Scholarly article on topic 'A Synthesis of Theoretical and Empirical Research on Sukuk'

A Synthesis of Theoretical and Empirical Research on Sukuk Academic research paper on "Economics and business"

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Abstract of research paper on Economics and business, author of scientific article — Muhamed Zulkhibri

Abstract This paper provides a critical review of the theoretical and empirical literature on sukuk (Shari'ah-compliant bonds) from three perspectives: their underlying theory and nature, the operational issues and structures involved in sukuk, and the role of sukuk in economic development. The article suggests that the literature on sukuk is largely qualitative rather than quantitative research, with the bulk of academic research in the form of conference and seminar papers. The research on sukuk in the form of journal articles, books, conference papers, reports, and magazines has increased substantially, but it is still in relatively short supply in comparison to other research on Islamic finance. This underdeveloped state of research on sukuk is mainly due to a lack of historical, reliable, and consistent data; a limited number of academic institutions dedicated to Islamic economics and finance; the small number of high-quality refereed journals as potential outlets for Islamic finance research; the unresolved concept of sukuk among Shari'ah scholars; and the absence of a global standard and accreditation for Islamic finance courses.

Academic research paper on topic "A Synthesis of Theoretical and Empirical Research on Sukuk"

Accepted Manuscript

A Synthesis of Theoretical and Empirical Research on Sukuk Prof. Muhamed Zulkhibri

PII: S2214-8450(15)00036-8

DOI: 10.1016/j.bir.2015.10.001

Reference: BIR 62

To appear in: Borsa istanbul Review

Received Date: 29 March 2015 Revised Date: 1 October 2015 Accepted Date: 22 October 2015

Please cite this article as: Zulkhibri M., A Synthesis of Theoretical and Empirical Research on Sukuk, Borsa istanbul Review (2015), doi: 10.1016/j.bir.2015.10.001.

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A Synthesis of Theoretical and Empirical Research on Sukuk

ABSTRACT

This paper provides a critical review of the theoretical and empirical literature on sukuk (Shari'ah-compliant bonds) from three perspectives: their underlying theory and nature, the operational issues and structures involved in sukuk, and the role of sukuk in economic development. The article suggests that the literature on sukuk is largely qualitative rather than quantitative research, with the bulk of academic research in the form of conference and seminar papers. The research on sukuk in the form of journal articles, books, conference papers, reports, and magazines has increased substantially, but it is still in relatively short supply in comparison to other research on Islamic finance. This underdeveloped state of research on sukuk is mainly due to a lack of historical, reliable, and consistent data; a limited number of academic institutions dedicated to Islamic economics and finance; the small number of high-quality refereed journals as potential outlets for Islamic finance research; the unresolved concept of sukuk among Shari'ah scholars; and the absence of a global standard and accreditation for Islamic finance courses.

JEL Classification: G10; G01

Keywords: Islamic finance; sukuk structure; sukuk research

I. Introduction

In recent years, many developed and developing Muslim and non-Muslim countries have become interested in sukuk as one of the best alternative for raising finance beyond conventional finance. Nigeria, Morocco, and South Africa in Africa, France and the United Kingdom in Europe, Kazakhstan in Central Asia, and Brunei in East Asia have amended their laws and regulations to allow sukuk to be issued in their financial markets, and many other countries are planning to do so. Thomson Reuters Zawya (2015) confirms that sukuk are becoming an increasingly important Islamic financial instrument in both Muslim and non-Muslim countries. Sukuk have also become a significant tool for raising finance effectively and efficiently in term of the allocation and mobilization of resources on international capital markets.

Sukuk began to be broadly issued1 in February 1988 after the Council of the Islamic Fiqh Academy of the Organization of Islamic Conference (OIC) held its fourth session in Jeddah, Saudi Arabia. Initially, the issuance of Sukuk was in response to the demands of issuers and investors in Muslim countries as an alternative mode for their financing and investment needs that complies with the Shari'ah requirements. In May 2003, the Accounting and Auditing Organization for Islamic Financial Institutions published the "Standard for Investment Sukuk, in which sukuk were defined as certificates of equal value representing undivided ownership shares in tangible assets, usufruct, and services. Recent innovations in Islamic finance have changed the dynamics of the Islamic capital market with respect to sukuk and securities. On

1The first modern sukuk issuance can be traced to 1983, when the Malaysian government launched a government bond known as government investment certificate (SPK) based on the concept of Qard al-Hasan (benevolent loans).

2Resolutions and Recommendations of the Council of the Islamic Fiqh Academy, Resolution No. 30 (5/4), p. 61.

3Defined in Shari'ah Standards for Financial Institutions 2008, published by the Accounting and Auditing Organisation for Islamic Financial Institutions, p. 307, para. 2.

international capital markets, sukuk have developed into one of the most acceptable Islamic structures for raising finance, which in turn has led to its increasing use in recent years by government and private institutions (Kusuma and Silva 2014).

The word sukuk comes from the plural of the Arabic word sakk, or bonds or securities structured according to Shari'ah principles, which prohibit Islamic issuers and investors from investing in conventional securities. Sukuk are also called Islamic bonds or Islamic investment certificates, which structure securitized leases (ijarah) and other Islamic financing contracts, such as murabahah (sale with markup), musharakah (a combination of equity contribution and proportional profit and loss sharing on the basis of partnership), and mudarabah (partnership between one person who contributes capital and another who provides managerial skills) (McMillen 2007a; Obaidullah 2007).

