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Structural risks in
Sukuk designs
Dr. Tariqullah Khan, Professor of Islamic Finance
QFIS – Hamad bin Khalifa University

CENTER FOR ISLAMIC ECONOMICS AND FINANCE

Symposium on Sukuk - Shariah, Legal and Economic
Issues - November 9, 2013
What are Sukuk?
Sukuk are special types
of bonds based on the:
Credit risk of the issuer
Ownership share of the underlying assets
Exposure to market risk based on underlying
contracts
Simultaneous compliance with Islamic and
prevailing laws
Yearly issuance in billion US dollars

140

Size of annual global Sukuk issues

Total outstanding
global Sukuk in 2013
are estimated at US$
210 billions

120
100
80
60
40
20

0
2004

2005

2006

2007

2008

2009

2010

2011

2012 2013Q3

Source: Zawya Sukuk Reports
Sukuk demand drivers
Simultaneous conformity with the Islamic and
prevailing legal regimes
Financial inclusion, deepening of financial
markets
Risk-return considerations & unique asset class
Infrastructure project finance
Synergy with other segments of Islamic financial
services
Progress in relevant financial infrastructures
Structural risks in the design
of Sukuk
is inhibiting & destabilizing

What is it?
How it exists?
How to alleviate it?
Sukuk are engineered and
structured products

by the architectural
players in conformity with
the required architectural
elements
⃝

⃝

⃝

⃝

⃝

Who are the architectural
players in designing the
product?
Architects – setting the principles, norms and
guidelines (Shariah & legal scholars);
Engineers - (product developers & arrangers)
Plumbers - (other professionals)
Influencers – independent
scholars, Muftees, media
Investors and users
What are the architectural
elements of the product design?
Universal ethical principles;
Tenets of religious faith;
Social norms;
Best practice business and industry
standards;
* External regulatory guidelines
* Internal operational and contractual
documentation
*
*
*
*
Violation of
architectural
principles
① Shaky
foundations of
the wall
② Raw rocks in
the wall

③ Too narrow

Structural risks of a
design
Narrow but
stable

Unstable but
not narrow

Noise among architectural
players will increase vulnerability
Preconditions for
structural/architectural
stability

Consensus among
lead architectural players
about
key architectural elements
The noisy
architectural players
and
structural risks in
the design of Sukuk
Top standard setter
of the industry
❶ Promise to repurchase the
Sukuk assets at the initial price
is not permissible
“Sukuk and their Contemporary Applications”
open source document 2007 by Muhammad
Taqi Usmani, President of the AAOIFI Shariah
Council

❷ Promise to repurchase the
Ijarah Sukuk assets at the
initial price is permissible
AAOIFI Sukuk Resolution 2008

If the AAOIFI position was #
2, why in #1 it was completely
ignored?
If #1 was an important internal
position paper, why it became
viral on the Internet even before
#2 was issued?
Hence the impression – there is
a disagreement between
Chairman and members of the
AAOIFI Shariah Board

Noisy architectural players – example 1
OIC Fiqh
Academy
Re-purchase of Sukuk or
their assets for a prefixed
price is impermissible in
the future cases of
issuance
Resolution No. 188 (2012) of OIC Fiqh
Academy on the subject of Sukuk

Top independent
Academy of the
industry
❶ Externally in conflict
with the 2008 AAOIFI
Resolution about
permissibility of
repurchase in case of Ijara
❷ Internally inconsistent
as it makes only future
cases of Sukuk with
repurchase impermissible

Noisy architectural players – example 2
Impression of the Market

&
- the 2 apex standard setters of
the industry disagree on what
is permissible and what is not
“Prospective Holders should note
that different Shariah advisers, and
Saudi courts and judicial
committees, may form different
opinions on identical issues and
therefore prospective Holders may
wish to consult their own legal and
Shariah advisers to receive an
opinion if they so desire.”
SABIC Sukuk Prospectus

Response of Sukuk
issuers to the noise
between
architectural players
by itself adds
additional noise

Noisy architectural players – example 3
Structural basis of Financial
Market Products
Ownership
risk of the
asset

