The case for and against Sukuk bonds

The Nigerian Supreme Council for Islamic Affairs (NSCIA) has asked the Christian Association of Nigeria (CAN) to stop being ‘islamophobic’.  NSCIA issued this statement after CAN alleged that Nigeria’s current issuance of Sukuk bonds – which are sharia complaint bonds — was an attempt to sell Nigeria to Islamic countries.

Truly, as NSCIA noted, more and more non-Muslim countries are embracing Islamic finance as countries seek to tap into the resources of cash-rich Middle Eastern investors.

From Goldman Sacks to HM Treasury, bond issuers have devised means of attracting Islamic investors, who cannot put their money in conventional bonds because they involve payment of interests, which is prohibited in Sharia law. (In Islam, making money from money is forbidden, so you have to generate economic activity to produce profits.)

Therefore, in Islamic finance, investors put their money into various real activities to generate a profit, and they receive a margin of this profit.

But Sukuk bonds have a common feature global investors know. For instance, when issuers expect low profits, they prefer Sukuk’s profit and loss financing scheme to minimize their loss in case of failure. But when issuers expect high returns, they prefer interest based financing – such as conventional bonds —to maximize their gains in case of success.

Fundamentally, less leveraged institutions, who are not in very good financial positions, have more incentives than developed countries to issue a security-based on Islamic principles — such as the profit and loss sharing principle rather than a fixed income instrument. So, technically, you could argue that Sukuk bonds are good for Nigeria.

And with Osun State’s successful issuance of Sukuk bonds in 2013, in which it raised $62 million, Nigeria’s Debt Management Office (DMO) seems to be excited about using these bonds to diversify instruments in Nigeria’s bond market.

But the N100 billion sovereign Sukuk bonds issued by the government, this September, seems to take away the risk and loss sharing nature that Sukuk is known for. The government is promising to pay subscribers of Sukuka risk-free rental income of 16.47% per annum. Almost the same “interest” with other fixed income investments in Nigeria.

The question is why call it Sukuk when the interest rates and the level of risks are almost the same as other conventional fixed income investments in Nigeria. The answer: being Sharia complaint in nature will attract many investors interested in Islamic financing.

Monies from these Sharia complaint investors could free government from borrowing internally and crowding out the private sector. But government still needs to explain the structure of these Sharia bonds so that it doesn’t look like assets are being taken over by these investors on a platter of gold, as CAN alleged.

When the UK became the first non-Muslim country to issue sovereign Sukuk bond in 2014, it was clear where the “profits” were coming from. The UK used the Al-Ijara structure for this bond. Therefore, UK’s Sukuk was underpinned by three central government properties which provided the rental income to investors.

But this is not exactly the case in Nigeria. The government says its bonds would be used to fund infrastructural projects in Nigeria. But the rental incomes from these assets should be clear.  Are the roads financed with these bonds going to be tolled to provide the “interest” for Sukuk bond holders?

To allay the fears from CAN — which NSCIA believes are unfounded – the government needs to explain that these bonds are truly based on a profit and loss structure and that they are not just a way of guaranteeing fixed and juicing interests to some investors interested in having Sharia structures in place.

Today, Sharia complaint investments are minimal, but there is a lot of liquidity in the Middle East and Sharia related investments could grow very rapidly. This might result in a situation where major parts of our financial systems are governed by Sharia related considerations.

This shouldn’t be a problem for many Nigerians. But for those who are worried about it, government needs to address their concern.