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06 May 2009
Moody's: Sukuk Investors Need To Focus On Substance Rather Than Form
Sukuk still have further to go to reach the asset-backed Shari'ah ideal
DIFC, May 06, 2009 -- In a new Special Report, Moody's Investors Service looks at
the future direction of 'sukuk' or Islamic bonds, emphasising
the need to focus on substance over form. Moody's examines
these issues, relevant Islamic principles and structural features
from an analytical perspective. The report focuses on credit risk
but with reference to the Accounting Auditing Organisation for Islamic
Financial Institutions (AAOIFI) recommendations made last year.
"As Sukuk issuers begin to face distress, it is important
that investors focus on the substance and not the form of their risk,
which is a concern in Islamic Finance" explains Khalid Howladar,
Senior Credit Officer for Asset-Backed and Sukuk Finance at Moody's
and author of the report. "Most Islamic market participants
are aware that sukuk should grant the investor a share of an asset or
business venture along with cash flows and risk commensurate to such ownership.
While this is indeed the Shari'ah 'ideal', most
current sukuk structures are designed to replicate conventional fixed
income instruments." The assets in the structure are commonly
there for Shari'ah compliance purposes only, and ultimately
have no bearing on the risk or performance of the sukuk investments,
particularly in a distress situation.
In the new report, entitled "The Future of Sukuk: Substance
over Form?", Moody's considers the goals of the
sukuk market and looks closely at the issue together with the AAOIFI recommendations.
The rating agency also looks at recent events and securitisations in the
The disparity between the 'substance' and the 'form'
of sukuk was highlighted by AAOIFI when it published six recommendations
in February 2008. However, Moody's believes --
as discussed in a recent Special Report on sukuk issuance volumes in 2008
-- that the decline in sukuk market volume has been due
more to prevailing global credit market conditions than as a direct reaction
to the AAOIFI statements.
In the rating agency's view, AAOIFI's comments constituted
a positive effort towards improving transparency and trying to bring the
'substance' of sukuk products closer to the tangible and risk-sharing
principles on which there is indeed a broad consensus. "It
is in the implementation of these principles that matters become complex
for investors," Mr Howladar notes. A number of terms
such as 'mudarabah', 'musharakah' and 'ijarah'
are widely applied for all types of sukuk, but the actual legal
structure and risk characteristics can vary significantly even within
a single type. "Until there is some broad standardisation,
investors will need to look at each structure individually to understand
the risk/return profile irrespective of the type of sukuk structure used,"
says Mr Howladar.
Moody's Investors Service was voted "Best Islamic Rating Agency" --
that is, best rating agency for Islamic finance ratings --
by the readers of Islamic Finance News in the publication's annual 2008
Awards poll. The award recognises Moody's superior ratings coverage
of Islamic financial institutions and Sukuk transactions during 2008.
NOTE TO JOURNALISTS ONLY: For more information please contact EMEA
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Structured Finance Group
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JOURNALISTS: 44 20 7772 5456
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Khalid F. Howladar
VP - Senior Credit Officer
Structured Finance Group
Moody's Middle East Ltd.
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