Sukuk

January 2016

CHALLENGES AND PROSPECTS FOR
INNOVATIVE DESIGNS

© Islamic Development Bank, 2016
King Fahd National Library Cataloging-in-Publication Data

Islamic Development Bank
    Sukuk challenges and prospects for innovative

    designs / Islamic Development Bank – Jeddah, 2016

     ISBN: 9960-32-319-6

1-Sukuk. 2-Structure. 3-Challenges l-Title
332.6323 dc  1437/7783

L.D. no. 1437/7783
ISBN: 9960-32-319-6

Cover image: Shutterstock.com

All rights reserved. No part of this publication may be reproduced or distributed in any form or by
any means, or stored in a database or retrieval system, without the prior written permission of the
Islamic Development Bank.

The views and analyses presented in this Report do not necessarily reflect the views or official
positions of the Islamic Development Bank Group.

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List of Figures ................................................................................................................................................ 3

List of Tables ................................................................................................................................................. 3

Introduction .................................................................................................................................................. 4

Section I: Sukuk Survey ................................................................................................................................. 5

1. Primary Market Growth ........................................................................................................................ 5

2. Issuer Base Diversification .................................................................................................................... 5

3. Sovereign and Corporate Sukuk ............................................................................................................ 7

4. Sukuk Denomination ............................................................................................................................. 8

5. Sukuk Tenors ......................................................................................................................................... 9

6. Sukuk Base Contracts .......................................................................................................................... 12

7. Sukuk Ratings ...................................................................................................................................... 13

8. Conclusion ........................................................................................................................................... 14

Section II: Sovereign Sukuk ......................................................................................................................... 16

1. Introduction ........................................................................................................................................ 16

2. Issues in the Prevailing Sukuk Model .................................................................................................. 16

3. Features of the Proposed Framework ................................................................................................ 18

4. The Sovereign Finance Corporation .................................................................................................... 18

5. SFC: The Assets Side ............................................................................................................................ 19

6. SFC: The Liabilities Side ....................................................................................................................... 21

7. Conclusion ........................................................................................................................................... 23

References .................................................................................................................................................. 23

Section III: Multi-Level Protection Sukuk .................................................................................................... 24

1. Introduction ........................................................................................................................................ 24

2. Product Description ............................................................................................................................ 24

3. Senior Musharakah: Best of two worlds ............................................................................................. 25

4. Illustrative Example ............................................................................................................................. 28

5. Capital Cushion ................................................................................................................................... 29

6. Determinants of MLP Sukuk profit rate .............................................................................................. 30

7. Third Party Protection ......................................................................................................................... 31

8. Conclusion: Advantages of MLP Sukuk ............................................................................................... 32

Section IV: Exchangeable Sukuk .................................................................................................................. 35

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1. Introduction ........................................................................................................................................ 35

2. Exchangeable Sukuk Structure ............................................................................................................ 35

3. Shari’ah Compliance ........................................................................................................................... 36

4. Tradability ........................................................................................................................................... 37

5. Credit Risk Protection ......................................................................................................................... 37

6. Target Investors .................................................................................................................................. 37

7. Numerical Simulations ........................................................................................................................ 37

8. Flexibility of the Exchangeable Sukuk Structure ................................................................................. 38

9. Conclusion ........................................................................................................................................... 39

Conclusion ................................................................................................................................................... 40

Appendix ..................................................................................................................................................... 41

1. What are Sukuk? ................................................................................................................................. 41

2. Sukuk Types ......................................................................................................................................... 41

References .................................................................................................................................................. 43

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List of Figures

Figure	1:	Primary	Sukuk	Issuances	by	year	of	Issuance.	..............................................................................	6
Figure	2:	Number	of	Countries	Issuing	Sukuk.	.............................................................................................	7
Figure	3:	Sukuk	Issuances	by	Country.	.........................................................................................................	7
Figure	4:	Issuances	in	non-OIC	Countries	....................................................................................................	8
Figure	5:	Sukuk	Issuances	by	Issuer	Type.	...................................................................................................	8
Figure	6:	Percentage	of	Corporate	Sukuk	in	overall	Issuances.	Comparison	of	GCC	Global	markets.	.........	9
Figure	7:	Issuances	by	Currency.	..................................................................................................................	9
Figure	8:	Currency	Composition	of	Outstanding	Malaysian	Sukuk.	...........................................................	10
Figure	9:	Country	Composition	of	USD	Denominated	Sukuk.	....................................................................	10
Figure	10:	Composition	of	Issuances	by	Sukuk	Tenor.	...............................................................................	11
Figure	11:	Evolution	of	Notional	Weighted	Tenor.	....................................................................................	11
Figure	12:	Shares	of	the	Corporate	Sector	in	Malaysian	Short	Term	Sukuk	..............................................	12
Figure	13:	Share	of	Short	Term	Issuances	in	Malaysian	Sukuk	..................................................................	12
Figure	14:	Composition	of	Sukuk	Issuances	by	Base	Contract.	..................................................................	13
Figure	15:	Evolution	of	Rated	Sukuk	Percentage.	......................................................................................	14
Figure	16:	Rating	Agencies’	Market	Share.	................................................................................................	14
Figure	17:	Rating	Agencies'	Participation	in	AAA	Sukuk.	...........................................................................	15
Figure	18:	SFC	Sukuk	Structure:	.................................................................................................................	21
Figure	19:	Hybrid	Seniorty	and	Risk	...........................................................................................................	27
Figure	20:	Determinants	of	MLP	Sukuk	profit	rate	....................................................................................	31
Figure	21:	Exchangeable	Sukuk	Structure	..................................................................................................	37

List of Tables

Table	1:	MLP	Sukuk	Characteristics	Compared	to	Common	Hybrid	Securities	.........................................	27
Table	2:	MLP	Sukuk	Comparison	to	Bonds	and	Equities	............................................................................	34
Table	3:	MLP	Sukuk	Comparison	to	Ijarah	Sukuk	.......................................................................................	35
Table	4:	Scenario	I	Cash	Flows	...................................................................................................................	39
Table	5:	Scenario	II	Cash	Flows	..................................................................................................................	39
Table	6:	Scenario	III	Cash	Flows	.................................................................................................................	39
Table	8:	Sukuk	Types	.................................................................................................................................	44

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The Islamic financial industry has been growing at double-digit rates over the past decade. Conceptually,

Islamic finance is appealing. Its main message has become particularly obvious and relevant after the

Global Financial Crisis 2007-2009, the repercussions of which are still felt in the world.  The

disentanglement of finance from the real economy is at the root of the Crisis. Islamic finance specifically

requires tight integration of the two domains from the ground up.

While the prospects of the Islamic financial industry in terms of size and volume seem promising, the pace

of development of new products and instruments that translate the above paradigm into practical reality

has been lagging behind. There are many challenges the industry understandably faces. These challenges

however should not impede us from searching for new and innovative solutions to lead the industry into

the 21st century.

This Report presents some new Sukuk designs that address important challenges facing the industry. They

are the outcome of collaborative efforts with experts in various fields including Shariah, law, accounting,

finance, and economics. The Financial Product Development Center has taken the lead in these new

waters in the hope of advancing the discussion with new insights and prospects for the future of the

industry. It is hoped that these new designs will promote healthy discussions and, subsequently, lead to

better structures and performance of Sukuk markets.

The Sovereign Sukuk model presented in Section II has been an outcome of collaborative effort with

several partners. Neil Miller and his team at Linklaters law firm, have contributed to the structure in many

respects, particularly from the legal side. Dr. Osaid Kailani, Abu Dhabi Islamic Bank; Dr. Abdul-Sattar Al-

Khouildi, International Center of Arbitration and Reconciliation, Dr. Giath Shabsig, IMF, Mr. Osman

Hamad, ex-CEO of Sudanese Financial Services Company, and Mr. Fahim Ahmed, International Islamic

Rating Agency, all have contributed positively at various stages to the structure.

The Multi-layer Protection (MLP) Musharakah Sukuk, presented in Section III, is an outcome of a joint

initiative of our partners: SABIC Chair for Islamic Financial Markets Studies of Imam University, Riyadh,

International Sharī’ah Research Academy (ISRA), Malaysia, and Agha & Co law firm, Dubai.

Other experts also contributed positively to the structure, including: Prof. Simon Archer, University of

Reading, UK, Dr. Osaid Kailani, Abu Dhabi Islamic Bank, among others.

The Exchangeable Sukuk, presented in Section IV, is the outcome of the efforts of the Mudarabah Sukuk

Task Force at the Islamic Development Bank. It reflects the joint efforts of members from the Treasury

Department, Investment Department, Finance Control Department, the Legal Department, the Group Risk

Management Department, and, most importantly, the Shari’ah Committee.

Despite the immense efforts that has been invested in these structures over the past four years, we think

that there is always a room for improvement and innovation. We therefore greatly appreciate valuable

feedback from our respected readers.

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The Sukuk market started tentatively in the mid-nineties with small-sized issuances before expanding

spectacularly over the next two decades with 2012 culminating in $145bn new issuances. Although the

first half of 2015 was relatively slow compared to 2014, market participants expect overall issuances to

stay on course and realize around $100-120bn by the end of 2015.

The Sukuk market is expected to carry on expanding as the low financing costs and liquidity abundance

make the sector attractive to issuers and investors alike.

Figure 1: Primary Sukuk Issuances by year of Issuance
Source: Zawya

One notable manifestation of the increased Sukuk attractiveness is the diversity of the supply side profile

with a large number of OIC (Organization of Islamic Cooperation) and non-OIC governments tapping Sukuk

funding. The charts below show the gradual opening of the market to a global issuer base. Initially

established by few pioneers, an increasing number of countries are now participating in the market with

a record 19 countries issuing Sukuk in 2014.

