Money Markets – Islamic Perspective

Money markets are extremely important, whether in the conventional or the Islamic financial system, for monetary stability and economic development. Central banks manage the liquidity issues of financial institutions like banks through reserves and short-term borrowing or investments in the money market. Islam prohibits the treatment of money as a commodity; it can only be considered as a medium of exchange. For banks to deal with their liquidity challenges, an efficient interbank market is required with very short maturities varying between overnight and a week. Developing a vibrant Shariah-compliant money market that enables market players to perform similar functions to those of conventional markets, without interest-based products or any form of Gharar or Maysir, is a major challenge of the modern Islamic finance industry. Islamic finance encourages developing financial instruments that are based on real assets such as certificates of Murabaha, Mudaraba and Wakala, as well as Ijara Sukuks. Islamic money markets extensively utilize the process of securitization of assets in a portfolio, and its risks and returns are assigned to the investors as owners of the securities, pro-rata to their ownership. These securities are traded both on exchanges and OTC. For the Islamic money market to be successful it needs the support of the government, the central bank and other regulatory bodies to ensure that it meets the needs of the participants and that the securities are Shariah compliant. An active money market indicates to the central banks the volume of open market operations that are required to ensure liquidity and monetary stability.

Thus, Islamic money market instruments are Shariah compliant, structured on assets, including both debt and equity, and require the approval of the financial regulators as well as of the SSB. On the other hand, conventional money market instruments are structured on debt only and require approval of the financial regulators only. Islamic treasury products are mostly in the form of deposit and investment instruments, and the instruments may have an underlying contract of Murabaha, Mudaraba or Wakala. Instruments currently used in the Islamic money market include Mudaraba-based accounts, negotiable Islamic debt certificates, Islamic treasury bills, Islamic accepted bills, commodity Murabaha, Islamic commercial paper, Salam and Ijara-based Sukuks.

Capital Markets – Islamic Perspective

Islamic capital markets include equity markets and asset-linked securities market, especially Sukuks. The Islamic capital market instruments are also required to be Shariah compliant and free of Riba, Gharar and Maysir. Major participants of this market are investment banks, brokers, fund managers and asset management institutions. The main international Islamic regulators involved in developing, regulating and promoting the Islamic capital markets are the IIFM, the IFSB and the AAOIFI.

Dealing with Non-compliant Stocks

With global markets changing and with mergers and acquisitions, Shariah-compliant stocks may become non-compliant, for example when a conglomerate with Shariah-compliant businesses acquires a subsidiary that deals with non-compliant business or which fails on the financial screening. Besides merger and acquisition, a company previously approved after industry and financial screening may change its area of business or its financial behaviour, making it unacceptable in the Shariah screening. In such cases, the following are recommended.

1. Temporary non-compliance. If the non-compliance appears to be unplanned and temporary, and the stock soon returns to compliance, the non-compliance is tolerated.
2. Short-term non-compliance. If the stock remains non-compliant for a brief period and then returns to compliance, the stock may be kept in the portfolio, but this non-compliance needs to be reported to the SSB and any income earned during the non-compliant period needs to be calculated and donated to charity to purify the income.
3. Permanent non-compliance. If it appears that the stock has become permanently non-compliant it needs to be sold off as unacceptable stock.

Purification of Income Distribution

Some scholars do not allow investment in stocks that involve any kind of conventional debt, while others allow such stocks with the condition that the income generated needs to be cleansed or purified in proportion to the Shariah-non-compliant activities. As such, any income that is interest or from any other non-compliant source is donated to charity. The view of Muslim jurists related to cleansing of capital gains is even more controversial. Some scholars feel that capital gains earning also needs to be purified by donating the proportion relevant to non-Shariah-compliant activities, while some scholars opine that no purification of capital gains is required since the company belongs to a Halal industry. Some scholars also allow the payment of Zakat as a measure of purifying the income.

Initially, Islamic equity funds were benchmarked against conventional indices like the Morgan Stanley Capital Index (MSCI). Over time, Islamic stock market indices were developed to provide benchmarks for Shariah-compliant investment in shares. Prominent Islamic indices include the Dow Jones Islamic Market Index, FTSC Global Islamic Index, S&P Global Investable Shariah Index, Kuala Lumpur Composite Index, Pakistan Meezan Islamic Fund, Global GCC Islamic Index, Jakarta Islamic Index, etc.

