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. Sharia

    Sharia is an Islamic religious law that governs religious rituals ...
  2. Certificate of Participation - ...

    A certificate of participation (COP) is a type of financing where ...
  3. Scripophily

    Scripophily is the hobby of collecting antique stock certificates ...
  4. Stock Certificate

    A stock certificate is a physical piece of paper representing ...
  5. Accounting and Auditing Organization ...

    The AAOIFI is a non-profit organization established to maintain ...
  6. Secured Bond

    A secured bond is secured by the issuer's pledge of a specific ...
Related Articles
  1. Investing

    Working With Islamic Finance

    Learn about working with Islamic finance, where there is no division between the spiritual and the secular.
  2. Tech

    How Did Stellar Become The Sixth-Largest Crypto?

    Multiple developments helped Stellar gain the sixth spot in the list of cryptocurrencies with the highest market cap
  3. Retirement

    Certifications For Estate Planning

    Learn about considerations when choosing a career in estate planning. Find information about different types of certifications, and how to get them.
  4. Trading

    An Introduction to Structured Products

    Use structured products to bring the benefits of derivatives into your traditional investment portfolio.
  5. 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.
  6. Investing

    A Guide to High Yield Corporate Bonds

    The universe of corporate high yield bonds encompasses multiple different types and structures.
  7. Investing

    Why Companies Issue Bonds

    When companies need to raise money, issuing bonds is one way to do it. A bond functions as a loan between an investor and a corporation.
  8. Investing

    Why Bond Prices Fall When Interest Rates Rise

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

    Basics Of Federal Bond Issues

    Treasuries are considered the safest investments, but they should still be analyzed when issued.
  10. 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.
RELATED FAQS
  1. The Most Typical Holding in an SPV

    Property-based investments are the most common kind of holding within a Special Purpose Vehicle, or SPV, and they help the ... Read Answer >>
  2. What role do SPVs / SPEs play in public-private partnerships?

    Find out why governments and private actors prefer to use special purpose vehicles, or SPVs, when they undertake public-private ... Read Answer >>
  3. After a Stock Split, What Happens to Certificates?

    Find out why a stock split will have little effect on the holders of stock certificates. Learn how shares are held in electronic ... Read Answer >>
  4. 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 >>
Trading Center