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Acknowledgement
This textbook was developed as part of the IRTI e-Learning Program (2010), which was established and
managed by Dr. Ahmed Iskanderani and Dr. Khalifa M. Ali.
Islamic Financial and Capital Markets
Table of Contents
Chapter 5....................................................................................................................................................... 6
Chapter Introduction .................................................................................................................................... 7
Learning Objectives....................................................................................................................................... 7
Key Innovative Activities Shaping Financial Markets .................................................................................... 7
Financial Engineering in the Islamic Financial System .................................................................................. 8
Derivatives and the Islamic Financial Markets.............................................................................................. 8
Historical Financial Innovation in Islamic Finance ........................................................................................ 8
Scope of Financial Engineering in Islamic Finance ........................................................................................ 9
Approaches for Financial Innovation in Islamic Finance ............................................................................. 10
Challenges to Innovation in Islamic Markets .............................................................................................. 11
Chapter Summary ....................................................................................................................................... 12
Key Terms.................................................................................................................................................... 13
Chapter 6..................................................................................................................................................... 16
Chapter Introduction .................................................................................................................................. 17
Learning Objectives..................................................................................................................................... 17
Sukuk as a Sharī’ah-Compliant Instrument ................................................................................................. 17
Framework for an Islamic Capital Market................................................................................................... 18
Securitisation and Sukuk ............................................................................................................................. 19
More about Sukuk ....................................................................................................................................... 19
Advantages and Pricing of Sukuk ................................................................................................................ 19
Parties in a Sukuk Issue ............................................................................................................................... 21
Chapter Summary ....................................................................................................................................... 21
Key Terms.................................................................................................................................................... 22
Chapter 7..................................................................................................................................................... 23
Chapter Introduction .................................................................................................................................. 24
Learning Objectives..................................................................................................................................... 24
Classes of Securitised Papers ...................................................................................................................... 24
The SPV ....................................................................................................................................................... 25
Risk, Contract and Cash Flow Analysis ........................................................................................................ 25
Types of Permissible Sukuk ......................................................................................................................... 26
Controversial Sukuk .................................................................................................................................... 27
Ijarah Contracts in Sukuk ............................................................................................................................ 27
Chapter Summary ....................................................................................................................................... 28
Key Terms.................................................................................................................................................... 29
Chapter 8..................................................................................................................................................... 30
Chapter Introduction .................................................................................................................................. 31
Learning Objectives..................................................................................................................................... 32
Muqaradah or Mudarabah Sukuk............................................................................................................... 32
Musharakah Sukuk...................................................................................................................................... 33
Basics of Ijarah Sukuk.................................................................................................................................. 34
Structuring the Ijarah Sukuk ....................................................................................................................... 34
Types of Ijarah Sukuk .................................................................................................................................. 36
Aspects of Ownership, Rent and Expenses ................................................................................................. 37
Issuance and Trading of Ijarah Sukuk ......................................................................................................... 37
Basics of Salam Sukuk ................................................................................................................................. 38
Ownership and Trade in Salam Sukuk ........................................................................................................ 39
Istisna‘a Sukuk............................................................................................................................................. 39
Trade of Istisna‘a Sukuk .............................................................................................................................. 40
Murabaha Sukuk ......................................................................................................................................... 40
Use of Murabaha Sukuk .............................................................................................................................. 41
Mixed Sukuk ................................................................................................................................................ 41
Chapter Summary ....................................................................................................................................... 43
Key Terms.................................................................................................................................................... 44
Chapter 5
Chapter Introduction
Innovations in Islamic Markets.
Financial markets have been evolving since the 1980s due to:
Learning Objectives
At the end of this chapter, you will be able to:
Describe the three key financially innovative activities that shape markets.
Explain the criticality of financial engineering to the Islamic financial system.
Explain the consequences of the lack of derivative instruments in an Islamic financial system.
Describe how historically Islam has facilitated financial innovation.
