The Mediaeval Period Of Islamic Civilisation

Published Date: 02 Nov 2017

In contemporary Islamic banking, the essence of sukuk lies in the concept of asset monetisation - the so-called 'securitisation' - which is achieved through the process of issuance of sukuk. Its great potential is in transforming an asset's future cash flow into present cash flow. sukuk, which may be issued on existing as well as specific assets that may become available at a future date, are certificates that represent ownership of specific, revenue generating underlying assets. As owners of the underlying assets, sukuk holders are entitled to the revenues generated by the underlying assets, minus any legitimate deductions such as management fees. sukuk are issued by way of securitisation, the process of converting illiquid, non-tradable assets into liquid, tradable securities. Some scholars stipulate that real assets such as buildings or land comprise at least 51 per cent of the portfolio of assets to be securitised. Other scholars take the view that receivables also qualify as assets for the purpose of securitisation (Wilson 2004, pp. 3).

However, some sukuk defaulted outright. On 27 April 2009, Kuwait-based The Investment Dar (TID) missed a US$100 million payment on its sukuk registered in Bahrain. TID, which claimed 50 per cent of British luxury carmaker Aston Martin in its portfolio of investments, had debts at that time amounting to nearly US$3.5 billion. The default was followed by a dispute with Lebanon's Blom Bank. The Dar default was followed on 12 April 2010 by a failure to pay a distribution payment of US$3.3 million, on a US$200 million sukuk by another Kuwait company, the International Investment Group (IIG) (Tariq 2004, pp. 43).

The same company defaulted a second time on 12 July 2010, failing to pay US$152 million due on another sukuk. The Saad Group of Saudi Arabia, which owns a stake in HSBC, and has been at the centre of fraud allegations, defaulted on a US$650 million sukuk. Texas-based East Cameron Gas Company, which issued a US-offering of sukuk worth US$165 million backed by oil and gas assets, was another defaulter. Most prominent among the 'near defaults' were sukuk issued by Nakheel World, a subsidiary of Dubai World, owned by the Dubai government.8 Due to the extraordinarily large sums involved, the Dubai 'near defaults' had the greatest impact on the sukuk market (Siddiqi 2005, pp. 9).

Islamic rulings (a’kam) for the conduct of commercial activities (mu'amalat) include the permissibility of trade (bay'), risk or profit and loss sharing in commercial enterprise, safeguarding of the public interest (masla?ah), fulfilment of contracts ('uqud), giving full measure in business transactions, documenting future obligations, the avoidance of gharar (excessive uncertainty) and ensuring that wealth circulates among all levels of society. Also included are the prohibition (nahy) of usury or riba, gambling (maysir), hoarding (ihtikar), manipulating markets to raise prices, and producing (or trading in) pork or alcohol. Apart from these basic commands and prohibitions, the principle of original permissibility (iba’ah) applies. This means that a practice is permitted unless it is specifically prohibited by a definitive (qa’'i) text. In general, "[t]he realisation of benefit and the prevention of poverty and hardship are among the cardinal objectives of the economic and political agendas of the Islamic government"(Wilson 2004, pp. 3).

Sukuk certificates are issued by one party (the issuer) and subscribed to (purchased by) another party (sukukholders). Sukuk - like conventional bonds - help channel surplus funds into areas where shortages may be experienced. The key difference between conventional bonds and sukuk is that bonds pay interest whilesukuk pay profit. In Islam, earning returns from the lending of money at interest (riba) is forbidden. Earning profit from trading or other business activity, by contrast, is not only permitted but encouraged. Profit can be earned through trading (distribution of goods and services) or by participating directly in the manufacturing of goods or the provision of services, public or private. Sukuk issued to finance the provision of goods and services provide opportunities for large numbers of people to participate in projects such as schools, hospitals, universities, clinics, factories, bridges, roads, ports, airports, highways and other enterprises. While the "focus of most sukuk offerings has historically been on real estate development projects and generally on acquiring real property [...] there is a recent trend towards new sectors such as energy, oil and gas, and renewable energy" (Siddiqi 2005, pp. 9).

