Complex Made Simple

Why many Islamic bonds are not Shariah compliant

Once regarded as the driving force behind the boom in Islamic finance, sukuk have been looked at more critically recently. Hari Bhambra, Founder and Senior Partner of DIFC-based Praesidium Consulting, which specialises in Islamic finance-related regulatory issues, explains why not all Islamic bonds have been structured in line with Shariah.

AME Info: Currently there are discussions that some 85% of sukuk might be haram (not Shariah complaint). Can you explain what impact this will have on the industry?

Hari Bhambra There have been discussions by some eminent scholars that the concept of profit and loss sharing, which underpins Islamic finance, has not been present in some of the sukuk models that we have seen over the past five to six years.

Typically, sukuk are often held out as being Islamic bonds, which tends to confuse the juristic basis of a conventional bond and sukuk. Sukuk is based on Islamic principles of profit and loss sharing, as the sukuk holders are deemed to be owners of the underlying assets supporting most sukuk structures.

In conventional bonds, bondholders do not have the same perspective. The debate that has arisen in respect of sukuk focuses on the use of guarantees which, at some level, conflicts with the concept of profit and particularly loss sharing.

Unlike with conventional bonds, sukuk holders are deemed to be owners of the underlying assets in the sukuk fund and therefore should be exposed to the risk associated with those assets as well as the profit, which some scholars have indicated has not been the case to date.

AME Info: Are there any particular sukuk that are in the spotlight?

Bhambra The initial comments were applied across all sukuk modes, but further discussion among the scholars has focused on the Sukuk-Al Musharaka and Sukuk-Al Mudaraba model.

AME Info: Would it help if an international regulatory body was in charge of issuing a fatwa for sukuk?

Hari Bhambra To have an international body covering Shariah compliant financial transactions is something which a number of practitioners have envisaged, but I am not sure this will be the case in the near future.

There are a number of differences across the Schools of Thought and unless a Board is formed which provides representation across these different perspectives the credibility of the fatwas issued will continue to be open to further debate or discussion.

The work of Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and Islamic Financial Services Board (IFSB) has been useful in trying to provide such a platform.

AME Info: If sukuk are listed at the DIFX, which is currently the biggest exchange for them with a total volume of $13.78bn, which regulatory body approves that the sukuk are halal (an ethical stock structured in line with Sharia, so having no interest, no short-selling and no derivatives)?

Hari Bhambra The DIFX is regulated by the DFSA, so the DIFX must have adequate business rules in place which set out how the market will be regulated. The DIFX will prescribe requirements for the issue of the sukuk and the required disclosures.

Similarly, where the sukuk falls within the remit of the DFSA Markets Law and Offered Securities Rules a degree of disclosure will be required pertaining to the Shariah status of the sukuk.

Currently, no regulatory body verifies that the sukuk is halal, but there must be systems in place to ensure compliance with Shariah and the requirements require the appointment of Shariah scholars, and in certain circumstances, enhanced disclosure in respect of the underlying sukuk model.

AME Info: Are indices such as the DJIM Citigroup Sukuk Index of help for more transparency?

Hari Bhambra Yes, and there are an increasing range of sukuk indices emerging which will provide a good benchmark for the market; by analogy we saw a number of indices emerge for Islamic Funds which have proven very useful to the market.

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