The United Kingdom, Hong Kong, the United States, Senegal and South Africa are among the most

significant new entrants to the market in 2014.

1
 1

0
 1
 2
 3
 5

5
 1

1
 2

0

3
7

2
1

3
3

5
3

9
0

1
4

5

1
2

1

1
2

3

1 9 9 6 1 9 9 7 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4

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Figure 2: Number of Countries Issuing Sukuk
Source: Zawya

Figure 3: Sukuk Issuances by Country
Source: Zawya

Malaysia maintains its status as a powerhouse in Sukuk with a stable 60%-70% primary market share. GCC

comes next, although by a wide margin, with a combined 20% share.

2014 was celebrated as the year of non-OIC Sukuk as record issuances from Hong Kong ($1bn) and the

United States ($1bn) helped non-OIC issuances to cross the historical bar of $1bn.

0

5

10

15

20

1995 2000 2005 2010 2015

Malaysia
, 52%

UAE,
25%

Saudi
Arabia,

9%

Bahrain,
6%

Kuwait,
2%

Pakistan,
2%

Others,
4.2%

1996-2008

Malaysia,
71%

Saudi
Arabia, 8%

UAE,
5%

Indonesia,
5%

Qatar, 4%

Bahrain,
2%

Turkey, 2%
Pakistan,

1%
Brunei

Darussala
m, 1%

Others, 1%

2009-2013

Malaysia, 66%
Saudi Arabia, 9%

UAE, 6%

Indonesia, 6%

Turkey, 3%Bahrain, 3%

Qatar, 2% Pakistan, 1%

Brunei Darussalam,
1% Hong Kong, 1%

United States, 1% Bangladesh, 1%

Others, 1%

2014-1H2015

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Figure 4: Issuances in non-OIC Countries
Source: Zawya

With a consolidated share of 80%, the sovereign and quasi-sovereign sectors became the main driver of

new issuances in the Sukuk market since the financial crisis. It should be noted however, that the public-

private composition is significantly more balanced when looking at international Sukuk.

Figure 5: Sukuk Issuances by Issuer Type
Source: Zawya

Global corporate Sukuk are not distributed evenly. Indeed, the GCC countries in particular are mobilizing

more Sukuk for corporate financing. In 2014, about half of GCC issuances were corporate Sukuk compared

to a quarter globally.

0

500

1000

1500

2000

2500

3000

3500

4000

0

2

4

6

8

10

12

14

16

2004 2005 2006 2009 2010 2012 2013 2014

Number of Issuances (left)

Notional (right)

58%

20% 21%

19%
68% 61%

23% 12% 18%

1 9 9 6 - 2 0 0 8 2 0 0 9 - 2 0 1 3 2 0 1 4 - 1 H 2 0 1 5

Corporate Sovreign Quasi-Sovreign

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Figure 6: Percentage of Corporate Sukuk in overall Issuances. Comparison of GCC Global markets
Source: Zawya

The charts below analyze the composition of the Sukuk market by currency denomination. It is clear that

most Sukuk are denominated in Malaysian Ringgit (MYR). This is due to the important Malaysian market

share, combined with the fact that Malaysian Sukuk target almost exclusively domestic investors as shown

the next chart.

Figure 7: Issuances by Currency
Source: Zawya

0%

20%

40%

60%

80%

100%

2004 2006 2008 2010 2012 2014 2016

GCC

All

0% 20% 40% 60% 80% 100%

1996-2008

2009-2013

2014-1H2015

MYR USD IDR SAR BHD QAR TRY BND AED Others

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Figure 8: Currency Composition of Outstanding Malaysian Sukuk
Source: Zawya

Indonesian Rupiah is noticeably more present thanks to the recent activity in the Indonesian Sukuk

market. On the other hand, fewer Sukuk are issued in Emirati Dirham as the UAE shifts its Sukuk to USD

denomination.

US Dollar is the second largest denomination of Sukuk and constitute one quarter of the global issuances.

The US Dollar is consistently the preferred denomination for international Sukuk.

Figure 9: Country Composition of USD Denominated Sukuk
Source: Zawya

Primary Sukuk market underwent a shift in the maturity profile during the last five years. The chart below

highlights a substantial increase of the very short-term financing most likely used for liquidity

management. Almost half of new issuances are less than one year. On the other hand, longer than 10

years issuances which once were the debut Sukuk instruments are now less popular with a mere 7% of

total volume.

MYR
93%

SGD
1%

USD
6%

UAE
35%

Saudi Arabia
21%

Malaysia
13%

Qatar
10%

Turkey
8%

Indonesia
6%

Others
7%

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Figure 10: Composition of Issuances by Sukuk Tenor
Source: Zawya

The notional weighted average tenor1 of new issuances has been steadily decreasing in the last five years

from an average of 11.5 years in 2007 to 4.5 years in 2014.

Figure 11: Evolution of Notional Weighted Tenor
Source: Zawya

The shortening of the Sukuk tenor is probably due to two factors. First, the corporate sector is less present

in the market and hence sovereign issues are driving market volumes. Second, governments and central

banks are overwhelmingly using the Sukuk as short-term liquidity papers. Taking the example of Malaysia,

the chart below shows how the contribution of the corporate sector to short-term Sukuk issuances has

1 Notional weighthed average tenor =

∑ 𝑁𝑜𝑡𝑖𝑜𝑛𝑎𝑙 ×𝑇𝑒𝑛𝑜𝑟

∑ 𝑁𝑜𝑡𝑖𝑜𝑛𝑎𝑙

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

<3M 3M-1Y 1-5Y 5-10Y >10Y

0

2

4

6

8

10

12

14

2000 2002 2004 2006 2008 2010 2012 2014

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spectacularly shrunk after the financial crisis. Malaysian sovereign issuances are about 75% shorter than

1Y compared to 8% for corporates.

Figure 12: Shares of the Corporate Sector in Malaysian Short Term Sukuk
Source: Zawya

Figure 13 shows the share of short-term issuances in corporate issuances as well as sovereign ones.

Figure 13: Share of Short Term Issuances in Malaysian Sukuk

0%

20%

40%

60%

80%

100%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

2006 2007 2008 2009 2010 2011 2012 2013 2014

Corporate Sovereign

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Almost half of the new issuances are based on Murabahah contracts. The industry has been steadily

moving in the past five years away from the Musharakah and Mudarabah-based Sukuk into more fixed

income-like contracts such as Murabahah and Ijarah.

The share of Ijarah Sukuk in the primary market has been stable around 20% since the first steps of the

Sukuk despite the shifts in Sukuk structures over time.

Figure 14: Composition of Sukuk Issuances by Base Contract
Source: Zawya

Al Salaam
2% Al-Istithmar

4%
Bai

Bithaman
Ajil

16%

Ijarah
26%

Modarabah
10%

Murabaha
6%

Musharaka
27%

Wakala
0%

Others
9%

1996-2008

Al Salaam
1%

Al-
Istithmar

2%Bai
Bithaman

Ajil
10%

Ijarah
20%

Modarabah
1%

Murabaha
49%

Musharak
a

9%

Wakala
3%

Others
5%

2009-2013

Al Salaam
1%

Al-Istithmar
1%

Bai Bithaman Ajil
7%

Ijarah
19%

Modarabah
2%Murabaha

45%

Musharaka
5%

Wakala
13%

Others
7%

2014-H12015

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Most of the Sukuk issuances are not rated, the share of unrated Sukuk is almost constant at 70% in the

last five years.

Figure 15: Evolution of Rated Sukuk Percentage.
Source: Zawya

The major four rating agencies for Sukuk are Malaysian Rating Corporation Berhad (MARC), Rating Agency

Malaysia Berhad (RAM), Moody’s and Fitch. They have been sharing market parts evenly in the last five

years.

Figure 16: Rating Agencies’ Market Share2
Source: Zawya

2 Some Sukuk are rated by more than one agency. Hence, participation ratios do not add up to 100%.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1996-2008 2009 2010 2011 2012 2013 2014 1H2015

Rated Non-Rated

0% 10% 20% 30% 40% 50%

Moody's

Fitch

RAM

MARC

2014 2009-2013 1996-2008

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The distribution is different when looking at AAA-rated Sukuk as MARC and RAM seem to be the agencies

consistently rating AAA issuances.

Figure 17: Rating Agencies' Participation in AAA Sukuk.
Source: Zawya

The Sukuk market is the fastest growing sector in Islamic Finance. It is expected to continue on this upward

trajectory in the coming years thanks to the collective efforts to make Sukuk a viable alternative to

conventional financing avenues. Last year’s unprecedented geographical reach, especially in non-OIC

countries, is a clear affirmation of Sukuk’s growing status and a manifestation of the trust of international

financial markets’.

During the last decade, the market converged into the Fixed Income-like contracts. This concentration of

risk profile highlights the pressing need for more product innovation in order to sidestep any structural

hurdles hindering the applicability of the most risk-sharing Sukuk types. The recent development of

perpetual Sukuk is a good sign of the willingness of the market to accept new structures with different

risk profiles. The following two sections of this paper outlines the Islamic Development Bank’s newly

developed product paradigms that serve sovereigns as well as corporates to issue Sukuk efficiently and

consistently.

Even if Islamic Finance fared a great deal better that the conventional sector, the financial crisis left a

subtle mark on the Sukuk market in particular. Governments and quasi-sovereign issuers stepped more

into the market to fill the financing gap left by the hurt corporate sector. The trend doesn’t show any sign

of reversing as the corporate share of the market oscillates around 20%. The GCC’s corporate sector is an

exception, however. With almost as much as government and quasi-sovereign issuances combined, it is

the most active region for corporate Sukuk.

