Islamic finance has been on the rise for the last several decades, and with it has come an increased interest in sukuk.
Sukuk investments have been popular since 2000 when Malaysian finance first released this type of product, quickly followed a year later by Bahrain.
Today state-run organizations and Islamic corporations use sukuk all over the world.
Since Islamic sharia law forbids “riba”, what Western finance refers to as “interest”, sukuk investments provide an alternative mode of halal investing that is permissible according to Islamic religious law.
Sukuk investments take up a rising share of the international fixed-income market.
In this article we will take a deeper look at what a sukuk is, how sukuk work, how they differ from traditional Western bonds, and how to invest in them.
What Is A Sukuk?
Much like what a bond is in Western financial terms, a sukuk is a financial certificate in Islamic finance. A sukuk closely follows the dictates of Islamic religious customs, also known as Sharia law.
In traditional Western financial systems, users pay back bonds with interest, but this is not allowed under Sharia law.
So what then is a sukuk? Basically, it is a certificate that the issuer sells to a group of investors.
The issuer then uses the profits from this certificate sale to buy an asset. The group of investors then directly owns part of the interest in this asset.
The issuer of the sukuk also signs a contract that states that they will buy the certificate back from the investor at a future time at face value.
So how does this comply with the prohibition on interest under sharia law?
In sukuk investments, the returns and cash flows of debt financing are connected to the particular concrete asset being purchased.
So the benefits of that specific asset are distributed among investors.
That means that an investor in a sukuk owns part of that asset, but not the debt obligation that the issuer of the certificate owes to the investor.
So sukuk investors receive profits in the form of earnings created by the specific asset linked to their certificates.
The Most Common Form of Sukuk
The most typical form of sukuk that investors find is a trust certificate.
While these trust certificates are governed by Western law as well, the sukuk version of these certificates takes on more levels of complexity.
First, the organization that is raising funds for the sukuk creates a special purpose vehicle offshore, or SPV. This SPV is the entity that issues the trust certificates.
Qualified investors purchase trust certificates, and the SPV uses the proceeds of these sales to fund the purchase of an asset.
The SPV creates a funding agreement with group of investors that stipulates how much of the profits connected to that asset each investor will earn.
One key part of this process is that the SPV must be formed in an offshore territory where this type of trust is permitted. This is not always the case.
When local jurisdictions prevent the creation of an SPV and trust certificates of this nature, there is another option.
A sukuk can instead be created as an alternative civil-law structure. For this version of a sukuk investment, a company is formed in its country of origin that is allowed to lease assets.
That company basically purchases the specific asset in question and then leases it back to the organization that needs financing.
How Is A Sukuk Different From Traditional Bonds
While sukuk investments and Western bonds both provide investors with streams of payment, there are key differences among them.
The most significant difference is that income that comes from a sukuk must not be speculative.
Speculative income would make that investment no longer halal, or compliant with sharia law requirements.
Both bonds and sukuk investments are granted to investors. Both can be used to raise money for a firm and are widely considered to be safer investments than equities.
Notably, however, a sukuk investment involves ownership of a tangible asset, unlike bonds which involve debt obligations.
If the tangible asset that backs a sukuk investment appreciates in value then the sukuk itself appreciates. The price of sukuk certificates is determined by the value of the asset in question.
This keeps sukuk investments halal, as they do not rely on “riba”, or interest.
Bonds, meanwhile, derive their yield from rising interest rates and their prices are determined by credit ratings, both of which make bonds a non-halal form of investment.
While bond investors receive occasional interest payments throughout the duration of their investment, sukuk investors receive periodic payments that come from the profits generated by the tangible asset upon which the sukuk is based.
How to Invest in a Sukuk
Given the careful way that sukuk investments comply with sharia law, sukuk investments are a great way for devout Muslims to start exploring halal-friendly investing.
On the Wealthface app, there are plenty of resources and helpful tips available to assist new investors who are interested in navigating the world of halal investing.
Unlike the traditional Western finance bonds, sukuk investments are compliant with the sharia law restrictions that prevent investments based on speculation and interest rates.
Instead, investors can feel safe as they get to know this relatively new form of halal investing and shariah compliant stocks.
The resources available on the Wealthface app make it easy for anyone to start investing in sukuk, from anywhere in the world.