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Paradox in Structuring Equity-Based Sukuk

The fundamental characteristics of equity based Sukuk are rooted in 2 basic features which are the capital
cannot be guaranteed and the periodic returns are also dependent on actual profit. But over time, the
structure of equity-based sukuk has evolved into debt-based obligation. Various credit enhancement and
strategies were introduced to the Mudharabah and Musharakah structure to achieve capital protection and
fixed period return.
Various credit enhancement mechanism in sukuk structure:
a. Liquidity-Facility Arrangement - A tool used in monetary policy that allows banks to borrow money
through repurchase agreements. This arrangement allows banks to respond to liquidity pressures and
is used by governments to assure basic stability in the financial markets. Liquidity adjustment facilities
are used to aid banks in resolving any short-term cash shortages during periods of economic instability
or from any other form of stress caused by forces beyond their control. Various banks will use eligible
securities as collateral through a repo agreement and will use the funds to alleviate their short-term
requirements, thus remaining stable. It is given by obligor
and obligor will provide cash to ensure smooth profit payment either in the form of loan or other
facility for instance tawarruq.
b. Purchase undertaking at a fixed formula is another credit enhancement mechanism in sukuk
structure. Here the obligor promises at maturity, or in the event of default to buy back, the sukuk
holders interest, in partnership asset at par/face value (outstanding principal plus accrued but unpaid
profit) regardless whether their value exceeds that of their face value.
c. Capping of profit with incentive payments- the sukuk holders will agree to forego any excess profit
beyond benchmark (example the expected return). For example if the expected return is 6.5% and
actual return is 10%, in this case the sukuk holder will take only 6.5%, and give the excess to the
Obligor for good performance.
d. Non distribution of expected profit constituting event of default it means if the Obligor fails to pay
profit, this will be considered as default.
In the Shariah perspective, it is a violation of the mudharabah principle to comply with such credit
enhancement facilities as practiced by the market. The Shariah supervisory board of the Accounting and
Auditing Organisation for Islamic Financial Institutions (AAOIFI) have decreed that providing liquidity
facility and purchase undertaking at par value by the sukuk providers are not permissible in the Shariah.
The Shariah board further advised the Islamic Financial Institutions to invest more on a profit-loss sharing
basis in order to achieve the maqasid al-Shariah.

SUBSTANCE AND FORM


The nature of equity based sukuk which dont guarantee the preservation of the capital, and fixed return
to customers resulted in the innovative creation of credit enhancement mechanisms in sukuk. These
mechanisms, if taken on their own are perfectly acceptable and permissible as it only involves the promises
of one party to give loan to another party, to buy an asset at the end of certain period, or to give incentive
for the job well done. Such transactions are not contradicting with the Shariah rulings; and it is in fact
becomes the reason why Shariah advisor deemed the mechanisms as permissible. However, when we see
it in a bigger perspective, where all the processes of sukuk involved, an issue arise to as whether such
practices amount to tricks or hiyal just to clear some prohibitions in bond by using legal means, but the
essence of the application are still the same as conventional bond.
One thing to noted is that even if a contract is valid in its legal form, its not sufficient to claim it as
permissible in Shariah. These mechanism strategies clearly maintained the legality of the form (sahih
qadaan) because it does not contradict with Shariah, but it totally neglected the legality of the substance
(sahih diyanatan) where the Islamic values of promoting equity and justice are violated. Surprisingly,
people are using Maqasid Shariah as the justification for adoption of these mechanisms, stating that this
mechanism is to help ensure the compliance with the Shariah when they are actually seeking for the
replication of conventional transaction.
People argue that the mechanisms serves maslahah to the investors, but as it happens with the expense of
Macro-Maqasid of Shariah. Macro Maqasid here means, the interest or benefits related to the overall wellbeing and welfare of economic system, which has been the objective of Islamic economics for so long.
Therefore, obviously macro-Maqasid are more important matters for concern and observations compared
to Micro Maqasid. The application of credit enhancement mechanism shifts the transaction from that of
asset market to the money (debt) market, where it brings no difference with the conventional bond in its
essence. The action of over emphasizing in debt-based instrument would never help to remove injustice
and harm, but it is in fact creates inequity in the distribution of income and wealth, and also creates greater
instability in the economy.

MISGUIDED DARURAH

This article also discusses about the application of the concept of darurah in Islamic finance. Obviously,
when Shariah prohibits something it provides alternatives, for example when it prohibits zina it permits
marriage, when it prohibits wine and pork for consumption it permits all other sorts of food and drinks.
Likewise, when Shariah prohibits certain contracts such as contract based on riba and gambling, it
alternatively permits many contracts like sale, lease, salam, istisna, mudarabah and musharakah. To
economists, such contracts are the better alternatives for riba and gambling, and ultimately can help to
produce a stable and a healthy economy. Besides that, economy based on riba and gambling which based
on exploitation, leads to inconsistency and inequitable of wealth distribution between rich and poor. So,
where is the darurah that may allow Muslim to abandon these beneficial contracts in favour of harmful
and destructive one? Islamic banks so far seem to still offer the same excuses of darurah. Supposedly,
legalizing a forbidden thing on basis of darurah will provide better solutions for a problem not creating a
bigger one.

There is a tendency in some Islamic banks today to conveniently use darurah as an excuse to legalise
certain activites such as bay al- ina-based transactions although all jurists agree on its impermissibility
if it is used to circumvent the prohibiton of riba as discussed earlier. Even if the justification of darurah is
considered valid, they should acknowledge the original ruling of the contract and not simply altering it
then attributing it to Shariah. Surprisingly enough, some use darurah as a justification for the adoption of
bay al- inah, which implies that they admit that this sale is originally prohibited; at the same time, they
justify the adoption of bay al-inah by claiming its permissibility through attributing it to the Shafii. The
whole situation here can be likened to a person who has already predetermined doing something shameful
without any considerations, then he tries to find as many excuses as possible to justify his action. Very
likely such a person is liable to give conflicting justifications. Same goes to another example such as the
excused to seek for a riba-based loan. They can never deny the original ruling of its prohibition.

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