IT HAS almost been more than four years since this writer presented a paper on muqarada sukuk at an Islamic finance conference.

The circumstances at that time were different from the present day where the term sukuk made its debut on the capital market.

Sukuk literally means "pieces of paper" or "document that acknowledges something."

SCALE MODEL: A worker putting the finishing touches on the scale model of a building project at The Star Property and Home Fair 2005 in Penang recently. The class of assets that may be used to issue "sukuk" is fast developing and includes tangible properties.

In a commercial sense it refers to instruments used in Islamic finance to allow one party to raise capital or funds in the capital market with the issuance of sukuk papers that list the rights and obligations of all parties involved in a transaction.

Sukuk are not bonds in the conventional sense as holders of the former are not expecting a fixed rate of return from their purchase of securities, as is the case with conventional bond holders.

In the case of sukuk, what is important is that holders must own the underlying assets to justify returns which are not fixed but are tied to actual returns generated by the assets.

Hence, in the case of sukuk musharakah, for example, investors are sold portions of assets to be used in business.

Returns to holders are in fact income or profit earned from the use of the assets in a manner specified in the sukuk contracts.

The class of assets that may be used for the purpose of issuing sukuk is fast developing, ranging from mere tangible properties to include rights and claims or receivables.

However, the latter classifications have been the subject of discussion by shariah scholars in terms of their status with regard to securitisation.

The emergence of sukuk in the market and their wide approval by international Islamic investors stems from the fact that they are asset-backed.

The underlying assets are normally in the form of real tangible assets, a portion of which are sold to investors as previously stated.

Therefore, sukuk are different from Islamic debt securities which are widely used in Malaysia.

Islamic debt securities consider outstanding debts to be the subject matters of the transactions that lead to the issuance of securities.

These debts are normally debts emanating from the sale and purchase of tangible assets by way of instalments or deferred price.

On the other hand, in the case of sukuk, the subject matter of a sale is the portion of tangible assets.

For Islamic debt securities these are debts and liabilities of the issuers.

There seems to be some misunderstanding among certain quarters on the permissibility of sale of debt (bai al-dayn) in Islamic finance.

For those who do not approve a sale of debt, their concern arises from the act of selling the debt for more or less than its worth provided this debt is a sum of money owed. 

Apart from this, they also insist that other conditions need to be fulfilled first before debts can be sold particularly to third parties.

This is done to safeguard the interests of all parties involved.

However, when the issued securities represent mixed assets comprising real tangible assets and debts, the trading of these securities is allowed provided that the value or proportion of real tangible assets surpasses that of the debts or at least 51% or more of the combination of the two.

The rationale behind this ruling is that since real tangible assets constitute the majority proportion, the law classifies that combination as tangible assets and not debts. 

Therefore, the relevant securities can be generally bought and sold in the market for whatever price.

Even if the portion of debt is more than 51%, provided that the selling or purchase price of the whole portion (the debt and real portions combined) is more than the value of the portion of debt if sold separately, the sale of the securities is allowed. 

The reason is that the selling price can cover both the value of the debts and the real assets.

It is not permissible if the securities are sold for less than the value of the portion of debt.

This is because a debt can only be sold at equal value.

In this case, it appears to be that the real asset portion has no value whatsoever.
Therefore, in structuring sukuk, which may involve a combination of assets and liabilities, the correct formula must be properly understood and applied to avoid being conned into a sale of debt which is not equal to its value.