What do you know about sukuk in the Kingdom?

There is little doubt that sukuk emerged as an inevitable consequence of rapid economic developments, and have since established themselves as one of the most consequential financial instruments available for supporting major projects, promoting investment activity, and thereby advancing the sustainable development aspirations shared by nations across the globe. This financial instrument offers a sophisticated alternative that is fully compliant with the provisions of Islamic Sharia, rendering it an attractive proposition for a broad range of investors and financial institutions operating in international markets. (1)

Where the available financial instruments fail to provide sufficient funding for projects — in a manner consonant with market needs and aligned with investor preferences — the search for a complementary mechanism capable of introducing meaningful diversity into the financing landscape becomes not merely desirable but necessary. In the absence of such an instrument, investors would be inclined to deposit their funds in foreign banks in exchange for fixed returns, thereby generating economic surpluses that reinforce the foreign investment climate at the expense of the economies of the majority of Arab and Islamic states. Conversely, certain investors prefer to retain their capital rather than entrust it to entrepreneurs operating within the traditional fixed-return system. It is within this tension between the two extremes that a genuine and pressing problem presents itself — one that demands a considered and effective solution. Sukuk emerge precisely to address the needs of a substantial segment of society, and to contribute meaningfully to resolving the challenges confronting those who require financing and those who possess capital and seek to deploy it productively.

As a financing instrument, sukuk cannot be disregarded; they perform an effective and demonstrable role in the financing of investment and are employed by private companies, banks, and public entities alike to fund their economic activities. Moreover, they make a significant contribution to the financing of infrastructure and major development projects. (2)

The United Nations Economic and Social Council has underscored the importance of sukuk and of participatory financing, noting that the latter assumes particular significance in comparison to the risks that conventional debt instruments pose to the broader economy. (3)

Although the Saudi legislator has yet to establish a comprehensive and dedicated legal regulatory framework for sukuk and their associated procedures within the Kingdom of Saudi Arabia — confining itself to the provisions set out in the new Companies Law issued pursuant to Royal Decree No. (M/132) dated 1/12/1443 AH, specifically in Section 2 of Chapter 4 of Part 4, entitled “Regulation of Debt Instruments and Financing Sukuk,” in Articles 117 through 120 — there is a compelling case for the Saudi regulator to enact a dedicated legislative instrument that encompasses the controls and governing rules for financing sukuk. This would follow the commendable precedent set by a number of Arab states that have enacted specific legislation in this domain, including the Jordanian Islamic Financing Sukuk Law No. 30 of 2012 and the Tunisian Islamic Sukuk Law No. 30 of 2013, among others — particularly given the Kingdom’s recognised standing as a leading nation within the Islamic finance industry.

The strong and sustained demand for Saudi sukuk undoubtedly reflects profound confidence in the resilience of the Saudi economy and its capacity to manage public debt with a high degree of efficiency. This confidence is not incidental but is rather the product of disciplined fiscal policies and strategic investments pursued under the framework of Vision 2030, which places particular emphasis on the diversification of income sources and the reduction of dependence on oil revenues. (4)

To arrive at a thorough understanding of Saudi financing sukuk, it is necessary to address the following operative questions: What do the terms “financing sukuk,” “issuance of financing sukuk,” and “convertible sukuk” signify? What are the defining characteristics of financing sukuk? What distinguishes financing sukuk from conventional debt securities? And what are the conditions and procedures governing the issuance of financing sukuk?

First: Definition of Sukuk

The Saudi legislator defined financing sukuk in Article (2/d) of the Capital Market Law (5) as “any instruments representing profit-sharing rights, any rights to the distribution of assets, or both.” Paragraph (e) of the same article further stipulates that the definition extends to “any other rights or instruments that the Council deems appropriate to include and approve as securities, where it considers this necessary to ensure market integrity or investor protection.”