0% 10% 20% 30% 40% 50% 60% 70% 80%

Fitch

MARC

Moody's

RAM

2014-2015 2007-2013 1996-2006

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As sovereign issuances drive the market, usage of Sukuk as liquidity papers has surged in the last five years

leading to a shortening of the average tenor from 11.5 years in 2007 to 4.5 years in 2014.

Given the weight of the sovereign sector, we believe more efforts are needed to make future issuances

sustainable. The next part proposes a novel framework for sovereign issuances that would achieve

pipeline sustainability in addition to operational and financial efficiency.

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With the steady growth of the Sukuk market, issuers are increasingly looking for more flexible and more

efficient structures. This is particularly true for sovereign Sukuk, which comprises the majority of domestic

Sukuk issuances.

Sovereign Sukuk represent more than 70% of all Sukuk for 2009-2014 (see Section I). Yet, the prevailing

structures used to issue sovereign Sukuk might not be sustainable. This section proposes an institutional

framework for issuing sovereign Sukuk efficiently and credibly. The framework allows governments to

issue Sukuk regularly to finance ongoing economic activities using a variety of Islamic modes of finance. It

is based on Sharī’ah resolutions of the OIC Fiqh Academy, as well as the Sharī’ah standards of AAOIFI, and

can be easily adopted in different jurisdictions.

One of the most common structures of Sukuk currently involves the sale of a tangible physical asset to a

Special Purpose Vehicle (SPV), on the condition that the asset is leased back to the seller (who needs

financing) with the undertaking to buy it back at maturity at nominal value. The certificates issued by the

SPV represent the Sukuk, which pay regular income reflecting the rental payments of the leased asset.

This model has the advantages of being simple and allows the issuance of tradable Sukuk due to ownership

of the tangible asset. The rental payments help to classify these Sukuk among fixed income instruments.

From a practical perspective, however, a number of obstacles emerge.

First is the transferability of the ownership of a sovereign asset to investors, particularly if they are non-

citizens. This leads to complex legal procedures for the Sukuk issuance in order to avoid the “true

ownership” of such assets. Hence, Sukuk were transformed from being “asset-backed,” i.e. representing

true and legal ownership of the underlying assets, to being “asset-based,” whereby Sukuk holders do not

fully and legally own the underlying. The underlying assets therefore, became of marginal value in the

structure, if any. This can be seen from the clauses common in Sukuk documents stating that:

“No investigation or enquiry will be made, and no due diligence will be conducted in

respect of any of the constituent assets”

“In particular, the precise terms of any of the constituent assets will not be known”

“No steps will be taken to perfect any transferor any of the relevant constituent

assets”

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These statements obviously are inconsistent with basic Sharī’ah requirements of a valid sale transaction.

As a result, such Sukuk are not fundamentally different from conventional bonds. They are explicitly

described in the Sukuk documents as “unsecured” papers, which is inconsistent with the purchase and

ownership of the underlying assets.

Rafe Haneef (2009) provides an overview of the developments of Sukuk since 2000, and concludes (p.

110):

Today, almost all Sukuk offerings are asset-based securities. The Sukuk will have

Sharī’ah-compatible underlying assets but the Sukuk holders will not have any

security interest over the assets. The asset-based Sukuk are treated as senior

unsecured securities similar to unsecured conventional bonds.

Secondly, Sukuk issuance is constrained by the existence of unencumbered, physical, Sharī’ah-compliant

assets with an aggregate value which is at least equal to the nominal amount of the Sukuk being used to

support each issue of Sukuk. Such assets may not be possible in all cases, nor as regular as needed.

Consequently, the structure does not give the flexibility to sovereigns to issue Sukuk on regular and

predictable basis.

From an accounting perspective, the assets used to issue the Sukuk are not transferred from the balance

sheet of the obligor or the seller, because of the undertaking to buy them back at nominal value. This

undertaking is a debt obligation on the obligor. With this debt on the balance sheet, the assets cannot be

transferred from the seller’s balance sheet. But the presence of these assets on the obligor’s balance

sheet is inconsistent with a true and genuine sale transaction.

Finally, the structure does not align Sukuk issuance with economic activities. The sale and lease

transactions are applied to assets of no economic contribution. Hence, the financing and economic values

are disconnected. This might lead to unproductive build-up of debt.

 ̄
Due to the Shari’ah-related problems facing this model of Sukuk, the International Islamic Fiqh Academy,

in its 20th conference in 2012, issued Resolution no. 188 prohibiting stipulated sale-and-lease-back that

ends up in obtaining money spot in exchange for more money in the future. The Resolution states:

“It is not permissible to sell an asset at a cash price on the condition that the seller

leases back this asset with a promise to own, at a total price, including the rent and

the price, that exceeds the cash price, regardless of whether this condition is

expressed or implied, because this is a form of ‘Einah that is prohibited by Sharī’ah.

Accordingly, it is not permissible to issue Sukuk based on this formula”.

This is in line with the Ijarah Standard issued by the Shari ̄’ah Board of AAOIFI. The Standard states that it

is not permissible to stipulate the lease-back in the sale contract. Paragraph 3/2 of Standard (9) states:

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“It is permissible to acquire an asset from a party and then lease it to that party. It is

not permissible however to stipulate the lease as a condition in the sale contract by

which the institution acquired the asset.”

Given these resolutions, and the above-mentioned difficulties, there is a serious need for a sound and

credible alternative that meets the needs of sovereigns in raising funds, meanwhile comply with the

principles of Islamic finance.

What governments need in order to issue Sukuk is a model with the following characteristics:

1. Flexibility with respect to assets: the model proposed below does not require a particular physical

asset for each Sukuk issuance, since such assets may not be always available.

2. Flexibility with respect to Sukuk ownership: The model allows non-citizen investors to own Sukuk

without complications related to ownership of sovereign assets.

3. Flexibility in the selection of the mode of financing, so that it is not limited to ijarah, but may also

utilize various suitable Islamic modes of financing.

4. Efficiency in issuance procedures, so that the costs of issuance are reasonably lowered, thereby

reducing the financing burden and enhancing returns.

5. Regularity of issuance so as to allow the government to plan its financial needs and enable the

financial market to manage liquidity in a more robust manner.

6. Scalability of financing volume. The proposed model can accommodate the needs of the

government as long as it is able to honor its obligations.

7. The most important characteristic is compliance to the rules and objectives of Shari ̄’ah in a

transparent and productive manner.

The model proposed hereunder has been developed by the Financial Product Development Centerof the

Islamic Development Bank, in collaboration with international experts in Sharī’ah, law, finance, as well

officials from Member Countries. In brief, the model can be summarized as follows. The detailed

description will follow.

1. The government establishes a Sovereign Finance Corporation (SFC) that will be responsible for

financing government economic activities in a Sharī’ah compliant manner.

2. The SFC is a fully-fledged financial institution, with a dedicated professional management team

as well as its own Shari’ah Board and auditor.

3. The SFC issues two types of shares:

a. Management shares, to be owned by the government (Ministry of Finance and the Central

Bank);

b. Participatory shares, to be owned by investors via Sukuk certificates.

4. The SFC establishes a Special Purpose Vehicle (SPV) and transfers the Participatory Shares to the

SPV.

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5. The SPV issues Certificates (Sukuk) to investors, backed by the Participatory Shares.

6. Proceeds of the Sukuk are used by the SFC to finance economic activities of the government.

These activities can be financed by any of Islamic modes of finance classified as fixed-income

instruments: Murabaha, Ijarah, Istisna’a, Salam.

7. The SFC finances only government activities, and therefore its assets are sovereign assets.

Furthermore, since the instruments used are fixed-income, the government guarantees the

payment as per the terms of the contract. Hence, the risk of SFC’s assets is primarily and

predominantly sovereign risk.

8. The Sukuk Certificates are redeemable in a defined period of time (say 5 years). The redemption

is performed at par but is contingent on the performance of the underlying assets. Thus, capital

is not absolutely guaranteed. Strictly speaking, the undertaking to redeem is not a legal debt on

the SFC. It is a contingent liability subject to the performance of the underlying assets.

9. However, since the underlying assets are obligations against the government, this means the SFC

will fail to redeem only if the government fails to pay its obligations. Sukuk Certificates, therefore,

are exposed mainly to the sovereign risk.

In this manner, the government has flexibility in selecting the suitable Sharī’ah-compliant modes of

finance as long as it creates a fixed income obligation, as above. Also, financing is not limited by the

availability of physical sovereign asset of the required value. This means that the government, via the SFC,

can issue Sukuk on regular basis to meet its economic targets to achieve development.

Thus, the above-mentioned features can be achieved by the proposed model of the SFC. The following

sub-sections elaborate on the details of the structure.

The objective of the SFC is to finance Sharī’ah-compliant economic activities of the government. The SFC

will finance only the government or government entities, not private entities/corporations.

Like any Islamic bank, the SFC will use ordinary Islamic modes of finance to serve these needs of the

government. To provide predictability of the cash flow of the SFC, the modes of finance used will be

restricted to those that create fixed-income assets: murabaha, ijarah, istisna’a, and the like. This also

serves the objectives of Sukuk holders, who usually prefer fixed-income investments. As we will see later,

the SFC Sukuk are not bonds or bond-like, but by structuring the assets of the SFC as fixed-income assets,

the Sukuk will have the properties of fixed-income investments.

The SFC shall have a clear and rigorous governance structure that specifies how to provide financing to

government entities. Governance is critical to control and manage operational and reputational risks. This

is also important to ensure Sharī’ah-compliance of the activities of SFC, and to protect Sukuk holders who

are investors in the SFC.

