What is Sukuk?

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What is Sukuk?

What is Sukuk?

Overview:

Meaning

Definition

Advantage of Sukuk over Conventional bonds

Categories

The distinction between Sukuk and Conventional bonds

Meaning

The word ‘Sukuk’ is the plural of an Arabic word ‘Sakk’, which means ‘certificate’.  Sukuk is a financial certificate which reflects participation rights in an underlying asset. Sukuk is the same as the conventional bond but the difference is that Sukuk is sharia-compliant. The conventional bond is prohibited as there is an element of interest.

In the Sukuk transaction, the issuer sells the financial certificate to the investor group or Sukuk holder and uses the sale proceeds for investment in order to generate profit.  The investor group gets partial ownership in the asset and receives a margin of that profit based on a pre-agreed ratio.  The issuer needs to make a contractual promise to buy back the bond at a future date at par value. On the maturity date,  the Sukuk holder will get back the principal amount of investment.

Definition

AAOIFI defines Sukuk as the “certificates of equal value representing an undivided share in the ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity. However, this is true after receipt of the value of the Sukuk, the closing of subscription and the employment of funds received for the purpose for which the Sukuk were issued.’’

categories of Sukuk

The Sukuk have been categorized into two broad categories as follows:

  1. Asset-based Sukuk
  2. Debt-based Sukuk

Asset-based Sukuk: In this type of Sukuk, the underlying asset remains with the issuer throughout the maturity period. Example of this type of Sukuk includes-Sukuk al-Musharakah, Sukuk al-Mudarabah, Sukuk al-Ijarah, Sukuk al-Wakalah etc.

Debt-based Sukuk: In this type of Sukuk, the underlying asset does not remain with the issuer throughout the maturity period. Example of this type of Sukuk includes Sukuk al-Murabahah, Sukuk al-Istisna and Sukuk-al-Salam etc.

Advantage of Sukuk over Conventional bond

  1. In Sukuk, when the value of asset increases then the value of the ownership of that asset, backed by the Sukuk also increases. This feature doesn’t exist in Conventional Bonds.
  2. Sukuk holders are rewarded with a share of the profits which is derived from the asset. They don’t get fixed interest as it is prohibited in Shariah.

    The distinction between Sukuk from Conventional Bonds

    Basis of Distinction Conventional bonds Sukuk
    Ownership of Asset In conventional Bonds, the investors don’t receive a share of ownership in any asset, project, business, or joint venture. In Sukuk, the investor receives partial ownership in the
    any asset, project, business, or joint venture.
    Investment criteria Conventional bonds are used to finance any asset, project, business, or joint venture that complies with prevailing legislation. This involves a fixed interest which is prohibited in Islam. In the case of Sukuk, the asset on which Sukuk are based must be sharia-compliant.
    Issue unit Each bond represents a share of the debt. Each Sukuk represents a share of the underlying asset.
    Issue price The bond price is based on the issuer’s creditworthiness which includes credit rating. Sukuk price is based on the market value of the underlying asset backing them.

     

    Rewards and risks involved Bondholders get periodic fixed interest payments for the life of the bond. The principal amount is guaranteed to be paid by the issuer at the bond’s maturity date. Sukuk holders get a share of profits from the underlying
    asset.
    Costs effect Bondholders generally are not affected by costs related
    to the asset, project, business, or joint venture.
    Sukuk holders are affected by costs related to the underlying
    asset.