In Islam, fixed income or termed as interest (riba’) bearing bonds are not permissible. Hence,Sukuk is considered as securities that comply with the Islamic law. Its investment principles prohibit the charging, or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets.Shariah-compliant assets worldwide are worth an estimated more than RM1,750 billion and havegrown at more between 8-12 per cent per year over the past decade, and in the Gulf and Asia,Standard & Poor’s estimates that 20 per cent of banking customers would now spontaneouslychoose an Islamic financial product over a conventional one with a similar risk-return profile.In the recent past, sukuk or Islamic bonds have become an important and popular issue.While the Arabic word claims an ancient past that outdates the history of modern finance (someallege that the term sukuk whose singular is sakk is the etymological root of the English word”check”), sukuk are a recent innovation that allows Islamic Finance to participate in yet another area of conventional finance. Based upon existing Islamic Financial transactions, sukuk offer Islamic financial institutions and investors another way to raise capital through profit sharingwithout a prime rate, but achieving the same result as conventional finance. Sukuk appear to bea product that contributes to and accelerates the process of convergence between the world of Islamic Finance and that of conventional finance, sparking a convergence based upon commoninterests and principles. Under certain circumstances, these sukuk may be traded on secondarymarkets, contributing to their widespread accessibility and popularity and, perhaps, to theemergence of certain hubs of Islamic Finance through out the world where these sukuk are traded.Modern sukuk or Islamic bonds are better described as Islamic investment certificates. Thisdistinction is as crucial as it is important, and it is stressed throughout this pioneering work thatsukuk should not simply be regarded as a substitute for conventional interest-based securities.The aim is not simply to engineer financial products that mimic fixed-rate bills and bonds andfloating-rate notes as understood in the West, but rather to develop innovative types of assets thatcomply with Shari’a Islamic law.In classical period Islam sakk (sukuk) – which is cognate with the European root ‘cheque’, meantany document representing a contract or conveyance of rights, obligations or monies done inconformity with the Shariah. Empirical evidence shows that sukuk were a product extensivelyused during medieval Islam for the transferring of financial obligations originating from tradeand other commercial activities..On the other hand, the essence of sukuk, in the modern Islamic perspective, lies in the concept of asset monetisation – the so called securitization – that is achieved through the process of issuanceof sukuk (taskeek). Its great potential is in transforming an asset’s future cash flow into presentcash flow. Sukuk may be issued on existing as well as specific assets that may become availableat a future date. The sukuk market valued for more than RM175 billion (at the end of 2006) is due for anexponential rise in 2007 with every issue likely to be oversubscribed 5 to 6 times amid a fastgrowing interest in the western countries. One point to note here that Shari’ah requires thatfinancing should only be raised for trading in, or construction of, specific and identifiable assets.Trading in ‘indebtedness’ is prohibited and so the issuance of conventional bonds would not becompliant. Thus all Sukuk returns and cash flows will be linked to assets purchased or thosegenerated from an asset once constructed and not simply be income that is interest based. For borrowers to raise compliant financing they will need to utilize assets in the structure (whichcould be equity in a ‘tangible’ company). It is worth noting that Equity financing is Shari’ahcompliant and fits well with the risk/return precepts of Islam.In the eyes of Islamic Jurisprudence or As Shari’ah, money is a measuring tool for value and notan ‘asset’ in itself, it requires that one should not take or receive income from money (or anything that has the genus of money) alone or in other words “if money generates money per say” it will tantamount to riba’. This generation of money from money (simplistically interest) is’Riba’, and is forbidden. The implications for Islamic financial institutions are that thetrading/selling of debts, receivables (for anything other than par), conventional loan lending andcredit cards are not permissible. Now come the question of uncertainty or ‘Gharar’ principle. It is widely understood to mean theuncertainty in the existence of an underlying asset in a contract and/or uncertainty in thecontractual terms and this is an issue for Islamic scholars to address when considering theapplication of derivatives. Syari’ah also incorporates the concept of ‘Maslahah’ (Public interest),denoting that, if something is overwhelmingly in the public good, it may yet be transacted – andso hedging or mitigation of avoidable business risks, may fall into this category but there is stillmuch discussion yet to come.Sukuk are widely regarded as controversial due to their perceived purpose of evading therestrictions on Riba. Conservative scholars do not believe that this is effective, citing the fact thata sukuk effectively requires payment for the time-value of money. This can be regarded as thefundamental test of interest. Sukuk offer investors fixed return on their investments which is also similar in appearance to interest in that the investor’s return is not necessarily dependent on therisks of that particular venture.Basic of sukukSukuk is popularly known as an Islamic or Sharia compliant ‘Bond’ whilst in actual fact; it is anasset-backed trust certificate. In its simplest form Sukuk is a certificate evidencing