What is Islamic Bond Sukuk?

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What is Islamic Bond Sukuk?

What is Islamic Bond Sukuk? SUKUK (Islamic Bond) may be the alternative channeling of funds for industrialization of Bangladesh

Contributor: Dr. Mohammed Shahid Ullah

There is a growing demand for shariah compliant instruments in the Islamic countries as well as the rest of the world as an alternative to conventional instruments. In the conventional financial system, the fixed income securities play a major role in raising capital and have a significant role in the world economy. Post-crisis fundraising activities through bond offerings have again proven the important role played by this segment of the financial system.

In Islamic Capital & Money Market, SUKUK is anticipated capital market product to play a similar role as it gives the industry the option to issue an instrument with a fixed rate of return profile; while at the same time SUKUK structuring also takes into account the removal of non-Shari’ah compliant features such as GHARAR (uncertainty), RIBA (interest/usury) and MAISIR(Gambling).

Over the past decade, SUKUK has emerged as a very important instrument, not only in the Muslim world but also in the global markets due to its characteristics. The introduction of SUKUK in 2001 has increased the variety of instruments that can be used to create an efficient Islamic portfolio. Moreover, SUKUK provides liquidity to this reasoning alone it is expected that the growth together with enhancement will continue in SUKUK management options both to the long end as well as to the short end of the market. Thus due to this reasoning alone, it is expected that the growth together with enhancement will continue in SUKUK. However, global SUKUK market size has reached to USD 139314.9 million in 2012 which is increasing at about 30% a year. Out of total SUKUK market, Malaysia is contributing about 69%.

The IIFM SUKUK report starts with the overview of the SUKUK market and emergence of fixed profile instrument covering international SUKUK issuances in greater depth as compared to the domestic issuances. It also aims to track the growth and development of different SUKUK structures in various jurisdictions active in issuing SUKUKs. Selected case studies based on widely used structures have been undertaken keeping in mind the international market and possible issuances from new jurisdictions who are currently contemplating issuing sukuk. The report briefly also covers trends and recent developments with respect to this very important the instrument of Islamic Capital Market.

In recent years, the Islamic finance industry has grown rapidly, at more than 15% per annum. Despite its remarkable growth, Islamic finance is still largely concentrated in the Banking Business. In many countries with a significant Islamic finance industry, markets for Islamic bonds (Sukuk) are still relatively small and underdeveloped. Well-developed Sukuk markets would help enhance access to financial services, deepen capital markets and create alternative investment instruments for Islamic populations.

More than 80% people of the country are practicing Muslims. They want to follow Islamic shariah is all aspects of life but only some commercial banks are providing banking products for their financial needs. Rest financial needs could not be fulfilled by the banks. SUKUK (Islamic Bond) can be a product which may fulfill other needs. In the process of industrialization of supply is very important. Obtaining capital from Bank (now the main sources) is costly and sometimes cumbersome. Sometimes, Banks are not willing to supply capital. The present capital market is not helpful to supply the required capital. The market also lost the confidence of investors. It is said that some time primary offering is being made without backing required assets. Sukuk may the alternative products for supplying capital as it will be real actual assets backed if sufficient regulatory support been given.

Introduction to Bond:

Economists consider financial markets as a primary pillar supporting and stimulating economic growth and also in setting the velocity of growth. The markets help in allocating savings and deciding on the optimal use in the economic circuit. The markets, in addition, provide an avenue for raising capital mainly for the private sector, the government and also public sector units. Every capital market has distinctive characteristics, resulting from history, culture, and legal structure though gradually today they tend to operate on common ground with identical basic features.

The bond market is a connected part of the financial market. A bond is a debt instrument issued for a specific period for the purpose of raising capital by borrowing. A bond is a long-term obligation. Generally, a bond is fixed interest financial instrument issued by Government, Corporate, and other large entities. In other words, a bond is an agreement to repay the principal along with the interest or coupon. There are some bonds which carry a zero coupon or interest but have fixed term. These bonds are called as zero coupon bond or deep discount bond bonds. These bonds are sold at a price which will be far below the face value of the bond depending on the risk characteristics and prevailing interest rates in the market.

