As to what follows: The issuance of Sukuk on the basis of the rules of the Shining Shariah of Islam is among the objectives of Islamic banking, and is also one of the greatest means of establishing Islamic economies in society. This, however, is on condition that the tools used to develop and structure Sukuk are in consonance with the fundamental principles which distinguish Islamic economic systems from others.
The interest-based system prevalent in the world today regularly issues bonds that yield interest from capital-intensive enterprises that bring great profits and regular revenues. Yet, the holders of such certificates are no more than lenders to the sponsors of such enterprises; and their earnings come from the interest on their loans in a percentage that accords with the price of interest in the marketplace. The profits of these enterprises after costs, including interest
payments (1), return exclusively to the sponsors.
The basic concept behind issuing Islamic Sukuk, however, is for the holders of the Sukuk to share in the profits of large enterprises or in their revenues. If Sukuk are issued on this basis they will play a major role in the development of the Islamic banking business and thereby contribute significantly to the achievement of the noble objectives sought by the Shariah. Among the benefits of Sukuk are the following:
- Sukuk are among the best ways of financing large enterprises that are beyond the ability of a single party to finance.
- Sukuk provide an ideal means for investors seeking to deploy streams of capital and who require, at the same time, the ability to liquidate their positions with ease whenever the need should arise. This is because it is envisioned that a secondary market for the trading of Sukuk will develop. Thus, whenever investors require cash from their investments, or from a part of the same, it will be possible for them to sell their Sukuk holdings, or a part thereof, and receive their value from their original investment plus earnings, if the enterprise is profitable, in cash.
- Sukuk represent an excellent way of managing liquidity for banks and Islamic financial institutions. When these are in need of disposing of excess liquidity they may purchase Sukuk; and when they are in need of liquidity, they may sell their Sukuk into the secondary market.
- Sukuk are a means for the equitable distribution of wealth as they allow all investors to benefit from the true profits resulting from the enterprise in equal shares. In this way, wealth may circulate on a broad scale without remaining the exclusive domain of a handful of wealthy
persons. (2) This is clearly among the most important of all the higher purposes sought by an Islamic economic system.
Today, there are many Sukuk in the market, all claiming to be Islamic Sukuk. In this brief study, I mean to shed light on the mechanisms they use and on the extent to which these comply with the precepts of Islamic jurisprudence, and its principles, and its higher purposes. The issuers of these Sukuk have expended a great deal of effort to make them competitive with the conventional bonds prevalent in today's capital markets. By endowing these Sukuk with the same characteristics of bonds, they have attempted to facilitate their acceptance in both Islamic and conventional markets.
The most prominent characteristics of conventional bonds may be summarized as follows:
- Bonds do not represent ownership on the part of the bond holders in the commercial or industrial enterprises for which the bonds were issued. Rather, they document the interest-bearing debt owed to the holders of the bonds by the issuer, the owner of the enterprise.
- Regular interest payments are made to the bond holders. The amount of interest is determined as a percentage of the capital and not as a percentage of actual profits. Sometimes the interest is fixed, while oftentimes in bonds with longer tenors the rate of interest is allowed to float.
- Bonds guarantee the return of principal when redeemed at maturity, regardless of whether the enterprise was profitable or otherwise.
The issuer of such bonds is not required to return more than the principal and the agreed amount of interest. Whatever profits may have been earned by the enterprise accrue entirely and exclusively to the issuer. So the bond holders have no right to seek a share in the profits beyond the interest.
These characteristics are not to be found in Islamic Sukuk, at least not directly. Even so, the issuers of Islamic Sukuk today have attempted to distinguish their Sukuk, however indirectly, with many of these same characteristics. For this reason they have developed a variety of mechanisms. Let us now study these mechanisms in the light of the following three points.
