Quora Answer: What are Sukuk Bonds?

The following is my answer to a Quora question: “What are swukuk bonds?  How do they work, and how are they Islamic?” 

Swukuk is not, despite its name, a bond.  A bond is a fixed-income security, a debt instrument for the sole purpose of raising capital.  They are a loan agreement, between the bond issuer, and the creditors, the investors, where the bond issuer is obligated to pay a specified amount of money at specific dates. 

Swukuk is a financial certificate, that is created to comply with an interpretation of shari’ah.  They circumvent the general prohibition against debt security, and concerns of usury.  In this case, the issue sells investors a certificate, using the proceeds to purchase the asset, whereby the investors have partial ownership.  Here, we have debt that is not a debt.  Capital is still raised.  The issuer is contractually obliged to buy back the certificate at par value, at a future date. 

While the bond has a yield, the holders of a swukuk certificate receive profits generated by the underlying asset.  This is because the swukuk certificate is actually a certificate of ownership of the underlying asset.  If the underlying asset appreciates, the swukuk certificate appreciates.  If it depreciates, then we have to consider the terms of issue.  Thus, the valuation of the swukuk certificate is calculated on the value of the backing assets, while bonds prices are determined by its credit rating, and demand on the secondary market.