Rating methodology and evaluating the issuer of sukuk

Abstract

Islamic financial institutions have recently extended their activities in capital markets. Currently, sukuk are the most important tools of the Islamic capital market. They play a significant role in mobilizing resources. Islamic investors prefer that the money is repaid, managed in compliance with Shari'ah and generates an acceptable rate of return. The main objective of this paper is to develop and evaluate an appropriate rating methodology for the issuers of sukuk. First, this research begins with studying the differences between sukuk and conventional bonds. The key idea is to detect the real factors that affect the rating decision for the issuer of sukuk. Second, referring to the structure of sukuk and the international rating agencies (i.e. S&P, Moody's, Fitch, MARC, and IIRA) and using literature based on previous rating research for the issuers of conventional bonds (financial and operational risks) and fiduciary rating (systems failure risk, governance and quality of management), this study proposes an integrated methodology that combines sukuk rating and fiduciary rating that analyses a firm's ability to repay its debt, manage compliance with Shari'ah and provides acceptable performance compared to the market. It investigates major factors influencing an issuer of sukuk and offers a suitable rating methodology. Our research will try to provide a more comprehensive rating methodology suitable for the issuer of sukuk that can be used by investors, financial institutions and the financial market.

Keywords:

• rating factors
• Islamic finance
• sukuk
• business risk
• financial risk
• default risk
• risk sharing
• fiduciary rating

Keywords:

• G15, G21, G32, O16, P51

Acknowledgements

We greatly appreciate the financial support of the SABIC chair for Islamic Financial Markets Studies at Al Imam Mohammad Ibn Saud Islamic University (IMSIU). We thank Professor Mohammad Al-Suhaibani for his consistent support during the course of this work. Our sincere gratitude and thanks go also to Al-Rajhi Capital, who provided us with data from Bloomberg that helped us complete this task through various stages.

Notes

^1. According to the AAOIFI (2004–5, Shari'ah Standards No. 17), it is permissible to establish a reserve account for the purpose of covering such shortfalls to the possible extent, provided this possibility is signaled in the prospectus.