Some scholars have defined sukuk as “the totality of issued financial products whose offering and trading are conducted in accordance with Sharia principles, such as the issuance of representative sukuk, participation sukuk, or istisna’a contracts, among others.” (6)

Others have characterised them as “securities of equal value, issued on the basis of a salam, istisna’a, or murabaha contract, in national or foreign currency, through public or private subscription, representing common shares in the ownership of their assets, with holders sharing in profits and losses, and subject to the term stipulated by law.” (7)

The International Islamic Fiqh Academy, for its part, defined securitisation as “the issuance of financial instruments or certificates of equal value representing common shares in the ownership of assets — comprising tangible assets, benefits, rights, or a combination of tangible assets, benefits, cash, and debts — that already exist or will be created from the proceeds of the subscription, issued in accordance with a Sharia-compliant contract and governed by its provisions.” (8)

Second: The meaning of issuing sukuk

Some scholars define the issuance of sukuk as “the offering of securities for subscription, with the aim of obtaining financing.” (9) Other jurists characterise the issuance of sukuk as “the process of bringing securities — including sukuk — into legal and commercial existence, so that those wishing to invest may subscribe to them, thereby transforming them from a theoretical construct into a tangible financial reality. This process entails a series of procedures commensurate with the nature of each specific type of sukuk, the character of which varies according to the safeguards the legislator intends to provide in order to ensure adequate protection for all parties involved in the issuance process.” (10)

Third: The meaning of convertible sukuk

Convertible sukuk constitute a distinct category of financing sukuk issued by a public joint-stock company; as their designation implies, they are capable of being converted into shares. These sukuk fall into one of two categories: they may be temporary financing sukuk — as is the case where the holder exercises the right to withdraw at a specified point in time and recover their value together with any accrued benefits — or they may be permanent financing sukuk that convert into shares. (11)

Some jurists define convertible financing instruments within the Saudi legal system as “a type of security issued by a public joint-stock company in the form of ordinary instruments, entitling the holder to convert them into shares at a specified date, or to receive the face value of the instrument together with a percentage of the profits, if realised, or to bear any losses incurred within the specified term, during the participation period and upon the termination of their relationship with the company.” (12)

Fourth: Characteristics of Financing Instruments

It is apparent from the foregoing definitions that the defining characteristics of financing sukuk are as follows:

1. Financing instruments are registered documents of equal nominal value.
2. The instrument represents a common share in real ownership of underlying assets.
3. The instrument is issued on the basis of a valid and Sharia-compliant contract and is governed by its provisions.
4. The absence of any guarantee by the manager, whether in the capacity of mudarib, agent, or managing partner.
5. Sukuk holders share in the distribution of profits in accordance with the specified ratio and bear losses in proportion to the share represented by the sukuk; the holder is not entitled to a predetermined percentage of the instrument’s face value or a fixed lump sum.
6. The investor assumes the full investment risk associated with the underlying assets or project.
7. Sukuk holders bear the burdens and consequences arising from ownership of the assets represented by the instrument, whether such burdens take the form of investment expenses, a decline in asset value, maintenance costs, or insurance premiums. (13) (14)

Fifth: The difference between financing instruments and debt securities

Sukuk are materially distinguished from conventional debt securities in that the latter are structured as a collective debt obligation owed by the company to its holders, who are entitled to the repayment of the principal amount together with a fixed and agreed rate of return, irrespective of whether the company generates a profit or sustains a loss. The company’s assets and capital serve as collateral in the event of insolvency or bankruptcy. (15)

By contrast, holders of sukuk enjoy no guarantees with respect to the value of their instruments, save for the entitlement to a return rate conditional upon the company generating profits. Where the company fails to generate profits, sukuk holders are not entitled to claim the agreed return rate set out in the prospectus; (16) rather, they are required to bear any loss sustained by the company to the extent that it falls within the company’s financial liability. It is beyond doubt that this regulatory characterisation of financing instruments, as elaborated above, is fully consonant with the provisions and principles of Islamic Sharia. (17)

Sixth: Conditions for Issuing Financing Sukuk

The following conditions must be duly satisfied for the issuance of sukuk to be legally valid:

