Suku and Conventional Bonds

From last decade Sukuk got popularity in world although they were issued from last three decades. Also now it is observed that Sukuk issuance significantly increases from last few years. In 2007, it was seen that Sukuk outstanding amount was $90 Billion which raise and increase and in 2010, it was projected to $200 Billion which proves the high increase in its popularity. Corporate and sovereign issued Sukuk in the year 2000-07 (Christophe J. Godlewski, Rima Turk-Ariss and Laurent Weill, 2011).

Sukuk is now considered as an alternative of conventional bonds and it is used by corporate sectors as well as by sovereign government. And many Islamic countries used this financial instrument rapidly and fund their debt into Sukuk.  Corporation issued Sukuk and raise funds in lower credit terms and also Sukuk have long maturity period which simply increase the corporation profits. The country which consider as a center of Sukuk market is Dubai. And Malaysia is a country which has the highest market share of Sukuk and it had almost 75% share of all Sukuk market. It is because Malaysia laws are helpful to establish higher Sukuk market. It is also observed that Sukuk market is not only popular in Islamic countries like Saudi- Arab, Dubai etc. but it also get famous internationally like London market promote such regulations that will be helpful for Sukuk market (Moody, 2007-8).

Difference between Sukuk and Conventional Bond:

Sukuk can be resource – based or resource – supported. Resource – upheld Sukuk are such where a real deal has occurred and the SPV controls the fundamental resource. Though a benefit – based Sukuk is a securitization of the advantages which is nearer in structure to a conventional bond. Conventional bonds don’t have any basic resources and are somewhat obligation instruments whereby financial specialists will get a coupon (interest) payment and at development the face value (Weill, L. 2013). This can be contrasted with the rental and continues got from the offer of the basic resource in a Sukuk. The rental that a Sukuk holder gets depends on the benefit or misfortune that the obligator makes from the use of the advantage. This is not quite the same as bonds where the return or hobby is foreordained.

Sukuk, as discussed above, is a certificate of ownership right in particular underline, and you get rent income from that particular source but as we know in case of the conventional bond source of income is not disclosed, nor bondholders have an ownership right on any particular underline asset, the company owns. So primary differences Sukuk and conventional bond have are; Sukuk provides ownership right whether bond doesn’t and income received by Sukuk holder must get from that underline whether in the conventional bond source of income is anonymous. Sukuk holders get rent on its shared underline asset while bondholders get interest on its bonds (Mustafa Mohd Hanefa &Akihiro Noguchi & Muhamad Muda, 2013). Sukuk and bond share some common features as well like both uses as a source of finance, and they trade in the secondary market.

In the occasion the supporter of a conventional bond defaults on a payment the bondholders can bring a claim against it and gather however much as could be expected. This contrasts on account of a Sukuk where the fundamental resource can be sold and the returns from the deal will be dispersed amongst the declaration holders. Conventional Bonds and Sukuk are distinctive in structure. Conventional bonds have cash as the hidden resource and on account of Sukuk a substantial resource (Weill, L. 2013). This distinction is for religious reason however practically no budgetary effect. However despite the fact that bonds have money as the fundamental resource, the payments can be produced using any source of salary and if the security defaults investors can grab any benefits of the organization while the Sukuk the main resource the Sukuk holder has rights to is the hidden resource.

Sukuk in a portfolio essentially decreases value at risk (VaR) of the portfolio. The increases of expansion by incorporating Sukuk in the bond should be assessed against the lower return and liquidity risk of Sukuk. The optional business sector for Sukuk is found to have an absence of action and this can demonstrate that Sukuk are illiquid (Weill, L. 2013). The illiquidity can represent a risk on the portfolio now and again of unpredictability, as financial specialists will be unable to purchase or offer any Sukuk in the auxiliary business sector. This low unpredictability might be a false sense as Sukuk are just valued in a comparable manner to property, where evaluating just happens once per year, yet the cost could have changed commonly inside of the period. Consequently a conceivably misguided feeling of low instability could be watched. Sukuk and conventional bonds, in spite of the fact that the same financially, effectively affect stock exchanges (Weill, L. 2013).

It is found that for the most part fiscally unfortunate organizations issue Sukuk rather than conventional bonds (Weill, L. 2013). This can be ascribed to benefit sharing being more gainful to a low benefit while set interest payments are more advantageous to high benefits. “On the off chance that backers expect a low benefit, they will incline toward benefit – and – misfortune sharing financing plans to minimize their misfortune in the aftereffect of disappointment. On the off chance that guarantors expect an exceptional yield, they will lean toward premium – based financing to amplify their increase in the occasion of achievement.” Since the business sector can separate in the middle of Sukuk and conventional bonds, and Sukuk has negative stunt there is a breaking point on the impetuses for organizations to issue Sukuk instead of conventional bonds (Turk, R., 2011). Further Sukuk issuance can turn into a pointer of terrible execution of a corporate, along these lines further influencing the negative execution stun in the share trading system. Market component may restrain the extension of Sukuk, which will be counteracted religious inspiration.