20 | P a g e

Figure 18: SFC Sukuk Structure:

1. SFC issues Management shares to the government, in exchange for in-kind investments.

2. SFC issues Participatory shares that are transferred to the SPVs

3. SPVs issue Sukuk of different maturities.

4. Cash proceeds of the Sukuk are transferred to the SFC.

5. SFC uses the proceeds to finance government activities using Sharī’ah-compliant modes of finance.

With a proper governance structure, the assets created by the SFC are sovereign, fixed income assets, the

risks of which are essentially sovereign risk. The exposure of investors in the SFC, therefore, will be limited

primarily to sovereign risks. In this manner, SFC Sukuk retain the major attributes of fixed-income

instruments, despite being a share rather than a debt instrument.

This is not too far from investment funds that invest mainly in Murabaha or leasing instruments. Although

fund units are shares in the fund’s assets, the underlying risks are mainly fixed-income or credit risks. The

SFC is different in that it is a full-scale financial institution owned by the investors. As we will see later,

this ownership of the institution plays an important role in tradability of the shares and therefore of the

Sukuk.

Furthermore, investors in the SFC will be better protected because they have a certain level of control

over the institution to protect their rights and to ensure that the SFC is fully abiding by the agreed

governance structure.

21 | P a g e

The SFC, as pointed out earlier, issues two types of shares:

1. Management shares: These are owned by the government, e.g. Ministry of Finance and the

Central Bank.

2. Participatory shares: These are non-voting shares that will back the Sukuk issued to investors.

The government will preferably pay for Management shares in-kind: For example, it shall transfer some

of its profitable investments to the SFC in exchange for the Management shares. This will enhance the

value of the Corporation and improve the cash flow, as we will see later.

Participatory shares are permanent or perpetual. Sukuk certificates, in contrast, are redeemable. To reach

this structure, the SFC needs to establish (one or more) SPV. The Participatory shares are transferred to

this SPV. Accordingly, the SPV will issue Sukuk certificates backed by these shares. These Sukuk certificates

are redeemable, as we will see later.

The SFC can issue Participatory shares of a volume sufficient for its expected financing needs over the

coming 10 years, say. These shares can be held either within the SPV or with the treasury of the SFC. Then,

Sukuk will be issued on regular basis according to the needs of the government. This will help the

government plan its financing needs ahead of time. In case of any unexpected needs that may arise, the

SFC can issue additional Participatory shares to meet such needs. However, it must be observed that the

volume of the participatory shares has to be in line with the economic activities of the government. Over-

issuance of shares and thus of Sukuk, will undermine the credibility of the SFC and hence will result in

higher costs of financing.

Since shares are issued prior to the commencement of financing activities of the SFC, there will surely be

a gap between Sukuk issuance and generating returns. This gap can be filled by the returns from the

investments the government has contributed in exchange for the Management shares at the start. As long

as Sukuk are issued based on carefully designed plans for the government’s needs, this gap will be

negligible.

The Sukuk usually are of a defined maturity. The SFC may issue short term Sukuk (1 year, say), medium

term (3 years), and long term (5 or 7 years). For this, the SFC will establish 3 SPVs, one for each maturity.

The SFC promises to redeem the Sukuk, i.e. buy them back, at par, subject to the performance of the

underlying assets and the generated cash flow. The SFC therefore issues a Purchase Undertaking (PU) to

buy back at nominal value, but this undertaking is conditional on the performance of the assets. Put

differently, the SFC issues a PU to redeem the Sukuk at par or at fair value, whichever is lower. This means

that the PU does not guarantee the principal of the Sukuk.

The PU, therefore, is not a debt obligation on the SFC. There is no guarantee by the SFC to the Sukuk

holders to buy back their Sukuk at par. In fact, there is no added value by this guarantee even if it is issued.

The reason is simple: Sukuk represent shares in assets that are already guaranteed to be paid by the

government, based on the fixed-income instruments utilized, as discussed earlier. Thus, Sukuk holders do

22 | P a g e

not need any additional guarantee. In fact, the guarantee on the Sukuk will add no value; if the

government fails to pay its obligations on the assets, it will also fail to honor its Sukuk guarantee.

The only case in which the SFC will redeem Sukuk at below par is when the underlying assets

underperform. And this can happen only if the government does not pay its obligations on time. But this

is the sovereign risk that investors are willing to accept from the start.

However, Sukuk holders may need  liquidity support given the possible mismatch between the maturity

of the Sukuk and that of government obligations. This can be provided by the Central Bank. The Central

Bank will provide a line of financing to the SFC. This can be done using an interest-free loan for example,

from the Central Bank to the SFC, and the Central Bank agrees to offset the resulting obligation of the SFC

with the assets which SFC holds against the government (the Ministry of Finance). Alternatively, the

Central Bank could purchase the Sukuk from investors, then exchange the Sukuk for assets of the SFC. In

all cases, the Central Bank is able to fill in the mismatch in maturities between the SFC Sukuk and SFC

assets. From Sukuk holders’ point of view, it is all sovereign risk.

Sukuk holders get dividends (coupon payments) based on the generated cash flow from the underlying

obligations of the government.

Sukuk with different maturities will have different dividends or coupon payments; for example, short-

term Sukuk will have smaller dividend amounts than long-term Sukuk. While the proceeds of all Sukuk

series will accumulate into a single pool, that of the SFC financing government activities, the dividends

paid to each series can be adjusted to fit the maturity of the Sukuk. This can be structured by setting

different sharing ratios between Sukuk holders and the SFC as the manager of the SPV issuing the Sukuk

certificates. This ratio will be in line with the maturity of the Sukuk. For example, for short term Sukuk,

the share of the SFC will be higher than its share in case of long-term Sukuk.

Since the SFC is a fully-fledged financial institution, its shares will be treated like the shares of any Islamic

banks. In principle, there are two views on the tradability of such shares:

(1) They are tradable following the Principle of Subordination (قاعدة التبعية) in Sharī’ah.3 This

principle implies that the institution as an entity is responsible for creating the underlying

financial assets. The entity, as a fully functioning corporate, is a set of tangible assets through

which the entity is able to function, create assets and generate returns. The set includes the

legal license, management, fixed assets and equipment, and similar productive assets. Since

shares represent an undivided ownership in this set, shares are tangible by implication. The

financial assets created by the institution are subordinated to the set that creates such assets.

Hence, as long as shares represent ownership in a genuine fully-operational institution, the

shares are tradable irrespective of the particular percentage of physical assets in the total

assets of the institution. In the absence of such subordination, the minimum of physical assets

and usufructs, according to the OIC Fiqh Academy, is 51%.

3 OIC Figh Academy Rulings no. 180 and 196.

23 | P a g e

(2) The other view requires the institution to have no less than a pre-specified percentage of

tangible (non-debt) assets. Usually this percentage is set at 51%, as indicated earlier, but it

varies from one Sharī’ah Committee to another. Some Sharī’ah Committees set the threshold

at 30%. The Sukuk Standard of Dubai Financial Market (DFM) requires a minimum of 10%.

As a new entity, the SFC will very likely require a separate new legislation to provide the necessary legal

environment to the entity for smooth operations and protection of its rights.

The Sukuk market has been growing steadily since the Global Financial Crisis. Yet, the prevailing structure,

particularly for sovereign Sukuk, is apparently not sustainable. This section presented an alternative that

was developed by an international team led by the Financial Product Development Center of the Islamic

Development Bank.

The proposed Sovereign Finance Corporation aims to address many difficulties facing the prevailing

structures of sovereign Sukuk. We can see how the SFC allows governments to achieve the objectives and

features set out in the beginning of the section.

The SFC is an institutional model for government financing. It has the potential to provide financing to

government activities on a regular basis, with high degree of transparency and good governance.

Haneef, R. (2009) “From ‘Asset-backed’ to ‘Asset-light’ Structures: The Intricate History of Sukuk,” ISRA

International Journal of Islamic Finance, vol. 1, pp. 103-126.

24 | P a g e

Islamic Finance went through an extraordinary expansionary phase during the last decade. Investors

turned to Islamic Finance as it presented a safe alternative market that weathered the financial crisis

relatively unscathed. The underlying principles of Islamic Finance echoed favorably with the financial

community as investors became disheartened with the practices that caused the great recession. Already

an integral part of OIC economies, Islamic Finance started making giant strides globally with non-OIC

countries also participating regularly in Islamic financial markets.

However, the sector has the opportunity to grow even faster only if products are more diversified. Taking

Sukuk as an example, market diversity actually shrank to a quasi-monotone product offering,

overwhelmingly composed of Murabahah and Ijarah Sukuk. It is essential that Islamic Finance diversifies

away from fixed income-like markets and into more innovative areas that are in accordance with its value

proposition: Risk sharing and Sharī’ah compliance. Such product innovation and diversification will

undoubtedly gear up the proven benefits of regulatory and institutional development. It will also attract

new type of investors and hence unlock so far untapped areas of growth.

The Sukuk structure presented here, Multi-Level Protection Sukuk is one innovative product which is

expected to provide Islamic Financial Institutions with an additional structuring dimension.

The Center started an initiative to develop a financial instrument that applies principles of Musharakah

while at the same time provides a variety of risk mitigation techniques to meet the diverse risk preferences

of investors. The outcome, Multi-level Musharakah Protection Sukuk (MLP Sukuk for short) is an

innovative structure that allows investors to diversify and issuers to tap potential new markets. MLP Sukuk

enjoys the following features:

 It provides a general-purpose, sustainable source of funding for corporates and Islamic financial

institutions.

 It represents non-debt financing to corporates, with multiple levels of protection and risk

mitigation to investors.

 It enjoys comparable levels of seniority as bonds.

 It provides an additional layer of protection through a “capital cushion,” which represents an

Islamic alternative to “over-collateralization” in conventional finance.