1. Bond Holders' Ownership of Enterprise Assets
The first point, or the bond owners' ownership of enterprise assets, is that the majority of Sukuk are clearly different in this respect from interest-based bonds. Generally, Sukuk represent ownership shares in assets that bring profits or revenues, like leased assets, or commercial or industrial enterprises, or investment vehicles that may include a number of projects. This is the one characteristic that distinguishes Sukuk from conventional bonds. However, quite recently, the market has witnessed a number of Sukuk in which there is doubt regarding their representation of ownership. For example, the assets in the Sukuk may be shares of companies that do not confer true ownership but which merely offer Sukuk holders a right to returns. Such Sukuk are no more than the purchase of returns from shares; and this is not lawful from a Shariah perspective. Likewise, there has been a proliferation of certain Sukuk that are based on a mix of ijarah, istisna' and murabahah contracts undertaken by Islamic banks or institutions such that these are packaged and sold to Sukuk holders who hope to obtain the returns from these operations. The inclusion of murabahah contracts into such
Sukuk, however, cannot but bring into question the issue of the sale of debt, (3)
even if the percentage of the murabahah contracts may be considerably less than that of the ijarah, musharakah and istisna' contracts. All of this requires careful review.
2. Regular Distributions to Sukuk Holders
In reference to the second point, most of the Sukuk that have been issued are identical to conventional bonds with regard to the distribution of profits from their enterprises at fixed percentages based on interest rates (LIBOR). In order to justify this practice, the issuers include a paragraph in the contract which states that if the actual profits from the enterprise exceed the percentage based on interest rates, then that amount of excess shall be paid in its entirety to the enterprise manager (whether a mudarib, or a partner, or an investment agent) as an incentive for the manager to manage effectively. I have even seen in the structure of certain Sukuk that they do not state that such excess will become the right of the manager as an incentive but, instead, they state no more than that the holders of the Sukuk will be entitled to a fixed percentage based upon the rate of interest at the time of regular distributions (as if the excess as an incentive was established by estimation or by exigency). If the actual profits are less than the prescribed percentage based on interest rates, then the manager may take it upon himself to pay out the difference (between the actual profits and the prescribed percentage) to the Sukuk holders, as an interest free loan to the Sukuk holders. Then, that loan will be recovered by the lending manager either from the amounts in excess of the interest rate during subsequent periods, or from lowering the cost of repurchasing assets at the time the Sukuk are redeemed as will be explained in detail in the third point, below, Allah willing.
3. Guaranteeing the Return of Principal
As to the third point, virtually all of the Sukuk issued today guarantee the return of principal to the Sukuk holders at maturity, in exactly the same way as conventional bonds. This is accomplished by means of a binding promise from either the issuer or the manager to repurchase the assets represented by the Sukuk at the stated price at which these were originally purchased by the Sukuk holders at the beginning of the process, regardless of their true or market value at maturity.
Then, by these complex mechanisms, Sukuk are able to take on the same characteristics as conventional, interest-bearing bonds since they do not return to investors more than a fixed percentage of the principal, based on interest rates, while guaranteeing the return of investors' principal at maturity.
We will now speak about these mechanisms firstly from the perspective of Islamic jurisprudence and secondly from the perspective of the higher purposes of Islamic finance and economics.
From the Shariah perspective, there are three questions:
First: Stipulating the amount in excess of the price of interest for the manager of the enterprise under the pretense that this is an incentive for good management.
Second: The manager's commitment, if the actual profits are less than the yield from the fixed rate of interest during any of the times for distribution, to lend the amount of the shortfall to the holders of the Sukuk. Thereafter the amounts of such loans will be recovered either through the actual profits of the enterprise at the times of following distributions or through the sale of the enterprise's assets at maturity.
Third: The binding promise by the manager that he will purchase the assets represented by the Sukuk at their face value, and not at their market value on the day they are redeemed.
One: Stipulating an Incentive for the Manager
With regard to the stipulation of an incentive for the manager of the enterprise, its justification may be found in what certain jurists have mentioned in regard to the lawfulness of offering incentives in contracts of wakalah or in brokerage. Al-Imam al-Bukhari mentioned the same on the authority of the Companion Ibn `Abbas and Ibn
Said Ibn `Abbas:"There is no impediment to one's saying, 'Sell this cloth and whatever is in excess of this or that4 will be yours.'" Said Ibn Sirin: "When someone says, 'Sell it for this much and whatever profits are realized beyond that will be yours, or will be shared between us,' then there is no problem with that."
