• Sukuk offer Sharia-compliant investment opportunities by providing ownership in underlying assets and distributing profits, making them attractive for ethical and sustainable investing
• The MENA region has seen significant growth in sukuk issuance, driven by demand for ESG-related projects
What are Sukuk?
Sukuk, often referred to as Islamic bonds, are financial instruments that comply with the Sharia, which prohibits the earning of interest (riba) common in conventional Western finance. Instead of representing a debt obligation, sukuk grant investors a share of ownership in an underlying asset, project, or investment, alongside a portion of the profit generated by that asset. This Sharia-compliant structure has made sukuk increasingly popular, particularly among investors seeking ethical and sustainable financial products.
Unlike traditional bonds, sukuk are structured to avoid interest payments. Instead, the returns for investors come from the income generated by the asset in which they hold a share. This could be anything from real estate to infrastructure projects, aligning the investment with tangible, real-world assets. The asset-backed nature of sukuk means their valuation is closely tied to the performance and value of the underlying asset, making them a unique instrument in the global fixed-income market.
Sukuk have gained traction globally since their inception in the early 2000s, with Malaysia being the pioneer in issuing the first sukuk. Over time, the market for sukuk has expanded significantly, attracting both corporate and sovereign issuers across the world, particularly in regions with large Muslim populations like the Middle East and North Africa (MENA).
Sukuk vs Bonds
Some similarities between Sukuk and conventional bonds include:
• Regular Payment Streams: Both sukuk and conventional bonds offer investors a series of payments. While bonds provide interest payments, sukuk distributeprofits generated by the underlying asset.
• Lower Risk Compared to Equities: Sukuk and bonds are generally seen as safer investment options compared to equities, offering a more stable return profile.
• Initial Issuance and Trading: Both sukuk and bonds are first sold directly to investors by the issuers. After issuance, they are traded in over-the-counter markets, providing liquidity to investors.
Some important differences include:
• Asset Ownership vs. Debt Obligation: Sukuk represent ownership in an underlying asset, while bonds are debt obligations.
• Appreciation Potential: The value of sukuk can increase if the underlying asset appreciates, whereas bond yields are fixed based on interest rates.
• Compliance with Sharia: Sukuk are backed by halal assets, adhering to Sharia law, while bonds may involve riba (interest) and could finance non-compliant or speculative activities.
• Valuation Basis: Sukuk valuation depends on the value of the underlying assets, whereas bond prices are primarily influenced by credit ratings.
The most common type of sukuk is a trust certificate. To issue these, an organisation creates an offshore special purpose vehicle (SPV), which then sells the trust certificates to investors. The funds raised are used by the organisation, and investors receive a share of the profits from the underlying asset.
What is an SPV?
An SPV is a subsidiary created by a parent company to isolate financial risk. Its legal status as a separate company makes its obligations secure even if the parent company goes bankrupt. A special purpose vehicle is sometimes referred to as a bankruptcy-remote entity for this reason. A parent company creates an SPV to isolate or securitize assets in a separate company that’s often kept off the balance sheet. It may be created to undertake a risky project while protecting the parent company from the risk of its failure or solely to securitize debt in some cases so investors can be assured of repayment.
This structure works only if the SPV can be set up in an offshore jurisdiction that permits such trusts. If not, an alternative approach involves creating an asset-leasing company in the issuing country, which buys the asset and leases it back to the organisation for financing.
Sukuk in 2024
In 2024, the sukuk market in the MENA region witnessed a significant surge, with issuances increasing by 48% to $6.2 billion in the first half of the year. Saudi Arabia led the MENA region with five sukuk issuances totaling $3.98 billion, highlighting the country’s role as a major player in the Islamic finance sector. The UAE also contributed significantly, with $2.25 billion raised from three issuances, including a notable debut by Emirates Islamic Bank, which issued a $750 million sukuk.
This growth was largely driven by green and social projects, reflecting a broader trend towards sustainable finance. The rise in sukuk issuance is part of a global movement towards ethical and ESG (environmental, social, and governance) investing, which has seen substantial growth in recent years.Sukuk have become an essential tool for funding infrastructure, green projects, and social initiatives, making them particularly appealing to ethical investors.
For instance, at the 2023 COP28 climate summit, the UAE made significant climate finance announcements, underlining the growing importance of Islamic finance in supporting sustainable development. The focus on ESG-related sukuk is expected to continue, with experts predicting further growth in the second half of 2024 as more issuers look to diversify their funding bases and tap into the growing demand for sustainable finance.
“Around 80 percent of GCC sukuk is now investment-grade, and the GCC DCM (debt capital market) is well on its way to crossing $1 trillion outstanding. Saudi Arabia, UAE and Malaysia will likely stay among the most active sukuk issuers,” said Bashar Al-Natoor, global head of Islamic Finance at Fitch Ratings (one of the world’s biggest credit rating agencies).
Fitch said that global outstanding sukuk expanded 10 percent year-on-year to $867 million at the end of the first quarter, with GCC countries accounting for 35 percent of this amount.
Islamic finance today
Islamic finance is today, as a whole, a $3.9 trillion industry spread over more than 80 countries with the bulk of it concentrated in very few markets. Comparing data from different sources shows that just 10 countries account for almost 95% of the world’s sharia compliant assets. Saudi Arabia and Iran lead the way with 25% to 30% market share each, followed by Malaysia (12%), the UAE (10%), Kuwait and Qatar (5.5%), Türkiye and Bahrain (3.5%), Indonesia and Pakistan (2%).
Over the past decade, Islamic finance grew at an exponential yearly pace of around 10%. According to the 2023 State of Global Islamic Economy report, total sharia-compliant assets will grow to $5.95 trillion by 2026 although that depends on the economic well-being of these 10 markets.
In the western world, London positioned itself to become the hub for sharia-compliant finance. Today, the UK boasts five licensed Islamic banks, over 20 conventional banks offering Islamic financial products. Germany has also issued several sukuk in the past and licensed its first full-fledged Islamic bank (KY bank AG) in 2015.
Russia has also started offering Islamic finance products through fintechs like Payzakat, or traditional banks. The idea is both to cater to its large Muslim population and help its banks scale into MENA markets, like Sberbank the leading Russian lender who set up in Abu Dhabi in 2020.
In the aftermath of the 2008 crisis, Islamic finance appeared as a relatively safe alternative to the Western banking system. Sukuks seemed like a good way to tap into new markets, Islamic funds represented opportunities to access large amounts of liquidity and Islamic banking was a way of monetizing local Muslim communities.
