Sukuk: The Shari’ah compliant response to government bonds

Compensation of employees, social spending and infrastructure development are some of the expenses governments have. In order to fund these activities governments need a evenue stream. The main source of government revenue is usually taxes. However, often, the taxes that a government levies on their citizens are insufficient to meet government spending. One way to make up the shortfall is for governments to issue bonds.

The U.S Securities and Exchange Commission explains a bond as “a debt security, similar to an IOU. Borrowers issue bonds to raise money from investors willing to lend them money for a certain amount of time. When you buy a bond, you are lending to the issuer, which may be a government, municipality, or corporation. In return, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the principal, also known as face value or par value of the bond, when it "matures," or comes due after a set period of time.”

Bonds play a significant role in funding government expenses. Government entities usually raise funds for large capital projects such as roads, power stations and hospitals. A bond may be listed on a debt board such as the Johannesburg Stock Exchange debt board. Investors may also sell the loan to other investors should they wish to; this allows for liquidity of bonds. According to the Johannesburg Stock Exchange, more than R1 trillion is currently listed on the Johannesburg Stock Exchange’s Debt Board.

In addition to assisting governments, government bonds have numerous advantages for an investor. These include:

·        Government Bonds are generally considered to be less risky than many other asset types

·        Relatively liquid

·        Active secondary market

·        Easily accessible

·        Steady stream of income

For a Muslim investor, or government looking to raise funds this raises several issues. The main issue is that bonds are a clear example of interest which is prohibited in Islam (Qur’an 2:275). An alternate method of raising funds is via a sukuk. The Accounting and Auditing Organization for Islamic Financial Institutions defines an investment sukuk as a “certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity, however, this is true after receipt of the value of the Sukuk, the closing of subscription and the employment of funds received for the purpose for which the Sukuk were issued.”

A sukuk is often referred to as an “Islamic Bond”, however, there are significant differences between the two. The main distinctions are the following:

·        Sukuk is indicative of ownership, not a debt obligation

·        The sale of a sukuk represents a sale of ownership in an asset backing the sukuk, not the sale of debt

·        Assets which back a sukuk will be shari’ah compliant

Allah Knows Best