Explain the three aspects to be considered for financial innovation in Islamic systems.
Describe the two approaches that can be used for financial innovation in Islamic financial
systems.
Describe the innovation of a synthetic currency forward contract.
Islamic markets primarily offer short-term options. There is a shortage of medium- and long-term
options. The lack of secondary market has affected liquidity. Investors are unable to expand portfolios.
The challenge is to give investors more options at the lowest cost.
Returns
Price risk
Credit risk
Country risk
Most modern markets have complex instruments that are built on a basic set of instruments. Islamic
markets are built upon the same basic structures, but without the complexity required for markets
today. Financial engineering must develop modern complex instruments that are also Sharī’ah-
compliant.
The challenge:
Financial engineering requires a thorough knowledge of Islamic legal system and economics, finance and
banking. Islamic nations have a long history of working in accordance with the Sharī’ah. Economics and
commerce in Muslim countries have developed based on rulings and precedents set by Sharī’ah experts
in accordance with the Sharī’ah. The practice of interpreting and applying Sharī’ah through the Ijtihad
must be revived.
Freedom of Contract
● Riba
● Gharar
● Qimar
● Ikrah
Traditionally, economic agents drawing up contracts would show them to Sharī’ah scholars to study
their legitimacy. Agents have the power to enter any kind of contract, provided they stay within the
Sharī’ah’s boundaries. Financial instruments and services must be seen as sets of contracts specifying
rights and duties of each party. Sharī’ah scholars verify if the rights and duties are in accordance with
the Sharī’ah.
It is necessary to understand the basic structures of a market. It becomes easy to build on top of these
building blocks. The main building blocks of Islamic markets are similar to the conventional financial
market. But Islamic financial system and modes of finance should be designed to be Sharī’ah-compliant
and to adhere to the Maqasid Al-Sharī’ah. However, practices by some financial institutions may cause a
deviation from these principles. This uniqueness must be understood while building complex structures
that are also Sharī’ah-compliant.
Risk/Return Profile
There is an assumption that Islamic finance is equity-driven. Non-equity contracts used in Islamic
markets are:
Trade financing
Leasing and sales
● Murabahah
● Ijarah
● Salaam
Reverse engineering
Innovative engineering
Reverse Engineering
Major benefit: Easy introduction and merger with conventional structures, particularly in markets
outside.
The challenge: The substitutes can be closely related to the original, but not completely Sharī’ah-
compliant. Contamination occurs due to misuse of instrument.
Innovative Engineering
Theoretical Foundation
Conventional markets have a strong theoretical foundation. Capital structure, portfolio diversification
and options pricing are well developed. It is easy to build complex structures over and above that.
Islamic markets have no theoretical foundation. Asset and risk pricing and derivatives are not well
established. Islamic markets must work on building a theoretical base. For this, they must resort to
cross-training. Sharī’ah scholars must be trained in banking and finance. Bankers and economists must
be trained in the Sharī’ah.
Investment in Infrastructure
Financial engineering requires established cells to conduct:
● Market research
● Product research
● Analytical modelling
Conventional institutions have a mechanism to collect market information, Islamic institutions don’t.
They are usually too small and lack the necessary funds and human resources. Islamic institutions must
come together to collectively pool resources and conduct research. This will help reduce costs and
create a research base.
Chapter Summary
You have completed the chapter, Innovations in Islamic Markets. The key points of this chapter are as
follows:
Financial engineering means designing new products, services and processes to:
Reduce costs
Increase returns
Increase opportunities
Key issues that help understand the extent to which financial engineering can be developed are:
Freedom of contracts that agents have
Basic building blocks of the market
Risk/return profiles of instruments
Islam forbids no contract. It allows agents freedom to enter contracts that do not violate
Sharī’ah.
The main building blocks of Islamic markets and Western markets are similar, but Islamic modes
of finance are envisaged to be Sharī’ah -compliant and to achieve the Maqasid Al-Sharī’ah.
