
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[edit] The Need for Tangible Assets
Shari’ah requires that financing should only be raised for trading in, or construction of, specific and identifiable assets. Trading in ‘indebtedness’ is prohibited and so the issuance of conventional bonds would not be compliant. Thus all Sukuk returns and cashflows will be linked to assets purchased or those generated from an asset once constructed and not simply be income that is interest based. For borrowers to raise compliant financing they will need to utilise assets in the structure (which could be equity in a 'tangible' company). Its worth noting that Equity financing is Shari’ah compliant and fits well with the risk/return precepts of Islam.
[edit] The Problem with Interest or ‘Riba’
As Shari’ah considers money to be a measuring tool for value and not an ‘asset’ in itself, it requires that one should not be able to 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 implications for Islamic financial institutions is that the trading/selling of debts, receivables (for anything other than par), conventional loan lending and credit cards are not permissable.
[edit] The Problem of Uncertainty or ‘Gharar’
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 and this causes issues for Islamic scholars when considering the application of derivatives. Shari’ah 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 there is still much discussion yet to come.
[edit] Controversy
Sukuks 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 Sukuk effectively requires payment for the time-value of money. This can be regarded as the fundamental test of interest.
[edit] Summary
With its Arabic terminology and unusual prohibtions, Sukuk financing can be quite mystifying for the outsider. 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 nothing that prevents the ‘conventional’ investor from participating in the Islamic market.
A short paper "Sukuk And Shari'ah: A Moodys Primer" covers all the above in far more detail.
This link is a good summary of global Sukuk issuance http://www.lmcbahrain.com/Global-table.asp
For Islamic finance read: http://sukkook.googlepages.com:
Explanation of the mechanics behind a Sukuk
For an overview of Islamic finance visit Philip Chandler
