A Critical Analysis of Asset-Backed Sukuk from Sharia Perspective and Observed Risk Mitigation Process in Sukuk Structure: A Case Study in Saudi Arabia

Abstract

Recent issuances of sukuk were confronted with wide criticism from, both by Islamic scholars and investors. The part of the problems arise due to the agency relations in sukuk structures that have a distinctive nature with great complexity and various features. Due to the higher complexity of the responsibilities undertaken by the agent, greater exposure to agency costs results. This research aims to examine sukuk associated risks, agency costs and Sharia issues. Specifically, it analyses asset-backed sukuk structures from financial and Sharia viewpoints. This is achieved by adopting a case study strategy and inductive approach to examine the legal and financial issues arising in three different types of asset linked sukuk structures. The data is collected using content analyses of sukuk prospectuses, AAOIFI Sharia standards and publications issued by international agencies with the aim of enabling the study to achieve insights into the market. Furthermore, information is gathered from Sharia scholars using semi structured interviews to generate some specific information on the issues involved.
The objectives of this study are to analyse three key issues: based on theoretical discussions identify the risks arising in securities in general and sukuk in particular; to carry out a comparative analysis of the principle/agent conflicts which arise in different cases of sukuk investment; and to determine the extent of adherence to Sharia rules. The dissertation discusses in depth the agency costs that arise in asset-backed sukuk structures. It determines how these costs are minimized and conflicts managed in the applications. Among the strategies and tools used to reduce agency costs is to apply the concept of co-ownership. Under this type of agreement between the originator and investors, the sukuk structure becomes more competitive and shows a better allocation of the risks.
Although the issuance of sukuk are reviewed and approved by eminent scholars, they show different levels of contradictions with AAOIFI Sharia standards. The study identifies the status of different stipulations of different contracts in terms of Sharia requirements. The research then shows the extent to which the compatibility of the sukuk cases differ with key Sharia principles. The analysis found that the key requirements are mostly related to the guarantee, ownership, principle, return and maintenance costs. It found out that SEC sukuk are far away from the spirit of Sharia as most of the essential requirements are not fulfilled. Sadara sukuk show better harmonious with AAOIFI requirements because of their unprecedented feature involved in their structure, which highlighted some of the distinctive nature of sukuk. Zamzam sukuk achieved the best harmonious with Sharia among the three applications. This positive result is attributed to the real ownership to the investment, meaning that there is no guarantee for the principle or the return.
The results show that there is a higher exposure to risks related to liquidity legality in sukuk cases than in conventional bonds. More importantly is that the credit risk in sukuk cases are higher than in bond investments. The three cases were more exposed to the credit risks since any loss in the assets has to influence both the distribution amounts and the purchase undertaking. The critical point found is that despite SEC and Sadara sukuk cases involve higher exposure to credit risk as required in Islamic finance, they do not provide in turn a recourse to the assets according to the concept of sukuk. The cases also show that the purchase undertaking solves the agency conflicts, caused by the originator being the servicer. The undertaking device has reduced the incentive asymmetries from different perspectives.