Islamic markets allow equity and non-equity-based instruments such as Murabahah, Ijarah and
Salaam. These even offer interest-like fixed returns.
IRTI’s multi-year project called “Products and Financial Instruments in Islamic Fiqh” aims to
extract new Islamic finance products from the original Fiqh sources, refine them and make
applicable to modern finance and banking.
Key Terms
Dharoora
Gharar
Ijtihad
Ijarah
Ikrah
Istisna‘a
Maisir or Qimar
Murabahah
Ribâ
Sharī’ah
Chapter 6
Chapter Introduction
Securitisation in Islamic Finance. Islamic banking and finance has gained momentum particularly in the
areas of Sukuk and securitisation. Shirkah-based instruments are in use since 1980s; Sukuk have been
issued only since 1992. Since 2002, Sukuk issues by both corporate entities and sovereign nations have
grown in value from a few hundred million dollars to several billion dollars. The underlying contracts
include Ijarah, Mudarabah, Musharakah, Istisna‘a and a mix of some of these.
Pioneering Example: The $400mn Islamic Development Bank- Solidarity Trust Services Sukuk issue in
2003
Estimates for Sukuk market size in 2015 (IRTI-IFSB Ten-Year Framework for Islamic Financial Services
Development):
Sukuk is preferred as an alternative source of funding for sovereigns and corporate bodies.
Sukuk provides a substitute to conventional fixed income securities issued for funding large
developmental and capital expenditures of big entities.
Sukuk facilitates Islamic Financial Institutions (IFIs) and investors to successfully manage
liquidity.
Learning Objectives
On completing this chapter, you will be able to:
Debt market involves Ribâ and Gharar and is not an active part of the Islamic financial market. In Hawalah, debts
can only be assigned to others on a par value without transferring the risk of default. Stock market investment is
subject to many conditions.
The conditions for trading stocks are covered in detail in Chapter 2 of this course, Advanced Islamic Instruments
and Markets. An Islamic capital market can be developed by:
• Issuing more Sukuk
• Introducing Islamic Depository Receipts (IDRs).
• Replacing debt financing
• Securitisation
• Fund management
Sukuk signify the common undivided shares in the ownership of underlying assets. Sukuk holders share the
return and bear the loss in proportion to their share in investment.
An IDR involves trading of stocks of Islamic companies in countries other than their origin. Importance of IDRs:
• Convergence of Islamic capital markets
• Alternative to cross-listing
• Provision of better regulatory environment
• Generation of funds for developing Muslim countries
• Standardisation of Sharī’ah compliance across jurisdictions
• Growth of Islamic capital markets
The originator of the underlying asset, an investor and the custodian bank engage in IDR.
Advantages of IDRs for the originators:
• Facilitates the expansion of the investor base
• Enables low cost of funds in extremely liquid markets
• Provides better securities by trading in more organized markets
Originator of Sukuk: Sells the assets to SPV and uses the funds; usually IFIs, governments or
corporations
SPV or issuer: Purchases assets from the originator and issues Sukuk to fund the purchase price
Investment bank: Manages and directs book-making services for Sukuk for a predetermined fee;
usually operate as syndicates
Subscribers of Sukuk: Buy securities issued by the SPV; central banks, IFIs and individuals are
subscribers
Obligor
Lead manager
Servicer
Cash administrator
Credit enhancement provider
Credit rating agency
Legal and tax counsel
Auditor
Custodian/ R&T agents
Chapter Summary
You have completed the chapter, Securitisation in Islamic Finance. The key points of this chapter are as follows:
Sukuk is preferred as an alternative source of funding, especially for sovereigns and corporate
bodies.
IRTI-IFSB Ten-Year Framework for Islamic Financial Services Development estimates Sukuk market to
be between $ 1.25 and $ 1.4 trillion by 2015.
A Sharī’ah-compliant investment certificate should not represent interest-bearing debt as a
dominant part of the underlying assets.