This opinion was adopted by the Hanbali school of jurisprudence. In Al-Kafi by Ibn Qudama it is written:
If someone says, "Sell this for ten, and whatever you receive in excess will be yours," then that excess will be lawful for the seller because Ibn `Abbas did not see any impediment to doing
This opinion is recorded by Ibn Abi Shaybah in his Al-Musannaf from Ibn `Abbas, Ibn Sirin, Shurayh, `Amir al-Sha`bi, al-Zuhri, and al-Hakam. `Abd al-Razzaq added Qatada and Ayyub to those who agreed. The arrangement, however, was considered makruh (undesirable) by Ibrahim al-Nakha`i and Hammad, as related by `Abd al-Razzaq, and by al-Hasan al-Basri and Tawus ibn Kaysan as related by Ibn Abi
Shaybah.(6) This is the opinion of the majority, other than the Hanbali scholars. Al-Hafidh Ibn Hajr commented on the opinion of Ibn `Abbas mentioned by
This, too, refers to the wages of a broker. But, as these are unknown (7), the majority of jurists have not allowed the arrangement, saying if the broker sells the item for the owner on this basis, he will be entitled to no more than the fee customarily awarded for similar sales. Some jurists have interpreted the statement by Ibn `Abbas to mean that he saw the situation as analogous to that of a partnership. The same interpretation was given by Ahmad ibn Hanbal and Ishaq. Ibn al-Tin recorded that some jurists stipulated, for its acceptance as
lawful, that people at the time understand the price of the goods to equal more than what was stated; but his opinion was challenged on the grounds that ignorance of the actual amount of the fee still
Badr al-Din al-`Ayni wrote:
As to the opinion of Ibn `Abbas and Ibn Sirin, well, the majority of scholars do not allow such a sale. Among those who disliked it are Sufyan al-Thawri and the jurists from Kufa. Likewise, al-Shafi`i and Malik did not allow it. If someone sells on this basis he will be entitled to a fee equal to what is customary for such a sale. Ahmad and Ishaq, however, have allowed the sale, saying, "This is actually a partnership, for at times a partner will not
Of course, all of this is said in relation to the fees of a broker if other than the excess over the stated original price of the sale is not specified. However, if the broker's fee is stated as a determined amount, and then the broker is told, 'If you sell this for more than this, the excess will be yours in addition to your predetermined fee,' then it should be clear that the majority will not oppose it. This is because the ignorance with regard to the fee is lifted when it is determined in advance. Then, if the broker sells the item for more than a certain amount, the excess will be his as an incentive for better management.
On this basis, the Standard for Mudarabah approved by the Shariah Council reads as follows:
If one of the two parties should stipulate for itself a specific amount (of profit), the mudarabah will be void. This prohibition, however, is not inclusive of an agreement by the two parties that if the profits exceed a certain percentage then one of those two parties will receive the excess exclusively such that the distribution will be according to what the two have
The operations manager in a Sukuk will manage on the basis either of its being a wage-earning employee (ajir) or an investment agent (wakil), thus resembling a broker, or on the basis of its being an investment manager (mudarib), or a working partner (sharik `amil). All of these possibilities are covered by the Standard. However, when the jurists gave permission for this arrangement, they did not consider that it would be used to carry out operations on the basis of interest rates or to maintain the status quo of the conventional, riba-based market. The right of the manager to an amount in excess of the prescribed percentage has been called an incentive for better management of the
assets. (11) Such an incentive, however, may only be understood as an incentive if it is linked to what exceeds the minimum amount of expected profits from the commercial or industrial enterprise for which
Sukuk were issued. For example: if the minimum amount of expected profits is 15%, then it may be said that the actual profits in excess of that percentage may be paid
the manager as an incentive. This is because that excess amount may logically be ascribed to good management. The problem is that the prescribed percentage in these Sukuk is not linked to the expected profits from the enterprise, but to the costs of financing or to the prevalent rates of interest in the market; rates that vary every day, or every hour of the day. Obviously, there is no connection between these and the profitability of the commercial or industrial enterprise. Oftentimes, this rate will be considerably lower than the expected rate of return from the enterprise. Thus, for example, if the expected rate of return from the enterprise is 15%, the interest rate at the same time may be no more than 5%. If, owing to poor management, the
actu of return from the enterprise falls to 10%, then how may what is in excess of 5%given to the manager as a reward for "good management"?12 How can this be,
even when poor management resulted in profits dipping from [an expected] 15% to onl10%? It should therefore be clear that what is being called an "incentive" in these Sukuk is not truly an incentive but rather a method for marketing these Sukuk onbasis of interest rates. It should also be clear that this aspect is not free of legal repugnance (karahah), even if we do not declare it prohibited
The foregoing is from the perspective of Islamic jurisprudence only. From the perspective of the higher purposes of Islamic economics, such "incentives" in today's Sukuk actually defeat the purpose of an Islamic economic system in which wealth is equitably distributed among investors. Sukuk that are based on such "incentives" distribute profits to investors on the basis of prevalent interest rates, and not on the basis of actual returns from an enterprise.
