IN THE NAME OF ALLAH

TOPIC

A brief introduction of sukuk and its kinds

RESPECTED SIR: DOCTOR ZESHAN Raees KHATAK SB.

Subject: Islamic economic system

PREPARED BY ABDUL BAQI

Enrollment :01-259212-001

MS ISLAMIC STUDIES ( ISLAM AND LIFE)

BEHRIA UNIVERSITY ISLAMABAD
 Sukuk
Introduction
A Sukuk is the islamic world’s version of a bond. It is also referred
to as an islamic bond. Because Islamic people do not believe in
charging or paying interest.
A Sukuk structure is slightly different, but the principle is the same
as a western bond. When a bank invests in a Sukuk or islamic
bond, it is considered to be an investment in a certain project or
asset that a company is working on.
A sukuk is an Islamic financial certificate, similar to a bond in
Western finance, that complies with Islamic religious law
commonly known as Sharia. Since the traditional Western
interest-paying bond structure is not permissible, the issuer of a
sukuk essentially sells an investor group a certificate, and then
uses the proceeds to purchase an asset that the investor group
has direct partial ownership interest in.
Back ground
According to Camille Paldi, the first sukuk transaction took place
in Damascus in its Great Mosque in the 7th century AD.
Muslim traders are known to have used the cheque or ṣakk
system since the time of Harun al-Rashid (9th century) of the
Abbasid Caliphate.
The modern Western word "cheque" appears to have been
derived from "sakk"] which during the Middle Ages referred to a
written agreement "to pay for goods when they were delivered"
and was used to "avoid money having to be transported across
dangerous terra.
The term of “sukuk” for Islamic financial instruments was first
suggested by jurisprudence committee of Islamic Development
Bank in 2002.

definition
“Sukuk” is an Arabic word and plural of “sakk”, which means
“cheque” in Persian or script of property ownership.
AAOIFI, 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

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.
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 Example
For example, Osman is looking to start a new production line in
his business that will require the equivalent of $1 million dollars.
Because Osman is building this line in Saudi Arabia, he plans on
financing the costs using this islamic bond. He then goes and
obtains the financing he needs from an islamic bank. The bank
invests in the project. They decide that Osman will owe the bank
rent of $80,000 per year and the final par value of the Sukuk, ($1
million) 10 years after the project is done. Notice that this is the
same set up as a regular bond where the rent expense of $80,000
is equal to an 8% interest rate. And the par value of the bond is
due at the end of the term like a bond.

:
Sukuk are structured in several different ways..

(Sukuk Al Musharaka)
These sukuk holders are also the owners of the originator issuing
the sukuk and participate in the decision-making. These sukuk can
be traded in the secondary market. . ◦ Musharakah 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. ◦ In practice, these have been very
similar to mudarabah certificates rather than being a distinct
asset class.
(Sukuk Al Istithmar).
The most commonly used sukuk structures replicate the cash
flows of conventional bonds. Such structures are listed on
exchanges, commonly the Luxembourg Stock Exchange and
London Stock Exchange in Europe, and made tradable through
conventional organisations like Euroclear or Clearstream. A key
technique to achieve capital protection without amounting to a
loan is a binding promise to repurchase certain assets; e.g. in the
case of Sukuk Al Ijara, by the issuer. In the meantime a rent is
being paid, which is often benchmarked to an interest rate (LIBOR
is the most common though its use is criticized by some Sharia
Scholars.
Sukuk adhere to an Islamic view of finance, avoiding Riba
(generating money from money, i.e. interest or usury), bonds are
securities that are very Riba due to the fact that they have a fixed
interest.

Istisnaá Sukuk .

These sukuk are complex and cannot be traded in the secondary

market or sold to a third party for less than its face value.
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 completed, the advances are repaid from the
revenue derived from the project. ◦ 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.
 Sukuk al Salam
The salam based contract is usually used for short-term
financing of underlying assets, and is based on spot sale
(salam) and/or deferred payment sale (bai al muajjal) or
deferred delivery sale (bai al salam) where the investor
undertakes to deliver a specific asset, which will be sold to
the client at an agreed profit margin. ◦ For example, a special
vehicle is set up to buy petroleum on a spot price basis and
the purchase price is entirely paid up front from the proceeds
of the issue sukuk certificates. ◦ The SPV will then sell the oil
at a later date to the beneficiary of the oil on a certain
designated delivery date.
In this sukuk the SPV does not buy an asset but agrees to buy one
at a future date in exchange for advance payments. The asset is
then sold in the future for its cost plus a profit by an agent. On (or
before) the date agreed to in the contract, the seller delivers the
asset to the agent who sells the asset who passes the proceeds
(minus expenses/fees) on to the SPV, which distributes the
proceeds to the sukuk holders.

