Published on All About Finance

Sukuk are just another capital markets instrument (and that is a good thing)

A gold bar on top of gold coins | © A gold bar on top of gold coins | ©

Sukuk are tradable securities. They are listed on major stock exchanges around the world and settle through the largest international securities clearing systems. They are, in other words, capital market instruments in the same way as stocks and bonds. Of course, they are structured to conform to specific Islamic principles. However, the fact that they are designed to be appropriate for Islamic investors does not change their fundamental nature. After all, a Tesla is still a car, even if it has been designed to appeal to a certain type of person.

Although sukuk are securities, in most major financial centers, from New York to Tokyo, they are not treated as an ordinary part of the capital markets. In fact, they seem to be viewed as something almost too exotic to touch. Anyone calling the capital markets department of a bank in one of those cities about sukuk will likely have their call transferred to the Dubai office before they can say another word.

Being seen as exotic can sometimes be good for business. For example, if someone opened a Moroccan restaurant in Wichita, Kansas, the “exotic” label may help attract the culinarily curious in that region. However, in the capital markets, exotic is rarely a good quality. That reputation usually comes at a cost, as investors either avoid products deemed exotic or require that they pay a premium over more plain vanilla ones.

Various reasons are used to justify the treatment of sukuk as an exotic and distant relative within the capital market’s family of products. The two most common are that sukuk are (1) extremely complex and (2) emerging market (EM) only instruments. 

On the first point, about complexity, it is certainly true that the legal documentation for sukuk can be lengthy. However, the argument for penalizing sukuk for their complexity only makes sense if bonds were simple in comparison. In reality, however, bonds documents are quite intricate in their own right. If, in some cruel experiment, a group of poets with no finance backgrounds were forced to read both a bond indenture and an underlying contract for a sukuk from front to back, they might very well conclude that bonds are the much more complicated instruments.

In fact, a large part of the reason sukuk are considered unusually complex is simply because of the use of some Arabic words, such as ijara and mudarabah But if the capital markets can adjust to other peculiar terms like force majeure, pari passu, and defeasance, surely they can make room for a smattering of Arabic. And, in any case, the contractual principles these words represent (e.g., leases and participations) are very familiar to any financial professional.

The use of Arabic words also plays a part in the second point, the belief that sukuk are fundamentally an EM only product. From the perspective of a trading desk in New York, London or Tokyo, what could seem more “EM” than a product that incorporates Shariah principles and makes use of some Arabic terms? And certainly it is true that many EM issuers fund with sukuk, and many EM based investors buy them. But those facts alone should not define the instrument itself as uniquely EM. After all, there are more companies listed on both the National Stock Exchange of India and the Shanghai Stock Exchange than in either of New York or London, but that is not interpreted to mean stocks are now an EM product.

Furthermore, the majority of internationally placed sukuk are not traditional EM instruments at all. Most are issued by sovereigns, supranationals, state owned enterprise and large multinational corporations with credit ratings toward the high end of the investment grade spectrum. And a number of significant Western issuers, such as the United Kingdom, Luxembourg and the International Financing Facility for Immunization (an international organization organized as a UK charity) have all executed sukuk. 

In other words, perception is often not reality when it comes to sukuk. Many financial market players write them off as overly complex, EM instruments without considering that they are fundamentally just securities. Like how a climate change denier looks at a snowstorm, they focus on certain superficialities of the product, such as the use of Arabic terms, and miss the underlying reality that sukuk can be a very valuable capital markets instrument.

For international investors, ignoring sukuk comes at a cost, as the product offers them diversifying credits and great credit stories.  The Islamic Development Bank, for example, is a supranational institution with the objective of promoting sustainable social and economic growth in its member countries, and it issues several billion dollars of triple-A rated sukuk every year. Any high grade, fixed income investor with an interest in sustainability should be considering those sukuk as valuable diversifying assets for their portfolios.

In summary, like stocks and bonds, sukuk are simply a type of tradable security. They do not have a specific nationality, and they are not meant only for a specific type of institution. The international capital markets stand to benefit if the fundamental nature of sukuk as a useful and diversifying instrument is more widely recognized. 


First published in the Islamic Finance News, April 12, 2023


Michael Bennett

Head of market solutions and structured finance, World Bank Treasury

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