Overview of Sukuk

BWFS 3013
ISLAMIC INVESTMENT

A202
 Topic Outline
◻ Securitization
◻ Bonds
◻ Sukuk
◻ Asset Backed
Securitization (ABC)
◻ Asset Based Securitization
(ABS)
 Introduction

◻ In normal conventional market, security is a document,

representing receivable amounts owed by the issuer in favour
of the holder
◻ Normally the amounts secured by a security are interests
bearing
loans
◻ Different bond represents different kinds of securities:
 Bonds issued by a company
 Bonds issued by a government
 Debentures (unsecured, not backed by asset, full faith of issuer, and
convertible)
 Certificates
 Notes
 Securitization

◻ Definition:
 “Issuing certificates of ownership, against an asset, investment pool
or business enterprise”
◻ If the securities represent the proportionate ownership of the
holder in illiquid or tradable assets, the trade of such
securities is permissible
◻ The sale of such security will be tantamount to the sale
of holder’s proportionate share in the assets
Securities from Shariah Perspective
Securities represents a loan or debt (such as bonds) cannot be
sold or purchased

If they are sold at a price higher or lower than their face value, it
is considered as riba

If they are purchased at their face value (bai al-dayn), this involves
gharar and hence are prohibited

However, securities may be assigned to a third party at par value

The difference between sale and assignment (al-hawalah) is

that transfer in al-hawalah is with recourse while transfer in
sales is without recourse
Benefits of Securitization

Originators Investors Capital Market

• Transforms relatively • Provides a variety of • The existence of
illiquid assets into liquid product choices at secondary
and tradable capital attractive spreads that securitization
market instruments attract a diversified markets for
investor profile benchmark purposes
• Cheaper financing costs
due to higher rating via • Allows investment • Facilitates and
credit enhancement products to be tailored encourages efficient
• Allows diversification of to meet specific allocation of capital
financing sources investor needs
- variety and flexibility of • Reduces risks within
• Facilitates removal of credit the banking system
- maturity and payment
assets from the structures
originator’s balance
sheet
Bonds

Bonds which is one of debt Instruments – are promissory notes that are
traded in the market

Bonds are categorised by

Issuer Tenor Coupon type

Types of Bonds

Types of bonds (by

issuer):
Government Corporate
Long Term Govt Bond Corporate Bonds
Short Term Treasury Bills Commercial papers

Types of bonds (by

tenor):
Callable bond Convertible bond
Callable by issuer at a predetermined price before maturity. Investor is Allows holder to redeem at face value or convert it to a
normally paid higher than straight bonds predetermined number of stocks

Types of bonds (by coupon type):

Interest
Zero coupon bonds
Coupon bonds Can be fixed or floating. Floating interests are
determined in reference to say KLIBOR + x%. If KLIBOR
Pay periodic interest based on coupons Pay no interest on maturity but only the face
value. The purchaser will buy at discount. is 10% and x is 2 then for a bond of RM1000 the interest
is RM120
Sukuk

Islamic
Sukuk Jurisprudence AAOIFI
Council

Sukuk (plural) and sakk “Any combination of

(singular) means legal assets (or the usufruct
“Investment Sukuk are
instrument, deed, and of such assets) can be
certificates of equal
check represented in the form
value representing
of written financial
undivided shares in
instruments which can
ownership of tangible
be sold at a market
assets, usufruct and
price provided that the
services or (in the
composition of the
Referred to any ownership of) the assets
group of assets
certificate representing of particular projects
represented by the
a contract or conveyance or special investment
sukuk consist of a
of financial rights, activity”
majority of tangible
obligations, or money
transactions that is assets”
Standard 17(2)
Shariah compliant
What are Sukuk?

The origin of sukuk can be

Sukuk refers to an Islamic
traced to the Middle Ages
investment certificate, which
whereby sukuk were largely
Sakk is believed to be the allows investors to have rights
used by Muslims during
source root of the European of ownership of the asset,
Umayyad caliphate as
Check including the cash flow and
papers representing
risks associated with such
financial obligations
ownership
originating from trade and
other commercial activities

First sukuk was issued by

Shell MDS Malaysia in 1990
Sukuk offers risk diversification Sukuk are asset-backed, followed by Majlis Ugama
for Investors for their tradable, and Shariah Islam Singapura (MUIS) in
portfolios. compatible trust certificates 2001. Global corporate
sukuk by Guthrie in 2001
Securitization and Sukuk

