Asset-based sukuk are sukuk in which investors hold a beneficial interest in the underlying assets, but legal title, control and the real economic risk of those assets stay largely with the originator. Investors are paid from the originator's rental or profit payments and, at maturity, from its promise to buy the assets back at face value. Their practical recourse is therefore to the originator, also called the obligor, rather than to the assets themselves. Most sukuk issued worldwide, by governments and companies alike, are asset-based.
They are contrasted with asset-backed sukuk, in which the assets are transferred by a legally effective true sale and investors can look to them for recovery if the originator fails. The distinction is not a type of contract: an asset-based or asset-backed issue can be built on ijarah, musharakah, wakalah or other contracts. It describes how far ownership really passes to investors.
Asset-based sukuk in plain terms
Think of two ways of lending a friend money against their car. In one, the friend signs a paper saying you have an interest in the car but keeps it in their name, keeps driving it, and promises to pay you back in full. In the other, the car is actually registered to you until you are repaid, and if the friend disappears you can sell it.
Asset-based sukuk work like the first arrangement. Investors have a recognised interest in a real asset, which keeps the deal on the right side of Islamic rules, but what really gets their money back is the issuer's promise. If the issuer is a strong government, that promise is very reliable. If the issuer runs into trouble, investors usually stand in line with other unsecured creditors rather than taking the asset.
How asset-based sukuk work
A typical issue uses a special purpose vehicle (SPV) that holds the assets on trust for investors:
- Beneficial transfer only. The originator sells the SPV a beneficial interest in identified assets, often without registering the change of title or notifying tenants, and keeps control of them.
- Income from the originator. The originator leases the assets back, as in ijara sukuk, or manages them as agent, and pays amounts calibrated to give investors a set return.
- Repurchase at face value. A purchase undertaking, usually a one-sided wa'd, obliges the originator to buy the assets back at maturity or on default for an exercise price equal to the outstanding face amount plus unpaid distributions.
- Unsecured ranking. The undertaking is a direct, unsecured obligation, so if the originator defaults investors claim against it as general creditors.
Asset-based versus asset-backed
The main differences can be set side by side:
| Feature | Asset-based sukuk | Asset-backed sukuk |
|---|---|---|
| Ownership passed to investors | Beneficial interest only | Full legal transfer by true sale |
| Source of repayment | Originator's purchase undertaking | Performance or sale of the assets |
| Position if originator fails | Unsecured claim on the originator | Recourse to assets outside its estate |
| Credit rating driver | Originator's own credit rating | Quality of the assets and structure |
| Economic resemblance | Conventional unsecured bond | Securitisation |
Because the risk sits with the originator, rating agencies generally rate an asset-based sukuk in line with the obligor's senior unsecured debt, much as they would its bonds.
Why most sukuk are asset-based
Several practical reasons push issuers towards the asset-based model:
- Restrictions on public assets. Many governments cannot legally sell state land or buildings outright, especially to foreign investors, but can grant a beneficial interest for the life of a sukuk.
- Costs of transfer. Registering a full transfer can trigger stamp duties, registration fees or taxes, unless the country has passed rules on tax neutrality for sukuk.
- Investor preference. Many buyers want a predictable, bond-like return and prefer to analyse a sovereign or bank rather than a building.
- Market convention. Bond documentation, ratings and index inclusion are built around obligor credit, which asset-based structures fit easily.
Sharia debate and legal tests
Critics argue that when investors bear no real asset risk, sukuk become debt in Islamic form, close to the forbidden riba. In late 2007 the scholar Muhammad Taqi Usmani, then chairman of the AAOIFI Sharia board, said that around 85% of sukuk did not meet Sharia requirements, mainly because of face-value repurchase promises in partnership-based structures. AAOIFI's February 2008 guidance required sukuk to represent real ownership of assets and barred managers in musharakah and mudarabah sukuk from promising to buy assets back at face value, while allowing an agreed repurchase price in lease-based issues.
The model's reliance on the originator's promise was tested in the Dana Gas sukuk dispute. In 2017 the UAE company argued that its US$700 million mudarabah sukuk had become unlawful and non-compliant, but in November 2017 the English High Court held that its English-law purchase undertaking was valid and enforceable. The case showed that investors in asset-based sukuk depend on contract law and the obligor's solvency, and it highlighted Sharia non-compliance risk as a real legal issue.