Islamic Unit Trust or Mutual Fund

A unit trust or investment fund is a collective investment scheme in which many investors with similar financial goals, investment strategy and risk tolerance pool their surplus funds to invest in a large diversified portfolio of financial instruments, professionally managed on behalf of the investors. An Islamic unit trust is very similar, except that the portfolio would be built with Shariah-compliant instruments and the professional managers would be responsible for following Islamic guidelines in the procedures and management of the unit trust, in addition to following all due diligence for a regular unit trust. Unit trusts or investment funds can be open-ended or close-ended.

An open-ended unit trust is one with the authority to issue new units and redeem existing units at any time. The fund manager of such a unit trust publicly offers the units and any proceeds received are added to the collective fund. On the other hand, investors can purchase units in such unit trusts directly from the unit trust company or its authorized agent, and are able to sell back their units to the unit trust company at the existing market price, which fluctuates every day depending on the performance of the fund. A close-ended unit trust can issue a limited number of units only. Once the original investors have acquired these units, any subsequent buying and selling of units happens only on the secondary market – the stock exchange. An initial public offering (IPO) of a company's shares is a form of close-ended investment where the share purchaser provides their investments to the company for good and if at any point they want to sell their shares, they do not get their money back from the companies but rather go to the stock exchange and sell the shares at the current market price.

Investment funds are managed either actively or passively. In case of active management, the fund manager actively designs the portfolio and buys and sells actively to manage it. In case of passive management, the role of the fund manager is to design the fund as close to a chosen index as possible with the stocks included in the index; the fund's value then moves up or down with the index. The main benefit of investing in a mutual fund for investors is that they can diversify at relatively low cost with smaller investment amounts. Diverse types of mutual funds and Islamic mutual funds are available, as will be clear from the next segment of this chapter, developed to meet the different profiles of the investors, their risk and return appetite, time horizon, the amount available to invest and the liquidity they require. Other advantages include convenience of investment, professional management, transparent operations and supervision under governmental oversight. Disadvantages of investing in a mutual fund include the fees to be paid, sales charges (called load) that may be paid at the onset of the investment or when the investment is redeemed; some mutual funds may not require any load payment. Other disadvantages are that the investor may not be sure of how much income will be earned or will have far less say on the fund design and its updates.

A variation of the mutual fund is called the exchange traded fund (ETF). Mutual funds became very popular during the 1980s and 1990s and were priced based on the closing price of each day rather than priced during the day as trade moved. To deal with this limitation, ETF, which are also mutual funds, were created but were traded on the exchange like the shares of a company, with the price determined by market forces. ETFs have all the advantages of the mutual funds discussed above but additionally are highly tradable instruments. Shariah-compliant ETFs are called Islamic ETFs or I-ETFs. The first one listed was at the Istanbul Stock Exchange and was called the DJIM Turkey ETF.

Common Types of Islamic Investment Fund

Islamic investment funds can be divided into various types depending on the way they are structured.

• Islamic debt fund. Invested in fixed-income Islamic instruments like Murabaha, Ijara, Istisna or Salam, which are deferred payment sales contracts that yield a fixed income over a given period, thus providing stability to the income generated by the fund and shared by the investors in the fund after deducting all relevant expenses.
• Islamic commodity fund. In this case the fund manager uses the common pool of funds to purchase a variety of commodities that would be resold based on a deferred payment system and at a profit, which constitutes the main income of the fund and is distributed pro-rata amongst the investors after deducting all relevant expenses.
• Ijara fund. This fund is created by investing money in purchasing a pool of suitable physical assets that can then be leased out to a third party, who would be the ultimate user. The rentals earned from the lease or Ijara constitute the income of the fund, distributed amongst the investors of the fund after deducting all relevant expenses. This fund has slightly higher risk then the debt or fixed-income fund and higher returns are also expected.
• Islamic equity fund. The assets of the fund are invested mostly in shares, with a small amount possibly invested in cash and other fixed-income Islamic securities. The chosen shares would be Shariah screened, and this is the most common type of fund used by Islamic fund managers globally. The fund aims less for income from dividends and more for long-term growth and earnings through capital gains. An Islamic equity fund may be structured as a Mudaraba contract or a Musharaka contract. In the Mudaraba contract the investors of the fund are the Rab al Maal and the fund manager is the Mudarib, performing the managerial functions; in the Musharaka contract the fund investors and the fund manager are equity partners who own the assets of the fund to the extent of their financing ratio. Profit and losses are shared according to the proportion of capital invested in the fund, after deducting all relevant expenses.
• Islamic balanced fund. A mutual fund that invests its pool of money to purchase a combination of Shariah-screened shares, commodities and Islamic fixed-income instruments is called a Islamic balanced fund and provides investors in one common fund the goals of both short-term income and long-term growth and capital gains.
• Islamic private equity. Such a fund is created by investing in shares of private limited companies that are not traded on the stock exchange. The shares of such companies are usually owned by a few large individual or institutional investors. To belong to Islamic private equity these companies need to belong to the Halal industries and their operations need to be screened to be at the acceptable level of Shariah compliance.
• Islamic venture capital. Venture capital is financing provided to small, new and promising start-up businesses which have good entrepreneurial, managerial and technical skills, but lack financing. Investors may pool their money and structure a fund which invests in prospective ventures on a long-term basis but is not traded on exchanges. The ventures that receive funding and their operations have to be Shariah compliant.