 The structure is consistent in principle with OIC Fiqh Academy resolutions and AAOIFI Sharī’ah

standards.

 The MLP Sukuk is a kind of “hybrid” securities, and as such it does not necessarily require

legislating new laws or regulations.

25 | P a g e

The transaction can be summarized in the following four steps:

1) A company interested in raising corporate financing (the “Corporate”), issues hybrid Sukuk

securities.

2) Sukuk holders share in the Corporate’s assets but not the liabilities.

3) Sukuk holders, in principle, have the right to monitor the management and performance.

4) The Corporate promises to redeem the Sukuk of investors from its share of aggregated profits

generated by the company.

In this manner, investors have a senior claim against their share of the assets, comparable to that of senior

creditors.

To attract investors, Corporate could offer investors a “discount” via additional Sukuk certificates, e.g. 10-

15% of their capital contribution. This cushion will result in the first 10-15% of loss being absorbed by the

Corporate. It plays a similar role of “over-collateralization” in conventional finance.

This cushion can be proportional to the value of the asset or a fixed amount. It could also be built over

time by pledging “collateral” gradually.

Risk-averse investors may obtain additional protection for their investment from a third party. This is done

as follows:

The Third Party (e.g. a Takaful company, an investment bank, or any other financial institution) shall

establish a fund, e.g. Sukuk Protection Fund, whereby Sukuk-holders trade in their Sukuk for units in the

Fund. The Fund shall invest in a variety of Sukuk and Islamic investments.

In addition, the Third Party shall invest some of its own capital in the Fund on a longer term horizon, such

that units of the Third party will be effectively “permanent,” while units of the investors are redeemable.

In this manner investors’ units become layered with protection and are buffered with additional capital

cushion. This mechanism offers an additional layer of protection, over and above diversification offered

by the Fund.

The Third Party would monitor the performance of the Sukuk and would act as an agent on behalf of

investee Sukuk-holders to oversee the performance of the Corporate. Naturally, returns on the Fund’s

units would be lower than returns on Sukuk issued directly from the Corporate on account of the Third

Party’s being responsible for establishment of the fund, transaction management, agency function and

reserves allotment.

An important aspect of the MLP Sukuk is the seniority of its holders with respect to the underlying assets.

This sub-section aims to clarify this feature, and to show how Sukuk holders compare to creditors of the

Corporate, or bond holders in conventional financing. In corporate finance, senior creditors have the first

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claim to the assets of the Corporate. All other investors (subordinated debt holders, preferred shares

holders, and common shareholders) are subordinated to senior debt holders. In MLP Sukuk, we aim to

put Sukuk holders at an equal level of seniority with respect to the underlying assets as of that of senior

debt holders. This is outlined below.

The MLP Sukuk will be issued as a hybrid security. Hybrid securities in general are instruments that

combine aspects of fixed income and equity. They have a range of seniority rankings and can be as senior

as secured debt. Hybrids can also absorb risk on an ongoing concern, i.e. while the corporate is still

operating, as well as on gone-concern basis, i.e. when it defaults and ceases to operate.

Figure 19: Hybrid Seniority and Risk

The table below compares the characteristics of the most common hybrid securities along with the MLP

Sukuk.

Feature
Simple

Bond

Convertible

Bond

Indexed

Bond

Subordinate

Bond

Preferred

shares
Equity MLP Sukuk

Value Fixed Fixed
Variable

(inflation)
Fixed

Variable

(net

assets)

Variable

(net assets)

Variable

(assets)

Maturity Fixed Usually fixed
Fixed or

perpetual

Fixed or

perpetual

Fixed or

perpetual
Perpetual

Perpetual

(callable)

Seniority 1 1 1 2 3 4 1

Risk-

absorbance
— — — — + + +

Table 1: MLP Sukuk Characteristics Compared to Common Hybrid Securities

As Table 1 above shows, conventional markets offer a variety of securities with different characteristics,

e.g. convertible bonds, indexed bonds, preferred shares, etc. Securities might be senior, have a fixed or

variable par value, absorb risks on an on-going-concern basis, or on a gone-concern basis. The MLP Sukuk

offers a unique set of features that are lacking in both the conventional and Islamic financial industry. As

we will see later, the features of the MLP Sukuk add value to both issuers and investors that current

securities do not offer.

Seniority Risk

Debt   Hybrid   Equity

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The Corporate and investors share profits as agreed. Investors get their agreed share of profits periodically

as dividends/coupons. It can be agreed that, if the share of investors in profits exceeds a certain level,

excess returns are put into a reserve account to give investors protection for fluctuations in future returns.

According to AAOIFI Standard no. 12 on Musharakah, clause 3/1/5/9, if the profit realized is above a

certain ceiling, it is permissible to agree that the profit in excess of such a ceiling belongs to a particular

partner. The share of the Corporate in aggregate profits shall be used to redeem the Sukuk held by

investors, as below.

In principle, the Sukuk can be perpetual, as it is the case with some of the Sukuk issued recently by Islamic

banks and other corporations. Or it can have an agreed maturity. For the MLP Sukuk, the Corporate issues

a promise to redeem the Sukuk held by investors if the Corporate’s accumulated share in aggregated

profits is adequate to accomplish such redemption. If this is the case, the Corporate shall redeem the

Sukuk at nominal value. If, however, the accumulated share of the Company in profits is not sufficient,

the Corporate is under no obligation to redeem, although it might decide voluntarily to redeem from other

resources. Hence, the promise to redeem is not a debt obligation on the Corporate. It is conditional upon

realization of sufficient profits. In this manner, the Sukuk are a genuine partnership in the underlying

assets. There is no guarantee by the Company that investors will get back their capital. If the Company

decides to redeem at nominal value, then investors agree to sell their Sukuk to the Company. Investors

agree to give up any capital gain in return for the liquidity provided by redemption.

Since the partners can agree to allocate profits beyond a certain level to one partner, as above, investors

can agree to give up capital gain if total profits are such that the Corporate’s share equals or exceeds the

nominal value of investors’ Sukuk. Note that, by the conditional promise, there is an implicit priority of

Sukuk holders over the Corporate in realized profits. The Corporate has to give up its share in profits to

buy investors’ Sukuk, which means that investors are getting the profits up to the nominal value of their

Sukuk. This gives an additional layer of protection to investors. However, since profits are not guaranteed,

investors are not guaranteed their capital.

If the Corporate’s share in aggregate profits is not sufficient to redeem Sukuk held by investors at nominal

value, the Corporate might offer investors one of two options. One is to redeem at loss. The other is to

keep the Sukuk as perpetual Sukuk. The MLP Sukuk therefore are perpetual Sukuk callable by the

Corporate at the agreed maturity date. The call however, is mandatory if the Corporate’s share in

aggregate profits equals or exceeds the nominal value of investors’ Sukuk. Otherwise, the call is not

obligatory, and Sukuk will be perpetual.

The idea of sharing assets without sharing liabilities has been known in Fiqh for quite some time. In

discussing Mudharabah arrangements, the capital provider (Rabb-ul-maal) has the right to require the

Mudharib not to buy on credit, and that if the Mudharib decides to do so, only the Mudharib is responsible

for such a debt (املوسوعة الفقهية، مضاربة). The Sharī’ah Committee of the Islamic Development Bank has

approved the concept whereby investors provide funds to the issuer or the Islamic bank, such that

investors share the assets of the bank (Mudharib) but not the liabilities (Ruling 26-2008). The idea was

28 | P a g e

discussed in the Islamic Financial Services Board (IFSB) while preparing the revised draft of its Capital

Adequacy Standard (IFSB-15, Dec. 2013), whereby the Standard notes that Rabb-ul-maal (investors)

“would not be liable for the general liabilities of the IIFS (and notably for the amount owed to current

account holders)” (p. 8, ftn 12). These findings consider this arrangement as part of Mudharabah, not

Musharakah whereby investors share the assets and liabilities of the issuer. The latter however, might be

better described as “equity” as they end up with the same rights and obligations of equity shareholders.

Since the MLP Sukuk represent a genuine partnership with the Corporate, they are tradable irrespective

of the composition of the assets (debts, cash, tangible assets, usufructs). This is in accordance with the

principle of “Subordination” in Sharī’ah (see Section II). According to this principle, assets are

subordinated to the company’s legal entity, management and tangible capital used for managing the

entity. Since Sukuk holders share of the ownership of these components, Sukuk are tradable regardless

of the nature of the underlying assets. The OIC Fiqh Academy adopted a resolution supporting this view

at its 21st session in 2013.

If the performance of the appointed management team becomes of concern, Sukuk holders have the

right, by a certain proportion of votes, to request the Company to replace the management team and/or

review its strategy and policies. However, the Company as such shall remain the manager of the assets.

The right to intervene in management gives investors an additional layer of protection. Unlike creditors,

investors supervise and monitor the performance of the Company so that, in principle, they can act before

signs of underperformance become apparent.

To make things concrete, suppose, Company XYZ (the Corporate) has three assets: Receivables, Office

equipment, and a Factory. Total value of the assets is $100 million. Further, the Company has debt

obligations of $60 million. Thus, total equity of the company is $40 million.

Assets ($millions) Liabilities ($millions)

Receivables                            25 Debt                                        60

Equipment                             15

Factory                                    60

 Equity                                      40

Total Assets                         100 Total Liabilities & Equity  100

The Company needs to expand its productive capacity by building a new factory, and needs say additional

$100 million to do so. For this purpose, the Company will issue MLP Sukuk worth $100 million.