(price
risk)
Equity shares

Credit risk of
the issuer &
interest rate
risk

Bonds
Independent Shariah
scholars
Asset
price
risk

Sukuk
Equity

Interest
rate
risk

Credit
risk

Bond

Structural risk free Sukuk will be
without repurchase agreement
Shariah Advisors of Sukuk
Issuers
Asset
price
risk

Equity

Interest
rate
risk

Credit
risk

Sukuk
Bond

Structural risk free Sukuk will be
with repurchase agreement
Repurchase at
initial price is not
permissible
Independent
team

noisy
arguments

fragility of

Repurchase at
initial price is
required
Advisors’
team

firm
argument
s
structure
Lack of consensus on
architectural elements
Independent
Shariah
scholars

More noise No noise

Shariah
Advisors

The one single most important
architectural element – repurchase of
Sukuk assets at initial price
Sukuk Structural Risk – bundled nature
of credit, price and return risk
Consequence
of disputes Return
and noise
risk
between
Shariah
Price
Credit
scholars

risk

risk

Sukuk

Credit
risk

Interest
rate risk

Bond
Asset
price risk

Equity
Can the market
have this type
of a product?

Return
risk
Price
risk

Credit
risk

Bundled risks

Independent
Shariah
Scholars –
No, because it has
credit risk and the
rate of return risk is
actually interest rate
risk

Shariah Advisors –
No, because rating and
pricing is not possible
Structural risk
originates from
the
disagreements of
Shariah scholars
and leads to the
bundling of
credit, price
and return risks

Such a financial market product could not exist
in the market by consensus of the Shariah
advisors and independent Shariah scholars
Structural risks could
cause wealth losses as
well as hamper growth
and depth of the Islamic
capital markets
Avoiding structural
risks is an imperative
for Islamic capital
market development
Avoiding structural risks
is an imperative for the
resilience and stability of
Islamic capital markets
The key architectural
players are actually
Finance Ministers

Central Bank Governors

Sukuk Issuers and Dealers

Islamic Bankers

Investors
“Independent” scholars
Looking ahead – a high
powered Apex Islamic
Finance Board of the
above mentioned key
stakeholders is needed to
avoid the structural risks of
the Sukuk industry
Announcement
Please be informed that the Qatar
Faculty of Islamic Economics does offer
an Executive Education Program on
“Sukuk and Islamic Capital Markets”
Thank you
tkhan@qfis.edu.qa

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Structural risks in the design of Sukuk

