SS 17: Investment Sukuk

What this standard is about

Sukuk are often called Islamic bonds, but the standard treats them as something different. A sukuk is a certificate of equal value that represents an undivided share of ownership. What you own is a slice of real things: tangible assets, the right to use an asset (usufruct), services, or the assets of a specific project or investment activity.

This standard covers many types of sukuk. These include sukuk for ownership of leased assets, ownership of the right to use assets, ownership of services, and sukuk based on the contracts Murabahah (cost-plus sale), Salam (advance-purchase sale), Istisna'a (manufacturing order), Mudarabah (profit-sharing partnership), Musharakah (joint partnership), investment agency, and farming partnerships such as sharecropping (Muzara'ah), irrigation (Musaqat), and tree planting (Mugharasah). It does not cover ordinary shares of companies, fund certificates, or investment portfolios.

The standard explains the relationship between the issuer and the investors. The issuer sells the assets or offers the contract. The subscribers pay the subscription money, which is the purchase price. After subscription closes and the money is put to use, the certificate holders own the assets together. They share profits and bear losses in proportion to what they hold.

Why it exists

Before this standard, sukuk practices varied widely and some products paid fixed returns like conventional bonds. That raised doubt about whether they were truly Islamic. The standard sets clear conditions so that sukuk represent genuine ownership of real assets and income from those assets.

In 2008, AAOIFI issued a separate resolution (not part of this standard's 2003 text) saying that for sukuk to be tradable, holders must own the underlying assets with all rights and obligations of ownership. The manager issuing the sukuk must record the transfer of ownership and may not keep the assets as its own. This stopped "asset-based" structures where investors only had a claim on the issuer rather than ownership of the assets.

The key rules, simply put

• Sukuk must represent ownership of tangible assets, the right to use them, services, or the assets of a specific project — not a loan owed by the issuer.
• Sukuk backed by tangible assets, usufruct, or services can be securitized and traded freely on the market.
• Debts owed to the issuer (for example, unpaid Murabahah prices) may not be securitized for the purpose of trading.
• Trading of sukuk follows the rules that apply to the rights the sukuk represent.
• Sukuk holders share the return stated in the prospectus and bear losses in proportion to the certificates they hold.
• Each sukuk type must follow a contract recognized in Islamic law (Shariah) for both issuance and trading.
• Investment Sukuk must be kept distinct from shares and bonds: shares represent ownership of a whole company with no fixed end date, while sukuk represent specified assets and pay returns based on the assets' cash flow.

An everyday example

A railway company owns a fleet of trains that it rents out. It sells equal-value certificates to investors; each certificate represents a share of ownership in the trains. The investors receive a share of the rental income. If the trains earn more rent, investors get more; if a train is damaged, investors bear their share of the loss. Nobody is promised a fixed return, and nobody owes the investors interest.

Words to know

• Sukuk — certificates of equal value representing ownership shares in real assets or projects
• Usufruct — the right to use and benefit from an asset, such as renting it out
• Murabahah — a sale where the seller states the cost and adds a known profit margin
• Salam — a sale where the buyer pays in full now and receives the goods later
• Istisna'a — a contract to manufacture or build something to order
• Mudarabah — a partnership where one party provides capital and the other manages the work
• Musharakah — a joint partnership where partners share capital, profit, and loss
• Riba (interest) — any guaranteed extra charged on money, which Islam prohibits

Source

• AAOIFI Shariah Standard No. 17 — https://islamicmarkets.com/publications/investment-sukuk-scope-of-the-standard