If Shariah supervisory boards have tolerated such irregularities (mafasid) when Sukuk began to be issued, and at a time when Islamic financial institutions were few in number, the time has now come to revisit the
matter... and to rid Sukuk from now on from such blemishes. Either Sukuk should be free of all such "incentives" or these should be based the enterprise's expected profits. These should certainly not be based on prevalent interest rates. This will then become a truly distinguishing characteristic of Islamic financial institutions, and one that sets them apart from their conventional, interest-based counterparts.
Two: Stipulating Loans when Profits Fall Below Prescribed Percentages
There is absolutely nothing in the Shariah to justify a loan when actual profits are less than the prescribed percentages. The one undertaking the loan is the operations manager, and the manager is the one that sells the assets to the Sukuk holders at the beginning of operations. If it is then stipulated that the manager will make loans to the Sukuk holders at times (for distribution) when actual returns fall below the (promised) rate of return, the transaction will come under the heading of a sale with a credit. It is well known that the Prophet, upon him be peace, prohibited sales linked to credits. The same was related by Malik in his al-Muwatta on the authority of trusted narrators (balaghan), and by Abu Dawud and al-Tirmidhi whose version reads, "A sale and a credit are not lawful." Al-Tirmidhi added, "This is a good and a sound hadith." In his commentary on this narration, Ibn `Abd al-Barr wrote:
This hadith is recorded on the authority of `Amr ibn Shu`ayb, from his father, from his grandfather, from the Prophet, upon him be peace. It is a sound
hadith that has been related by many reliable narrators on the authority of `Amr ibn Shu`ayb; and `Amr ibn Shu`ayb is a reliable narrator (i.e., his narrations are reliable) when those who relate his narrations are themselves
The entire community of scholars is agreed on this (prohibition) and no one is known to have held a dissenting opinion. Ibn Qudamah wrote:
If someone sells on condition that the purchaser give credit (to the seller), or advance him a loan, or if the buyer stipulates the same, that will be unlawful and the sale will be void. This is the opinion of Malik and al-Shafi`i, and I know of no dissenting
At another place, he wrote:
If he stipulates that he lease his house to him at a rate lower than the market rate, or that he take a lease on the lender's house at a rate higher than the market rate, then this will be even more
With regard to the mechanism used in the Sukuk, the manager is not willing to offer the loan unless he receives more than his due share of the actual profits by means of the "incentive" which is stipulated for him when the percentage of actual profits exceeds the percentage based on the prevalent interest rate of interest. Therefore, such a loan, in view of the opinion voiced by Ibn Qudamah, is emphatically all the more unlawful.
At times, the manager who undertakes the loan may be a partner in the enterprise, or a mudarib. Such an undertaking [on his part], too, is in opposition to the requirements of the contract and falls under the same prohibition as that against a sale linked to a credit (or a loan) in exactly the same way. Thus, it is not lawful.
Three: The Manager's Promise to Repurchase Assets at Face Value
The third issue is that in true commercial enterprises, where the Shariah is concerned, the return of investors' capital cannot be guaranteed. In Shariah compliant dealings, reward always follows after risk. The legal presumption with regard to Sukuk is that there can be no guarantee that capital will be returned to investors. Instead, they have a right to the true value of the [Sukuk] assets, regardless of whether their value exceeds that of their face value or not. All of today's Sukuk, however, guarantee by indirect means Sukuk holders' principal. The manager pledges to the Sukuk holders that he will purchase Sukuk assets at face value upon maturity, regardless of their true value on that day. What this means is that the principal paid originally by the Sukuk holders will be returned to them at maturity. There is no other significance to such a commitment. If the enterprise is not profitable, the losses will be borne by the manager. If it is profitable, however, the profits will accrue to the manager, regardless of how great the amount. The Sukuk holders have no right to other than the return of their principal, as is the case in conventional bonds.
