Sukuk

Sukuk (singular sakk) are certificates of equal value that represent undivided ownership shares in tangible assets, usufructs, services, or the assets of a particular project or investment activity. Holders receive a return from the income those underlying interests generate, rather than interest on a loan. Sukuk are the main capital-market instrument of Islamic finance and are widely issued by governments, banks and companies in the Gulf, Malaysia, Indonesia, Turkey and elsewhere.

Sukuk are often called "Islamic bonds" because they pay periodic amounts and usually return principal at maturity, much like bonds. The label is convenient but legally misleading: a conventional bond is a debt obligation, whereas a sukuk certificate is meant to be an ownership interest in something that earns income.

Sharia prohibits riba, which rules out paying or receiving interest on money lent, and restricts the sale of debt at anything other than face value. A conventional bond therefore cannot be issued as-is. Sukuk solve this by linking the investor's return to the ownership or use of an asset or to a profit-sharing venture. The AAOIFI standard on investment sukuk sets out definitions and conditions, and each issue is approved by a Sharia supervisory board, which issues a fatwa on its structure.

In a typical structure, the originator sells or leases assets to a special purpose vehicle (SPV), which issues sukuk certificates to investors and uses the proceeds to pay for the assets. The SPV holds the assets on trust for the investors and passes on the income, such as rent, as periodic distributions. At maturity, the originator buys the assets back, commonly under a purchase undertaking, at a price that returns the investors' capital. Any asset that generates permissible income can in principle serve, from office buildings and toll roads to land and timberland, although sovereign issuers most often use public buildings or land.

Example

A government wants to raise $1 billion for five years. It sells a portfolio of public buildings to an SPV for $1 billion and leases them back. The SPV issues $1 billion of sukuk. The government pays annual rent of $50 million, which the SPV passes to investors as a 5% distribution. At the end of year five, the government repurchases the buildings for $1 billion, which is paid to the investors.

• Sukuk al-ijarah: based on a lease (ijarah), the most common structure for sovereign issuers.
• Sukuk al-mudarabah: investors provide capital and the originator manages it under a mudarabah profit-sharing contract.
• Sukuk al-musharakah: a joint venture (musharakah) in which investors and originator share profits and losses.
• Sukuk al-wakalah: the originator acts as agent (wakalah) to invest in a pool of assets.
• Sukuk al-murabaha, salam and istisna': based on cost-plus sale (murabaha), forward sale (salam) or manufacturing contracts (istisna'). Because these represent receivables, they generally cannot be traded except at par.

An asset-backed sukuk involves a true sale, so investors have recourse to the assets if the originator defaults. Most sukuk issued are instead asset-based: legal title may not pass, and investors rely on the originator's credit through the purchase undertaking, making the economics close to unsecured debt. Rating agencies typically rate asset-based sukuk on the originator's credit.

In 2007, Sheikh Muhammad Taqi Usmani, then chairman of the AAOIFI Sharia board, stated that most sukuk in issue did not comply with Sharia, mainly because purchase undertakings at face value guaranteed the capital in profit-sharing structures. AAOIFI issued guidance in 2008, and the market shifted toward ijarah and wakalah structures. Critics continue to argue that many sukuk replicate conventional debt in form while differing only in documentation, which creates Sharia non-compliance risk. In 2017, Dana Gas argued that its own sukuk had become unlawful under UAE law, a dispute that raised questions about enforceability and the interaction between Sharia, local law and English law. Standard-setters such as the IFSB address the treatment of sukuk in Islamic banks' capital and liquidity.