In 1990, the first sukuk were issued in Malaysia by Shell MDS (a foreign-owned non-Islamic corporation). Since then, the market for sukuk has flourished, but Islamic financial markets are having difficulty in fully developing in many emerging Muslim countries because Islamic finance is still limited with respect to interest rate swaps and other conventional derivative instruments. Managing risk requirements for sukuk and considerations of competitiveness should force the sukuk structures to further evolve and offer Shari'ah-compliant alternatives to traditional derivatives.

The sukuk market is also seen as a way to channel the world's growing pool of Shari'ah-compliant capital to be used to promote sustainable and equitable economic development. As of

2014, the global sukuk market was worth more than US$600 billion, and it continues to drive the growth and development of Islamic finance (IIFM 2014; Thomson Reuters Zawya 2014). New sukuk markets are opening up in a number of countries, such as Morocco, Nigeria, Oman, and South Africa, and Tunisia is finalizing regulations to allow sukuk to be issued. The sukuk sector is the fastest-growing segment of the global Islamic financial industry, with a compound annual growth rate (CAGR) close to 20 percent in between 2010 to 2014. The issuance of sukuk has increased rapidly, there is still potential for further growth. Global sukuk issuance totaled about US$114.5 billion in 2014 (see Figure 1). Malaysia held about 65 percent of global sukuk issuance in terms of market share, while the Middle East and North Africa (MENA) accounted for 23.7 percent. Saudi Arabia, the second-most-active sukuk market, accounted for 10.3 percent, followed by Indonesia (5.4 percent), the United Arab Emirates (UAE) (5 percent), and Turkey (3.6 percent). Malaysian ringgit-denominated issues topped the charts in value, with 60 percent of total global issuance, at US$68.4 billion. Sovereign issuances dominated the global sukuk market, with US$439 billion, or more than 60 percent of total issuances in 2004-2014 (see Table 1).

Research on sukuk has gained momentum and popularity among policymakers, academics, and practitioners since the late 1990s. The amount of research in the form of articles, books, conference papers, and other materials—such as reports, magazines, blogs, and newspaper articles - has increased substantially. However, the literature concentrates largely on descriptive analysis of sukuk structures, issuances, and Shari'ah issues, rather than empirical and scientific analysis. Given the fact that research on sukuk has increased dramatically, the objective of this article is to provide a critical review of the state of research on the sukuk and to evaluate the gaps in the literature so as to recommend directions for future research. Issues in the existing literature and unanswered questions are also identified.

Table 1. Global Sovereign Sukuk Issuance,

2004-2014 (in US$ billion)_

Country No. of Issuance Amount ($m)

Bahrain 226 12,545

Gambia 401 194

Malaysia 1,388 351,494

Pakistan 17 7,669

Brunei 113 6,093

Tu rkey 7 6,900

Hong Kong 1 1,000

Luxembourg 1 272

Indonesia 65 21,890

South Africa 1 500

Senegal 1 200

United Kingdom 1 340

Qatar 17 19,655

Nigeria 1 71

Germany 1 123

Singapore 5 193

UAE 11 6,855

Yemen 2 250

Sudan 26 2,868

Total 2,285 439,111

Source: Zawva. IFIS (2014)

This paper is organized as follows: Section 2 describes the challenges involved in developing a sukuk market. Section 3 offers a critical review of the existing literature on sukuk. Section 4 is the conclusion.

Figure 1. Global Sukuk Issuance (in US$ billion)

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Source: Zawya, IFIS (2014)

2. The Challenges of Developing a Sukuk Market

Sukuk are developing into a global asset class, supporting development with the participation of a wide range of issuers and investors irrespective of religious orientation. International development agencies and multilateral institutions, such the World Bank and the Asian Development Bank, can explore various options for structuring and issuing more innovative sukuk as well as overcoming the limitations that currently exist in the sukuk market to unleash their potential as a source of development finance. This issue is interesting, as financial engineering of sukuk seems to be taking place by simply modifying the existing conventional

products to be in accordance with Islamic legal requirements and maintaining the other objectives of the capitalist financial system. Therefore, sukuk should essentially be structured in the spirit of creating an Islamic financial system, which is based on Islamic principles and serves the noble goals prescribed by Islam (Maqasid al-Shari 'ah). However, efforts by Islamic scholars and practitioners are skewed toward structuring products and contracts to resemble those of existing conventional products to ensure the contracts are legally valid.

Although sukuk markets are still in a formative stage, they have developed at a significant pace. If corporate sukuk are issued regularly, coupled with an initiative to develop a secondary market and harmonize a regulatory framework, sukuk markets will mature. At present, only a small proportion of sukuk are traded, with most investors taking a buy-and-hold approach. The major constraints on sukuk investments include: (1) there is neither a recognized secondary market nor active trading; (2) most major investors use a buy-and-hold strategy ; (3) there are few, if any, market makers; (4) some countries lack regulatory support; (5) a lack of harmonization exists among sukuk structures; and (6) various Shari'ah boards use different interpretations.

