200 AN INTRODUCTION TO ISLAMIC FINANCE
that a contractual obligation that would otherwise be found to be enforce-
able under the governing law of the contract may nonetheless be determined
to be unenforceable due to some defi ciency in its compliance with Shari’ah
principles. This risk was highlighted by the 2009 English High Court judg-
ment in The Investment Dar Company KSCC v. Blom Developments Bank
case, in which the court found reasonable grounds for a claim by an Islamic
fi nance house that its obligations under a contract governed by English
law were unenforceable because the contract was not truly compliant with
Shari’ah law.
There is also a lack of legal certainty with respect to the recourse to
assets underlying many sukuk issues in the event of the insolvency of an
obligor. While the existence of an underlying transaction involving real
assets is an essential component of most sukuk structures, many issues are
“asset - based,” as opposed to “asset - backed” or “asset - linked.” In an asset -
based structure, there is rarely a security interest granted in, or recourse to,
the assets involved in the transaction. This issue was highlighted in a Shari’ah
ruling of AAOIFI which criticized existing structures on these grounds. In
particular, Shari’ah experts have criticized the fact that many agreements
underlying asset - based sukuk transactions stipulate that the underlying
assets are to be bought back at par instead of at prevailing market value.
Challenges for the Sukuk Market
The sukuk market is in its embryonic phase, but holds great potential for
further growth of the Islamic fi nancial industry. The following are some of
the issues currently faced by this market:
■ (^) The sukuk issued so far (with the exception of those by the Islamic
Development Bank) have been linked to a particular real asset, rather
than to a pool of assets. This model can work for sovereign, supra-
national or multilateral borrowers who have large - scale assets to secu-
ritize, but poses diffi culty for institutions that want to raise capital on
a smaller scale. In addition, sukuk issued against salam or murabahah
contracts cannot be traded in the secondary markets. The majority of
Islamic banks hold a large portion of assets that can be securitized,
but so far no Islamic commercial bank has issued sukuk, mainly due
to the lack of large - scale assets or the holding of short - term salam or
murabahah - based assets. Islamic banks should make serious efforts
to utilize the securitization process to take the assets off their balance
sheets in order to enhance the liquidity of their existing portfolios. The
challenge is to develop sukuk based on pools of heterogeneous assets
with varying maturities and different credit qualities. The participation
of Islamic banks will further develop the market.
■ (^) Issuers, investors and intermediaries need to nurture the market patiently.
Islamic transactions often face a competitive disadvantage vis - à - vis con-
ventional bond issues in cost - effi ciency terms. Each new issue incurs