What is Sukuk?
Sukuk (Islamic bond or “Sharia-compliant” bond) is an Islamic financial certificate that represents the portion of ownership in a portfolio of eligible existing or future assets. They can be considered as an Islamic version of conventional bonds.
Sharia (Islamic law) prohibits lending with interest payments (riba), which is considered usurious and exploitative in nature. Thus, the bonds are forbidden in Islamic finance.
Sukuk does not represent a debt obligation. Upon its issuance, the issuer sells certificates to investors. Then, the issuer will use the proceeds from the certificates to purchase the asset, and investors receive partial ownership of the asset. The investors are also entitled to the profits generated by the asset.
Sukuk vs. Bonds
Sukuk is an alternative to the conventional bonds. Islamic and conventional bonds share the following characteristics:
- Investors receive a stream of payments: Conventional bonds provide investors with interest payments, while sukuk allow investors to receive profit generated by the underlying asset.
- Less risky investments than equity: Sukuk and bonds are considered less risky investments relative to equities.
- Initially sold by the issuers: Sukuk and bonds are initially sold by the issuers to the investors. Afterward, both securities are traded over the counter.
Despite the similarities, there are few important differences between Islamic and conventional bonds, as summarized in the table below:
|Ownership||Partial ownership of the asset||Debt obligation|
|Compliance||Complies with Sharia||Complies with country/region of issuance|
|Pricing||Based on the value of the underlying asset||Based on issuer's creditworthiness|
Issuing Process for Sukuk Certificates
The unique nature of sukuk requires a specific issuing process for the financial instrument. The following steps are common in the issuance process:
- A company that requires capital (referred to as the “originator”) establishes a special purpose vehicle (SPV). The SPV protects the underlying assets from creditors if the originator suffers from financial problems.
- The special purpose vehicle (SPV) issues sukuk certificates that are sold to the investors.
- The originator purchases the requires asset using the proceeds from the sale of the certificates to the investors.
- The SPV buys the asset from the originator.
- The SPV pays the asset sale proceeds to the originator.
- The SPV sets up the lease of the asset to the originator. The originator makes the lease payments to the SPV, which later distribute the payments among the holders as lease income.
- On the termination date of the lease, the originator purchases the asset back from the SPV at its nominal value. The SPV distributes the proceeds to the holders.
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