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Monday, 4 August 2014

Institutions, individual investors can bank on sukuk structure

Since 2003, the global sukuk market has been experiencing a steady pace of growth. The Islamic finance assets could reach $1.35tn by the end of 2014. Ernst & Young predicts that Islamic banking alone will grow to $3.4tn by 2018.

Islamic finance has many modes of financing and provides several contracts that meet the needs of clients. Sukuk is one of the most important tools for banks and corporates to raise funds.

Sukuk in general may be understood as a Shariah-compliant ‘bond’. In its simplest form sukuk represents ownership of an asset or its usufruct.

The Accounting and Auditing Organisation 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.” It is necessary to outline the two main principles that govern sukuk as stipulated by the Shariah legal framework.

* Riba (interest) is a term that literally means an increase, premium or surplus.

* Gharar (speculation) is an Arabic term that means uncertainly, risk or hazard.

The global sukuk market, currently worth over $313bn, continues to drive the growth and development of the Islamic finance industry with $80bn sukuk issued this year (at the time of publication).

Notably, cross-border sukuk issuances are gaining momentum as both investors and issuers seek diversification.
The appetite and demand for sukuk remain and continue to outstrip supply by $230bn, while demand will grow to $936.79bn by 2018.

The UK government has just issued a £200mn sukuk, and new sukuk markets are opening up, with a number of countries working to finalise regulations to allow the issuance of sukuk.

Countries such as Morocco, Nigeria, Oman, South Africa and Tunisia have shown great interest in issuing sukuk in 2014, particularly to support and fund several infrastructure projects.

The sukuk instrument can be structured in a different contract or could be based on two different contracts such as:
Murabaha: This contact is similar to a deferred sale. The deferred price would include the cost price of the asset, plus a pre-agreed mark up.

Salam: Salam is based on an underlying forward financing transaction where the financial institution pays in advance for buying specified assets, which the seller will supply on a pre-agreed date.

Ijarah: The Ijarah is similar to a lease agreement in which the owner leases out an asset to a third party in return for a predetermined rental fee.

Istisna Sukuk: Istisna translates into an “order to a manufacturer to manufacture a specific good for the purchaser”. Under an Istisna, it is important that the price and specification of the good to be manufactured are agreed at the outset.

Musharakah: Musharakah is similar to venture capital financing.

Wakalah: The Wakalah structure is based on agency relationship between agent (Wakeel) and the principal (Muwalil).

Mudharbah: Mudharbah is an agreement between two parties, the lender (capital provider) and the borrower (entrepreneur).

Tenures of sukuk differ greatly by region, with GCC (Gulf Co-operation Council) corporate sukuk averaging tenures of between five/six years compared to Malaysia where the average corporate sukuk tenure stands around 10 years. GCC believes that there is little appetite for longer-term issuance.

Sukuk has many benefits for the financial institutions and the sukuk holders. For the financial institutions, it is part of liquidity management and balance sheet management.

For investors, it is a Shariah-compliant asset class that offers a lower level of risk and a predictable rate of return. It’s worth to mention that based on the sukuk contract, many types of sukuk could be tradable in the secondary market.

(Gulf Times / 02 August 2014)
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