Developing asset-light Sukuk

Such Sukuk can be issued without being backed by substantial physical assets

KARACHI:

Sukuk, the Islamic alternative to conventional bonds, offers a unique financial instrument that can significantly contribute to economic development.

By adhering to Islamic principles of ethical investment and interest-free nature, Sukuk can attract a broader investor base, including those with religious or moral concerns. This increased liquidity can facilitate infrastructure development, housing projects, and other vital sectors of the economy.

Additionally, Sukuk can provide a Shariah-compliant alternative to conventional debt financing, diversifying funding sources for governments and corporations.

According to S&P, global Sukuk issuance is projected to reach approximately $170 billion in 2024, compared to $168.4 billion in 2023. The outstanding Sukuk in international markets is expected to cross the $1 trillion mark during 2024. Looking forward, it is likely that the market could reach $3 trillion by 2032.

The increasing expansion of Islamic finance and banking institutions, the rising diversification of assets, the growing infrastructure development, and the development of comprehensive and investor-friendly regulatory frameworks by Islamic finance authorities and standardisation bodies are some of the factors propelling the market.

Furthermore, governments and corporations are increasingly turning to Sukuk to raise capital for infrastructure projects, refinance debt, and fund economic development.

According to the IIFM Sukuk report of 2023, sovereign Sukuk issuance accounts for more than 52% of the global issuance, while Malaysia, Saudi Arab and Indonesia dominated the global Sukuk issuance with a combined market share of 70% worth $1,260 billion.

Sovereign issues refer to Sukuk floated by national governments or state-owned entities. These Sukuks are generally considered the most secure and attract a large pool of investors due to their low risk, backed by the creditworthiness of the issuing government.

Backed by the creditworthiness of national governments, these instruments are primarily used to finance public projects such as infrastructure and social welfare programmes. Their low-risk nature and high liquidity make them attractive to a broad range of investors, both domestic and international.

Various Islamic financial authorities, including SECP in Pakistan, are establishing robust regulatory frameworks and guidelines, enhancing market integrity and investor confidence. The adaptability of Sukuk is a driving force for growth as it can be structured to cater to various sectors, including real estate, infrastructure, and renewable energy, providing both issuers and investors versatility.

The asset-backed structure of a typical Sukuk offers a transparent and secure investment avenue, which appeals to issuers and investors. However, over the years, the Sukuk market has evolved to accommodate various needs and it is continuously developing new structures, one of the more recent innovations being asset-light Sukuk, which brings certain advantages to both issuers and investors.

Traditional Sukuk typically requires the ownership of tangible assets to ensure compliance with Islamic principles. However, asset-heavy structures are not always suitable or practical for all issuers, particularly those in sectors with fewer tangible assets, such as financial services or technology or even sovereign states converting to the Islamic financial system.

Asset-light Sukuk aims to address this challenge by allowing Sukuk to be issued without the need for substantial physical assets.

Instead of being directly based on ownership of real assets like land, buildings, or machinery, asset-lite Sukuk can be structured around intangible assets or a combination of tangible and intangible assets, future cash flows arising from a trade transaction, rights to future services, airtime rights, bandwidth rights for telcos, or similar service-oriented projects.

These structures provide more flexibility for entities seeking to raise capital in compliance with Islamic finance principles.

On the domestic front, as the banking system in Pakistan is moving towards conversion to Islamic principles in light of the Federal Shariat Court decision and the SBP policy guidelines for conversion by 2027, a mammoth task of converting over Rs40 trillion of government's local debt to Islamic guidelines poses a significant challenge and merits exploring a new structure in addition to the Ijarah Sukuk programme to facilitate the conversion of banking sector and public debt to Shariah-compliant modes.

Pakistan made its debut in the domestic Sukuk market in 2008 by issuing Ijarah-based Sukuk and, as of August 2024, the government had issued Ijarah Sukuk valued at over Rs6.5 trillion. Pakistan's sovereign Sukuk recorded a surge in 2023, with issuances totaling a record Rs1.77 trillion.

The primary objective of the Sukuk is to replace costly interest-based debt and meet the government's budgetary requirements as part of Pakistan's ongoing financial system reform. In the current year, the government has successfully issued Ijarah Sukuk of over Rs750 billion at PSX.

Since 2008, the sovereign Sukuk issued in Pakistan is based on the Ijarah principle, where investors are required to invest in the ownership of physical assets like motorways, airports, etc. However, given the challenge regarding the availability of physical assets, new models of Sukuk, such as hybrid or asset-light Sukuk, are being explored.

The government has already introduced the Asset Light Sukuk (ALS) framework and Ijarah Sukuk rules have been amended to allow the flexibility of issuing Shariah-compliant instruments under different modes like Salam (advance for commodity sale), Murabaha (sale of goods), Istisna (construction contract), Musharakah and Mudarabah (partnership for commercial ventures) and Wakalah (investment agency).

Sukuk rules also allow the issuance of hybrid Sukuk where more than one mode is used to invest the funds generated from investors. This feature allows the flexibility of Sukuk to become tradeable in secondary markets.

This approach aims to increase the issuance of Sukuk by using intangible or non-traditional assets, enabling Pakistan to tap into Islamic capital markets more frequently and with a much larger ticket size.

Pakistan can also learn valuable lessons from the international Sukuk issuance for developing asset-light Sukuk for the domestic market.

Bahrain's central bank regularly issues Sukuk Al Salam for the domestic market based on the trade of oil and aluminum. Malaysian domestic Sukuk market has also witnessed regular issuance of Murabaha Sukuk based on deferred sale of commodities like palm oil. Recently in August 2024, Saudi Arabia issued a hybrid asset-light Sukuk worth 6.018 billion riyals based on Murabaha and Mudarabah.

Similarly, in Pakistan, we can develop asset-light Sukuk based on the Murabaha of commodities like imported oil, locally and internationally available real commodities, exploring the use of telecom spectrums like 4G and 5G, etc.

Moreover, hybrid Sukuk based on Ijarah combined with Murabaha and other trade-based modes need to be explored with a strong government directive to concerned stakeholders to extend cooperation and support.

Asset-light Sukuk provides a flexible and efficient solution for entities and governments seeking Shariah-compliant financing without significant physical assets. By expanding the scope of issuance, reducing transaction costs, and adhering to Islamic finance principles, these Sukuk play a crucial role in the continued growth of Islamic finance industry and the conversion of the country's domestic debt to Islamic modes.

Policymakers in the capital need to assign a high priority and lend full support to ensure timely development of an asset-light Sukuk programme.

Ahmed Ali Siddiqui is the Director of IBA Centre of Excellence in Islamic Finance and Dr Uzma Kashif is the Assistant Professor at Superior University Lahore