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Sukuk Definition and History

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  • Sunday, 12 June 2016 15:19

Historical background of Islamic instruments

The financial market is divided into money and capital markets; as a result, the financial instruments applied in these markets are divided into two groups of money market instruments and capital market instruments.

The first idea of Islamic financial instruments was raised in the mid 1970s, when the first Islamic banks in countries such as, Egypt, Saudi Arabia and Sudan made their debut and afterwards Islamic banking was established in Pakistan and Iran, too, which mainly focused on Riba-free banking.

In line with the development of transactions structures by the Islamic banks, the idea of Islamic financial instruments was also improved in the capital market.

The idea of issuing Ijarah certificates as the first Islamic financial instrument was brought up by Dr. Monzar kahf in 1997. Kahf considers the international sukuk issuances of Malaysia and Bahrain in 1999, as the debut of Islamic financial instruments.

Sukuk Definition

The term of “sukuk” for Islamic financial instruments was first suggested by jurisprudence committee of Islamic Development Bank in 2002. “Sukuk” is an Arabic word and plural of “sakk”, which means “cheque” in Persian or script of property ownership. Juridical standard No. 17 of accounting & auditing organization of Islamic financial Institution, have defined Sukuk as: "The certificate with equal nominal value after underwriting operation, confirms the payment of forenamed nominal sum in certificate by purchaser to publisher and their holder will become owner of one or more assets, the profit of assets or beneficiary of a project or a specific investments activity".

Differences between sukuk and the conventional bonds (Riba securities with fixed interest)Benefits of sukuk

 

Conventional Bonds

Sukuk

Asset ownership

Bonds don’t give the investor a share of ownership in the asset, project, business, or joint venture they support. They’re a debt obligation from the issuer to the bond holder.

Sukuk give the investor partial ownership in the asset on which the sukuk are based.

Investment criteria

Generally, bonds can be used to finance any asset, project, business, or joint venture that complies with local legislation.

The asset on which sukuk are based must be sharia-compliant.

Issue unit

Each bond represents a share of debt.

Each sukuk represents a share of the underlying asset.

Issue price

The face value of a bond price is based on the issuer’s credit worthiness (including its rating).

The face value of sukuk is based on the market value of the underlying asset.

Investment rewards and risks

Bond holders receive regularly scheduled (and often fixed rate) interest payments for the life of the bond, and their principal is guaranteed to be returned at the bond’s maturity date.

Sukuk holders receive a share of profits from the underlying asset (and accept a share of any loss incurred).

Effects of costs

Bond holders generally aren’t affected by costs related to the asset, project, business, or joint venture they support. The performance of the underlying asset doesn’t affect investor rewards.

Sukuk holders are affected by costs related to the underlying asset. Higher costs may translate to lower investor profits and vice versa.

 

There are several benefits in sukuk. According to some authorities, sukuk is considered as a bridge between money market and capital market. Major advantages of sukuk are as the followings:

1-       It increases the originator’s liquidity

2-       Sukuk can be used by corporates to achieve an optimum balance between debt and equity on their balance sheet.

3-       Although a part of originator’s assets is isolated, he can still use it.

4-       Since sukuk are issued based on assets, they reduces the risks and funding costs.

5-       It affects the capital market development by changing the assets to securities (securitization)

6-       Sukuk are tradable in secondary markets.

Sukuk background in Iran

SPVs Involved Sukuk Issuances in Iran Capital Market

The history of Islamic securities Issuance in Iran dates back to 1994 when Tehran Municipality issued 43 million USD participation paper (named as Musharakah Securities). The Law for the Issuance of Participation Papers was enacted by Iran’s Parliament in 1997.

Before passing The Securities Market Act (SMA) of the Islamic Republic of Iran in 2005, financial instruments in the Iranian capital market were restricted to only common stocks, share rights, depository receipts, and participation papers. Since enactment of the SMA in 2005 and The Law for Development of New Financial Instruments and Institutions in 2009, dramatic changes have taken place in the Iranian capital market such as establishing the Securities and Exchange Organization (SEO) as the sole regulatory and supervisory authority to the market, establishment of Shariah Board of the SEO as an unified and independent shariah governance body, establishment of new financial institutions and issuance of new financial instruments, to name but a few. The ratification of different kinds of Sukuk (such as Ijarah, Murabaha, Istisna, Standard Parallel Salam, Manfa’ah (Usufruct), mortgage-backed, and discounting debt sukuk by the Shariah Board, has made them prominent and dominant instruments for financing and investing. In essence, Sukuks have been used, applying different underlying assets such as tangible assets and financial assets (like stock as underlying assets of Ijarah Sukuk) to finance public and private sectors.

sukuk-issued-by-SPVs-in-Iran-Capital-Market

Apart from Participation Papers (Musharakah Securities), the first Sukuk was issued in the Iranian capital market on March 12, 2011, worth 297,500 million IRR to finance Mahan Air. The underlying contract was Ijarah and its structure was based on sale and lease back. Since 2011, the Iranian capital Market has witnessed 48 issuances of Ijarah Sukuk cumulatively worth 175,585,149 million IRR.

In addition, the first Murabaha Sukuk was issued on March 16, 2013, worth 301,306 million IRR. So far, Murabaha sukuk has been issued 18 times worth 85,945,306 million IRR cumulatively.

On March 6, 2018, Iran’s government issued the first Manfa’ah (Usufruct) Sukuk worth 30,000,000 million IRR. The structure has been used 9 times worth 222,000,000 million IRR cumulatively.

Mortgage-backed Sukuk which stems from Murabaha loans provided by different banks (particularly Maskan Bank that is a dedicated bank for housing loans) to their customers has been issued 3 times worth 8,087,205 million IRR as a means of financing for banks or corporations.

Regarding other Sukuk structures, Istisna Sukuk was issued only once on November 23, 2015, worth 54 million USD and asset-backed (Dayn) Sukuk was issued on June 18, 2019, worth 3.2 million USD.

Structural Break-up of Sukuk Issued by SPVs in Iran Capital Market

Besides issuing Sukuk in the capital market, there are some other Islamic instruments in the market such as Islamic Treasury Bills issued by the government to settle its debts to contractors. Actually, the government gives securities (called Islamic Treasury Bill) to contractors, whose amount equals what the government owes. Contractors can either hold them to maturity (at most for one year) or can sell it at discount in the secondary market. Contractors must not be part of the government (or affiliated to the government).

Although the Iranian Islamic Capital Market is dominated by the issuance of stock and Sukuk, there are always innovative ways to foster its development. Using Islamic contracts or combination of contracts to resolve needs of the market has emerged from the interaction between the SEO and the Shariah Board.

As an untapped market, the Iranian Islamic Capital Market enjoys plenty of unique potential to rival other Islamic markets in terms of diversity, depth, and return. Our market is promising for the entire Muslim and non-Muslim investors around the world to have a safe, secure, and high-yielding investment.