Salman Ahmed Shaikh
Sukuk is an alternative Islamic finance instrument for conventional bonds. Sukuk is a certificate that represents ownership in underlying real asset(s). Islamic law does not permit interest and hence conventional coupon paying bonds are impermissible as per Islamic law. However, Islamic law allows sale and lease of real assets and the resulting income in the form of profit on sale or rental income stream on lease of assets. Holders of Sukuk share in the lease or profit income generated from the ownership of real assets that the Sukuk certificate represents.
A typical Ijarah Sukuk would work like this. For instance, if a manufacturer requires industrial equipment, it will issue Sukuk that can be purchased by institutional and/or retail investors. From the proceeds of Sukuk, the industrial equipment is purchased and is leased to the manufacturer. During the period of lease, the manufacturer will pay rent and that will generate income stream for the Sukuk holders who had invested in Sukuk. After the lease period is over, the manufacturer will purchase the asset in a separate contract and this will enable the Sukuk holders to be able to redeem their investment.
Sukuk could turn out to be an instrument of choice after the current financial crisis. Not only Muslim countries, but non-Muslim majority countries are also taking interest in it. UK treasury is issuing a Sukuk worth £200 million. It will become the first sovereign state outside the Muslim world to issue an Islamic bond.
In Pakistan, capital markets are not as developed and most of the formal sector financing takes place through banks. Savings rate is very low (12%-14%) and the inflation rate on average had remained above 10% during the last 10 years or so.
Capital market instruments require long term investment horizon and liquidity. Due to political instability and policy inconsistency, usually, the long term investments are not very popular among the investors. In the last few years, only a handful of IPOs had taken place. The bond market is also very small and dominated by sovereign issues than corporate bonds.
While risk averse investors had found comfort with bank investments even though banks do not offer inflation beating returns, most savers with adequate risk apatite look to invest in secondary market for equities. Karachi Stock Exchange had provided return of 48% and 49% in 2012 and 2013 respectively. Hence, the less risk averse investors favor equity investments in liquid stocks for parking their surplus funds.
There are many reasons why corporate bond market did not develop as per expectations in Pakistan. The national savings scheme instruments issued by the government of Pakistan are offering very attractive yields and they are default free. Some national saving scheme instruments are also tax-free and hence after-tax yield on such instruments are even higher as compared to the corporate bonds.
Moreover, the corporate sector itself has lost confidence and interest for long term big investments in the country ever since the episode of nationalization in the 70s. Afterwards, indirect taxation and removing import barriers had also made corporate investment more challenging in the 80s and 90s. Then, the rise of industrializing countries on the external front together with energy and security crisis in the domestic front had resulted in even more challenging times for formal corporate sector businesses, especially in the manufacturing sector. As a result, neither new IPOs nor corporate bonds had much of a success during the last 6-7 years in the country.
In Pakistan, 78 Sukuk had been issued so far for an amount of Rs 637.43 billion. Out of the total 78 issues, 32 Sukuk issued for an amount of Rs 100.10 billion had been fully redeemed.
Government of Pakistan (GoP) had issued Ijarah Sukuk on numerous occasions in past to meet its escalating borrowing requirements. Government sector companies like Water & Power Development Authority (WAPDA) and Sui Southern Gas Company Limited (SSGC) had also issued Sukuk in past. Karachi Shipyard has also issued an Ijarah Sukuk in 2007.
Sovereign Ijarah Sukuk issued by the Government of Pakistan (GoP) have been structured in such a way that it allows the government to mobilize funds. The Sukuk holders are also able to earn Shari’ah compliant income. It also facilitates Islamic banks to manage their liquidity as well as meet statutory liquidity requirement stipulated by the central bank of Pakistan.
In the corporate sector, Sitara Chemical Industries Limited, Wateen Telecom, Engro Chemicals, Dawood Hercules, Century Papers & Boards, Attock Generation Limited, Arzoo Textile, Lieberty Power, Amreli Steels, Eden Builders, Quetta Textile, Pakistan American Fertilizers, PEL and Kohat Cement are some of the companies that had issued Sukuk in past. One private sector entity Maple Leaf defaulted on Rs 8 billion Sukuk in 2009. Maple Leaf default on its Sukuk liabilities had demoralized already minimal investor confidence. But, capital markets – especially led by a buoyant stock market – are experiencing resurgence in investor participation and interest.
Recently, K-electric (formerly KESC) issued Rs 6 billion Sukuk which is also listed on the Karachi Stock Exchange (KSE) and Lahore Stock Exchange (LSE). There was no Pre-IPO placement and the entire amount of Sukuk issue was offered to retail investors and it was fully subscribed in a matter of few hours.
In recent times, Meezan Bank also arranged the country’s first airtime-based Sukuk. These Sukuk use intangible assets such as minutes of mobile telephone use. The structure of these Sukuk is based on Ijarah and sub-Ijarah of services. Assets are airtime (minutes) represented by prepaid calling cards and identified by the serial number of each card.
On the regulatory front, Securities and Exchange Commission of Pakistan (SECP) had issued guidelines for the issuance of Sukuk. According to SECP, the issuer must not have over-due loan and the issuer’s as well as the instrument rating should not be lower than triple B minus (BBB-).
SECP has decided that Sukuk would be offered in three types, that is Sukuk-1 of up to Rs 750 million for a tenor of thirteen months, Sukuk-2 of up to Rs 3,750 million for a tenor of three years and Sukuk-3 of Rs 1,500 million for a tenor of five years.
The SECP explained that the subscription period would be for three months. The rate of return on Sukuk-1 will be one month KIBOR plus 100 bps, Sukuk-2 will be three month KIBOR plus 225 bps and Sukuk-3 will be three month KIBOR plus 275 bps. KIBOR is Karachi Interbank Offered Rate and used as a benchmark in pricing time based intertemporal financial products just like the use of LIBOR in the international markets.
Through issuance of more Sukuk, the investment class assets universe will expand and it will enable the Islamic-conscious individual and institutional investors to effectively diversify their portfolios. Treasuries of Islamic banks will also have an expanded set of investment avenues. It will increase liquidity of these Sukuk and generate wider interest among all investors in the economy to consider investing in these investment vehicles.
In most developing countries, the governments pay more than 50% of their tax revenues in servicing debt and spend very little on development. Often, these governments trim development spending to cover other non-discretionary current expenditures. Going forward, Sukuk can be used to finance the purchase of infrastructure that can be used in development projects.