Islamic Real Estate Investment Trusts

A real estate investment trust (REIT) is an investment vehicle which invests mostly in real estate. The regulatory requirement on the minimum percentage of assets in a REIT that should be real estate varies between jurisdictions. According to PriceWaterhouseCooper (2017), the minimum percentage of REIT income that should be generated from real estate, for example, is 75% in the UK and the USA while in Malaysia it is 50%, and the minimum distribution to investors in all three countries is 90%. The PWC REIT Report (2017) estimates the current market capitalization of REITs globally at USD1.7 trillion, up from USD734 billion in 2010, which is almost 230% growth.

Real estate investment could be through direct ownership of the real estate or through a single purpose company whose principal asset comprises real asset or items that relate to real estate, and whose main income is real estate rentals. Islamic REITs usually use Ijara contracts or Ijara–Istisna contracts. These are often designed as equity REITs, where investors may get proportional ownership of the underlying real estate and earn stable rent income. Islamic equity REITs are structured like an Ijara fund, the difference being that the Ijara fund has fixed maturity while that of the Islamic REIT (I-REIT) is long-term or ongoing. Like all other investment funds, the REITs and I-REITs are structured by individual investors placing their funds into a common pool, which is invested in a managed pool of real estate, generating income from renting, leasing and selling real estate. The income of the REIT or I-REIT net of all management expenses is distributed regularly amongst the investors pro-rata to their investment, including any capital gains generated by the fund.

Structured as limited companies, most REITs and I-REITs are listed on stock exchanges and those not listed are traded OTC as private REITs or I-REITs. According to their core function, REITs and I-REITs can be divided into (1) those that manage owned real estate, (2) those that provide financing for real estate owners or operators and (3) the hybrids that are involved in both types of function. The biggest advantage offered by REITs and I-REITs is the opportunity for investors to more effectively and efficiently diversify their real estate investment at a much lower amount compared with direct real estate investments, and to have a much higher liquidity since they are traded on the stock exchange and it is so much easier to sell the units of the REIT or I-REIT than to sell the actual property. Investors can also choose locations of REITS and I-REITs to achieve further diversification compared with their investments in other categories of instruments. REITs are usually treated differently for tax purposes and are exempt from corporate tax, provided 90% of the income is distributed to investors.

Similarities Between REITs and I-REITs

Table 11.1 lists the similarities between REITs and I-REITs.

Differences Between REITs and I-REITs

Table 11.2 lists the differences between REITs and I-REITs.

