Capital Markets

How Sukuk differs from conventional bonds


A Sukuk is a bond-like instrument whose issuance and trading copies with Islamic law. PHOTO | SHUTTERSTOCK

Last week, the Capital Markets Authority (CMA) approved the issuance of the first Sukuk bond in Kenya, which will be rolled out by a trust that is developing 3,069 institutional houses for the government.

The approval of Linzi Finco Trust to raise Sh3 billion will be a test of the country’s readiness for the Shariah-compliant bonds, whose issuance has been aided by law changes a few years ago to provide clarity on the taxation of Islamic financial products in the country.

The government has over the years talked of the possibility of floating a Sukuk bond, primarily to diversify its options for external commercial financing of its budget deficit beyond the traditional European and North American markets.

The private sector has, however, beaten the State to the punch through the issuance of the Linzi Sukuk, which will offer an internal rate of return at 11.13 percent as per the CMA disclosure.

What are Sukuk bonds and how do they differ from conventional bonds?

A Sukuk is a bond-like instrument whose issuance and trading copies with Islamic law.

Although it is called a bond, a Sukuk differs fundamentally from the conventional bonds issued by the government (Treasury bonds) and corporates in that it is not a debt instrument that pays interest.

It instead offers the holder a share in the returns generated by an underlying asset, given that Islamic law prohibits interest.

A Sukuk is, therefore, a certificate that represents partial ownership in an asset, which entitles the holder to a proportionate share of the return generated by that asset.

It also stipulates the return of the capital to the holder at a future date, similar to the return of the principal upon maturity of conventional bonds.

Pricing also differs. Sukuk is priced according to the real market value of the underlying assets represented by the certificate, while conventional bond prices are determined by the credit or risk rating of the issuer.

While Sukuk has been used to represent financial commitments from as early as the 7th Century AD, the instruments as we know them today have only been issued in the last 30 years, with Malaysia (the world’s biggest Sukuk market) developing the first sovereign Sukuk from 1983.

Which types of projects can they fund?

The requirement that the Sukuk be Shariah-compliant dictates the type of projects that they can be used to fund.

They are, therefore, suitable for financing housing, energy, healthcare, transport, water and sanitation projects, which can provide an underlying asset and also provide profits to be shared with the bondholders.

These projects must be beneficial and not be harmful to society, meaning for instance that one cannot float a Sukuk to invest in ventures touching on gambling or alcohol, or for speculative purposes.

Sukuk must adhere to the strict rules and requirements of Shariah at every stage: structuring, issuance and trading.

Has any been issued in Kenya so far and are they backed by law?

The Linzi Finco Trust Sukuk will be the first ever issued in Kenya, six years after the government made changes in the law to accommodate such Islamic financial products.

Earlier this year, the National Treasury said that a sovereign Sukuk is among the options being considered for use to refinance the $2 billion Eurobond that matures next June.

The issuance of Sukuk bonds in the country was made possible by various Act changes implemented via the Finance Act 2017.

The Act made changes to the Income Tax and VAT Act, primarily to expand the definition of interest to include Islamic finance return, which was previously not provided for.

The Stamp Duty Act was also amended to recognise Islamic property finance arrangements, while under the Public Finance Management Act, the definition of national government securities was expanded to include Sukuk.

The Co-operative Societies and the Sacco Societies Acts were also amended to recognise Islamic financing and saccos in the country.

Where else have Sukuk bonds been issued in Africa?

A number of African countries have issued Sukuk bonds in recent years, with their performance indicating that there is demand for the product.

Morocco and Nigeria issued $105 million (Sh15.5 billion) and $327 million (Sh48.3 billion) of Sukuk securities, respectively in 2018. The Morocco issuance was oversubscribed 3.6 times.

In February this year, Egypt raised $1.5 billion (Sh221.5 billion) via three-year Sukuk bonds, which attracted bids worth $5.4 billion (Sh797.2 billion).

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