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Wednesday, 2 July 2008

Kenya: Islamic bonds opening up new vistas in finance


Written by Cathy Mputhia

July 2, 2008: Islamic banks are constantly coming up with innovative products to cater for their clients’ diversified needs.

Last week, First Community Bank announced plans to introduce sharia bonds (sukuk bonds) to the Kenyan market, subject to regulator approval.

Sukuk bonds are those issued in compliance with Islamic banking principles, the main tenets being; the avoidance of interest, profit and loss sharing relationship between the customer and the bank and finally the avoidance of risk and speculation when undertaking investments.

Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) defines sukuk as being:

“Certificates of equal value representing after closing subscription, receipt of the value of the certificates and putting it to use as planned, common title to shares and rights in tangible assets, usufructs and services, or equity of a given project or equity of a special investment activity”.

Sukuk bonds like any other conventional bond, may be issued by either a sovereign state in which it becomes a sovereign sukuk, or by a corporate entity thus a corporate sukuk.

Sovereign sukuks have been used in Malaysia, Singapore and Qatar. In Pakistan, a sovereign sukuk issue financed road building.

Corporate sukuks on the other hand are issued by corporate issuers. In international financing, international sukuks have been issued across borders.

In the middle ages, Sukuks were widely used by Muslims as papers representing financial obligations arising from trade. Over the years their nature has been modified.

The main difference between conventional bonds and sukuks is that a bond is an obligation where the issuer is bound to pay bondholders on certain dates.

Undivided shares
However, in the case of sukuks the sukuk holder claims an undivided share in the underlying asset. Sukuks are mostly asset-backed issues. They have a variety of uses and may be either project specific, asset specific or balance sheet specific.

Project specific sukuks are issued with the aim of financing a project. The Qatar government formed an SPV (Special Purpose Vehicle), which issued a sukuk for funding construction of Hamad Medical City in Doha.

Asset specific sukuks are issued when the right to the underlying asset is sold to investors. In Bahrain, the Government issued a sukuk to fund extension of the airport.

The airport land formed the underlying asset and was sold to an SPV formed by the government and the SPV issued the sukuk. Sukuk structures are complex and largely depend on the nature of the transaction. They could either be mudaraba sukuks where a trust is established between the issuer and investor, a musharaka, which is equity based and where the certificate holders own the asset pro rata on their shares, ijara sukuks which have a rental nature, murabaha, salam, Istisna and hybrid sukuks. Each of them have a unique nature and therefore different legal documents are drafted in each case.

Islamic financing has become popular due to the ethical and moral principles which guide the relationship between the lender and the borrower.

The venture is also safer due to the application of the principle of risk avoidance. It is also in line with globalization, as a rise in demand for products has been witnessed internationally from both Muslims and Non-Muslims alike.

Mputhia is an advocate of the High Court of Kenya.

(Business Daily Africa)

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