Unraveling of a Sukuk transaction

I hope by going through my last two articles, readers may now have a better understanding of how Sukuk have gained a sound footing in the fixed income segment of the capital market in a relatively short period of less than two decades.

Starting from today, I will explain from A–Z how a Sukuk facility is issued. This will be a mixed expedition of theory and my own hands-on experience, first from the corporate banking side and then as the Shariah advisor.

Readers should know at the outset that there is no mention of Sukuk in the Fiqh books written either by the four great scholars (Imam Abu Hanifa, Imam Shafai, Imam Ahmed Ibn Hanbal and Imam Malik) themselves, or by their students based on the lectures they used to attend. Then, the question which should naturally arise in your minds is: how can Sukuk be classified as an Islamic product?

As a matter of fact, the Islamic teachings have proved to be universal and they are applicable from 7th Century AD for as long as this world exists. At the beginning of the series, I had written in detail on how Islamic finance is relevant to the modern-day financial industry. You may go through those articles to know the perpetual nature of the Islamic financial system.

In fact, Islamic finance has never been as germane as it is now, given the repeated failure of the conventional financial industry in instilling financial discipline, fair practices and most importantly the removal of poverty from the world.

Sukuk may not have been a thing of the past but it is also not out of the Shariah realm. I had stated in article 147 that Sukuk are similar to the body of a car which sits on the chassis, for ease of understanding, whereas the Shariah nominate contracts can be compared to the chassis and Sukuk may be equated as the body of the vehicle. No Sukuk can come into being without the need for a Shariah nominate contract, or a combination thereof.

As such, Islamic financing and investment contracts and parameters are everlasting and can be utilized to meet the evolving needs of changing times and circumstances, but at no cost should these principles be compromised; the Shariah boundaries are always adhered to and respected. This canon equally applies to Sukuk which are a modern-day invention.

Moving on, the first thing in the process of issuing Sukuk is the realization of a funding need by the potential originator of Sukuk. Here, I am referring to the private sector commercial organizations and financial institutions. I will discuss later the paraphernalia for the issuance of Sukuk by the government and government-related entities.

The initial discussion with the invited banks, which possess the required skills to facilitate the issuance of Sukuk, sets the tone vis-à-vis the structure of the Sukuk to be asset-based or asse- backed. To recall, asset-based Sukuk are where investors have dual recourse, ie to the Sukuk assets as well as to the originator (or obligor) whereas asset-backed Sukuk are pure securitization with investors’ recourse only to the Sukuk assets.

The potential originator provides the details necessary for review by the banks to assess whether they will be able to successfully complete the transaction and if so, to submit their respective proposals to act as the arranger for the issuance and management of Sukuk affairs.

The core details to banks include the audited financials, projected cash flow for the duration of the Sukuk, the availability of assets for the issuance of the Sukuk, the purpose and application of the Sukuk proceeds, the tenor, the return to investors and the security and collateral.

It is quite possible that the originator does not have any assets to offer for the issuance of Sukuk but it does not mean that Sukuk cannot be issued. I will explain in the following weeks how Sukuk can still be issued even if there are no assets available.

Other ancillary details may include if the originator wants the greenshoe option (see article 148), possibility of prepayment, choice of issuance currency (or currencies), Sukuk program or single issue, preferred class of investors, minimum subscription amount, listed or privately placed, etc.

The originator appoints a bank (or more than one bank) to be the mandated lead arranger for the issuance of the Sukuk. One of the main factors behind the originator’s decision is the bank’s track record in assisting for the successful issuance of Sukuk — here it would certainly add to the bank’s credentials if its previous issuances were oversubscribed. Another important factor in the originator’s decision-making process is the arrangement fee charged by the bank for offering its services.

It is important to note that the capital market norms are more or less the same and are neutral to whether it is an Islamic or a conventional security.

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]

Next week: Discussion on the issuance of Sukuk to continue.