The sukuk shakeout arrives

By Felix Salmon
June 16, 2009

The first sukuk (Islamic bond) defaults have arrived, and no one has a clue how they’re going to shake out. Which might actually be a feature rather than a bug, going forwards.

Bondholders often have a large amount of complacency derived from the fact that an enormous amount of equity needs to be wiped out before they take any hit at all. And that complacency does the system no favors in the long term. If capital structures get muddied a little, and debt takes on more equity-like uncertainty — as seems to be the case in the sukuk market — then maybe investors will be more assiduous about examining underlying risks, rather than relying on capital structures to protect them.

Comments
3 comments so far

Succint remarks Felix..

The outcome of these proceeding will have a positive (in my view) impact on the industry and hopefully Sukuk will emerge as an asset class with unique risk characteristics. This will also make more clear the difference between “asset-based” and “asset-backed” Sukuk structures

Posted by Sulaiman Alireza | Report as abusive

One of the most interesting parts of the defaults in a few sukuk is how they are viewed. Some view it as the economic problems spreading into Islamic finance, which is true, but somewhat overlooks the more important point. Islamic finance is a new industry and sukuk are even newer. They were virtually unknown before Malaysia issued one in 2002. They grew rapidly throughout the decade until 2008 when the credit crunch hampered new issues (most are benchmarked to LIBOR which is permissible according to scholars because it is analogous to a store selling halal goods pricing them to remain competitive with other products that are similar but not halal).

The resolution of the issue of whether the structure stands up in cases of default or bankruptcy is at this point unknown, although in most cases the structure is nearly identical with other securitizations. However, in some cases it is not true. The Investment Dar which defaulted on its sukuk had structured the sukuk as a joint-venture (musharaka) and in case of default the sukuk holders could force TID to buy out their remaining share in the joint-venture without giving them access to the underlying assets.

I wrote an article in March on the East Cameron Partners bankruptcy which was the focus of the WSJ article (http://www.cpifinancial.net/v2/Magazine .aspx?v=1&aid=1942&cat=IBF&in=40) and I have also added my thoughts on the East Cameron sukuk on my blog (http://investhalal.blogspot.com/2009/06  /sukuk-defaults-attracting-wider.html).

The next sukuk to run into trouble may be the $3.52 billion Nakheel sukuk, one of the largest ever issued, which I described and analyzed on Zawya.com blog (http://blogs.zawya.com/blakegoud/090506 063401/)

“The resolution of the issue of whether the structure stands up in cases of default or bankruptcy is at this point unknown, although in most cases the structure is nearly identical with other securitizations”

I wouldn’t say that, except in a handful of cases (although in Malaysia it’s more common). Most sukuk don’t have subordination or credit enhancement, have recourse to the borrower, and repayment isn’t directly tied to the performance of the assets. There are certainly many similarities in principle, and “asset backed” sukuks are much closer in practice, but the vast majority of corporate sukuk don’t have any of the defining features of securitisation.

” If capital structures get muddied a little, and debt takes on more equity-like uncertainty ”

Shhh. Don’t use the word “uncertainty”. That’s gharar, and is forbidden in Islamic finance. You mean “shared risk”.

Posted by Ginger Yellow | Report as abusive
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