Sukuk are sometimes portrayed as "the Islamic and Shariah compliant alternatives to fixed income, conventional bonds and debt securities". This characterisation is only partly true. Sukuk and conventionalbonds resemble one another in so far as both constitute means of raising and allocating funds in the capital markets. Yet they do so in different ways. In the case of sukuk, funds are raised by selling investment certificates to investors that signify proportionate ownership in an underlying asset, and entitle the holders of the certificates to a proportionate share of the profit generated by that asset or pool of assets. In the case ofsukuk issued to finance trade, this profit is fixed in advance. In case of the sukuk issued to finance other activities, the profit varies according to market conditions. In the case of bonds, however, funds are raised in the form of interest bearing loans (Richard 2005, pp. 1).

With bonds, the principal amount of the loan has to be repaid on a specified date in the future, known as the maturity date. During the life of the bond, the issuers are obliged to make periodic payments of equal value (interest), determined in advance, to the bondholders. The issuer of a bondeffectively borrows at interest from the buyers of the security. In the case of sukuk, the incentive for investors to participate in business is a share of the profit. In the case of bonds, it is a fixed amount of interest, to be paid regularly, no matter how well - or poorly - the business being financed may perform. The relationship between the buyers (investors) and sellers (issuers) of sukuk is one of partners. The relationship between the issuers and buyers of bonds is of a less equal nature, such as exists between creditors and debtors, where in most cases the creditors hold the upper hand (McNamara 2005, pp. 4).

Sukuk are issued to finance private or public enterprise, specifically trading and the provision of goods and services. Sukuk issued to finance trade appear to have the character of contracts of exchange ('uqud mu'awa’at) while those issued to finance the production of goods and the provision of services take the form of contracts of participation ('uqud ishtirak). Both types pay profit rather than interest. All sukuk require assets "to be sold, leased, or invested in. This is the essence of sukuk [...] the certificate should represent an ownership interest in the underlying asset."In contracts of exchange (trade) sukuk evidence a commitment by the sellers (issuers) of the sukuk to pay counterparties (which may be financial institutions) the cost of an asset plus a mark-up, from which comes the profit to the financial institution after expenses associated with the transaction have been paid. The payment is made on a deferred basis. Examples of this type are sukuk muraba’ah where payment is made on a deferred basis (McNamara 2005, pp. 4).

Investors can also participate in profit and loss sharing contracts by means of purchasing sukuk issued by partnerships, such as the mu’arabah or musharakah. Sukuk musharakah and mu?arabah are risk (profit and loss) sharing investment participation contracts par excellence. Sukuk issued (and sold) to raise funds for purposes of participating in productive enterprise evidence the obligation on the part of the issuer to pay proportionate profits to the investors (sukuk holders). The amount of the dividends to be paid to investors (sukuk holders) out of total profits earned depends on a pre-agreed ratio of profit sharing, as well as on the efficiency of the assets purchased using the raised funds. It has been noted that sukuk mu’arabah and musharakah are similar to shares in conventional banking. Like ordinary shares, sukuk enable risk sharing (although more so in the case of participatory contracts than in contracts of exchange). While there are some differences, for example those relating to voting rights, the musharakah sukuk, the mu?arabah sukuk, and conventional shares are all profit and loss sharing forms of participation in productive enterprise. Bona fide profit and loss sharing sukuk cannot default any more than ordinary shares can. The possibility of default in sukuk structured as genuine risk sharing securities in other words does not arise (Hassan 2005, p. 4).

There may be losses from time to time, and these have to be shared just as profits have to be shared, but there are no defaults. The fact that investors are exposed to the possibility of losses is in keeping with the profit and loss sharing principle of Islamic finance. The possibility of losses in risk sharing is, however, mitigated by the possibility and, indeed the prospect that profits, in particular over the longer term, will be greater than losses, if any. In other words, the great advantage of sukuk mu?arabah or musharakah to issuers is that they are less risky to issuers precisely because the risk is shared with investors. Sukuk mu’arabah and musharakah in other words resemble equity financing: "equity financing is less risky in term of cash flow commitments. There is no obligation or liability to distribute or service profit when there is no profit made (Gadar, 2004, pp. 7)."

