Defining Sukuk

Introduction

Sukuk, often referred to as Islamic bonds, represent a cornerstone of Islamic finance, offering a Shariah-compliant alternative to conventional debt instruments. As global demand for ethical and Shariah-compliant financial products grows, Sukuk have gained prominence, with the global Sukuk market reaching $6.2 trillion in outstanding value by 2023, according to the Islamic Financial Services Board (IFSB). This article provides a comprehensive exploration of Sukuk, covering their definition, basic principles, a detailed comparison with conventional bonds, and their key features and characteristics.

History of Sukuk

The term “Sukuk” (صكوك) is derived from the Arabic word “Sakk” (صك), which translates to ‘legal instrument’, ‘deed’, or ‘cheque’. The origins of this term can be traced back to the classical period of Islam, where “Sakk” referred to documents that represented financial obligations arising from trade and other commercial transactions within Muslim societies.

Historical accounts suggest that the first documented Sukuk transaction occurred in Damascus during the 7th century AD. Interestingly, the modern Western term “cheque” is believed to have evolved from “sakk,” which in the Middle Ages denoted a written agreement to pay for goods upon delivery, facilitating trade by reducing the need to transport money across potentially dangerous routes.

Some linguistic analysis also suggests that the Arabic term “ṣakk” might have been borrowed from the Classical Persian word چک (čak), meaning “legal document, document, contract, deed of sale, bill”. This historical context illustrates that the concept of Sukuk is not a recent innovation but has deep roots in the early commercial practices of the Islamic world.

Defining Sukuk

Sukuk (plural of sakk, meaning certificate) are financial instruments that represent an undivided share in the ownership of tangible assets, usufruct (the right to use an asset), or a project, issued to raise capital in a Shariah-compliant manner. Unlike conventional bonds, which are debt obligations promising fixed interest payments, Sukuk are structured to comply with Islamic law by avoiding interest (riba), excessive uncertainty (gharar), and prohibited activities (haram).

The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) defines Sukuk as:

“Certificates of equal value representing undivided shares in ownership of tangible assets, usufruct, and services, or (in the ownership of) the assets of particular projects or special investment activity” (AAOIFI Shariah Standard No. 17).

Similarly, the IFSB describes Sukuk as:

“Certificates with each sakk representing a proportional undivided ownership right in tangible assets, or a pool of predominantly tangible assets, or a business venture”.

This distinction is crucial as it highlights that unlike conventional bondholders who are creditors of the issuer, Sukuk holders possess a direct ownership interest in the underlying assets.

These underlying assets can take various forms, including tangible assets, the right to use an asset (usufructs), services, or investments in specific projects or business activities, all of which must adhere to Shariah principles. This variety in the nature of the underlying assets provides flexibility in structuring Sukuk to finance a wide range of economic endeavours.

Sukuk are often likened to bonds due to their role in capital markets, but they differ fundamentally in structure and intent. They are issued by governments, corporations, or financial institutions to finance projects or operations, with returns derived from the underlying asset’s performance rather than interest. For example, a government might issue Sukuk to fund infrastructure projects, with investors receiving profits from the project’s revenue, such as tolls from a highway.

Sukuk Case Studies

Malaysia (2002)
Malaysia issued its landmark sovereign Sukuk, pioneering the global Islamic finance market. Utilizing the Ijarah (leasing) structure, the Malaysian government issued a USD 600 million Sukuk, backed by tangible assets, to finance its infrastructure projects. The successful issuance set a global benchmark, highlighting sovereign Sukuk as viable instruments for government fundraising.

Emirates Airline (2015)
Emirates successfully raised USD 913 million through a Sukuk issuance structured under the Ijarah principle. The proceeds were used to finance the acquisition of Airbus aircraft, demonstrating the practical application of Sukuk in corporate finance. This issuance underscored the growing acceptance and utility of Sukuk for international corporate entities seeking Shariah-compliant capital.

Indonesia Green Sukuk (2018)
Indonesia launched the world’s first sovereign green Sukuk, raising USD 1.25 billion. This groundbreaking issuance was designed to finance environmentally sustainable projects aligned with Islamic principles. By combining sustainability and Shariah compliance, Indonesia set a new precedent for innovative and socially responsible financial instruments within the Islamic finance sphere.

Conclusion

In conclusion, Sukuk represent a vital innovation in global finance, seamlessly aligning ethical principles and economic pragmatism. As evidenced by their historical roots, Sukuk are not a modern invention but rather a revival and evolution of early Islamic commercial practices, offering a compelling alternative to conventional bonds.

Their robust growth and diverse applications—from sovereign fundraising and corporate financing to groundbreaking green Sukuk—clearly demonstrate their adaptability, relevance, and broad appeal. As investors increasingly prioritise ethical considerations and sustainable investments, Sukuk are positioned to play a pivotal role in shaping inclusive, responsible, and resilient financial systems globally.