Ijara Sukuk

This is the most common form of Sukuk, based on the Ijara contract, and mostly used for leasing and project finance. In Ijara Sukuk, the issuer in need of financing first sells the asset to the investors, thus collecting the funds it needs. The issuer then leases the asset back from the investors based on the Ijara mode and issues the Ijara Sukuk certificates to the investors who are also the lessors now. The Sukuk certificates represent the undivided proportional ownership and right to lease in the leased asset of the investors/lessors. Ijara Sukuk are tradable on the secondary market, as they are backed by real tangible assets and are usually issued on stand-alone assets included in the balance sheet, like land, buildings, equipment, vehicles, etc. The lease payments can be variable based on the market rental rates and paid to the investors similar to coupons. Sometimes the Ijara Sukuk may include the right of the issuer to buy back the asset from investors at the end of the lease period, as in the case of an Ijara wa Iqtina contract. The purchase price either has to be pre-agreed or needs to be determined based on the market price. But this is a debatable feature amongst Shariah scholars, since it may represent a pure buy-back clause that is not considered Shariah compliant and if included, all regulations to ensure Shariah acceptance need to be inserted. Some of the risks associated with Ijara Sukuk are that the lessee defaults or is genuinely unable to pay rentals, the lessee refuses to or is unable to buy back the asset at the end of the Ijara, or the asset itself may be damaged through no fault of anyone or may become obsolete.

Ijara Sukuk is quite popular in mobilizing funds for long-term infrastructure projects and for subsequent trading in the secondary market. Some variations of the Ijara Sukuk include the following.

1. Sukuk of ownership in leased asset. This Sukuk mainly aims to sell the asset with a title transfer to the Sukuk holders, who would then jointly own the asset through undivided proportional ownership and have the right to both any profit or loss arising from the asset. This type of Ijara Sukuk is used to purchase new assets.
2. Sukuk of ownership of usufructs of assets. This kind of Sukuk is issued to transfer the right of usufruct in an identified asset to the Sukuk holders, who become joint owners only to usufruct called Al Manfaah in Arabic, where the owners of the asset have only leased the usufruct to the Sukuk holders and not sold the asset to them. Sukuk holders may be allowed to sublease the usufruct of the asset to a third party.
3. Sukuk of ownership of services. This type of Ijara Sukuk gives the Sukuk holders the right to prescribed services and they may also sublease such services to a third party.

Figure 11.1 gives an overview of the Ijara Sukuk.

Istisna Sukuk

This form of Sukuk uses the Istisna mode of Islamic finance to fund manufacturing, real-estate development, large industrial projects, construction of major items like power plants, ships, aircraft, etc. To raise the requisite funds, the issuer or bank produces Sukuk certificates that provide the holders with proportional ownership in the asset to be manufactured or constructed. Once the asset is completed, its ownership may be passed on immediately to the ultimate client and the deferred payments made by the client are passed on to the Sukuk holders. Sometimes, instead of ownership transfer, the asset is leased to the client and the Istisna Sukuk converts into an Ijara Sukuk. The Istisna Sukuk is usually of long term. The detailed specifications and costs of the asset are mutually agreed between manufacturer and client. Once a Sukuk is raised, the full costs are provided to the SPV, who may pay the manufacturer in instalments in accordance with the production schedule. After production and delivery is completed, the buyer starts repaying the price in deferred instalments, which are passed on to the Sukuk holders as their payments. The risk involved could be a manufacturer failing to produce and deliver, the asset becoming damaged or obsolete, or the client defaulting on payments.

The steps of the Istisna Sukuk are given below.

1. The SPV raises funds by issuing Sukuk certificates to Sukuk holders.
2. These funds are used to finance the Istisna project by paying the constructor, manufacturer, producer, fabricator or assembler as per the parallel Istisna contract.
3. The contracted asset is then sold to the original bank customer as per the first Istisna contract.
4. The delivery of both Istisna and parallel Istisna contracts is usually at the same time. At delivery, the title to the asset is transferred to the SPV, while the asset is delivered to the original bank customer.
5. The customer makes payments through regular instalments.
6. The funds received from the payments are distributed to the Sukuk holders.

Figure 11.2 gives an overview of the Istisna Sukuk.

Salam Sukuk

This is based on the Salam mode of financing, where the buyer pays the full price of the asset in advance on spot; usually the buyer gets a discount on the price for paying in advance. The seller would deliver at a mutually agreed future date. The contract is like a conventional forward contract. The majority of Salam Sukuks are short term. The SPV established for the Sukuk raises funds by selling the certificates to Sukuk holders and finances the seller on spot as advance payment to produce the asset under contract. Once production is completed, the seller sells the asset to the end buyer and pays the Sukuk holders the original finance amount plus a markup via the SPV. The asset in this case is not transferred to the Sukuk holder when the Sukuk is issued; as such, the Salam Sukuk cannot be traded and needs to be held till maturity. The Salam Sukuk has similarities to a conventional zero-coupon bond, where no payments are made during the life of the bond or Sukuk and a single payment is made at maturity. The risks that can occur are that the seller is not able to confirm a buyer for the asset or cannot deliver the asset on time, or is not able to sell it at a price to pay the Sukuk holders their original funds, the markup and make a profit itself.

