Sukuk Defaults: On Distress Resolution in Islamic Finance

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractIslamic strictures require investors to share risks with the entrepreneurs they finance.Sukuk (Islamic securities) come mostly in two varieties, musharakah (basically a joint venture agreement) and ijarah (more like an operational lease agreement). Yet defaults did happen, even in the case of musharakah (joint venture) sukuk discussed in this study. So is Islamic finance failing to deliver on its promises? To answer that question, we analyse four major defaults onSukuk that have happened recently in the aftermath of the worldwide credit crisis that has engulfed the world since 2007. These case studies make clear that in most cases, the problems can be traced back to clauses and structures that made the sukuk more like conventional bonds.Furthermore, once default happened, most of the sukuk discussed did not transfer the underlying assets to the sukuk holders. So, in the event of default, due to limited recourse provisions, sukuk holders often had nothing to resort to, as effectively there were no underlying assets in their ownership. The case studies highlighted the importance of the legal institutions of the country where the collateral is likely to be contested. Interestingly enough, strict adherence to shariah principles would have considerably simplified restructuring because shariah compliance implies a clear allocation of property rights: in sukuk, investors will receive full title to the underlying sukuk assets in distress situations. So the answer to the question we asked, is Islamic Finance failing to deliver on its promises, is a qualified no.

Why do companies issue sukuk?

“…The sukuk relies only on the SPV assets which are owned by the investors, while in case of default the issuer's liability is not in question. Even when the sukuk performance is guaranteed by the issuer, Van Wijnbergen and Zaheer (2013) show that major default costs arise when determining the liability of the issuer, because the underlying assets are mainly used to pay the investors.…”

“…If the firm misses a payment, the sukuk is in default and it is technically the issuer's liability to refund investors. However van Wijnbergen and Zaheer (2013) point out that the complex structuration of sukuk makes uncertain the default process and reinforces the default cost.…”

Can Islamic injunctions indemnify the structural flaws of securitized debt?

“…Furthermore, it would also contribute towards addressing the incoherence in interpretation of Islamic rulings that has led the industry to employ ad hoc methods to structure Islamic papers across regions of the Muslim world. For example, Wijnbergen and Zaheer (2013) observe that the current 'asset-based' sukuk which is permissible by several Islamic jurists does aggravate legal risk. This provides strong support to the employment of tangible 'asset-backed' sukuk, meticulously configured to alleviate both asymmetric information and agency costs of debt to make it truly 'bankruptcy-remote', as promoted in our study.…”

Nexus between risk sharing vs non-risk sharing financing and economic growth of Bangladesh

“…Although Sukuk are an equity-like structure which is comparatively more conservative than traditional debt instruments. However, incidents of Sukuk default have increased in recent times as reported by The National (2009), Aziz (2010), Khnifer (2010), Boey (2013) and Wijnbergen and Zaheer (2013), Halim et al (2017), Klein et al (2017), Smaoui and Khawaja (2017), Ariff et al (2018) and Borhan and Ahmad (2018), among others. Some of these recent defaults have created uncertainties in Sukuk and have given rise to negative implications as described by Laldin (2013) and Majid et al (2011).…”