Principles of Islamic banking and finance/PIBF203/Sukuk/Overview

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An important component of the financial system is the capital market, which is any market where a government, an approved government entity or a corporate entity can raise capital to fund their operations as well as long term investment. In conventional system capital is generated in two markets, bond market and stock market, where bonds and stocks, respective, are traded. Until the recent two decades, there was no Islamic counterpart to conventional bonds, due to which the growth of the Islamic finance industry was significantly constrained. Though not without controversy, that gap has been filled with the introduction of Sukuk.

The main principles underlying the Sukuk contract structure is as old as the Classical fiqh. However, the product Sukuk is a rather recent phenomenon that began in Malaysia with a US $30 million Sukuk offering by a private company. With the stamp of approval from the Malaysian Shariah scholars and the blessing of the Malaysian government, the Sukuk market exploded over a very short period of time and helped the Islamic finance industry push rapidly through the trillion US dollar threshold. This was further facilitated as Islamic financial institutions in other parts of the world, especially in the Gulf region, joined in.

Sukuk is popularly known as Islamic bonds that helped fill an important void in the capital market context. These are better understood as ‘trust certificates’ or ‘participation securities’ whereby an investor seeking fixed or stable return is granted a share of the underlying asset along with the cash flows generated by the asset, accompanied by risk consistent with such shareholding. The most important requirement of issuing Sukuk is the existence of suitable assets on the balance sheet of any relevant entity, whether government, corporate or banking/financial institution that intends to raise funds in the capital market. This process begins with identifying suitable assets that can be structured as Special Purpose Vehicles (SPV). It is also a prudential requirement that the pool of assets underlying a Sukuk should not comprise solely or primarily debt-creating Islamic financial contracts, such as Istisna, Murabaha, etc.