Sukuk: Introduction and Current State of Play
Rayenda Brahmana
This afternoon (9 April 2009) I went to a talk show that held by School of Management, University of Science Malaysia. It discussed about Sukuk or Islamic Bond. The speaker was Muhammad Zahid Abdul Aziz, an expert in Islamic Finance. Muhammad Zahid Abdul Aziz is the Director and Owner of Muamalat Financial Consulting Sdn Bhd. His career started as an auditor and investment banker. Nowadays, he and his company are well known as consultant in underwriting of Islamic Finance product.
The seminar is fairly shocking. As a person who does not know much about Islamic finance, I got new information. First phase, he described about Islamic finance and Sukuk. I just knew that Islamic Bond (Sukuk) already established in Germany, China, and Japan. Then, he described the current state of play in Middle East (because he worked there for many years).
Islamic Capital Market, itself, is not a new object in finance. It already established around 40 years ago. Thus, it was forgotten. Islamic Capital Market is a market that the transaction, operation, and services comply with Islamic rules.
Islamic Capital Market has to be free from 4 main items, which are (1) activities prohibited by Islam, (2) Usury or Riba, (3) Gambling or Maysir, and (4) Ambiguity or Ghahar.
First, there are lot of sukuk types. Because Sukuk is lay on one of Islamic Instruments and indeed can be structured in different techniques. There are Sukuk Salam, Sukuk Istisna, Sukuk Mudharaba, Sukuk Musharaka, etc. In Malaysia, as presented by the speaker today, there are Sukuk Isthimar (Investment), Sukuk Ijarah (leasing), and Sukuk Musharaka (Joint Venture).
Sukuk Ijarah is based on Ijarah concept. Ijarah in conventional finance is leasing. It means selling benefit or to use or service for a fixed price. Sukuk Ijarah is issued to finance the Ijarah transaction.
There are also Sukuk that based on Musharaka. This sukuk was very well known in Islamic Finance until February 2008. As we all know, the investor is always conservative; thus wants higher return. This kind of investor who always plays in conventional finance does not want to have risk sharing. Then scholars found a new way to attract investor. Scholars were re-engineering the sukuk musharaka to find the fixed rate and of course still in the Islamic Finance path. Scholars added LIBOR as another gain that investor can get. The latter, this situation creates debates.
As I note from the speaker, all the transaction involves agents and SPV (special purpose vehicle). The reason is to avoid debt trading. Further, the interest rate that applied in Sukuk is based on Internal Rate of Return. Actually, I want to ask about IRR but due to time I could ask him today. In my point of view, IRR is a concept of Time Value of Money including uncertainty (Ghahar) and of course, Riba. I do really want to know about the IRR concept in Sukuk.
The main point is every transaction in Islamic Finance has to follow Islamic Rules. It is also applied in Sukuk. The basic and important “criteria” in Sukuk are (a) asset must be clearly owned by sukukholders, (b) Objection in debt trading, (c) Not allowed to restructure bank facilities, (d) not permissible to structure Price undertaking (including taking collateral).
The seminar was not only talking about Sukuk, but also about Islamic Money Market products. It discussed Islamic Medium Term note (IMTN) and Commercial Paper (ICP). IMTN, similar with conventional MTN, has maturity from 1 up to 7 years. It based on Murabahah. FYI, Murabahah is a concept where the sale of goods at a price which includes a profit margin agreed to by both parties. IMTN is almost similar with rent-to-own agreement. IMTN has to be private placement basis. In other hand, ICP has to be tender and underwritten basis. It has less than one year maturity. ICP is also based on Murabahah.
Information that I can also “extract” in the seminar was about the Credit Card. Islamic card must based on Bai Al – Inah. Bai Al-Inah is sale and buy-back agreement. The most shocking information that I can acquire in the seminar is “Islamic Finance is part of Islamic Economics. Islamic Economics can run well if the country also applies Islamic Law. Thus, the problem is….Not every Islamic Country applies good Islam Law due to politics, even in Middle East”. Then, I remembered with a proposal defense in School of Management by Fareed M Alyagout from Saudi Arabia. Fareed told the examiner that in business, Saudi Arabia applies different business law. Saudi Arabia has two courts to intermediate business problems. One court is adopted from UK law and another one indeed applies Islam Law. Thus, in Business, in Saudi Arabia, They are more comfortable to use International Law which adopted from UK.
Penang, 9 April 2009
Rayenda Khresna Brahmana 
From my reading, one of the objections of Muslim scholar towards current financing practices is the predetermined return as in the case of riba or interest. But now we have sukuk based on leasing (ijarah) which take the form of predetermined return, that is from the periodic payment made by lessee to lessor. And now, we have a group of Muslim scholar who permits this kind of predetermined return because the ijarah mode is permissible in Islam.
I never really understand Islamic Finance or Economy,
but after reading the article…I still don’t understand yet 😀
but i am certainly enlightened when i read this article.
Thanks for sharing Ye, let me know if you write another article about Islamic Finance okay…this is one of the chapters in finance that i’m really blind about
I would like to add a note about Islamic Finance,
I asked my friend about how Syariah works, and the part that you wrote “Islamic Economics can run well if the country also applies Islamic Law”
is entirely true (based on my friend’s info)
This is a simple example of financing businesses
Lets say I need fresh funds of $10 millions to start a new business,
and you as the source of fund agree to lend me the money, of course with pre-determined contract such as the percentage of profit sharing.
If everything went okay, than there will be no problem…but if something went wrong, this is the part that makes it interesting (and confusing as well)…
Lets say the business tanked and me as the borrower only manage to return $2.5 millions of the total fund. If that failed business is not staged (the business really TANKED, not made to look as if it failed) and you as the lender trust & accept my explanation…then for everyone, this is a WIN-WIN situation
why?
because me as the borrower had already tried everything to revive the business (and thus cannot be blamed for the failed business), and you as the lender will receive the lost money of $7.5 millions from HEAVEN, somehow…
I didn’t understand this but I’m pretty certain this is what my friend said :
“If the lender accept the loss of money dengan ikhlas, then the God has already prepared to return the loss…dengan berkat duniawi (materi), ataupun surgawi”
This is under the assumption that everyone that have part in this agreement totally obey Islamic Law…it means that no one is trying to deceive or anything like that.
Your response, Raye?
Frankly speaking, I do not dare to write anything regarding islamic finance. Because it is hard to discuss this field if you meet certain narrow minded person. Some more, this is not my field 😛
However, I have friend doing this field. Til now, his opinion is Islamic Finance is not purely islamic as it is adopted certain part of conventional finance (or may be the way around). In Malaysia for instance, when the central bank rate is increasing, how come the rate in islamic banking also increasing? If there is comovement between the riba asset and non riba asset, how can we distinguish islamic finance and conventional finance? I still search the answers.
Furthermore, the most forgotten even in Islamic Finance is most of Sukuk is default. But not much scholars want to discuss it further.
Sorry for not answering anything… 😛
From my reading, one of the objections of Muslim scholar towards current financing practices is the predetermined return as in the case of riba or interest. But now we have sukuk based on leasing (ijarah) which take the form of predetermined return, that is from the periodic payment made by lessee to lessor. And now, we have a group of Muslim scholar who permits this kind of predetermined return because the ijarah mode is permissible in Islam.