184 AN INTRODUCTION TO ISLAMIC FINANCE
followed by the introduction of the Muqaradah Bond Act of 1981. Similar
efforts were made in Pakistan, where a special law called the Mudarabah
Companies and Mudarabah Flotation and Control Ordinance of 1980
was introduced. However, neither of these efforts resulted in any notewor-
thy activity, because of the lack of proper infrastructure and transparency
in the market. The fi rst successful introduction of Islamic bonds was by
the Malaysian Government in 1983 with the issuance of the Government
Investment Issues (GII) — formerly known as “Government Investment Certi-
fi cates (GIC).” The pace of innovation was very slow and IFIs were unable
to develop an active market for such securities. Meanwhile, the success of
securitization of assets in the conventional markets provided a framework
which could work for Islamic assets as well. It was not till the late 1990s
that a well - recognized structure of an asset - backed security in the form of
sukuk was developed in Bahrain and Malaysia. This structure is attract-
ing the attention of borrowers and investors and is considered a potential
vehicle to develop Islamic capital markets.
There are several advantages offered by a market for Islamic bonds or
sukuk to meet the demands of the users of funds and a whole range of inves-
tors. The former gain direct access to the funds through the sukuk market
and, at the same time, bypass intermediaries. They expect that an effi cient
sukuk market will ultimately lower their cost of funding. For investors,
sukuk present them with greater choices on maturity and portfolio selection.
A well - functioning primary and secondary sukuk market can provide much-
needed liquidity to institutional investors and fi nancial intermediaries, who
become better equipped with portfolio and risk management. Finally, in many
cases, the payoffs of sukuk resemble a conventional fi xed - income debt security,
which is popular among conventional investors. In this respect, sukuk can
also serve as an integrating tool between Islamic and conventional markets.
What are Sukuk?
The word sukuk (plural of the Arabic word sakk, meaning “certifi cate”)
refl ects participation rights in the underlying assets. The term is not new and
is recognized in traditional Islamic jurisprudence. The idea behind sukuk is
simple. The prohibition of interest virtually closes the door for a pure debt
security, but an obligation that is linked to the performance of a real asset
is acceptable. In order words, the Shari’ah accepts the validity of a fi nan-
cial asset that derives its return from the performance of an underlying real
asset. The design of sukuk is very similar to the process of securitization
in conventional markets where a wide range of asset types are securitized.
These asset types include mortgages, auto loans, accounts receivables, credit
card payoffs, and home equity loans. Just as in conventional securitization,
a pool of assets is built and securities are issued against this pool. Sukuk are
participation certifi cates against a single asset or a pool of assets.
Formally, sukuk represent proportionate benefi cial ownership of an
asset for a defi ned period when the risk and the return associated with cash