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Opinion & Analysis

Kenya should see Sukuk as the next frontier of finance

Treasury secretary Henry Rotich (right) and principal secretary Kamau Thugge. FILE PHOTO | NMG
Treasury secretary Henry Rotich (right) and principal secretary Kamau Thugge. FILE PHOTO | NMG  

Ongoing development of Islamic finance in Kenya is expected to cause one of the biggest financial services sector engineering and innovations in the country’s history.

Financial engineering includes the design, development as well as implementation of innovative financial processes, instruments and formulation of creative solutions.

The essence of financial engineering is to stimulate the drive towards greater economic efficiency through risk sharing, reduction of information asymmetry, agency and related transaction costs.

With financial engineering comes a totally new class  of instruments, new forms of securities, processes and solutions designed to lower the cost of funding, prudently  managing risk and liquidity challenges and also enhancing return on investments.

One area that will see a hive of activity in the local market will be the introduction of Islamic bonds, dubbed Sukuk.

As we speak today, the Kenyan government is preparing to issue the first Sovereign Sukuk with the aim of diversifying sources of funding at competitive rates.

This development will place Kenya in the global market as an attractive destination for investors keen to diversify their portfolios and maximise opportunities for good returns.

Sukuk are considered to be the highest profile of the Islamic finance and are widely appreciated as one of the key drivers of Islamic finance’s rapid integration into the global financial architecture.

Sukuk is the plural of the term Arabic word Sakk, which means deed or instrument. Sukuk is believed by a significant number of scholars to be the root of the term “cheque” since it was used to describe any item or document that represented a financial liability.

The Accounting and Auditing Organisations of Islamic financial Institutions (AAOIFI) has defined Sukuk as certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or in the ownership of the assets of a particular project or special investment activity.

Sukuk investors subscribe for the trust certificates through payments of due subscriptions to the issuer, who may be a Special Purpose Vehicle (SPV) that channels the subscription monies to procure the defined Sukuk assets from the originator.

In return, the Sukuk holders get entitled to receive income generated from use of the underlying Sukuk assets.

The standard practice of the global market has provisions of marking income due to the Sukuk holders against some defined market rates or index such as the London Interbank Offered Base (Libor).

It is worth noting that Sukuk just like other Shariah-compliant instruments are regulated by Shariah principles that prohibit provisions of interest, investments in non-permissible ventures, gambling, and businesses that carry ambiguities.

The imminent issuing of Sukuk by either the government or the corporate entities should certainly contribute to the vibrancy of our capital market in terms of risk management, cost of funds, transparency and an increase in investor base, among others.

What makes Sukuk appealing to investors is the fact that they indicate ownership of earmarked asset or assets backing the transactions, and not a debt obligation as is the case in the conventional bonds. 

The asset backing the Sukuk transactions should meet the Shariah standards. For instance, no assets used for non-Shariah permissible ventures like alcohol production and arms trade can be used to back  Sukuk transactions.

Sukuk unlike conventional bonds are priced in accordance with the real market value of the assets that back the Sukuk certificates, whose sale in the secondary market constitutes the sale of ownership in the assets.

Bond pricings reflect the ratings given by credit rating of the issuer and this usually determines the basis on which the sale of the same as “debt obligation” in the secondary market.

One of the benefits that accrue to the Sukuk holder, unlike the bond holder, is that Sukuk value gets enhanced as the value of assets backing the Sukuk certificates appreciate.

The conventional bonds lack this important characteristic since the same are taken as debt obligations.

Both Sukuk and the conventional bonds can be turned into cash through the sale of the same in the secondary market and can also be ranked or rated by the rating agencies.

One of the recent surprising development in the global Sukuk market that continues to shake the investors’ world is that of the Dana Gas.

Dana Gas is Sharjah-based gas producer that declared its own Shariah-compliant Sukuk worth $700 million issued four years ago under the United Arab Emirates laws as unlawful and unenforceable from Shariah perspective.

The company is seeking to apply Shariah non-compliance as the reason for its case to have the Sukuk restructured and have the investors exchange their Sukuk for new instruments with lower profit distribution adversely affecting the investor interest.

The matter is coming up for full hearing in September in the London High Court between Dana Gas and Deutsche Bank, representing the Sukuk investors.

Usually, Sukuk derives its financing structure from the nature of the underlying assets available to the originator, regulatory and tax considerations as well as perspectives expressed by the Shariah scholars sanctioning the transaction.

What may be declared as Shariah-compliant by a team of scholars could be rendered invalid and non-Shariah-compliant by a team of other scholars in the absence of harmonised standards and guidelines like that issued by AAOIFI.

This, indeed, informs the need to have one central Shariah body that regulates the industry with a view to minimising confusion emanating from multiple non-structured Shariah opinions.

Kenya is on course to developing the necessary infrastructure to facilitate the issuing of Sukuk  and it is just a matter of time before we get to see heightened activities in the financial market.

However, we have to exercise due diligence by  putting in place the required mechanisms to address and mitigate against potential risk, including regulations, Shariah governance and legal framework.

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