Sukuk: Borrowing for development without fear of interests

Sukuk: Borrowing for development without fear of interests
Finance Minister, Kemi Adeosun

The Federal Government N100billion sukuk offer was concluded on Friday though the brickbat it generated between the Christian Association of Nigeria (CAN) and the Nigerian Supreme Council on Islamic Affairs (NSCIA) still reverberates. SULAIMON OLANREWAJU looks at what sukuk is, its operation, upsides as well as downsides.

 

While Nigerians and the rest of the world await the outcome of the nation’s first N100billion offer which ended on Friday after a two-day extension, its issuance has divided the country along religious lines. In a reaction to the sukuk offer, the Christian Association of Nigeria (CAN) described the issuance as a subtle attempt by the Federal Government to Islamise Nigeria. The body, therefore, called on the government to abrogate the laws and framework behind the sukuk issuance, failing which it would seek legal redress.

In a statement signed by its General Secretary, Rev. Musa Asake, CAN noted that it “has been protesting against this aberration since the Osun State Government, under Governor Rauf Aregbesola, embarked on this violation of the constitution.

“Rather than stand in the defence of the constitution, it is disappointing to note that the Federal Government is pursuing what is an outright confirmation of an Islamisation agenda.

“The recent floating of sukuk bond by the government is not only sectional but illegal and a violation of the constitution. Every law that has been promulgated to back the sukuk issuance and promote an Islamic banking system in Nigeria is ultra vires, illegal, null and void.”

But in its reaction, the Nigerian Supreme Council for Islamic Affairs (NSCIA), accused CAN of “Islamophobia.”

In a statement signed by its Deputy Secretary General, Salisu Shehu, the body said, “CAN cannot claim ignorance about the fact that even the World Bank has been involved in issuing sukuk and the floating of sukuk bonds. Interestingly also, several non-Muslim countries across Africa, Europe and Asia have also instituted Islamic Financial System generally and Sukuk in particular. Worthy of mention here are Kenya, Tanzania, South Africa, United Kingdom, Luxembourg, Russia, China, Singapore and a number of firms in the United States.

“Less than two years ago, Britain hosted a World Conference on Islamic Banking and Finance and David Cameron, the then British prime minister, openly declared that their intention was to make UK the hub of Islamic Finance in the World.”

It added that, “It would certainly be embarrassing for CAN to be told that the first and foremost state in Nigeria to submit application for loan to the Islamic Development Bank is a Christian-dominated state in the South-East.”

NSCIA then appealed to CAN to “in the spirit of Biblical injunctions, uphold the truth for its sake and tread the path of honour and refrain from statements capable of causing disaffection and promoting disharmony that may lead to conflict in the country.”

 

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 loans, hence sukuk, which encourages profit sharing rather than interest earning, 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?

Mr Mounir Gwarzo, Director General of the Securities and Exchange Commission, while explaining the rationale behind his organization and the Debt Management Office (DMO) working together to ensure a buy-in into sukuk by the Federal Government, said, “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.”

Former Director General of the DMO, Dr Abraham Nwakwo, 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.

In his own view Dr Benedict Nwafor of the University of Lagos, said the attraction for Nigeria is its present challenge. “For Nigeria, anything that will reduce the debt burden will be welcome. If a country expends 66 per cent of her earnings on debt repayment, that country cannot experience development. The government has to develop critical infrastructure to engender development. The sukuk is an opportunity for raising funds without raising the nation’s debt profile,” he said.

According to him, although sukuk is founded in Islamic belief, it is nothing other than a financial instrument for mobilizing funds. He added that each country has its own reason for embracing sukuk.

He explained that while South Africa welcomed sukuk because of its desire to broaden its investor base and to set a benchmark for state-owned companies seeking diversified sources of funding for infrastructure development, Hong Kong adopted sukuk because “As China’s global financial centre, it is an important conduit for Mainland companies to access the international markets and the preferred offshore capital raising centre for Mainland issuers.”

 

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.”

Sukuk: Borrowing for development without fear of interests
Budget and Planning Minister, Udoma Udo-Udoma

Mohammed adds that investors on the secondary market who are looking for investments that can be liquidated easily will find thatsukuk 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 sukukcertificates 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 promoters. This explains why a country like the United Kingdom has fully embraced it. 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 sovereignsukuk. 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.

 

Drawbacks

Sukuk is not without its drawback. The major drawback is what happens to a sukuk holder should asukuk fail. What is the status of a sukuk holder when a sukuk fails? 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 owners 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, somesukuk 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 whethersukuk 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 involving sukuk, Rodney Wilson, Emeritus Professor of Economics at Durham University in the UK, who is also Visiting Professor, Qatar Faculty of Islamic Studies and Adjunct Professor, International Centre of Education in Islamic Finance (INCEIF), Kuala Lumpur, opined that “when sukukpayments 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.” This will unfailingly raise moral hazard problems.

But beyond these concerns, Nwafor is of view that sukuk certificates can transfer state-owned projects to sukuk holders in case of default. According to him, “A sukuk holder is a part owner of a project until he is fully repaid. So, if a project funded by sukuk fails or is so badly managed that the investors cannot recoup their investment, the project will owned by the investors until the investors are able to get back their capital. This is one of the complications withsukuk. This grey area has to be sorted out to avoid the country and the people being short-changed. The government must come out clean on what happens to a project and the investor in case of project failure. We cannot pretend that it cannot happen. Projects fail regularly here in this country. Should that happen, what becomes of the project and those who invested in it?”

He added that the Federal Government has a lot to do in educating the public on the benefits of sukuk to ensure a buy-in. “The government must also do all it can to assure Nigerians that this scheme is not intended to favour a section of the society. I am of the view that if other non-Muslim countries can accept it, so can Nigeria but the government has to work extra hard to convince Nigerians that it means well for all Nigerians with the sukuk.”

 

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