Some scholars see Sukuk not as Islamic financial instruments but as "Islamic bonds" or fixed income instruments that are Shari'ah-compliant (Al-Jarhi 2013). Others argue that sukuk as Shari'ah-compliant financial instruments have a broader responsibility to consider social goals such as sustainable development. Sukuk can be either asset based or asset backed.4 Table 2 lists the fundamental differences between these two structures. In asset-based sukuk, the sukuk

4In practice, there are three kinds of sukuk: asset based, asset backed, and cash-flow finance.

holders have beneficial ownership in the asset or equitable interest in the assets to a special purpose vehicle (SPV) issuer. The principal is covered by the capital value of assets, but returns and repayment to sukuk holders are not directly financed by these assets. Therefore, it is not a true sale. The sukuk holders have recourse to the originator if there is a shortfall in payment. For this reason, these are merely credit-backed securities with no real recourse to physical assets. From the perspective of Shari'ah, it is essential for sukuk to be backed by a specific, tangible asset throughout its entire tenure, and sukuk holders must have a proprietary interest in the assets that are being financed (Yean 2009).

Table 2. Comparison of Salient Features of Asset-Backed and Asset-Based Sukuk

Feature Asset-based Sukuk Asset-backed Sukuk

Ownership Only provides artificial ownership rights to the "usufruct" of certain physical underlying assets, instead of relying on the obligor's credit quality to ensure that the sukuk performs. Asset-backed sukuk imply that ownership rights extend to the actual underlying assets such as physical real estate or rights/usufruct from particular intangible but valuable assets.

Asset recourse to the investor The recourse of the investor is to the creditworthiness of the ultimate obligor Recourse of the investors is to the asset-issuing vehicle, and sukuk investors bear any losses in case of impairment of the sukuk.

Rating Corporate rating methodology is used for asset-based transaction of sukuk whenever a corporate obligor is the key driver affecting credit risk of sukuk. Asset-backed rating methodology will be used for the asset-backed sukuk transaction, which involves securitization. Here, credit risk is determined solely by the performance of underlying assets.

Source: Adapted from Noor (2009).

Malaysia has the largest sukuk market in the world and has pioneered many innovative sukuk structures (IIFM 2014), despite facing many constraints in developing it. The strong growth of sukuk in Malaysia has been supported by the following key factors: (1) the growing sophistication of Sukuk structures; (2) the transparency of regulatory treatment; and (3) a strategic focus on developing a comprehensive Islamic financial system. Malaysia has adopted a

holistic approach to strengthening the sukuk market through rules that facilitate their issuance, a well-defined Shari'ah governance framework, competitive pricing, innovative Sukuk structures and human capital development, incentives for sukuk investment activities, and a comprehensive infrastructure for Islamic capital markets.

To move the sukuk market forward as well as to capitalize on its enormous growth potential, the issue of Shari'ah harmonization should be addressed with greater cooperation and coordination among the industry players. There is also an urgent need for new capital market products to be restructured to comply with Shari'ah as well as the creation of an international sukuk fund. There is also a need to diversify the type and maturity of the sukuk in the market and to help portfolio managers to manage their funds effectively. To address these matters, investors and issuers should regularly circulate sukuk with different maturities to create a benchmark yield curve. Another aspect of growth is concerns over pricing issues (i.e., securities need to be efficiently priced and credible), and further initiatives to develop sukuk indicators are also needed for sukuk markets.

The development of sukuk market will be facilitated by the creation of a guide for issuers and investors that can act as a complete reference concerning Shari'ah decisions that are transparent and fully disclosed. This guide would help ensure proper governance and wider acceptance of Shari'ah decisions, particularly on cross-border transactions as well as attainment of the convergence of Shari'ah principles and interpretation to ensure market confidence among investors. Continuous investments in intellectual capital and greater engagement among Shari'ah scholars are needed to achieve convergence in the sukuk market. The harmonization of standards

and practices are also important for the global acceptance of Islamic financial products including sukuk. In recent years, the Islamic Financial Services Board (IFSB) has formulated comprehensive prudential treatment for sukuk investment by Islamic financial institutions, as stipulated in its capital adequacy standards based on Basel-III to ensure market confidence among investors. The new guideline can help increase the issuance of sukuk by highly rated governments and companies as well as meet increased demand for investing in sukuk by Islamic banks trying to meet Basel-III liquidity requirements.

3. What Can We Learn from Sukuk Literature?

Although the number of research publications on sukuk in the form of articles, books, conference papers, market reports, and magazines has increased in recent years, the existing research on sukuk is relatively sparse. More empirical- or scientific-based literature on sukuk has been published in the form of conference papers and proceedings, but it concentrates largely on descriptive- or qualitative-based analysis in the form of market reports, popular magazines, blogs, and newspaper articles. Very little research on sukuk has been published or indexed by major academic publishers (see Table 3). The bulk of the academic research on sukuk was done in the late 1990s in the form of conference and seminar papers.

Table 3. Publication of Sukuk Research from

1990 to 2014

Database or Total No. of No of Sukuk

Publisher i i 1/ Journals Articles2/

Science Direct 5177 12

Scopus Elsevier 5300 31

Taylor & Francis 168 1

Wiley-Blackwell 53 2

Springer 92 0

Inderscience 70 2

Emerald Insight 84 11

1 Notes: All journals classified under the subject of

economics, finance accounting, business and

management. Using keyword "sukuk" or "Islamic

Bonds" or "Islamic Securities."

