Weighing in on the Role of Sukuk in Combating COVID-19

By Greget Kalla Buana

The Coronavirus Disease (COVID-19) has not only caused a serious health crisis, but has also had pressing economic, social, and political ramifications globally. According to the IMF, the economic impact is worse than the 2008 recession. Many countries have incurred higher foreign debt, including Indonesia. The World Bank has estimated that the outbreak will slash the country’s economic growth to 2.1 percent.

Having the largest Muslim population in the world, people in Indonesia pay much attention to the lockdown strategy exemplified during the lifetime of Prophet Muhammad as a hadith says, “If you hear of a plague in a land do not enter it; and if it breaks out in the land where you stay, do not leave.” Some also refer to the Prophetic manners, which is to cover the mouth when yawning and sneezing.

In addition to that, zakat as an Islamic charitable giving whose potential collection up to US$16 billion has been in the spotlight. Zakat, along with other Islamic donations, such as infaq, sadaqah, and waqf are acting as a reliable social safety net in the society. Islam has more than that, including financial stimulus for the battle against the outbreak.

The Government of Indonesia issued US$4.3 billion in bonds to combat the current economic turmoil which may threaten the achievement of the SDGs. The dollar-denominated bonds are part of Government’s plan to complement the fiscal measure. Despite being issued amid the pandemic, the bonds are not pandemic bonds.

Pandemic bonds are a type of catastrophe bonds (CAT bonds) or insurance-linked securities (ILS)—an investment vehicle whose values are driven by insurance loss events issued by insurance company, financial institutions, and governments—to protect against the cost of a pandemic by transferring specified risks from issuer to investors. Investors receive higher coupons in compensation for the risk of losing the principal upon occurrence of qualifying perils, and the issuer receives the money to cover their losses.

CAT bonds have been issued around the world, most notably in Africa (Democratic Republic of Congo, Kenya), Asia (Japan, Philippines), and Latin America (Chile, Colombia, Mexico, Peru), which comprise natural disaster and adverse climatic conditions, such as drought, earthquake, flood, hurricane, tsunami. It bolster the case for Indonesia to issue these bonds considering three major disasters occurred in 2018. Since the ongoing outbreak can be construed as a natural phenomenon, the same approach can be used to issue pandemic bonds.

In 2017, the World Bank launched the first pandemic bonds worth US$500 million scheduled to mature on July 15. Unfortunately, COVID-19 has threatened losses that the bonds would likely pay out. Since the bonds require certain death rate to occur as part of its trigger criteria, they have been criticized as “nonsensical”.

Given that Indonesia holds the lead in regularly issuing sukuk (Islamic bonds) it is timely to explore them as an alternative solution for the current financial conjuncture.


New formulas to old problem

Sukuk are a good way to access large scale financing by structuring instruments that promote social good through risk sharing. Unlike conventional bonds which are essentially debt, the underlying asset in sukuk should be considered. As sukuk grant partial asset ownership, investors have the right to receive profits, meaning that selling sukuk is selling benefits of the ownership. Combining sukuk with other Islamic finance instruments is interesting.

First, sukuk retakaful. Takaful is an Islamic insurance where members pool money to protect one another against loss. It is based on tabarru’ contract of which a portion of the contribution is treated as donation, hence, it is not solely for commercial purposes. According to a report by IMARC Group titled Takaful Market: Global Industry Trends, Share, Size, Growth, Opportunity and Forecast 2020-2025, global takaful market reached US$23.7 billion in 2019 and projected to reach US$48.1 billion by 2025. The growing takaful market has resulted in much greater demand for retakaful—a shariah-compliant reinsurance—due to limited capital to cover the whole risks in takaful portfolio.

In conjunction with CAT bonds, reinsurance shifts part of the risk to strengthen insurance sectors in spreading losses to a wider group of risk carriers. This risk-sharing is important in the case of CAT bonds whose risk is low in probability, yet high in severity. CAT bonds are an example of conventional insurance securitization—transforming illiquid asset into securities—which transfers risks from issuer or sponsor to capital market investors. Such scheme, by definition, is a reinsurance mechanism.

In Islamic securitization, asset-backed is the most suitable method due to the transfer of assets as well as the most effective in preventing crisis, especially if the likelihood of moral hazard increases. Sukuk retakaful are one way of takaful securitization. Both sukuk retakaful and CAT bonds are uncorrelated with the financial markets and unaffected by economic conditions that make them more appealing to investors. They solely rely on predetermined catastrophe incidents. Consequently, the coupons are stable even when the market goes down.

However, sukuk retakaful, by concept and structure, are different from any regular sukuk of which principal must be returned to the investor. Sukuk retakaful are basically insurance securitization, which are structured for a relatively short-time maturity (three to five years) and expected to be purchased by institutions, namely mutual funds, pension funds, sovereign wealth funds, not individual. Investors receive a coupon that is greater than other fixed-income securities for two actions: contributing money and bearing catastrophic loss when it happens.

