Wednesday, April 16, 2008

Sukuk Ijarah & its structural features: How much of it IS 'Shariah' compliant?

Sometime in November 2007, Shaikh Muhammad Taqi Usmani, the chairman of the Shariah board of the standard-setting body, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) created news headline when he mentioned that in the Gulf, around 85% of Sukuk Ijarah are suspect of being Shariah compliant.

Subsequently, in February/March, AAOIFI released some guidelines with emphasis, among other things, on the need for Sukuk structures to be asset-backed (actual transferral of asset i.e. asset is off the balance sheet) rather than asset-based (mere transfer of cashflow only). However, it is also interesting that one section from the guidelines noted:
Fifth: It is permissible for the lessee in a Sukuk al-Ijarah to agree to purchase the leased assets when the Sukuk are extinguished for their nominal value, as long as the lessee is not also an investment partner, mudarib, or agent.
To repeat the sentence, so the guideline above states it is allowed for the originating party (be it government or corporation issuing the sukuk) whom technically is the lessee to buyback the asset at nominal value as long as this party is not 'an investment partner, mudarib or agent'. In my view, it opens a curious thought onto what is meant by 'investment partner, mudarib or agent' or how these terms are to be defined or interpreted.

If the originator of the Sukuk creates a Special Purpose Vehicle (SPV) to sell the asset in the initial stage, does the originator fall under the definition of 'investment partner'? After all, the SPV is essentially under the realm of the government or corporation that originated the Sukuk. Does the originator not have some form of power or influence in the buyback at nominal vs market value? Even if the lessor is not the SPV but a bank, does the originator have no say in the buyback at nominal vs market value? This is one issue that needs addressing.

Secondly, in my opinion, the bigger picture for Sukuk Ijarah to progress as a Shariah compliant product lies in the need to clearly answer whether the permissibility of buyback at nominal value is in compliance with Shariah as it is so close to riba. To answer this, we must continuously re-learn and clarify within ourselves as to why riba is prohibited. Is it because of the positive, predetermined returns on a loan or is it because of the adverse effects of the loan?

If it is the latter, we have to be very careful with Sukuk Ijarah, with the buyback notion at nominal value. With this nominal value issue, the cash flow of the overall transaction appears similar to riba. If this is the case, would the effects of a riba-based loan exist in a Sukuk Ijarah (structured at nominal value) as well? This, I believe, need some research or deeper analysis.

At present, Islamic finance may be at the limelight with many new markets opening up such as those in the West and other countries whom are attracted to the growth of the Sukuk market. I fear this growth may lead us to be rich and prosperous in this lifetime but are we prepared to be accountable for the hereafter (Only God knows).

The above are my thoughts only. Anyone whom can explain the guideline to me better or correct me if I'm wrong is very much encouraged to give comments.

For readings on a Sukuk structure, there is a good section in 'Islamic Capital Market Products - Developments & Challenges' in an IRTI website.



Farhan said...

Did you ever find your answer as to why buy-back at nominal value is allowed to Ijarah Sukuk? I'm trying to find the answer to this as I'm unable to grasp the concept. Buy-backs for Mudharabah and Musharak Sukuks have not been allowed but is allowed for Ijarah Sukuk.

Umar A. said...

Waalaikumsalam Farhan,

Unfortunately, no, even in Taqi Usmani's other explanations related to Sukuk (, I have yet to find a good answer as to why it's still allowed or deemed less controversial than those on Mudarabah & Musharakah.

The only 'answer' I can think of, is that it is shariah compliant (in form/structure), similar to IFIs that use inah under the guise of BBA, and organized tawarruq. Therefore, it appears that shariah compliancy continues to look at form rather than substance.

My thoughts.

However, do share your answer, if you come across it. Insya Allah, will update if I do.