Sukuk implementation in Malaysia: A literature survey

By: Iliyas Ismail

(Sample version. The full version can be requested from the author)

Introduction

The sukuk market has seen unprecedented growth over the years with the increasing acceptability and growing popularity of Islamic finance in countries across the globe. Islamic finance itself as a field, has grown from its niche market serving primarily Muslim customers to having a wide acceptability among people as a whole. Malaysia as a country is able to position itself as a leading country in this field, among several other leaders including Bahrain and Saudi Arabia. In 2017, Malaysia issued $36.5 billion worth of sukuk, and retains the country’s position as the worlds largest issuer of sukuk for that year, retaining the position from previous years. With this in mind, it is of great interest to see the future direction of sukuk in Malaysia and how it could face the challenges.

Sukuk structure

Jalil and Rahman (2012) made a comparison of two structures of long term sukuk and found that the investment in a sukuk ijarah would be a better investment compared to the musharakah mutanaqisah, regardless of the number of years, so long as it is for long term.  This finding seems to be valid, since a search in the database shows that sukuk ijarah receives a wider attention by academicians discussing about sukuk.

Sukuk rating

Like its conventional counterpart of bonds, sukuk issuers also needs to be rated by relevant bodies. There are several determinants to the issuance of rating to Sukuk agencies. Borhan and Ahmad (2018) states that among the determinants for the rating includes the type of sukuk issued, whether it is ijarah, musharakah, salam, istisna’ or other forms of sukuk. This finding concurs with other earlier studies such as that of Arundina et al (2015) and Godlewski et al (2014) which also states that types of sukuk will have a bearing on its ratings. Borhan and Ahmad (2018) found that the companies issuing sukuk ijarah tend to receive higher ratings as compared to those that issue sukuk musharakah, due to  the perceive of greater risk. It would seem that debt based sukuk such as ijarah and musharakah sukuk has a lesser risk compared to partnership based musharakah sukuk.  Abulgasim et al (2015) also describes sukuk structure as having an influence on the sukuk ratings, as well as other variables under corporate governance and financial measures.

Hamid et al (2014) showed the significance of sukuk ratings to firms’ the corporate performance, by examining 312 listed firms.

Comparison with bonds

When comparing between the two, some scholars note that there are no significant differences between the two in terms of returns and structure, for instance Miller et al. (2007) and Wilson (2008) states that sukuk does not provide an alternative financing mechanism due to their close similarity.

However, scholars such as Sherif and Erkol (2016) describes how sukuk issuance created an abnormal return in the stock market compared to conventional bond, especially after the financial crisis period of 2008. Godlewski et al. (2013) is in agreement with this conclusion in their findings, that shows that there is an adverse negative stock market reaction to the issuance of the Islamic sukuk as compared to conventional bonds. The reason for this is stated as many sukuk issuing companies are described as making lesser profits compared to those issuing conventional ones, and an increase in sukuk issuing companies could be taken to mean that these companies are shut out from the more profitable conventional bond markets. However, it is also opined that this gives an opportunity for investors to tap into the sukuk market with the encouragement of these lesser profitable companies to engage in profit and loss sharing with investors in an Islamic sukuk market that portrays a high demand.

To give a perspective to Islamic finance and Islamic economics, scholars such as Mahomedy (2013) and Nasutay (2007) criticized the current trend of Islamic economics by noticing the similarity of the field with conventional ones, and how the former could not distinguish itself to create a distinct discipline, while Ayub (2007) laments how Islamic finance as a subset of Islamic economics faces a similar conundrum. These seemingly similar perceived conditions of the two fields however, can be contrasted by findings such as that of Godlewski et al (2013), which shows that the market readily differentiates between the two clearly, and reacts differently. Some of these reactions could be very positive towards the Islamic sukuk market.

The dissimilarity that is translated in the yield of the two forms of bonds, while not necessarily having correlation with each other, nevertheless display a difference, and these differences could mean that theories and models normally used for conventional bonds should not be applied to sukuk (Arif and Safari, 2012). Al Sayed (2013) disagrees with this view, and states that the conventional risk measurements can be used for sukuk evaluation, including for that of systematic and total risk. The differences in yield returns, though, might not be observed across the board. Ariff et. Al. (2017) found that, although corporate sukuk have generally less yields compared to bonds, sukuk issued by the government could have higher returns instead, and this is based on the study of the Malaysian market.

Understanding the risk structure and implementation of sukuk

Studies in various markets have found that sukuk can have lesser risk and is a more stable financial tool compared to conventional bonds. Nasir (2017) found that, based on his study of the Pakistani market, by studying 15 sukuk and 30 term finance certificates in the country, found that sukuk as a financial instrument is less risky and more stable than that of conventional bond. This is explained by the diversification theory and liquidity perspective, and also risk sharing. In fact, to lessen the risk for sukuk is what is presented, as the advantage of Islamic finance. Sukuk risk is reduced by the transactions that are backed by assets, fixed and guaranteed returns and prohibition of gharar, among others (Junaid and Azhar, 2010).

Zaidi (2009) however, disagreed and stated that the risk associated with sukuk is broader even if it is lesser each, due to the risks that is faced specifically by sukuk, such as shariah risks, sukuk-specific market risks, regulatory risks and those risks associated with assets underlying the sukuk. In his paper, Alswaidan (2017) compares the various literatures on risk in sukuk and provides a sukuk risk classification matrix, classifying the sukuk into debt based, equity based, asset based and agency based.

In theory, sukuk would have no risk for defaulting since it represents an ownership of the asset owned, and not merely a debt instrument, however due to the structuring of sukuk that is based on conventional bond, there is still the likelihood, mostly due to the obligor (negligence or weakness in management) or mismatch between asset and liability (ISRA, 2016). A study of the Malaysian company Sunway for its treasury sukuk, found that it has a lower risk of default risk, due to its ownership of 3000 acres of land (Uddin et al, 2015). 

Conclusion

The sukuk market in Malaysia is expected to witness continuous growth as has been in the past several years, but challenges in terms of default risk and disagreements over sharia issues in sukuk structure will continue to be two of the main challenges that will be faced by sukuk issuing companies