Raising funds for financing activities other than trading can also take place by means of sale and leaseback of assets, known as sukuk ijarah. Like sukuk muraba’ah, the ijarah is a sale contract, with the added features of a leaseback of the underlying assets by the investors to the originators. In sukuk ijarah, originators first sell specific assets to investors. The same assets are then leased back to the originators by the investors. At maturity, the assets are sold back to the originators by the investors (sukuk holders). The initial sale of the assets to the investors enables the issuers to raise a lump sum of capital. The leaseback from the sukukholders by the originator allows the payment of a regular and (in the short run) fixed stream of income (rent) tosukuk holders. The repurchase of the assets by the originators at maturity enables investors to recoup their principal amounts. Sukuk ijarah have been widely used, by both private sector companies as well as by governments to raise funds in the capital markets for a variety of purposes. The London Stock Exchange listed its first sukuk in July 2006. In part due to generous tax incentives, increasing numbers of non-Muslim institutions are raising capital by issuing sukuk. Sovereign issues have declined in part as a result of difficulties experienced by countries such as Iceland, Spain, Greece and, most recently, Ireland. Sukuk are also becoming popular in the United States. In 2009, General Electric became the first major US company to tap the sukuk market, with a US$500 million issue backed by revenues from its aircraftleasing business (Eastern 2005, p. 2).

Global issuance of sukuk has been fuelled by rising revenues from the sales of oil. The main centres of trading of sukuk are Kuala Lumpur, Dubai, and London. Countries that issue both sovereign and corporate sukukinclude the United Arab Emirates, Malaysia, Saudi Arabia, Qatar, the United Kingdom, Germany, Pakistan, the Philippines, and Indonesia. Since 2002, there have been "seven major types of sukuk and issuance in four currencies and by ten countries". Issuance has been growing on average by 20 per cent per year. In 2007, less than a year before the financial and economic crisis of 2008, a record of US$31 billion sukuk were sold globally. In 2008, global issuance fell to US$14.9 billion.22 Global issuance then rose to US$24.7 billion in 2009.23 In 2010, global sales stood at US$17.1 billion (Eastern 2005, p. 2).

Securitisation

Sukuk are products of securitisation, the process of transforming illiquid assets into marketable securities (liquid assets). A distinguishing feature of 'asset-backed' sukuk is that sukuk holders are paid dividends generated by underlying productive assets that also serve as collateral. These assets are either real (property), debts (financial receivables), or a combination of the two. Securitisation takes place as follows. The originator or party seeking to raise funds (the obligor) sells some of its assets to another company established specifically for the purpose of securitisation (Dommisse, 2005, pp. 7).

This company is known as a special purpose vehicle (SPV) or a special purpose mu?arib (SPM). It acts as a trustee on behalf of the sukuk holders and manages the assets and liabilities of the SPM for a specified period of time, independently of the sponsoring (originating) company. The SPM needs to be bankruptcy remote from the sponsoring company (originator) in order to protect sukukholders from risks arising out of originator bankruptcy. When the SPM is bankruptcy remote from the originator, the investments of the sukuk holders/buyers remain safe even if the originator (the company that sold the assets to the SPM) goes bankrupt. The originator cannot 'claw back' any assets it sold to the SPM in order to stave offa potential bankruptcy or to pay for any of its liabilities (Dommisse, 2005, pp. 7).

The mu’arib (SPM) next issues (and sells) sukuk to both local and foreign investors. The buyers of sukukbecome the sukuk holders (investors). The proceeds of the sale of sukuk pay for the assets bought by the mu?arib from the originator. The SPM remits dividends generated by the underlying assets periodically (twice a year) to the sukuk holders, less agreed-upon fees due to the mu’arib. Most sukuk - like bonds but unlike ordinary shares - come with maturity dates. On 'maturity date' the originators 'redeem' the sukuk by repurchasing the underlying assets back from the sukuk holders, at a previously agreed upon price. This price is invariably the same as the price at which the assets were originally sold by the originator to the sukukholders (investors). The repurchase has the effect of returning to the sukuk holders their initial investments (Aquil 2005, pp. 15).