Bonds are tradable and basically ,the price of a bond depends on the existing interest rates in the market for a equally risky instrument and the coupon on the bond. A bond market has the role to facilitate the flow of long-term funds from surplus units to deficit units. Thus bond acts as a loan where the buyer or holder of the bond is the lender or creditor, the issuer is the borrower or debtor and the coupon is the interest. A simple way to classify bonds is based on the different kind of the issuers. The three main issuers are government, governmental agencies, and corporations.


Sukuk is a plural of Sakk Which means “legal documents, deed, check”. It is an Arabic name for financial certificate but it can be seen as an Islamic equivalent of the conventional bonds.

AAOIFI defined sukuk as.

‘certijicates of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity’.

Often referred to as an ‘Islamic bond’, Sukuk are asset-backed trust certificates evidencing ownership of an asset or its usufruct (earnings or fruits). However, Sukuk securities comply with Islamic commercial jurisprudence and it is investment principles which prohibit the charging or paying of interest.

Based on the above-mentioned definition, sukuk can be further defined as a commercial paper that provides an investor with ownership in an underlying asset. It is asset-backed trust certificates evidencing ownership of an asset or its usufruct (earnings or fruits). It has a stable income and complies with the principle of Shariah. Unlike conventional bonds, sukuk need to have an underlying tañgible asset transaction either in ownership or in a  master lease agreement.

Various Categories of SUKUK

Sukuk al mudaraba (Sukuk based on equity partnership)

In simple mudaraba contracts, investors are considered to be silent partners (rab al mal), and the party who utilizes the funds is the working partner (mudarib). The profit from the investment activity is shared between both parties based on an initial agreement.

The same type of contract applies to sukuk. In a mudaiaba sukuk, the sukuk holders are the silent partners, who don’t participate in the management of the underlying asset, business, or project. The working partner is the sukuk obligator.

The Sukuk obligator, as the working partner, is generally entitled to a fee and/or share of the profit, which is spelled Out in the initial contract with investors.

Steps to issue Sukuk al Mudarabah (Sukuk based on equity partnership):

Sukuk al murabaha (Cost plus or deferred payment sukuk)

A murabaha contract is an agreement between a buyer and seller for the delivery of an asset; the price includes the cost of the asset plus an agreed-upon profit margin for the seller. The buyer can pay the price on the spot or establish deferred payment terms (paying either in installments or in one future lump sum payment).

With sukuk that are based on the murabaha contract, the SPV can use the investors’ capital to purchase an asset and sell it to the obligator on a cost-plus-profit-margin basis. The obligator (the buyer) makes deferred payments to the investors (the sellers). This setup is a fixed-income type of sukuk, and the SPV facilitates the transaction between the sukuk holders and the obligator.

The murabaha contract process begins with the obligator (who needs an asset but can’t pay for it right now) signing an agreement with the SPy to purchase the asset on a deferred-payment schedule. This agreement describes the cost-plus margin and deferred payments.

Steps to issue Sukuk al Murabaha (cost plus or deferred payment of sukuk):

Sukuk al-salam (Deferred delivery purchase sukuk):

In a salam contract, an asset is delivered to a buyer on a future date in exchange for full advance spot payment to the seller. Sharia allows only salam and istisna contracts to be used to support advanced payment for a good to be delivered in the future. This same mechanism is used for structuring the salam sukuk.

In salam sukuk, the sukuk holders’ (investors’) funds are used to purchase assets from an
obligator in the future. The SPV provides the money to the obligator. This contract requires an
agent (which may be a separate underwriter) who will sell the future assets because the investors
want money in return for their investment — not the assets themselves.

The proceeds from the sale (typically the cost of the assets plus a profit) are returned to the sukuk
holders. Salam sukuk are used to support a company’s short-term liquidity requirements.


Sukuk al-salam (deferred delivery purchase sukuk):

The ijara contract is essentially a rental or lease contract: It establishes the right to use an asset
for a fee. The basic idea of ijara sukuk is that the sukuk holders (investors) are the owners of the
asset and are entitled to receive a return when that asset is leased.

