As the most active Islamic debt market instrument, there are certain underlying Shariah principles that Sukuk must comply with. The following requirements are in addition to the major requirement that all Islamic finance products such as Sukuk must be free of riba, maysir, gharar, and involvement in prohibited activities.
Sukuk Requirements
When you deal with Islamic bonds, that is Sukuk, the additional requirements are:
- You must use all funds raised through the Sukuk issuance for permissible, halal activities.
- Where the funds raised are used to finance needed tangible assets, specificity of assets is essential. You must specify the assets being financed. Unlike bonds, you can not use Islamic bonds to fund the general financial needs of the issuer.
- Income received by Sukuk holders must come from the cash flows generated by the underlying asset. Income should not come from other sources external to the asset.
- Sukuk holders possess the right to the underlying asset and its cash flows.
- Both the originator and Sukuk holders must specify and know the rights and obligations of each other to the transaction.
- Similar to all other Islamic finance instruments, there should be no fix returns.
Different risk-returns between Sukuk and conventional bonds
Here we list 3 risk-return differences between Sukuk and bonds.
- Unlike bonds, there will be no fixed coupon payments in the case of Sukuk.
- You can not fix the redemption amount at maturity.
- Unlike conventional bonds whose returns derive from the earnings performance of the issuer, a Sukuk holder’s returns derive from cash flows/earnings generated by the asset underlying the Sukuk. While conventional bonds provide the same coupon rate despite the issuer’s earnings over the period, bondholders can foreclose on the issuing entity if it can not pay the predetermined coupons on time. Sukuk holders’ returns will depend on underlying asset returns. According to the Sukuk contract, even though the Sukuk-issuing firm performs well, Sukuk holders will receive low or no returns if the underlying asset performs poorly.
Considering all these differences, we can conclude that while the risk profile of a bond depends on the issuer, the profile of Sukuk would depend on the underlying asset.
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