No debt about it

Sharia-compliant sukuks have been attracting notice on the international financial markets, but a regulatory framework is essential if they are to realise their potential, says Roger Wedderburn-Day

The rapid development of the sukuk, or Islamic trust certificate, market has garnered significant attention from the international financial world. Initiated in 2002 with the $600m (£323.9m) global sovereign sukuk issue by Malaysia, the sovereign and corporate sukuk market currently exceeds an aggregate issuance value of approximately $8bn (£4.32bn) and is expected to surpass the $12bn (£6.48bn) mark before the end of this decade.

Sukuks are medium to long-term, sharia-compliant trust certificates backed by sharia-acceptable assets, usufructs or services. While their performance mimics conventional fixed-income debt securities, sukuks cannot be categorised as either debt or security under conventional capital markets terminology. Sukuks represent a profit and risk-sharing partnership between the issuer and the investor, where the underlying investment is limited to specific asset classes. Essentially, sukuk investors purchase an ownership interest in a tangible asset, where risks and rewards are tied to the performance of the underlying asset.

In order to conform to the sharia prohibition against interest, or riba, sukuk returns must be linked to the performance of the underlying asset otherwise the structure would resemble a creditor-debtor relationship and any extracted profits would amount to unlawful loan charges. Islamic law also proscribes aleatory agreements. Therefore, underlying assets must be sufficiently tangible so that the investment is void of uncertainty, or gharar. The partnership model has led to a trend among sukuk investors to hold on to their investments until maturity, which has consequently hindered the development of an active secondary market. Moreover, the development of the sukuk market is necessarily limited by the availability of assets that generate a sharia-compliant income stream.

The challenges

Notwithstanding current growth rates, certain commercial and legal challenges could also impede the development of a liquid sukuk market. While sukuks are currently listed on exchanges in the Middle East, South East Asia and Europe, they remain relatively illiquid due to the absence of a diverse investor pool and a tailored regulatory framework. The majority of current sukuk investors are concentrated in Muslim majority countries, although non-Muslim investors have begun to express an interest in this particular investment product.

Yet the investor pool will not expand significantly beyond the traditional Muslim base and the sukuk market will not be able to sustain its growth rate unless a regulatory framework develops that is sufficiently tailored to monitor Islamic financial products and that consequently fosters investor confidence. The launch of each of the Dow Jones Citigroup Sukuk Index (DJCSI), the world’s first sukuk index, in March this year and the Dubai International Financial Exchange (DIFX) in September 2005 marks a strong commitment by market participants to promote continued market growth and to cultivate secondary market trading.


Dow Jones & Company and Citigroup jointly launched the DJCSI, intending it not only to serve as a benchmark for investors seeking exposure to sukuk investments, but also to facilitate secondary and cross-market trading. The DJCSI is comprised of US dollar-denominated sukuks certified as sharia-compliant by a recognised sharia supervisory board and which conform to the standards set by the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) – the primary standard-setting organisation in the Islamic financial markets. Underlying assets are screened for sharia compliance through business guidelines established by Dow Jones. Sukuks included in the DJCSI must also have a maturity of at least one year, an issue size of at least $250m (£135m) and a credit rating of at least BBB-/Baa3 (or equivalent) accorded by a recognised international ratings agency.

At present, the DJCSI tracks seven sovereign and corporate fixed-rate and floating-rate sukuk issues with a total market value of approximately $4bn (£2.16bn). The DJCSI, coupled with the Dow Jones Islamic Market Indexes (DJIMI), evidences recognition by conventional market actors that Islamic financial products are sufficiently unique so as to require tailored guidelines and standards. Both the DJCSI and the DJIMI provide investors with comprehensive tools for evaluating sukuks, which provides issuers with an incentive to meet international market standards and, in turn, encourages new investors to enter the sukuk market.


The second significant event in the market in the recent past was the establishment of the DIFX, the first international financial exchange in the Gulf region. The DIFX’s regulatory framework follows international standards and the exchange seeks to be the leading trading venue for both conventional and Islamic financial products.

While established financial centres in New York, London and Hong Kong provide sukuk issuers with access to a more diverse investor pool, their respective regulatory frameworks do not contemplate the unique features of Islamic financial products, and as such cannot adequately monitor and promote sukuk trades. For example, following implementation of the EU Prospectus Directive across the European Economic Area, it is anticipated that European exchanges will treat sukuks as a debt instrument for the purposes of admission to trading on a regulated market, despite the fact that sukuks do not and cannot create or acknowledge indebtedness, a key component of the definition of ‘debt’ under the EU Prospectus Directive. The DIFX’s reputation as a viable alternative to these well-established exchanges was enhanced further recently, as it was the exchange of choice for the $3.5bn (£1.89bn) sukuk issue by Dubai Ports earlier this year, particularly as it was the first convertible instrument in the Islamic financial markets and the largest sukuk issuance to date. If the DIFX is able to capitalise on the current momentum and successfully diversify its investor pool, Dubai could soon emerge as a leading global financial centre and the sukuk market will inevitably benefit.

The sukuk market will require innovative product structures, a broader investor pool and a reliable trading forum if it is to sustain its strong growth rate and develop an active secondary market. Recent developments indicate that regulators, market participants and investors recognise the potential in the market, as well as the primary obstacles to its continued growth.

Roger Wedderburn-Day is a partner at Allen & Overy. He was assisted by associates Anzal Mohammed and Sahar Kianfar