Status and Timeline
Islamic finance standards No. 62 (Sukuk) was released in exposure draft in November 2023. It is not yet adopted as the official standard. It represents the future of Sukuk standards and reflects response to market practices and Shari'ah concerns identified under the Investment Sukuk standard. Practitioners are strongly encouraged to familiarize themselves with the Sukuk standard for deeper conceptual understanding.
Rationale for Addressing Gaps in the Investment Sukuk standard
the Investment Sukuk standard, while comprehensive, has been interpreted in ways that sometimes conflict with strict Shari'ah principles. For example: (1) "Asset-Based Sukuk" have sometimes been structured to minimize the issuer's true asset exposure, making them nearly debt instruments in economic substance. (2) Some Sukuk have relied on excessive credit enhancement (guarantees from the issuer or third parties), converting variable-return instruments into fixed-return securities. (3) Sukuk have occasionally been sold and repurchased in ways that circumvent the original Shari'ah rationale. the Sukuk standard tightens these loopholes.
Enhanced Shari'ah Compliance Requirements in the Sukuk standard
1. Substantiality of Asset Ownership
the Sukuk standard emphasizes that Sukuk certificateholders must have genuine, substantive ownership of underlying assets, not merely a shadow claim on issuer cash flows. This means: (a) Assets must be real and identifiable, not abstract. (b) The issuer cannot simply "pledge" assets as collateral while retaining all benefits. (c) Certificateholders' claims on assets must be senior to issuer's general creditors in case of insolvency.
2. Restrictions on Credit Enhancement
the Sukuk standard limits guarantees and credit enhancement. A guarantee from the issuer that "protects" Sukuk holders from loss transforms the Sukuk into a liability-backed security (like a bond), not an asset-backed security. The standard permits limited credit support but requires it to be structured carefully: support can be for currency risk, operational risk, or technical default (issuer unable to liquidate assets); support cannot protect investors from business risk or market losses on assets.
3. Prohibition on Sham Purchases
The standard explicitly prohibits: (a) Repurchase agreements where the issuer agrees to repurchase assets at a predetermined price, effectively eliminating investor risk. (b) "Back-to-back" structures where Sukuk proceeds finance purchases that are immediately resold to the issuer at a guaranteed price. (c) Stipulations that contracts remain binding even if they prove invalid—a safeguard to prevent Sukuk from being treated as risk-free debt.
4. Ownership Transfer and Balance Sheet Recognition
The standard requires proper legal transfer of asset ownership to Sukuk certificateholders (or their representatives). Assets must be: (a) Removed from issuer's balance sheet. (b) Recorded in the Sukuk entity's balance sheet in the name of certificateholders. (c) Documented with legally enforceable deeds of ownership. If legal or tax constraints prevent such registration, specific conditions must be met to ensure issuer creditors cannot compete with Sukuk holders for the assets.
Structural Requirements in the Sukuk standard
Asset Eligibility
- Assets must be Shari'ah-compliant (no prohibited industries: conventional banking, alcohol, gambling, etc.).
- Assets must be transferable in law and capable of bearing the rights/obligations of Sukuk holders.
- If underlying assets include shares in companies, those shares must meet Shari'ah screening criteria per the Financial Papers standard.
- Assets cannot be pledged to interest-bearing loans (Riba-based financing).
Certificateholder Rights
- Right to disposal: Certificateholders (collectively) must retain the right to sell, lease, or otherwise dispose of underlying assets.
- Right to returns: Certificateholders must be entitled to all benefits arising from asset ownership (rent, profit, appreciation).
- Right to bear risk: Certificateholders must bear the risk of asset loss, depreciation, or non-performance.
- These rights cannot be permanently restricted without violating Shari'ah.
Common Changes from the standard to the Sukuk standard
| Issue | the Investment Sukuk standard Approach | the Sukuk standard Approach |
|---|---|---|
| Asset ownership | Certificateholders "own" assets (broad interpretation) | Certificateholders must have substantive, transferable ownership |
| Credit enhancement | Limited guidance; guarantees sometimes accepted | Restrictive; guarantees against business risk prohibited |
| Repurchase agreements | Permitted if asset purchase genuine | Prohibited if predetermined price eliminates investor risk |
| Asset transfer documentation | Flexible approach | Strict legal documentation required |
| Sukuk basis switching | Sukuk can convert from one type to another | Restricted; material changes require certificatholder consent |
Practical Impact: Are My Sukuk Still Valid?
Sukuk issued under the Investment Sukuk standard will remain valid as long as they comply with their own stated structures. the Sukuk standard will apply to new issuances prospectively (after adoption). However, as market practice evolves toward the Sukuk standard, existing Sukuk may face Shari'ah scrutiny if they fail to meet the stricter standards. Issuers of new Sukuk should anticipate the Sukuk standard requirements even during the transition period.