Raising funds through sukuk: The prospects, the drawbacks
The Federal Government’s definite steps on the issuance of N100billion ($328million) sukuk, Shariah compliant bond, this week, brings to a tidy close a process that commenced last year.
The first inkling of the government’s plan to resort to sukuk for raising funds was given last year by Alhaji Mahmoud Isa-Dutse, Permanent Secretary at the Ministry of Finance on the sidelines of the annual meeting of the Islamic Development Bank in Jakarta, when he said, “The government wants to primarily access concessionary sources to fill its funding needs, but any shortfall would be covered through the capital markets. Out of those debt plans, hopefully sukuk will be one of the sources – either domestic or foreign,” adding that sukuk could be linked to a wide range of projects, from power plants to railways.
This was later amplified by other government officials before the Director General of the Debt Management Office, Dr Abraham Nwakwo, and his counterpart at the Securities and Exchange Commission, Mr Mounir Gwarzo, announced their collaboration to facilitate the birth of the Federal Government’s first sukuk issue.
The sukuk is a 7-year tenor debt instrument which will go on sale from June 28, 2017, for three days via book building. It will be traded on the Nigerian Stock Exchange (NSE) and the FMDQ Securities Exchange OTC platform. The bond will target retail and institutional investors and First Bank and Islamic wealth manager Lotus Capital will act as managers for the sale. Minimum subscription amount is N10,000.00 with multiples of N1,000.00 thereafter.
What is Sukuk?
The essence of sukuk is to raise funds without having to bother about interest, which in Islamic parlance is known as riba. Islamic laws forbid interests on facilities, hence sukuk, which encourages profit sharing rather than interest earning mode is embraced by financial operators in Arab world. However, the appeal of sukuk currently transcends the Islamic world as many non-Islamic countries have now embraced it.
According to the Rules and Regulations of the Securities and Exchange Commission (SEC Rules 2013), sukuk refers to investment certificates or notes of equal value which evidences undivided interest/ownership of tangible assets, usufructs and services or investment in the assets of particular projects or special investment activity using Shariah principles and concepts and approved by the SEC.
Writing along this line, Majeed Oladunjoye, in an article published in Journal of Islamic Banking and Finance, says sukuk can be defined as “certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investments,” adding that sukuk is more than a mere bond.
Sukuk is contrasted with conventional bond in the sense that while in the case of conventional bonds the issuer has a contractual obligation to pay to bond holders, on certain specified dates, interest and principal, under a sukuk structure the sukuk holders each hold an undivided beneficial ownership in the underlying assets.
Under a sukuk structure, returns to sukuk holders (investors) represent rights to receive payments from a trade transaction or ownership of a particular asset or business venture. However, the returns to conventional bondholders represent the right to receive interest for borrowed monies.
In other words, a sukuk holder is not just a mere investor but a part owner of the project. A sukuk investor has a common share in the ownership of the assets linked to the investment although this does not represent a debt owed to the issuer of the bond. So, sukuk is a trust certificate.
Why opt for Sukuk?
Gwarzo, Director General of the Securities and Exchange Commission, in an interaction with journalists last year, explained the rationale behind his organization and the DMO working together to ensure a buy in into sukuk by the Federal Government, thus, “Within the context of continued decline in the prices of crude oil in the international markets, attendant drop in both foreign exchange and government revenues as well as fragility of growth from major emerging markets like China, the need for alternative sources of capital to finance infrastructure becomes increasingly more compelling. Both government agencies (SEC and DMO) therefore agreed on the urgent need to begin mobilising capital in order to address the nation’s investment needs. Particularly, issuing a sovereign sukuk will attract significant amounts of affordable capital from the Gulf countries and other established Islamic markets around the world into Nigeria.”
On his part, Dr Nwakwo, Director General of DMO, said that sukuk is part of the DMO’s 2013-2017 Strategic Plan which mentions the goal of using “non-interest debt financing instruments (such as sukuk) for investment in critical national development priorities and sectors.”
He added that the issue was “part of the plan to fast track the development of infrastructure and engage in … project-tied capital raising,” adding that Nigeria has challenges with road, railway and power infrastructure.
Gwarzo predicted that Nigeria’s maiden sovereign sukuk would be oversubscribed with enhanced participation of domestic and foreign investors.
