English Module

Finance and Islamic Banking: Lesson 2

Master One 2021/2022

Investing in Islamic Bonds: Sukuk

A. Defining Sukuk
Sukuk is the plural form of the Arabic word sakk, which means “certificate” or “written docu
ment” (A fun bit of trivia: Some experts say the word check may derive from the Arabic work
sakk.), they were used in the Middle Ages by Muslims to represent financial obligations that
originated from commercial activities. Modern-day sukuk differ from the historical sukuk;
Muslims in the Middle Ages certainly didn’t have access to the broad spectrum of
sukuk products that exist on the market today.
The Islamic Financial Services Board (IFSB) defines sukuk this way: Sukuk . . . are certificates
with each sakk representing a proportional undivided ownership right in tangible assets, or a pool
of predominantly tangible assets, or a business venture. These assets may be in a specific project
or investment activity in accordance with Sharia rules and principles. The Accounting and
Auditing Organization for Islamic Financial Institutions (AAOIFI) defines sukuk as “certificates
of equal value representing undivided shares in ownership of tangible assets, usufruct,
and services.” Usufruct is the right to earn profit from property owned by another person or
from property that has common ownership.
Common or collective ownership refers to a situation in which many people own an asset, such
as land. For example, if a tribe or family has common ownership of a piece of land, then the asset
isn’t public property and no individual can claim ownership of any part of the land (and therefore
can’t sell even a small piece without consent from the rest of the owners). Clear as mud? Don’t
worry; in this section, I help you parse these definitions by first identifying the key
characteristics of conventional bonds and then providing an overview of sukuk characteristics
and comparing the two financial products.
B. Walking through the Process of Issuing Sukuk
Issuing sukuk is similar to issuing conventional bonds. Consider how simple, conventional
corporate bond issues work:
1. The company structures the bonds with its board’s approval, specifying the face amounts,
interest rates, and maturity date and determining how many bonds it plans to issue (indicating
how much money it hopes to raise).
2. The company prepares the bond prospectus, which explains the bond specifics to potential
investors.
3. The company contracts an underwriter (a large financial institution, such as a bank, insurer, or
investment house) to conduct the bond issuance. The under- writer offers insurance to the issuer
that it will purchase any bonds that investors don’t buy.
4. The underwriter acts as middleman, selling bonds to investors on behalf of the corporation.
Although a sukuk issuance goes through a similar procedure, different types of sukuk products
require different structures. Therefore, the first step of the process is unique to the specific sukuk
product.

1
English Module
Finance and Islamic Banking: Lesson 2
Master One 2021/2022

C. Identifying the parties involved

Any sukuk issue involves three main parties; an optional fourth party (the under-writer) may or
may not come on board:
 Obligator: The obligator is the government or corporation that is going to benefit from
the sukuk issuance.
 Trustee or issuer: This party, called the Special Purpose Vehicle (SPV), is the middle
man between the obligator and the investors.
 Investors: These entities are the sukuk holders.
 Underwriter: With sukuk, an underwriter doesn’t usually conduct the actual bond
issuance and isn’t required in every situation. However, an underwriter may be brought
in as insurance to the SPV, to guarantee that any unsold sukuk will be purchased. The
leading conventional banks or their Islamic subsidiaries (for example, HSBC Amanah,
CIMB Investment Bank, and Standard Chartered Bank) are most often the underwriters
for sukuk.
Unlike conventional bonds, which are issued via an underwriter (such as an existing bank,
insurer, or investment house), sukuk usually require the obligator to create a new entity, an SPV,
to act as trustee or issuer. In the upcoming section “Creating the SPV for acquiring assets,” I
explain what an SPV is. (Hint: It’s not the latest spinoff in the Law & Order franchise.)

D. Setting up the sukuk’s general structure

The first step in issuing sukuk is setting up their general structure. The obligator (issuing
government or corporation) gets the help of sukuk arrangers to complete this step.
Arrangers are Islamic financial service providers and professionals who know the sukuk
process. (If a sukuk underwriter is needed, the arranger usually fills that role as well.)
For this step, the obligator must describe the following:
Purpose of the sukuk: The purpose refers to the underlying asset (which can be a tangible
asset, project, joint venture, and so on) set to directly benefit from the issuance.
Legal issues/relevant regulations: When conventional bonds are issued, they must be approved
by the regulatory authorities of the countries in which they are to be publicly issued (or listed in
exchanges). In the same way, sukuk need to be approved by the relevant authorities for public
offerings. A public sukuk offering in Saudi Arabia, for example, needs to be approved by the
Capital Market Authority of Saudi Arabia. The Security Commission of Malaysia needs to
approve sukuk that will be listed in its exchange.
The sukuk structure must include language that explains which regulatory approvals are
required.
In addition, it must describe the legal status of the SPV (the sukuk trustee/issuer).
 Information about the obligator: This description of the obligator must include what
type of business it conducts and its historical performance along with a list of its board of
directors and its outstanding shares.

2
English Module
Finance and Islamic Banking: Lesson 2
Master One 2021/2022

 Units: This description documents the number of sukuk involved in the issuance.
 Currency: The currency of the sukuk transactions in the primary market must be
specified.
 Structure: This part details the Islamic contract on which the sukuk functions. It
explains whether the issue is based, for example, on an ijara, musharaka, or mudaraba
contract
The obligator (just like a conventional bond issuer) must then create a prospectus, which
includes the general structure information as well as the following:
 The obligator’s rating per the independent rating agencies.
 Risk factors related to the sukuk issuer (the SPV), to the obligator, or to the sukuk trust
certificates themselves. Examples include the absence of a secondary market, the
potential early redemption of trust certificates in certain cases, potential taxation issues,
and potential legal issues (if the law were to change to become unfavorable to sukuk).
 The ownership of the issuer (the SPV).
 Names and affiliations of the administrators of the SPV and the sukuk ar- rangers.
 Names and affiliations of the sharia advisors or board charged with ensuring that the
sukuk issue complies with Islamic law.
 Dissolution issues, such as how the issuer redeems the sukuk trust certifi- cates at the
maturity date.
 A diagram of the sukuk structure and its cash flows.
 The terms and conditions of the trust certificates.
 Organizational information about the obligator, such as its shareholders, board of
directors, and employees (including an organizational chart).
 An introduction to the obligator’s industry. Transaction documents and taxation issues.

E. Insuring sukuk purchases After the sukuk structure and the SPV are in place (see the
preceding sections), the sukuk issuance begins. An underwriter may insure the sukuk
issuance, promising the SPV to buy all the unsold sukuk. (In some cases, the underwriter
may also serve as the sukuk issuer to the primary market.)