Annex 2: Islamic Debt Securities

International Monetary Fund
Published Date:
November 2009
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Islamic finance

A2.1 Islamic finance is governed by Islamic rules and principles (Sharī’ah), which, among other things, prohibit usurious payment (RIba), including predetermined returns on borrowed funds for specific terms. The Sharī’ah also forbids investment in businesses that provide goods and services considered contrary to its principles (Haraam), such as gambling. Nonetheless, Islamic finance encourages trading and business, mainly through risk and profit sharing participation in permitted activities.

A2.2 In view of the prohibition of Riba, Islamic finance uses financial instruments that either:

  • are backed by returns from a real asset and earn a variable rate of return tied to the performance of the asset, or
  • offer returns that are unspecified before the investment is made but shared based on a pre-agreed ratio on actual earnings.

A2.3 Islamic finance has progressed and expanded its business activities from offering basic alternatives to conventional interest-bearing accounts and loans to encompass Islamic capital markets and Islamic insurance services (Takaful).38

Existing international statistical standards

A2.4 The 2008 SNA classification scheme for financial instruments can provide additional detail to include special categories for statistics on Islamic financial instruments. The MFSM indicates that Islamic debt securities consist of various investment participation certificates that have the characteristics of negotiable securities and are not investments in the permanent capital of the issuer. Included are most negotiable investment certificates recorded as liabilities of the issuer.


A2.5 In Muslim and non-Muslim countries, institutional units issue Sharī’ah-compliant participation certificates or securities, frequently referred to as Sukūk. Sukūk represent a proportional undivided ownership right to tangible assets, a pool of assets, or the assets of a specific project or investment activity. According to the Islamic Financial Services Board (IFSB), Sukūk differ from conventional interest-based debt securities in a number of ways.

  • In the case of asset-backed Sukūk, the underlying asset has to be Sharī’ah compliant. Furthermore, funds raised through the issuance of Sukūk should be applied only to permissible (Halal) assets, projects or businesses. These would require a Sharī’ah Board to advise and supervise Sharī’ah compliance aspects of the Sukūk.
  • The tradability of Sukūk is dependent on their structure, as the Sharī’ah generally prohibits the sale of debt at a discount. For example, one of the mechanisms to trade Sukūk at a variable price is when the Sukūk relies on a lease structure (Ijārah39) where the lease rentals can be changed or revised from time to time.

Criteria for distinguishing Islamic debt securities and equity securities

A2.6 There are two categories of criteria that distinguish Islamic debt securities from equity securities. The first category comprises criteria that are used to differentiate conventional debt securities and equity securities.

  • A debt security represents indebtedness or borrowing by the issuer, whereas an equity security represents partial ownership in the issuing corporation.
  • A debt security holder has first claim, ahead of equity holders, in the event of liquidation of a corporation.
  • A debt security offers a holder a fixed or variable rate of return over its life and the principal at redemption, whereas an equity security may offer its holder a variable dividend depending on the profitability of the issuing corporation.
  • A debt security (except a perpetual debt security) usually has a maturity date, whereas there is no maturity date for an equity security.
  • A debt security is usually rated for the risk of credit default, whereas an equity security is not.
  • A debt security is usually issued and exchanged in the over-the-counter market, whereas an equity security is usually issued and its ownership transferred on an exchange.

A2.7 The second category comprises additional criteria that are used to distinguish Islamic debt securities and Islamic equity securities.

  • All Islamic equity securities are negotiable in the secondary market, but depending on the nature of the contract, not all Sukūk are negotiable. For example, Murābahah40 are based on a cost-plus contract and are usually not transferable, since the Sharī’ah rules and principles prohibit the sale of debt at a discount.
  • The credit rating of Sukūk that is backed by a guarantee must ensure that the institutional unit providing the guarantee is not related to the issuer. In this case, the Sukūk issuer is allowed to apply a third-party guarantee on the capital invested under the principles of Mudārabah41 or Mushārakah.42
  • Equity securities issued by corporations that conform to specific Sharī’ah criteria can be classified as Sharī’ah compliant. In contrast, conventional debt securities are classified as non-Sharī’ah compliant, hence the need for Sukūk.
  • Equity securities have the risk of becoming Sharī’ah non-compliant if the corporation enters into new ventures or engages in transactions that breach the criteria set under Sharī’ah rules and principles.

