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Association of Islamic Banking Institutions Malaysia

What is Sukuk?

Sukuk (Arabic: 5CHC, plural of 5C sakk, "legal instrument, deed, check") is the Arabic name for a financial certificate but
can be seen as an Islamic equivalent of bond. However, fixed income, interest bearing bonds are not permissible in
Islam, hence Sukuk are securities that comply with the Islamic law and its investment principles, which prohibits the
charging, or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with
their tradability and non-tradability in the secondary markets.

Conservative estimates by the Ten-Year Framework and Strategies suggest that over $700 billion of assets are managed
according to Islamic investment principles.[1] Such principles form part of Shari'ah, which is often understood to be
‘Islamic Law’, but it is actually broader than this in that it also encompasses the general body of spiritual
and moral obligations and duties in Islam.

Sharia-compliant assets worldwide are worth an estimated $500 billion and have grown at more than 10 per cent per
year over the past decade, placing Islamic finance in a global asset class all of its own. In the Gulf and Asia, Standard &
Poor's estimates that 20 per cent of banking customers would now spontaneously choose an Islamic financial product
over a conventional one with a similar risk-return profile.

With its Arabic terminology and unusual prohibitions, Sukuk financing can be quite mystifying for the outsider. A good
analogy is one of ethical or green investing. Here the universe of investable securities is limited by certain criteria based
on moral and ethical considerations. Islamic Finance is also a subset of the global market and there is nothing that
prevents the conventional investor from participating in the Islamic market.

History

In classical period Islam sakk (sukuk) – which is cognate with the European root "cheque" (which itself derives
from Persian)- meant any document representing a contract or conveyance of rights, obligations or monies done in
conformity with the Shariah. Empirical evidence shows that sukuk were a product extensively used during medieval Islam
for the transferring of financial obligations originating from trade and other commercial activities.

The essence of sukuk, in the modern Islamic perspective, lies in the concept of asset monetisation - the so called
securitisation - that is achieved through the process of issuance of sukuk (taskeek). Its great potential is in transforming
an asset’s future cash flow into present cash flow. Sukuk may be issued on existing as well as specific assets that
may become available at a future date.

Valued at the end of 2006 more than US$ 50bn the sukuk market is due for an exponential rise in 2007 with every issue
likely to be oversubscribed 5 to 6 times amid a fast growing interest in the western countries.

Principle

Shari’ah requires that financing should only be raised for trading in, or construction of, specific and identifiable
assets. Trading in indebtedness is prohibited and so the issuance of conventional bonds would not be compliant. Thus all
Sukuk returns and cashflows will be linked to assets purchased or those generated from an asset once constructed and
not simply be income that is interest based. For borrowers to raise compliant financing they will need to utilise assets in
the structure (which could be equity in a tangible company). Equity financing is Shari’ah compliant and fits well
with the risk/return precepts of Islam.

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Association of Islamic Banking Institutions Malaysia

As Shari’ah considers money to be a measuring tool for value and not an asset in itself, it requires that one
should not be able to receive income from money (or anything that has the genus of money) alone. This generation of
money from money (simplistically interest) is "Riba", and is forbidden. The implications for Islamic financial institutions is
that the trading and selling of debts, receivables (for anything other than par), conventional loan lending and credit cards
are not permissible.

This principle is widely understood to mean uncertainty in the contractual terms and/or the uncertainty in the existence of
an underlying asset in a contract and this causes issues for Islamic scholars when considering the application of
derivatives. Shari’ah also incorporates the concept of "Maslahah" or "public benefit", denoting that if something is
overwhelmingly in the public good, it may yet be transacted – and so hedging or mitigation of avoidable business
risks, may fall into this category but there is still much discussion yet to come.

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