Structural risks in the design of Sukuk

Structural risks in Sukuk designs

Dr. Tariqullah Khan, Professor of Islamic FinanceQFIS – Hamad bin Khalifa University

Symposium on Sukuk - Shariah, Legal and Economic Issues - November 9, 2013

CENTER FOR ISLAMIC ECONOMICS AND FINANCE

What are Sukuk?

Credit risk of the issuerOwnership share of the underlying assetsExposure to market risk based on underlying contractsSimultaneous compliance with Islamic and prevailing laws

Sukuk are special types of bonds based on the:

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Q30

20

40

60

80

100

120

140

Size of annual global Sukuk issues

Source: Zawya Sukuk Reports

Year

ly is

suan

ce in

bill

ion

US

dolla

rs

Total outstanding global Sukuk in 2013 are estimated at US$

210 billions

Sukuk demand driversSimultaneous conformity with the Islamic and

prevailing legal regimesFinancial inclusion, deepening of financial

marketsRisk-return considerations & unique asset class

Infrastructure project financeSynergy with other segments of Islamic financial

servicesProgress in relevant financial infrastructures

Structural risks in the design of Sukuk

is inhibiting & destabilizing

What is it? How it exists?

How to alleviate it?

Sukuk are engineered and structured products

by the architectural players in conformity with the required architectural

elements

⃝<Architects – setting the principles, norms and guidelines (Shariah & legal scholars);

⃝<Engineers - (product developers & arrangers)⃝<Plumbers - (other professionals)⃝<Influencers – independent scholars, Muftees,

media⃝<Investors and users

Who are the architectural players in designing the

product?

* Universal ethical principles;* Tenets of religious faith;* Social norms;* Best practice business and industry

standards; * External regulatory guidelines* Internal operational and contractual

documentation

What are the architectural elements of the product design?

Structural risks of a design

Violation of architectural principles

① Shaky foundations of the wall

② Raw rocks in the wall

③ Too narrow

Narrow but stable

Unstable but not narrow

Noise among architectural players will increase vulnerability

Preconditions for structural/architectural

stabilityConsensus among

lead architectural players about

key architectural elements

The noisy architectural players

and structural risks in

the design of Sukuk

❶ Promise to repurchase the Sukuk assets at the initial price is not permissible

“Sukuk and their Contemporary Applications” open source document 2007 by Muhammad Taqi Usmani, President of the AAOIFI Shariah Council

Noisy architectural players – example 1

❷ Promise to repurchase the Ijarah Sukuk assets at the initial price is permissible

AAOIFI Sukuk Resolution 2008

If the AAOIFI position was # 2, why in #1 it was completely ignored?If #1 was an important internal position paper, why it became viral on the Internet even before #2 was issued?Hence the impression – there is a disagreement between Chairman and members of the AAOIFI Shariah Board

Top standard setter of the industry

OIC Fiqh Academy

Re-purchase of Sukuk or their assets for a prefixed price is impermissible in the future cases of issuance

Resolution No. 188 (2012) of OIC Fiqh Academy on the subject of Sukuk

Noisy architectural players – example 2

Top independent Academy of the industry

❶ Externally in conflict with the 2008 AAOIFI Resolution about permissibility of repurchase in case of Ijara❷ Internally inconsistent as it makes only future cases of Sukuk with repurchase impermissible

&

- the 2 apex standard setters of the industry disagree on what is permissible and what is not

Impression of the Market

“Prospective Holders should note that different Shariah advisers, and

Saudi courts and judicial committees, may form different opinions on identical issues and therefore

prospective Holders may wish to consult their own legal and Shariah

advisers to receive an opinion if they so desire.”

SABIC Sukuk Prospectus

Noisy architectural players – example 3

Response of Sukuk issuers to the noise between architectural players by itself adds additional noise

Structural basis of Financial Market Products

Equity shares Bonds

Ownership risk of the

asset (price risk)

Credit risk of the issuer & interest rate

risk

Asset price risk

Interest rate risk

Credit risk

BondEquity

Independent Shariah scholars

Structural risk free Sukuk will be without repurchase agreement

Sukuk

Asset price risk

Interest rate risk

Credit risk

Bond Equity

Shariah Advisors of Sukuk Issuers

Structural risk free Sukuk will be with repurchase agreement

Sukuk

Repurchase at initial price is

required

Repurchase at initial price is not

permissible

noisy arguments

firm arguments fragility of structure

Independent team

Advisors’ team

More noise No noiseShariah Advisors

Lack of consensus on architectural elements

The one single most important architectural element – repurchase of

Sukuk assets at initial price

Independent Shariah

scholars

Sukuk Structural Risk – bundled nature of credit, price and return risk

Sukuk

Credit risk

Interest rate risk

Asset price risk

Bond

Equity

Consequence of disputes and noise between Shariah scholars

Return risk

Credit risk

Price risk

Return risk

Credit risk

Price risk

Can the market have this type of a product?

Independent Shariah

Scholars – No, because it has credit risk and the rate of

return risk is actually interest rate risk

Shariah Advisors –

No, because rating and pricing is not possible

Bundled risks

Structural risk originates from the disagreements of Shariah scholars and leads to the bundling of credit, price and return risks

Such a financial market product could not exist in the market by consensus of the Shariah advisors and independent

Shariah scholars

Structural risks could cause wealth losses as well as hamper growth

and depth of the Islamic capital markets

Avoiding structural risks is an imperative

for Islamic capital market development

Avoiding structural risks is an imperative for the

resilience and stability of Islamic capital markets

Investors“Independent” scholars

The key architectural players are actually

Finance Ministers Central Bank Governors Islamic Bankers

Sukuk Issuers and Dealers

Looking ahead – a high powered Apex Islamic Finance Board of the above mentioned key

stakeholders is needed to avoid the structural

risks of the Sukuk industry

Please be informed that the Qatar Faculty of Islamic Economics does offer

an Executive Education Program on “Sukuk and Islamic Capital Markets”

Announcement

Thank you

[email protected]