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Sukuk

Definition

Sukuk, also referred to as Islamic bonds, are financial instruments used in Islamic finance and sharia-compliant transactions. Unlike traditional bonds, sukuk holders have an ownership interest in the underlying asset with profit and risk-sharing. Sukuk serves as an income-generating investment, structured in a way to generate returns without infringing Islamic laws against usury (riba).

Phonetic

The phonetics of the keyword “Sukuk” would be /sʊˈkuːk/.

Key Takeaways

  1. Sukuk, also known as Islamic bonds: These are types of financial certificates that comply with Islamic Sharia law. Unlike traditional bonds, Sukuk does not involve the payment of interest – which is prohibited in Islam – and instead provides returns to investors through a tangible asset or business.
  2. Asset-Backed Investment: Sukuks represent ownership in a tangible asset, service, project, business, or a joint venture. The Sukuk holder thus has an ownership stake in the asset or project and they receive income from the returns that these assets or projects generate.
  3. Risk-sharing: In the case of Sukuk, the risk and returns are shared between the issuer and investor instead of debt for equity. This principle of mutually shared risks and returns is a cornerstone of Islamic finance, which sets sukuk apart from traditional bonds.

Importance

Sukuk, commonly referred to as “Islamic bonds,” is a significant term in business and finance because it denotes a financial instrument that complies with Islamic Sharia law, which forbids charging interest. Sukuk are structured in such a way that it generates profit or returns to investors without infringing on these religious principles. This makes Sukuk an essential tool for raising finance in the Islamic world and increasingly, in the global market. The demand for such ethical, faith-based investment tools is high, boosting economic growth and promoting financial inclusion for Islamic investors. Moreover, they attract a diverse group of investors, both Muslim and non-Muslim, offering a compliant, ethical investment. Hence, Sukuk plays a vital role in facilitating investments, enhancing the liquidity of the capital market, and furthering the development of the Islamic financial sector.

Explanation

Sukuk, often referred to as “Islamic bonds” , are used as an alternative to conventional bonds within the field of Islamic finance. The purpose of Sukuk is to provide an investor with an asset-backed income, which is in alignment with the Islamic law, or Sharia. This law prohibits usury, which is understood as lending money at exorbitant interest rates, and thus discourages making money from money – a fundamental characteristic of conventional bonds that involve charging interest. In the global marketplace, Sukuk are utilized to finance projects, especially large-scale infrastructure projects, while adhering to Sharia law. They cater to both the need for economic development and the demand from the growing class of ethical and Islamic investors. Rather than being a debt obligation as in the case of conventional bonds, Sukuk signify ownership in a tangible asset, an investment project, or a business venture. This means the Sukuk holder receives income from the profit generated by the underlying asset, rather than interest. Hence, Sukuk represent an investment in a specific activity that generates a specific stream of revenue.

Examples

1. Dubai World: In 2009, Dubai World faced significant economic trouble and was unable to repay its debt obligations. As a part of its debt restructuring plan, the company issued a $2.92 billion Sukuk, which is a form of an Islamic bond, to its creditors. Dubai World used this financing method as it complies with Islamic law, which prohibits interest and instead uses a profit-sharing or rental model.2. Goldman Sachs: In 2014, Goldman Sachs became one of the first Western banks to issue a Sukuk, raising $500 million. This issuance was aimed at diversifying the bank’s funding sources and attracting investors from the Middle East. The Sukuk was designed to pay returns equivalent to a 2.5% yield and structured under a Murabaha format, a common type of Islamic financing structure.3. Malaysia’s government: The Malaysian government regularly issues Sukuk as part of its financing strategy. In 2020, it announced a $4.8 billion Sukuk issuance to finance the budget deficit, following a decrease in revenue due to the COVID-19 pandemic.These real-world examples illustrate how both companies and governments can use Sukuk as a form of debt financing that complies with Islamic law.

Frequently Asked Questions(FAQ)

What is Sukuk?

Sukuk is a financial certificate, similar to a bond, that complies with Islamic Sharia law. It represents ownership in a tangible asset, service, project, business, or a joint venture.

How does Sukuk differ from traditional bonds?

The key difference between Sukuk and traditional bonds lies in compliance with Sharia law. Traditional bonds focus on raising money by borrowing and paying interest, which is prohibited in Islam. Sukuk, on the other hand, involves the sale of an asset and its leaseback for a period, and beneficiaries get a share of the profits.

Is Sukuk only available in Islamic countries?

No, Sukuk are not limited to Islamic countries. While they originate from Islamic finance, these financial instruments have gained popularity globally and are now issued by corporations and governments worldwide.

What are the types of Sukuk?

There are various types of Sukuk, including Ijarah (Lease based), Mudarabah (Partnership based), Musharakah (Joint Venture based), Salam (Forward Sale based), and Istisna (Contract to Manufacture).

Who can invest in Sukuk?

Both individuals and institutional investors can invest in Sukuk. They are a popular investment for those looking to diversify their portfolios and comply with Islamic principles.

How is the return on Sukuk calculated?

The return on Sukuk is not calculated as interest, as in conventional bonds. Instead, it is based on the profit generated by the underlying asset or project.

Are Sukuk risk-free?

No investment is truly risk-free, and Sukuk are no exception. Like other investments, the level of risk can vary depending on the specifics of the agreement and the underlying assets.

How can I invest in Sukuk?

Investors can buy Sukuk through Islamic banks, brokerage firms, or sometimes directly from the entity issuing the Sukuk. It’s advisable to seek out expert financial advice before investing.

Is Sukuk a form of ethical investment?

Yes, Sukuk are often considered a form of ethical investment as they comply with Islamic principles, which prohibit activities considered harmful to society. Also, they promote asset-backed investments and risk-sharing.

How is Sukuk traded?

Sukuk can be traded on the secondary market. However, not all Sukuk are tradable, it depends on the structure and the underlying assets. It’s important to understand the terms and conditions of the specific Sukuk before investing.

Related Finance Terms

  • Islamic Finance
  • Sharia Law
  • Mudarabah (Profit Sharing)
  • Ijarah (Leasing)
  • Takaful (Islamic Insurance)

Sources for More Information

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