In February 1988, the Fiqh Academy of the Organisation of Islamic Conference (OIC) declared that issuing and selling sukuk to investors, assuming the required conditions are met, is an acceptable and riba-free way of raising funds in the Islamic capital market. However, the following conditions, among others, need to be satisfied: "The Manager issuing Sukuk must certify the transfer of ownership of such assets in its (Sukuk) books, and must not keep them as his own assets." Moreover, sukuk assets must be "owned by the investors, who would have all the rights and obligations of ownership with respect to the underlying real assets".28 It needs to be emphasised that the claim embodied in sukuk is "not simply a claim to a cash flow but an ownership claim". The sukuk would "lose their Shari'ah compliance without a share in ownership of the asset" (Dommisse, 2005, pp. 7).

In practice, however, it became clear that "many companies do not want to 'sell' their quality assets to investors". As a result, most sukuk have been structured to enable originators to "legally retain" ownership of the underlying assets. The control of the SPMs that purportedly act on behalf of the sukukholders independently of the originators, has likewise in most cases remained with the originators. Accordingly, such SPMs can hardly be described as 'bankruptcy remote'. In still other cases, the underlying assets are not even sold to the mu’arib (SPM) supposedly acting on behalf of the sukuk holders, but remain on the balance sheets of the originators. It would appear that "the assets in the structure are commonly for Shari'ah compliance only. As a result of this practice, in case of a bankruptcy of the originator, sukuk holders would merely have the status of creditors rather than owners of the underlying assets. This produces a considerable degree of risk to sukuk holders (Gadar, 2004, pp. 7).

Asset-based and Asset-backed Sukuk

Sukuk where the ownership of the underlying asset is transferred by way of a true sale to the sukuk holders are known as 'asset-backed'. The "holder of an asset-backed sukuk is the owner of the underlying asset which behaves like collateral". When asset-backed sukuk are sold to investors in this way, the assets become bankruptcy remote. This means that the originator cannot 'claw back' any of the assets in case he goes bankrupt. Sukuk holders become the legal owners of the assets. The true sale and bankruptcy remoteness of the assets ensure that the sukuk are truly 'backed' by assets: "if the originator defaults in its obligation, thesukuk-holders can dispose of [sell] the assets to third parties". Thus the investments of the sukuk holders are protected. Consequently, sukuk holders face less risk. Specifically, they face asset risk rather than originator risk. In case the underlying assets fail to pay expected dividends, sukuk holders can recover their initial investment by selling the underlying assets in the secondary market (Hassan 2005, p. 4).

By contrast, with sukuk where the sale of the underlying assets to the sukuk holders is not a true sale, legal ownership of the underlying assets remains with the originators, or with an SPM controlled by the originators. With asset-based sukuk the ownership of the underlying assets is not legally transferred to the sukukholders. The sukuk holders have only 'beneficial ownership' of the assets. Asset-based' sukuk resemble conventional unsecured bonds, similar to bonds that are not collateralized. Owners of asset-based sukukthus face higher risk than owners of asset-backed sukuk. They face originator risk rather than asset risk (Richard 2005, pp. 1).

Most sukuk are 'asset-based', handing investors ownership of the cashflows but not of the assets themselves. Holders of the vast majority of sukuk do not have proprietary rights but instead, beneficial ownership. The legal standing of investors is akin to that of creditors. In insolvency proceedings, "sukuk [holders would] rank as creditors rather than equity holders. Rating agencies assign lower or no ratings to asset-based sukuk. Only 30% of the sukuk issued have been rated. When they do assign a rating to asset-based sukuk, they assign it on the "creditworthiness of the issuer rather than the assets because of doubts over investors' claim to the assets"(McNamara 2005, pp. 4).

