Education

Five Important Differences Between Sukuk and Traditional Bonds
By
today 26 July 2014 GMT

Although a common starting point for explaining sukuk is to use bonds as a comparison point, it is important to understand that there are certain fundamental differences.


Sukuk adhere to an Islamic view of finance, avoiding Riba (generating money from money, i.e. interest or usury), bonds are securities that are very Riba due to the fact that they have a fixed interest.


There are five important differences between sukuk and traditional bonds:


1. Sukuk indicate ownership of an asset. Bonds indicate a debt obligation.


2. The assets that back sukuk are compliant with Shariah. Assets backing bonds may include products or services that are against Islam.


3. Sukuk are priced according to the value of the assets backing them. Bond pricing is based on credit rating.


4. Sukuk can increase in value when the assets increase in value. Profits from bonds correspond to fixed interest, making them Riba.


5. When you sell sukuk, you are selling ownership in the assets backing them. The sale of bonds is the sale of debt.


Sukuk are backed by tangible assets, rather than by debt. Sukuk ownership indicates ownership of an asset that has value. Although, a bond may also indicate this, the real definition of a bond simply indicates a debt obligation. At its root, the relationship between the issuer of a bond and the consumer is very different from the relationship between the issuer of sukuk and the purchaser of sukuk. In the case of a bond, the consumer is acting as the loaner and the bond issuer as a loan recipient. In this case, the loan has a fixed interest, therefore being Riba. In sukuk, the purchaser is purchasing an asset that has value rather than participating in an implicit loan agreement.


Another important difference between bonds and sukuk is that the assets involved in sukuk certificates comply with all laws of Islam. In the case of bonds, the bond certificate may be backed by assets that are not compliant with Shariah, which may be bundled together with other types of assets without the consumer’s knowledge. The consumer of sukuk is assured that the value of the certificate corresponds to assets that are in the public good and not related to activities or products that are against Islam.


Although some may argue that the differences between sukuk and bonds are merely technicalities, these differences matter to Muslims. In fact, the practice of profiting from money alone, at the expense of productivity and real people has been one of the drivers for many of the economic problems that have plagued the world in the last decade. Interest and artificial inflation of prices based on debt rather than on real value is the main reason why bubbles form, burst, and then lead to recessions and depressions. Sukuk, unlike bonds, are priced according to the real market value of the assets that are backing the sukuk certificate. Bond pricing is based on the credit rating of the issuer. This is necessary in the case of bonds because when you sell a bond on the secondary market, you are actually selling the debt in the underlying loan relationship. The sale of a sukuk on the secondary market is simply the sale of ownership in the asset.


The main advantage of sukuk over traditional bonds is that their value increases in relationship to the assets backing the sukuk certificate. If the asset raises in value, then the value of the ownership of that asset, backed by the sukuk, increases. Bonds do not have this characteristic. It is not possible to raise the main debt in a bond and increase in revenue from a bond is the direct result of the fixed interest rather than in any kind of tangible increase in value or productivity.


This is not to say that bonds and sukuk are not similar in certain ways. Both can be turned into cash by selling them on the secondary market. Based on the strength of their backing, both bonds and sukuk can be ranked by ranking institutions. There is also similar variance in bond and sukuk designs and issuers, allowing consumers to have a variety of options when looking into these financial instruments.


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