Source: author's compilation

Research on Islamic finance, specifically on sukuk, is underdeveloped for several reasons, among them the limited number of academic institutions and a shortage of quality-refereed journals dedicated to the subject, the lack of a global standard and accreditation for Islamic finance courses, the absence of available and consistent data, and disagreement on the concept of sukuk among Shari'ah scholars.5 Nevertheless, the existing literature can be divided into at least three main areas of research (see Table 4): (1) research on the theoretical principles and nature of sukuk; (2) discussions on the operational matters related to sukuk issuance and structure in practice; and (3) the role of sukuk in economic development.

3.1 Theoretical Nature of Sukuk

In the first group of research, the literature revolves around the underlying theoretical and legal nature of sukuk from the perspective of Shari'ah. Debate is still ongoing among Islamic scholars on the theoretical and legal aspects of sukuk. However, the epistemological formulation of sukuk comes from a combination of dalil al-al-naql (revealed knowledge) and dalil al-naqli (man-made knowledge) by using the ijtihad 6method. The history of sukuk can be traced back to the era of the second caliph, Umar b. al-Khattab (A.D. 634-644). Selling sukuk was also reported during the caliphate of Marwan b. al-Hakam (A.D. 684-685), which was prohibited after objections were raised by some of his companions. However, the term sukuk has actually existed since the time of Caliph Mu'awiyah (A.D. 661-680). The literal meaning of sukuk, as an area of

5Definition of quality journal is based on the widely used journal rankings and impact ratings, such as the Thompson Reuters Journal Citation Reports (JCR) Impact Factor and the Institute for Scientific Information (ISI) Web of Science h-index, which reflect the position of a journal within its field, the relative difficulty of being published, and the prestige associated with it.

6 Ijtihad means making effort and endeavor in order to achieve presumption (zann) regarding a hukm (law) of the Shari'ah.

study, were formulated by Imam Al-Nawawi (A.D. 1234-1277), a jurist from the Shafi'i school offiqh (Islamic jurisprudence).7

In this regard, Rohim and Shereeza (2013) analyze the thoughts of Imam Shafi'i (A.D. 767-820) and Imam Abu Hanifah (A.D. 699-767) on sukuk. The paper argues that the ongoing debate among Shari'ah experts can be divided between two main schools of thought: the first rejects sukuk and is influenced by the qiyas (analogical) method of Imam Shafi'i, which holds that sukuk have the conventional characteristics of risk (gharar) and gambling (maisir); and the second accepts sukuk and is influenced by the thought of Imam Abu Hanifah, who contended that sukuk are subject to the judgment of Islamic law and individual interpretation and thus should be evaluating using the ijtihad method. Nevertheless, both schools of thought in essence accepted sukuk as an Islamic financial instrument.

Most Shari'ah scholars take the position that trade in debt instruments (at prices different from their face value) as riba (usury). Distancing sukuk from debt is required in order to make Islamic finance serve its purpose of enhancing prosperity with justice and equity. Moreover, according to Usmani (2008), most current practices in sukuk issuance replicate the structure of conventional bonds (lack of ownership, right to a fixed return, and the guarantee of repayment of

7 During this period, Sukuk refers to securities or stock certificates issued by the national leaders (rulers) to the person entitled to receive food items or objects, who then they sell these securities or stock certificates before receiving the goods (Nawawi and Syariff 1992).

8 This is because Imam Abu Hanifah relied on the istihsan (juristic preference) method, while Imam Shafi'i not only used the qiyas (deductive analogy) method but also employed the takhsis (exclusion) theory, the resource levels of legal sources theory and the language approach theory. However, these theories relied on by Imam Shafi'i are all in essence the istihsan theory according to Imam Abu Hanifah. Takhsis (i.e., the specification or qualification of a general text) could occur by means of rationality and circumstantial evidence (i.e., rationality (aql), custom (urf) and other rational proofs). It would follow from this that takhsis is possible by means of speculative evidence such as qiyas and solitary Hadith.

principal). Similarly, Rosly and Sanusi (1999) also criticize the application of Bay Al-Innah (sale and buy-back contract) and Bay Al-Dayn (sale of debt contract) for sukuk issuance in Malaysia, which is contrary to the opinion of the majority of Shafi'i scholars.

Other research argues that sukuk mirror conventional bonds to ensure an equivalent return, but are different in that the return on sukuk is generated from an underlying asset and not from the obligation to pay interest (Miller et al. 2007). The reason for this is to take into account the distinctive and specific pricing risk characteristics in Islamic finance, with the aims of simplifying investors' risk assessment of the new investments (Wilson 2008). Therefore, many financiers take special care to make sukuk identical to other conventional securities.

Although the process of issuing sukuk—rating, issuance and redemption procedures, coupon payments, and default clauses—are similar to that for conventional bonds, sukuk are different types of instruments from conventional bonds. The returns on sukuk (ijarah, musharakah, and mudarabah) are much smaller than those for eurobonds. The evidence also shows that there is difference in price behavior (Ariff and Safari 2013; Cakir and Raei 2007). The study suggests that, diversification by including sukuk in an investment portfolio significantly reduces the portfolio's value-at-risk (VaR), compared to a portfolio of only conventional bonds.

