Risk Management in
Islamic Financial Instruments
28
since they, not the obligor, are viewed as the owners of the asset (Dusuki and Mokhtar, 2010).
Dusuki and Mohktar make specific mention that in unsecured asset-based sukuk and sukuk
holders do not create any claim or charge on the underlying asset. And so, they are normally
ranked pari passu with other unsecured creditors of the obligor. However, in secured asset-
based sukuk, the sukuk holders create charge or claim (either fixed or floating) on the asset.
Interest rate risk is probably the risk factor examined above that concerns sukuk the most,
despite the fact that sukuk rates, unlike conventional bond rates, rely on fixed market rates.
This is the case because when market rates rise, fixed income values fall. For example, suppose
in 01/2014, an investor purchases a 2 year sukuk bond at a 10% annual rate of return, but in
02/2014, market rates increase to 12%. Consequently, his asset earns 2% less than the newly
risen market rates, leading to the investor’s suffering from reinvestment risk, i.e. the
opportunity cost of investing at the new, higher rate (Arsalan, 2004). Additionally, one should
note that, unless the rates in the market fall, then the negative effects of rising market rates
will be sustained by the investor for the duration of their sukuk’s maturity.
Another risk, which underlines the foundation on which sukuk’s have been developed, is the
fact that these instruments are asset-backed, not asset-based, meaning that sukuk holders’
income is partly contingent upon the amount of revenue generate by the underlying asset. This
is not the case in asset-based bonds, which have no P/L characteristics and, in some ways,
from a theoretical perspective, offer more stability in this regard when compared to asset-
backed bonds whose underlying assets could unpredictably fail to generate sufficient monies.
Having said that, because sukuk holders, unlike conventional bondholders, possess the right to
dispose of underlying assets, a way to mitigate asset-backed sukuk transactional risks.
As mentioned earlier in this paper, sukuk, as an Islamic entity, have developed, as financial
instruments, perhaps more than other Islamic entities. Please find Figure 2.4 outlining the risk
characteristics of different sukuk structures, from which one can see that, not only are there
several types of sukuk, from floating rate Ijara sukuk to Musharakah term finance sukuks
(MTFS), but the ways by which credit, interest, and other risks are, for the most part, distinct
from one another. FX risk, barring the fact that diversification could alleviate some exchange
rate-related issues, will not deviate significantly between the different types of sukuk, given
that FX rates are country, not instrument, specific. Price risk, on the other hand, is a
characteristic of the underlying asset’s profitability.
Please see the chart below for a comprehensive outline of the various types of sukuks and how
they are affected by different risk metrics.