MUDARABAH SUKUKS: ARE THEY REALLY RISKY?
Mudarabah sukuk (sukuk is plural form of sakk-
commercial certificate/document, nevertheless here the term is used as a
singular word as generally treated) came to the forefront when Dana Gas case
was at its highest point in 2017/2018. Then everyone was discussing Dana Gas in
the context of the so-called impending default when the company declared that
its Mudarabah sukuk was no longer Shariah compliant and thus illegal and
unenforceable under UAE law. The issue then was about profit payment by Dana
Gas to holders of the sukuk: what are the rights of the sukuk holders when the
so-called profit was not going to be paid as expected and as to whether that
would trigger a default. Basically there are many questions that have been
raised in this Mudarabah sukuk, among others are the followings:
·
Whether
non-payment of profit by the Mudarib (Dana Gas) constitutes a default?
·
What are actually
profits in the context of Mudarbah?
·
Whether the
purchase undertaking provided in the agreement was valid and enforceable in
law?
·
What are the
rights of Mudarabah sukuk holders when the sukuk was declared as not valid or
not Shariah compliant?
·
What laws are to
be used the settling the dispute between the sukuk issuer and its sukuk
holders?
·
What was actually
the nature of a Mudarabah contract entered into by the parties: whether it is
truly a Mudarabah of something else?
As it turned out later, the parties to the debacle had
managed to resolved their dispute seemingly through an amicable settlement
toward the end of 2018, and that development was indeed something that was
commendable given the fact that settlement of disputes through compromise (sulh) leading to final resolution is in
fact the best Islamic option among several other options in dispute settlement.
Notwithstanding the positive development and the terms used by the parties in
their settlement agreements, many relevant questions about Mudarabah and Sukuk
Mudarabah are far from being clearly addressed in actual practices.
One factor that may have given rise to this negative
state of affairs is related to the fact that market practitioners especially
investors are, for a very long period of time, used or accustomed to fixed
incomes securities structured more like conventional bonds underpinned by debt
contracts rather than investment ones. More specifically, in the context of
Islamic finance they are generally called asset-based Islamic securities/sukuk
where they are more or less (according so some) conventional bonds/securities
in disguise, the situation that led to the widely reported pronouncement in
2007 by Sheikh Taqi Usmani that 85% of sukuks issued up to that period were not
Shariah compliant. The crux of the matter is that asset-based structures negate
the very essence of sukuks as investment certificates/securities rather than
debt ones.
It seems that the true contest taking place in the market
for quite sometime is actually between two forces. On the one hand, there are
sincere parties who are trying to bring back Islamic capital market practices
into its original form that is basically anchored on the spirit of fair
partnership between capital provider/investor and investment agents/companies
where their relationship is not one that is based on creditor-debtor positions.
While on the other side of the fence, there are those who relentlessly pushing
the market players to maintain such debtor-creditor mentality thanks to their
conventional upbringing and outlooks. For this last group, debt-based
securities or sukuks are supposed to be the way mainly because for them these instruments
are more efficient and less risky not to mention their attachment to debt-based
finance underpinned by interest charges described sometimes in different
terminologies.
The above situation is not something new: this writer
can vividly recall far back around 2007, when he presented in an international
Islamic finance conference held in Singapore on the topic related to Sukuk for
global acceptance. (Before that in 2001 the writer used to present about
similar topic but appropriate for that early date of Islamic securities
development, the topic reads something like “Muqarada (Mudaraba) bonds as
alternatives for debt-based bonds”). During that morning session of 2007
conference, the writer stressed the need to be mindful of the fact that sukuks
should be for all intent and purposes be considered as investment certificates
or securities where returns could not be fully guaranteed like the conventional
bonds. Came the afternoon session when a fellow presenter representing an Islamic
financial institution took his turn when he with full force told participants
that Sukuks were no different from other kinds of fixed income securities where
investors could be assured of the outcome of their so-called investment in
sukuks. The result was, many participants were confused with such conflicting
descriptions of sukuks and as a result they seemed to end that day’s session
with more questions than answers. This experience is no less different from
when the writer participated in an Islamic finance round-table session in Dubai
in the same year. The topic of Mudarabah was discussed and it turned out that
many so called Islamic finance important players who participated voiced their
negative views about Mudarabah. The writer later discovered that many of those
who were holding such views were no other than conventional bankers involved in
Islamic banking windows in that part of the world. Not long after the end of discussion
about Mudarabah, came the topic of personal financing and these same group of
players seemed to be very adamant in proving that their versions of tawarruq as employed in the their
Islamic credit cards are more Shariah compliant than their competitors!. Although we are now in the beginning of the
year 2020, don’t be surprise to experience the same kind of encounter with many
practitioners with the same kind of mentality as narrated above: for them nothing
but debts.
So much we want to make it clear to these fellows
about the correct understanding about sukuks as investment certificates rather than debt ones, just because of their views
that debt financing is better that non-debt based one, they always try to pull
sukuks into the domain of the so called debt market. The problem is that once
this is the adopted framework, it is not surprising to find that sukuk
structures are adjusted to achieve their suspect motive even at the expense of
real Shariah compliance objective. The evidence for this is not difficult to
find: read properly many of the sukuk issuance prospectuses, it is not
difficult to discover how terms and conditions governing the sukuks were laid
down in such a way that at the end of the day the objective of protecting the
principal and profit were to be attained through “clever/smart” documentation contrary
to the Shariah dictate about investment in its true sense. This so called risk
management strategy employed in the legal documentation of many sukuks issued
so far is the clearest testimony of the intended framework within which sukuks
have been practiced all these while.
The reason for this development to happen are numerous
but in this posting the writer only would like to highlight one possible factor
that has lead to this situation. It is the lack of deep understanding about the
nature of Shariah contracts used in structuring many sukuks. Take for example Mudarbah
sukuk; a big issue raised revolves around Mudarabah as being more risky from
risk management perspective and the claim of investors not being fully
protected if this contract is used especially after the AAOFII declaration of
2007 where it was widely reported that there was obvious decline in the number
of Mudarabah sukuks issued after the statement. The market is said to view the
prohibition by AAOIFII of the often used capital and profit protection
mechanisms widely employed before that time as making Mudarabah sukuks to be
more risky to investors. This understanding basically shows to the fact that
the market participants are very lacking in terms of proper understanding about
the nature of Mudarabah especially in the context of protecting the interest of
both the investor and the mudarib involved. For sure risk management is
important in any type of investment decision to be made by any investor, but to
adopt risk mitigation strategy commonly employed for debt-based contracts to
Mudarabah (which is not debt contract) is indeed very unfortunate and shows
among others lack of proper understanding about Mudarabah itself. In the next
posting the writer will discuss further what should be known about risk
management in the context of Mudarabah investment as elaborated by Muslim
jurists to show how, if the guidance is followed, Mudarabah can hopefully be given fair treatment it truly
deserves.