The difference between the asset-backed and asset-based sukuk may not be of much consequence so long as the underlying assets perform well for the sukuk holders (pay the promised dividends). The difference between asset-based and asset-backed sukuk, however, becomes crucial in the event of a default or a prospect of default by the originator, when the protection of the investments of the sukuk holders becomes an issue. In the case of asset-backed sukuk, the investments of the sukuk holders are protected because they are the legal owners of the underlying assets. The sukuk holders can sell the underlying assets - should the need arise - in the secondary market to recover their investments. In the case of asset-based sukuk, however, since legal ownership of the underlying assets remains with the originators, sukuk holders are not able to sell the underlying assets because they do not legally own them. Simply put, although the asset exists in asset-based sukuk structures, in default cases it does not provide protection to the sukuk-holders because they cannot sell it to third parties(Gadar, 2004, pp. 7).

Investors in 'asset-based' sukuk thus face the risk of losing their initial investment in toto. Not every sukukinvestor appears to have realised this. A number of investors appear to have been under the impression that their sukuk "were 'asset-backed', giving them a claim on the assets in the event of a default. In 90% of cases, that is incorrect. Although linked to an underlying asset, most sukuk are not secured instruments and should not be treated as such.

While most sukuk have been asset-based, there have been notable exceptions. In the United Arab Emirates both Tamweel and Sorouh PJSC issued bona fide asset-backed sukuk. The ownership of the assets was fully transferred to the sukuk holders, resulting in a legal ownership of the assets by the sukuk holders, rather than merely in 'beneficial' ownership. Such sukuk holders are exposed to asset risk rather than credit risk (Aquil 2005, pp. 15).

Bond-like Characteristics of Islamic Securities

There is no doubt that adverse economic conditions contributed to the defaults and near defaults. However, the fact that sukuk - apart from not paying interest - were structured to have "bond-like characteristics" also played a role.Despite outward compliance with the shari'ah, "much of Islamic finance today is focused on replicating the conventional system an inevitable consequence is that any problems/flaws are also likely to be replicated (emphasis added)." Sukuk ijarah in particular are customarily structured to resemble conventional bonds. The bond-like features of sukuk are commonly justified by saying that the "market tends to [expect sukuk to be within the 'fixed income' types of investment with minimal or controlled risks and capital preservation features". The "market participants [...] expect sukuk to behave like conventional bonds in terms of capital preservation, periodic distribution frequency and rate of return, and [to possess] any other additional investor protection mechanisms like the ability to take collaterals and credit enhancements" (Hassan 2005, p. 4).

Among features that imparted to sukuk the character of conventional bonds was the undertaking (wa'd) by issuers to repurchase the underlying assets from the investors at par value, on a specified maturity date in the future. The repurchase undertaking (wa'd) is at bottom little more than a way to "repay principal to theSukuk investors".By obliging issuers to repurchase the underlying assets on the maturity date of thesukuk, the arrangers of sukuk (banks or other financial institutions), effectively create an "amount owing" by issuers to sukuk holders. This replicates for issuers a risk similar to that facing issuers of conventionalbonds, the risk of default. The risk takes the form of a possibility that by the time the sukuk 'mature', issuers might not have enough money to repurchase the underlying assets from the sukuk holders. This risk is more precisely known as the asset redemption risk. Asset redemption risk arises "due to the fact that the originator has to buy back the leased assets". It occurs when the originator does not have enough capital "to buy [the underlying assets] back from the certificate holder" (Dommisse, 2005, pp. 7).

While the repurchase undertaking (wa'd) is advantageous to the investors in that it "guarantees" them a repayment of their original investment on a specified date in the future, the need to repurchase the underlying assets imposes an obligation on issuers to ensure that they have sufficient sums of money ready to redeem the sukuk by the time they mature. The requirement to repurchase the underlying assets effectively transforms what should be a profit and loss sharing relationship in the first place - a partnership (musharakah or mu.arabah) - into a creditor/ debtor relationship(Siddiqi 2005, pp. 9). Sukuk have other features "in common with conventional fixed income or 'debt' instruments" sukukagreements are characterised by an absence of a provision to share losses. They promise only profits. Moreover, the quantum of these profits is fixed in advance. By right, profits should fluctuate according to the profitability of the underlying assets, as is the case with all risk sharing securities. The payment of fixed returns, without any provision for sharing losses, is a distinguishing characteristic of conventional, interest-bearing bonds(Wilson 2004, pp. 3).