Sukuk al Ijarah
These are "essentially" rental or lease contracts, or conventional
lease-revenue bonds. With these sukuk, the borrower's tangible
asset is 'sold' to the financier and then 'leased' back to the
borrowers. The borrowers then make regular payments back to
the financiers from the income stream generated by the asset.
The sukuk are based on the underlying tangible assets that
the SPV has acquired rather than being debt securities,
which is the case with the issuance of conventional bonds. ◦
Instead, the sukuk al-ijarah structure uses the leasing
contract as the basis for the returns paid to investors, who
are the beneficial owners of the underlying asset and as
such benefit from the lease rentals as well as sharing in the
risk.
. Sukuk al-Ijarah ◦ The structure commences with a
party who is in need of financing, here referred to as
the originator. ◦ The originator will establish an SPV, a
separate legal entity with the sole purpose of
facilitating this transaction. ◦ Next, the SPV purchases
certain tangible assets from the originator at an agreed
pre-determined purchase price, which will be equal to
the principal amount of the sukuk.

Sukuk al-Mudarabah.
Sukuk al Mudarabah is structured through the
mudarabah contract, with one party looking for
Shari’ah compliant financing, the originator. ◦ The
originator will establish the SPV and enter into a
mudarabah contract with this SPV. ◦ Both the originator
and the SPV will be partners to the Mudarabah
contract. ◦ The originator will act as the managing
partner, the entrepreneur of the mudarabah venture.
. Sukuk al-Mudarabah ◦ As the mudarib, the managing
partner will contribute his labor, skills, and expertise. ◦
The SPV will act as the silent partner, the rabbul mal of
the mudarabah venture. ◦ As the rabbulmal, the SPV
contributes in the form of financial investment.
These sukuk are not common because their payments to investors
represent debt and are therefore not tradable or negotiable
according to sharia. (If diluted with other non-murahaha sukuk in
a mixed portfolio they may be traded)
Sukuk ul murabaha
Murabahah receivables cannot fetch any return and their
assignment has to be at face value. ◦ Murabahah 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. Sukuk al Murabahah ◦ The
government will issue certificates according to the number of
installments. ◦ Each certificate having maturity date would
represent property right of the seller that can change hands
provided amount of the claim does not change. ◦ The seller
or the original certificate holder can transfer his collection
rights to another party against payment that would be equal
to the face value of the certificate minus collection cost at the
transferee’s end.
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 (secur
6. The main advantage of sukuk is to comply with Sharia
while boosting the standard of living in Islamic society and
developing these societies’ economies. However, sukuk
also bring several other important benefits.

7.Sukuk provide an ideal way of financing large projects for

the public good that would otherwise not be possible. There
are many economic activities or projects that are out of
reach of individuals, companies, or, in the case of various
developing Islamic economies, governments. In these
cases, sukuk are perfect for financing these projects without
falling into interest-based debt.

Sukuk vs. Traditional BondsDifferences between sukuk and

the conventional bonds (Riba securities with fixed interest)

Conventional Bonds Sukuk

Asset ownership

1.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.

2.Sukuk give the investor partial ownership in the asset on

which the sukuk are based.

Investment criteria

1.Generally, bonds can be used to finance any asset,

project, business, or joint venture that complies with local
legislation.

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

compliant.
Issue unit
1.Each bond represents a share of debt.
2.Each sukuk represents a share of the underlying asset.
Issue price
1.The face value of a bond price is based on the issuer’s
credit worthiness (including its rating).
2.The face value of sukuk is based on the market value of
the underlying asset.
Investment rewards and risks
1.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.
2.Sukuk holders receive a share of profits from the
underlying asset (and accept a share of any loss incurred)
Effects of costs
1.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.

2.Sukuk holders are affected by costs related to the

underlying asset. Higher costs may translate to lower
investor profits and vice versa.
2.Sukuk investors receive profit generated by the underlying
asset on a periodic basis while bond investors receive
periodic interest payments
CONCLUSION

Sukuk is considered as a reliable asset and such

asguaranteedsecurities(Islamic)andclassifiedroutinely is
more powerful than classifiable bondsand investing by
companies and institutes andpublic. This financial
instruments can be used toattract and gather the dispersed
society assets andalso to take appropriate portfolio for
provide mostadvantage with Islamic beliefs for
investors.Governmental Sukuk sales in overseas, need to
berank them by the rating agencies. In this study,
thedefinition and types of Sukuk bonds and types
andstructure of them was proceeds and it was statedthat the
Sukuk investors, by their nature, have theright to have the
necessary information about theirinvestment assets in other
investments. This helps to create amarket discipline. Sukuk
can be found competitiverequired structure for market; in
that case, thedeveloping economies that are origin of Sukuk
arethat will benefit greatly from it. So the governmentcan
have a proper planning and preparations forthis new
financial instrument, have an importantstep to take usury-
free banking law. The use of thisnew finances tool, can
solve many problemsrelated to financing economic
enterprises that allthese cases, are the intrinsic functions of
Islamicgovernment is to achieve stable development.

The end