Ijara Sukuk

Ijara sukuk, also written sukuk al-ijarah, are sukuk built on a lease. Investors buy certificates that represent undivided ownership shares in an asset, such as public buildings, land or aircraft, which is leased to the company or government that raised the money. The rent the lessee pays becomes the investors' periodic return, and at maturity the asset is sold back so that their capital is returned. Ijara sukuk are the most widely used structure for sovereign sukuk.

The name comes from ijarah, the Islamic contract of lease, but the two are not the same thing. Ijarah is a single contract under which a lessor grants a lessee the usufruct, or right of use, of an asset. An ijara sukuk is a capital-market instrument that wraps an ijarah lease inside a vehicle owned on behalf of many investors, adds a sale at the start and a repurchase promise at the end, and turns the arrangement into tradable certificates.

Imagine a group of neighbours pooling their savings to buy a building, which they then rent to the local council. Each neighbour owns a slice of the building and receives a slice of the monthly rent. When the agreed period ends, the council buys the building back at a price set at the start, and everyone gets their savings returned.

An ijara sukuk works the same way, only on a much larger scale and with certificates instead of handshakes. The investors' return is rent for something real that is being used, not interest on money lent, which is why the arrangement is acceptable under Islamic rules against riba. Because each certificate stands for a share of a real asset, investors can sell it to someone else before the end of the term.

Most issues follow a sale-and-leaseback pattern:

1. The originator sells identified assets to a special purpose vehicle (SPV), which issues the sukuk and pays the purchase price from the proceeds.
2. The SPV, holding the assets on trust for investors, leases them back to the originator for the life of the sukuk.
3. The originator pays rent, usually every six months, and the SPV passes it to investors as periodic distributions.
4. At maturity, or on default, the originator buys the assets back under a purchase undertaking, a one-sided promise or wa'd, at a price equal to the face value of the certificates.

Ownership duties are allocated separately. The lessor is responsible for major maintenance and insurance, usually arranged through takaful, but these tasks are typically delegated back to the originator under a service agency agreement. Rent may be fixed, or reset each period by reference to a benchmark such as SOFR; most Islamic scholars accept the benchmark as a way of measuring rent, not as interest.

Each certificate receives its share of the rent paid in a period:

• $D$ is the distribution paid on one certificate each period.
• $F$ is the face value of one certificate and $S$ is the total size of the issue.
• $A$ is the annual rent paid by the lessee.
• $m$ is the number of rental payments a year.

Suppose a government issues $1 billion of ijara sukuk in $1,000 certificates, with annual rent of $45 million paid in two instalments. Each payment on one certificate is $D = \frac{1{,}000}{1{,}000{,}000{,}000} \times \frac{45{,}000{,}000}{2} = 22.50$ dollars. Over a year the holder receives $45 per $1,000 certificate, a 4.5% rental return.

Ijara sukuk have several features that suit issuers and investors:

• Tradability. Because the certificates represent ownership of a tangible asset rather than a debt, they can be bought and sold at market prices in the secondary market. Sukuk based on murabaha receivables, by contrast, are generally treated as debt that may be traded only at face value.
• Predictable income. Rent can be fixed in advance, giving a return profile similar to a conventional bond.
• Accepted repurchase at face value. In its February 2008 guidance on sukuk, the Sharia board of AAOIFI objected to face-value repurchase promises in partnership sukuk, but the lessee in an ijara sukuk is not a partner or manager of the investors, so a promise to buy the asset at an agreed price remains widely accepted.

The structure has a long sovereign record. Malaysia's US$600 million global sukuk of 2002, backed by government properties, is widely described as the first global sovereign sukuk and used an ijara structure. In June 2014 the United Kingdom became the first country outside the Muslim world to issue a sovereign sukuk, a five-year £200 million ijara issue based on central government office buildings.

Most ijara sukuk are asset-based sukuk: investors hold beneficial ownership of the asset but in practice rely on the originator's promise to pay rent and buy the asset back. If the originator defaults, investors usually rank as unsecured creditors rather than taking the building. Critics argue this makes many issues economically close to bonds, and that assets are sometimes chosen for their availability rather than their value. Other risks include total loss of the asset, which ends the lease, and Sharia non-compliance risk if a court or scholar later questions the structure. Issues that use a full legal transfer, known as asset-backed sukuk, are rarer.

• Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)
• GOV.UK: Government issues first Islamic bond
• Faisal Khan: Sukuk Explained