Assets ($millions) Liabilities ($millions)

Receivables                            25 Debt                                        60

Equipment                             15

Factory                                    60

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Factory 2                              100 Sukuk                                    100

 Equity                                      40

Total Assets                         200 Total Liabilities & Equity  200

Investors now are partners in the Company; they share 50% of the assets of the Company as per their

contributions. Seniority however, is achieved by having the Sukuk held by investors protected from the

creditors of the Company in case the Company defaults. So in principle, creditors of the Company and

investors are at the same level of seniority with respect to the assets.

Although investors have a senior claim against their share in the assets of the Company, they are still

taking the risk of the assets, since assets may for any reason fail to perform as expected.

To elaborate, suppose the assets of the Company lose 20% of its value.  Then Total Assets = 160. Since

Sukuk holders own 50% of Total Assets, their share of the Total Assets = 80. The remaining 80 is enough

to pay the creditors their debt of 60. The remaining of 20 goes to shareholders.

Assets ($millions) Liabilities ($millions)

Receivables                            20 Debt                                        60

Equipment                             12

Factory                                    48

Factory2                                  80 Sukuk                                      80

 Equity                                      20

Total Assets                         160 Total Liabilities & Equity  160

It is important to emphasize that the MLP Sukuk do not affect creditors’ rights. Without the MLP Sukuk,

the 20% loss would have still allowed creditors to get 80 of total assets, which is enough to pay their debt.

Sukuk holders get their share of total assets, which is what they have contributed in the first place. They

therefore have a senior claim on their share, but they are exposed to the risk of assets, however. The next

paragraph discusses how to mitigate this risk.

The basic idea of a Capital Cushion is to offer investors a cushion against losses up to a certain limit. The

concept is close to that of “over-collateralization” in conventional finance. However, over-collateralization

usually applies to debt-based instruments, while capital cushion applies to equity and Musharakah based

instruments, rather than debt-based instruments. A capital cushion effectively plays the economic role of

a “guarantee” without being a guarantee. From an economic point of view, a guarantee simply means

that the guarantor is pledging additional assets to the creditor/beneficiary. Equity, in contrast, offers no

additional assets. For Sukuk, an issuer may offer investors additional certificates, which will give investors

protection comparable to that of a guarantee, without being legally a guarantee. But there are important

differences between the two instruments:

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1. A capital cushion does not lead to default or bankruptcy of the issuer in case of loss beyond the

additional protection. In case of debt, in contrast, the debtor must cease operations, leading to

economic and social losses. Thus, cushion capital serves essentially the same objective of a

guarantee, but without the negative costs associated with default and bankruptcy. To some

extent, it combines the best of both: debt and equity.

2. A capital cushion is specified and assigned upfront to Sukuk holders. A guarantee, in contrast,

does not assign any specific portion of assets to investors. Since the company may borrow and/or

issue guarantees to several different parties, the ultimate portion of assets backing each of these

obligations will not be specified to investors upfront.

To apply capital cushion in MLP Sukuk, investors are offered the option to own additional Sukuk

certificates, at no upfront cost. (Obviously, the return they get will be reduced accordingly) The option to

own the additional Sukuk is to be exercised at maturity. In case the Company fails to redeem the principal

Sukuk certificates, investors have the right to liquidate their Sukuk in the market. In this case, they can

use the additional Sukuk to recover any possible losses. However, if the Company redeems the Sukuk at

par, then investors give up the right to own the additional Sukuk. That is, investors have the right to own

the additional Sukuk only in case the Company does not redeem their certificates at par.

The MLP valuation is akin to a non-recourse secure financing. The investment is backed by a real pool of

assets and investors do not have recourse beyond their share of assets (including the cushion). The

following factors are the main determinants of the fair price of Sukuk certificate.

Figure 20: Determinants of MLP Sukuk profit rate

Next, we elaborate on how exactly they influence the value of MLP Sukuk.

MLP Sukuk being backed by a pool of assets, their value is naturally dependent on the quality of the latter.

More specifically, assets determine Sukuk returns in two ways: Expected cash flow generation and asset

value in case of default.

Expected Cash Flow Generation
Returns of a Musharakah contract are generated from the activity of the Musharakah “entity”. In our

example, the pool of assets generates an income that will be used to distribute returns to Sukuk holders.

As a result, the remuneration of Sukuk holders is highly sensitive to the expected cash flows to be

generated by the asset.

Asset Value in Case of Default
The value of assets backing the Sukuk will, in general, be impacted by the default event. The extent of this

impact is, however, dependent on the nature of the company and the industry it operates in. For example,

Asset

Quality

Manager’s

Quality

Capital

Cushion

Upside

Incentive
Sukuk Profit Rate

31 | P a g e

Sukuk of a company with a large ratio of intangibles such as goodwill may be impacted more than Sukuk

of a company with easily tradable assets.

The issuer plays three roles in the MLP Sukuk structure. First, it is a partner and the manager of the

Musharakah.  Second, it operates as a liquidity provider in the secondary market if enough profit is

generated. Third, the issuer has the ability to trigger default of the Sukuk through the default of the

Company. We will examine how each of these roles contributes to the value of the Sukuk.

The Issuer is contributing with tangible and intangible assets to the Musharakah. It also acts as manager

of the Musharakah. The assessment of the issuer’s ability to successfully manage the Musharakah, apart

from being an important due diligence point, will also determine the management fee that Sukuk holders

will pay to the issuer in his capacity as a manager.

Investors would expect a premium for the illiquidity of any investment. The MLP Sukuk, being tradable

assets, would actually be impacted positively compared to non-tradable debt-based Sukuk. In addition,

the issuer volunteers to provide a secondary market under pre-specified conditions. This additional

liquidity should reduce the price of the Sukuk.

MLP Sukuk default if the Issuer defaults. In such a scenario, the Sukuk are impacted through

- Illiquidity

- Asset liquidation value

- Default costs

As a result, it is clear that the credit rating of the Issuer, as a metric for its default probability should be

taken into account when determining the profit rate of the Sukuk.

Risk mitigation via capital cushion would intuitively imply that the expected return of the Sukuk should

move inversely with the size of the cushion. The Issuer would expect to pay less having provided recourse

to a larger share of the asset.

Sukuk holders might give up income beyond a pre-defined rate. That income will serve as an incentive to

the Issuer in his capacity of manager. This means that Sukuk holders would expect to be compensated for

it through other favorable terms e.g. high capital cushion.

Sukuk investors vary in their abilities and propensities to take risk. Although the MLP Sukuk structure so

far provides for several layers of protection, there is room to offer a general mechanism for mitigating

Sukuk risks. There have been some proposals for “Sukuk insurance” based on the concept of Takaful.

However, given the size of the Sukuk market, it might not be feasible to offer blanket insurance to

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hundreds of billions of Sukuk. We can learn from the bonds insurance industry. After the crisis, almost all

of bond insurers went out of business after guaranteeing billions of dollars’ worth of subprime debt that

soured during the financial crisis (Financial Times, Mar. 18, 2012). A more resilient and transparent model

is presented below.

An entity willing to provide protection to Sukuk holders (an insurance company, an investment bank, or

any other financial institution) establishes a Sukuk Protection Fund. Investors who prefer to get additional

protection on their Sukuk exchange their Sukuk certificates for units in Fund. The Fund shall accept only

Sukuk of a certain quality and with sufficient diversity. In this manner, Sukuk holders are able to diversify

their investments. In addition, the Third Party shall contribute from its own resource 5-10% say of the

Fund assets. The contribution of the Third Party is long term or permanent, and thus cannot be liquidated

ahead of other investors. Hence, the 5% contribution plays the same role of a capital cushion as discussed

earlier. It provides a cushion to Sukuk investors against possible losses in the underlying Sukuk issues.

Also, the Third party shall allocate a certain percentage of the returns on the Fund as a reserve account

to provide additional protection to investors. Furthermore, the Third Party works as an agent for MLP

Sukukholders, representing them in the management of the Corporate. The Third Party naturally has an

interest that none of the Sukuk of the Fund fails or loses money. Hence, the Third Party has a direct

interest in monitoring the Corporate and assuring that assets are managed as planned. As an institutional

investor, the Third Party is better able than small investors to play this role. The role of the fund here will

reduce the moral hazard risk. In return for these services, the Third Party gets a percentage of the returns

on the underlying Sukuk of the Fund.

In summary, the Sukuk Protection Fund offers several layers of protection:

1. Diversification

2. Reserves

3. Capital cushion

It is helpful at this stage to compare the three kinds of financial instruments: bonds, equity, and MLP

Sukuk. The following table summarizes the comparison.

Feature  Bonds MLP Sukuk Equity

Priority over assets + + -

Intervention in management - + +

Upside gain (potential) - + +

Cushion against loss + + -

Risk sharing - + +

Table 2: MLP Sukuk Comparison to Bonds and Equities

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MLP Sukuk share with bonds the most two important features of debt financing: priority over assets, and

cushion against losses through capital cushion. However, beyond the cushion, Sukuk holders share the

risk with the Corporate. Unlike debt, losses do not cause the Corporate to default and declare bankruptcy.

Bankruptcy is a dead-weight loss to all parties, and it is in the interest of all parties to avoid it as much as

possible. For this reason, MLP Sukuk holders have the right to intervene in the management of the

Corporate to overcome any mismanagement or malpractice, in order to save their investments and allow

it a better opportunity to recover. This feature is absent from bonds but is an important feature of equity.

Since MLP Sukuk imposes no debt burden upon the Corporate, it is a kind of risk sharing that the Corporate

would prefer over borrowing or debt financing. Overall, MLP Sukuk combines aspects of both debt and

equity such that it offers a unique set of features to both issuers and investors.

MLP Sukuk provide a versatile structuring tool. Indeed, risk mitigation features allow the fine-tuning of

this product’s risk profile in order to fit investors and issuers’ demands.

