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Mon, 15 Jun 2009 06:17 GMT

Bahrain: AAOIFI proposals spark fresh Sukuk debate

Arab News -21/04/2008

(MENAFN - Arab News) The global Islamic capital market, of which the Sukuk sector is the most
important, is still reverberating from the recommendations of the Shariah Committee of the
Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)
relating to current Sukuk structures and their issuance. One scholar reportedly said that 80 percent of
current Sukuk structures are not Islamic, a statement which has unfortunately made the headlines the
world over.
The developments stem from a meeting of the Shariah Committee of AAOIFI held in Bahrain in
February 2008 which issued new recommendations regarding Sukuk structures and issuance especially
relating to the ownership of underlying assets in a Sukuk transaction and the guarantee of the principal
investment to Sukuk certificate holders. The immediate reaction of some bankers has been that the
recommendations may put a dampener on the issuance of future Sukuk because of these extra
'constraints' and thus affect their future tradability.
The Sukuk market has been flourishing for the last decade or so, albeit it has gained momentum only
in the last three or four years. The total outstanding issues in the global Islamic capital markets,
including the Malaysian corporate and government issuances, is estimated at just under $200 billion.
Sovereign issuances were spearheaded by the Malaysian Global Sukuk in 2002, the first sovereign
issuance. Since then the sector has seen a number of sovereign issuances by Qatar, Bahrain and
Pakistan; several from quasi-sovereign entities; some from international agencies including the Islamic
Development Bank, the World Bank and its private sector funding arm, the International Finance
Corporation; publicly-listed corporates; privately-owned corporates; and even the odd social Sukuk by
religious councils such as the Singapore Islamic Religious Council (MUIS) securitizing Waqf
properties.
Thus far sukuk structures have comprised Sukuk Al-Salam; Sukuk Al-Ijara; Sukuk Al-Musharaka;
Sukuk Al-Mudarabah; Sukuk Al-Intifa'a; Sukuk Al-Istisna and Sukuk Al-Murabaha. The majority of
Sukuk structures are based on Sukuk Al-Ijara involving a sale-and-leaseback arrangement done
through a special purpose vehicle (SPV). Musharaka Sukuk is also gaining in popularity although
there has been some controversy relating to certain equity and risk-sharing arrangements.
The recommendations of AAOIFI's Shariah Committee, headed by its President Sheikh Taqi
Usmani, in a series of meetings in 2007 and the latest one in Bahrain on 13 and 14 February, 2008, are
quite emphatic. These are:

Tradable Sukuk must represent ownership for Sukuk holders, with all of the rights and obligations
that accompany ownership, in real assets, whether tangible or usufructs or services, that may be
possessed and disposed of legally and in accordance with the Shariah. The manager of a Sukuk
issuance must establish the transfer of ownership of such assets in its books, and must not retain
them as its own assets.

It is not permissible for tradable Sukuk to represent either revenue streams or debt except in the
case of a trading or financial entity that is selling all of its assets, or a portfolio which includes a
standing financial obligation such that debt was incurred indirectly, incidental to a physical asset or
a usufruct.

It is not permissible for the manager of Sukuk, regardless of whether the manager acts as an
investment manager, or a partner, or an investment agent, to undertake to offer loans to Sukuk
holders when actual earnings fall short of expected earnings. It is permissible, however, to establish
a reserve for the purpose of covering such shortfalls to the extent possible, on condition that the
same be mentioned in the prospectus.

It is not permissible for the investment manager, partner, or investment agent to agree to purchase
assets from Sukuk holders or from whoever represents them for a nominal value of those assets at
the time the Sukuk are extinguished at the end of their tenors. It is permissible, however, to agree
to purchase the assets for their net value, or market value, or fair market value, or for a price agreed
to at the time of their purchase, in accordance with Shariah rules of Partnership and modern
partnerships, and on the subject of Guarantees.

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, investment manager, or agent.

Shariah supervisory boards must not consider their responsibility to be over when they issue a
fatwa on the structure of Sukuk. Rather, they must review all contracts and documentation related
to the actual transaction, and then oversee the ways that these are implemented in order to be
certain that the operation complies at every stage with Shariah guidelines.
These recommendations, though timely, should have been in place at the outset. How ironic that there
is an implicit rebuke to Shariah scholars in the AAOIFI recommendations that the Shariah governance
process does not end with the issuing of a fatwa but must continue for the entire tenor of the
transaction or the issuance, when the Sukuk issuances to date okayed for Shariah compliance were
given the go-ahead by some of the very members of the AAOIFI Shariah Committee and wider
membership.
The Sukuk debate once again raises questions about the very nature of Shariah governance in the
Islamic finance sector. In too many markets, the Shariah advisory process is still ad hoc with hardly
any control over who offers such advice. A registered and regulated Shariah advisory market as in
Malaysia surely would lessen the propensity for such a free-for-all as we have seen in some markets.
The good news is that other countries are following the Malaysian example of a National Shariah
Council at the central bank, including Pakistan and more recently, the UAE.