Riyadh, Asharq Al-Awsat-For the first time since the initial issuance of a Sukuk bond in Malaysia in 2001, cases of payments being defaulted on have occurred in the USA, Kuwait, and Malaysia. There are five legal cases that involve the default on payment of Sukuk [so far]. There are also some Sukuk cases that involve technical failures that are expected to develop into cases of legal default at any moment. Therefore the legal risk surrounding this type of [financial] bond – that falls under the provisions of Islamic Shariaa law – is beginning to become apparent. The majority of Sukuk fall under the jurisdiction of the British courts and is arbitrated by British law so long as this does not contradict the provisions of Islamic Shariaa law. Furthermore, many Sukuk issuers have resorted to establishing special purpose companies in certain places around the world for legal or tax purposes, such as in the Cayman Islands, where Sukuk assets can be [safely] transferred.

So how will the default on these Sukuk bonds be dealt with? Will they be treated in the same manner as default on conventional bonds? How will the judiciary deal with cases where British law and Islamic Shariaa law conflict? And in cases of bankruptcy, how will the judiciary deal with Sukuk assets? Will they be considered assets of the Sukuk holders, or will they be included in bankruptcy, thus reducing the Sukuk holders to the level of other creditors with regards to splitting the loss?

In the case of non-secured Sukuk, will Sukuk holders have the right to the Sukuk-issuing company’s assets, or will they be treated as the other normal creditors? And what is the precise definition of payment default under the provision of Islamic Shariaa law? Is it not possible to reschedule these payments, or provide compensation when payment is delayed? Moreover, are the local courts, especially those in the Gulf States, even qualified to provide rulings on Sukuk cases?

These questions and many others are what concern Sukuk-holders and judicial figures today. Everybody is now searching for answers to such questions, whereas under the economic growth seen previously such questions were not even being considered as everybody seemed to be under the impression that Sukuk is immune to the risk of payment default. As a result of this, the risk in Sukuk received no attention from all parties involved in this market whether these parties were governments, financial institutions, or individual investors, although [Islamic financial] specialists warned against ignoring this possibility. Perhaps this comes as a blessing in disguise. [This is because] I believe that the cases of default on payment and the accompanying legal problems will lead governments – represented by their legislative and regulatory bodies – to create the legal framework and the legislative infrastructure to look into this issue and allow the Sukuk market to continue to develop. However the persistence of such legal problems without a solution being found will ultimately lead to investors being reluctant to invest in Sukuk due to the high risk that this represents.

Therefore, I suggest that the Islamic Financial Services Board [IFSB] should take the initiative and work with the international Islamic Fiqh Academy to create a bill to govern the transaction of Sukuk bonds which will serve as a foundation so the IFSB member states can adopt this bill. The absence of any written Islamic Shariaa laws prevents the realization of non-contradiction in the rulings delivered by the British courts and the Islamic Shariaa law in British courts.

I also suggest that the IFSB enacts a Sukuk legislative bill covering all legal aspects of Sukuk risks such as cases of default on payment, bankruptcy and when or when not to resort to the Sukuk assets in a detailed and accurate manner.

The Sukuk market has grown and should not remain without legislations and laws that are appropriate to its individuality and provide the suitable legal environment for investors to engage in this market. There is no point in setting up secondary markets for circulating Sukuk if the laws and legislations guaranteeing the rights of all parties with full transparency and clarity under an effective and qualified judicial system have not been enacted in the first place. This issue is too serious to be delayed.