[Explained] Islamic Sukuk

“Egypt’s First Islamic three-year Sovereign Sukuk with a yield of 11-11.6 percent” has been ricocheting across the news recently. Most of us have heard about sovereign bonds, but what is an Islamic Sukuk, and why did Egypt decide to finally tap this market for the first time, a move that has been anticipated for some time and now has made its debut?

Let us understand.

Islamic bonds explained

Islamic Sukuk is derived from the Arabic word “Sakk” which means an order of payment. The Islamic sukuk are defined as financial certificates representing a portion of ownership in an existing or future asset, or a portfolio of assets.

Since interest rates might not be congruent with Islamic laws, sukuk act as an alternative financial tool since they does not come with any debt obligations, instead, the issuer uses the proceeds to purchase or lease an asset of which the sukuk holder receives partial ownership and gets the return from that purchase/lease at maturity.

Types of Islamic Bonds

“Sukuk are like a spectrum; there are different types of Islamic Sukuk,” said Hany Genena, Economist and Adjunct Professor of Management, at AUC School of Business. The different types of Sukuk include:

Murabaha Sukuk (Receivables):

They are based on receivables transactions, which are sales of products with markup and a profit margin. A marked-up asset is sold by the government to an investor, who subsequently leases it back to the government for a preset time. Periodic payments are then given to the investor by the government.

Ijara Sukuk (Lease):

They are based on the sale and leaseback of a tangible asset, most commonly a governmental asset. The government creates a third-party, special purpose vehicle (SPV), that issues the Sukuk, then this SPV purchases an asset and then sells ownership in the asset to the Sukuk holders who effectively become co-owners of the asset who then lease it to the SPV in exchange for periodic returns on investment. At the end of the lease period, the originator (the government) purchases the asset back from the SPV at its nominal value and the SPV distributes the proceeds to the sukuk holders who receive the initial investments plus the profit from the asset according to the agreed-upon payments.

Wakala Sukuk (Trustee):

They are issued in accordance with a contract in which one party serves as the other party’s agent. To manage a particular pool of investment assets, the government hires an agent, who then issues Sukuk based on the anticipated profits from the project. The Sukuk holders receive a portion of the profits from which the fee of the agent is deducted.

Mudaraba Sukuk:

They are referred to as Sukuk, which one party contributes funds and another contributes with his/her knowledge in the management of the investment. The funding is provided by the government, and the investment is managed by an investor. A portion of the gains, which are essentially interest payments, are paid to the investor.

Musharaka Sukuk:

They are based on a joint enterprise that is funded by the government and an investor; the investor then issues Sukuk based on the anticipated revenues from the enterprise. Periodic payments are made to the investor in a manner akin to interest payments.

In a nutshell, all Sukuk are based on assets from which the Sukuk holder receives a portion of the proceeds. Other types of Sukuks are emerging such as the Sustainable ESG Sukuk.

Difference between Islamic Bonds and Conventional Bonds

Sukuk and conventional sovereign bonds are both financial instruments issued by governments to raise capital; however, they differ vastly in structure, risk sharing, and interest payment mechanism.
Sukuk are asset-backed securities, and they are priced based on the asset’s value which increases/decreases with the change in the asset’s value in which the holder shares the risk with the government. While conventional bonds are debt securities that pay a fixed/variable interest. The sale of sukuk is basically selling ownership of the assets, while a sale of conventional bonds indicates the sale of debt.

The global Sukuk market

The Global Sukuk market is a huge market; according to Fitch Ratings. Outstanding Sukuk globally grew by 7.6 percent from the previous year with defaulted sukuk accounting for only 0.21 percent of all issues. Outstanding ESG sukuk volumes increased 62.9 percent in 2022 reaching $24.5 billion accounting for 3 percent of global sukuk volumes.

Sovereigns continued to be the primary issuers dominated by Malaysia, Saudi Arabia, and Indonesia. Whilst Malaysia continues to be the world’s largest Sukuk issuer, seven of the top ten largest issuances in 2022 came from Saudi Arabia. Non-Islamic governments have also entered this market; such as the UK. The Managing Director of Albaraka Capital, Sarah Hosni says, “Other non-Islamic governments have benefited from the expanding global Islamic finance industry, demonstrating the Islamic finance sector’s enduring and potent appeal.”

The secondary sukuk market has historically demonstrated stronger resilience to economic shocks than conventional bonds, as evidenced by a comparison of the performance of the FTSE Ideal Ratings sukuk indices with the FTSE Emerging Markets Broad Bond Index which showed that Sukuk indexes have outperformed emerging market bonds thus far in 2022.

Impact on the Egyptian economy

“It is important to put Egypt on the global Sukuk map via promoting the domestic Sukuk market to further harness its potential and the ample liquidity of this asset class in bridging the funding gap for the private and public sectors,” Hosni said.

The Corporate Sukuk framework, primarily introduced in Egypt in 2019, was a stepping stone toward the issuance of the Sovereign Sukuk Regulatory framework in Egypt in 2021. Egypt tapped this market as a diversification tool to finance its debt needs. Sukuk issuance is considered “an economic reformation tool” in which the country would be obliged to have economic reforms to guarantee the repayment to the investors as “The private sector is unforgiving, unlike the international funding organizations,” Genena explained.

Investors from all over the globe have shown interest in the newly issued Sukuks which were oversubscribed more than four times, according to Minister of Finance, Mohamed Maait. Hosni further elaborated on the impact of the Sukuk Issuance where she believes that the “traction and growth” of the global market will help in the development of the domestic market, as well as, encourage new corporate entrants to the market and expand the country’s “investor base”.

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