THE HISTORY OF SUKUK

By: Camille Paldi

CEO of FAAIF

INTRODUCTION: THE ORIGIN OF SUKUK

Sukuk is derived from the word sakk, which can mean

legal instrument, deed, and cheque. Sakk can also mean

to strike a seal on a paper document.

The first sukuk transaction took place in Damascus, Syria

in the Great Mosque of Damascus (Umayyad Mosque) in

the 7th Century AD. Syria is a treasure house of culture

and history.

SHEIKH ZAYED MOSQUE, ABU DHABI, UAE

SUKUK DEFINITION

Securitization or taskeek in Arabic refers to the

process of the division of the ownership of tangible

assets or rights to use those assets or both or right

to a project into units, which have equal value and

the issuance of those units to investors.

In simple terms, securitization describes the

process of aggregating assets and packaging them

into marketable securities.

SUKUK LINGUISTIC ORIGIN AND DEFINITION

Tawriq (from wariq) means to render something into cash. Taskik (from Sakk) is also used as securitization though literally refers to the process of dividing the assets into papers (Sukuk).

Tawriq is defined as: “transforming a deferred debt for the period between the establishment of the debt and the maturity period into papers, which can be traded in the secondary market.” (in Majallah Majma ‘Al Fiqh’)

AAOIFI in its Shari’ah Standard 17(2), defined

investment sukuk (Sukuk Istithmar) as “certificates

of equal value representing undivided shares in

ownership of tangible assets, usufruct and services,

assets of particular projects or special investment

activity.”

The IFSB, in its Capital Adequacy Standard (IFSB

2), defined sukuk as “Certificates that represent the

holder’s proportionate ownership in an undivided

part of an underlying asset where the holder

assumes all rights and obligations to such asset.”

Sukuk is described in a decision of the Islamic

Jurisprudence Council of February 1988, which

provides that:

Any combination of assets (or the usufruct of such

assets) can be represented in the form of a written

financial instrument, which can be sold at a market

price provided that the composition of the group of

assets represented by the sukuk consists of a

majority of tangible assets.

Securities Commission Malaysia (SC)

defined sukuk as a document or certificate, which

represents the value of an asset.

In terms of AAOIFI, the IFSB, and SC, the AAOIFI

and IFSB do not recognize financial assets as

assets that would qualify to form the underlying

assets of a tradable sukuk, while the SC does allow

such assets.

MAIN FUNCTION OF SUKUK

The main function of sukuk is to provide an

alternative to conventional bonds, in other

words, to provide the benefits associated with

conventional bonds, but in a Shari’ah compliant

manner.

SUKUK V BONDS

A conventional bond is a contractual debt obligation

whereby the issuer is contractually obliged to pay to

bond holders, on a certain specified date, interest

and principal.

Under a Sukuk structure, the Sukuk holders each hold

an undivided beneficial ownership interest in the

underlying assets.

Sukuk holders are entitled to a share in the

revenues generated by the Sukuk assets.

In sum, Sukuk are monetary denominated

participation certificates of equal unit value to be

issued to investors to represent their proportionate

share in the ownership of the underlying assets and

a pro- rata share in the income generated by those

assets.

SUKUK V BONDS

While bonds represent pure debt obligations from

the issuer to the investors or bondholders, the

sukuk represent ownership of a well-defined asset.

The sale of sukuk, both in primary and secondary

markets, is a sale of a share of an asset, while

selling a bond is basically the sale of debt.

SUKUK V BONDS

In terms of pricing, sukuk prices are market driven

and depend on the fluctuation of the market value

of the underlying assets. In the case of the issuer’s

default, sukuk holders will possess the asset and

they can sell it to other buyers or keep it as an

asset.

On the other hand, bondholders depend solely on

the creditworthiness of the issuer without any

specific assets to be relied on. Therefore, in the

case of the issuer’s failure, unsecured bondholders

will be jointly seeking the assets of a bankrupt

company.

SUKUK V BONDS

The aim of bond traders usually is to make capital

gains as fixed-interest bond prices rise when

variable market interest rates fall.

Bond trading is therefore largely about exploiting

interest rate developments and trading in paper that

is usually unrelated to the value of any underlying

asset.

SUKUK V BONDS

The major risk for holders of conventional bonds is

of payments default, but this risk is usually

assessed solely on the basis of credit ratings, with

the ratings agency rather than the bond purchaser

estimating the risk.

Hence, the bonds are regarded as mere pieces of

paper with third parties estimating the risk and the

purchaser, at best, only making a risk/return

calculation without any reference to the business

being financed.

SUKUK V SHARES

Sukuk is an undivided ownership share in specific

assets while holding shares means holding an

ownership share in a corporation or a company.

In sukuk, the assets should be Shariáh compliant

and a minimum of 51% are tangible assets.

Ordinary shares do not require the company to be

Shariáh compliant and the percentage of tangible

assets is not determined.

TYPES OF SUKUK

Leased-based sukuk, i.e., sukuk al ijarah.

Partnership-based sukuk, i.e., sukuk mudharabah

and sukuk musharakah.

Sale-based sukuk, i.e., sukuk murabahah, sukuk

istisnaá, and sukuk salam.

SUKUK HISTORY

In 1990, in Malaysia Shell MDS Sdn Bhd issued

a sukuk ijarah worth RM 125 million. Issuances

grew 145% in 2006 compared to 2005 to reach

US$27 Billion. The sukuk market peaked at US$47

Billion in 2007 and dropped by 55% to US$21

Billion in 2008.

The market recovered in 2009 to reach a total

issuance of US$31 Billion, which was higher than

the total issuance in 2006.

2012 saw US$110 Billion in sukuk issuances

while 2013 tapered off with US$79 Billion.

