Sukuk and Their Importance for the Islamic Capital Market

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Currently, the demand to invest in accordance with Islamic law continues to grow; the trend has been facilitated by viability of attractive investment packages from Islamic financial institutions. The boom has led to formation of Islamic capital markets, especially in Middle East, Malaysia, and Saudi Arabia. Some products traded in Islamic capital markets include sukuk. This notion refers to financial certificates, which are very similar to financial bonds in conventional banking system, but bear no interest in accordance with Sharia norms (IIMF 2009, p. 5).

This paper is aimed at discussing the functioning of sukuk, their advantages, disadvantages, and the risks associated with these financial instruments. It is also necessary to show the applications of Sukuk in Islamic countries and explain their structure. Furthermore, one of the tasks is to analyze the legal aspects of sukuk. This discussion will explain the benefits of these financial instruments, especially in comparison with conventional bonds.

The main peculiarities of Sukuk

The key principles of Sukuk

At this point, it is vital to focus on the main peculiarities of sukuk. On the whole, the term sukuk or Sakk, which is the singular form of the noun, can be defined as the trust certificate which proves the ownership of a certain asset or its earnings (IIMF 2009, p 5). These financial instruments must be directly liked to the returns which the asset generates. These certificates have to comply with the rules of Sharia which prohibits interest rates and fixed income bonds. According to Muhammad Usmani (n. d), Sukuk enable investors to achieve beyond fixed interest rate (p. 2). Thus, from the investor’s point of view, they can be more advantageous. Moreover, these tools allow enterprises to monetize their future cash flows.

Sukuk can be viewed a partial ownership of asset, business, debt, or investment. According to Islamic law, financial dividends ought to be derived from assets, but from money, itself (Saeed 1996, p 122). The aim of sukuk market is to develop original types of assets that comply with Islamic law. The purchasers of sukuk are guaranteed the right to information as to how their investment will be managed (IIMF, 2009).

Legal aspects of Sukuk

If Sukuk can be viewed as a contract, one has to single out its major parties, the issuer of the financial instrument and the holder. While a traditional bond is primarily a debt obligation according to which the issuer or company has to repay the loan, the holders of sukuk are entitled to ownership of the asset and the profits that it brings (Abdulkader, Cox, & Kraty 2005 p. 154). To a great extent, this is an advantage of these financial instruments. In this case, the investors are able exercise more control over companies. Moreover, one should bear in mind that sukuk reflect the market value of an asset (Abdulkader, Cox, & Kraty 2005 p. 154).

It is possible to say that Sharia prohibits asymmetry of knowledge or information availability. In other words, the holder of sukuk has a right to know about the business structure of the firm, their revenues, and liquidity. By acquiring this financial instrument, a person becomes one of the owners of the enterprise. Thus, legal aspect can be considered as another advantage of these financial certificates over conventional bonds. At this point, we need to speak about the benefit and drawbacks of this approach with regard to the Islamic capital markets.

Advantages and disadvantages of Sukuk

First, it should be mentioned that Sukuk increases cash flows to the securitized asset market. It can tap new and diversified source of finance through the capital market and make inactive investors more willing to entrust their money to enterprises or financial institutions (Bahrain Monetary agency, 2002). Sukuk reduce the risk of the cost of funding entrepreneurs. Sukuk can lead to development of capital markets by allowing less capitalized market players who have specialization in securitization and issuance to participate in the capital market (Bahrain Monetary agency, 2002). In other words, this approach can make financial investment more attractive to people and subsequently provide a powerful stimulus to the development of companies that will be able to develop new projects or products. Furthermore

The initial structuring and issuance cost if Ijara Sukuk is quite high and it requires a large size of separable assets, rating, outspoken legal, and investment banking fee as well as a great amount of documentation. Given these limitations only the large, reliable and visible institutions will be able to participate in Ijara Sukuk market (Bahrain monetary agency, 2002). As it has been said in the previous section, Sharia norms imply that the issuers of such certificates provide comprehensive information about themselves. Admittedly these rules are aimed at reducing the risks of sukuk holder but at the same time, they significantly slow down the process of transaction.

Risks associated with Sukuk

One should not forget about the risks which are usually associated with Sukuk. First, these financial certificates are asset-backed which means that the holder’s revenues are strongly dependent on the market performance of assets (IIMF, 2009). The second point that companies should keep in mind is that sukuk value depends on foreign exchange rates. The mismatch between dollar exchange rate and the exchange rate of local currency can result in significant losses for them. Yet, the owners of sukuk are usually shielded from risk by the government as it was the case in Malaysia (Visser & Visser, 2009, p 64). This is another benefit of this approach.

Sukuk structures

The sukuk structures include lease (Ijara), sales (murahaba and Salam structures) and mudabara and musharaka which are joint ventures (Adbulkader Cox, & Bryan, 2005). Advantages of sukuk –Ijara includes; flexibility of sale where by the Ijara contract does not limit the right of leaser to sell the leased asset. There is autonomy of ownership of assets and the partners can sell their assets as they wish. There is flexibility in timing of inflow and outflows whereby it is not necessary for the flow of usufruct benefits coincide with the timing of rent payment. Another advantage is that, there is flexibility in initiation because Islamic law does not always insist that the asset which backs Ijara contract should exist at the time when the contract is signed (Adbulkader Cox, & Bryan, 2005).