Table 4. Summary of Related Literature on Sukuk

Author(s) Type of Research Objectives Methodology Findings

Rohim and Shereeza (2013) Nature of sukuk; Qualitative Analyze the thought of Imam Abu Hanifah and Imam Shafi'i on sukuk instruments. Descriptive analysis. The study finds that both schools of thought in essence accepted sukuk as an Islamic financial instrument

Usmani (2008) Nature of sukuk; Qualitative Analyze the mechanisms of sukuk and on the extent to which these comply with the precepts and principles of Islamic jurisprudence. Descriptive analysis. The study proposes that sukuk be issued for new commercial and industrial ventures. The returns of enterprises should be returned to sukuk holders regardless of the amount after costs.

Rosly and Sanusi (1999) Nature of sukuk; Qualitative Analyze pertinent issues on the creation of Islamic bonds in Malaysia and analyze the underlying reasons behind the rejection of bay' al-in h and bay' al dayn. Descriptive analysis. The study finds no significant Shari'ah justification of bay' al-inah. While the trading of Islamic bonds at a discount using bay' al-dayn has been found unacceptable by the majority of ulema' (Jumhur Ulama') including al-Shafi'i.

Cakir and Raei (2007) Nature of sukuk; Quantitative Analyze the difference between sukuk and eurobonds for the same issuer. This paper assesses the impact of bonds issued according to Islamic principles (sukuk), on the cost and risk structure of investment portfolios. Value-at-risk (VaR) method based on delta-normal method and Monte Carlo simulation method. This paper shows that sukuk - contrary to earlier literature - are different types of instruments from conventional bonds, as evidenced by their different price behavior. The analysis employing the deltanormal as well as Monte-Carlo simulation methods implies such gains are present and in certain cases very significant.

Godlewski et al. (2010) Nature of sukuk; Quantitative Examine whether announcements of sukuk and conventional bond issues lead to significant abnormal returns for the issuers for Malaysian listed companies, which issued conventional bonds and sukuk. A standard market model to estimate abnormal returns around the event date for a security issue The study finds the absence of significant stock market reaction to conventional bond announcements, negative reaction to sukuk issues and, as a corollary, a significant difference between stock market reactions to sukuk and conventional bond issues.

Ariff and Safari (2013) Nature of sukuk; Quantitative Examine whether sukuk instruments are equivalent to conventional bonds as practiced by the market. Statistical and causality tests using a large traded data set on sukuk and conventional bonds. The results suggest that sukuk instruments are priced significantly differently and that their yields are not Granger-caused by conventional security yields or vice versa. This empirical finding does not support the market's current practices based on the assumption that sukuk are like normal bonds.

Jobst et al. (2008) Operational aspects of Review the current state of the sukuk market, examines pertinent legal and Descriptive analysis. The study suggests that administrative considerations can lead to additional costs while limiting fiscal

sukuk; Qualitative economic implications of Shari'ah compliance on the configuration of sukuk issuance, and informs the debate about the prospects of sukuk issuance by sovereign issuers flexibility. The initial structuring and issuance costs of sukuk are likely to be higher than they are for a standard security. Sovereign issuers' revenues may need to be ring-fenced, effectively limiting fiscal flexibility. Non-Islamic sovereigns, in particular, would need to consider the necessary organizational changes needed to administer the Shari'ah-compliant structure.

Kordvani (2009) Operational aspects of sukuk; Qualitative Examines the key elements of sukuk within the context of the Shi'a fiqh (jurisprudence) and the principles of contract law in Iran, which is based primarily on the Shi'a fiqh. Descriptive analysis. An examination of Shi'a jurisprudence on the contract of ijarah (leasing contract) shows that such an adjustment can be accomplished in Iran. It has been shown how obstacles to the legitimacy of lease-to-purchase agreements have been overturned by relying on a more flexible interpretation of contractual conditions.

Rahman (2003) Operational aspects of sukuk; Qualitative Examines contemporary accounting regulatory issues on Islamic bonds or Islamic private debt securities (IPDS) or sukuk. Investments in Islamic bonds (sukuk) give rise to a number of accounting and reporting issues. Descriptive analysis. The study suggests that a proper development of the Islamic financial market requires a well-regulated Islamic financial instrument that is in accordance with Islamic accounting regulations. It requires a sound accounting and reporting standard for Islamic financial instruments that meet the requirements of Shari'ah and can be practiced.

Fathurahman and Fitriati (2013) Operational aspects of sukuk; Quantitative Analyze the ratio between yields on sukuk and conventional bonds using model calculations yield to maturity and portfolio optimization model Basic statistical tests for sukuk and conventional bonds in Indonesia. The paper concludes that the mean yield to maturity of sukuk is greater than the mean yield of conventional bonds. In term risks, sukuk standard deviation is relatively larger than the standard deviation of conventional bonds.

Wijnbergen and Zaheer (2013) Operational aspects of sukuk; Quantitative Examine the resolution process following default, not the reasons the default was triggered and the recent sukuk (near) defaults from an Islamic finance perspective. Case studies of four sukuk defaults. These case studies make clear that most of the problems that triggered defaults or blocked smooth resolution of distress afterward arose from ill-defined property rights and conceptual mismatches between relevant jurisdictions and the legal structures chosen. In most cases, the problems can be traced back to clauses and structures that made the sukuk more like conventional bonds.

Tariq and Dar Operational Assess the sukuk structures and Descriptive analysis. The study highlights that different Shari'ah perceptions

(2007) aspects of sukuk; Qualitative analyze the various risks underlying the Islamic sovereign and corporate sukuk structures. could be a risk, which may affect sukuk pricing. Furthermore, through Shari'ah-compatible financial engineering, sukuk can also become highly competitive in the market and accessible to the public as an investment opportunity.

