How Sukuk (Islamic Bonds) Differ from Conventional Bonds

Definition of Sukuk
An Islamic financial certificate, similar to a bond in Western finance, that complies with Sharia,
Islamic religious law. Because the traditional Western interest paying bond structure is not
permissible, the issuer of a sukuk sells an investor group the certificate, who then rents it back to
the issuer for a predetermined rental fee. The issuer also makes a contractual promise to buy back
the bonds at a future date at par value.
Sukuk represents undivided shares in the ownership of tangible assets relating to particular
projects or special investment activity. A sukuk investor has a common share in the ownership of
the assets linked to the investment although this does not represent a debt owed to the issuer of
the bond.
In the case of conventional bonds the issuer has a contractual obligation to pay to bond holders,
on certain specified dates, interest and principal. In contrast, under a sukuk structure the sukuk
holders each hold an undivided beneficial ownership in the underlying assets.
Consequently, sukuk holders are entitled to a share in the revenues generated by the Sukuk
assets. The sale of sukuk relates to the sale of a proportionate share in the assets.
Since the beginning of 2000, sukuk have become important Islamic financial instruments in
raising funds for long-term project financing. The first sukuk were issued by Malaysia in 2000,
followed by Bahrain in 2001. Since then sukuk have been used by both the corporate sector and
states for raising alternative financing. While sukuk issuance was affected by the global
financial crisis, since 2011, sukuk have been growing in popularity
Definition of Conventional Bonds
A debt investment in which an investor loans money to an entity (corporate or governmental)
that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by
companies, municipalities, states and U.S. and foreign governments to finance a variety of
projects and activities.
Bonds are commonly referred to as fixed-income securities and are one of the three main asset
classes, along with stocks and cash equivalents.
Rewarding Investors for Sukuk
With sukuk, the future cash flow from the underlying asset is transferred into present cash flow.
Sukuk may be issued for existing assets or for assets that will exist in the future. Investors who
purchase sukuk are rewarded with a share of the profits derived from the asset. They dont earn
interest payments because doing so would violate sharia.

Repurchasing Sukuk at Maturity

As with conventional bonds, sukuk are issued with specific maturity dates. When the maturity
date arrives, the sukuk issuer buys them back (through a middleman called a Special Purpose
Vehicle).
However, with sukuk, the initial investment isnt guaranteed; the sukuk holder may or may not
get back the entire principal (face value) amount. Thats because, unlike conventional bond
holders, sukuk holders share the risk of the underlying asset. If the project or business on which
sukuk are issued doesnt perform as well as expected, the sukuk investor must bear a share of the
loss.
Most sharia scholars believe that having sukuk managers, partners, or agents promise to
repurchase sukuk for the face value is unlawful. Instead, sukuk are generally repurchased based
on the net value of the underlying assets (each share receiving its portion of that value) or at a
price agreed upon at the time of the sukuk purchase.
In practice, some sukuk are issued with repurchase guarantees just as conventional bonds are.
Although not all sharia scholars agree that this arrangement complies with Islamic law, a product
called sukuk ijara may come with a repurchase guarantee.
Ensuring Sharia Compliance with Sukuk
The key characteristic of sukuk the fact that they grant partial ownership in the underlying asset
is considered sharia-compliant. This ruling means that Islamic investors have the right to receive
a share of profits from the sukuks underlying asset.
Putting Bonds and Sukuk Side-By-Side
When you have the basics about how conventional bonds and sukuk work, its time to put them
next to each other. This table offers a quick look at the key ways in which these investment
products compare.

Distinguishing Sukuk from Conventional Bonds

Conventional Bond
Asset ownership

Investment criteria

Issue unit

Issue price

Investment
rewards and risks

Effects of costs

Bonds dont give the investor a

share of ownership in the asset,
project, business, or joint
venture they support. Theyre a
debt obligation from the issuer
to the bond holder.
Generally, bonds can be used
to finance any asset, project,
business, or joint venture that
complies with local legislation.
Each bond represents a share
of debt.
The face value of a bond price
is based on the issuers credit
worthiness (including its
rating).
Bond holders receive regularly
scheduled (and often fixed
rate) interest payments for the
life of the bond, and their
principal is guaranteed to be
returned at the bonds maturity
date.
Bond holders generally arent
affected by costs related to the
asset, project, business, or joint
venture they support. The
performance of the underlying
asset doesnt affect investor
rewards.

Sukuk
Sukuk give the investor
partial ownership in the
asset on which the sukuk
are based.

The asset on which sukuk

are based must be shariacompliant.
Each sukuk represents a
share of the underlying
asset.
The face value of sukuk is
based on the market value
of the underlying asset.
Sukuk holders receive a
share of profits from the
underlying asset (and
accept a share of any loss
incurred).

Sukuk holders are affected

by costs related to the
underlying asset. Higher
costs may translate to
lower investor profits and
vice versa.

References
Investopedia. Definitaion. Retrieve from
http://www.investopedia.com/terms/s/sukuk.asp
Definition of sukuk (Islamic bonds). Retrieve from http://lexicon.ft.com/Term?
term=sukuk-%28Islamic-bonds%29
Investopedia. Definitaion. Retrieve from
http://www.investopedia.com/terms/b/bond.asp
Dr. Faleel Jamaldeen. Islamic Finance for Dummies. Retrieve from
http://www.dummies.com/how-to/content/how-sukuk-islamic-bonds-differ-fromconventional-b.html