Different types of SUKUK

There are numerous Shari’ah contracts that could be used in structuring sukuk,
such as the 14 types stated by AAOIFI. However, according to Ariff et al. (2012, p. 23) and
Yaakub et al. (2011, p. 23), there are six types of commonly used contracts, such as the ijārah,
mu_ dārabah, mushārakah, murābahah, salam and isti _snāc. These sukuk could be further
classified into tradable and non-tradable sukuk.

asset-based and asset-backed sukuk. Both of these categories have emerged

due to the securitization process.

The Islamic Financial Services Board (IFSB) in Guideline No. 2 has identified two main
categories of sukuk, which are the asset-based and equity-based sukuk. Asset-based sukuk is
defined as “sukuk where the underlying assets offer fairly predictable returns to the sukuk
holders”. This could be found in several sukuk such as the sukuk salam, isti _snāc and ijārah.
Meanwhile, the equity-based sukuk is defined as “sukuk where the returns are determined on
a profit and loss sharing of the underlying investment, which does not offer fairly
predictable returns”. The contracts involved are something like the mushārakah or
mu_ dārabah (IFSB, 2005).

According to the Malaysian Securities Commission (MSC), the division of sukuk into
asset-based and asset-backed is based on the sukuk’s technical and commercial
characteristics. For the asset-based category, the underlying asset used in the sukuk
structure is maintained in the originator’s balance sheet after the issuance of sukuk. The
originator only transfers the asset’s beneficial ownership to the sukuk holder, while the legal
ownership is still with the originator. The consequence is that the sukuk holder cannot sell
the assets to a third party besides not being able to have recourse to the assets. On the
contrary, the sukuk holder only has recourse to the originator/obligor. In other words, it
seems that the actual sale is non-existent in the asset-based structure because the sukuk
holder has no interest in the underlying asset (Hidayat, 2013, pp. 25-26).
As for the asset-backed sukuk, the transfer of the underlying asset’s legal ownership
occurs from the originator to a third party, which is usually the special purpose vehicle (SPV).
The SPV acts as the trustee for the investor (sukuk holder) who receives a fee, while the
sukuk holder is the legal owner of the underlying asset who receives returns on investments
based on the performance of the asset. Besides that, the underlying asset has been separated
fromthe balance sheet originator, hence avoiding a recourse on the originator.
Based on the breakdown of these categories, the issue of ownership is evident in the
asset-based sukuk, whereby there is no transfer of legal ownership but only beneficial
ownership. This means that the issue of beneficial ownership is only related to assetbased
sukuk cases, and this raises a polemic, which was heavily criticized by Usmani.
Steps in SUKUK structure

Based on Figure 1, it could be briefly understood that the sukuk structure involves five
steps, such as:
(1) The seller or originator sells the asset to the SPV to obtain finances for a project
related to the asset. This kind of sale is called the sale of beneficial ownership, as
there is no transfer of legal ownership from the legal perspective.
(2) The SPV would issue sukuk certificates that are in equal value of purchase price.
The sukuk would then be sold to the investor (sukuk holder) to finance the
purchasing of the asset. Sukuk represents the beneficial interest in the asset, which
indicates that the sukuk holder has a beneficial interest in the asset. (The SPV
would then declare a trust via a trust declaration over the asset for the benefit of
the investors, who are the beneficiaries).
(3) The SPV would lease back the underlying asset to the seller for a certain period
under the ijārah agreement.
(4) The income received by the seller/renter from the off-takers would be used to pay
ijarah rental to the SPV.
(5) The SPV would then distribute the received rental from the investors (sukuk
holders) as income in the form of periodic income distribution payment.

Usually, the seller and the SPV would conclude a service agency agreement to certify and
validate the agreement stating that the seller would be responsible for all forms of
maintenance and insurance for the underlying asset. The seller and buyer would initiate sale
and purchase undertakings that are agreed upon in the case of company winding-up/
dissolution, default or breach or upon the maturity of the rental period (which is usually
similar to the sukuk’s date of maturity). The sale and purchase undertakings will be
exercised by the seller and the SPV. In this situation, the SPV would re-sell the underlying
asset to the originator at an exercise price, and the proceeds are used to redeem the sukuk.
The declaration of trust over the asset must be established upon completion of the sale of
asset to the originator. After this declaration, the SPV and the investors do not have any
rights or interest on the underlying asset.

Beneficial VS Legal ownership

As
clearly discussed, when property is subject to a trust, a distinction must be drawn between
the legal ownership and the equitable ownership, i.e. beneficial ownership. As opposed to
beneficial owner, legal owner is the one who holds legal title to property for the benefit of
another, which also termed as trustee.
In Malaysia, the meaning of beneficial ownership related to securities provided by the
Securities Industry Act 1991 is probably the most useful. It provides definition as follows:
Beneficial owner, in relation to deposited securities, means the ultimate owner of the deposited
securities who is the person who is entitled to all rights, benefits, powers and privileges and is
subject to all liabilities, duties and obligations in respect of, or arising from, the deposited
securities, and does not include a nominee of any description,
It is apparent therefore that beneficial owner is the true owner and has all ownership
attributes except the title is not registered under his name. Furthermore, whenever the
dispute between legal and beneficial owner occurs, the decision of court in determining the
true owner would go to the beneficial owner, as the legal owner is only considered as a
trustee, who is holding the property for the benefit of beneficial owner. There are many
decisions of the Court in Malaysia applying the principle of equity in recognizing the
beneficial or equitable ownership as obviously seen in Kersah La’usin v. Sikin Menan [1966],
2 MLJ 22; Munah v. Fatimah [1968], 1 MLJ 54; Tengku Mariah v. Halimah [1980], 2 MLJ 54
and Othman v. Mek [1972], 2 MLJ 158.

A similar definition was

recorded by the Harmonisation Committee for Islamic Financial Law (Bank Negara
Malaysia, 2013, p. 97) in which, “a person who enjoys the benefits of land ownership even
though the land title is in another’s name”. This shows that from a legal perspective, a
beneficial owner is the actual owner and enjoys the entire benefits and advantages of the
asset despite not possessing any legal title.

Hence, according to the discussions above, it shows that equity law differentiates
between legal and beneficial ownership. Equity recognises the beneficial owner as the actual
owner, although the name has not been registered officially. A beneficial owner has all the
rights pertaining to the land. Meanwhile, the legal titleholder only has a hold based on trust
until the legal title is eventually transferred to the buyer. It is clear now that the term
beneficial owner usually refers to someone who has much more ownership attributes
compared to the legal owner. However, the only thing absent from the beneficial owner is
that he does not have a legal title from a legal aspect. This means that the person’s name is
not registered on the official document (the grant, if it is a piece of land), although the
contract of sale and purchase has been completed.