Types and Structure of Sukuk
Sukuk are among the most recent products that are created using structural application in the Islamic financial markets. In order to design flexible securities that could respond to different financing needs of economic agencies in the capital market on one hand and to comply with Islamic principles and standards on the other hand, Muslim scholars started thinking about designing Islamic financial instruments. To this aim, expansive studies were conducted into Shariah-compliant contracts and their ability to be used as instruments so that to design financial instruments that would be able to replace bonds and preferred stocks, which are mainly based on Riba and loans with interests. Eventually, Sukuk was designed as an alternative investment instrument for securities with fixed returns such as bonds that are Hiram in the holy Shariah of Islam. After the successful implantation of the Riba-free banking, Muslim scholars managed to design different financial instruments based on Sharia rules and the actual needs of the Islamic countries. These instruments could be divided into three categories:
First, non-profitable financial instruments that are based on the interest-free contracts. Second, profitable financial instruments with specified return rates that are designed based on trade contracts.
Third, profitable financial instruments that are designed with expected profit rates based on partnership contracts.
Now we discuss the some of the fourteen types of sukuk with respect to different types
Ijarah Sukuk are related to leased properties and assets, they carry equal values, and are issued by the owner of the leased property or his agent. The aim of the transaction at the end is to sell the leased property through issuing Sukuk, accordingly, the holders of the certificates or Ijarah Sukuk own the asset and its charges during the rental period, each in proportionate to the certificates of Sukuk held in the leased asset. Under an ijarah contract, the usufruct of a particular property is transferred from the owner to another person in exchange for a rental payment. In other words, it is a leasing agreement with the lessor referred to as the mujir, the lessee called the mustajir and the rent paid to the lessor called ujrah. Sharia law imposes restrictions on ijarah agreements that are not present in conventional leasing contracts, largely to protect the parties as far as possible from uncertainty and to ensure there is no ambiguity in the agreement
For example, there might be a leased building, the monthly or annual income of which goes to the certificate of Sukuk holders who are considered as partners in the ownership of the building. In addition to the return from rent, the holder of Sukuk may sell the same in the stock market.
In particular the duty to repair and maintain the property being leased remains with the lessor as owner as if the lessee was liable this would introduce an additional element of uncertainty with respect to the costs to the lessee as maintenance payments could be regarded as an extra rental element. Expenses related to the operation of a leased asset are, however, the responsibility of the lessee, such as fuel in the case of a leased vehicle or aircraft, or fertilizer and seeds in the case of leased land. Where a leased asset is accidentally destroyed or its usufruct value reduced, as in the case of leased farmland during periods of prolonged drought, then ijarah contracts can be cancelled by the lessee, but in modern practice leased assets usually are insured against such contingencies. If lessees are negligent in using the asset, which results in a reduction or the complete destruction of its value, they may be liable to compensate the owner. In practice ijarah leasing agreements have many clauses that are similar to conventional leasing arrangements. Where payments are late, the lessor cannot impose a penalty, as any gain from this would represent an additional burden for the lessee and a gain for the owner that would be comparable to Riba. The lessee may be obliged to donate an amount to charity however, as recognition that there has been a delay in the rental payment. If no payment is made, then use of the leased asset will revert to the owner, and the lessee may still be liable for the rental payments stipulated in the original contract. As an ijarah contract is for a predetermined period, and as the rent provides a regular monthly, quarterly or annual income, it is clearly well suited to be covered by the issue of securities that have many of the characteristics of bonds. As ijarah bonds are securities representing the ownership of well-defined assets subject to a lease contract, they may be traded in a secondary market at the prevailing price determined by market forces. There can be many issuers of ijarah securities, including ministries of finance, central banks, municipalities, and authorities responsible for waqaf or religious endowments, investment banks, or public or private companies. Such securities have maturity periods of five years or more, although at present there are few issues running for more than 10 years. It is important to note that ijarah certificates or securities represent a proportionate ownership claim over a leased asset, and therefore those who hold the securities have ownership responsibilities that only terminate when the securities mature, or if they are sold to another party who then assumes the responsibilities.
2- Contractor’s Sukuk:
A contractor’s or a supplier’s Sukuk can be issued by a contactor or a supplier of a good or a service. The Sukuk could be for existing commodities or those which would be offered during a contracted time in future. These sukuk carries equal values issued by a covenanter to provide or sell services described in the security, such services are to sold in a form of sukuk, so that the holders of the same shall to be the owners of such services and shall gain the proceeds from selling the same in the markets. An example of that is to provide educational or health programs in universities or hospitals. The holders of sukuk contribute in financing such educational or health programs till they are ready for the demanding students or patients. The sales income of such programs for the beneficiaries is one fourth return to the sukuk holders.