HISTORY OF SUKUK IN THE USA

The US has seen two major sukuk issuances

including the East Cameron Gas Sukuk, which was

the first ever musharakah sukuk in America backed

by oil and gas assets and the General Electric

Sukuk, which was an ijarah sukuk backed by

aircraft leases matured in November, 2014.

Although the Cameron Gas Sukuk experienced

some technical difficulties, the General Electric

Sukuk performed well and there is a large potential

for sukuk in the United States as a capital raising

instrument for American firms.

US STATE LEGISLATION FOR SUKUK

In fact, both the state of New York and the state of

Illinois have initiated state bills in their legislatures

enabling sukuk transactions.

Illinois Bill Title: Bill Islamic Finance Sukuk.

New York Senate: Bill Introduced by Senator Parker

in the New York State Senate in 2011.

*Copies available upon Request.

EAST CAMERON GAS SUKUK

East Cameron Partners LP saw the sukuk issuance

as an affordable and flexible finance opportunity

through which it could raise the funds needed to

purchase other shares from its non-operating

partner, Macquarie Bank, whom wished to sell its

share in the business.

East Cameron Partners LP (“ECP” or the

“Originator”) is an independent oil and gas

exploration and production company, based in

Houston, Texas whose producing assets consisted

of two gas properties located offshore of the State

of Louisiana, USA.

EAST CAMERON GAS SUKUK

East Cameron Partners (ECP) issued sukuk of USD165.67 million in June 2006 with a maturity period of 13 years.

This was the first sukuk issued by a company based in the United States and rated by Standard & Poor’s.

The underlying contract was musharakah (co-ownership/joint venture) in which sukuk investors own so called Overriding Royalty Interest (ORRI) in two gas properties located in the shallow waters offshore the State of Louisiana through an SPV acting as a trustee of sukuk holders.

EAST CAMERON GAS SUKUK

The SPV was called East Cameron Gas Company (ECGP) and incorporated in the Cayman Islands.

The originator also contributed its funds into the musharakah.

The assets of the musharakah were co-owned by the sukuk holders and the originator company ECP.

The sukuk were secured by a mortgage on the assets of the issuer, which included the ORRI and secured accounts. The sukuk were initially rated CCC+ by Standard & Poor’s and then downgraded to CC and finally D.

EAST CAMERON GAS SUKUK

The East Cameron Gas sukuk had a fixed payment

of 11.25% annually. However, there was also a

variable component because the sukuk returns

depended upon the production quantities (the

overriding royalty interest (ORRI) specified a fixed

quantity of natural gas be delivered to the SPV).

It also contained a redemption feature by where a

percentage of the sukuk would be redeemed if

production exceeded a certain level.

EAST CAMERON GAS SUKUK

Sukuk holders were also exposed to risks found in

the energy sector (i.e.) the volatility of natural gas

and condensate prices, which may adversely affect

payments on the sukuk.

In order to hedge against severe price fluctuations

in oil and gas markets, there was a Shariáh

compliant hedge that established a price collar

between $7 and $8 per million BTU (MMbtu) on half

the expected products gas production and a put

option at $6 per MMBtu for an additional quarter of

anticipated production (Goud, 2009).

EAST CAMERON GAS SUKUK PARTIES

Originator: East Cameron Partners

Issuer: East Cameron Gas Company

EAST CAMERON GAS SUKUK SUMMARY

Sukuk Name: East Cameron Gas Company Sukuk

Issue Size: USD $165,670,000

Closing Date: 15 June 2006

Shari’ah structure: Musharakah

Currency: USD

Maturity/Tenor: 13 years

Underlying Assets: Oil and gas

Rated by: Standard & Poor’s

Rating: CCC+ to CC and in March 2009 D

Payments: Quarterly

Return: 11.25% (Courtesy of Jassim Mahadik)

EAST CAMERON GAS SUKUK

Instead of being solely used to support the

capital and operating costs of drilling and

operating wells in the Gulf of Mexico for East

Cameron Partners, the proceeds were also used

to pay most of the conventional debt of the

company.

This brought the debt- to- equity ratio of the

company to a Shariáh compliant level, however,

also bankrupted the sukuk.

EAST CAMERON GAS SUKUK

On October 16, 2008, East Cameron

Partners filed for bankruptcy protection

under chapter 11, claiming its inability to

pay the periodic returns on its USD166

million sukuk issued in June 2006.

GENERAL ELECTRIC SUKUK PARTIES

Originator: Sukuk Aviation Leasing Inc through GE

(SAL is a subsidiary of GE Capital).

Issuer: GE Capital Sukuk Limited

GENERAL ELECTRIC SUKUK SUMMARY

Sukuk Name: GE Capital Sukuk

Issue Size: USD $500,000,000.00

Closing Date: Shari’ah structure: Ijarah

Currency: USD

Maturity/Tenor: 5 years due for maturity in November 2014

Underlying Assets: Aircraft leases

Rated by: Standard & Poor’s

Rating: AA+

Payments: Semi- annually (May and November, due in 2014)

Return: 3.875% (Courtesy of Jassim Mahadik)

POPULARITY OF SUKUK AND CONCLUSION

The sukuk instrument is growing in popularity around the

world as an innovative financing instrument and a way to raise

funds for various projects, business expansion, and increased

competitiveness, which attracts ethical and creative investors

worldwide. The UK just announced it is the first Western

Nation to issue a sukuk (200 Million Pounds). The USA should

join the competition.

THE END

AL HUDA CERTIFIED SUKUK PROFESSIONAL

COURSE

FEEL FREE TO CONTACT ME AT

CAMILLE@FAAIF.COM

The End