1. A resolution must be issued by the extraordinary general assembly.
2. The company must have been actively engaged in business operations for a minimum of three years, in accordance with Article (22/3) of the Rules for the Offering of Securities and Continuing Obligations. (18)
3. The prospectus must expressly provide for the possibility of converting the financing sukuk, in accordance with Article (117/2) of the Companies Law, in the case of convertible sukuk.
4. The issuing entity must issue a formal resolution approving the offering of the financing sukuk.
5. The assets and liabilities of the financing sukuk project must be precisely identified and specified.
6. The financing sukuk must be issued pursuant to a formal and legally binding contract.
7. A Sharia Committee must issue a ruling expressly approving the issuance of the sukuk in conformity with the provisions of Islamic law.
8. The preparation and submission of a prospectus, which constitutes a legally binding document issued by the issuer of the security. (19)

What are financing sukuk under the Saudi system?

Under the Saudi legal system, as defined by the Capital Market Authority, financing sukuk are characterised as “any instruments representing profit-sharing rights and any rights to the distribution of assets, or either of them.” The definition further encompasses any other rights or instruments that the Capital Market Authority deems appropriate to classify as securities for the purpose of ensuring market integrity and protecting investors.

Beyond the formal legal definition, the substance of financing sukuk may be further clarified through the jurisprudential and technical definitions found in the relevant sources, as follows:

• Securities of equal value: Issued on the basis of Sharia-compliant contracts — such as salam, istisna’a, or murabaha — whether denominated in the national or a foreign currency.
• Representation of common shares: These instruments represent common shares in the ownership of assets that already exist or will be brought into existence from the proceeds of the subscription, and such assets may take the form of tangible assets, usufructs, rights, or a combination thereof.
• Profit and loss sharing: Holders of these sukuk participate in the financial results of the underlying project — whether profit or loss — and their tenure is subject to the term prescribed by the applicable legal framework.
• Sharia-compliant financing instrument: A category of financial products offered and traded in accordance with Sharia principles, constituting an advanced and legally sound alternative that provides the financing necessary for projects outside the conventional fixed-return system.

In addition, specialised types exist, most notably convertible sukuk, which are issued by public joint-stock companies and confer upon their holders the right to convert them into shares at a specified date, or alternatively to redeem their face value together with any realised profits.

What are the key characteristics of financing sukuk?

Financing sukuk possess several defining characteristics that distinguish them as an investment and development instrument. The most prominent of these characteristics, as identified in the relevant sources, are as follows:

• Nominal documents of equal value: Sukuk are issued in the form of certificates or instruments of equal face value.
• Representation of a common share in real property: The instrument does not represent a debt obligation of the issuer, but rather a common proprietary share in real underlying assets, whether tangible assets, usufructs, rights, or a combination thereof.
• Based on a Sharia-compliant contract: The instrument is issued on the basis of a Sharia-compliant contract — such as a salam, murabaha, or istisna’a contract — and all legal consequences arising from that contract attach to the instrument accordingly.
• Absence of managerial guarantee: The manager — whether in the capacity of mudarib, agent, or managing partner — is legally prohibited from guaranteeing the value of the instrument to its holders.
• Profit and loss sharing: Sukuk holders share in the realised profits according to the specified ratio and bear losses in proportion to the share represented by the sukuk. A fundamental restriction exists whereby the specification of a fixed lump sum or a predetermined percentage of the sukuk’s face value as the investor’s return is legally impermissible.
• Assumption of investment risks: The holder of the instrument assumes the full investment risks associated with the project or the underlying assets represented by the instrument.
• Assumption of asset ownership liabilities: Sukuk holders are responsible for all costs and liabilities arising from ownership of the underlying assets, including maintenance expenses, insurance premiums, depreciation charges, and operational investment costs.

What are the conditions for issuing financing sukuk in the Kingdom?