Figure 11.3 gives an overview of the Salam Sukuk.

Murabaha Sukuk

The Murabaha Sukuk is based on the Murabaha mode of financing, where a seller interested in acquiring assets to resell using the Murabaha mode may raise the cost to acquire the assets by issuing Sukuks. The Sukuk holders would own the assets till they are resold, and will be entitled to the marked-up sales price in proportion to the shares in the Sukuk issue.

Figure 11.4 gives an overview of the Murabaha Sukuk.

Mudaraba Sukuk

Mudaraba Sukuks are equity-based, unlike the previous Sukuks discussed, which are a deferred payment debt like instruments or leasing. In Mudaraba one party, the Rab al Maal, pays the entire capital; the other party, the Mudarib, provides the effort and entrepreneurship. The two parties share the profit according to a pre-agreed ratio, but the entire financial loss is borne by the Rab al Maal and the Mudarib loses their effort. When the Sukuk is structured, it represents undivided ownership of units of equal value in the Mudaraba equity and these units are registered in the names of the Sukuk holders who contribute their capital into a specific project to be managed by the issuer or Mudarib. The Rab al Maal is the Sukuk holders, while the Mudarib could be the bank or SPV or an entrepreneur with a good business concept but in need of capital. Usually, the restricted Mudaraba concept is used, which provides clear guidelines on the type of business, the location of the business and the period during which the business will be conducted. The return on this partnership Sukuk is variable, and as such it is still not a very popular mode of constructing the Sukuk, since Sukuk holders prefer a regular stream of income.

The Islamic Fiqh Academy of the OIC, in its fourth session in 1988, stipulated the following resolutions related to the Mudaraba Sukuk.

1. The Mudaraba Sukuk represents common ownership of the Sukuk holders in the specific Mudaraba project.
2. The Sukuk prospectus should provide all details related to the Mudaraba project and its securitization.
3. The Mudaraba Sukuk is tradable and the holder has the right to transfer their ownership to anyone willing to buy in the secondary Sukuk market, provided the sale follows Shariah requirements. If the Mudaraba capital comprises money, then the exchange of money for money must be in accordance with the Shariah rules of Sarf; if the capital is in the form of debt, it must follow the principles of Islamic debt trading; if the capital is a combination of cash, receivables, tangible and intangible assets and benefits, the trade must be as per the market-based price reached through mutual consent.
4. The Sukuk manager or SPV who collects the contributions from the Sukuk holders may also invest their own funds in the Mudaraba project.
5. The issuer or Sukuk manager is not allowed to provide any guarantee, either for the capital of the Mudaraba project or for a fixed profit, lump sum or percentage. As such, the prospectus or Sukuk contract cannot stipulate any specific amount to be paid to the Mudaraba Sukuk holders, rather the profit is to be divided and distributed as per Shariah rules and the profit and loss-related information needs to be transparent, published and shared with the Sukuk holders.
6. Reserves can be created for the Sukuk, to deal with contingencies such as loss of capital or less than expected profits. The reserve is built by taking out a portion of the higher than expected profits in good years, but this process needs to be communicated to the Sukuk holders and have their consent.

Figure 11.5 gives an overview of the Mudaraba Sukuk.

Musharaka Sukuk

Musharaka is based on an equity partnership where all parties provide the capital and the profits are shared in a pre-agreed ratio, while the losses are borne according to the capital contribution. Musharaka Sukuks are structured to raise funds for new projects or to extend an existing project or for a huge business activity based on a joint venture. The Musharaka Sukuk certificate gives the Sukuk holders proportional ownership in the assets of the Musharaka equity partnership project, and these certificates are negotiable instruments which can be traded in the secondary capital market. Each shareholder of the Musharaka and the Sukuk holder in case of Musharaka securitization has the right to participate in the management of the enterprise or project if they so wish. The shareholders or Sukuk holders may also choose to appoint the issuer or SPV to act as their agent and manage the Musharaka venture. More often the company or business acts as the managing partner while the SPV, on behalf of the Sukuk holders, may act as the silent partner, not getting involved in the day-to-day business.

