Thread by @SafdarAlam

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(If anyone wishes to help translate this to BM, please let me know)

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INTRODUCTION to Bonds and Sukuk

What are bonds?

Bonds are just like loans. Rather than one person giving a loan to another, in bonds we have a large group of investors giving a loan to a company (or to a government).

But there is one key difference between bonds and loans, which I will explain shortly.

So we get a group of investors (also called financiers) and they pool their money together, and give a loan to the company. The company agrees to pay interest on the loan. This interest can be the same amount every year (eg fixed rate), for example, 6% per annum, or it can

vary every year – this is called a floating rate. Here we will focus on fixed rate payments (called coupons).

Ok, so when the investors give the loan, they receive a piece of paper that outlines their loan – eg you have given £10,000 to Company X for 5 years

, and you will receive 6% pa (per annum, meaning every year). At the end of the bond (the maturity of the bond) the investors get their capital back (this process is called redemption of the bond). See example in this pic:

This paper is called a security (because it “securitises” the future cash flow), and this security is the bond paper. Here is the difference between a loan and a bond – the investor can trade this paper in the markets. He does NOT have to own this paper for the whole of the

5 years duration of the bond.
Why would someone sell this bond paper? Well, firstly, perhaps the investor decides he wants to cash out his £10k to invest elsewhere, or needs the money for other reasons.

Or perhaps the bond value has increased in price. When first issued, the bond price is (normally) 100. This value can go up or down like any financial instrument. It can go up to 101 or down to 99.

So if you buy at 100, and the price goes up to 101, you can decide to sell the paper, if you want to.

With loans, you generally can NOT sell the paper, as there is no market for this trading to occur. If you join a group of investors to give a loan to the same company,

you will NOT be able to trade your loan paper. This liquidity is one key benefit of owning a bond compared to a loan.

So, is this permissible for Muslims? – the answer is no, because this is a loan at interest. However, bonds are incredibly useful for companies as it lets them raise money from investors, without having to do other more expensive things like selling new equity to raise money.

And for investors, bonds are great because they are quite safe investments, they are quite likely to get their 10k investment back, and they get an annual coupon too.
So, the Islamic banking system found a way to deliver bonds, but in a Shariah compliant way.

This is what a Sukuk is – an Islamic version of a bond.

How does a Sukuk work?

What happens is this:
The investors pool together, and they deliver the funds to the company (we can call the company the issuer of the Sukuk).

The issuer can not just agree to deliver an annual return, as this is just interest. So the issuer has to use this money and earn some profit. This profit is then shared with the investors.

The profit is delivered to investors annually, like a bond.

However, the profit is now earned by the issuer making profits from using the money.

Now we get to the part that makes Sukuk a little complicated – remember that bonds are tradeable – so Sukuks MUST also be tradeable, otherwise they are not useful to investors.

So, in order to make them tradeable, the investors must use their money to actually buy ASSETS. Once they own assets, then the Sukuk paper represents their ownership of these assets.

It is these assets that earn profit for the investors.

So lets say the total size of the Sukuk is £100 million. We get a pool of Sukuk investors to put in some money each, and once they reach £100m, they now use the money to buy some assets.

Often these are assets that are already owned by the Issuer.

Now assets are used to make profits. These profits are delivered to the investors.

If the Sukuk is for 5 years, then what happens is that, after 5 years are up, the assets (which belong to the investors) are now SOLD (often back to the Issuer) for £100m.

This enables the Sukuk investors to receive their capital back at maturity. This is just like redemption of the bond.

So ALL the key elements of a bond are all replicated in a Sukuk – the initial investment, the profit/interest payments - and then redemption at maturity

Initial Investment
BOND – investors just deliver the money to the issuer
SUKUK – investors buy assets

Annual returns
BOND – interest payments
SUKUK – returns made from the assets

Return of capital at maturity
BOND – issuer simply repays the debt
SUKUK – the assets are sold, the money delivered to investors

Hope this is useful!

/THREAD