Shari’ah and Legal Risk Issues in Sukuk Structures:
An Analytical Case Study on SABIC Sukuk in Saudi Arabia

Abstract

As part of the Islamic financial development, Islamic capital markets have been developing in terms of structures and instruments in the last two decades. In particular, sukuk or Islamic bond market has proved to be a successful instrument for long-term project financing. While developments in sukuk market have demonstrated success, sukuk structures are not immune to various risk dimensions including Shari’ah, legal and regulative risks as well as financial risks.
This study, hence, aims to explore and examine three particular non-financial risk areas relating to sukuk structures in the case of SABIC sukuk, which was issued in three tranches in Saudi Arabia in the years 2006, 2007 and 2008. In doing so, this research particularly examines the risks emerging from the performance of Shari’ah Board in charge of the Shari’ah compliancy of SABIC Sukuk as well as Shari’ah compliancy and legal risks.
In order to examine the identified risk areas, in addition to rendering an in-depth literature based critical analysis in discursive nature, elite interviews were conducted with the Shari’ah scholars involved in the issuance of SABIC sukuk. In addition, in an attempt to provide non-Shari’ah perspective, finance professionals, lawyers, academics and technocrats were also interviewed to explore their understandings of the three identified risk areas in the case of SABIC sukuk in particular, and sukuk in general.
Since the AAOIFI standards have asserted that the Shari’ah Supervisory Board (SSB) has to be involved in controlling as well as monitoring sukuk structures from the time of issuance until maturity, which is expected to provide guarantee of the performance of the product in a Shari’ah compliant manner. This aims to ensure that the progress and performance will not veer from the right track of Shari’ah through close investigation and follow up by the members of SSB. This study found that one of the risks emerging from the SSB is that the Shari’ah supervision based on AAOIFI standards is still not observed and implemented by many SSBs. The findings indicate that a clear method and mechanism for the SSB members to conduct their examination for Shari’ah complicacy has not been established; and for this end, a comprehensive fatwa will play an essential role in ensuring sukuk structure Shari’ah compliant. Another finding is that the failing of issuing a binding and a comprehensive standard for SSBs to follow as well as clear methods to be implemented have resulted many Shari’ah and legal risks.
With regards to Shari’ah risks, the findings show that any inconsistency with the rules and principles of Shari’ah will lead sukuk to be Shari’ah incompliant. The inconsistency between sukuk structures issued in the Saudi Arabian market and AAOIFI standards is considered as a Shari’ah risk, as there still exist some major similarities between SABIC sukuk structure and riba-based bonds structure. Therefore, an array of Shari’ah issues needs to be resolved, which include ownership and the related issues in the sense of ‘real ownership’, the guarantee of the capital and returns, distribution of profits based on LIBOR instead of the performance of the project, the reserve account and the related issues.
As for legal risks, this research established that the absence of a special law featuring sukuk in Saudi Arabia is considered to be the main legal risk faced by Islamic capital markets in the country. The findings also show that the rules and regulations issued by the CMA have failed to provide a specific law related to sukuk, which might expose sukuk holders to the risk of treating sukuk as riba-based loan bonds. However, failure to differentiate between sukuk and bonds might lead to certain risks such as the failure of sukuk holders to become incapable of proving their rights regarding their ownership of the assets they carry. Consequently, the legal position of sukuk holders is unclear in the Saudi Arabian market, which is due to the absence of a sukuk law. Therefore, it is necessary that the regulatory and legislative bodies in Saudi Arabia should provide a suitable legislative and regulatory environment for the issuance of sukuk taking in consideration the legal and Shari’ah risks that sukuk structures might be exposed.