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 offshore 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 SPV can be created in an offshore jurisdiction that allows trusts. This is sometimes not possible. If an SPV 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. Islamic Banking

    Islamic Banking is a banking system that is based on the principles ...
  2. Islamic Financial Services Board ...

    The Islamic Financial Services Board sets global standards and ...
  3. Currency Certificate

    A currency certificate grants the right to change a sum of one ...
  4. Periodic Payment Plan Certificate

    A certificate representing ownership interest in a periodic payment ...
  5. Murabaha

    An Islamic financing structure, where an intermediary buys a ...
  6. Certificated Stock

    The stock of a commodity that has been inspected by qualified ...
Related Articles
  1. Insights

    What Is a Silver Certificate Dollar Bill Worth Today?

    Although a silver-certificate dollar bill no longer can be exchanged for silver, the date, grade and unique features make certain certificates very valuable.
  2. Trading

    An Introduction to Structured Products

    Use structured products to bring the benefits of derivatives into your traditional investment portfolio.
  3. Investing

    Six biggest bond risks

    Bonds can be a great tool to generate income, but investors need to be aware of the pitfalls and risks of holding corporate and/or government securities.
  4. Tech

    Wahed Invest: A Look at the New Islamic Robo-Advisor

    For religious Muslims governed by Sharia, Wahed Invest Inc. is likely a welcome platform in the robo-advisor environment.
  5. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  6. Retirement

    How To Set Up A Trust Fund In Australia

    No, they're not just for the super-rich. But you need to know the rules.
  7. Investing

    Why Bond Prices Fall When Interest Rates Rise

    Never invest in something you don’t understand. Bonds are no exception.
  8. Investing

    A Guide to Faith-Based Investing

    If you've wondered how to invest in a way that reflects your faith, we've got the answers for you.
  9. Investing

    How Interest Rates Impact Bond Values

    The relationship between interest rates and bond prices can seem complicated. Here's how it works.
RELATED FAQS
  1. What is the most typical holding in an SPV?

    Learn why property-based investments are the most common kind of holding within a Special Purpose Vehicle, or SPV, and how ... Read Answer >>
  2. I lost my share certificate. Do I still own the stock?

    Regardless of whether a shareholder loses his or her stock certificate, that person still owns the shares. However, in order ... Read Answer >>
Hot Definitions
  1. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  2. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  3. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  4. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  5. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  6. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
Trading Center