Key components of an Islamic capital market are Sharī’ah-compliant stocks, Islamic funds and
Islamic investment certificates.
Debt market, which deals in debentures and bonds, usually involves Ribâ and Gharar and, hence, it
cannot be a part of Islamic financial market.
Stocks of the joint stock company are traded in equity market, which is also known as stock market.
IDR involves trading of stocks in countries other than their origin. Sharī’ah-compliant stocks and
other instruments are traded in IDRs.
According to AAOIFI, investment Sukuk is a certificate representing undivided shares in the
ownership of tangible assets, usufruct and services or in the ownership of assets of the any
particular projects or activity.
Securitisation is a process of pooling/repackaging the non-marketable and illiquid assets into
tradable certificates of investment.
Sukuk is similar to conventional securitisation. However, Sukuk does not encourage Ribâ, Gharar and
the activities prohibited by Sharī’ah.
Key parties involved in Sukuk transactions are the originator of Sukuk, SPV, investment banks and
subscribers of Sukuk.
Sukuk in the form of new securities:
Assist the development of capital markets.
Attract conservative buyers.
Draw international capital.
Facilitate the efficient sharing of risks.
Key Terms
Hawalah
Ijarah
Ijarah Sukuk
Mudarabah
Mudarabah Sukuk
Musharakah
Musharakah Sukuk
Murabahah
Ribâ
Sharī’ah
Sukuk
Chapter 7
Chapter Introduction
Structure of a Sukuk. Sukuk refers to an instrument in which the ownership of the underlying assets is
transferred to a large number of investors.
Pool-based securitisation
Future flow securitisation
The lead bankers undertake minute risk analysis, contract analysis and cash flow analysis with respect to
several aspects of an issue. In the Islamic world, Sukuk first became popular in the 1990s. However, the
use of Bai’ al-Dayn and Bai’ al-Inah contracts in these were deemed to be against the Sharī’ah principles.
Since then, Sukuk have been widely accepted in Islamic financial markets around the world.
Before we proceed, note that you can learn about various other aspects of Sukuk in various chapters of
this course:
Learning Objectives
On completing this chapter, you will be able to:
Pool-based Securitisation
Mortgage-backed securitisation
Collateralised debt obligations (CDO)/Collateralised loan obligations (CLO)
Lease rentals securitisation
The SPV
Purpose of an SPV
A Special Purpose Vehicle (SPV) is a separate legal entity that manages the securities issues. An SPV:
Bankruptcy remoteness
Thin capitalisation
When the ownership is transferred to the SPV, the discretion of the original owner ends. It cannot be
reversed even if the original owner is declared insolvent. The legal structure of an SPV is based on its
regulatory and legal environment.
Pass-through structure
Pay-through structure
SPVs reinvest the funds and pay investors according to a predetermined schedule. SPVs also serve as
“conduits” for multiple issuances.
Risk Analysis
Securitisation mitigates risks with respect to various factors and it differs from an originator’s and an
investor’s perspective.
The Sukuk holders or the issuers adopt some methods to manage and mitigate risks. They are as follows:
Contract Analysis
Contract analysis mainly focuses on the following with the purpose of knowing the ability to fulfill the
rights and obligations:
Identify key variables and expected patterns of the underlying cash flows under various scenarios.
Determine the rating of the issue.
The AAOIFI, in its Sharī’ah standard for Investment Sukuk, has put forth eight types of investment
certificates or Sukuk.
On one side, investment Sukuk have to be structured according to Shirkah but can be designated
as Ijarah Sukuk, Salam Sukuk and Istisna‘a Sukuk.
On the other side, they must use participatory or fixed return modes/instruments.
Variable
Quasi-fixed
However, any third party guarantee can make the Sukuk fixed-return certificates of investment.
