Sukuk and blockchain. In this session, We will define the concepts of Sukuk and Blockchain We will learn the characteristics of the Blockchain technology We will see the benefits of issuing Sukuk on such technology, then We will learn how Sukuk can be issued on a Blockchain What are Sukuk? Sukuk is a financial certificate that represents an interest in an underlying securitised asset. Sukuk allows companies to raise finance through capital markets by issuing certificates to investors. Sukuks come in various structures such as Ijarah, Murabahah, Mudarabah, and many other forms. They have come a long way since the 1990, which saw the first Sukuk issued by Shell MDS in Malaysia. Today, Sukuk total issuance surpasses USD 1.35 trillion, and over 15,000 have been issued by a variety of sovereign, quasi-sovereign bodies, financial institutions and corporates across 31 countries. To date, Sukuk have been issued via legacy-based systems on centralised exchanges. Sukuk have been listed on various exchanges including Bursa Malaysia, Nasdaq Dubai and the London Stock Exchange. However, with the rise of Bitcoin and cryptocurrencies, there has been a great enthusiasm towards issuing Sukuk on blockchain. Characteristics of the Blockchain Technology What is a Blockchain? Put simply, blockchain is a shared, distributed ledger that facilitates the process of recording transactions and tracking assets in a network. An asset can be tangible a house, a car, cash, land or intangible like intellectual property, such as patents, copyrights, or branding. Virtually anything of value can be tracked and traded on a blockchain network, reducing risk and cutting costs for all parties involved. With blockchain, many people can write entries into a record of information, and a community of users can control how the record of information is amended and updated. It is this difference that makes blockchain technology so useful it represents an innovation in information registration and distribution that eliminates the need for a trusted party to facilitate digital relationships. The Key Elements of Blockchain are: The distributed ledger technology All network participants have access to the distributed ledger and its immutable record of transactions. With this shared ledger, transactions are recorded only once, eliminating the duplication of effort that’s typical of traditional business networks. Records are immutable No participant can change or tamper with a transaction after it has been recorded to the shared ledger. If a transaction record includes an error, a new transaction must be added to reverse the error, and both transactions will be visible. Smart contracts These are self-executing contracts that follow written lines of code describing the contracts’ terms and conditions. The code is created on a distributed and decentralised blockchain network, and the transactions are automatically executed when the agreed terms and conditions are met without any central authority. As a result, the transactions are trackable and irreversible. Benefits of Sukuk on Blockchain Some of the purported benefits of issuing Sukuk on a blockchain are as follows: Traceability of transactions, Using blockchain could help reduce the industry’s exposure to risks related to transaction security or identity theft. It could also disrupt the way sukuks are issued and managed. Blockchain could resolve three challenges related to sukuk issuance and management: The traceability of underlying assets, which would help investors to better understand the risks related to sukuks in their portfolios. The traceability of cash flows, which would help issuers to implement prompt corrective actions if one of the underlying assets underperforms. The traceability of investors, which together with smart-contract protocols could create faster, and even out-of- court, resolutions for sukuk disputes. Improved governance, Regulatory technology could help the Islamic finance industry with more robust tools to achieve compliance with regulations and Shariah requirements, assuming agreed Shariah standards are in place. It could also minimise the reputation risk related to a potential breach of Shariah requirements, and free up Shariah scholars to focus on innovation. A prerequisite for fintech to enrich the Islamic finance industry is the provision of an adequate physical infrastructure and the implementation of the necessary supervision and regulatory framework. This is why several regulators and authorities in the GCC and elsewhere have launched incubators or specific regulatory “sandboxes”, where fintech companies can test innovations in the real market but in a restricted regulatory environment. Reduced costs, Intermediaries can potentially be reduced on a blockchain and therefore lower the costs associated with Sukuk issuance. At present, Sukuk carry various costs including legal costs, Special Purpose Vehicle (SPV) costs, listing costs, agent & registrar costs, rating agencies’ costs, Joint Lead Manager (JLM) fees, and other fees. The future certainly looks bright for Sukuk and Blockchain. The next decade will be pivotal in further experimentation. Sukuk on Blockchain In October 2019, the Indonesian Islamic microfinance cooperative BMT Bina Ummah raised 710 million rupiah (about USD 50,000) through the world's first primary sukuk issuance on a public blockchain. This was issued through Blossom Finance’s platform. The first Smart Sukuk™ launched by Blossom was a Mudarabah-based facility underpinned by 80 Microfinance Institutions (MFIs) in central Java, Indonesia. The Sukuk issued on Blossom’s platform ran on the Ethereum blockchain, a public blockchain that supports smart contracts. These programs can facilitate safe and secure transfer of value including certificates representing ownership of assets, like sukuk. An important consideration for sukuk are the pro-rata rights of investors. Periodic profit distributions must be paid correctly based on the current ownership of the sukuk. Since sukuk is a capital market instrument, the ability to trade in secondary markets and grant custody to third parties are important features. As such, these attributes are key when developing sukuk on a blockchain and that’s why Ethereum was selected as it permits these functionalities. Another potential Sukuk structure which has been conceptualised on a blockchain is the Ijarah Sukuk. The transaction flow on a blockchain would be as follows: Investors purchase Ijara sukuk issued on a blockchain at a determined price. The proceeds will be channelled through an SPV to the originator of the assets (lessor) The blockchain will be used to track the pool of Ijara assets Having the rights to use the assets, lessees will make all payments to the lessor on the blockchain to track cash flows As the Sukuk mature, payments will be channelled from the lessor to the Sukuk holders through the SPV The blockchain will enable tracking the investor base and automating some of these transactions. This automated execution on a blockchain when certain terms and conditions are met is what we call a Smart Contract. Module Summary In this session, We have defined concepts of Sukuk and Blockchain We have identified the characteristics of the Blockchain technology We have seen the benefits of issuing Sukuk on Blockchain, and we have learned how Sukuk can be issued on a Blockchain