The foundation for the issuance of fixed income Islamic instruments was laid down nearly two decades ago by the Fiqh Academy in the Organization of Islamic Conference. The ruling of the Fiqh Academy carries considerable weight for the Islamic financial services industry and its rulings are generally widely accepted. Still, it took the industry another 12 years before the instrument "Sukuk" was finally launched in 2000. The reasons for this delay were the non-existence of an Islamic capital market and the absence of innovations not associated with conventional fixed return debt instruments.
Depending upon how it is structured, Sukuk can be termed as equity, debt, hybrid or securitized.
As per the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Sukuk is defined as follows: "Certificates of equal value representing after closing subscription, receipt of the value of the certificate and putting it to use as planned, common title to shares and rights in tangible assets, usufructs and services or equity of a given project or equity of a special investment activity." Since its launch, there has been continuing growth and innovation in structuring.
Sukuk mainly began with adoptions on Ijarah (leasing), Murabaha or Istis'na contracts.
However, within a few years the market was able to introduce Sukuk based on a combination of contracts including Musharaka, Mudarabah, etc.
Shariah scholars together with market participants have managed to innovate through research and deliberation to such a degree that hybrid Sukuk could be floated in convertible and exchangeable instruments starting in 2006.
The stage is now set for a major explosion of issues, similar to the late 1980s surge in the high yield debt market. As of Q1 2007, the total Sukuk issued globally is USD around 65 billion. The market size by 2010 is estimated to be in excess of USD 200 billion, indicating phenomenal trend line growth.
The corporate sector has taken the lead role in Sukuk issuance, while issuance by sovereigns is still very limited but expanding.
Up to now, we have witnessed sovereign issuance by Bahrain, Malaysia, Pakistan, Brunei and Qatar. This year may also see sovereign issuance by Indonesia and perhaps several other jurisdictions.
The size of the Sukuk market is very small, and there is a huge gap in supply and demand, which is keeping the secondary market activities at low levels.
However, we expect this situation to soon change as a number of institutions beside Liquidity Management Centre (LMC), such as the European International Islamic Bank (London), Sukuk House (Bahrain) and Kuwait Finance House (Kuwait), to start secondary market trading. The reported secondary market trade of USD 65 million by LMC during 2006 is expected to almost triple during 1Q 2007 to more than USD 150 million.
Within this current trend, the International Islamic Financial Market (IIFM) serves as the industry's market oversight, that is, the body responsible for development, uniformity and promotion of Islamic capital and money markets.
IIFM has launched or is in the process of implementing several major Sukuk market initiatives, including:
Primary Market Sukuk issuance recommendations and best practices for offering circulars, naming conventions, etc.
Development of Sukuk based Islamic repurchase agreements. This project, if developed, would make a major impact in the Sukuk secondary market trade.
However, given the challenge in developing such a framework for repo contracts, the project could well be for the medium term.
Development of Sukuk trade matching, repo matching and ISO message formats for more flexible and efficient settlement.
Development of an Islamic management system where trading platforms, clearing and settlement can be addressed.
The above are some of the intended projects. However, there is a likelihood that IIFM's Documentary Convergence Working Group or Liquidity Management Working Group may find it feasible to work on unified product development, which is one of the core mandates of IIFM.
In order to have a transparent and robust Islamic finance structured instruments market, uniformity is the key element and core work of IIFM.
However, IIFM's approach is to move with industry consensus and involvement so that the innovation and flexibility available to Shariah continues and the industry is developed in an orderly manner.
By Ijlal A. Alvi
ABANA Review 2007