Controversial Sukuk
Sukuk issues are based on the concept of Ijarah, whereas few are based on Shirkah, Salam or pooled
assets. Sukuk issues are criticised due to the involvement of controversial contracts like Bai’ al-‘Inah, Bai’
al-Dayn and other non-Sharī’ah compliant traits. Most jurists do not accept these although the debt
represented by Sukuk is supported by the underlying assets. But some of the traditional Muslim jurists
and contemporary Sharī’ah scholars agree on the point that Bai’ al-Dayn with discount is not allowed
according to the Sharī’ah. Some scholars have allowed this kind of sale based on the ruling of the Shafi‘e
school. They do not consider the fact that the Shafi’e jurists allowed it only in a case where a debt was
sold at its par value. The OIC Islamic Fiqh Council of all Islamic countries approved the prohibition of Bai‘
al Dayn.
Bai’ al-Dayn and Bai’ al-Inah contracts are covered in detail in Chapter 8, Controversial Financing & Fee-
based Products, of the course, Islamic Financial System.
The sale and lease-back technique involves the purchase of an asset from a party that can again be
leased to the same party. The experts in Sharī’ah principles allow its use. The sale and lease-back
technique does not create any Sharī’ah-related problem with respect to Sukuk issue on the basis of
Ijarah. The use of sale and lease-back technique in case of consumer durables is not considered
desirable by many Sharī’ah scholars and practitioners, except when the client wants to avoid interest-
based financing and there is no other way out.
1. Sufficient time should pass before the lessee repurchases the asset.
2. This period creates the chance of a change in the value and structure of the asset being sold and
leased back.
3. The client should purchase back the asset at least one year after the sale to avoid an interest-based
transaction.
Ijarah has a great flexibility and potential for Sukuk issue. Some of the aspects of Ijarah Sukuk that need
to be considered before issuing are:
The issue of Ijarah Sukuk carries systemic risk of non-Sharī’ah-compliance. Note however that Sukuk
originating from Sudan, Bahrain and other Middle Eastern countries are based on Shirkah, Ijarah, Salam,
Istisna‘a, Istisna‘a-cum-Ijarah or a pool of mixed assets. These Sukuk issues are acceptable to almost all
of the Islamic scholars and banking experts.
Chapter Summary
You have completed the chapter, Structure of a Sukuk. The key points of this chapter are as follows:
Sukuk refers to an instrument in which the ownership of the underlying assets is transferred to a
large number of investors.
The major classes of securitised papers include pool-based securitisation and future flow
securitisation.
An SPV is both capital and tax efficient. However, there are legal costs in establishing and managing
an SPV.
Some of the alternative payment structures are Pass-through and Pay-through structures.
The lead bankers perform the following analysis on various aspects with respect to securitisation
issues.
The most important Sukuk or investment certificates with sizeable potential are Shirkah, Ijarah,
Salam and Istisna‘a.
Thus, the rates of return on Sukuk will be either variable or quasi-fixed.
Sukuk issues are based on the concept of Ijarah, where as few are based on Shirkah, Salam or pooled
assets.
Sukuk issues are criticised due to the involvement of controversial contracts like Bai’ al-‘Inah, Bai’ al-
Dayn and other non-Sharī’ah compliant traits.
The sale and lease-back technique involves the purchase of an asset from a party that can again be
leased to the same party. The experts in Sharī’ah principles allow its use.
Key Terms
Bai’ al’-Inah
Bai’ al-Dayn
Ijarah
Ijarah Sukuk
Istisna‘a
Mudarabah
Mudarabah Sukuk
Musharakah
Musharakah Sukuk
Murabahah
Ribâ
Takaful
Tabarru
Sharī’ah
Shirkah
Sukuk
Chapter 8
Chapter Introduction
Categories of Sukuk.
Muqaradah or Mudarabah Sukuk are certificates that represent projects or activities managed on the
basis of Mudarabah principle. The purpose of Muqaradah or Mudarabah Sukuk issue is to enhance
public participation in investment activities in any economy.
Musharakah Sukuk
Musharakah Sukuk serve as the mode of security for projects involving huge amounts. As redeemable
certificates, Musharakah Sukuk are issued for:
Rehabilitation or employment.
