Islamic Finance: Harnessing the Potential of ‘Sukuk Bonds’ for Zanzibar’s Development

Islamic finance is gaining popularity across the globe and Islamic banking assets are steadily growing. The share of Islamic assets in core Muslim majority markets is steadily rising with Saudi Arabia’s reaching over 49% and various other markets expanding with double-digit growth, according to the report released by Thomson Reuters ahead of the Global Islamic Economy Summit in Dubai few years ago.

The existing Islamic finance market stands at an estimated over $1.5 trillion in assets based on disclosed assets by all Islamic finance institutions – full Shariah-compliant as well as those with Shariah Windows – covering commercial banking, funds, Sukuks, Takaful and other segments.

A Sukuk is an Islamic financial certificate, similar to a bond in Western finance that complies with Islamic religious law commonly known as Sharia. Since the traditional Western interest-paying bond structure is not permissible, the issuer of a Sukuk essentially sells an investor group a certificate, and then uses the proceeds to purchase an asset that the investor group has direct partial ownership interest in. The issuer must also make a contractual promise to buy back the bond at a future date at par value.

With the rise of Islamic finance, Sukuk have become extremely popular since 2000, when the first such products were issued in Malaysia. Bahrain followed suit in 2001. Fast forward to current times, and Sukuk are used by Islamic corporations and state-run organizations alike around the globe, taking up an increasing share of the global fixed-income market. Global Sukuk issuance was set to hit $185 billion in 2022 and was projected to reach $257 billion by 2027.

Thus, Sukuk represent aggregate and undivided shares of ownership in a tangible asset as it relates to a specific project or a specific investment activity. An investor in a Sukuk, therefore, does not own a debt obligation owed by the bond issuer, but instead owns a piece of the asset that is linked to the investment.

The Sukuk issued in global capital markets have been predominantly structured as trust certificates, typically governed by English law. Some civil-law jurisdictions that do not recognize the concept of trust have sometimes issued Sukuk structured options as participating notes under legislation similar to that used for asset-backed securities.

In a typical trust certificate transaction, the entity trying to raise funds (the obligor) will establish an orphan offshore special-purpose vehicle (SPV) in a suitable jurisdiction. The SPV issues trust certificates to investors and uses the proceeds to enter into a funding arrangement with the obligor, and the rights of the SPV as financier are held under an English law trust in favor of the certificate holders. The most common structures for funding arrangements in the Islamic market include: a sale and leaseback (Ijara) structure, a form of trade finance (Murabaha) and a joint-venture equity investment (Musharaka).

The trust certificate structure above requires the concept of a trust to be recognized in the relevant jurisdiction where the obligor is located. In many jurisdictions, particularly those from the civil-law tradition, this is very rarely the case. As such, alternative structures have begun to emerge so as to allow for Sukuk transactions to be carried out in accordance with local laws.

 An interesting example of such a trend is exemplified by Turkey, which has passed specific legislation to enable the use of the Sukuk. This legislation allows for the formation of asset-leasing companies, which themselves are a form of SPV regulated by the Capital Markets Board of Turkey.

Tanzania is still in the early stages of adopting Islamic finance as it is at nascent stage of development. Despite that, it has shown positive impact in enabling financial inclusion Up to the end of 2022, the value of issued Sukuk in Tanzania had reached TZS 44.6 billion with potential to more.

According to Zanzibar’s Blue Economy Policy, priority areas include Fisheries and Aquaculture, Maritime Trade and infrastructure, Energy, Tourism, and Marine and Maritime governance.

Fishery subsector, for instance, faces difficulties due to lack of capital to invest in modern facilities. Moreover, there is a deficiency in capacity at seaports to handle the volume of arriving vessels, resulting in significant time wastage and revenue leakages.

Fishery and other sub sectors listed require substantial funds to address existing challenges and significantly contribute to the economy. One key funding avenue that the Zanzibar government could tap into is financial resources and opportunities that are available in islamic banks and windows as well as from the local and international institutions and investors.

Given that the majority of Zanzibar’s fishermen are Muslims who prefer avoiding interest-based loans, Islamic microfinance and Islamic banks/windows present viable alternatives.

To address this issue, the government could consider issuing retail government Sukuk bonds. These bonds would enable common people to invest small amounts, such as not exceeding Tanzania Shillings 50,000/=, to collectively raise the billions needed for projects like acquiring new equipment.

Through profit and loss sharing arrangements, trade-based financing, or leasing arrangements, these institutions can provide much-needed financing to meet the  requirements.

The massive potential for renewable energy particularly through solar and wind among others that can be financed through multiple Islamic financial instruments such as Sukuk, syndicated financing through local and international players that will enable Zanzibar to be self-reliant on energy sources particularly renewable energy.

Sovereign Sukuk requires a legal framework that reflects Islamic principles and incorporates distinctive features. It holds immense potential for Zanzibar.Top of FormBottom of Form

Retail Sukuk shall enable Zanzibar people to, directly, finance their government on reasonable commercial terms rather than existing arrangement of government borrowing on interest basis from commercial banks at high commercial interest rates. The former arrangement brings income directly to people whereas the later is largely for the bankers and shareholders.

The Revolution Government of Zanzibar (RGoZ) is on a path of exploration, seeking alternative financing avenues to drive its development plans and Vision 2050. In a significant stride towards this goal, the government is excited that UNDP Tanzania is at the forefront, paving the way for the issuance of a Sukuk Bond.

With unwavering dedication, UNDP Tanzania pledges its full support towards this transformative initiative. The Zanzibar’s efforts are backed by UNDP’s unparalleled global expertise, gained from supporting similar initiatives in other countries.

Zanzibar will be provided with a vital technical and financial assistance, ensuring that Zanzibar’s journey towards sustainable development is guided and supported every step of the way.

Islamic financial instruments have huge potential and opportunity to finance Zanzibar Blue Economy agenda and projects development. To achieve this, government and stakeholders must attract and retain talent with Islamic finance qualifications, consult and involve Islamic financial practitioners locally and abroad to address several economic challenges facing the Isles.

Dr. Mohammed Mansour