Figure 11.6 gives an overview of the Musharaka Sukuk.

Sukuks can also be classified or grouped as tradable, non-tradable, debt-based and equity-based. Tradable Sukuks are those that represent ownership in tangible assets or in an enterprise that can be bought or sold at the Islamic capital market – for example Ijara, Mudaraba and Musharaka Sukuks. Non-tradable Sukuks are those that represent receivables as cash or goods and hence not tradable – for example Murabaha and Salam Sukuks. Equity-based Sukuks are those that are modelled on partnership-based Islamic instruments, like Musharaka or Mudaraba. Debt-based Sukuks are based on receivables, like those arising from Murabaha or Salam.

Another classification divides Sukuks into three groups.

1. Pure Ijara Sukuk. These certificates are issued on underlying assets that are stand-alone on the balance sheet, like land or equipment, and the rental income can be fixed or floating and depends on existing market forces.
2. Hybrid or pooled Sukuk. These Sukuks are based on Istisna, Murabaha as well as Ijara contracts; the return on these Sukuk certificates is fixed and predetermined.
3. Zero-coupon non-tradable Sukuk. These Sukuk certificates are based on underlying assets that would be sold in the future (most probably assets being built under a Salam or Istisna contract) and therefore cannot be traded now.

Another manner of classifying Sukuks is related to what recourse is available to the Sukuk holders; Sukuks are grouped as asset backed and asset based. According to Dr Sayd Farook, Global Head, ICM, Thomson Reuters (Hassan, Kayed & Oseni, 2013), asset-backed Sukuk certificate holders rely on the underlying asset to generate yield and recover their investments. An example could be a building with rental income which provides the return to the investors but if the issuer fails to repay, the asset could be sold to return the investors' money. On the other hand, the asset-based Sukuk involves purchase and sale of the asset, as in Murabaha or Ijara contracts where the asset already exists, and the investors depend on this asset as the last resort to recover their investment. So, we can see that in case of the asset-backed Sukuk the asset is still in the ownership of the Sukuk holders and thus recourse to it is easier. On the other hand, in asset-based Sukuk the asset was purchased and sold, and its deferred payments make payments to the Sukuk holders so in case of non-payment, ownership of the asset is no longer with the Sukuk holders, thus the main recourse is the creditworthiness of the customer who purchased the asset.

Common Advantages of Both Conventional Bonds and Sukuks

Sukuks are called the Islamic alternatives to conventional bonds, and both products have similar advantages.

1. Diversification of funding sources. Bonds and Sukuks are both excellent techniques used by the issuer to raise large amounts of finance from the public instead of depending on a single financier, allowing governments and corporations to diversify their sources of funds.
2. Traded in the secondary markets. As we know, bonds are traded in the secondary markets and this adds to their attractiveness to investors. Similarly, most Sukuks are also traded in the secondary markets when they are monetized real assets, which are liquid in nature, and their ownership can easily be transferred to another.
3. Liquidity management. Banks and other financial institutions, as well as corporations, use bonds and Sukuks to manage their liquidity since both products are traded in the secondary market, so when they have excess cash they buy bonds or Sukuks and when they have a shortage of cash they sell them.
4. Rated instruments. Both bonds and Sukuks are evaluated and given a rating varying from ‘AAA’ to ‘C’, based on a range of factors that indicate reliability and risk–return expectations by various rating agencies, which can be global or local. A good rating increases the popularity of the bond or Sukuk.
5. Various structures. Both bonds and Sukuks can be structured in diverse ways to match the needs of the investor. Sukuks can be modelled on the various Islamic finance products and investors can choose from them, based on their legal and tax jurisdictions, and the requirement for variable or fixed income options. With conventional bonds we already know that they also come in fixed or variable rates, as zero coupon and with other options, designed to match the differing needs of investors.
6. Attractive investment option. Both bonds and Sukuks are ideal investment vehicles for investors who may participate with a small amount of funds, choose from a variety of structures available, having regular income and also easily divest themselves if needed by selling in the secondary market.
7. Pricing benchmark. Bonds provide a pricing benchmark for the conventional capital markets and with time, as the Sukuk market develops, they will also be a major benchmark for the Islamic capital markets.
8. Recognition. Since bonds and Sukuks are both sold in the exchanges and can be accessed by international investors, they enhance the global profile of the issuers.
9. Government infrastructure funding. Bonds help governments raise funds for infrastructure development and similarly Sukuks are being used by governments of Muslim countries to build up their infrastructure.