Unlike CAT bonds that expose investors to the risk of substantial losses when triggered, sukuk possibly provide a different attitude since the issuance of sukuk retakaful promotes an asset-backed securitization to investors. The risk of loss can presumably be modified using sharia-compliant pricing model as well as the presence of underlying assets in sukuk. Although existing studies on sukuk and takaful do not document the practice of sukuk retakaful, merging the distinctive feature of sukuk (asset-backed) and the nature of takaful (tabarru’) can be an innovation to boost both financial and real economy.

Second, waqf sukuk as known as cash waqf-linked sukuk (CWLS). A social investment where cash waqf invested in sukuk. This type of sukuk does not require the actual coupon to be given to sukuk holders, but harnessed to finance social projects. The principle of perpetuity that preserves the waqf asset and redistribute the benefits distinguishes it from other endowment or charitable fund.

The Indonesian Government, for the first time, has issued CWLS SW001 through private placement in March. The Rp50 billion (US$3 million) sukuk is for five years with investment returns in the form of discount and 6.15 percent coupon. The discount, which is paid once at the beginning of transaction, is used for renovation and provision of medical equipment to support the development of Retina Center at a waqf hospital Achmad Wardi while the coupon is paid every month to finance free-of-charge cataract surgery services at the same hospital. It demonstrates how exactly waqf sukuk multiplies the benefits.

Through Presidential Decree No. 7/2020, Government appointed the National Disaster Mitigation Agency (BNPB) to lead emergency measures regarding COVID-19 considering it as a catastrophic plague. Financing disaster recovery is governed in accordance to Law 24/2007 on Disaster Management of which the Government is responsible for relief operation, infrastructure reconstruction, and financial assistance. The Agency has estimated an ideal disaster fund of Rp15 trillion annually. However, the available resource is away from that figure. How can waqf sukuk help address this gap?

Through private placement, waqf sukuk can be expanded to the market without excluding individual participants. Since there is approximately US$12 billion cash waqf potential stored in the society, financial intermediary institution eligible to receive individual cash waqf should be present to increase the collection of cash waqf. The more people donate cash waqf, the higher value of sukuk can be issued.    

The next waqf sukuk issuance is expected to put in a framework of COVID-19 responses. In the context of unprecedented pandemics, waqf sukuk helps provide additional amount as part of front-loading strategy. Proceeds of the sukuk can be used for building additional infrastructure while the return can support relief operation and financial assistance, in particular provision of personal protective equipment, cash transfer or cash-for-work for those losing their jobs.

Third, murabahah sukuk. A less commonly used sukuk structure, which is intrinsically a sale and purchase agreement based on shariah principle. Murabaha itself is a contract of sale at an agreed cost-plus-profit, hence, the murabahah sukuk include a disclosure of the original cost and the mark-up price.

In 2014, vaccine sukuk using murabahah sukuk structure were issued by International Finance Facility for Immunization (IFFm) for US$500 million to help finance the immunization program with Gavi, the Vaccine Alliance. It was followed by $200 million vaccine sukuk one year after signaling warm market reception. The vaccine sukuk brought the concept of socially responsible investing to the market by delivering social returns to the world in the form of live-saving mission.

In late 2018, IFFm completed a private placement of US$50 million vaccine sukuk with Islamic Development Bank as the investor. To date, there are many COVID-19 candidate vaccines under development. Nevertheless, it requires commitment in terms of funding from governments or any supranational entities. Vaccine sukuk is a proven solution that worth tapping into.

Global sukuk issuance is set to grow modestly in 2020 with a projected increase to nearly US$75 billion (US$71 billion last year) according to rating agency Moody’s. Within the last 15 years, the overall growth of sukuk market amounted to a compound annual growth rate of 30.6 percent (Islamic Financial Services Board, 2019). It is the fastest growing segment of Islamic Finance industry.

In Indonesia alone, domestic sukuk market has not been significantly affected by the COVID-19. The Government has absorbed Rp14 trillion (~US$900 million) through 10 series of Sukuk Negara just within last month with Rp25.1 trillion oversubscribed. Thus, sukuk appetite is relatively high amidst the pandemic.

Ethical finance that is put to social and environmental use is getting massive concern during this pandemic. Islamic finance incorporates social elements, even within its commercial universe. Sukuk aim for such a social good and can potentially be leveraged to help combat the COVID-19. By attaining business goals in a way to benefit the society as a whole, sukuk eliminate the counterintuitive issue.

Lastly, development investment must be ‘fit for purpose’. To build back better after COVID-19, prospective and corrective measures need to be integrated. The above-mentioned sukuk can manifest both of them along with social intention to increase resilience of human and the planet.

About the Author

Greget Kalla Buana is an Islamic Finance Specialist graduated from Master of Islamic Finance and Management, Durham University, the United Kingdom. His work experiences have always been in Islamic Finance sector, such as Dompet Dhuafa, Islamic Banking Department of Indonesia Financial Services Authority, and United Nations Development Programme.

The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.