The sukuk contract can be of any duration as long as the asset of the subject remains in existent and continue to offer its services. The owner is liable for the maintenance of the asset, while the operation of expenses lie on the shoulders of the lessee. Ijara contract is cordial to securitization in form of a bond because it can be transferred from a leased asset to a financial asset. These are the main structures of Sukuk. At this point it is necessary for us to explain how these certificates are used in different countries.

Applications of Sukuk in Islamic countries

Sukuk in Malaysia

Malaysia is a leading contributor to the growth and spread of Islamic capital markets and their financial instruments. In Malaysia, Islamic financial services play similar roles as Islamic banking systems. This country is considered to be the pioneer in development and spread of Sukuk. It was the first country to introduce the first global supreme Sukuk (Visser & Visser, 2009, p 64). Malaysia has contributed in many ways in promotion of Islamic capital market. Among their major achievements one can single out tax incentives which prompt companies to issue sukuk. These financial incentives made these certificates much more popular among corporate citizens and private investors.

Malaysia also established the first Islamic equity unit trust funds the Arab Malaysian Tabung Ittikal in 1993 (Visser & Visser, 2009, p 64). The main reason why people of this country chose to acquire these securities is because they were backed by the government. For instance, we can mention Global Sukuk Corporations which belonged to the Ministry of Finance. To some degree, the state acted as a guarantor in this situation. The citizens of this country can purchase different types of financial certificates, such as Ijara, Mudaraba, or Istisma sukuks (Visser & Visser, 2009, p 65). There are intended for both private and corporate investors..

Sukuk in Saudi Arabia

Another country where these financial instruments are quite widespread is Saudi Arabia. It should be noted that this state has always a very strong Islamic banking industry; however, they introduced Sukuk in 2006 with the establishment of SABIC Sukuk. This change enabled people to invest in local and foreign financial instruments that had passed vetting test by Shariah Supervisory Committee of a Saudi Arabian Bank (SABB Amanah).

Prior making these financial instruments available the issuers and banks had to convince the Shariah Supervisory Committee of a Saudi Arabian Bank (SABB Amanah) that the facility was compliant with Islamic banking system thus was necessary for the economy. There are concerns relating contemporary SABIC Sukuk in relation to regularity in payment of assets. Some are paid more than they were sold or fewer returns to pay fixed amount on SABIC Sukuk. This may be as a result of the issuer offering the asset at the original price sold into the SABIC Sukuk structure. SABIC Sukuk markets have been growing rapidly among Islamic financial market.

Tradability of sukuk instruments is significant as the Islamic financial industry attempts to develop sound, sustainable finance-side capital markets. Issuance of sukuk has been structured to include a variety of different types of debt instruments (Daliah, 2009). Since 2003, sukuk issuance in this country has accelerated which revealed the potentiality of sukuk to become the cornerstone of the national financial system. Currently there are several standards which sukuk issuers have to make, Namely, these certificates must be supported by tangible assets of an organization (Daliah, 2009). In this case we need to speak about its products, revenues, technologies, and so forth. These rules are valid not only in Saudi Arabia other Islamic countries as well.

Accoriding to the rules imposed by Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), sukuk must be supported by tangible assets of an enterprise, and the holder must be able to dispose of it at the time he/she wants (AAOIFI, 2002). This emphasizes on application of Sharia’h values during possession and deposition of assets in any Sukuk instrument. Services should also comply with Islamic law in any sukuk issuance.

Apart from that this organization requires insists that these securities should not be backed up by debt collateral since this increases potential risks of a holder and violates the norms of Sharia (AAOIFI, 2002). These standards are compulsory for the companies operating in Saudi Arabia. Several sukuk transactions have been designed to ensure a fixed income is streamed to the sukuk owner even when the financial performance of assets is not stable. However, according to AAOIFI, (2003) loans of this type are impermissible. The clarification permits accumulation of profits or payments on the underlying obligations to be used the issuer to pay sukuk during the times of shortfall. This is how Sukuk are managed in Saudi Arabia as well as other parts of the Islamic world.


Although Sukuk may resemble conventional capital markets financial bonds, it has some very distinctive features. The facility has attractive package that tap new and diversified source of finance to the capital market. Investors through the Sukuk system are assured of returns if the prevailing business environment allows investment to bring returns.

The main advantage of these financial instruments is that they enable the holder to exercise more control over the asset. In fact, this person becomes its owner and this differs significantly from conventional bonds. The main challenge that the investors have is they suffer loss in the event the instrument brings negative returns. However, such risks are typical of many financial securities, not only Sukuk.


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Daliah, M., 2009. Scholar critique spurs ijara Islamic bond. New York: Wiley.

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