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Bond investments are common, conventional fixed income instruments. The issuer promises to make regular interest payments to the investor until a specified date (the maturity date). Once the bond matures, the interest payments cease, and the issuer is required to repay the face amount of the principal to the investor. Bonds are effectively loans with interest. If a company defaults on its bonds and goes bankrupt, bondholders will have a claim on the company’s assets and cash flows. The bond’s terms determine the bond-holder’s place in line, or the priority of the claim. Priority will be based on whether the bond is, for example, a secured bond, a senior unsecured bond or a junior unsecured (or subordinated) bond. Whether a bond is senior or subordinated, conventional bonds are non-Shariah compliant. Practitioners in the Islamic finance industry have endeavoured to engineer alternative Shariah compliant products. Proposed alternatives to senior and subordinated bonds are senior and subordinated Sukuk. Sukuk in essence were designed to provide an Islamic alternative to a bond instrument. Tranching and subordination in Sukuk led to debatable Sukuk products. A concept known as Tanazul (wavering) is proposed by some Shariah scholars to develop subordinated Sukuk. Other Shariah scholars have raised concerns on such Sukuk structures and have proposed alternative and more acceptable methods to engineer Shariah compliant subordinated Sukuk. This may be possible by utilising different profit and loss sharing models, splitting the underlying Sukuk assets into an equity and debt instruments in two different contracts forms. Such engineering can create tranching effects which do not contravene Shariah principles.
The entire paper can be downloaded from the following link:
https://shariyah.com/insights-research/

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Research Paper – Measuring Shariah Compliance in Senior & Subordinated Bonds

  • November 25, 2018
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