Apart from the huge funding made available through the instrumentality of sukuk, for a country that spends a fortune on debt servicing, sukuk provides a refreshingly different alternative. According to Vitor Gaspar, International Monetary Fund’s Director of Fiscal Affairs Department, in April this year, Nigeria spends 66 per cent of its tax revenue on debt servicing. Similarly, the Emir of Kano, Muhammadu Sanusi, said the Federal Government expends 66 per cent of the country’s revenue on servicing debt interest, while 34 per cent of the revenue was used for capital and recurrent expenditures.
So, sukuk is a relief.
Benefits of sukuk
Sukuk provides access to a vast and growing Islamic liquidity pool in addition to the conventional debt. According to Naveed Mohammed, an Islamic finance scholar, sukuk provides an ideal way of financing large projects for the public good that would otherwise not be possible.
He says, “There are many economic activities or projects that are out of reach of various developing Islamic economies and governments. In these cases, sukuk is perfect for financing these projects without falling into interest-based debt. This makes sukuk an important avenue for redistribution of wealth and achievement of social justice. The use of sukuk to fund large projects means that investors in sukuk are incentivized to help economies develop by creating and producing rather than by consuming or manipulating others. Islamic finance is based on principles of fairness and justice which are achieved by avoiding riba.”
Mohammed adds that investors on the secondary market who are looking for investments that can be liquidated easily will find that sukuk is ideal. “Thanks to the secondary market for Islamic securities, investors can sell their securities and obtain the cost of their certificates. If the projects that back their sukuk certificates have generated profits, this results in a quick return in investment. This means that Islamic financial instruments are well suited for fund management. Banks or institutes can use part of their funds to purchase Islamic securities and then sell them on the secondary market when liquid assets are needed.”
Sukuk’s major appeal is the removal of interest burden as well as the vast resources available to its Muslim promoters.
This explains why a country like the United Kingdom has embraced it in full. The immediate past British Prime Minister, David Cameron, once said he would want London to stand alongside Dubai and Kuala Lumpur as one of the greatest capitals of Islamic Finance in the world. With that, in June 2014, the United Kingdom became the first country outside of the Islamic world to issue a sovereign sukuk. The UK government raised £200 million to fund the construction of residential buildings. Other non-Islamic countries have since keyed into sukuk as a means of raising funds. These include Hong Kong, Senegal, South Africa and Luxemburg.
Sukuk is not without its drawbacks. The major drawback is what happens to a sukuk holder should a sukuk fail. What is the status of a sukuk holder when a sukuk goes under? A sukuk holder is said to be a part-owner of a project. What happens in the eventuality of the failure of the project? Can he and other sukuk holders move in and take possession of the project or does he bear the consequences of that failure by forfeiting his investment?
According to Ibrahim Warde, Professor of International Finance at The Fletcher School of Law and Diplomacy, Tufts University, it is not clear what will happen when a sukuk fails. He says, “This is an issue that has not been tested in court. In Malaysia, some sukuk issues have junk status, and two other sukuk are already in default: the Easter Cameron Gas company in the United States and Investment Dar of Kuwait. One of the unresolved questions is whether sukuk holders should stand in the line of creditors or in the line of the owners of underlying assets.”
Also expressing confusion over the status of a sukuk holder, Muddassir Siddiqui, who is both a licensed Shariah jurist and a-U.S. trained attorney, said, “Through reading many cases that have so far been litigated in courts around the world, I have found that in almost all cases, the courts have struggled to reconcile the substance and form of the contract. Was it a sale, lease, construction or partnership contract or a financing arrangement between the parties?”
Lending his voice to the complexity involved in the sukuk structure, Rodney Wilson, Emeritus Professor of Economics at Durham University in the UK, who is also a Visiting Professor at Qatar Faculty of Islamic Studies and Adjunct Professor, International Centre of Education in Islamic Finance (INCEIF), Kuala Lumpur, opined that “when sukuk payments are delayed or fail, the means of redress are potentially more complex than for conventional notes and bonds because under Shari’ah leniency towards debtors is favoured.”
The inability of sukuk holder to seek redress in court when payments are not made by the sukuk issuer will unfailingly raise moral hazard problems. So, until the status of a sukuk holder is cleared and means of seeking redress becomes unambiguous, a pall will always be cast on sukuk as a means of raising funds, especially outside Islamic jurisprudence.