A Sukuk Guarantee Dressed as a Sale
Jabal Real Estate issues USD 300 million of seven-year musharaka sukuk through an SPV. The SPV contributes land and buildings valued at USD 300 million to a musharaka with Jabal; Jabal contributes development expertise. Sukuk holders receive 90% of musharaka profit. Jabal grants the SPV a purchase undertaking to buy the musharaka assets at face value at maturity or on default. The assets are leased back to Jabal at market rent. The sukuk are rated AA because of the undertaking. Two years later Jabal defaults; the assets are valued at USD 180 million and lease income has stopped. Investors claim USD 300 million under the undertaking. A Sharia scholar argues the structure is a guarantee dressed as a sale and that investors never bore ownership risk. The trustee is unsure whether to enforce the undertaking or liquidate the assets.
1. Is this sukuk asset-based or asset-backed? Explain the risk allocation and the Sharia concern.
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This is asset-based, not asset-backed. The SPV owns the musharaka assets, but the purchase undertaking gives investors recourse to Jabal at face value, so the credit risk is mainly Jabal’s, not the assets’. The rating reflects the undertaking, not the property. The Sharia concern is real: if the undertaking guarantees capital and unpaid profit, it resembles a guaranteed return and can be riba. Many Sharia boards permit a purchase undertaking at face value for principal, or at a formula or market value, but not a guarantee of profit. The structure would be stronger if the assets were truly ring-fenced, the undertaking priced at fair value, and investors genuinely exposed to asset risk. The scholar is right that investors did not bear normal ownership risk; the question is whether the undertaking is a permissible exit mechanism or a disguised guarantee.
2. What should the trustee and investors do, and what are the likely recovery prospects?
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The trustee should first establish the true sale and bankruptcy remoteness of the assets, then enforce the undertaking. If Jabal is insolvent, the claim under the undertaking is an unsecured claim unless secured; the assets worth USD 180 million are the investors’ first recourse. Recovery is likely to be the asset value plus a dividend on the unsecured claim, not USD 300 million. The trustee should accelerate, preserve the assets, review the lease and insurance, and negotiate a consensual restructuring. Any restructuring must not add a time-based increase to the claim. Investors should be told the expected recovery range and its basis. If the undertaking is unenforceable or challenged as a guarantee, the Sharia board and legal counsel should be involved before any settlement.
3. An Islamic bank holds 10% of the sukuk. How should it classify, measure and impair the holding after the default?
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The bank should classify the sukuk according to its business model. If held to collect contractual cash flows, amortised cost may be appropriate, but the bank must look through to Jabal’s credit because the sukuk is asset-based. Under AAOIFI FAS 30 or IFRS 9, assess expected credit losses using the default, the USD 180 million asset value and recovery timing; recognise impairment. If held for sale, fair value the sukuk using the distressed price. The bank should disclose its concentration to Jabal and the valuation method. It should not rely on the AA rating after default.