In considering the lawfulness of this commitment, we note that the manager of the Sukuk may act in his capacity as an investment manager, mudarib, for the Sukuk holders, or as a partner, sharik, or as an investment agent, wakil, for them.
A Commitment by a Mudarib
That such a commitment to investors on the part of a mudarib is void should be obvious because it is a capital guarantee by the mudarib to the investors, and no jurist has ever averred that such an arrangement is lawful. The Standard on Mudarabah approved by the Shariah Council states:
If the loss at the time of closing operations is greater than the earnings, the losses will be deducted from the capital and the manager, in his capacity as a trust holder, amin, will not bear any of the loss as long as there is no negligence or mala fides on his part. If the costs are equal to the earnings, the investors will receive their capital back, and the mudarib will earn nothing. When profits are earned, these will be distributed among the two parties (investor and manager) in accordance with what the two have
Thus, I can see no possible justification for such a commitment by a mudarib. It is, however, mentioned in some Sukuk that the manager does not make this commitment in his capacity as a mudarib, but in another capacity. This is clearly illogical because the mudarib has no other capacity in this deal.
A Commitment by a Sharik
The manager may also act as the partner of the Sukuk holders. Then, in the same way that it is unlawful for a mudarib to guarantee the return of capital to investors, it is also unlawful for one partner to guarantee the return of capital to the other partner or partners. This is because to do so would effectively interrupt the partnership in the event of losses; and that is something that no jurist has ever allowed. The Standard on Musharakah approved by the Shariah Council states:
It is unlawful for the conditions of partnership or for the basis of profit distribution to include any text or condition that leads to the possibility that the sharing of profits will be interrupted. If this happens, the partnership will be
The Standard specifically mentions the unlawfulness of such a commitment in one of the following paragraphs, where it states:
It is lawful for one of the parties to the partnership to issue a binding promise to purchase the assets of the partnership during the period of partnership or at the time of dissolution at market value or at an agreed price at the time of purchase. A promise to purchase the assets at face value, however, is
In the Basis for Conclusions for the Standard it is stated:
The justification for the ruling of "unlawful" with regard to the binding promise by one of the partners to purchase the assets of the partnership at face value is that this is the same as a capital guarantee, which is unlawful. The justification for a ruling of "lawful" for repurchase at market value comes from the fact that there is nothing in this arrangement that guarantees anything to the
Certain contemporary scholars have attempted to justify a commitment that implies a capital guarantee by saying that while it may be prohibited in a partnership of contract, shirkah `aqd, it is not prohibited in a partnership of property, shirkah milk. They then claim that the sort of partnership that occurs in Sukuk (especially Sukuk with leased assets) is a partnership of property and not a partnership of contract. However, when we consider the reality of these two types of partnership, it is clear that the type of partnership that occurs in Sukuk is a partnership of contract and not a partnership of property. This is because the purpose of the partnership [in these Sukuk] is not merely to own physical assets for the purpose of consumption or personal benefit but for the purpose of joint investment. This is the fundamental difference between a partnership of property and a partnership of contract.
To be more specific, when we consider what the classical jurists have mentioned regarding the reality of a partnership of contract, it should be clear to us that a partnership of contract may be distinguished from a partnership of property in three ways:
- The purpose of the partnership of contract is to jointly seek profits; whereas the purpose of the partnership of property is no more than to have possession of something and make use of it.
- A partnership of contract makes each partner the agent of the other in investment enterprises, whereas partners in a partnership of property are entitled to dispose of their own share [of the jointly owned property] as they wish; while they are absolute strangers with regard to the shares of the other partner or partners.
- The partners in a partnership of contract are free to distribute profits among themselves in whatever proportion they agree among themselves. A partnership of property is different. In it, each partner is entitled only to the profits earned by his own share. So, when each partner puts his share to work separately, each partner will profit solely from the returns earned by his own share.
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