Shafi et al. (2013) Operational aspects of sukuk; Qualitative Identify strategies to reduce sukuk risk, propose sukuk model with embedded option and a mathematical model to compute returns before conversion Descriptive analysis. The study suggests the application of sukuk with embedded options as to mitigate the risk faced by sukuk holders. Embedded options are a way to mitigate the risk, so the study proposes using a real asset, such as real estate.

Wilson (2008) Operational aspects of sukuk; Qualitative Examines the market for, and usage of, sukuk, notably as tools for liquidity management. There is also an analysis of different sukuk structures from a financial perspective. Descriptive analysis. The study proposes sukuk based on participatory structures, with risk sharing by investors, as a way forward. The risk with these proposed structures is of variable returns rather than of default, which may well be more acceptable to informed investors in any case.

Alam et al. (2013) Operational aspects of sukuk; Quantitative Examines the impact of sukuk and conventional bonds announcement on shareholder wealth and their determinants using 79 sukuk and 87 conventional bonds over the period of 2004-2012 in six developed Islamic financial market. Event study methodology to calculate the abnormal returns of sukuk or conventional bond issuance and a multivariate regression. The study shows that from a short-run perspective, the effect of announcement of sukuk on firm value is negative, while the effect of announcement of conventional bond is positive for all periods except for the post-crisis period. Therefore, in spite of having a religious motivation to issue sukuk, the negative effect might hinder firms in raising funds for sukuk.

Ashhari et al. (2009) Operational aspects of sukuk; Quantitative Study the impact of Islamic bond and conventional bonds announcement on shareholder wealth for firms listed on the Bursa Malaysia (stock market) for the period 2001 to 2006. A standard event study methodology with beta refinement using Blume's method. The study finds that there is a wealth effect on sukuk issues announcement but not for conventional bond announcement. The study further establishes that the size of the bond offering is a significant factor in stock returns for both sukuk and conventional bonds, but the sign for sukuk was negative and contrary to that for conventional bonds.

Ahmad and Rahim (2013) Operational aspects of sukuk; Quantitative Investigate whether the market reacts asymmetrically to the issuance of selected sukuk structures (ijarah and musharakah) in Malaysia. Event study methodology using cumulative average abnormal return on The results support the hypothesis of positive market reaction on FTSE KLCI index after ijarah and musharakah issuance in Malaysia. The positive market reactions can be interpreted in two ways. First, the

symmetric and asymmetric events. market can readily distinguish the news. Second, there are confidence effects that shareholders wealth will be increased through the issuance of ijara and musharakah sukuk.

Majid et al. (2010) Operational aspects of sukuk; Qualitative Discuss the sukuk defaults in Malaysia and its implications on the Malaysian capital market with special reference to the selected Malaysian defaulted sukuk. Descriptive analysis The study indicates that sukuk default in Malaysia may not pose a significant threat to the local capital market. However, it does have an impact on the overall reputation of Malaysia as the hub for global Islamic finance.

Ibrahim and Minai (2009) Sukuk and economic development Examine the wealth effect of Islamic debt issuance and its determinants. Event study analysis and cross-sectional regression The study finds that investors reacted positively to the announcement of Islamic debt issues, while they are indifferent to the announcement of conventional issues.

Danila and Malangkucec wara (2010) Sukuk and economic development Examine factors that affect retail sukuk investment by individual investors. Descriptive analysis The study supports the important role of Muslim governments in financing the budget through domestic sukuk issuance, but not to be exposed to exchange rate risks related to sukuk denominated in nondomestic currency. The result also suggests that the rate of return (mudarabah deposit) and foreign exchange rate have an impact on sukuk price.

Ahmad et al. (2012) Sukuk and Economic Development; Quantitative Examine macroeconomic influences on sukuk issuance in Malaysia based on aggregate level data Vector autoregressive model (VAR) The findings indicate that the causality runs from sukuk to GDP. In the short-horizon, sukuk is driven by its own dynamics. The study argues that since sukuk issuance Granger-causes GDP, policy makers should introduce policies to modernize the functional aspects of Islamic capital market.

Said and Grassa (2013) Sukuk and economic development; Quantitative Investigate the influence of the macroeconomic factors the construction of a certain structure of sukuk in the most sukuk issuers' countries namely: Saudi Arabia, Kuwait, UAE, Bahrain, Qatar, Indonesia, Malaysia, Brunei, Pakistan, and Gambia. Multivariate regression The results show that macroeconomic factors—GDP per capita, Muslim population, economic size and trade openness as well as regulatory quality—have a positive impact on the development of sukuk market. However, since the amount of sukuk issued has declined considerably in recent years, the financial crisis has affected negatively the development of sukuk market.

There are few studies on the link between the sukuk issuance announcements and the stock markets. Most studies used the adverse selection mechanism, which favors the use of sukuk by lower-quality debtor companies to explain the differential reaction to stock market announcements. A more recent paper that investigates investors' reactions to the announcements of issues of sukuk and conventional bonds shows a significant negative relationship between an announcement of sukuk and the stock market reaction compared to the neutral stock market reaction to an announcement of conventional bonds (Godlewski et al. 2010). The view that differences exist between sukuk and conventional bonds is supported in the literature because the market players are able to differentiate between these two types of securities.