In the modern Islamic

perspective, sukuk lies
in the concept of Its great potential is in
asset monetization – transforming an
or also called asset’s future cash
securitization - that is flow into present cash Sukuk may be issued
achieved through the flow on existing as well as
process of issuance of specific assets that
sukuk may become available
at a future date

Tawriq Tasnid Taskik

• Means to render • Means the • Means the process of
something into cash transformation of dividing assets into
illiquid debts papers (sukuk) or
• It is about transforming into negotiable certificates.
a deferred debt for papers (sanadat)
the period between • Securitization of assets
the establishment of into papers,
the debt and the securities, or
maturity period into certificates with the
papers, which can be features of liquidity,
traded in the tradability, and cash
secondary market equivalence
Securitization and Sukuk
◻ The funds raised through the issuance of sukuk should be
applied to investment in specified assets rather than for
general unspecified purposes
◻ This implies that identifiable assets should provide the basis for
Islamic bonds
◻ Since the sukuk are based on the real underlying assets,
income from the sukuk must be related to the purpose for
which the funding is used
◻ The sukuk certificate represents a proportionate ownership
right over the assets in which the funds are being invested
◻ The ownership rights are transferred, for a fixed period
ending with the maturity date of the sukuk, from the original
owner (the originator) to the sukuk holders (IFSB, Jan. 2009)
◻ SC defines sukuk broader to represent the value of any asset
 Reasons for Issuing Sukuk

Governments or corporates are The funds collected also serve

able to raise funds for their the purpose of liquidity
working capital or project management for financial
Growing demand from investors financing for infrastructure and institutions and individuals
to place their funds in accordance development projects under a undertaking Shariah compliant
with Shariah compliant Shariah compliant framework business because it complies with
principles. instead of debentures or loans their internal monetary and
with high interest rates. regulatory policies.

Sukuk are a means for the

To facilitate the development of
equitable distribution of wealth
the local, regional, and global
as it allows all investors to
sukuk market, and to tap into a
share returns from the true
wider investor base.
profits generated from the
asset.
Sukuk vs Bonds
Sukuk Definition Bonds
• Sukuk are financial Underlying Asset • Bonds are proof of debt and
certificates representing not a share of ownership in
beneficial ownership of real the asset
assets • It is a debt obligation from
• It gives the investor the issuer to the bond
proportional beneficial holder
ownership in the asset on
which the sukuk are based
• The asset on which sukuk Issuer Representation • Bonds are issued to finance
are based must be tangible almost any purpose that
and in compliance with complies with local
the Shariah and Islamic regulatory legislation
principles
• In sukuk, the issuer is not a Issue Unit • Bonds are debts, whereby
borrower, but can either Issuers are the borrowers
be: from the investors (bond
• A buyer in a sale contract; holders)
A lessee in a lease
contract; Or a partner in a
partnership contract
• Each sukuk represents a • Each bond represents a
share of the underlying share of debt
asset
 Sukuk vs Bonds
Sukuk Bonds
The face value of sukuk is Issue Price The face value of a bond price
based on the market value of is based on the issuer’s
the underlying asset creditworthiness (including
it’s rating)
Returns are termed as Returns Sharing Returns are termed as
dividends and will depend on coupons
the underlying Shariah contract Bond holder's returns can be
used ascertained and they receive
Sukuk holders receive a share regularly scheduled (and
of profits from the often fixed rate) interest
underlying asset (and accept payments for the life of the
a share of any loss incurred) bond regardless of Issuer’s
The amount of profit cannot be loss or gain
ascertained, it could be fixed
or vary as it is based on the
sharing of profit and loss
The capital is not guaranteed Capital Guarantee The bond principal amount is
for sukuk holders guaranteed upon and
Upon maturity, Sukuk is payable upon maturity date
valued based on the market
value, a pre-arranged figure
(agreed upon by the two
parties) or a fair value
Sukuk vs Bonds

Bond Item Sukuk

Short, Medium and Long Term Tenor Short and Med-Term (≤5 yrs)

Debt Financing Category No debt but ownership of

specific asset
and its cash flows
Not necessary, unless Underlying Asset Necessary underlying asset,
collateralized usually tangible asset
Fixed in time and amount Claim Ownership claim on specific
asset and its cash flows
Depends on rating, yield Pricing Use of indicative yields-
environment, and benchmarked on reference
demand (book-building) rates
Fixed income Total Returns No guarantee in returns
(known/predetermined cash
flows)
Unrestricted Funding Purpose Restricted for use in Shariah
compliant assets, in a
predetermined manner
Sukuk Payment Structures