One can design defensive Sukuk that provide a maximal protection. Such product would be popular with

risk-averse or fixed income type investors. On the other hand, investors with more risk appetite would

prefer to participate in assets’ capital gains and would not mind taking some losses. The structure can also

accommodate this type of investors via Sukuk that have minimal capital cushion and a substantial

potential upside.

It is also helpful to compare MLP Sukuk with some of the common forms of Sukuk. Most Sukuk structures

end up in a debt obligation on the Company, hence the common description as “Islamic bonds.” As already

pointed out, MLP Sukuk create no debt obligation upon the Company, and are a genuine partnership

arrangement. In addition, the MLP Sukuk structure is more efficient and transparent than the prevalent

Ijarah structures. The table below summarizes the main aspects of the two.

Ijarah Sukuk MLP Sukuk

Investors own specific tangible asset(s)  Investors share in the general pool

Represent a debt obligation  Represent a share in assets—no debt

Issuance is limited by availability of
tangible assets

Issuance is limited by productivity of the
Company

Table 3: MLP Sukuk Comparison to Ijarah Sukuk

The MLP Sukuk structure avoids the main Sharī’ah issues in some Ijarah Sukuk structure, namely the

undertaking to buy back. The buy-back undertaking is essentially a debt obligation, and it is the basis for

rating the Sukuk, if a rating is provided. The buy-back undertaking gives the traditional Sukuk transaction

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the same risk profile as a bond. As discussed, MLP Sukuk offer contingent redemption based on the

generated profits. Ultimately, it is the quality of the underlying assets that gives investors the assurance

of their investment. The rating of the MLP Sukuk therefore, is based primarily on the quality of the

underlying assets. Capital cushion offers an additional enhancement of the Sukuk. From an economic

point of view, MLP Sukuk involves no “redundant” assets going back and forth for no reason except to

obtain financing.

Further, as there is no one-time structure involved; the process can be used for regular and sustainable

issuance of Sukuk. The prevailing Sukuk structure, in contrast, is designed as a one-time solution only.

Judging by the substantial costs of issuance, a one-time issue is highly inefficient. MLP Sukuk holders are

partners in the Corporate, and thus own both assets and management rights. Hence, the composition of

the assets of the Company is not a constraint on issuance, as discussed earlier. In this manner, the

Company is able to share (“securitize”) any of its assets, tangibles and non-tangibles. This gives corporates

great flexibility for issuances. In short, MLP Sukuk are more efficient, more flexible, and serve the

objectives and parameters of Shari’ah in a manner that is more credible than some of the prevailing Sukuk

structures.

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The ideal model of Sukuk, according to which many of the early Sukuk issuances were structured, is for

Sukuk to be asset-backed securities. Investors had legal ownership of the underlying asset and the

coupons were generated by the asset’s performance. The industry however, moved gradually over the

years into structures where the asset plays a mere secondary role. In many cases, asset value is unrelated

to the Sukuk notional and Sukuk holders are not the real owners of the securitized asset which frequently

stays on the issuer’s balance sheet.

In addition to inherent Shari’ah issues with these type of Sukuk, an issuer’s ability to raise capital is

considerably constrained by the availability of unencumbered assets or the sensitivity around strategic

assets. We present in this section a concept product that is being developed in IDB that addresses the

aforementioned issues. The product is an asset-backed Sukuk where investors are the legal owners of the

asset. Moreover, this new concept does not require the pre-existence of tangible assets on the issuer’s

balance sheet; Shari’ah-compliant tangible assets can be obtained from the market. In addition, the

structure is credit-enhanced to provide a better rating of the Sukuk.

In very simple terms, the exchangeable Sukuk structure is done in two steps:

Issuer purchases a Basket of Shari’ah-compliant shares for a Deferred Price plus a Premium. The Basket is

purchased (via SPV) from an Original Asset Seller (OAS, for example an investment bank) on wa’ad basis,

i.e. the right of the buyer to put back the Basket to the OAS.

Issuer uses the Basket of Shares to issue Sukuk to investors.

If the Basket underperforms, Sukuk holders have the right to exchange the Basket for the Deferred Price

of the issuer. This Deferred Price sits within the SPV from inception. In this manner, the principal (and the

return) of the Exchangeable Sukuk are backed by the payment obligation of the issuer.

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Figure 21: Exchangeable Sukuk Structure

Sukuk issuances are generally based on the sale of issuer’s assets to Sukuk holders. The current industry

practice of adding an unconditional re-purchase undertaking to the sale operation entails the persistence

of the sold assets on the issuer’s balance sheet, even after Sukuk issuance. This point is much debated as

it poses potential Shari’ah issues vis-à-vis the validity of the sale operation. Because Exchangeable Sukuk

are truly asset-backed, the legal ownership of the underlying asset is completely transferred to Sukuk

holders at Sukuk issuance. Moreover, the structure does not involve any Purchase Undertaking by the

issuer at maturity. As a result, the assets will be genuinely off the balance sheet of the issuer once the

Sukuk are issued.

The structure does not involve ‘einah, since the cash price of Sukuk is paid by investors, not by the OAS.

The OAS only provides a hedge mechanism to take back the basket and net out the payment obligations.

There is no implicit loan between the issuer and the OAS.

Further, the structure does not involve gharar, where one party wins at the expense of the other. If the

Basket performs, all parties win, and that is the objective of the structure. For this reason, the Basket has

to be thoroughly evaluated and assessed, such that it is more likely to generate expected returns than

otherwise. The issuer, as an arranger and advisor to investors, will get a share of the upside of the Basket.

This share is used to offset the Premium associated with the structure. This makes the structure a genuine

investment whereby the returns play a vital role in facilitating the structure.

Premium

Sukuk backed by
Basket

Proceeds

Issuer

OAS SPV

Basket Basket

Deferred Price +

Premium

Investors

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The Exchangeable Sukuk represent the legal ownership of a Shari’ah compliant tangible asset and as such

to do not have any element that prevent tradability of the Sukuk on the secondary market.

It is worth noting that Sukuk holders are fully insulated from OAS’s credit risk. The only credit risk exposure

Sukuk holders have is that of the Sukuk issuer. Moreover, by virtue of their legal ownership of the

underlying asset, Sukuk holders have the extra credit protection from direct recourse to the assets. In this

sense, Exchangeable Sukuk are a safer investment compared to Sukuk where investors do not have direct

recourse to the assets. Issuers would expect to pay a lower financing cost due to this credit enhancement.

The Sukuk market is traditionally geared toward “fixed-income” investors. In order to accommodate the

traditional Sukuk investor base, the exchangeable Sukuk, by way of the OAS’s wa’ad, can provide full

protection of the Sukuk.

The issuer on the other hand, will be compensated for arranging the transaction by benefiting from the

full appreciation of the assets as Sukuk holders are mainly interested in the capital protection.

The investment assets can be adequately lined up with the issuer’s activity and market views. From the

perspective of the issuer, the above structure can thus play the dual role of firstly, financing and secondly,

investment or hedging.

We illustrate in this section the respective cash flows at maturity in different asset performance scenarios.

We take an example $100 structure.

In the case where the asset did not appreciate nor depreciate, the cash flows at maturity are summarized

in the following table.

Cash flows at maturity

Issuer Deferred Price Asset Value OAS Sukuk
Issuer
Upside

$(-105) $100 $100 $105 -

- Issuer pays deferred price of $105 to SPV.

- OAS receives $100 from asset sale.

- Sukuk holders get $105 from SPV.

Relative Return

Asset Value Sukuk

0% 5%
Table 4: Scenario I Cash Flows

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In the case where the asset appreciates by 10%, investors will give up the appreciation to the benefit of

the issuer. The cash flows at maturity are summarized in the following table.

Cash flows at maturity

Issuer Deferred Price Asset Value OAS Sukuk Issuer Upside

$(-105) $110 $100 $105 $10

- Issuer pays deferred price of $105 to SPV.

- OAS receives $100 from SPV.

- Sukuk holders receive $105 from asset sale.

- Issuer gets the remaining proceeds in the SPV of $10.

Relative Return

Asset Value Sukuk

10% 5%
Table 5: Scenario II Cash Flows

In the case where the asset depreciates by 30%, Sukuk holders will be protected from this depreciation.

The cash flows at maturity are summarized in the following table.

Cash flows at maturity

Issuer Deferred Price Asset Value OAS Sukuk Issuer Upside

$(-105) $70 $70 $105 -

- Issuer pays deferred price of $105 to SPV.

- Sukuk holders put back the asset to the SPV.

- Sukuk holders receive $105 from SPV.

- SPV puts back the asset with a value of $70 to OAS.

Relative Return

Asset Value Sukuk

-30% 0%
Table 6: Scenario III Cash Flows

The structure provides a great degree of flexibility and can be adapted to fit the needs of specific issuers

and target investors. The cost structure of the aforementioned model could be expensive for Islamic

Financial Institutions (IFIs) who do not have any investment needs or IFIs with investment targets order

of magnitudes lower than financing needs.

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In order to lower the cost for the issuer, several viable avenues are available. One possibility is for the

OAS’ wa’ad to cover only a predefined level (say 30%), so that the Basket is hedged only up to a drop of

the market of 30%. This will reduce the cost and lower the premium. We can then construct two classes

of Sukuk: Class A and Class B.

Class A Sukuk holders are typical fixed-income investors. They own 30% of the Basket, and are hedged

100%. Class B Sukuk holders are risk-taking investors looking for above-average returns. They are

protected only up to 30% loss. Beyond that, they are exposed to market risk. Class B investors are

compensated for this partial hedge with a higher participation in the profits from the Basket.

The result is a lower cost Sukuk issuance with two Classes of Sukuk targeting two types of investors.

