Introduction to Sukuk: Definitions and Role in Economic Development Abayomi Alawode, head of Islamic finance April 19, 2015

Principles of Islamic Finance Money is not a commodity and has no intrinsic value; it is a medium of exchange The payment or receipt of interest on transactions is therefore prohibited (riba) Profit must be linked to real economic transactions and is a reward for taking risks Avoid transactions with high uncertainty (gharar) Prohibition of financing or investment in certain activities (e.g. alcohol, gambling)

Sukuk Concepts (1) Sukuk are financial trust certificates and resemble conventional bonds Defined by AAOIFI as “….certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity….[Sharia Standard No. 17] Although Sukuk holders share in the ownership of the asset, and their holdings specify the proportionate shares, the respective shares cannot be divided (i.e. definite physical boundaries not determined) Sukuk therefore provides a medium to long-term investment instrument that is also liquid (more on this later)

Sukuk Concepts (2) Sukuk are structured using existing Sharia-compliant products or techniques: Sales based Sukuk al-Murabaha (mark-up sale) Sukuk al-Istisna’ (manufacturing sale) Sukuk al-Salam (forward sale) Lease based Sukuk al-Ijara (asset lease) Agency based Sukuk al-Wakala (agency for investment) Partnership based Sukuk al-Musharaka (equity participation) Sukuk al-Mudaraba (trust finance)

Sukuk Concepts (3) Asset-backed Sukuk Reliance on the underlying asset to generate returns and to recover the investment of Sukuk holders In case of non-payment, Sukuk holders can sell the underlying asset Asset-based Sukuk Sale of asset not “true” or perfected (recourse only in the event of a default) Reliance on the creditworthiness of the issuer or obligor Tradable Sukuk Sukuk that represent tangible assets or proportionate ownership of a business; can be bought and sold on the capital markets (e.g. Sukuk al-Ijara, Sukuk al-Musharaka, Sukuk al-Mudaraba) Non-Tradable Sukuk Sukuk that represent receivables of cash or goods; their sale would be like selling debt which is prohibited in Sharia (e.g. Sukuk al-Murabaha, Sukuk al-Salam)

Sukuk vs Bonds Sukuk Conventional Bonds Partial ownership of each holder in the asset Promise to repay a loan Profits based on returns from underlying asset and paid pro rata Fixed interest payments Issuer and Sukuk holders have a partnership relationship Issuer and holders in debtor-creditor relationship Requires asset backing Not required although some conventional bonds are backed by assets (e.g. receivables) A sukuk issuer shall be engaged in Shariah-compliant business activities. An issuer of conventional bonds is not limited in its business activities. Enjoys a wider investor base from both Islamic and conventional investors. Conventional bonds can only tap conventional investors.

Rapid Growth in Global Sukuk Market In 2001, global Sukuk issuance was around $1.2 billion, rising to $93 billion issued in 2011 The growth has been driven by several factors Increasing familiarity with Sukuk amongst investors High levels of liquidity in Islamic financial institutions Interest from non-Muslim countries Flexibility of Sukuk (no need to have an Islamic finance industry)

Role of Sukuk in Economic Development Usage Example Fiscal support Sudan: Over $100 million of Sukuk issued in 2012 to raise funds for the government Liquidity management Bahrain, Gambia and Brunei: Short-term Sukuk as tools of liquidity management Education Osun State, Nigeria: Local currency, sub-sovereign Sukuk issue ($62 million equivalent) for the construction and rehabilitation of 24 schools in 2013 Health World Bank, 2014: Global Sukuk for $500 million raised by International Financial Facility for Immunization to fund the supply of vaccines to some of the world’s poorest nations Infrastructure Saudi Arabia: Global Sukuk for $1.7 billion to finance electricity projects in 2010. Malaysia: Global Sukuk for $300 million to finance the Klang Valley Rapid Mass Transit Project

Challenges to the Development of Sukuk Markets Enhancing Regulatory and Supervisory Framework Developing Institutional Capacity and Market Infrastructure Strengthening insolvency/bankruptcy principles Promoting Standardization Rebalancing Tax Treatment (e.g. stamp duty) Ensuring adequate liquidity (prevalence of buy-and-hold)

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