Sukuk Securities: New Ways of Debt Contracting

CHAPTER 14 A Matter of Choice: Sukuk or Bond?

The market for sukuk securities described so far is about a new class of corporate and sovereign debt instruments that are increasingly being viewed as an alternative to conventional interest-based issuances. This new security is increasingly being issued across the world by both private firms and governments and their agencies. This funding is for production, not consumption. In fact, the first public issue in this market was by an international firm, the Shell Oil Company. In recent years, the World Bank issued medium-term sukuk to raise capital for its development financing. Available statistics further suggest that there are slightly more sovereign debt issues than private-sector debt issues in the sukuk markets (not counting over-the-counter contracts).

The question that arises is why sukuk is chosen by borrowers to raise money instead of common bonds. This question is especially interesting because AAA yields of private sukuk instruments are significantly lower than the yield of equivalent conventional bonds, which makes this form of funding slightly less expensive for borrowers. What the attraction is of a funding mode that offsets the lowered cost of sukuk financing is a pertinent question. Zero-risk sukuk yields are higher than common zero-risk bonds. In this chapter, we speculate on the economic logic behind the choice of this new profit- and risk-shared financing over the one-sided, prenegotiated, interest-based financing. ...