Additionally, Sukuks have another advantage and that is equitable distribution. Sukuks are an instrument which can be used for equitable distribution of wealth, since all investors benefit from the actual profit generated by the underlying assets.

Differences Between Conventional Bonds and Sukuks

Table 11.4 details the differences between conventional bonds and Sukuks.

When making investment decisions, Islamic investors also need to choose between the purchase of Sukuks or the purchase of Shariah-screened shares. Some differences between Sukuks and shares are listed in Table 11.5.

Discussion Questions

1. Discuss the conventional investment markets.
2. Are the Islamic investment markets subdivided very differently or quite similarly as in the case of conventional investment markets? Discuss.
3. Are all stocks Shariah compliant for Islamic investments? Discuss.
4. Explain the Shariah screening process for stock selection.
5. Once screened as acceptable, do stocks need to be monitored for continuing Shariah compliance? Discuss.
6. How do fund managers deal with the non-compliance of stocks in their portfolios?
7. Explain the concept of purification of income distribution for Islamic funds.
8. Discuss Islamic asset and fund management.
9. What is the Islamic unit trust or mutual fund?
10. What are the types of Islamic funds? Describe each briefly.
11. What do you understand by the REIT?
12. What is an Islamic REIT or I-REIT?
13. Discuss the similarities and differences between REITs and I-REITS.
14. What are the challenges faced by Islamic investments and fund managers?
15. How important is the SSB for Islamic investment?
16. What are the differences of Islamic investments from conventional investments?
17. How did the AAOIFI define Sukuks?
18. Discuss the main characteristics of Sukuks.
19. What is an Ijara Sukuk? Describe.
20. What are the types of Ijara Sukuks?
21. Describe an Istisna Sukuk.
22. What is a Salam Sukuk? Explain.
23. What does a Murabaha Sukuk mean?
24. What is a Mudaraba Sukuk? What are the resolutions related to Mudaraba Sukuks put forward by the Islamic Fiqh Academy?
25. Describe the Musharaka Sukuk.
26. What does tradable, non-tradable, debt-based and equity-based Sukuk mean?
27. Explain pure Ijara, hybrid and zero-coupon Sukuks.
28. Define an asset-backed and an asset-based Sukuk.
29. Discuss the controversy faced by Sukuks during the early part of this century.
30. What are the Shariah implications put forward by the AAOIFI related to Sukuks?
31. How are Sukuks rated?
32. Can Sukuks be traded in the secondary markets like bonds?
33. What are the common advantages of both bonds and Sukuks as investment tools?
34. What are the differences between Sukuks and conventional bonds?
35. Compare Sukuks with Shariah-screened stocks.
36. Al Rashidiya Company produces furniture and is interested in purchasing a new plant that will automate the production process. The sophisticated plant is expensive, and they will need finance to purchase it. They are looking at Islamic finance and have chosen to finance the new plant by dividing the ownership of the machine into equal ownership parts as certificates and selling those parts to prospective investors. Answer the questions below related to this case.
    1. What Islamic financial instrument are they considering and what is the similar product under conventional finance?
    2. Discuss any two variations of this product that will be suitable for this financing.

Multiple Choice Questions

Circle the letter next to the most accurate answer.