The commitment to pay predetermined dividends without requiring investors to share losses, mitigates much uncertainty for the suppliers of capital. It provides them with a contractual certainty of earning 'profits' - specified in advance and in isolation from the efficiency of the underlying assets. At the same time, it absolves the investors from any responsibility to share any losses. The promise to pay predetermined dividends, generated in an uncertain business environment, amounts to promising contractual certainty (of profits) on the basis of operational uncertainty. Such an agreement appears rather lopsided and can thus hardly be viewed as a genuine risk-sharing partnership(Gadar, 2004, pp. 7).

The twin practices of refunding to investors their capital by 'repurchasing' the underlying assets (redeeming thesukuk) and paying pre-determined dividends to sukuk holders without requiring them to share any losses, "created sukuk instruments that, in substance, attempt to be identical to conventional bonds". While sukukmay have achieved shari.ah compliance in form, it is less certain that they achieved it in substance. "Questions have been raised as to whether mirroring existing products and returns through financial engineering is a sound basis for the industry to develop. Islamic finance differentiates itself from other forms of finance through the sanctity of the shariah principles on which it is based . If this sanctity is compromised, then the point of Islamic finance is lost. For these and other reasons, The AAOIFI Sharia Board recommends and advises Islamic financial institutions to limit their dependence on operations which closely replicate traditional lending and borrowing, and to capitalize on real musharakah transactions based on profit and loss sharing, in a way that better achieves Shariah objectives (Usmani 2002, pp. 75).

The recommended form of business participation in Islam is the partnership, in the form of the mu.arabah or the musharakah. "Mudharabah may be viewed as equity due to its feature of no pre-fixed periodic payments; rather payments are made from profits, similar to dividends. Further, as a general rule, the rab al-mal cannot foreclose or take legal action if there are no profits for distribution. "Unlike interest-based transactions in which the profit is predetermined, fixed and essentially non-speculative, in the profit-sharing transactions envisaged by the Shari.ah, the profit level remains undetermined and generally predicated on speculative risk-taking."

Advantages of Risk Sharing

"Risk-taking [is] integral to the Islamic modes of commerce such as mudarabah and musharakah." Whensukuk are structured as bona fide risk sharing, asset-backed sukuk, the possibility of default does not arise. There may be losses, but there are no defaults. "If Shariah principles are to be adhered to", the originator or obligor need not pay sukuk holders when there are "no profits to be distributed". Risk sharing securities such as common shares (equity), unlike interest bearing debt securities, do not commit issuers to pay profits without regard to the performance of the underlying assets. Much less do they commit issuers to pay only profits whose magnitude, moreover, is specified in advance. Profits by definition depend on the efficiency of the underlying assets generating them. The prospect that sukuk structured as profit and loss sharing instruments may fail to pay dividends in itself should not be cause for alarm, as the possibility of incurring losses is balanced by the prospect of earning profits (Tariq 2004, pp. 43).

With sukuk designed as profit and loss sharing securities, the requirement to share risk automatically mitigates against overinvestment, as business plans with limited prospects of success will attract few investors. Buyers are more likely to exercise care when investing in risk sharing securities, because they know that they agree to share not only profits but also losses: "investors need to conduct a thorough analysis and due diligence of the underlying assets themselves before they take the decision to invest". The experience of pension funds, insurance companies, hedge funds and investment banks, that suffered multi-billion dollar losses in the recent financial crisis despite the fact that they purchased 'AAA' rated securities, has shown that it is risky to rely on the assessments of rating agencies alone (Siddiqi 2005, pp. 9).

