Status and Timeline
The newer sukuk reform draft was released in November 2023. It is not yet adopted as the official standard. It represents the future direction of sukuk standards and reflects the response to market practices and Shari'ah concerns identified under the investment sukuk baseline. Practitioners are strongly encouraged to understand its reform direction for deeper conceptual understanding.
Rationale for Addressing Gaps in Current Practice
The investment sukuk baseline, while comprehensive, has been interpreted in ways that sometimes conflict with strict Shari'ah principles. For example, some asset-based Sukuk have minimized the issuer's true asset exposure, some have relied on excessive credit enhancement, and some have used sale-and-repurchase mechanics that undermine the original Shari'ah rationale. The newer framework tightens these loopholes.
Enhanced Shari'ah Compliance Requirements in the Newer Framework
1. Substantiality of Asset Ownership
The newer framework emphasizes that Sukuk certificateholders must have genuine, substantive ownership of underlying assets, not merely a shadow claim on issuer cash flows. This means:
- Assets must be real and identifiable, not abstract.
- The issuer cannot simply pledge assets as collateral while retaining all benefits.
- Certificateholders' claims on assets must be senior to the issuer's general creditors in case of insolvency.
2. Restrictions on Credit Enhancement
The newer framework limits guarantees and credit enhancement. A guarantee from the issuer that "protects" Sukuk holders from loss transforms the Sukuk into a liability-backed security (like a bond), not an asset-backed security. Limited credit support can be structured for currency risk, operational risk, or technical default, but it cannot protect investors from business risk or market losses on assets.
3. Prohibition on Sham Purchases
The newer framework explicitly prohibits structures that turn Sukuk into risk-free debt, including:
- Repurchase agreements where the issuer agrees to repurchase assets at a predetermined price, effectively eliminating investor risk.
- Back-to-back structures where Sukuk proceeds finance purchases that are immediately resold to the issuer at a guaranteed price.
- Stipulations that contracts remain binding even if they prove invalid, a safeguard to prevent Sukuk from being treated as risk-free debt.
4. Ownership Transfer and Balance Sheet Recognition
The newer framework requires proper legal transfer of asset ownership to Sukuk certificateholders or their representatives. Assets must be:
- Removed from the issuer's balance sheet.
- Recorded in the Sukuk entity's balance sheet in the name of certificateholders.
- Documented with legally enforceable deeds of ownership.
If legal or tax constraints prevent such registration, specific conditions must be met to ensure issuer creditors cannot compete with Sukuk holders for the assets.
Structural Requirements in the Newer Framework
Asset Eligibility
- Assets must be Shari'ah-compliant (no prohibited industries: conventional banking, alcohol, gambling, etc.).
- Assets must be transferable in law and capable of bearing the rights/obligations of Sukuk holders.
- If underlying assets include shares in companies, those shares must meet the financial-paper screening criteria.
- Assets cannot be pledged to interest-bearing loans (Riba-based financing).
Certificateholder Rights
- Right to disposal: Certificateholders (collectively) must retain the right to sell, lease, or otherwise dispose of underlying assets.
- Right to returns: Certificateholders must be entitled to all benefits arising from asset ownership (rent, profit, appreciation).
- Right to bear risk: Certificateholders must bear the risk of asset loss, depreciation, or non-performance.
- These rights cannot be permanently restricted without violating Shari'ah.
Key changes in the newer sukuk framework
| Issue | Baseline approach | Newer framework approach |
|---|---|---|
| Asset ownership | Certificateholders "own" assets (broad interpretation) | Certificateholders must have substantive, transferable ownership |
| Credit enhancement | Limited guidance; guarantees sometimes accepted | Restrictive; guarantees against business risk prohibited |
| Repurchase agreements | Permitted if asset purchase genuine | Prohibited if predetermined price eliminates investor risk |
| Asset transfer documentation | Flexible approach | Strict legal documentation required |
| Sukuk basis switching | Sukuk can convert from one type to another | Restricted; material changes require certificatholder consent |
Practical Impact: Are My Sukuk Still Valid?
Sukuk issued under the existing baseline will remain valid as long as they comply with their own stated structures. The newer framework will apply to new issuances prospectively after adoption. However, as market practice evolves toward the stricter framework, existing Sukuk may face Shari'ah scrutiny if they fail to meet the stronger ownership and documentation expectations. Issuers of new Sukuk should anticipate these requirements even during the transition period.