In this scenario, the SPV receives the sukuk proceeds from the investors; in return, each investor
gets a portion of ownership in the asset to be leased. The SPy buys the title of the asset from the
same company that is going to lease the asset. In turn, the company pays a rental fee to the SPy.
The ijara contract process begins when a company that needs an asset but can’t afford to purchase
it outright contracts with an SPV, which agrees to purchase the asset and rent it to the company
for a fixed period of time.

Sukuk al musharaka (Joint venture Suku)

The musharaka contract supports a joint venture business activity in which all partners contribute
capital, labor, and expertise. The profit and losses are shared among all parties based on agreed-
upon ratios.

With musharaka sukuk, the sukuk holders (investors) are the owners of the joint venture, asset, or
business activity and therefore have the right to share its profits. In a musharaka sukuk, unlike
sukuk based on mudaraba, a committee of investor representatives participates in the decision-
making process. Musharaka sukuk can be traded in the secondary market.

The musharaka sukuk process begins when an obligator signs a musharaka contract with the SPV
that specifies a profit-sharing ratio and indicates that the obligator will transfer assets (such as
cash and property) to the joint venture.


Sukuk al Istisna (Islamic project bond)

istisna is a contract between a buyer and a manufacturer in which the manufacturer agrees to
complete a construction project by a future date. The contract requires a fixed price and product
specifications that both parties agree to. If the end product doesn’t meet contract specifications
the buyer can withdraw from the Contract.

Istisna sukuk are based on this type of contract. The sukuk holders are the buyers of the project,
and the obligator is the manufacturer. The obligator agrees tõ manufacture the project in the
future and deliver it to the buyer, who (based on a separate ijara Contract) will lease the asset to
another party for regular payments.

The process of issuing istisna sukuk begins when the obligator (manufacturer or contractor) and
the SPy sign an istisna contract.

Steps taken to issue Sukuk al Istisna (Islamic Project Bond):


Sukuk Structuring Considerations: 

There are many issues that arise in relation to Sukuk structures and transactions. We set out bek –
some of these issues:

Transfer of Title

Depending on the relevant jurisdiction, the nature of the title to assets held or to be transferred
and the Shari ‘a structure used, it may be necessary to consider local law issues pertaining to the
transferability of title to the assets underlying a Sukuk. These may include any formalities (such as
registration and the payment of any associated fees or taxes) necessary for the transfer of title to
be effective.

Nature of the Assets

The relevant assets intended to underpin the Sukuk structure must be used by the obligor for
Shari’a-compliant purposes. Activities or businesses relating to alcohol, pork-related products,
conventional finance, gambling etc. are prohibited.

The relevant assets must be unencumbered as at the issue date of the relevant Sukuk. Their market
value on the issue date must equal or exceed the principal amount of the Sukuk being issued. The
valuation methodology and the timing thereof must, therefore, be carefully considered.

Although Sukuk can be structured as secured instruments, the vast majority of Sukuk are structured so as to be “asset-based” rather than “asset-backed” investments. This means that Certificateholders do not typically have recourse to the assets which underpin the Sukuk structure. Rather, investors only have an unsecured claim against the obligor for the repurchase price of such assets, which are required to be sold back to the obligor by the SPV issuer on maturity, an event of default or any early redemption.

Tax and Zakat

The acquisition or purchase of assets, or other transactions under Shari ‘a-compliant structures
used to generate profit for Sukukholders, could potentially create exposure to capital gains, value
added or income taxes. The ownership of an asset may also be taxable or create tax residency

Governing law

There are differences amongst Scholars relating to the interpretation of various Islamic principles. As such the market practice is that documents be governed by the law of a particular jurisdiction rather than by Shari‘a law.

Tradability of Sukuk

Due to the impact of Bay’ Al-Dayn, in order to enable traceability of Sukuk in the secondary market in accordance with Shari ‘a principles, the Sukuk must represent an interest in physical assets rather than simply representing debts or obligations.