Securitisation structures for Sukūk issues

A2.8 The IFSB suggests that there are two broad securitisation structures for Sukūk issues.

  • A “pay-through”43 Sukūk structure, where the Sukūk issuer purchases assets from the originator, issues the Sukūk to investors to finance the purchase of assets, and leases the assets back to the originator on behalf of the Sukūk investors. Normally, the assets will be returned to the originator on maturity of the Sukūk through a repurchase or sale-and-leaseback transaction.
  • A “pass-through”44 Sukūk structure, where a Sukūk-issuing institutional unit that is separate from the originator purchases assets from the originator, issues the Sukūk to investors to finance the purchase of assets, and packages the Sukūk investors into different pools. The pools that the investors are in may affect the distribution of returns.

A2.9 In many jurisdictions, including some in which Sukūk issues take place, there may be legal obstacles to setting up an appropriate type of securitisation corporation. This is especially important for risk mitigation and credit enhancement purposes where a securitisation corporation needs to be “bankruptcy remote” from the originator. In such legal environments, it may not be possible to transfer beneficial title to the assets to the investors, or to ensure that the investors are able to exercise these rights (for example, to repossess Ijārah leased assets) in case of default. In such circumstances, it is not feasible to create a structure for issuing non-recourse securitisation debt securities.

A2.10 The assets in Sukūk securitisation structures must comply with Sharī’ah rules and principles. The underlying assets to be securitised generally comprise properties that generate lease incomes. However, the underlying assets may also combine a portfolio of assets comprising different categories of contracts, such as Ijārah leased assets, Murābahah or Salam receivables,45 Istisnā46 assets, or equity ownership (Mushārakah or Mudārabah). While sales-based Sukūk securitisation structures, such as Murābahah and Salam, are not negotiable, the latter may be combined in a pool with other negotiable contracts, such as Ijārah, in order to design a negotiable Sukūk, provided that the proportion of other tradable contracts is not less than a certain acceptable ratio. Business ventures organised as Mushārakah or Mudārabah partnerships may also be securitised, resulting in Sukūk that are negotiable.

Islamic debt securities classification

A2.11 The sector and sub-sector classifications in existing international statistical standards, such as 2008 SNA, also apply to Islamic debt securities. Institutional units in the following sectors and sub-sectors usually issue Islamic debt securities: general government, financial corporations (including deposit-taking corporations and the central bank) and non-financial corporations. The IFSB also suggests that Sukūk can be classified by type of underlying contract, such as Murābahah, Ijārah, Salam, Istisnā, Mushārakah, Mudārabah, and Wakalah.47

A2.12 Most of the other classifications described for conventional debt securities, that is, currency, maturity and market, may also be applied to Islamic debt securities.

A2.13 With regard to classification by interest rate, as noted earlier, Sharī’ah rules and principles prohibit usurious payment (Riba), including predetermined returns on borrowed funds for specific terms. Furthermore, some Sukūk structures, such as Mushārakah or Mudārabah, may not reflect the exact variation in the real return from the business venture. Therefore, the returns cannot be predetermined at the time of issue. This situation makes the pricing of these securities difficult, as does the lack of benchmark profit rates and the diverse types of Sukūk securitisation structures. Thus, in order for the Sukūk pricing mechanism to be efficient and credible, further initiatives have to be undertaken to develop benchmark indicators. For example, if the Sukūk issue is based on the Ijārah principle, where a property is used as its underlying asset, the actual rate of return on the underlying asset may be used to determine the rate of return of the Sukūk. The price of the Sukūk would then fluctuate in line with the supply and demand in the market for that underlying asset.

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