3-Potential Services Sukuk:
These Sukuk carries equal values issued by a contractor (or a supplier) or an agent having
A saleable services to Sukuk holders and such holders shall have the right to sell the same
In the stock market.
4- Istisna’a Sukuk:
Project financing can be undertaken through an Istisna’a contract, whereby funds are advanced to pay for the supplies and labor costs by an Islamic bank. Once the project is Overview of the sukuk market Originally, Istisna’a was seen as an appropriate way of financing manufacturing as goods have to be produced and costs incurred before they are sold. To introduce sukuk based on Istisna’a a parallel Istisna’a contract is generally used whereby the financier enters a contract with a subcontractor who actually builds the facility being financed. To use Istisna’a, the public authority or private company commissioning the project provides details of the specifications and timing of the schemes. The financier then sets these out in the tender documents. Bids are subsequently invited from contractors who will specify how they intend to sell completed parts of the project over time and the amount of each payment instalment expected. These instalments will include an element of profit over the construction costs. As the financier is expecting a stream of payments over a specified period, certificates can be issued based on the income expected. It should be noted that as the deferred price certificates represent debt obligations they cannot be traded for cash at below face value in a secondary market. They can, however, be used to purchase goods or services whose price is equal to the face value of the certificate. The purchase price of the goods may be less than the deferred price as this represents a trading transaction. Permission to transfer the debt contract from the financier to a supplier of goods and services must be sought from the original debtor, the public authority or private company commissioning the project. Istisna’a is applicable on building and establishing ships, airplanes, bridges, roads, power generation stations, water supply stations and the alike according to a specific specifications stipulated in the contract and according to a pre-stated delivery date and value
5- Salam Sukuk
Sukuk or certificates of Salam carry equal values for mobilizing the capital necessary to produce some specified commodities contracted for deliverance at specified periods of time in future hike their value prices are fully paid in advance. A separate parallel Salam contract could be signed by the Salam item buyer with a third party, without linking it to the first contract. Ethically, the contractors should be committed towards their contract parties, and should not transfer their own responsibilities in a contract to their parties in another one.
6- Murabaha Sukuk
These Sukuk carry equal values and are issued by the merchant or his agent in order to finance the purchasing a commodity then to sell the same at a known Murabaha as for equipment’s required within an Istisna’a contract where the equipment’s shall be purchased on a known Murabaha and the holders of Sukuk will be the owners of such equipment’s and of the sales income from the same. Murabaha Sukuk Murabaha Sukuk are more likely to be used in respect of purchases of goods by the public sector. In case the government needs items of huge price, it may purchase them through credit sale by paying in installments. The seller will amortize his cost and return over the period of installments. Any ‘Murabaha Funds’ can also issue Murabaha Sukuk proceeds of which could be used for sale of assets on the basis of Murabaha to give quasi fixed return to the Murabaha Sukuk holders.
5. Zero-coupon non-tradable Sukuk
Another possible sukuk structure can be created where the assets to be mobilized do not exist yet. Consequently, the objective of the fund mobilization would be to create more assets through Istisna’a. However, certiﬁcates of this nature would not readily be tradable because of Shariah restrictions. The primary asset pools to be generated would be of a nature warranted by Istisna’a and instalment purchase/sale contracts that would create debt obligations. The certiﬁcate on these debt arrangements can be termed as ﬁxed-rate zero-coupon sukuk.
6. Musharaka Sukuk
These Sukuk carry equal values and are issued by the supplier (entrepreneur or a covenanter )or his agent, to finance a project or projects where the holders of Sukuk will be the owners of such projects, this is far similar to partnership companies although they might differ if the S Musharaka involves establishing a partnership or company to provide financing with the participants sharing in the profits in relationship to the size of their investment share Notes can be issued on the basis of such financing and both Sudan and Iran have launched such securities. Sukuk issuer is authorized to select the projects which are transferred and constructed.