What is Islamic Bond Sukuk? 

Challenges of Shariah-based products exploration in countries like Bangladesh are:

  1. Sound monetary and fiscal policy;
  2. Stable and credible government;
  3. Safe, sound, and smooth settlement procedure;
  4. Efficient tax, legal and regulatory procedure; and
  5. A liberalized financial system with rational intermediaries;
  6. An appropriate reference rate;
  7.  Strong secondary markets in Bangladesh;
  8. Overall awareness etc. to make shariah-based products a success;

Govt. should take initiatives to form regulation for strong capital/bonds (Sukuk) market and all-out effort should be taken by the regulatory authority like SEC. DSE/CSE, Bangladesh Bank so that the challenges should be overcome to explore a strong bond/Sukuk market.

In recent years, the Islamic finance industry has grown rapidly. at more than 15% per annum. Despite its remarkable growth, Islamic finance is still largely concentrated in the Banking Business. In many countries with a significant Islamic finance industry, markets for Islamic bonds (Sukuk) are still relatively small and underdeveloped. Well-developed Sukuk markets would help enhance access to financial services, deepen capital markets and create alternative investment instruments for Islamic populations.

More than 80% people of the country is practicing Muslims. They want to follow Islamic shariah is all aspects of life but only some commercial banks are providing banking products for their financial needs. Rest financial needs could not be fulfilled by the banks. SUKUK (Islamic Bond) can be a product which may fulfill other needs.

Now the people who don’t want to invest in non-Islamic products, investing their money to land and buildings (real asset) as it is not involved with non-shariah items, resultantly the price of land of the country is rising continuously. Sometimes it becomes impossible to middle-income people to purchase a piece of land for their home building. If shariah based financial products can be given in the capital/bond market, the people can invest their fund to that products.

Bangladesh is now in the process of industrialization. Commercial Banks are now the only sources to provide project (term) loan to establish the industrial unit in addition to fulfill working capital need. Industrialists are now depended on banks for their long-term loan to establish industrial unit as their have no effectively regulated capital-bond market in the country to supply them required capital. Sometimes it is cumbersome to lift capital from the present capital market. Sukuk may be the alternative source of finance for industrialization of the country. Savers may be eager to finance as they will get ownership of underlying assets under sukuk finance. LegaL
support is required in this respect.

In the industrialization process, the infrastructure barrier is the main barrier in Bangladesh. The infrastructure
project is a long lifetime & capital intensive project. Banks may not allow such types of facility (huge funds involvement), long term project with extensive gestation period and shortage of legal support. Sometimes financial engineering may not be supportive for bank finance. To fulfill all types of barrier of financing in the infrastructure project, sukuk may be the model financial products. Appointed Special Purpose Vehicles (SPV) may collect funds for the infrastructure projects like Padma Bridge, Elevated Express Way, Underground Railway, Long over bridge etc. from savers through selling Sukuk under the ownership of underlying assets. It may be very favorite investment products for Muslim community like Bangladesh.

Capital market of Bangladesh has lost the confidence of the investors. The market also has some
namely companies which help only in speculation in the market. In this situation, market confidence may be bought by introducing assets based securities like SUKUK. The market regulator should take initiatives to arrange for regulatory framework to introduce SUKUK.

Finally, Bangladesh is a developing country with the process of the inning into middle-income group country. At this moment available capital is very important for the entrepreneur including the new entrepreneur. If people come forward for the establishment of a new industrial unit but they could not establish it, the negative impact will fall to the whole economy. In the process of industrialization of Bangladesh, capital supply is very important. Obtaining capital from Bank (now the main sources) is costly and sometimes cumbersum. Sometime, Banks are not wiUing to supply capital. Present capital market is not helpful to supply the required capital. The market also lost the confidence of investors. It is said that some time primary offering are being made without backing
required assets. Sukuk may the alternative products for supplying capital as it will be real/actual assets backed, if sufficient regulatory support been given.

What is Islamic Bond Sukuk? 

Source: Orthoniti Gobesana, Volume-14, November 2013, Page-199-211

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