The Islamic finance industry, now surpassing $3 trillion in assets globally, continues to mature as it seeks to offer financial instruments that are both commercially viable and compliant with Shariah principles. Among its most ambitious innovations is the asset-backed sukuk, a structure rooted in the concept of real ownership and economic activity. In theory, asset-backed sukuk represent the gold standard of Islamic capital market instruments—anchored in true sale, bankruptcy remoteness, and the securitisation of tangible, income-generating assets. However, despite their theological and financial strengths, the global issuance of asset-backed sukuk has remained exceptionally rare. Instead, what dominates the market are asset-based sukuk, which replicate the economic effect of low-risk traditional assets while preserving a level of Shariah compliance in its structuring.
To understand why asset-backed sukuk remain a niche product, one must delve into their structure, the philosophical and legal ideals they are meant to embody, and the practical difficulties issuers and regulators face. Moreover, examining actual market examples helps to reveal how asset-backed sukuk behave under stress and why their limited uptake may be both a missed opportunity and a rational response to systemic barriers.
The Ideal of Asset-Backed Sukuk
Asset-backed sukuk are designed on the principle that investors are not merely lending money, but are taking an ownership stake in real, productive assets. These sukuk involve a true sale of assets from the originator (the entity seeking capital) to a special purpose vehicle (SPV), which acts as an independent entity. The SPV issues sukuk certificates to investors, collects proceeds, and uses these to purchase the assets from the originator. As the new legal owner, the SPV either leases the assets back to the originator or operates them to generate income, which is then distributed to sukuk holders.
This structure differs profoundly from an asset-based sukuk, in which the underlying assets serve as a reference point or collateral, without transferring actual legal ownership to the investors. Investors have an interest in the underlying asset that is structured. In most cases, asset-based sukuk holders have a contractual claim against the originator, and the assets are not truly ringfenced in the event of insolvency.
In asset-backed sukuk, on the other hand, investors hold ownership rights, not structured rights that turn into claims. The structure is bankruptcy remote, meaning that even if the originator becomes insolvent, the assets remain with the SPV and the investors. This distinction has profound implications for risk-sharing, compliance, and investor protection.
Accounting and Legal Treatment
From an accounting perspective, asset-backed sukuk may qualify for off-balance sheet treatment, particularly where the underlying assets have been sold to the SPV through a demonstrable “true sale.” International accounting frameworks, including IFRS 9 and IFRS 10, generally require derecognition of assets from the originator’s balance sheet if control has been transferred and the risks and rewards of ownership have been shifted to another entity.
This is often beneficial for originators seeking to improve capital ratios or liquidity, especially in financial institutions. However, gaining auditor and regulator comfort on this derecognition depends on a robust legal structure that ensures the SPV’s independence and the enforceability of the asset transfer. In jurisdictions without strong securitisation laws, accounting treatments may remain conservative, and auditors may be hesitant to allow derecognition.
Legally, the crux of asset-backed sukuk lies in the validity and enforceability of the true sale. This requires clarity in property and trust laws, the legal personality of SPVs, and the jurisdiction’s recognition of asset-backed structures. Without such clarity, investors may not be able to enforce their rights over the assets in case of a default, undermining the whole rationale of “asset-backing.” For this reason, countries like Malaysia and the UAE have worked toward strengthening the legal infrastructure to facilitate Islamic capital market instruments, but full harmonisation remains elusive.
Shariah Treatment and Superiority Over Asset-Based Structures
From a Shariah perspective, asset-backed sukuk represent the ideal form of sukuk issuance. They fulfil the real Islamic economic paradigm and philosophy by promoting real economic activity and trade, avoiding pure financialisation and the paper economy that so often involves Riba and debt. Asset-backed sukuk ensure risk-sharing and protect investor rights through tangible backing.
Furthermore, in asset-backed sukuk, the income generated for investors must arise from the use of assets or participation in business risk—such as rent in an Ijarah sukuk or profit in a Mudarabah sukuk—rather than a fixed interest rate. This ensures that the return is linked to real performance and not artificial benchmarks.
However, the industry has shown pragmatic flexibility by approving asset-based sukuk where full asset transfer was not possible. While this has enabled market growth, it is always helpful to review and rethink the market, and do a gap-analysis on how the industry can improve not only from a financial and growth perspective, but more importantly, in aligning as much as possible with Shariah principles
Risk Implications of Asset-Backed Sukuk
Asset-backed sukuk come with a unique risk profile that must be carefully assessed by issuers, investors, and regulators. On the positive side, the bankruptcy remoteness of the SPV and the legal separation of the underlying assets can provide strong protection to investors in case of originator insolvency. This is particularly important in sovereign or corporate distress scenarios, where the protection of investor rights becomes paramount.
However, the flip side is that asset-backed sukuk expose investors to asset performance risk. If the assets underperform—due to market conditions, operational inefficiencies, or legal encumbrances—the returns to sukuk holders may fall short. In structures like Mudarabah or Musharakah, investors also bear loss unless caused by negligence or misconduct.
There is also a liquidity risk, as the secondary market for asset-backed sukuk is relatively shallow. If investors need to exit their position before maturity, they may not find ready buyers or may have to sell at a discount. Unlike asset-based sukuk, which mimic bond-like features, asset-backed sukuk do not guarantee principal repayment, unless structured with repurchase undertakings that remain compliant.
Finally, legal enforcement risk remains significant. In jurisdictions where insolvency laws are underdeveloped, SPVs may struggle to enforce asset ownership in practice, especially if the assets are located in multiple or unfriendly jurisdictions. This risk was starkly demonstrated in the Nakheel case.
Case Study: The IDB Sukuk Programme
Under its Medium-Term Note programme, The Islamic Development Bank (IsDB) has issued sukuk backed by a pool of eligible Ijarah assets, such as leased infrastructure projects. In these structures, the IsDB transfers ownership of the underlying assets to a trust, which then issues sukuk certificates to investors.
This model has several important implications. First, it demonstrates the viability of asset-backed sukuk when the issuer is a multilateral development institution with a high credit rating, access to reliable asset data, and political influence to secure legal enforceability. Second, it shows that long-term development assets—such as schools, roads, and energy projects—can be securitised in a Shariah-compliant manner. The IsDB’s ability to mobilise funds through such sukuk has helped finance critical infrastructure in the developing world.
Conclusion
Asset-backed sukuk, in principle, offer the most authentic form of Islamic capital market instruments—grounded in real ownership, bearing proportionate risk, and engaging in real economic activity. They hold immense promise for infrastructure financing, public-private partnerships, and ethical investing. However, their adoption remains stifled by a complex web of legal, regulatory, and commercial challenges.
The rarity of their issuance is not merely a failure of will but a reflection of market realities. Until legal frameworks evolve, tax treatments are harmonised, and investors become more comfortable with real asset risk, asset-backed sukuk will not always be the go-to structure. Nonetheless, their continued inclusion in the dialogue around Islamic finance is essential in raising the industry to more equitable structures.
As the sector matures and as regulatory clarity deepens, it is conceivable that asset-backed sukuk will eventually take centre stage in funding long-term, sustainable development.
