The global Islamic capital market, of which the Sukuk sector is the most important, is still reverberating from the recommendations of the Shariah Committee of the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) relating to current Sukuk structures and their issuance. One scholar reportedly said that 80% of current Sukuk structures are not Islamic, a statement which has unfortunately made the headlines the world over.
The developments stem from a meeting of the Shariah Committee of AAOIFI held in Bahrain in February 2008 which issued new recommendations regarding Sukuk structures and issuance especially relating to the ownership of underlying assets in a Sukuk transaction and the guarantee of the principal investment to Sukuk certificate holders. The immediate reaction of some bankers has been that the recommendations may put a dampener on the issuance of future Sukuk because of these extra ‘constraints’ and thus affect their future tradability.
The Sukuk market has been flourishing for the last decade or so, albeit it has gained momentum only in the last three or four years. The total outstanding issues in the global Islamic capital markets, including the Malaysian corporate and government issuances, is estimated at just under US$200 billion.
Sovereign issuances were spearheaded by the Malaysian Global Sukuk in 2002, the first sovereign issuance. Since then the sector has seen a number of sovereign issuances by Qatar, Bahrain and Pakistan; several from quasi-sovereign entities; some from international agencies including the Islamic Development Bank, the World Bank and its private sector funding arm, the International Finance Corporation; publicly-listed corporates; privately-owned corporates; and even the odd social Sukuk by religious councils such as the Singapore Islamic Religious Council (MUIS) securitising Waqf properties.
Thus far sukuk structures have comprised Sukuk Al-Salam; Sukuk Al-Ijara; Sukuk Al-Musharaka; Sukuk Al-Mudarabah; Sukuk Al-Intifa’a; Sukuk Al-Istisna and Sukuk Al-Murabaha. The majority of Sukuk structures are based on Sukuk Al-Ijara involving a sale-and-leaseback arrangement done through a special purpose vehicle (SPV). Musharaka Sukuk is also gaining in popularity although there has been some controversy relating to certain equity and risk-sharing arrangements.
The recommendations of AAOIFI’s Shariah Committee, headed by its President Sheikh Taqi Usmani, in a series of meetings in 2007 and the latest one in Bahrain on 13 and 14 February, 2008, are quite emphatic.
- Tradable Sukuk must represent ownership for Sukuk holders, with all of the rights and obligations that accompany ownership, in real assets, whether tangible or usufructs or services, that may be possessed and disposed of legally and in accordance with the Shariah. The manager of a Sukuk issuance must establish the transfer of ownership of such assets in its books, and must not retain them as its own assets.
- It is not permissible for tradable Sukuk to represent either revenue streams or debt except in the case of a trading or financial entity that is selling all of its assets, or a portfolio which includes a standing financial obligation such that debt was incurred indirectly, incidental to a physical asset or a usufruct.
- It is not permissible for the manager of Sukuk, regardless of whether the manager acts as an investment manager, or a partner, or an investment agent, to undertake to offer loans to Sukuk holders when actual earnings fall short of expected earnings. It is permissible, however, to establish a reserve for the purpose of covering such shortfalls to the extent possible, on condition that the same be mentioned in the prospectus.
- It is not permissible for the investment manager, partner, or investment agent to agree to purchase assets from Sukuk holders or from whoever represents them for a nominal value of those assets at the time the Sukuk are extinguished at the end of their tenors. It is permissible, however, to agree to purchase the assets for their net value, or market value, or fair market value, or for a price agreed to at the time of their purchase, in accordance with Shariah rules of Partnership and modern partnerships, and on the subject of Guarantees.
- It is permissible for the lessee in a Sukuk Al-Ijarah to agree to purchase the leased assets when the Sukuk are extinguished for their nominal value, as long as the lessee is not also an investment partner, investment manager, or agent.
- Shariah supervisory boards must not consider their responsibility to be over when they issue a fatwa on the structure of Sukuk. Rather, they must review all contracts and documentation related to the actual transaction, and then oversee the ways that these are implemented in order to be certain that the operation complies at every stage with Shariah guidelines.
Reports pointed out that there is an implicit rebuke to Shariah scholars in the AAOIFI recommendations that the Shariah governance process does not end with the issuing of a fatwa but must continue for the entire tenor of the transaction or the issuance, when the Sukuk issuances to date okayed for Shariah compliance were given the go-ahead by some of the very members of the AAOIFI Shariah Committee and wider membership.
The Sukuk debate once again raises questions about the very nature of Shariah governance in the Islamic finance sector. In too many markets, the Shariah advisory process is still ad hoc with hardly any control over who offers such advice. A registered and regulated Shariah advisory market as in Malaysia surely would lessen the propensity for such a free-for-all as we have seen in some markets.
On the other hand, some countries are following the Malaysian example of a National Shariah Council at the central bank, including Pakistan and more recently, the UAE.