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What is sukuk?

What is sukuk?

With continued growth in demand for Islamic assets by both Islamic and conventional investors, sukuk provides an alternative means for African countries to raise funds to finance infrastructure. Mushtak Parker explains how these Islamic bonds are structured

Sukuk is a financial instrument, commonly referred to as the Islamic equivalent of a conventional bond. The issuer releases sukuk certificates (investment trust certificates), which it sells to investors thus granting them a share of a tangible asset or its usufruct (use) relating to particular projects or special investment activity, along with the commensurate cash flows and risk.

Because of the Shariah (Islamic law) proscription on interest and trading in debt, Sukuk must link the returns and cash flows of the financing to the assets purchased, or the returns generated from an asset purchased.

In the case of conventional bonds, which merely confer ownership of a debt, the issuer has a contractual obligation to pay to bond holders, on certain specified dates, interest and principal.

In contrast, under a sukuk structure, the sukuk holders each have an undivided beneficial ownership in the underlying assets. Consequently, sukuk holders are entitled to a share in the revenues generated by the sukuk assets. The sale of sukuk relates to the sale of a proportionate share in the assets. The issuer also makes a contractual promise to buy back the sukuk certificates at a future date at par value.

The Bahrain-based multilateral Islamic accounting standards organisation, AAOIFI, defines sukuk as “certificates of equal value representing after closing subscription, receipt of the value of the certificates and putting it to use as planned, common title to shares and rights in tangible assets, usufructs and services, or equity of a given project or equity of a special investment activity”.

There are several different types of sukuk. The most common one is the sukuk al-Ijarah (leasing sukuk) where the issuer who is in need of financing will sell his assets to investors for the financing amount. The same asset is then leased back to the issuer for a lease rental. The periodic lease rental will constitute the periodic distribution to the investors. The issuer will then issue the sukuk al-Ijarah securities to the investors who are also the lessors.

The sukuk market in particular has grown on the back of high levels of surplus savings in Asia and the Gulf Cooperation Council (GCC) countries, leading to investors seeking out Shariah-compliant products. This is also buoyed by growing wealth within the Islamic world, further enhanced by greater understanding of sukuk instruments and clarity of documentation, as well as credit ratings from international agencies.

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Written by Mushtak Parker

Mushtak Parker is Editor of Islamic Banker Magazine, one of the foremost journals in the industry with a global circulation in the major Islamic Financial institutions. He also contribute articles to one of the leading magazine on Africa's current affairs, New African.

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