Sukuk defaults: on distress resolution in Islamic finance

Purpose: This study aims to analyze three major defaults on Sukuk since 2007. These case studies make clear that, in most cases, the problems can be traced back to clauses and structures that made the Sukuk more like conventional bonds. The case studies highlighted the importance of the legal institutions of the country where ownership rights are likely to be contested. Strict adherence to Shariah (Islamic Jurisprudence) principles would have considerably simplified restructuring because Shariah compliance implies a clear allocation of property rights: in Sukuk, investors will receive full title to the underlying Sukuk assets in distress situations. 

Design/methodology/approach: The study follows a qualitative research method base on detailed case studies of the Sukuk defaults occurred in the aftermath of financial crises 2007. The focus in this paper is on the resolution process following default, not on the reasons why the default was triggered to begin with. The authors analyze the Sukuk defaults from an Islamic finance perspective. Specifically, after providing basic information on each Sukuk (issuer, arranger, SPV, term period, rate of return, etc.), the authors present an exposition of the underlying contracts of each Sukuk, their structure, reasons for defaults and restructuring process thereafter. Finally, the authors provide a discussion on the critical issues related to Sukuk structures, namely, ownership of underlying Sukuk assets, rights of the investors including recourse, if any, to core assets in case of distress, risk factors including legal and Shariah risks regarding Sukuk structures, purchase undertakings and credit enhancements. 

Findings: The case studies highlighted the importance of the legal institutions of the country where ownership rights are likely to be contested. Interestingly enough, strict adherence to Shariah (Islamic Jurisprudence) principles would have considerably simplified restructuring because Shariah compliance implies a clear allocation of property rights: in Sukuk, investors will receive full title to the underlying Sukuk assets in distress situations. So, the answer to the question the authors asked, is Islamic Finance failing to deliver on its promises, is a qualified no. 

Originality/value: The paper provides in depth analysis of the Sukuk defaults and provide the main reasons for that along with recommendations that compliance to Shariah principles of ownership and risk sharing would reduce incidence of defaults and facilitates restructuring.