Generally, the payments of sukuk

are structured in two forms:

Amortizing Securities or Amortizing Non-amortizing securities or non-

Sukuk amortizing sukuk

The payments of the derived profits

(fixed or floating) are made periodically
The payments represent the
during the tenure of the sukuk,
amortizing of the invested capital
together with the profits (fixed or While the payment that represents the
invested sum is scheduled at the end of
floating) derived from the investments period i.e. at the final maturity date
of the sukuk
Sukuk Payment Structures

◻ However, there have been innovations whereby the

redemptions to the sukuk are in the form of exchangeable
such as equities or commodities
◻ In the case of exchangeable with equity, the periodic
payments to the sukuk could be in the from of the dividend
income stream paid to the equity
 Risk in Sukuk
SUKUK- RISK RISKS
Macro risks Risk in macro environment
Credit/
counterparty risk Risk of non-repayment
Liquidity risk Risk arising from thin trading
Market/ price risk Risk due to fluctuation of price
Inflation risk Risk from loss of purchasing power
Foreign exchange
risk Risk arising from changes in exchange rate
Interest rate risk Risk arising from change in asset value
Shariah
compliance risk Risk arising from non-compliance
Tradability of Sukuk

Tradabl Based on the Tradable sukuk are

very essential for
underlying tangible
The sukuk can be e assets or Islamic financial
institutions to enable
classified as Proportionate
them to manage
Non- ownership of a
business or
their short-term
liquidity
investment portfolio
requirements

tradable
Tradable Sukuk

AAOIFI Shariah Standard (17) on Investment Sukuk

• Sukuk, to be tradable, must be owned by sukuk holders, with all rights and
obligations of ownership in real assets, whether tangible, usufructs or services,
capable of being owned and sold legally as well as in accordance with the rules of
Shariah
• The manager issuing sukuk must certify the transfer of ownership of such assets in
its (sukuk) books and must not keep them as his own assets

AAOIFI Shariah Standard (21) on Financial Papers

• Sukuk, to be tradable, must not represent receivables or debts, except in the

case of a trading or financial entity selling all its assets or a portfolio with a
standing financial obligation, in which some debts, incidental to physical assets
or usufruct, were included unintentionally, in accordance with the guidelines
mentioned in
• As per AAOIFI Sukuk based on ijarah, istisna’, mudharabah, or musharakah
principles are tradable. Non-tradable sukuk represent receivables of cash or goods.
For example, sukuk of salam or murabahah are non-tradable sukuk
Tradable Sukuk

In Malaysia, as per the resolution of the SAC of the SC, bay

al- dayn is permissible and it must be made in cash

It recognizes:

Bay al-dayn or debt trading as one of the

This enables
acceptable principles for sukuk issuances tradability of debt and
equity based sukuk in
the secondary market
Shariah-compliant cash receivables arising from
contracts such as murabahah, bai' bithamin
in accordance with
ajil (BBA), ijarah, or istisna’ are converted Shariah principles
into tradable debt instruments
Sukuk Structure

From Shariah perspective, Islamic financing should only be raised for trading in
specified and identified Shariah compliant assets
Issuance of Sukuk must be supported by an underlying asset

In general, trading of indebtedness is prohibited, unless it is traded at par

Malaysia – Trading of indebtedness is permissible

Middle East and some other jurisdictions - Only at any value provided the underlying contract is
allow debt trading at par Shariah e.g. Bai’ Bithaman Ajil/Bai’ Dayn

Return for investment in sukuk in most cases are linked to cash flows and
performance of underlying assets
Factors for considering a Sukuk
structure

Economic Level of debt

objectives of Availability that the
the Issuer of assets company has

Tax
Credit rating Legal implication
of the framework of a structure
Issuer
Definition of Assets

Under Shariah, the assets must

meet the necessary conditions:

Must exist physically (land, building,

machinery);

Must be pure;

Must have beneficial usage (however

restricted to halal use and not for example
for operations of casino or alcohol sales
outlet);
Must be owned by the seller;

Must be free from encumbrances;

Must be known by specifications,

descriptions, location etc.
Sukuk Must Comply to the
Underlying Shariah Principles
Funds raised must be used for Shariah compliant (halal) activities

