The History of Sukuk

THE HISTORY OF SUKUK By: Camille Paldi

CEO of FAAIF

INTRODUCTION: THE ORIGIN OF SUKUK

Sukuk is derived from the word sakk, which can mean legal instrument, deed, and cheque. Sakk can also mean to strike a seal on a paper document.

The first sukuk transaction took place in Damascus, Syria in the Great Mosque of Damascus (Umayyad Mosque) in the 7th Century AD. Syria is a treasure house of culture and history.

SHEIKH ZAYED MOSQUE, ABU DHABI, UAE

SUKUK DEFINITION

Securitization or taskeek in Arabic refers to the process of the division of the ownership of tangible assets or rights to use those assets or both or right to a project into units, which have equal value and the issuance of those units to investors.

In simple terms, securitization describes the process of aggregating assets and packaging them into marketable securities.

SUKUK LINGUISTIC ORIGIN AND DEFINITION

Tawriq (from wariq) means to render something into cash. Taskik (from Sakk) is also used as securitization though literally refers to the process of dividing the assets into papers (Sukuk).

Tawriq is defined as: “transforming a deferred debt for the period between the establishment of the debt and the maturity period into papers, which can be traded in the secondary market.” (in Majallah Majma ‘Al Fiqh’)

AAOIFI in its Shari’ah Standard 17(2), defined investment sukuk (Sukuk Istithmar) as “certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services, assets of particular projects or special investment activity.”

The IFSB, in its Capital Adequacy Standard (IFSB 2), defined sukuk as “Certificates that represent the holder’s proportionate ownership in an undivided part of an underlying asset where the holder assumes all rights and obligations to such asset.”

Sukuk is described in a decision of the Islamic Jurisprudence Council of February 1988, which provides that:

Any combination of assets (or the usufruct of such assets) can be represented in the form of a written financial instrument, which can be sold at a market price provided that the

composition of the group of assets represented by the sukuk consists of a

majority of tangible assets.

Securities Commission Malaysia (SC) defined sukuk as a document or certificate, which represents the value of an asset.

In terms of AAOIFI, the IFSB, and SC, the

AAOIFI and IFSB do not recognize financial assets as assets that would qualify to form the underlying assets of a tradable sukuk, while the SC does allow such assets.

MAIN FUNCTION OF SUKUK

The main function of sukuk is to provide an alternative to conventional bonds, in other words, to provide the benefits associated with conventional bonds, but in a Shari’ah compliant manner.

SUKUK V BONDS A conventional bond is a contractual debt

obligation whereby the issuer is contractually obliged to pay to bond holders, on a certain specified date, interest and principal.

Under a Sukuk structure, the Sukuk holders each hold an undivided beneficial ownership interest in the underlying assets.

Sukuk holders are entitled to a share in the revenues generated by the Sukuk assets.

In sum, Sukuk are monetary denominated participation certificates of equal unit value to be issued to investors to represent their proportionate share in the ownership of the underlying assets and a pro- rata share in the income generated by those assets.

SUKUK V BONDS

While bonds represent pure debt obligations from the issuer to the investors or bondholders, the sukuk represent ownership of a well-defined asset.

The sale of sukuk, both in primary and secondary markets, is a sale of a share of an asset, while selling a bond is basically the sale of debt.

SUKUK V BONDS

In terms of pricing, sukuk prices are market driven and depend on the fluctuation of the market value of the underlying assets. In the case of the issuer’s default, sukuk holders will possess the asset and they can sell it to other buyers or keep it as an asset.

On the other hand, bondholders depend solely on the creditworthiness of the issuer without any specific assets to be relied on. Therefore, in the case of the issuer’s failure, unsecured bondholders will be jointly seeking the assets of a bankrupt company.

SUKUK V BONDS

The aim of bond traders usually is to make capital gains as fixed-interest bond prices rise when variable market interest rates fall.

Bond trading is therefore largely about exploiting interest rate developments and trading in paper that is usually unrelated to the value of any underlying asset.

SUKUK V BONDS

The major risk for holders of conventional bonds is of payments default, but this risk is usually assessed solely on the basis of credit ratings, with the ratings agency rather than the bond purchaser estimating the risk.

Hence, the bonds are regarded as mere pieces of paper with third parties estimating the risk and the purchaser, at best, only making a risk/return calculation without any reference to the business being financed.

SUKUK V BONDS

Sukuk is an undivided ownership share in specific assets while holding shares means holding an ownership share in a corporation or a company.

In sukuk, the assets should be Shariáh compliant and a minimum of 51% are tangible assets.

Ordinary shares do not require the company to be Shariáh compliant and the percentage of tangible assets is not determined.

TYPES OF SUKUK

Leased-based sukuk, i.e., sukuk al ijarah.

Partnership-based sukuk, i.e., sukuk mudharabah and sukuk musharakah.

Sale-based sukuk, i.e., sukuk murabahah, sukuk istisnaá, and sukuk salam.

SUKUK HISTORY

In 1990, in Malaysia Shell MDS Sdn Bhd issued a sukuk ijarah worth RM 125 million. Issuances grew 145% in 2006 compared to 2005 to reach US$27 Billion. The sukuk market peaked at US$47 Billion in 2007 and dropped by 55% to US$21 Billion in 2008.

The market recovered in 2009 to reach a total issuance of US$31 Billion, which was higher than the total issuance in 2006.

