Sukuk: Islamic Bonds and Their Role in Global Finance

Introduction to Sukuk and Shari'ah Principles

Stocks and bonds are among the most common ways of investing and raising capital in financial markets today. Investors in the international arena are presented with a myriad of choices in terms of bond types. One relatively recent bond market to emerge from the Islamic community is known as Sukuk — a term used to describe Islamic bonds. This bond type distinguishes itself from its Western counterpart by its adherence to Shari'ah principles, one of which is the prohibition on charging or paying interest (Islamic Development Bank, 2010). Compliance is achieved by granting the investor a share of the investment asset, along with its associated cash flows and risk. The growth and success of the Sukuk market has been remarkable, catering to an investor base that seeks to diversify its holdings beyond the traditional.

Foreign and domestic investors who buy Sukuk must work with structures approved by Shari'ah boards consisting of Islamic scholars. Issuers generally include sovereigns and corporations in the Middle East and Southeast Asia, attracting investors from some 56 Islamic Development Bank (IDB) member countries and more than 100 non-member countries. In this way, Sukuk acts as a bridge between issuers and investors, where money raised can be allocated to infrastructure initiatives in a transparent and efficient manner.

Sukuk Market Growth and Structural Varieties

In 2010, Sukuk demonstrated its resilience during difficult economic times, and particularly throughout the global economic downturn. Sukuk issuance increased, for example, from U.S. $14.9 billion to U.S. $23.3 billion between 2008 and 2009, with issuance especially strong across Asia. By 2010, the global Sukuk bond market was growing at a rate of 10–15% (Islamic Development Bank, 2010).

Within the Shari'ah framework, Sukuk can take various structural forms. Most commonly, Sukuk represents partial ownership of an asset — also referred to as Sukuk al-ijarah. It can also represent a partially owned debt, known as Sukuk murabaha; a partially owned project, known as Sukuk al-istisna; a business arrangement within Sukuk, known as Sukuk al-musharaka; or a partially owned investment, referred to as Sukuk al-istithmar (Financial Times, 2011). Each structure is designed to generate returns for investors through permissible means rather than through conventional interest payments.

Pakistan's Sukuk Issuances and International Performance

From 2010 onwards, Sukuk made rapid strides not only in Asian markets but also internationally, as evidenced by its growing presence in foreign currency transactions. According to Rana (2014), Pakistan raised $1 billion from international debt markets in 2014 through its second-largest such transaction in less than a year. This was accomplished by issuing five-year, dollar-denominated Sukuk bonds. The capital raised would substantially bolster Islamabad's foreign currency reserves and help satisfy conditions set by the International Monetary Fund (IMF).

The profit rate of the transaction was 6.57%, approximately half a percent lower than the five-year Eurobond sold in April 2014. While the Eurobond carried no collateral requirement, Sukuk has an inherent collateral requirement built into its structure. The government therefore pledged the Islamabad–Lahore Motorway as collateral, and in doing so maintained an interest rate lower than the Eurobond transaction while reaching a total of $2 billion. This places Sukuk on par with, and in competition with, the Eurobond in the international market. Furthermore, the 6.75% profit rate for the $1 billion Sukuk bond is 5.17% higher than the five-year U.S. Treasury rate used as a benchmark (Rana, 2014).

This trend follows the global economic downturn and is further fueled by concerns about slowing economic progress (Rana, 2014). The trend is evident in the original projected target of $500 million for the bond, against which actual investor interest generated $2.3 billion — almost five times higher than the projection.

On the strength of this success, Pakistan harbored further hopes of raising $1.2 billion from the sale of its remaining 42.5% stake in HBL. In 2014, Pakistan was also asked to increase its foreign currency reserves to $13 billion by June 2015, up from their $8.5 billion level in 2014.

Conclusion

Sukuk appears to be positioned globally to attract high-level investors and raise substantial capital that can be usefully applied to social and construction projects. The Islamic bond therefore offers global investors a credible alternative to mainstream Western investment options. Operating upon a distinctive combination of economic and religious principle, Sukuk has brought renewed energy to a struggling global market. As an instrument grounded in asset-backed, ethically governed finance, Sukuk could play a meaningful role in global economic revival — benefiting both investors seeking diversification and nations seeking capital for large-scale development projects.

References

Financial Times (2011). Definition of Sukuk. Retrieved from: http://lexicon.ft.com/Term?term=sukuk-(Islamic-bonds)

Islamic Development Bank (2010). What is Sukuk? Retrieved from: http://thatswhy.isdb.org/irj/go/km/docs/documents/IDBDevelopments/Internet/thatswhy/en/sukuk/what-is-sukuk.html

Rana, S. (2014, November 27). Pakistan raises $1b through Sukuk bonds. The Express Tribune. Retrieved from: http://tribune.com.pk/story/798044/pakistan-raises-1b-through-sukuk-bonds/

Reuters (2014, May 1). Pakistan will issue dollar-denominated sukuk soon: Dar. Dawn. Retrieved from: http://www.dawn.com/news/1103402