Fund raised may be used to finance needed tangible assets. Specificity of assets is important,
since Sukuk unlike conventional bonds cannot be used for general financial needs of the issuer

Income received by sukukholders (investors) must be derived from the cash flows
generated by the underlying

Sukukholders have a right to the ownership of the underlying asset and its cash-flows

Clear and transparent specification of rights and obligations of all parties to the transaction,
in particular the originator (customer) and sukukholders

No fixity in returns
Shariah Contracts Underlying
Sukuk
Sukuk can be structured in different ways depending on the underlying contract

A sukuk can be structured based on any or a combination of two or more, of the

Islamic contracts of transactions such as
The contracts of exchanges (uqud mu’awadat)
The contracts of participation (uqud ishtirak) of such as bai’ bithamin ajil, murabahah,
mudarabah and musharakah salam, istisna’a, and ijarah

The application of these contracts of transaction results in the sukuk backed or

secured by such assets, thus having an in-built security to the investments.
 Type of Sukuk,
Characteristics, and
Underlying Contracts
Type of Sukuk Characteristics Underlying Contract
Pure ijarah Sukuk ∙ Issued on stand-alone assets identified on Ijarah
the balance sheet
∙ The rental rates of returns on these Sukuk can
be both fixed and floating
Hybrid/Pooled Sukuk ∙ The underlying pool of assets can comprise of Istisna’, murabahah
Istisna’, Murabahah receivables as well as receivables, and ijarah
Ijarah
∙ The return on these certificates can only be
a predetermined fixed rate of return
Variable Rate Redeemable ∙ Redeemable in nature Musharakah
Sukuk or Musharakah Term ∙ Has relatively stable rate as compared to
Finance Certificates (MTFCs) dividend payouts
∙ The floating rate of return on these
certificates would not depend on
benchmarking with market references such
as LIBOR but would instead be contingent on
the firm’s balance sheet actualities
Zero-coupon non-tradable Sukuk ∙ The primary asset pools to be generated Istisna’
would be of the nature warranted by istisna'
and installment purchase/sale contracts
that would create debt obligations
∙ Non-tradable
Embedded Sukuk ∙ These could be Sukuk whether zero- Pure ijarah or hybrid
coupon, pure-ijarah, or hybrid
∙ Has embedded option to convert into other
asset forms depending on specified conditions
Asset Backed Securitizations

◻ Asset Backed Securitizations create new opportunities to

popularize mudharabah or qiradh, and/or musharakah
contracts
◻ Ability to ring-fenced risks with more secured contracts such
as ijarah, murabahah, salam or other compounded contracts
of exchanges, whereby;
 Risks mitigated through secured cash-flow streams and with lesser
operational and credit risks,
◻ More shariah compliant due to Special Purpose Vehicle involved
in direct investments or business activities – avoidance of bai’
al-dayn issues
 Special Purpose Vehicle
in Sukuk Structure
Special Purpose Vehicle (SPV) is normally established based on the
common law distinction between legal and equitable
right/ownership
SPV is considered to assume legal
A split is thereby caused to the concept of If he is truly to be considered as a true
ownership (right as recognized by court of
ownership as a result of which the owner as per the Shariah provisions that
law) of the underlying asset used in sukuk
beneficiary is not empowered to take or will give him several rights that include
or securitization for the benefit of the
assumed all rights as an established owner right of free disposal and possession
beneficiary (whose interest or right is
of the asset as is required by Shariah law without restriction.
recognized by the court of equity)

Characteristics of SPV

Formed for specific purpose; no Do not add to the cost of

Bankruptcy remoteness Thinly capitalized transaction; capital and tax
other activities undertaken
efficient
 Asset Backed Securitizations

SPV 7
Subscription for Certificates ($)

(Mudharib)
1

Expenses for meeting

4

requirements
operational
Direct Investments
Mudharaba through ijarah,
or Musharakah murabahah or other
Certificates real estate businesses or
trading activities
2
5
6
Pool of Investors Cash-flow stream ($)
(Rabb al Mal or Musharkah
Partners) Profit Distribution
Asset Backed Securitizations

3.
3a.
2.
Originator SPV Investors
4.
1.