The profit and loss sharing character of sukuk reduces the likelihood that issuers (sellers) of sukuk will raise funds in excess of what is needed to finance viable business proposals. This increases the stability of the issuer and, by extension, of the capital market in which risk sharing securities are extensively utilised. The utilisation of risk sharing securities distributes risk more widely throughout the system, and thus reduces overall exposure for everyone. It also provides a strong incentive to all parties to do what they can to ensure that their respective counterparties remain stable, as all share a common fate. In order to raise funds, issuers of profit and loss sharing (PLS) sukuk need to convince investors that potential profits on the sukuk being offered significantly outweigh potential losses. Business proposals with prospects of success should face little difficulty in attracting sufficient liquidity. By contrast, business proposals with poor prospects will attract few investors. The expanded use of PLS sukuk will thus contribute not only to greater stability of the financial system, but also to a more efficient allocation of capital and the reduction of waste (Richard 2005, pp. 1).

The fact that risk sharing sukuk do not come with guarantees does not mean that holders of such securities cannot recover their investments. Depending on timing and market conditions, holders of risk sharing securities can liquidate their holdings in the secondary market. Sukuk would, however, first have to be structured as asset-backed rather than asset-based securities. "Backing by real assets ensures that a Sukuk is tradable." Backing sukuk by assets would bring the added advantage of stimulating trading in the secondary markets, which are known to be sluggish under the current regimen (McNamara 2005, pp. 4).

While structuring securities in shari'ah compliant ways may not guarantee profits, it does guarantee doing business in ethical and shari'ah compliant ways. Since all business carries risks, there can never be a guarantee of profits any more than there can be a guarantee against losses. Bona fide risk sharing instruments do not come with predetermined and 'guaranteed' profits, 'maturity periods', or 'refunds' of shareholders' capital. These are characteristics of conventional, interestbearing bonds, structured to minimise, if not eliminate, most risks facing creditors. Instead of being structured as risk sharing securities, conventional interest-bearing bonds are structured as risk-shifting instruments, which means that they effectively transfer nearly all risk to the borrowers. Among recent manifestations of this trend is the introduction of variable 'profit rate' housing loans, in which home buyers pay variable amounts on their monthly instalments over the lifetime of the loan, depending on the movements of a benchmark, such as the Base Lending Rate (BLR), to which the 'profit rates' on those loans are pegged. (Wilson 2004, pp. 3)

The practice of pegging or benchmarking protects financial institutions from increases in the costs of their own borrowings. These costs may rise due to increases in the rate at which financial institutions borrow from other institutions, such as the interbank rate. The interbank rate in turn is pegged to the Bank Rate, which is the rate at which the central bank may lend funds to financial institutions as the need arises. While passing on the risk of increases in current interest rates to homeowners may be comforting to financial institutions, it produces a considerable degree of uncertainty to the borrowers, as it means that they never know in advance what amount they may be asked to pay in any given month, with little prior notice.

Between January 2006 and December 2007, before the economic and financial crisis of 2008, Dubai companies issued numerous sukuk. In January 2006, PCFC of Dubai issued $3.52 billion convertible musharakah sukuk, guaranteed by Dubai World, to fund DP World's acquisition of P&O, the UK's biggest ports and ferries operator, the third largest in the world. Dubai World also purchased the Turnberry golf course and a 21 per cent interest in the London Stock Exchange. In December 2006, Nakheel World, a subsidiary of Dubai World, issued US$3.5 billion sukuk. This was soon followed by an additional US$750 million of sukuk. In addition, Jebel Ali Free Zone issued US$2 billion, and Dubai World US$1.5 billion worth of sukuk.74 In 2007, Dubai World purchased the luxury liner Queen Elizabeth 2.