ownership of an asset .The Sukuk structures rely on the creation of a Special Purpose Vehicle (SPV).SPVwould issue Sukuk certificates which represent for example the ownership of an asset,entitlement to a debt or to rental incomes or even accumulation of returns from various Sukuk (ahybrid Sukuk). The return provided to Sukuk holders therefore come in the form of profit from asale, rental or a combination of both.Sukuk could be based on Mudaraba, Musharaka, Murabaha,Salam, Istisna, Ijara or hybrid of these.Standard and Poor’s estimates that 20 per cent of those investors, with billions to invest, wouldnow spontaneously choose an Islamic financial product over a conventional one with a similar risk-return profile. That has led to the increased use of the Sukuk, especially in the Gulf countriesand Malaysia. The Accounting and Auditing Organization for Islamic Financial Institutions(AAOIFI), defines Sukuks as “certificates of equal value representing after closing subscription,receipt of the value of the certificates and putting it to use as planned, common title to shares andrights in tangible assets, usufructs and services, or equity of a given project or equity of a specialinvestment activity.” Introduced in varied structures and sizes, Sukuks worth $20 billion hit themarket in 2006 and are expected to surpass $50 billion in 2007 as the companies seek todiversify their sources of financing. Although companies in Kuwait, Bahrain, Saudi Arabia andQatar have all been actively using Sukuk financings over the years, Malaysia led the Sukuk issuemarket in 2006 with a share of about 60 per cent. That year also witnessed the first Sukuk thatoriginated in the United States. The trends in 2007 clearly suggest that the United Arab Emirates,especially Dubai, have most likely taken over the lead. Sukuk structures are being used for avariety of purposes and have evolved rapidly in response to the demands of issuers and investors.Sukuk issues have ranged from the simple sale and leaseback (Ijara) structures, such as the $1 billion Dubai Department of Civil Aviation Sukuk issued in November 2004, to the $2.53 billion trust finance Sukuk structure issued by Aldar Properties in March 2007, demonstrating theflexibility of Islamic finance principles. TYPES OF SUKUK Sukuk Ijarah:Ijarah is a contract according to which a party purchases and leases out equipment required by the clientfor a rental fee. The duration of the rental and the fee are agreed in advance and ownership of the assetremains with the lessor. Hence, the relationship between the parties differs from that of a debtor-creditor relationship since it is based on buyer-seller of an asset.Ijarah bonds, on the other hand are securities of equal denomination of each issue, representing physicaldurable assets that are tied to an ijarah contract as defined by shari’ah. The basic feature of Ijarah bonds isthat they represent leased assets, i.e. without relating the bonds holders to any common organization,company or institution. For instance, an aircraft leased to an airline can be represented in bonds andowned by a thousand different bondholders, each of them, individually and independently, presenting his bond (s) to the airline company and collecting the periodic rent without having to have any relation withother bondholders. In other words, the Ijarah bondholders are not owners of a share in a company thatowns the leased airline, but simply a sharing owner, who only owns one thousandth or more of the plane itself.SUKUK ISTISNA: Istisna is a contract to sell a manufacturable thing with an undertaking by the seller to present itmanufactured from his own material, according to specified description and at a determined price.This type of sukuk is used for the advance for funding for real state development, major industrial products or large items of equipment such as turbines, power plants, ships or maybe aircrafts.The Islamic financial institution funds the manufacturer or the contractor during the construction of theassets,, acquires title to that asset and up to completion either immediately passes title to the developer onagreed deferred payment terms or, possibly, leases the asset to the develop under Sukuk Ijarah. IjarahSUKUK MUDARABAH:This is an agreement made between two parties, one who provides the capital and the other party (theentrepreneur) provides the services. It is to enable the entrepreneur to carry out business projects, whichwill be on profit sharing basis, according to predetermined ratios agreed on earlier by the two parties. Incase of loses, loses are born by the provider of the funds only. Sukuk Mudarabah is used to enhance public participation in big investment projects. It should be noted thatmudarabah bond bears closeresemblance to revenue bond financing in the conventional system. Revenue bonds are generally backedonly by revenue generated by the project funded by the bond issue.For example a city wants to build a new airport, believing that the new facility will attract industry to thearea. The local government issues revenue bonds to finance the construction of the airport. The money for the periodic dividend payment and eventual retirement of the bonds come from airplane lending fees,ticket counter and concession rental, hanger rentals airline fuel surtaxes, and other revenue associatedwith the facility. In other words, only revenue generated by the airport can be used to service the airportrevenue bonds. If the airport generates enough revenue to pay off the bonds, then bondholders receivetheir interest and principal in full and on time. However, if the airport does not generate enough revenue, bondholders either receive their interest and principal later or nothing at all. They have no recourse to the local government’s general treasury fund. The bondholders are solely dependent on the revenue generated by the project being financed.