Understanding and evaluation of risk in Sukuk structures

Abstract

Purpose This paper aims to reviews Sukuk risk classification schemes based on extending and adapting the risk classification schemes of conventional finance. It is then argued that risk classification schemes based on Sukuk structure provide significant insights into Sukuk risk not obtainable from conventional schemes. This is because Sukuk structure risk classification schemes link Sukuk risk more directly to the fundamental causal factors creating those risks. These links are less evident in conventional risk classification schemes. It is hypothesised that Sukuk structure risk factors will prove to be highly significant in multifactor expected return regressions. Design/methodology/approach The paper argues that, given the paucity of the empirical data currently available to researchers in Islamic finance, greater care needs to be taken in hypothesis development than is necessary for conventional finance. The limited data available should be used for testing hypotheses and not “wasted” in hypothesis formation. Through a meta-analysis of the existing literature on Sukuk risk, it is hypothesised that Sukuk structure risks will be highly significant in explaining Sukuk returns and returns volatilities in empirical tests. Findings The main Sukuk structures, debt based, equity based, assets based, agency based and hybrid structures, arise directly from the requirement of Sukuk to conform to the Shariah and to the fundamental ethical principles of Islamic finance and business. Further, Sukuk risk profiles are directly related to Sukuk structures. Thus, Sukuk structure risks are essentially Shariah risks. The paper presents a Sukuk risk classification matrix based on an evaluation of Sukuk structure risks. Research limitations/implications The findings on the relation of Sukuk risks to Sukuk structures require corroboration by rigorous empirical tests. Social implications The paper contributes to work on the creation of evidence-based risk management techniques in Islamic finance and to the expansion of ethical financial management. Originality/value The paper is one of the early detailed academic studies on the evaluation of risks arising from Sukuk structures.