In October 2008, as the global financial crisis was gripping the rest of the world, Dubai announced an ambitious US$38 billion development plan, that included the tallest tower in the world. In the run up to the global financial crisis Dubai World and its investment arm, Istithmar purchased a number of 'trophy properties' that included:

CityCenter Casino & Resort, a large Las Vegas development in which Dubai World teamed with MGM Mirage. Dubai World's share of the CityCenter investment was $5.4 billion . Barneys, the luxury retailer, bought in 2007 for $942 million; 450 Lexington Ave in Manhattan, bought for $600 million in 2006; a stake in the Mandarin Oriental, a 248-room hotel in Manhattan in 2007 at $380 million; and a 50% stake in the Fontainebleau Miami, an 876-room resort hotel in Miami for $750 million [and] the iconic art-deco former Adelphi hotel building on the Strand, WC2. By the end of 2009, Dubai World and its companies accumulated debt of over US$100 billion to over 100 lenders.76 Its debts currently exceed its GDP.77 Publicly, Dubai "acknowledges having US$80 billion of liabilities".78 US$50 billion of its liabilities are scheduled to mature by 2013.79 The United Arab Emirates has a population of 4.5 million and is smaller than South Carolina.

The credit squeeze and a 50 per cent drop in oil prices in 2008 from their peak levels ended a six-year boom, fuelled in part by high oil prices. Sales, profits and asset prices all declined. Property prices likewise dropped 50 per cent from their pre-crisis peak in 2008. In Saudi Arabia the stock market lost up to two thirds of its market capitalisation.80 "Cheap money, leverage and expectations of ever-rising property prices generate 'hot money inflows' which ultimately reverse in spectacular fashion when the bubble bursts." According to several reports, funds from doubtful sources helped fuel the boom. In early 2008, "authorities embarked on a series of high-profile corruption investigations at some big real-estate and finance firms".

The sukuk market "has not escaped the throes of the credit crisis [...] with investment banks and finance houses worldwide still reeling from the collapse of the U.S. sub-prime mortgage market and the breakdown of the wholesale money markets amid persistent counterparty risk concerns and deep-seated investor distrust in credit-sensitive assets". Since the crisis started, approximately US$430 billion of planned development projects, the majority of them in Dubai, have been cancelled (Wilson ,2005 , pp. 27).

Poor investment decisions contributed to the problems. "Many of the high profile sukuk defaults have taken place as the result of poor business decisions, not Shariah."87 With the onset of the economic and financial crisis in 2008, the market for luxurious properties weakened. In 2009 oil prices fluctuated between US$35 to US$80 per barrel. Sales and rentals of properties slowed. There was not enough demand for the newly constructed facilities to generate the income necessary to pay offall the commitments on a timely basis.

In the first half of 2009 Nakheel, which issued sukuk guaranteed by Dubai World but not the Government of Dubai, declared a loss of US$3.65 billion. This compared to a profit of US$722 million during the same period a year earlier. Losses were attributed to slower sales and write-downs in the values of properties. On 22 February 2009 the Abu Dhabi-based central bank of the United Arab Emirates bought US$10 billion of sukukfrom Dubai. Two banks backed by the Government of Abu Dhabi bought another US$5 billion of Dubai Worldbonds. In October 2009, one month before the call for a standstill on sukuk issued by Nakheel, Dubai sold an additional US$2.5 billion of sukuk.

When the economic downturn came, sales and rentals of newly constructed waterfront residential and commercial properties did not generate enough revenue to redeem the assets underlying US$4.1 billion worth of sukuk, the largest ever issued, which matured on 14 December 2009. On 25 November 2009, in a 200 word statement, Dubai World announced that it was seeking six additional months to repay $26 billion of maturing liabilities, including the US$4.1 billion Nakheel sukuk due on 14 December 2009. The announcement sent shockwaves through the global financial markets, raising fears of default on sovereign debt, and triggered an extensive capital flight. "Credit-rating agencies quickly downgraded all governmentrelated debt."The subscribers (buyers) of the sukuk issues comprised both foreign and local investors. A refusal to grant a standstill or restructuring would trigger default and formal bankruptcy proceedings. Such proceedings would have been complex due to the fact that a number of the sukuk agreements lacked clarity regarding the rights and obligations of the counterparties.

Few laws exist in Dubai to govern bankruptcy proceedings: "the prospect of losses has forced creditors to think about some of the uncertainties surrounding