7– Mudarabah Sukuk
Mudarabah has been most successful in the case of investment deposits with an Islamic bank where the return is calculated annually based on the bank’s profits. Certificates of deposit based on these Mudarabah deposits could be issued and traded, although this has not happened so far. It should be noted that holders of Mudarabah sukuk do not enjoy the same rights and benefits as equity investors as they are only entitled to a profit share and there is no provision for capital gains based on the market valuation of the company. This type of Sukuk, carry equal values issued by the contractor to provide the entrepreneurship and to manage the proposed project, for the purpose of financing such project or a combination of projects which are specified or those in which he is authorized to act upon. Thereby, the Sukuk holders shall be the owners of the capital of the project and the project shall remain a partnership between them and between the entrepreneur at an agreed portion of the profits and shall bear the expected losses in capital The Mudarabah stakeholders are not registered owners, and cannot attend or vote at the annual general meeting. On the other hand, although the value of their notes cannot be guaranteed.
Institutional Investor PLC shareholders rather than Mudarabah sukuk holders who are more likely to suffer from capital losses in the event of the company performing badly. In the case of bankruptcy the note holders will be in a higher position in the pecking order than equity investors, who are likely to lose all of their money. Mudarabah sukuk were first issued in Pakistan under an ordinance passed in 1980, with companies with a paid-up capital of at least PRs5 million allowed to offer such certificates. These enjoyed some limited success but the returns were disappointing, partly reflecting the weakness of the companies involved and, more generally, the poor performance of Pakistan’s economy. The Jordanian Ministry of Waqaf has issued Mudarabah sukuk, although there was some controversy concerning the guarantee of capital on maturity, and the Islamic Fiqh Academy recommended that this should be a voluntary commitment, referred to as Tabarru, rather than an absolute guarantee. Conventional banks in Egypt, notably Bank Misr, have also issued Mudarabah sukuk as one of their Islamic products, but there has been some concern about possible co-mingling of funds and the guarantees of the bond principal, which violate the Sharia principle of no reward without risk or effort.
8. Hybrid/Pooled Sukuk
The underlying pool of assets can comprise of Istisna’a, murabaha as well as ijarah. Indeed, having a portfolio of different classes of assets allows for greater mobilization of funds. Murabaha and Istisna’a assets can comprise a portfolio of funds. However, at least 51% of the pool must be made up of ijarah assets. Due to the fact the murabaha and Istisna’a receivables are part of the pool, the return on these certiﬁcates can only be a pre-determined ﬁxed rate of return.
The above-mentioned two types of sukuk would partially represent the strength of the issuer’s balance sheet.
9- Muzaraa Sukuk:
These Sukuk carry equal values issued by the owner of the agricultural land in order to finance the agricultural costs according to a Muzaraa contract where the holders of Sukuk become partners in the produced crops as per the terms stipulated in the contract
These Sukuk carry equal values, issued by the owner of the plants, the subject of the contract, in order to finance the processes of irrigation and cultivation, where the holders of Sukuk become partners in the produced crops as per the terms stipulated in the Musaqat contract.
11 – Musharaka Sukuk in Investment Agency:
These Sukuk carry equal values and are issued by an investment agent. They represent projects and activities, where the investment agent shall be appointed as a mediator who manages the investment on behalf of the Sukuk holders in consideration of a percentage out of the profits.
12- Mugharasah Sukuk (Planting):
These Sukuk carry equal values and are issued by the owner of the land subject of the contract for financing the costs of plantation under Mugharasah contract. The holders of the Sukuk shall jointly share the ownership of the trees planted together with the ownership of the land on which such trees were planted according to the contract.
13- Sukuk of Reducing Ownership:
These Sukuk carry equal values issued by the owner of the innovated idea, the subject of the contract, in order to finance a project pursuant to the establishment contract ending by transferring the ownership of the assets or services to the owners of the idea or to the founding after a specified period of time. The owners of the innovated idea shall be partners in the project either by employment (work), by capital or both together. i.e. the partner shall be an employee who entitles a wage against his work, or a partner by business who shall start paying for the value of the project to the holders of Sukuk out of 6his share in the profit in a manner reducing the number of Sukuk holders making him a partner with an increasing share, the more he is able to pay out of his share. Thus the shares of Sukuk holders diminishes, while the shares of the working partners increases ending to stage where the ownership of the assets and its associated services, the asset alone or the services alone in favor of the partners. This formula combines the limited period lease Sukuk for assets and services.
The above could be summarized as, funds would be mobilized for establishing companies that could be partially owned by the holders of the Sukuk certificates. Gradually, the Sukuk holders can buy the capital share of their partners in the company so that they entirely own the company, as per the agreed contractual conditions. The Issuance of Sukuk depends on conducting approved feasibility studies which explain the expected costs and returns, the payback period, to evaluated and classify the same by competent evaluation entities further to the other requirements which constitutes the pre-conditions of approving their issue by the competent authorities. The administration of Sukuk issuing process shall be organized through banks and financial and consultant institutions.