1. Which one below is not a requirement of Shariah-compliant investment?
   1. Avoid all forms of Riba
   2. Avoid speculative investments
   3. Take no risk
   4. Be involved in socially responsible and ethical investing
2. Which one below is not a responsibility of the Islamic fund manager?
   1. Select investment instruments that are devoid of Riba, Gharar and Maysir
   2. Ensure the investment process does not involve any Shariah-prohibited elements
   3. Commit a reasonable return to their clients
   4. The contract signed with the client must follow Shariah guidelines
3. The most prominent Islamic indices are:
   1. Dow Jones Islamic Market Index
   2. FTSC Global Islamic Index
   3. S&P Global Investable Shariah Index
   4. All of the above
4. The Shariah screening process for stock selection involves:
   1. Industry screening
   2. Financial screening
   3. Income purification
   4. All of the above
5. Islamic investment funds can invest in the following instruments:
   1. Corporate bonds
   2. Treasury bills
   3. Certificates of deposit
   4. None of the above
6. Which one below cannot be an Islamic investment fund?
   1. Ijara fund
   2. Derivatives fund
   3. Venture capital fund
   4. I-REIT
7. Which fund below is formed with private limited companies with a few large individual or institutional investors?
   1. Islamic private equity fund
   2. Islamic venture capital fund
   3. Islamic debt fund
   4. Ijara fund
8. Which characteristic below is common to both a private equity fund and a venture capital fund?
   1. Not traded on exchanges
   2. Existing privately owned companies
   3. Provide funding to promising new and start-up businesses
   4. All of the above
9. Which Islamic product is a certificate of equal value representing undivided ownership shares in tangible assets, usufructs and services, specific projects or special investment activity?
   1. Ijara funds
   2. Sukuk
   3. Shariah-screened stocks
   4. Waqf funds
10. Common benefits shared by Sukuks and conventional bonds include:
    1. Liquidity management
    2. Issuer profile enhancement
    3. Diversification of funding source
    4. All of the above
11. Classifications of Sukuks include:
    1. Tradable and non-tradable
    2. Short term and long term
    3. Debt-based and equity-based
    4. a and c
12. Which one below is not a tradable Sukuk?
    1. Murabaha Sukuk
    2. Ijara Sukuk
    3. Mudaraba Sukuk
    4. Musharaka Sukuk
13. Which one below is not a type of Ijara Sukuk?
    1. Sukuk of ownership in leased assets
    2. Sukuk of ownership of usufructs of assets
    3. Sukuk of ownership of services
    4. Sukuk of ownership of bonds
14. The two most popular classifications of bonds and Sukuks related to investment quality are:
    1. Investment grade bonds and junk bonds
    2. Corporate bonds and government bonds
    3. Investment grade bonds and sovereign bonds
    4. None of the above

True/False Questions

Write T for true and F for false next to the statement.

1. Speculative investment activities may involve both uncertainty or Gharar and gambling or Maysir, and both are prohibited in Islam.
2. Islamic investing includes conventional insurance and derivatives.
3. Stocks in Halal industries, even if they are using conventional financial products, are allowed in Islamic investment funds.
4. A stock market index indicates the performance of stocks in a financial market.
5. Islamic fund managers are permitted to speculate but not to undertake any unnecessary risks.
6. Some scholars allow Zakat payment to be part of the purification process to remove Shariah-non-compliant income in Islamic investments.
7. Sukuks are negotiable instruments that cannot be traded in the secondary market.
8. A major issue Islamic fund managers face is related to liquidity when they want to sell their instruments quickly.
9. Sukuk holders do not need to have an ownership interest in the underlying asset.
10. Reserves cannot be created for Sukuk payments to even out the profit distribution.
11. The AAOIFI has developed standards and rulings related to various Sukuk issues and their trading in the secondary markets.
12. The rating agencies rate bonds as well as Sukuks in a range from ‘AAA’ which is the highest to ‘C’ which is the lowest.
13. Credit rating provides professional judgement to potential investors to make informed investment decisions.

Calculation Problems

1. Great Auto Repair (GAR) wants to expand its business significantly by adding an auto assembly plant at a cost of €100 million. The land for the plant, valued at €10 million, will be provided by GAR. When GAR approaches Islamic Bank (IB) for financing of the balance of €90 million the bank suggests a Musharaka Sukuk. The bank sets up the SPV which would raise the amount by issuing tradable Musharaka Sukuks offering an expected 5% annual return. The SPV plans to set up a reserve fund from years of above expected return to compensate for years of below expected return. Profit and loss sharing will be as per capital contribution. The GAR assembly plant makes a net profit after all expenses, including SPV management expenses, at the rate of 8%, 5% and 4% in the next 3 years. Calculate the below:
   1. In each year how much return is earned in euros?
   2. What amount is paid to GAR in each year?
   3. What amount is paid to the Sukuk holders in each year?
   4. What amounts are added into the reserve fund or allocated to Sukuk holders from the reserve fund?
2. The dividend received from a Shariah-screened stock is $10,000. The company belongs to a Halal industry but has some conventional financial transactions that contribute a 2% Shariah non-compliant portion to the net profit and hence the dividend. How much of the dividend (in dollars) has to be donated for income purification?