Sukuk and conventional bonds as various money related instruments. This waterway so be a reason that Sukuk performs superior to anything bonds. This together with the risk profile demonstrates that the speculation is that Sukuk ought to offer preferred returns over bonds. As it is known a benefit with higher risk is frequently connected with higher comes back to make up for this hazard, the negative effect of Sukuk available and the difference test have a tendency to concur with this theory (Turk, R., 2011). Further hazard can be seen from the feedback of Sukuk as certain Islamic researchers trust that Sukuk are accurately organized tends to build hazard the same number of takes after of Islam might will to dump the Sukuk if it somehow managed to named breaking the religious practices.

Sukuk outflank conventional bonds, while the risk on Sukuk is observed to be higher. The higher risk could be a purpose behind Sukuk having higher return execution. In the money related space, an advantage that has a higher risk profile needs to repay the financial specialist and this 14 remuneration is through higher returns. In the relative level of risk as measured by standard deviation for the Sukuk is moderately bigger than the standard deviation of conventional bonds (Turk, R., 2011). The level of risk as measured by standard deviation for the Sukuk is more noteworthy than the risk of conventional bonds to ten haphazardly chose bunches.

In general both conventional bonds and Sukuk issues sent negative sign to advertise affirming the loss of speculators’ confidence in firms falling back on shoddy source of financing. To clarify why Sukuk issuance made more negative effect than conventional bonds issuance, we propose that just borrowers who have low return desires will have an allurement towards Sukuk. On the off chance that backers expect a low benefit, they will lean toward benefit and-misfortune sharing financing plans to minimize their misfortune in the occasion of disappointment (Turk, R., 2011). On the off chance that backers expect an exceptional yield, they will lean toward hobby based financing to augment their increase in the occasion of achievement. Accordingly, bonds exchange members will anticipate that less educated borrowers will issue Sukuk and will translate such issuance as a negative sign on the budgetary position of the issuing firm.

Besides, because of a solid interest for Sukuk from Muslim countries and Islamic banks connected with the restricted supply of Sukuk in the business sector prompts an abundance interest for Sukuk that makes these instruments more prominent and less demanding to showcase than conventional bonds. Along these lines, organizations that are monetarily frail and are not in a position to issue a conventional bond may even now have admittance to financing through Sukuk issuance. Market takes this as a believable flag and does not respond emphatically to the Sukuk issuance (Turk, R., 2011). One plausible clarification for the positive resources impact of Islamic bond issuance declarations in respect to conventional bond issuance declarations in post-emergency period is that the bigger financial specialist base for Islamic obligation bonds with respect to that for conventional obligation made cost favourable circumstances for Sukuk issuing firms prompting a lower expense of capital.

Sukuk got popularity in the Islamic countries, and now it’s used as a substitute of a conventional bond. As interest is not allowed as per Islam so to address and compliance with Shari’a Sukuk is a certificate that shows the ownership right on an underline asset that is shared amongst holders, and they own the obligation associated with that underline (IFSB.org, 2010)(Alaa Abdo, 2014). There are many types of Sukuk in the market those names are; pure Ijarah Sukuk, Hybrid/Pooled Sukuk, variable rate redeemable Sukuk and zero couple redeemable Sukuk etc. (Ali Arsalan Tariq, 2004).

Volatility with Sukuk and conventional bond:

There are a couple of studies like Cakir and Raei in 2007 and Christophe J. Godlewski, Rima Turk-Ariss and Laurent Weill in 2011 demonstrated that Value at Risk (VAR) related to the mixture of the portfolio that consists of Sukuk & bonds was lower than a portfolio that consists of pure conventional bonds. The reason behind this fact is evident that Sukuk has an underline asset in the backup that provides more security to holders as well as Sukuk is an ownership right that helps the corporation to lower its leverages hence ultimately reduce the risk.

 Risk associated with Sukuk certificate:

There are few risks associated with Sukuk as every asset class has like bond have default risk and interest rate risk etc. The first risk associated with Sukuk is varies risk. Varies risk is a risk that arises when underline assets got issues in its operation or inefficiencies observes in the operation of underline asset. The second risk associated with Sukuk is market risk as Sukuk trades in the secondary market so when fluctuation is observed in the market that will impact Sukuk as well. Third risk associated with Sukuk is Shari’a risk. Sukuk is Shari’s compliance and with the passage of time there was significant innovation had been seen in types of Sukuk so there is a possibility that in future Shari’s board change their opinion regarding Sukuk there may be a risk that after sometimes there may be a change in Shari’a Laws regarding Sukuk (Marwa M.Elteir, Amira Y.Ragab, Nada H.Eid, 2013). Mr Taqi Usmani addressed in AAOIFI held in the year 2007 and he said conventional bonds considered as standardized while Sukuk didn’t, Mr. Taqi Usmani said that around 80% Sukuk was not follow the Guld Shari’a Law and also said statistics might not be accurate but there is some truth in it (Alaa Abdo, 2014).