2012 saw US$110 Billion in sukuk issuances while 2013 tapered off with US$79 Billion.

HISTORY OF SUKUK IN THE USA

The US has seen two major sukuk issuances including the East Cameron Gas Sukuk, which was the first ever musharakah sukuk in America backed by oil and gas assets and the General Electric Sukuk, which is an ijarah sukuk backed by aircraft leases due for maturity in November, 2014.

Although the Cameron Gas Sukuk experienced some technical difficulties, the General Electric Sukuk is performing well and there is a large potential for sukuk in the United States as a capital raising instrument for American firms.

US STATE LEGISLATION FOR SUKUK

In fact, both the state of New York and the state of Illinois have initiated state bills in their legislatures enabling sukuk transactions.

Illinois Bill Title: Bill Islamic Finance Sukuk. New York Senate: Bill Introduced by Senator

Parker in the New York State Senate in 2011.

*Copies available upon Request.

EAST CAMERON GAS SUKUK

East Cameron Partners LP saw the sukuk issuance as an affordable and flexible finance opportunity through which it could raise the funds needed to purchase other shares from its non-operating partner, Macquarie Bank, whom wished to sell its share in the business.

East Cameron Partners LP (“ECP” or the “Originator”) is an independent oil and gas exploration and production company, based in Houston, Texas whose producing assets consisted of two gas properties located offshore of the State of Louisiana, USA.


East Cameron Partners (ECP) issued sukuk of USD165.67 million in June 2006 with a maturity period of 13 years.

This was the first sukuk issued by a company based in the United States and rated by Standard & Poor’s.

The underlying contract was musharakah (co-ownership/joint venture) in which sukuk investors own so called Overriding Royalty Interest (ORRI) in two gas properties located in the shallow waters offshore the State of Louisiana through an SPV acting as a trustee of sukuk holders.


The SPV was called East Cameron Gas Company (ECGP) and incorporated in the Cayman Islands.

The originator also contributed its funds into the musharakah.

The assets of the musharakah were co-owned by the sukuk holders and the originator company ECP.

The sukuk were secured by a mortgage on the assets of the issuer, which included the ORRI and secured accounts. The sukuk were initially rated CCC+ by Standard & Poor’s and then downgraded to CC and finally D.


The East Cameron Gas sukuk had a fixed payment of 11.25% annually. However, there was also a variable component because the sukuk returns depended upon the production quantities (the overriding royalty interest (ORRI) specified a fixed quantity of natural gas be delivered to the SPV).

It also contained a redemption feature by where a percentage of the sukuk would be redeemed if production exceeded a certain level.


Sukuk holders were also exposed to risks found in the energy sector (i.e.) the volatility of natural gas and condensate prices, which may adversely affect payments on the sukuk.

In order to hedge against severe price fluctuations in oil and gas markets, there was a Shariáh compliant hedge that established a price collar between $7 and $8 per million BTU (Mbtu) on half the expected products gas production and a put option at $6 per MMBtu for an additional quarter of anticipated production (Goud, 2009).

EAST CAMERON GAS SUKUK PARTIES

Originator: East Cameron PartnersIssuer: East Cameron Gas Company

EAST CAMERON GAS SUKUK SUMMARY

Sukuk Name: East Cameron Gas Company SukukIssue Size: USD $165,670,000Closing Date: 15 June 2006Shari’ah structure: MusharakahCurrency: USDMaturity/Tenor: 13 yearsUnderlying Assets: Oil and gasRated by: Standard & Poor’sRating: CCC+ to CC and in March 2009 DPayments: QuarterlyReturn: 11.25% (Courtesy of Jassim Mahadik)

EAST CAMERON GAS SUKUK Instead of being solely used to support the

capital and operating costs of drilling and operating wells in the Gulf of Mexico for East Cameron Partners, the proceeds were also used to pay most of the conventional debt of the company.

This brought the debt- to- equity ratio of the company to a Shariáh compliant level, however, also bankrupted the sukuk.


On October 16, 2008, East Cameron Partners filed for bankruptcy protection under chapter 11, claiming its inability to pay the periodic returns on its USD166 million sukuk issued in June 2006.

GENERAL ELECTRIC SUKUK PARTIES

Originator: Sukuk Aviation Leasing Inc through GE (SAL is a subsidiary of GE Capital).

Issuer: GE Capital Sukuk Limited

GENERAL ELECTRIC SUKUK SUMMARY

Sukuk Name: GE Capital SukukIssue Size: USD $500,000,000.00Closing Date: Shari’ah structure: IjarahCurrency: USDMaturity/Tenor: 5 years due for maturity in November 2014Underlying Assets: Aircraft leasesRated by: Standard & Poor’s Rating: AA+Payments: Semi- annually (May and November, due in 2014)Return: 3.875% (Courtesy of Jassim Mahadik)

POPULARITY OF SUKUK AND CONCLUSION

The sukuk instrument is growing in popularity around the world as an innovative financing instrument and a way to raise funds for various projects, business expansion, and increased competitiveness, which attracts ethical and creative investors worldwide. The UK just announced it is the first Western Nation to issue a sukuk (200 Million Pounds). The USA should join the competition.

THE END

AL HUDA CERTIFIED SUKUK PROFESSIONAL COURSE

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The History of Sukuk

Economy & Finance

Transcript of The History of Sukuk