The issuance of financing sukuk in the Kingdom of Saudi Arabia requires the satisfaction of a comprehensive set of regulatory, legal, and technical conditions, designed to safeguard the integrity of the issuance process and protect the interests of investors, as follows:

• Issuance of a resolution by the Extraordinary General Assembly: The issuance must be formally initiated by an official resolution of the company’s Extraordinary General Assembly.
• Engagement in actual business operations for a specified period: The company must have been engaged in substantive business operations for a minimum of three years, in accordance with the rules governing the offering of securities and continuing obligations.
• Approval of the offering: The issuer must issue a formal resolution expressly approving the offering of the sukuk.
• Identification of assets: The assets and liabilities of the financing sukuk project must be accurately and comprehensively identified.
• Contractual basis: The sukuk must be issued pursuant to a formal and legally binding contract.
• Sharia approval: Issuance is permissible only upon a Sharia committee issuing a ruling authorising the issuance of the sukuk in conformity with the provisions of Islamic Sharia.
• Prospectus: The issuer is obligated to prepare and submit a prospectus, which constitutes a legally binding document issued by the issuer of the security.
• Conversion condition (for convertible sukuk): Where the sukuk are convertible into shares, the offering document must include express and unambiguous language clarifying the possibility of such conversion in accordance with the applicable provisions of the Companies Law.

What is the economic significance of these sukuk within Vision 2030?

Sukuk constitute a strategic instrument within the contemporary Saudi economic landscape and assume particular significance in the context of the objectives of the Kingdom’s Vision 2030, as elaborated upon through the following considerations:

• Diversifying sources of income: Sukuk form an integral component of the strategic investments and disciplined fiscal policies that Vision 2030 promotes, with the overarching aim of reducing the economy’s overall dependence on oil revenues.
• Boosting global confidence in the economy: The strong and sustained demand for Saudi sukuk reflects substantial confidence in the resilience of the national economy and its demonstrated capacity to manage public debt with a high degree of efficiency — confidence that is a direct consequence of the strategic planning and institutional framework of Vision 2030.
• Financing infrastructure and major projects: Sukuk perform a pivotal role in financing major development projects and the economic activities of private companies, banks, and public entities, thereby providing material support to the Kingdom’s urban and developmental progress.
• Attracting investment and localising capital: Sukuk provide a sophisticated investment alternative that is compliant with Islamic Sharia, thereby dissuading investors from depositing their savings in foreign financial institutions. In their place, domestic economic surpluses are generated that serve to strengthen the local investment climate.
• Supporting sustainable development: These instruments perform a vital role in supporting projects and promoting investment activity, thereby making a direct and measurable contribution to the sustainable development objectives to which the Kingdom is committed.
• A safe alternative to conventional debt: Participatory financing instruments — such as sukuk — assume considerable significance as a less risky financing alternative relative to conventional debt instruments and the systemic risks the latter pose to the broader economy.
• Bridging financing gaps: Sukuk effectively address the needs of a substantial segment of society seeking Sharia-compliant investment channels, connecting those in need of financing with capital holders in a manner that generates broader macroeconomic benefits.

Conclusion

This article examines financing sukuk as a modern financial instrument that is compliant with the provisions of Islamic Sharia and performs a fundamental role in supporting major development projects and advancing the objectives of sustainable development. The article highlights the significance of these sukuk in attracting domestic investment and preventing the outflow of capital, while emphasising their contribution to the strengthening of the Saudi economy within the framework of Vision 2030. The article further reviews the legal and definitional dimensions of sukuk, elucidates the fundamental distinctions between sukuk and conventional bonds with respect to risk allocation and profit distribution, and addresses the defining characteristics of sukuk and the regulatory conditions governing their issuance within the Kingdom. It underscores the imperative for the establishment of a comprehensive regulatory framework befitting Saudi Arabia’s leading position within the Islamic finance industry. The article additionally presents the various types of sukuk — including convertible sukuk — as a flexible and innovative instrument capable of meeting the expectations of both investors and corporate issuers.

Sources

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