Other contentious issues related to sukuk are contracts for reselling salam sukuk (contract for deferred delivery) before taking possession, which might lead to gharar or riba, guarantees for sukuk, and using the London Interbank Offering Rate (LIBOR) as a benchmark in pricing sukuk (al-Amine 2008). These practices may not be acceptable for stringent Shari'ah investors. Nevertheless, Saeed and Salah (2014) argue that an imbalance is created in the sukuk market between an idealistic approach to sukuk structures and the pragmatic approach that has been adopted by many sukuk practitioners. It is most likely that, in practice, a combination of these two approaches will be used to develop the sukuk market.

3.2 Operational Aspects of Sukuk

The second group of literature focuses on the operational aspects of sukuk with respect to issuance, risk, and structure. This includes legal and regulatory considerations, performance, and

innovation in sukuk. As sukuk are securitized instruments, research in this regard also provides a framework for assessing and managing risk as well as addressing the legal and regulatory issues involved in sukuk issuance and structure. These considerations and information form the basis of the research in evaluating the modus operandi of sukuk structures and the underlying risks.

The literature has also identified legal and regulatory divergence, which gives higher weight to the costs than the benefits of sukuk issuance from the investors' perspective (Jobst et al. 2008). The study points to two important unresolved issues of legal and regulatory issues are harmonization with Shari'ah and important role in overcoming non-standard laws and regulations. In the same vein, it discusses the need to have a credible standard set for sound Islamic accounting standards, which can be adopted for sukuk issuance. A strong effort to improve and provide an ideal accounting standard is necessary for enhancing reliable financial statements. This lack of standardization gives rise to legal challenges to issuing sukuk in non-Islamic jurisdictions. Most of the literature claims that sukuk can benefit various international stakeholders in a new form of investment cooperation (Abdel-Khaleq and Richardson 2007). However, in the case of Iranian Ijara sukuk (leasing contract) issuance, harmonization, and standardization alone do not increase the level of efficiency of sukuk markets.

A few studies examine the nature and application of sukuk structuring techniques, with an emphasis on legal considerations (McMillen 2007b), accounting regulatory issues (Rahman 2003) and governing law clause in a sukuk prospectus (Oseni and Hassan 2015). The essences of the literature suggest that to ensure the benefits of integration of the Islamic financial sphere with the Western financial sphere in a globalized economy, there must be Shari'ah-compliant

transactions in purely secular Western jurisdictions in which the governing law recognizes Shari'ah as a matter of substantive and procedural law. Enforceability of Shari'ah can be achieved by incorporating it into the law of the land and then choosing the law of the Shari'ah incorporated jurisdiction as the governing law of the relevant transaction. Moreover, investments in sukuk give rise to a number of accounting and reporting issues related to accounting recognition, measurement, and disclosure. A sound accounting and reporting standard for Islamic financial instruments is the main requirement for a well-regulated Islamic financial market that meet the requirements of Shari'ah-compliant and market practicality.

Study with regard to sukuk default indicates that most of the problems that trigger defaults or block smooth resolution of distress have arisen from conceptual mismatches between relevant jurisdictions, ill-defined property rights, and the choice of legal structures (Majid et al., 2010; Wijnbergen and Zaheer 2013). In most cases, these problems can be traced to the structures and clauses that made the sukuk similar to conventional bonds. Moreover, sukuk default occurs due to the breach of any binding obligations under the original terms of the agreement between the issuer and the sukuk holders. However, sukuk default may not pose a significant threat to the overall sukuk market. Therefore, Shari'ah-compatible risk mitigating techniques could be developed by embedding options and swap features in sukuk as hedges, such as real estate (Shafi et al. 2013; Tariq and Dar 2007).

The importance of sukuk issuance announcements on shareholder wealth has been studied in the literature (Ahmad and Rahim 2013; Alam et al. 2013), which points to a mixed picture. Some studies show that, in the short run, the effect of a sukuk announcement on firm value is

negative, while other studies show a positive effect (Ashari et al. 2009). The offering size appears to have a negative impact on the cumulative abnormal return for sukuk and is reported to be significant factor in that return. A similar line of research demonstrates that the market reacts asymmetrically to the issuance of selected sukuk. The evidence indicates positive, significant, and both symmetric and asymmetric market reactions to sukuk issuance. Hence, the capital market reacts positively and asymmetrically to an announcement of sukuk issuance.

Studies that explore the use of alternative benchmarks for sukuk pricing are gaining momentum because the market fails to address the criticism that sukuk pricing is linked to the LIBOR (Wilson 2008). Among the proposed alternatives to LIBOR are structuring sukuk securities with innovative structures based on musharakah or a hybrid of different sukuk structures. Some of the studies suggest that alternative benchmarks to LIBOR can be adopted and linked based on macroeconomic indicators of real activity (i.e., GDP growth) for sovereign sukuk and firm performance for corporate sukuk. However, creating financial derivatives for sukuk structures is controversial and not always permissible by Shari'ah because they are regarded as mere "promises," rather than real assets.

3.3 Sukuk and Economic Development

The third group research focuses on the development aspects of economic sectors by using sukuk as instruments for capital market development and as an alternative financing tool for economic development. This emphasis acknowledges that providing interest-free financial contracts is not the primary aim of having a financial system. In this light, the original expectations of having a financial system and practices that are truly based on Islamic principles is to serve the noble

goals as prescribed by Islam (Maqasid al-Shari 'ah). Sukuk are addressed in this literature as vital vehicles for resource mobilization, whether in the public or private sector, in particular by international development and multilateral development banks.