Sukuk- A viable source of financing:

It is known by all that companies always have two options to get finance for their company. These options are:

  • Companies owners directly pay their own money to fulfill capital needs
  • Companies borrow money from others.

Borrow money from others leads to take loans from banks or issued bonds or issued Sukuk. It is also note able that if companies take loans or issue debt then these are considered as the liability of company but if Sukuk is issued then it is not a liability, it is considered as proportionate share of ownership. Funds created from Sukuk are considered as equity and at maturity of Sukuk bond companies has a right to redeem the ownership. Sukuk issued on some asset and the rental payments are made to holders from those asset income.

The answer of this question that Sukuk is whether viable source of financing or not is analyzed by the research study of the impact of Sukuk on corporate financing in which it is shown that Malaysia considered as the biggest issuer of Sukuk and they issued almost 72% Sukuk of total market in 2011 and it proved that Sukuk is a viable source of financing for corporate sectors (Razali Harona, Khairunisah Ibrahim, 2012). Also it is observed that Sukuk doesn’t have too much influence on capital structure and also leverage ratio is reduced by Sukuk because it is treated as redeemable equity. And because Sukuk leads lower leverage, it created lower operational risk in corporation. But it is also a fact that Sukuk risk are higher than conventional bonds risks because conventional bonds risks can be managed by derivatives but Sukuk risks can’t be manage by derivatives. So, corporation should keep in mind the different risks which are associated with Sukuk. Investors know better that where they should use their capital because Sukuk holder knows that which asset should be finance with their fund.

Is Sukuk is better than conventional bond:

These are some outline that helps to conclude this discussion that Is Sukuk is better than conventional bond or not?

Item Conventional Bond Sukuk (Islamic Bond)
Underline asset There is no particular underline present in conventional bond. Particular underline is present in Sukuk.
Revenue sharing There is no revenue sharing in conventional bond instead they offer interest as use of capital. Revenue share amongst Sukuk holders in shape of rent
Transparency As corporation doesn’t need to disclose the purpose to use the finance In Sukuk issuer must clearly state the motive behind issuing the Sukuk
Flexibility in maturity, payment and time horizon Plain vanilla bond have certain maturity and fixed coupon while some other bonds do have variable coupon and redemption option Sukuk provide flexibility in term of maturity as holder feels underline perform well or not hence they negotiate the issue according to that.
Trading Bond trades throughout a day Sukuk only trades one a day so there is less volatility observes in Sukuk prices.

Source: (Faleel Jamaldeen, nd al)

From the above discussion it is easily to conclude that Sukuk is better than conventional bond in many features. Those features are listed below,

  • Provide ownership right
  • Underline is present on backup
  • Results in lower the leverage of business
  • Less risky than bond in term of interest rate sensitivity, default risk and credit risk
  • Less volatile than conventional bond
  • Sukuk as viable of source of finance for corporation by share liabilities with them as well

 

Reference

Alaa Abdo, (2014). “A Critical Review of the Sukuk Market A qualitative study to identify current risks and opportunities”.

Ali Arsalan Tariq, (2004). “MANAGING FINANCIAL RISKS OF SUKUK STRUCTURES”

Godlewski, C. J., Turk-Ariss, R., & Weill, L. (2013). Sukuk vs. Conventional bonds: A stock market perspective. Journal of Comparative Economics, 41(3), 745-761.

Godlewski, C. J., Turk, R., & Weill, L. (2011). Do markets perceive Sukuk and Conventional bonds as different financing instruments?

ISLAMIC FINANCIAL SERVICES BOARD, (2009). “CAPITAL ADEQUACY REQUIREMENTS FOR SUKŪK, SECURITISATIONS AND REAL ESTATE INVESTMENT” retrieved from < http://www.ifsb.org/standard/eng_%20IFSB-7%20Capital%20Adequacy%20Requirements%20for%20Sukuk,%20Securitasations%20and%20Real%20Estate%20investment%20(Jan2009).pdf>

Mustafa Mohd Hanefa &Akihiro Noguchi & Muhamad Muda, (2013). “SUKUK: GLOBAL ISSUES AND CHALLENGES”.

Mohamed Ariff and Meysam Safari, (2012). “Are Sukuk Securities the Same as Conventional Bonds?”

Marwa M.Elteir, Amira Y.Ragab, Nada H.Eid, (2013). “Sukuk: Does it minimize risk?”.

Razali Haron, Khairunisah Ibrahim, (2012). “The Impact of Sukuk on Corporate Financing: Malaysia Evidence”.

Faleel Jamaldeen, (nd al), “How Sukuk differ from Conventional bond” retrieved from < http://www.dummies.com/how-to/content/how-sukuk-islamic-bonds-differ-from-conventional-b.html>