  • 1. Structural risks in Sukuk designs Dr. Tariqullah Khan, Professor of Islamic Finance QFIS – Hamad bin Khalifa University CENTER FOR ISLAMIC ECONOMICS AND FINANCE Symposium on Sukuk - Shariah, Legal and Economic Issues - November 9, 2013
  • 2. What are Sukuk? Sukuk are special types of bonds based on the: Credit risk of the issuer Ownership share of the underlying assets Exposure to market risk based on underlying contracts Simultaneous compliance with Islamic and prevailing laws
  • 3. Yearly issuance in billion US dollars 140 Size of annual global Sukuk issues Total outstanding global Sukuk in 2013 are estimated at US$ 210 billions 120 100 80 60 40 20 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Q3 Source: Zawya Sukuk Reports
  • 4. Sukuk demand drivers Simultaneous conformity with the Islamic and prevailing legal regimes Financial inclusion, deepening of financial markets Risk-return considerations & unique asset class Infrastructure project finance Synergy with other segments of Islamic financial services Progress in relevant financial infrastructures
  • 5. Structural risks in the design of Sukuk is inhibiting & destabilizing What is it? How it exists? How to alleviate it?
  • 6. Sukuk are engineered and structured products by the architectural players in conformity with the required architectural elements
  • 7. ⃝ ⃝ ⃝ ⃝ ⃝ Who are the architectural players in designing the product? Architects – setting the principles, norms and guidelines (Shariah & legal scholars); Engineers - (product developers & arrangers) Plumbers - (other professionals) Influencers – independent scholars, Muftees, media Investors and users
  • 8. What are the architectural elements of the product design? Universal ethical principles; Tenets of religious faith; Social norms; Best practice business and industry standards; * External regulatory guidelines * Internal operational and contractual documentation * * * *
  • 9. Violation of architectural principles ① Shaky foundations of the wall ② Raw rocks in the wall ③ Too narrow Structural risks of a design
  • 10. Narrow but stable Unstable but not narrow Noise among architectural players will increase vulnerability
  • 11. Preconditions for structural/architectural stability Consensus among lead architectural players about key architectural elements
  • 12. The noisy architectural players and structural risks in the design of Sukuk
  • 13. Top standard setter of the industry ❶ Promise to repurchase the Sukuk assets at the initial price is not permissible “Sukuk and their Contemporary Applications” open source document 2007 by Muhammad Taqi Usmani, President of the AAOIFI Shariah Council ❷ Promise to repurchase the Ijarah Sukuk assets at the initial price is permissible AAOIFI Sukuk Resolution 2008 If the AAOIFI position was # 2, why in #1 it was completely ignored? If #1 was an important internal position paper, why it became viral on the Internet even before #2 was issued? Hence the impression – there is a disagreement between Chairman and members of the AAOIFI Shariah Board Noisy architectural players – example 1
  • 14. OIC Fiqh Academy Re-purchase of Sukuk or their assets for a prefixed price is impermissible in the future cases of issuance Resolution No. 188 (2012) of OIC Fiqh Academy on the subject of Sukuk Top independent Academy of the industry ❶ Externally in conflict with the 2008 AAOIFI Resolution about permissibility of repurchase in case of Ijara ❷ Internally inconsistent as it makes only future cases of Sukuk with repurchase impermissible Noisy architectural players – example 2
  • 15. Impression of the Market & - the 2 apex standard setters of the industry disagree on what is permissible and what is not
  • 16. “Prospective Holders should note that different Shariah advisers, and Saudi courts and judicial committees, may form different opinions on identical issues and therefore prospective Holders may wish to consult their own legal and Shariah advisers to receive an opinion if they so desire.” SABIC Sukuk Prospectus Response of Sukuk issuers to the noise between architectural players by itself adds additional noise Noisy architectural players – example 3
  • 17. Structural basis of Financial Market Products Ownership risk of the asset (price risk) Equity shares Credit risk of the issuer & interest rate risk Bonds
  • 19. Shariah Advisors of Sukuk Issuers Asset price risk Equity Interest rate risk Credit risk Sukuk Bond Structural risk free Sukuk will be with repurchase agreement
  • 20. Repurchase at initial price is not permissible Independent team noisy arguments fragility of Repurchase at initial price is required Advisors’ team firm argument s structure
  • 21. Lack of consensus on architectural elements Independent Shariah scholars More noise No noise Shariah Advisors The one single most important architectural element – repurchase of Sukuk assets at initial price
  • 22. Sukuk Structural Risk – bundled nature of credit, price and return risk Consequence of disputes Return and noise risk between Shariah Price Credit scholars risk risk Sukuk Credit risk Interest rate risk Bond Asset price risk Equity
  • 23. Can the market have this type of a product? Return risk Price risk Credit risk Bundled risks Independent Shariah Scholars – No, because it has credit risk and the rate of return risk is actually interest rate risk Shariah Advisors – No, because rating and pricing is not possible
  • 24. Structural risk originates from the disagreements of Shariah scholars and leads to the bundling of credit, price and return risks Such a financial market product could not exist in the market by consensus of the Shariah advisors and independent Shariah scholars
  • 25. Structural risks could cause wealth losses as well as hamper growth and depth of the Islamic capital markets
  • 26. Avoiding structural risks is an imperative for Islamic capital market development
  • 27. Avoiding structural risks is an imperative for the resilience and stability of Islamic capital markets
  • 28. The key architectural players are actually Finance Ministers Central Bank Governors Sukuk Issuers and Dealers Islamic Bankers Investors “Independent” scholars
  • 29. Looking ahead – a high powered Apex Islamic Finance Board of the above mentioned key stakeholders is needed to avoid the structural risks of the Sukuk industry
  • 30. Announcement Please be informed that the Qatar Faculty of Islamic Economics does offer an Executive Education Program on “Sukuk and Islamic Capital Markets”