Sukuk

What is a 'Sukuk'

A sukuk is an Islamic financial certificate, similar to a bond in Western finance, that complies with Sharia - Islamic religious law. Since the traditional Western interest-paying bond structure is not permissible, the issuer of a sukuk sells an investor group a certificate, and then uses the proceeds to purchase an asset, of which the investor group has partial ownership. The issuer must also make a contractual promise to buy back the bond at a future date at par value.

BREAKING DOWN 'Sukuk'

Islamic law prohibits what's known as "riba," or interest. Therefore, traditional, Western debt instruments cannot be used as investment vehicles. To circumvent this, sukuks were created in order to link the returns and cash flows of debt financing to a specific asset being purchased, effectively distributing the benefits of that asset. This allows investors to work around the prohibition outlined under Sharia and still receive the benefits of debt financing. However, because of the way that sukuks are structured, financing can only be raised for identifiable assets.

Thus, sukuks represent aggregate and undivided shares of ownership in a tangible asset as it relates to a specific project or a specific investment activity. An investor in a sukuk therefore does not own a debt obligation owed by the bond issuer, but instead owns a piece of the asset that's linked to the investment. This means that sukuk holders, unlike bond holders, receive a portion of the earnings generated by the associated asset.

Two Examples of Sukuks

The most common form of a sukuk is a trust certificate. Surprisingly, these certificates are governed by Western law. However, the structure of this type of sukuk is fairly complicated. The organization raising funds first creates an off-shore special purpose vehicle (SPV). The SPV issues trust certificates to qualified investors and puts the proceeds of the investments toward a funding agreement with the issuing organization. In return, the investors earn a portion of the profits linked to the asset.

Sukuks structured as trust certificates are only applicable if the SVP can be created in an off-shore jurisdiction that allows trusts. This is sometimes not possible. If an SVP and trust certificates can't be created, a sukuk can be structured as an alternative civil-law structure. In this scenario, an asset-leasing company is created in the country of origin, effectively purchasing the asset and leasing it back to the organization in need of financing.

The Origin of Sukuks

Sukuks have become extremely popular since 2000, when the first sukuk was issued by Malaysia. Bahrain followed suit in 2001. Fast forward to current times, and sukuks are used by Islamic corporations and state-run organizations alike, taking up a large share of the global bond market.

RELATED TERMS
  1. Trust Certificate

    A bond or debt investment, usually in a public corporation, that ...
  2. Sharia

    Islamic religious law that governs not only religious rituals, ...
  3. Islamic Banking

    A banking system that is based on the principles of Islamic law ...
  4. Takaful

    A type of Islamic insurance, where members contribute money into ...
  5. Riba

    A concept in Islamic banking that refers to charged interest. ...
  6. Mutual Investment Certificate

    A certificate issued by a local or municipal authority for the ...
Related Articles
  1. Retirement

    Working With Islamic Finance

    There is no division between the spiritual and the secular in this type of socially responsible investing.
  2. Financial Advisor

    Advising FAs: Explaining Bonds to a Client

    Most of us have borrowed money at some point in our lives, and just as people need money, so do companies and governments. Companies need funds to expand into new markets, while governments need ...
  3. ETFs & Mutual Funds

    4 Best Legg Mason Fixed-Income Funds (LM)

    Discover the four best mutual funds administered and managed by Legg Mason and its subsidiaries that specialize in investing in fixed-income securities.
  4. Markets

    7 Questions to Consider Before Investing in Bonds

    There is a significant number of questions every investor, private or institutional, should consider before investing in bonds.
  5. Managing Wealth

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  6. Retirement

    Index-Linked Certificates Of Deposit: Upside Potential, Low Risk

    Index-linked CDs generate returns similar to indexes, without the potential for loss.
  7. Markets

    Common Bond-Buying Mistakes

    Avoid these errors made daily in bond portfolios everywhere.
  8. Managing Wealth

    A Guide to High Yield Corporate Bonds

    The universe of corporate high yield bonds encompasses multiple different types and structures.
  9. Markets

    Why Bad Bonds Get Good Ratings

    Credit ratings are not the only tool to rely on when assessing bonds. Find out why they sometimes fall short.
  10. Financial Advisor

    Structured Notes: What You Need to Know

    Structured notes are complex, high risk and might not be suitable for individual investors. Here's why.
RELATED FAQS
  1. What is an Islamic investment policy?

    Islamic investments are a unique form of socially responsible investments because Islam makes no division between the spiritual ... Read Answer >>
  2. Is this stock certificate worthless?

    I bought 50,000 shares of restricted common stock from a company in December 2015 and received a stock certificate. I then ... Read Answer >>
  3. How do you get a hard copy of a stock certificate?

    Before online brokers and personally-directed accounts, holding a physical stock certificate was a necessity, as this was ... Read Answer >>
  4. How do I transfer all the stock of my company to my brother?

    I started a Shell corporation in 2014 with myself as the sole stockholder. There is no revenue to date... Read Answer >>
  5. Who are the key players in the bond market?

    The bond market can essentially be broken down into three main groups: issuers, underwriters and purchasers. The issuers ... Read Answer >>
  6. I hold stock certificates in a company that just had a stock split. What happens ...

    The short answer is that a stock split will have little effect on the holder of stock certificates. In most cases when an ... Read Answer >>
Trading Center