There is much research on the development of economic sectors using sukuk but not too many studies available on the relationship between sukuk and economic growth. However, the empirical studies that have been conducted so far have mainly examined the types of sukuk instruments and consumer and investor perceptions of sukuk with respect to economic development. In the short term, sukuk are driven by their own dynamics. The evidence argues that, because sukuk issuance Granger-causes GDP, policy makers should introduce policies to modernize the functional aspects of Islamic capital market (Ahmad et al. 2012) to include sukuk. Furthermore, because global markets in many Muslim countries are largely untapped, sukuk have a competitive advantage for international institutional investors.

The link between Islamic finance and corporate finance is always an interesting topic in sukuk literature. Most studies point to the fact that investors react positively to announcement of Islamic debt issuances (Ibrahim and Minai 2009). These findings are attributed to a larger investor base for Islamic debt securities relative to that of conventional debt, which creates cost advantages, lowering the cost of capital. The literature also sees an important role for the government to support the development of sukuk market and to find alternative financing for economic development. Specifically, the role for governments in Muslim countries regarding financing the budget by mobilizing resource using domestic sukuk. However, exposure to

exchange rates increases the risks for sovereign issuers of sukuk, particularly those denominated in nondomestic currency.

Said and Grassa (2013) investigate similar issues on the determinants of sukuk market development in ten countries. The results show macroeconomic factors—GDP per capita, Muslim population, economic size, and trade openness as well as regulatory quality—have a positive impact on the development of a sukuk market. However, the amount of sukuk issued has declined considerably in recent years, and the financial crisis has negatively affected the development of the sukuk market. At the same time, conventional bond markets contribute positively to the development of the sukuk market. It appears that the conventional bond market and the sukuk market are complements rather than substitutes.

4. Conclusion

The sukuk market has grown a great deal, but significant gaps remain. It faces constraints due to a lack of standardization, concerns over investor protection, and low liquidity mainly due to fragmentation. A holistic approach is needed to facilitate the development of domestic markets and access to international markets. The development of money markets is important for a more active sukuk market. A standard solution for the design of suitable money market instruments in the sukuk market is still a work in progress, and the same applies to derivative products. Similarly, rating is a major challenge for potential issuers in accessing the international markets, but a broad set of credit enhancement solutions is almost nonexistent.

Compared to the literature on conventional bonds, the existing research on sukuk is relatively thin, largely consisting of qualitative rather than quantitative work in the form of market reports, articles in popular magazine, blogs, and conference papers. Very few research papers on sukuk are published in top scientific academic journals with impact factors. The underdeveloped literature on sukuk, especially in the scholarly empirical research, can be attributed mainly to a lack of available historical, consistent, and reliable data as well as the limited number of Islamic journals and funding for Islamic finance research.

The bulk of the literature focuses on operational matters of sukuk issuance and structure in practice, which revolve around their need to be Shari'ah-compliant. Limited literature has undertaken study on capital markets and corporate financial aspects of sukuk, followed by their theoretical nature, and very few studies examine the implications of sukuk for the real economy. New research should provide a new theoretical framework on sukuk and for sukuk practices that do not merely replicate and modify existing practices and label them as Islamic products.

As the acceptance and growth of sukuk continue, research on sukuk should be pushed further into mainstream economics and finance. Collective efforts by Islamic finance experts, educators, and trainers are greatly needed to expand the current understanding of sukuk. Research should also explore various possibilities of using scientific approaches for understanding sukuk behavior as well as ways of structuring more innovative sukuk. In addition, more research on sukuk is needed to identify factors affecting sukuk pricing and performance of various sukuk structures, differentiate between risk-sharing and risk-shifting approaches for

sukuk, and understanding the impact of sukuk on market functioning with respect to economic development and social welfare.

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Table 1. Sovereign Sukuk Issuance (2004-2014)_

Country No. of Issuance Amount ($m)

Bahrain 226 12,545

Gambia 401 194

Malaysia 1,388 351,494

Pakistan 17 7,669

Brunei 113 6,093

Turkey 7 6,900

Hong Kong 1 1,000

Luxembourg 1 272

Indonesia 65 21,890

South Africa 1 500

Senegal 1 200

United

Kingdom 1 340

Qatar 17 19,655

Nigeria 1 71

Germany 1 123

Singapore 5 193

UAE 11 6,855

Yemen 2 250

Sudan 26 2,868

Total 2,285 439,111

Source: Zawya, IFIS (2014)

Table 3. Publication of Sukuk Research from 1990 to 2014

Database or Publisher Total No. of Journals^ No. of Sukuk Articles2/

Science Direct 5177 12

Scopus Elsevier 5300 31

Taylor & Francis 168 1

Wiley-Blackwell 53 2

Springer 92 0

Inderscience 70 2

Emerald Insight 84 11

Notes: 1 All journals classified under the subject of economics, finance, accounting, business and management. 2 Using keyword "Sukuk" or "Islamic Bonds" or "Islamic Securities." Source: author's compilation

Figure 1. Global Sukuk Issuance (in US$ billion)

140 120 100 80 60 40 20 0

2012 2013

Others «MENA

Source: Zawya, IFIS (2014)