S&P modifies approach to weighing up sukuk risk

S&P has changed its methodology for evaluating the risk of sukuk to take into account the unique features of Sharia-compliant fixed income products.

S&P will now evaluate the risk associated with complex sukuk contracts in emerging market legal jurisdictions.

Sukuk are usually underpinned by specific assets. These assets earn rent, which is paid to investors as dividends.

But when a company defaults on a sukuk, this structure makes it harder for investors to get their money back.

When Nakheel defaulted on its sukuk in 2009, investors did not realise that they had no legal claim to the underlying assets. Lengthy court proceedings, and assistance from Abu Dhabi, meant that investors were eventually repaid – but not before they realised that they had not properly understood the risks.

This is a kind of risk, unique to the structure of sukuk, that investors and ratings agencies need to take into account.

Some analysts have argued the extra risk is not related to the sukuk, but to the legal systems of countries that issue them. Most sukuk use special purpose vehicles or trusts, which hold assets in beneficial ownership for investors.

The law must also specify procedures for default that reimburse creditors.

Unlike corporate bonds, which are usually almost identical in legal terms, sukuk may have many different legal structures. This can make life difficult for lawyers and investors.

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