Monday, February 11, 2008

Scholars debate Taqi's paper on sukuk in London

(The Malaysian Reserve, 11 Feb 2008)


Regulators are at loggerheads on what to do next after a study revealed that the majority of Islamic bonds do not comply with Islamic laws

Sukuk, or Islamic bonds that notched global sales of up to US$30.8 billion (RM 99.47 billion) last year, almost doubling sales the year before, is currently under intense scrutiny of Shariah scholars. It became an industry hot potato when it was reported that a whooping 85% of Gulf sukuks did not fully comply with Islamic laws.

The figure, coming from prominent contemporary Islamic jurist Muhammad Taqi Usmani (PIX), expectably caused a stir. Sheikh Taqi, the chairman of the Shariah Council of Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), is a retired Pakistani Shariah judge, a permanent member of the OIC Fiqh Academy and an influential scholar.
Last week, his paper on sukuk was the focus of deliberation at a workshop in London conducted by a select group of Islamic legal scholars, economists and bankers. It was organised by the Islamic Finance Project (IFP), a venture by the Islamic legal studies program at Harvard Law School and the London School of Economics (LSE).

The discussion is timely as sukuk fast gain currency. Japan is reportedly planning to sell its first sovereign sukuk this month. Thailand has expressed interest while Hong Kong is actively wooing Islamic finance players. The workshop organisers estimated that the sukuk industry is currently valued at over US$150 billion.
It is precisely this explosion that prompted Sheikh Taqi to raise caution in the air on sukuks, which are generally structured as debt instruments.

The organisers noted sukuk criticism has come from two fronts: Economists who object to such instruments being debt based and certain scholars who voiced criticism of some interpretations of specific jurisprudential concepts employed in structuring sukuks. Shedding some background on the issue, Jeddah-based King Abdulaziz University Shariah supervisor and Professor Mohamed Elgari, in his response to Taqi's paper, wrote that AAOIFI Shariah Council had discussed the matter.

On its sitting in Makkah late last year, the sukuk discussion ended without conclusion. "Then came the storm, when a number was quoted by Justice Taqi Usmani during a speech in Bahrain. Reporters love numbers," he said.

Taqi's Arguments

Sheikh Taqi, who served a term as Pakistan's Federal Shariah Court judge, outlined three issues in his paper entitled 'Sukuk and their contemporary applications', signing off as AAOIFI Shariah Council president.

The Bahrain-based organisation is an Islamic international autonomous non-forprofit corporate body that prepares accounting, auditing, governance, ethics and Shariah standards for Islamic financial institutions. His concerns were on bondholders' ownership of enterprise assets, regular distributions to sukuk holders, and guaranteeing the return of principal.

On the first issue, Taqi said that sukuk represent ownership shares in assets that bring profits or revenue, one characteristic that distinguishes sukuk from conventional bonds. Recently, cracks have appeared in that respect. He cited the example where the assets in the sukuk may be shares of companies that do not confer true ownership but which merely offer sukuk holders right to returns. "Such sukuk are no more than the purchase of returns from shares; and this is not lawful from a Shariah perspective," he said.

On distribution, he noted that most sukuk issued today are identical to conventional bonds with regard to the distribution of profits from their enterprises at fixed percentages based on interest rates. As to the third point, he argued that virtually all sukuks issued today guarantee the return of principal to holders at maturity, just as in conventional bonds. This is accomplished by a binding promise from either the issuer or the manager to repurchase the assets at the stated price, regardless of their true or market value at maturity.

In Shariah-compliant dealings, he pointed out that reward always follows after risk. The legal presumption with regard to sukuk is that there can be no guarantee that capital will be returned to investors. Instead, he added they have a right to the true value of the assets, regardless of whether or not it exceeds the face value.

"All of today's sukuk, however, guarantee by indirect means sukuk holders' principal," he wrote in what must a hard pill to swallow for many practitioners. On purported "incentives" to sukuk managers, one of the issues under query, he said: "If Shariah supervisory boards have tolerated such irregularities (mafasid) when sukuk began to be issued, and at a time when Islamic financial institutions were few in number, the time has now come to revisit the matter and to rid sukuk from now on from such blemishes."

In the 14-page discussion paper on sukuk, Sheikh Taqi also discussed about the 'higher purposes' of Islamic economics. He argued that Islamic banks were not established so that they could offer the same products, and engage in the same operations, as conventional banks in the prevalent interest-based banking system. "What is happening at the present time, however, is the opposite. Islamic financial institutions have now begun competing to present themselves with all of the same characteristics of the conventional, interestbased marketplace, and to offer new products that march backwards towards interestbased enterprises rather than away from these.

"Often times these products are rushed to market using ploys that sound minds reject and bring laughter to enemies," he wrote. Academic, Industry Feedback A number of scholars and practitioners have presented their views on Taqi's arguments. Among them are India's Aligarh University former professor Mohammd Nejatualla Siddiqi, Seif I Tag el-Din from Leicestershire's Markfield Institute of Higher Education, Durham University's Prof Rodney Wilson and Mansoor Shakil, the director and head of HSBC Amanah Central Shariah Group, Dubai, UAE.

In his arguments, King Abdulaziz University's Mohamed Elgari wrote that sukuk cannot be objectionable because they deliver the same conventional outcome or behave in the market in similar way to bonds. "On the contrary, they are desirable because they do so," he said.

In his notes of discussion, local Shariah scholar from International Islamic University Malaysia (IIUM), Dr Mohamad Akram Laldin (PIX) touched on concern that today's sukuk behave like debt and suggestion by some quarters that it should be structured to behave more as an equity product. "While Islam allows debt, it does not encourage debt if there is no necessity to take debt.

"However, in modern day transactions, where liquidity is needed to facilitate mega projects and to fulfil the need of the market, such arrangement fall under the category of permissible things in Islam, provided that the requirements and restrictions of taking debt are observed. The same shall apply in the sukuk market," said Akram, who also sits on the HSBC Amanah's regional Shariah committee for Malaysia.

Rafe Haneef, former head of Islamic Finance for Asia at Citigroup, responded with a lengthy paper of his own, arguing that the industry has not yet reached the stage of maturity that could invoke the full force of the higher objectives of Shariah.

"The author submits that unfortunately, the time has not yet arrived to raise the standards in the Islamic finance industry," he said, responding to Taqi's assertion that the number of Islamic banks and financial institutions today is not to be overlooked. The debate is far from over and will continue as Islamic finance pushed ahead in the name of faith, business and innovation.


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