OVER the years, Islamic finance has not only increased in size, but has also grown complex as finance professionals compete furiously to produce new sharia-compliant transactions and instruments. This innovation is most visible in the world of sukuk.

Generally referred to as “Islamic bond”, sukuk signifies, speaking more accurately, an investment certificate.

The Accounting and Auditing Organisation for Islamic Finance Institutions (AAOIFI) defines sukuk as certificates of equal value put to use as common shares and rights in tangible assets, usufructs, and services or as equity in a project or investment activity.

AAOIFI sets sukuk apart from equity, notes, and bonds. It is made clear that sukuks are not debts of the issuer; they are interests in underlying assets or investment activities.

There are various sukuk structures for instance, sukuk al ijara, sukuk al mudaraba, sukuk al musharaka, etc. used in the market.

All sukuk structures employ techniques that are well developed in conventional markets for structured finance, and have become a significant mechanism for raising finance in the international markets by institutions, corporations, and sovereign and state entities.

The market for sukuk has grown tremendously in recent years (from less than $8 billion in 2003 to $50 billion by mid-2007) as sukuk provide issuers with access to the huge and growing Islamic liquidity pool, in addition to the conventional investor base.

In 2006, banks including UBS, ABN Amro, Barclays, Deutsche Bank, and Société Générale underwrote 190 sukuk issues, raising more than $27 billion. At the moment, sukuk issuance stands at an estimated $80 billion in outstanding debt.

However, the ongoing turmoil in the world economy and the sharp decline in the price of oil have had an adverse impact on the sukuk market.

According to Standards & Poor’s, in the first eight months of 2008, sukuk issuance fell to $14 billion compared to $23 billion over the same period in 2007.

Since the start of October, the market has seen only a handful of sukuk issuances.

Nevertheless, as the Middle East markets remain strong despite the fall in the price of oil, the slump in the sukuk market is expected to be a temporary phase. In fact, analysts are anticipating growth in the sukuk market as there are over $1,000 billion worth of infrastructure projects planned in the Gulf over the next decade and majority of these projects will be seeking sharia-compliant funding.

Though Malaysia and the GCC countries are the centres for sukuk issuance, sukuk issuance is not limited to Muslim countries: there is a growing number of issuers based in the United States, Europe, and other parts of Asia.

For instance, in June 2006, the US saw the issuance of its first sukuk in Texas by Houston-based oil and gas concern East Cameron Partners, which raised $166 million.

Sukuks are offered in specialised exchanges such as the Labuan Exchange in Malaysia, the Third market in Vienna, and the Dubai International Finance Exchange. They are assessed and rated by international rating agencies, and are mostly issued in dollars. However, this issuance in dollars means currency risk for all non-dollar investors.

Not all sukuk structures are beyond controversy. It is an unfortunate fact that, at times, in order to create an Islamic product, finance professionals blithely re-engineer a conventional one and then sprinkle it with Arabic names and terminology.

The future of Islamic finance, in general, and sukuk, in particular, does not look gloomy at least, as long as the Arab oil money is around. However, Muslims need to be careful while devising new products.

They need to make sure that Islamic principles are properly observed and that they don’t present an un-Islamic idea as Islamic just because there is more profit in it.

It is a fact that Islamic financial products generally provide fewer avenues of returns than their western counterparts and, consequently, western investors are less inclined towards putting their funds in sharia-compliant schemes.

But Islamic finance is mainly for Muslims. There is no need to compromise the standards just to make things more acceptable to the western markets.