1. Sale of asset to the SPV – True Sale

2. SPV issues asset-backed securities to investors
3. Proceeds from the sale of ABC go to the
Originator
4. (Interest) & principal repayments to Investors
Asset Backed Securitizations

True sale – legally belong to SPV

Non-recourse sukuk/ABS - credit

risk performance is determined
solely by underlying asset

Islamic Asset SPV – bankruptcy remote

Backed Sukuk (independent)
adds a new
dimension to ICM Correspondence of income
streams with actual income and
products value of the assets

Ratings are primarily dependent on a

risk analysis of the assets or
performance of assets

Unilateral purchase undertaking

(if any) – at market value
Asset Based Securitizations
◻ Majority of sukuk issued has been on simple ijarah structure –
unsecured financing or known as asset based securitization
◻ Originator seeking financing “sells” the assets to SPV for a
value equals to financing required and lease it back
 SPV – subsidiary of originator
◻ Lease payments provide fixed income stream which may
be benchmarked to an index/LIBOR
 Asset Based Securitizations
◻ Conducted on non true-sale basis so repayment and
risk/performance is not asset backed but originator
based
◻ Purchase undertaking of asset at maturity with predetermined
value
◻ Ratings are primarily dependent on the riskiness of
the borrower/sponsor/originator/lessee
◻ Assets only used to facilitate Shariah compliance
Asset Based Securitizations
◻ Based on Ijarah:

Sukuk
Sale of asset Sukuk
Sukuk
Sukuk proceeds
Sukuk
Sukuk proceeds
Originator SPV

Asset repurchase
Periodic payments:

Lease & repurchase Lease flows and principal (via

payments for amortisation/repurchase)
assets
◻ Non-true sale – condition to repurchase at maturity
◻ Payment of rental/profit can be derived from ijarah or other
sources
Asset Based Securitizations
◻ There are also structures of sukuk ijarah under an asset
backed scenario
 True sale, though
 The ownership of the SPV is transferred to the originator or the
lessor at the end of lease. Original underlying sale has been true
sale.
Asset Based Securitizations

Investors Asset Provider

2.

Certificates
of 3. Sale & Purchase
Investments of Asset (payment
of asset acquisition
1. Cost US$) Asset
Offer for Sale
of
securities

$ SPV 4. Transfer of Ownership

of
Asset to SPV

1st Transaction: SPV and Asset Provider Step 1

1st Relationship: SPV and Investors

Creation of Sukuk al Ijarah

Asset Based Securitizations

SPV Project Owner

1. Execution of al
ijarah
contract

2. Rental of Asset on fixed term and

fixed rental basis

ASSET

Ijarah Rental
Obligation
3. Issuance of ijarah rental Obligations Promissory Notes to Certificates
SPV implying cash flow stream on asset. (evidence of obligations)

Step 2
Asset Based Securitizations

1.Regular Ijarah
Rental
SPV Payments Project Owner
3. Final Repayment
Representing Total
Settlement equal to
Initial Purchase
Price Of Asset by
SPV

5. Asset transferred to Project

Owner

Asset

Investment
Certificates
2. Scheduled Distributions of Coupon Payments to Holders
Holders Of Investment Certificates issued by SPV
4. Payment of Final Amount being final settlement
of Obligations under Ijarah Contract
Asset Based Securitizations

◻ Assets purchased by the SPV are funded by the

issuance of floating rate Trust Certificates,
representing beneficial ownership in the assets, and
having beneficial rights on the lease;
◻ Upon maturity of the lease, SPV sells asset to the
project owner at the original price
◻ Proceeds from this sale will be utilised to
meet the final payment to investors
 Asset Based Sukuk vs. Asset Backed
Sukuk
Asset based Sukuk Asset backed Sukuk
Ownership Legal ownership with right to No right to dispose of the underlying
dispose of asset

Process Securitization of receivables Securitization of tangible assets

Character Debt-like Equity-like

Sources of Market driven mainly depending Mainly based on the strength of the
on originator/issuer credit asset cash flow
payment
rating/standing
Rating Corporate rating of issuer/obligor Strength of cash flow

Issuer Company SPV

 Sukuk Valuation
• Sukuk valuation process uses the same process as bond valuation

• The theory behind conventional bond pricing is to calculate the

present value of future cash flows

• In bond, the cash flows are periodic interest payment and

redemption of principle

• Sukuk also involves profit payment and redemption of principle

• At this point, the same bond pricing formula can be applied for
sukuk pricing as well
Sukuk Price (Valuation)
Yield to Maturity
Bond/Sukuk Price
Bond/Sukuk Price
Summary
Securitization

Bonds and
In this Sukuk
chapter
Asset Backed
you have
Securitization
learned
about: Asset Based
Securitization
Sukuk Valuation
Thank you