Purchase of automobiles for their commercial use.
Establishment of high-standard clinics, hospitals, factories, trading centres, endowments, etc.
Ijarah Sukuk
Ijarah Sukuk or certificates serve as an evidence for the purchase of proportion of asset that a lessor
wishes to recover the cost of purchase to get liquidity or for the purpose of profit even after executing
the Ijarah contract.
Salam Sukuk
In a Salam Sukuk, an advance payment is made for goods that would be delivered in future. A Salam
buyer can onward sell the Salam commodity using a parallel contract. The specifications of the two
contracts and delivery dates may conform to each other.
Istisna‘a Sukuk
Istisna‘a Sukuk is a contractual agreement for manufacturing goods, allowing advance payment for
future delivery of goods or allowing future payment and future delivery of goods, as per the contract.
Houses
Plant
Bridges
Roads
Highways
Murabaha Sukuk
In a Murabaha Sukuk, the purchaser on credit signs a paper to document his indebtedness towards the
seller. This paper signifies a debt receivable by the seller. The paper can be transferred to third party
only at par value and the transfer should adhere to the rules of Hawalah.
Note that various structural aspects of Sukuk are described in the following chapters of this course:
Learning Objectives
On completing this chapter, you will be able to:
In terms of the Resolution of the Islamic Fiqh Council of the OIC (fourth session, 1988),
the following are the salient features of Mudarabah Sukuk (MS) or certificates:
Note: The third party should be totally unrelated to the parties involved in the contract. Islamic financial
institutions can offer MS to the investors who would subscribe and participate in the investment transactions.
Musharakah Sukuk
Nature of Musharakah Sukuk:
Basic Sharī’ah rules apply to both Musharakah Sukuk and Mudarabah Sukuk apart from the fact that the
intermediary party involved will be a partner of the Musharakah certificate holders.
The proceeds of the Sukuk can be used: To buy and lease certain equipment.
The Musharakah structure is considered more equitable and safer for the investors than the Mudarabah
structure. Musharakah Sukuk holders will have added comfort and security due to the manager’s
participation in the Musharakah capital.
Since 1998, central bank Musharakah certificates (CMCs) and government Musharakah
certificates (GMCs) have been issued for investors. The CMCs are sold or bought by the
central bank through auctions.
Ijarah funds can be raised by purchasing and leasing assets through Sukuk issues.
Note: Mudarabah Sukuk can also be used to raise funds through services and leases apart
from selling goods.
Rental Mechanisms in Ijarah Sukuk
For first term of lease, rental must be specified in clear terms. For the future renewable terms, it could
be constant, increasing or decreasing.
Note: Mufti Muhammad Taqi Usmani (2000a) explains that even though benchmarking with
any interest rate as reference is not desirable, it is permitted as long as all the Sharî‘ah
requirements are satisfied.
These certificates are issued for the leased asset or for the asset to be leased (by promise) either
The mobilised funds from subscription are the purchase price of the usufructs. The certificate holders
become owners of the usufruct along with the risks and rewards. When the assets are sub-leased, the
certificate will represent the rent receivables. The issuer is allowed to redeem the tangible assets either
at the market price or as agreed upon at the time of purchase.
These certificates are issued for the assets to be leased. The rental is recovered from the subscription
income. The holders of the certificates are the owners of the usufruct of the future assets. The
subscribers are the buyers of usufructs and will have both the risks and rewards. It is not valid to sub-
lease or trade or made available the asset prior to identification.
The asset to be leased and the amount of rent should be known to the parties involved in an Ijarah
contract. Ijarah Sukuk can be issued on an asset or a building that is yet to be constructed.
Capital and basic expenses of asset are the responsibility of the owner.
Maintenance expenses are to be borne by the lessee.
If the asset is destroyed without any fault or negligence of the lessee, the loss has to be borne
by the Sukuk holders (lessor).
Roles of SPV:
Serves as a manager.
