What is Sukuk?
Sukuk is an Islamic financial debt instrument that allows an issuer to raise capital for the purpose of financing a project or business activities. Sukuk can be securitised and made available for investment in the public markets by both Muslims and non-Muslims.
According to the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), Sukuk are certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs (the right to use an asset) and services or (in the ownership of) the assets of particular projects or special investment activity. Sukuk may be tradable or not tradable according to the nature of the governing contract, or arrangement, as well as the nature of the underlying assets or business. (https://aaoifi.com/wp-content/uploads/2017/03/Sukuk-standard-with-BOC-v5-.pdf)
Hence, the key difference between Sukuk and conventional debt instruments is that Sukuk are structured to comply with Islamic Law. This will be explained in more detail below.
How is a Sukuk issued?
A Sukuk can be issued by a company or government. Companies issue Sukuk to raise financing for projects, business activities or general financing needs, while government agencies typically use the funds for significant initiatives such as developing infrastructure or developmental projects. There are various Sukuk structures such as Ijarah, Mudharabah, Wakalah, etc.
In a Sukuk structuring phase, issuers will opt for a Sukuk structure that fits their financing needs and bases it on the type of assets and business, desired tenor and return profile, target investor base, and regulatory considerations.
During the structuring phase, issuers will also determine whether the Sukuk will be listed on an exchange as a Sukuk may be a public offering or private placement.
How does a Sukuk comply with Syariah principles?
As an Islamic financial instrument, Sukuk have key differences from other debt instruments such as conventional bonds. Primarily, Sukuk follows Syariah principles, which typically require an investment to be backed by tangible assets such as real estate to represent partial ownership in the assets.
Sukuk investments adhere to strict rules that in turn offer higher transparency in their disclosures. The Issuer is obligated to make disclosures and announcements available to the public.
A Sukuk issuer must not be involved in activities that are prohibited such as firearms and weapons, interest related activities, pork, tobacco, alcohol, and gambling.
Interest payments (also known as Riba’) to investors are not allowed and deemed haram. According to the type of Sukuk agreement, investors are entitled to returns derived from the profits generated by the underlying assets or business activities. Inversely the risks of loss are also shared between issuers and investors, where degrees of risk-sharing in practice depend on the structure of the agreement.
Excessive uncertainty (also known as Gharar) is a broad concept that includes unclear or suspicious claims of ownership, uncertain existence, quality or characteristics of a commodity, pure speculation on an outcome with unshared risks, and even a lack of openness and information in a contract. Examples of this include gambling (Maysir), derivative transactions, or unclear terms in a contract. A Sukuk issuer is required to disclose accurate and complete information prior to fundraising and throughout the term of the Sukuk for the benefit of its investors.
In Brunei Darussalam, the Syariah Financial Supervisory Board (SFSB) has been established and mandated to ascertain the Islamic law on any financial matter, to issue rulings on matters referred to it, and to advise on any Syariah issues relating to Islamic financial business, activities or transactions.
What are the benefits of investing in Sukuk?
Sukuk appeal to those who prefer to make investments that align with the values of Islam. However, Sukuk investments also appeal to those of non-Muslim faith as it offers different value propositions from conventional bonds.
Investors may find it reassuring to know that their investment is backed by tangible assets, services, projects, or business activities that have real value. As an ethical financial instrument, it aligns with investors seeking Environmental, Social and Governance (ESG) investments.
Sukuk also gives the opportunity to its investors to share in the returns from any profits generated throughout its term and is generally known for being a stable investment. Typically, investors will receive their principal investment upon maturity (end of the Sukuk term).
What are the risks?
Sukuk investments also carry a fair share of risks for any investor. Such risks may include the risk of loss during the Sukuk term that is shared between the Issuers and investors. If the project underperforms and does not make a profit, then the Issuer and Sukuk shareholders will bear the loss together.
The value of the Sukuk may also increase or decrease according to the different performance or
economic factors. As it is a debt instrument, a Sukuk issuer can also default on its obligations, which
risks a decrease in its value.
A Sukuk may even be deemed non-Syariah compliant during its term if it fails to continuously adhere to Syariah principles. This may affect investor confidence causing its value to potentially fall.
While Sukuk are structured with the expectation that investors will receive their full principal investment back upon maturity (at the end of the Sukuk term), it may not always be the case as the Sukuk structure and agreement may provide different arrangements.
The issuer is responsible for ensuring that all risks are managed accordingly. At the same time, investors should always be aware of the activities in a Sukuk by regularly going through the disclosures and reports that are released during the investment term.
How should I approach investing in Sukuk?
A Sukuk issuer will release a prospectus with all the salient information about the Sukuk, including the principal terms, conditions, and risk factors related to the investment. Going through this document will ensure that you are well informed about the Issuer’s proposition to make a decision.
Furthermore, different Sukuk offer different term periods for investment, either short, medium or long term. Some Sukuk offer a term of 3 months and others may offer 1 year or even multiple years. From the offerings, you may want to gauge the length of time you are comfortable with before committing to an investment.
You may want to consider the type of Sukuk and the purpose it is raised for. Try to understand it and the risks as best as you can before committing to it as it may be a long-term Sukuk.
For additional guidance, the supporting industry participants in Brunei Darussalam are also strategically set up to educate and convey advice to you on financial matters. These include licensed financial institutions such as banks, securities firms, and financial advisory firms.
Disclaimer: the contents are for educational purposes only. We do not offer investment advice.
Consult a financial advisor before investing. Not for redistribution.