The Exchangeable Sukuk concept is a novel idea that aims to solve the asset-scarcity issue faced by many

Sukuk issuers and prospective issuers. It also provides a cleaner Shari’ah and accountancy treatments of

the Sukuk transaction as it allows the underlying assets to genuinely leave the issuer’s balance sheet.

The structure permits the potential alignment of investment and funding objectives. It could also be used

for hedging purposes when the underlying asset and the issuer activity have opposite business cycle

sensitivities for example.

The generalization of such Sukuk, especially Class B Sukuk, will engage a new investor base and ultimately

improve the depth and liquidity of the global Sukuk market.

Finally, by virtue of credit enhancement through collateralization, the Sukuk will allow a larger spectrum

of prospective issuers to tap the Sukuk market.

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Sukuk have demonstrably been the Islamic Financial industry’s instrument of choice for access to capital

markets. The sector enjoyed a rapid growth in the last decade thanks to a propitious environment for

development. On one hand, Islamic Finance Infrastructure Institutions have set the stage via framework

standardization. On the other hand, Islamic Finance practitioners strived to use the framework in

ingenious ways in order to reach investors.

There are, however, some well-known gaps in the current Sukuk offerings. Ijarah and Murabahah

constitute the overwhelming majority of Sukuk contracts, relegating genuine profit and loss sharing

contracts such as Musharakah and Mudarabah to niche market status. Moreover, the industry lacks a

generic and sustainable Sukuk issuance model. The majority of Sukuk programs seemingly rely on the

hardly sustainable case-by-case asset identification approach.

This Report introduced two novel ways to structure Sukuk; Musharakah Sukuk: Multi-Level Protection

Sukuk and Exchangeable Sukuk. The first one is a hybrid security that enjoys the best of both equity and

fixed income worlds. Investors are participants in issuer’s assets but not in its liabilities and hence benefit

from the same level of seniority as debt holders in case of default. It is, to the best of our knowledge, a

completely new instrument in both Islamic and conventional finance. The second structure is a versatile

framework for resource mobilization without pre-ownership of tangible assets. Thanks to the true sale

operation involved, investors benefit from a direct recourse to the asset in case of default. In addition,

common Shari’ah and accounting issues are mitigated since the securitized asset does not subsist on the

issuer’s balance sheet after the sale operation.

On the sovereign financing side, this Report proposed an institutional solution for a robust and efficient

Sukuk issuance program. With a fully-fledged Islamic financial institution dedicated to sovereign financing,

the Sovereign Finance Corporation (SFC) model constitutes a leap in terms of efficiency and regularity

when compared to existing practices. Issues relating to sovereign asset availability and the sensitivity of

ownership transfer are elegantly resolved in the proposed model.

Each of these structures, needless to say, can borrow from the other two, resulting in a wide variety of

additional structures that might suit the needs of different issuers in different circumstances. By this, we

hope that the Report helps to open the door for a new era for Sukuk and Islamic capital markets.

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Sukuk is the plural of the Arabic word Sakk )صك(. They are the resulting ownership certificates from the

securitization of an economic asset. In addition to commensurate ownership rights, Sukuk holders benefit

from the returns generated by the economic activity of the securitized asset. More precisely, the

Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) defined of the Sukuk in

Standard 17 as:

(…) Certificates of equal value representing undivided shares in ownership of tangible

assets, usufruct and services (in the ownership of) the assets of particular projects or

special investment activity; however, this is true after receipt of the value of the

sukuk, the closing of subscription and the employment of funds received for the

purpose for which the sukuk were issued.

Sukuk are structured around various Islamic contracts. The table below summarizes the characteristics of

the most common types of Sukuk based on the underlying Islamic contract involved.

Ijarah  (Certificate
of ownership in
leased asset)

 These are certificates that carry equal value and are issued either by the
owner of a leased asset or an asset to be leased by promise, or by his
financial agent, the aim of which is to sell the asset and recover its value
from subscription, in which case the holders of the certificates become
owners of the assets.

 These securities would suit the classification of asset-based because the
leased asset will be transformed into units of proportionate ownership to
be subscribed by the investors.

Manfa'ah
(Certificate of
ownership of
usufructs of
existing assets)

 Certificates of equal value issued by the owner of an existing asset either on
his own or through a financial intermediary with the aim of subleasing the
usufruct and receiving the rental from the revenue of subscription so that
the holders of the certificates become owners of the usufruct.

 These are also part of asset-based securitization though the asset is in the
form of usufruct and services.

Intifa’
(Certificates of
ownership of
usufructs of

 These are documents of equal value issued for the purpose of leasing out
tangible future assets and for collecting the rental from the subscription
revenue so that the usufruct of the described future asset passes into the
ownership of the holders of the certificates.

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described future
assets)

 These are deemed to be part of assed-based securitization although the
underlying asset is the services that are to be provided in the future.

Milkiyyat Al-
Khadamat
(Certificates of
ownership of
services of a
specified supplier)

 These are documents of equal value issued for the sake of providing or
selling services through a specified supplier (such as educational programs
in a nominated university) and obtaining the value in the form of
subscription income, in which case the holders of the certificates become
owners of the services.

 Similar to the other Ijarah-based securities, these securities come under the
purview of asset-based securitization.

Al-Khadamat Al-
Mawsufah fi Al-
Zimmah
(Certificates of
ownership of
services to be
made available in
the future as per
description)

 These are documents of equal value issued for the purpose of providing
future services through described provider (such as certain prescribed
educational benefits from university without naming the educational
institution) and obtaining the fee in the form of subscription income so that
the holders of the certificates become owners of the services.

 Services, although to be provided in the future, are deemed as an asset
thus making this security a type of asset-based securitization.

Salam
(Salam Certificate)

 These are documents of equal value issued for the purpose of mobilizing
Salam capital so that the goods to be delivered on the basis of Salam basis
come to be owned by the certificate holders.

 The Salam Sukuk represent the ownership of the investors in the asset to
be delivered in the future.

 These Salam Sukuk can be issued but are not traded even on the basis of
par value because the Salam asset which is represented by the Salam Sukuk
cannot be sold to another party without the initial buyer taking possession
of the asset.

Istisna’a (Istisna’a
Certificates)

 These are certificates of equal value issued with the aim of mobilizing funds
to be employed for the production of goods so that the goods produced
come to be owned by the certificate holders.

 This definition refers to the Sukuk that represent the proportionate
ownership in the asset to be constructed. This is an asset-based structure
until the asset is delivered to the buyer.

 As practiced in some jurisdictions like in Malaysia, Istisna’a Sukuk refers to
debt securitization that is the receivables owing to the contractor. This type
of issuance, from an international Shariah standpoint, cannot be traded
freely as it reflects debt-trading instead of asset-trading.

Murabahah
(Murabahah
Certificates)

 These are certificates of equal value issued for the purpose of financing the
purchase of goods through Murabahah so that the certificate holders
become the owners of the Murabahah commodity.

 Similar to Istisna’a Sukuk, this definition refers to an activity of pooling
monies to purchase a commodity to resell the same to another party under
Murabahah sale. This Sukuk, if issued, is an asset-based securitization.

 However, as practiced in Malaysia, Murabahah Sukuk may refer to the
securitization of the seller’s receivables. This issuance cannot be traded
except on face value principal in accordance with AAOIFI Shariah standards

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because Murabahah receivables connote debt or financial obligation which
is deemed to be money in character.

Musharakah
Certificates

 These are certificates of equal value issued with the aim of using the
mobilized funds for establishing a new project, developing an existing
project or financing a business activity on the basis of any of partnership
contracts so that the certificate holders become the owners of the project
or the assets of the activity as per their respective shares.

 There are three modes of issuing securities based on Musharakah concept:
(1) Musharakah Sukuk (Participation Certificates). These are certificates

representing projects or activities managed on the basis of Musharakah
by appointing either one of the partners or another person to manage
the operation.

(2) Mudharabah Sukuk (Issuer is the mudharib or manager). These are
certificates that represent projects or activities that are managed on
the basis of Mudharabah by appointing the mudharib for the
management of the operation.

(3) Wakalah Sukuk (Investment agency Sukuk). These are certificates that
represent projects or activities that are managed on the basis of
investment agency by appointing an agent to manage the operation on
behalf of the certificate holders.

Istithmar   These are Sukuk which are hybrid in nature. They combine both financial
assets such as Murabahah receivables and tangible assets such as Ijarah
(leased) asset according to a proportion of 70:30 respectively.

 The issuance of these securities which was initiated by the Islamic
Development Bank was a breakthrough in addressing the issue of
receivables securitization.

 These securities have been deemed as asset-based securitization and
therefore are tradable in the secondary market.

Table 7: Sukuk Types

Source: INCEIF, Rasameel.

Rasameel, Quarterly Global Sukuk Report, July 2014.

The Financial Product Development Center (FPDC) was established in Muharram 1432H (December
2010G). Its main purpose is to enhance the leadership of the Islamic Development Bank Group in the
development and promotion of innovative Islamic financial products within the framework of the Maqasid
al-Shariah. This is accomplished while further strengthening the financial soundness and relevance of the
IDB Group.

The Center is the focal point for the development of new and innovative financial instruments at IDB
Group, and for this purpose it also collaborates with various institutions in the Islamic financial industry.

Strategic Objectives

The Center has three major strategic objectives:
 Developing Business Process for new product development.
 Building capacity of product developers.
 Designing new financial products.

These three objectives are summarized by the “3Ps” that the Center works along: Process, People, and
Products.

For any queries, please contact:
Financial Product Development Center

Islamic Development Bank
19th Floor, HQ Building

Jeddah, Kingdom of Saudi Arabia

Email: fpdc@isdb.org
Tel: +966 12 646 7469
Fax: +966 12 636 7554

www.isdb.org