Makes payment for purchasing the asset.
Collects rental payments from lessee and distributes it among Sukuk holders.
Rental Payment:
The lessee makes periodic rental payments to the SPV as stipulated by the lessor in advance with the
possibility of small variation.
The holders become owners of the assets and the issuer can:
Tradeability of Sukuk is covered in greater detail in Chapter 9 of this course, Tradability, Structures and
Potential of Sukuk.
In Parallel Salam, the holder of Salam Sukuk is entitled to the Salam commodity or the selling price of
the commodity at the time of delivery. Usually, investment banks may act as arrangers, i.e. sell the right
to take delivery of the commodity at a future date.
The seller of Salam contract can enhance his cash flow in advance.
The buyer has the advantage of lower Salam price.
In June 2001, the Bahrain Monetary Authority (BMA) developed Salam-based securities with LIBOR-
related three-month tenures used for maintaining Statutory Liquidity Ratio (SLR) by Islamic banks.
1. Bahrain government sells a specified amount of aluminium to Bahrain Islamic Bank (BIB) at a
future date.
2. BIB appoints the government as its agent.
3. Agent promotes aluminium at the time of delivery at a price which provides returns to the
security holders.
Such short-term Sukuk can be developed based on the commodities being traded, like crude oil and
cotton.
Istisna‘a Sukuk
Istisna‘a is a contractual agreement for future delivery of manufacturing goods that allows advance or
future payment. An Istisna‘a contract helps to finance construction of different projects. A Parallel
Istisna‘a contract with subcontractors enables Islamic banks to undertake construction of any project
and sell it for a deferred price, but outsource the actual construction to the subcontractor. Upon
delivery of goods, the ownership of the constructed item is transferred to the purchaser against the
deferred sale price. The price covers the construction costs and profits, which would include the cost of
locking funds during the repayment period.
Istisna‘a Sukuk:
Are certificates of equal value issued for mobilizing funds required for producing goods.
Document the deferred price that needs to be paid.
Are issued by the manufacturer (seller).
Are held by the subscribers who are the buyers of the goods.
If the funds are transformed into assets owned by the certificate holders through business or
trade.
If the funds are immediately offered as a price in a Parallel Istisna‘a contract.
If the manufactured item is handed over to the purchaser.
Prohibition of Ribâ permits the sale of the debt certificates to a third party at any price other than their
face value. Big entities sell certain goods to IFIs on a deferred payment basis and issue Istisna‘a Sukuk
according to the date of payment. In exchange, the certificate holder may acquire the goods for a
deferred price and dispose them off in any way. The certificate holder acquires the goods at a price
higher than the spot price. The holder then relinquishes to the seller the differential price he obtained
above the construction cost of the project.
Murabaha Sukuk
Bank’s credit sale transaction that gives rise to a monetary right or obligation cannot be the basis of a
negotiable instrument. Hence, securitisation of Murabaha receivables to create negotiable Sukuk is not
possible. It is permissible to trade relevant certificates if the commodity has been purchased by a trader
but not sold to a different party.
Reason:
Mixed Sukuk
A mixed portfolio having many transactions may issue negotiable certificates provided the asset pool
comprises more than 50% of Ijarah or other fixed assets. However, Hanafi scholars permit trading even
if the non-liquid assets are more than 10% of its total worth.
Use of Murabaha Sukuk
Purchase of goods by the public sector involves use of Murabaha Sukuk. Government may pay for very
expensive goods in installments. Over the period of installments, the seller recovers cost and makes
profit. Number of installments =number of certificates issued
Collection rights can be transferred to another party by the seller or the original certificate holder if
there is a default in payment that equals the face value of the certificate minus the collection cost at the
transferee’s end. An organisation with access to Murabaha funds can also issue Murabaha Sukuk. The
proceeds are used for sale of pre-specified and general assets on the basis of Murabaha, which provides
Murabaha Sukuk holders with partially-fixed return. Arcapita Bank B.S.C (Bahrain) issued five-year
multicurrency Murabaha-backed Sukuk with a five-year bullet maturity in 2005. The proceeds of the
Sukuk are used to trade the assets through Murabaha transactions. As Murabaha generates fixed
return, to avoid Ribâ, Sukuk holders are offered returns equivalent to three-month LIBOR plus 175 basis
points (bps). The SPV has full recourse to Arcapita. Hence, Sukuk is a freely transferable instrument
based on the mechanism approved by Arcapita’s Sharī’ah supervisory board. Presumably, SPV will
maintain inventory or fixed assets and make its Sukuk negotiable.
