COMMENT

March 2006
NewHorizon
The emergence and growth of Sukuk (Islamic Bonds) instruments have revolutionised the Shariah compliant debt securities sector. It not only provided impetus to Islamic Financial Industry but also provided grounds for the development of secondary markets for these instruments, which in the long-term will match with the well-established conventional debt markets.

The aggregate value of issues made in 2005 exceeds four billion US$ in different jurisdictions and these are just a fraction of total demand. Looking at past trend, current market conditions and future prospects of growth in Muslims countries, it is likely that the number of Sukuk issues in the next decade will exceed the figure of $12 billion and its growth will continue at same pace.

Sakh is the singular and Sukuk is the plural and it refers to the asset-based obligations. Sukuk had been used by the Muslim societies of the Middle Ages as forms of papers representing financial obligations originating from trade and other commercial activities. Recently, the concept for its origination started with the conventional concept of securitisation or asset monetisation.
Increasingly, creative and practical applications for Sukuk are being developed, which demonstrate that Islamic assets may be monetised in a Shariah-compliant manner that is compatible from a risk and asset management perspective with the traditional roles of fixed income securities. This recent introduction to the Islamic Finance industry is a genuine contribution and resonates well with conventional capital markets tools. In the Muslim world and increasingly in the West, significant segments of the institutional and retail markets are actively considering the new alternative for their financing and investment needs.

Looking at the rapid growth of Sukuk instruments, Accounting and Auditing Organisation of Islamic Financial Institutions (AAOIFI) issued Shariah standard entitled “Investment Sukuk” in May 2003, which became effective from 1st January 2004. It states that Sukuk represents a common share in the ownership of the assets made available for investment, whether these are non-monetary assets, usufructs, services or a mixture of all these plus intangible rights, debts and monetary assets. The wide application parameters of the product can be seen from the fact that Sukuk may be issued both on existing as well as specific assets that may become available at a future date.

Though, Sukuk are debt securities but these are fully Shariah Compliant and the following are prime features of such securities: complete transparency with regard to all information relating to offering and to the underlying assets, representing actual and legal ownership stakes in specified tangible assets and services, issued and traded on the basis of Shariah nominated investment contracts and in accordance with the specific Shariah rules that may govern such contracts.

The creation of Sukuk has introduced an instrument that is expected to meet all of the economic objectives of conventional fixed-income securities without breaching the fundamental principles of the Shariah. It possesses qualities of Shariah compliance, marketability, asset-backed, versatility and Zakat advantages. The Sukuk market potential is far from being realised and as a matter of fact the total value of Sukuk issues so far represents only a fraction of the market demand.

Some of the major shortcomings cited for the industry at the moment include the fact that Sukuks are mostly held to maturity by the fellow big players and are also not short-dated. There are still problems of standardisation in contracts across different jurisdictions and also the lack of a central settlement system creating liquidity problem. However, these problems are being overcome gradually as the volume of issues increases with more players coming in and creating demand for secondary markets. Already regulators like Bahrain Monetary Agency are playing an active role in the development and implementation of regulations for these securities. This will provide momentum to the expansion of this sector and build investor confidence in these securities. No doubt the debut of Sukuk as tradable securities backed by tangible assets and services should naturally succeed because of their ability to also offer invaluable protection against the dangerous debt cycles frequently seen in conventional finance.

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