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Glossary

Sukuk

Category — Islamic Finance
Sukuk is an Islamic financial certificate, a so-called bond equivalent of the Western financial system.

Islamic bonds became popular in 1990s, when Malaysia issued the first sukuk. Now sukuk is used by both the Islamic corporations and government agencies. Sukuk has become such a popular form of borrowing that it takes a significant share in the global bond market.

Sukuk’s special feature is its conformity to the Islamic religious law (Sharia), where interest-bearing loans and financial speculation are impossible. As a result, Muslims were not able to use standard interest-bearing bonds. Transactions under Sharia law are guided by the principle of sharing profits and risks. It means that each party to the transaction takes its portion of the risks. However, yield may not be guaranteed.
Thus, the sukuk principle is based on the right of a bondholder to share its profit or loss with the issuer. The bond yield is not guaranteed.

Sukuk and standard interest-bearing bonds: similarities
• Cash flows. Both provide investors with payment flows.
• Profit of investors. Sukuk investors gain profits generated by the underlying asset on a recurring basis, while bond investors receive recurring interest payments.
• Low-risk assets. Sukuk and standard bonds are viewed as more reliable financial instruments than, for instance, stocks.

Sukuk and conventional bonds: differences
• Principle. Sukuk involves ownership of assets, while bonds are debt securities.
• Yield. If the sukuk-backing asset increases in price, then the sukuk may increase in price. As for bonds, their yields are highly dependent on the interest rate.
• Law. The sukuk-backing assets are in compliance with the Islamic law, while bonds can be used to finance companies that are not Sharia-compliant.
• Price. Sukuk’s price is based on the value of the sukuk-backing assets, while the price of bonds is mostly determined by their credit rating.

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in its Sharia Standard 17 on Investment Sukuk has classified 14 different types of Sukuk structure, the most widely used structures are:
• Ijara Sukuk
• Mudaraba Sukuk
• Musharaka Sukuk
• Murabaha Sukuk
• Salam Sukuk
• Istisna Sukuk

Advantages:
• Providing Sharia-compliant returns
• Broadening investors’ choice with the access to the Islamic capital markets

Disadvantages:
• Additional costs
• Structuring constraints
• Lack of market depth.
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