The South African government issued its debut $500 million sukuk in 2014. The sukuk was four times oversubscribed, highlighting the appetite for this product.
There have been a number of sovereign backed sukuks of this nature across the Muslim world and elsewhere, such as the UK, where the government issued its first sukuk in 2014. Corporates have been slow to take up sukuk. Banks have, however, issued balance sheet specific sukuk as a liquidity management tool. There is scope for banks and corporates to raise capital using the sukuk model.
What is sukuk?
Sukuk is a Shariah compliant bond. Unlike conventional bonds sukuk are asset-based securities, not debt instruments. Sukuk represents ownership in a tangible asset, a service, a project, a business, or a joint venture, or the use and enjoyment of an asset. This is different from a regular bond where holders only have a debt claim. Each sukuk has a face value based on the value of the underlying asset. An investor may pay that amount or buy it at a premium or at a discount. Purchasers of sukuk are rewarded with a share of any profits derived from the asset. In keeping with Shariah, sukuk don’t earn interest payments. Sukuk are investment certificates consisting of ownership claims in a pool of assets.
As with a conventional bond, sukuk are issued with maturity dates. When the maturity date arrives, the issuer of the sukuk buys the sukuk notes back. But the initial investment is not guaranteed. A sukuk holder may not get back its full principal (face value) amount. Sukuk holders share the risk in the underlying asset. If the project or business on which sukuk are issued does not perform as well as expected, the sukuk investor must bear a share of the loss.
Sukuk can be structured using a number of different Shariah compliant contracts.
South Africa used an ijara (lease) sukuk structure. Typically, ijara sukuk represent ownership of equal shares in rented property or the use and enjoyment of the property. Sukuk holders are given the right to own the real estate, receive the rent and dispose of their sukuk in a way that does not affect the right of a lessee of the property. The underlying asset is a well-defined, existing and known property that is leased. The rental is the return paid to sukuk holders.
South Africa’s sukuk would have been structured along the following lines:
Government would sell property or a right in property to a special purpose company (SPV) at an agreed pre-determined purchase price.
The SPV raises financing by issuing sukuk certificates to investors in an amount equal to the purchase price and costs of acquisition.
The amount raised by the SPV is paid to government (as seller of the property receiving the purchase price).
A lease agreement is signed between the SPV and the government for a fixed period, where the government leases the assets as lessee.
The net values of the periodic rentals received by the SPV from government are distributed among the sukuk holders.
At maturity of the sukuk the SPV will sell the property back to government at a predetermined price. This price should at least be equal to the amounts still owed under the terms of the sukuk.