Mixed Sukuk
Mixed Sukuk consists of a pool of Musharakah, Ijarah, Murabaha, Istisna‘a, and Ju‘alah contracts. These
contracts may be securitised by the banks. Depending on the chosen mix of the contracts, the return
and risk of securities arises. Salam contracts cannot be included in mixed Sukuk since trade in Salam
Sukuk is prohibited.
They are issued using a tool, which converts non-marketable and illiquid assets to negotiable
instruments holding a secondary market.
These are particularly suitable for investment banks and development financial institutions
(DFIs).
$400 million mixed Sukuk issued by the Islamic Development Bank (IDB) in 2003
Characteristics
IDB guarantees the payment in respect of assets owed by the trustee, referring to the schedule
of payments.
The payment guarantees the amount payable by the obligors of the underlying transactions in
respect of the assets.
IDB meets any shortfall due to any loss in returns of the Sukuk assets.
IDB provides the STS with an interest-free facility to ensure timely payment on the trust
certificates.
IDB purchases the Sukuk assets earlier than the maturity or dissolution date. The trust
distributes the proceeds among the certificate holders.
Chapter Summary
You have completed the chapter, Categories of Sukuk. The key points of this chapter are as follows:
The six categories of Sukuk are Muqaradah or Mudarabah Sukuk, Musharakah Sukuk, Ijarah Sukuk,
Salam Sukuk, Istisna‘a Sukuk and Murabaha Sukuk.
Muqaradah or Mudarabah Sukuk are issued to enhance public participation in investment activities.
Musharakah Sukuk are issued by or to the corporate sector or to individuals for their rehabilitation
or employment, for the purchase of automobiles.
The concept of Ijarah can be used for mobilising funds for the development of long-term
infrastructure projects.
Ijarah Sukuk can be used to solve liquidity management problems and finance public sector in
developing countries.
Procedure for the issuance of Ijarah Sukuk to the investors involves the creation of an SPV to
purchase the assets.
In a Salam contract, money is paid in advance for goods that would be delivered in future.
Salam Sukuk are certificates of equal value issued to raise funds equal to the price of the
commodity, but paid in advance in the Salam contract.
The secondary market trading of Salam Sukuk is prohibited because the Sukuk certificate represents
a share in the Salam debt and speculators who are not interested in the final delivery may seek to
profit from Parallel Salam transactions
Istisna‘a is a contractual agreement for future delivery of manufacturing goods that allows advance
or future payment.
Istisna‘a Sukuk are certificates of equal value issued for mobilizing funds required for producing
goods.
Istisna‘a certificates can be traded or redeemed if the funds are transformed into assets owned by
the certificate holders through business or trade.
Purchase of goods by the public sector involves use of Murabaha Sukuk.
An organisation with access to Murabaha funds can also issue Murabaha Sukuk.
Mixed Sukuk consists of a pool of Musharakah, Ijarah, Murabaha, Salam, Istisna‘a, and Ju‘alah
contracts.
Key Terms
Bai’ al’-Inah
Bai’ al-Dayn
Ijarah
Ijarah Sukuk
Istisna‘a
Istisna‘a Sukuk
Mudarabah
Mudarabah Sukuk
Musharakah
Musharakah Sukuk
Murabahah
Ribâ
Salam Sukuk
Sharī’ah
Shirkah
Sukuk