Breaking down the AAOIFI definition of Sukuk

In the last article, I provided a little bit of explanation on the difference between bonds and Sukuk with the help of the definition on Sukuk by quoting from the relevant AAOIFI Shariah standard.

Realizing that the definition may not have gone down well with the readers not familiar with Sukuk, today I would like to break it down for ease of understanding but for this, I will requote the definition as follows:

“Investment Sukuk are certificates of equal value representing undivided share in the ownership of tangible assets, usufruct and services or in the ownership of the assets of particular projects or special investment activity. However, this is true after the receipt of the value of Sukuk, the closing of subscription and the employment of funds received for the purpose of which the Sukuk were issued.”

Starting from the initial wording, let me explain the asset classes which can be used for the issuance of Sukuk. First, these are tangible assets such as immovable assets (real estate) or movable assets (aircrafts, vehicles, cranes, etc). For both, the condition is common which is that the asset must not be utilized for any non-permissible purpose.

The mention of real estate automatically leads one to property, but wait a second; legally these are two different things. While real estate refers to ‘real’ tangible property such as land and the building erected on it (that is why it is called ‘real estate’), the ‘property’ consists of the real estate and together with it certain rights, such as lease rights to the lessee to enjoy the ‘real estate’ for a defined period of time.
In other words, the real estate only consists of physical things but the property includes the rights over the real estate. Shariah principles have no reservations for such a statutory approach. In fact, this diversity will help me explain a type of Sukuk which means it actually conforms to the Shariah approach.

In this context, I would like to emphasize that the common law and civil law both follow Shariah law. A case in point is the inheritance right to a wife which was denied in England and Wales until the 19th century on the pretext that she is not the blood relative of the deceased whereas Islam accorded the inheritance right to the widow starting from the 7th century AD.

Moving on, the next term used in the AAOIFI definition is ‘usufruct’. Does it sound familiar? Of course for the readers who went through 19 Ijarah articles, the term ‘usufruct’ should be well understood. However, for the new readers, please refer to my article 62 which provides for the following definition of usufruct:

“Usufruct is the right to enjoy the usage and taking advantage of someone else’s property for an agreed period of time at an agreed cost, in a manner that the property remains intact at the end of the period. Putting it in another manner, a lease agreement is the sale and purchase of the usufruct for a certain defined period of time. A question then arises: is the usufruct a commodity that can be bought and sold through an Ijarah agreement? The answer is yes. The Shariah approach is clear that the usufruct fulfills the Shariah criteria of being a commodity and hence it can be freely bought and sold.”

From the aforementioned definition, we now understand that usufruct is also an asset class which can well be used for the issuance of Sukuk — details to follow.

Now the next asset class mentioned in the AAOIFI definition of Sukuk is the services which are purchased by the Sukuk investors from the providers and sold at a profit to the end-users. These include educational, health, travel and other Shariah compliant services.

In some way, the aviation industry has successfully utilized services Sukuk through monetizing the future capacity which is reflected as RTK or revenue ton kilometers, or in simple terms the revenue load in tons multiplied by the distance flown. I took part in providing the Shariah guidance in the first such Sukuk launched by Emirates which was followed by Garuda and Flydubai. A similar structure was also used in Dubai for an Islamic consortium financing against monetizing the future road toll vouchers.

The last asset class appearing in the AAOIFI definition is ownership of the assets of a particular project or special investment activity. If the originator of the Sukuk is the owner of an industrial plant and needs funds for the expansion, he can issue the Sukuk by making the existing plant an asset class for the Sukuk investors.

One of the structures through which it can be done is by transferring the ownership of the existing plant to a special purpose company representing the Sukuk investors and appointing the industrialist as the agent for and on behalf of the Sukuk investors to run the plant and deposit the revenue to an escrow account from where the distribution of profit to Sukuk investors takes place. The industrialist uses the sale proceeds for expansion and also receives his fee for being a servicing agent, in addition to a certain agreed incentive income, if granted by the Sukuk investors. Such a structure is called ‘purchase and agency’ and has been frequently used in the industry.

I will explain in the next article the last part of the AAOIFI definition which is: “However, this is true after the receipt of the value of Sukuk, the closing of subscription and the employment of funds received for the purpose of which the Sukuk were issued.”

The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.

Sohail Zubairi is an Islamic finance specialist and AAOIFI-certified Shariah advisor and auditor. He can be contacted at [email protected]