What Is a Sukuk?

What Is a Sukuk?

Let me explain what a sukuk is. Sukuk are Islamic financial certificates that work much like bonds in Western finance, but they stick to Sharia principles. Instead of dealing with interest-bearing bonds, sukuk let you sell certificates to investors, giving them partial ownership in an asset bought with those funds.

The issuer agrees to buy back these certificates at a set future date and at face value. This setup lets you do debt financing without interest, tying your returns directly to how a real asset performs.

Key Takeaways

You should know that sukuk are Sharia-compliant tools similar to bonds, but they give you ownership of an asset, not a debt promise. They've gained traction since starting out, thanks to Islamic law banning interest, or riba, which rules out regular Western bonds for Islamic investors.

As a sukuk holder, you get returns from the profits of the underlying asset, unlike bondholders who collect fixed interest. The most typical sukuk are trust certificates, using an offshore special purpose vehicle to handle the investment.

Sukuk's value ties to the backing assets' performance, so they can appreciate if the asset value rises, unlike bonds that depend on interest rates.

The Growth and Mechanics of Sukuk

Since Malaysia issued the first sukuk in 2000, these Sharia-compliant instruments have taken off. Bahrain followed in 2001, and now Islamic companies and government organizations around the world use them, claiming a bigger slice of the global fixed-income market.

Islamic law forbids riba, which is basically interest as we know it in the West. That means traditional debt tools aren't options for raising capital or investing if you're following Sharia. Sukuk get around this by connecting debt financing returns and cash flows to a specific asset you're buying, sharing the benefits of that asset.

This way, you can follow Sharia and still use debt financing, but remember, sukuk only work for tangible assets. So, sukuk give you undivided shares in ownership of a real asset tied to a project or investment. As an investor, you own part of the asset, not a debt from the issuer, and you get income from the asset itself, not interest payments.

Comparing Sukuk and Traditional Bonds

Sukuk and traditional bonds have some overlaps, but key differences set them apart. Both give you payment streams as an investor, and they're issued to raise capital for a company. They're generally safer than stocks.

With sukuk, you receive periodic profits from the asset, while bonds pay out interest regularly. But sukuk involve owning the asset, whereas bonds are just debt obligations. If the sukuk's backing asset goes up in value, so can the sukuk, but bond yields stick to their interest rate.

Sukuk assets are halal, meaning compliant with Sharia, while bonds often involve riba and might fund non-compliant businesses or speculation. Sukuk get valued based on their assets, but bonds rely mostly on credit ratings.

Example of Sukuk Structures: Trust Certificates

The most common sukuk type is the trust certificate, governed by Western law but with a detailed structure. If you're the organization raising funds, you first set up an offshore special purpose vehicle (SPV). This SPV issues trust certificates to qualified investors and uses the proceeds for a funding agreement with you.

In return, investors get a share of the profits from the asset. Trust certificate sukuk only work if you can establish an SPV in an offshore spot that allows trusts. If that's not feasible, you can structure sukuk as an alternative civil-law setup.

In that case, you create an asset-leasing company in your home country, which buys the asset and leases it back to you for financing.