Islamic Finance: Issues in Sukuk and Proposals for Reform

Mohammad Hashim Kamali, A.K. Abdullah

• Publisher: The Islamic Foundation
• Year: 2014
• Print ISBN: 9780860375517
• eBook ISBN: 9780860375784
• Topic: Theology & Religion
• Subtopic: International Economics

This collection of essays brings together leading scholars and practitioners to discuss contemporary issues in the rapidly expanding sukuk market, and frankly debates the challenges facing it since the 2008 financial crisis.

Highly recommended for practitioners, scholars, and students of Islamic finance.

Professor Mohammad Hashim Kamali is the founding chairman and CEO of the International Institute of Advanced Islamic Studies (IAIS) in Malaysia, and is a leading authority in Islamic jurisprudence, Islamic finance, and human rights in Islamic law.

A.K. Abdullah is an assistant research fellow at the IAIS.

1

The ‘Ping-Pong’ of the Asset-Backed/Asset-Based Ṣukūk Debate and the Way Forward

Faizal Ahmad Manjoo

Introduction

This article explores the underlying debate that is taking place posed by the fiqhī issue as to whether ṣukūk should be asset-backed or asset-based. In both instances there have been shock waves in the industry and the need to settle this issue is of paramount importance. Criticism has been levelled against issuers and investors alike. The reality is that we are dealing with a new mindset of the homo Islamicus compared to the homo economicus, in the words of Muslim economists. It would seem that the root of the problem is that ‘Islamic’ finance participants want to operate the industry with a ‘conventional’ mind. This research reveals that there is a need to adopt the asset-backed ṣukūk. However, despite the Accounting and Auditing Organisation for Islamic Financial Institutions’ (AAOIFI) pronouncement against asset-based ṣukūk in 2008, it is difficult to reverse the trend. Data have been collected to ascertain the various types of ṣukūk issuance. In addition, a qualitative analysis has been carried out to understand the underlying problems of a true sale and ‘purchase undertaking’, which are causing this jurisprudential havoc. It is hoped that this discourse will shed some light on the fiqh and legal aspects of the issues so that the ṣukūk industry can become more cautious, despite the cry for standardisation of contracts and products.

When the first ṣukūk was issued by Shell MDS in 1990 following the OIC resolution of 1988 approving the concept of ṣukūk,¹ the ṣukūk industry was still slumbering. Many sceptics did not realise its potential in the Islamic capital market and that ṣukūk would be viewed as a panacea for overcoming challenges in liquidity management. Various reasons explain why the ṣukūk market developed at a tortoise-walking rate. Primarily it was due to the intricacies linked to asset-backed securitisation, as discussed below.

The market developed fairly slowly until September 2001, when Bahrain issued its first sovereign ṣukūk, which gave a boost to the ṣukūk market and other successful issuances followed. Subsequently the market was quick to realise that ṣukūk could be used to forecast various trends in Islamic finance in general. Industry players discovered the potential for a relatively stable return compared with the share market. Ṣukūk filled a gap in the Islamic capital market by providing mid- and long-term investment vehicles that could be readily traded on the secondary market. Presently, the ṣukūk market stands at $100 billion, according to a report from the Saudi Gazette.² This achievement has been realised within 10 years of its existence and projections indicate exponential growth in the coming years.

As the need to lay down Sharīʿah and regulatory standards was felt, the AAOIFI issued further consolidated standards on ṣukūk in 2008. The Islamic Financial Services Board (IFSB) issued its Standard 7 in 2009, which differed from the AAOIFI Standard as it endorsed asset-based ṣukūk. The AAOIFI’s original Sharīʿah standard was not really heeded by the industry and most of the ṣukūk tended to be asset-based until 2007, when Sheikh Taqi Usmani, Chairman of the AAOIFI, blew the whistle by stating that the practice was not in line with Sharīʿah.³ The market responded immediately by coming to a near standstill. At the same time many wondered what went wrong. The debate was inflamed when investors took cognisance from the fact that the AAOIFI’s strong insistence on asset-backed ṣukūk was to bring some sanity into the market, especially after some big blows being inflicted on the market by cases such as Nakheel, Dar Investment and East Cameron Gas. In the interim, the market, which was mainly driven by Islamic institutions who wanted a pseudo-bond product, realised that ṣukūk were not bonds and that the problems had been created by two main issues:

1. The lack for the true sale of the underlying assets.

2. The purchase undertaking by the obligator.

We analyse these issues in the following sections.

Assessment of the Market’s Psyche

The fact that the market is driven by two forces – investors and the ṣukūk originators/obligators – creates a dichotomy. The originators want to raise money by replicating the conventional bond and to tap a different source of funds. They wish to raise money by issuing ṣukūk but retain ownership of their assets at the same time. This mindset was, and is often, inherent within bond issuers, as echoed in the East Cameron Gas case in the USA, where the originator refused to accept that the ṣukūk holders had ownership of the royalty in the exploitation of natural resources. The investors, on the other hand, are interested in the guarantee or protection of their capital investment and a fixed return. They do not really want to take the risk in the assets. So the asset-based ṣukūk seemed to be the ideal solution whereby the issuer keeps the ownership of his assets by not doing a true sale and camouflages the whole transaction with trust law, mainly English trust law, whe...

Table of contents

• Cover
• Title Page
• Copyright Page
• Contents
• Preface
• Introduction
• 1. The ‘Ping-Pong’ of the Asset-Backed/Asset-Based Ṣukūk Debate and the Way Forward
• 2. Unresolved Sharīʿah Issues in Ṣukūk Structuring
• 3. Ṣukūk: Perception, Innovation and Challenges
• 4. Ṣukūk and Bonds: A Comparison
• 5. Measuring Sharīʿah Compliance in Ṣukūk Ratings: A Survey of Existing Methodologies
• 6. Concession Rights as Underlying Assets for Ṣukūk
• 7. The Case for Receivables-Based Ṣukūk: A Convergence between Malaysian and Global Sharīʿah Standards on Bayʿ al-Dayn?
• Interviews
• 2. Raja Teh Maimunah – ‘Issues in the Prevailing Financial Architecture with Special Reference to Ṣukūk’
• Contributors’ Biographies
• Transliteration Table
• Glossary
• Index