In defense of sukuks

By Blake Goud

The sukuk market has developed rapidly over the past decade from nearly nothing. Now that a few sukuk have defaulted (or nearly in the case of Nakheel), many are asking whether sukuk are worthwhile for corporate or sovereign issuers. Sukuk are useful because there continues to be a demand from investors for Shari’ah-compliant debt alternatives.

The default of these few sukuk issuers, even one as large as Nakheel, is not created by the use of a sukuk. The same issuers would have defaulted on conventional bonds. However, that does not give sukuk a free pass and the argument that Islamic finance is ‘different’ and somehow immune from overreaching in a property bubble or during a recession should be laid to rest.

Relevant products

Sukuk will remain relevant financial products because there continues to be demand from Islamic banks and takaful companies. This will tempt companies and sovereigns inside the GCC and globally (like GE Capital and the World Bank’s International Finance Corporation) to issue sukuk alongside their existing conventional debt.

The primary difference between sukuk and conventional debt is their structure at this point. The economic outcome is in many cases identical, but with a growing number of Islamic banks and takaful companies looking for fixed income assets, there will be a growing demand for sukuk.

That is largely where the sukuk industry is today – sukuk are largely identical to conventional bonds. As the number of issuers and maturity profile of outstanding sukuk broadens, there will be greater and greater pressure from investors and Shari’ah scholars for the sukuk structure to diverge from just mimicking conventional debt.

The sukuk markets will need to mature by developing secondary markets, new structures and reducing costs for the additional structuring. At that point, there may be sukuk that have a different risk and return profile from conventional bonds.

Evolving market

The evolution in the sukuk market remains at an early stage and the defaults in sukuk small and large do pose a challenge for the perceptions of Islamic finance generally and sukuk in particular. The defaults, however, are not caused by anything unique in the structure used in sukuk.

If anything, there should be more security for sukuk creditors if sukuk are secured by an underlying asset, as it is often claimed. However, in many cases, the asset is removed from the equation by a purchase undertaking exercisable at maturity or in a default turning the sukuk unsecured. That perhaps should be the biggest lesson taken from the Nakheel sukuk crisis.