Sukuk – an Islamic Perspective to Finance
Islam is a religion that teaches man to excel in all dimensions of life. It teaches man how to deal with any situation in such a way that he could secure divine satisfaction. One important aspect of life is his financial dealings. Islam has not been silent in this aspect, rather many principles have been provided allowing one to derive financial recommendations and prohibitions from them.
There are plenty of rules pertaining to trade, partnership, banking, investment, and loans. There are also areas of financial transactions which are prohibited, for instance interest (riba) and anything to do with particular sinful products, such as wine and alcohol. The main areas which constitute a prohibited and invalid financial transaction from the Islamic point of view are: speculation (maysir), unjust enrichment or unfair exploitation, interest, and uncertainty (gharrar).
A sukuk is an Islamic financial investment scheme and some forms of it have been approved by the shari’ah. The official definition provided by the Auditing Organization for Islamic Financial Institutions (AAOIFI) is that sukuk certificates are: “certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity.” The sukuk is an actual certificate which proves the ownership of interest in the tangible asset giving the possessor interest in that asset in proportion to its investment.
The sukuk product was developed because of a lack of Islamic financial schemes which serve as a long term investment and which can be traded on the secondary market. There were reasons that such schemes were rare, such as practicality and shari’ah components. The practical aspect was that there was not an existing secondary market where one could barter his investments. The sukuk solved this problem because it constitutes real ownership of a tangible asset and therefore the investor can easily trade it. The sukuk product has grown immensely ever since the first sovereign sukuk bond was issued by the Central Bank of Bahrain in 2001. The ACCA estimates that “by the end of 2012 Islamic financial assets will have exceeded $1,600bn, which is around 1–2% of global financial assets worldwide.”
The important characteristics of the sukuk product, which are in direct contrast to its conventional cousin, the interest bond, are: First, the sukuk certificate points to a form of joint ownership of the profits of the business project or physical assets. This is why they must be organized in connection to a familiar Islamic partnership contract. The contracts can have conditions placed upon them according to the generality of the popular prophetic tradition: “Believers are upon their conditions.”
The second characteristic of Islamic sukuks revolves around the method of distributing profits. The method that they are distributed is relative to the type of contract that was issued. There are three main categories of sukuk in regards to the distribution of profits.
The first group is based on the purchase and sale of the loan. This group is comprised of the sukuk al-istisna’ and sukuk al-murabaha and is the closest to the conventional interest bond. In this sukuk, the owner receives specified profits over a specified amount of time. There are differences of opinions regarding the religious permission of these sukuk. The majority of Shia scholars allow the sale of loans to third parties while the majority of Sunni scholars and a minority of Shia scholars, including Ayatollah Khumayni, considers it to be an instance of interest.
The second group is based on the purchase and sale of physical assets. The most prominent sukuk in this category is the sukuk al-ijara, especially with the condition of ownership after the lease agreement is finalized. When the owner of the sukuk certificate sells it to a third party in the secondary market what he is actually doing is selling his portion of the physical asset to the future owner. Islamic scholars are unanimous in condoning this type of contract.
The third group is based on a partnership in profits of an economic plan. In this sukuk, the owner of the sukuk certificate becomes an investment partner for an economic project. He is given a portion of the profits of said project in relation to the amount of his certificate. For instance, one purchases a sukuk for the building of a metro line. The more progress that is made on the project the more valuable the sukuk certificates become and when the project finishes the value of the completed project is distributed amongst the owners of the sukuk certificates. Thus, the potential profits of these sukuk certificates are based on predictions that do not always actualize. Hence, there is a risk of loss.
The third main characteristic of the Islamic sukuk is based on securing the principle investment. The difficulty in promising the return of the principle investment from an Islamic perspective is that it takes risk out of the equation. This would seem to be in contradiction to the tradition: “The one who gains [potential] profit [can] incur [potential] loss.” According to this tradition, and the principles of Islamic finance, the investor must have a certain amount of risk in his investment. Hence, if the issuer of the sukuk goes into bankruptcy then he would not be able to return the principle investment of the owners of the sukuk contracts.
Therefore, if the issuer of the sukuk does not promise a return of the principle investment then it is completely in congruence with the Islamic jurisprudential system. The question remains, what if the return of the principle investment is promised in the form of a condition of the sukuk contract? The answer to this question depends on the which of the three above mentioned categories the sukuk falls under:
Promising the return of the principle investment in sukuk products which are based on the purchase and sale of a loan
Ayatollah Taskhiri, a teacher of the Islamic seminary, states: “In this group, the financial institution which offers the sukuk al-murabaha, takes on the position of the representative of the owners of the sukuk certificates and uses their investments to purchase an asset outright and then sell that asset in the form of a long term sale on credit (bay al-nasiyah). Then, the purchaser of the asset will pay the amount of the principle investment coupled with the specified profit to the representative of the investors.”
When this sukuk is sold in the secondary market the principle investment and specified profits transfer ownership as well. In this case, if one accepts the purchase and sale of loans in the secondary market the security of the principle investment and specified profits will become an essential part of the sale on credit. But, if one does not accept this sale, as some prominent Shia scholars and the majority of Sunni scholars do not, then selling the sukuk contracts on the secondary market would be problematic.
B. Promising the return of the principle investment in sukuk products which are based on the purchase and sale of physical assets.
Ayatollah Taskhkiri describes this group in the following manner: “The financial institution of this group, representing the owners of the sukuk certificates, purchase and then lease a physical asset. They continuously collect lease payments and issue them to the owners of the sukuk certificates. At the end of the rental period they either transfer ownership of the leased property to the renter (if the contract was a lease with the condition of ownership) or it is returned and sold in the market (if the contract was a normal lease agreement). Hence, there are three dangers that prevent securing the principle investment in this group of sukuk.”
The three dangers are: current expenses, unexpected costs, and a decline in the value of the current asset. These dangers are mitigated in a number of methods. The current expenses are mitigated by placing them as a condition in the lease contract stipulating that the renter must pay them. This would be jurisprudentially sound according to the Islamic legal code. But, according to the popular opinion amongst Islamic scholars, the second danger, unexpected costs, cannot be placed in the responsibility of the renter, unless the renter was reckless with the property. An example of an unexpected cost would be if the asset was an airplane which crashed. One possible method of mitigating this danger would be insuring the asset with a portion of the funds accumulated from rental payments. The decline in value of the asset is mitigated by the condition of ownership after the lease period finishes for free or for a specified price. This condition does not change with the fluctuation of the value of the asset.
C. Promising the return of the principle investment in sukuk products which are based on a partnership.
Ayatollah Tashkiri states that: “The financial institution which issues the sukuk certificates collects the investments of the owners of the certificates and then represents them in the construction of industrial, agricultural, or commercial projects in a partnership, mazara’ah, masaqat, or mudaraba contract with other economists.”
The popular Islamic opinion is that one partner cannot stipulate a promise of securing the principle investment of the other partner as a condition of the partnership contract. But, a number of contemporary scholars have mitigated this danger of loss by permitting the condition of compensation for possible loss by one of the parties in the contract. This means that the contractor will compensate for any loss to the investment of the investor from his own money.
by: Shaykh Hamid Waqar
originally published: Islam Today Magazine