Sukuk Credit Ratings in Light of the Federal Partnership Financing Act

Derzayeva Guzel Gabdelhakovna ORCID: 0000-0002-2530-2887 PhD in Economics Associate Professor; Department of Accounting, Analysis and Auditing; Kazan (Volga Region) Federal University 420043, Russia, Republic of Tatarstan, Kazan, Vishnevsky str., 8/35, sq. 12 guzelchan@mail.ru Other publications by this author

Introduction

The adoption in Russia on July 28, 2023 of the federal law on partner Financing No. 417-FZ dated 08/04/2023 "On conducting an experiment to establish special regulation in order to create the necessary conditions for the implementation of partner financing activities in certain subjects of the Russian Federation and on amendments to certain legislative acts of the Russian Federation" provided Russian organizations with the opportunity to finance their activities with the help of new tools that previously applied only to Islamic banking. An example of such a tool is the sukuk, traditionally perceived as a security issued in accordance with the principles and rules of Sharia. In 2024, the first issue of sukuk in Russia took place. The resident of the Innopolis special economic zone in the Republic of Tatarstan, the Universal Blockchain IT Corporation, has released a digital sukuk with a volume of 1 million rubles on the platform of the Masterchain information system operator.. The Analytical Credit Rating Agency (ACRA) has published the document "Methodology for assigning credit ratings to financial instruments of Islamic finance – sukuk". Thus, the activities of Russian companies to finance their projects through the sukuk partner financing tool have received their positive start.

For Russia, the use of the sukuk tool is still a fairly new economic phenomenon, so Russian researchers, practitioners and specialists regularly turn to foreign research and practical experience in the production of sukuk in the East. Sukuk is most widely used as a financing tool in countries such as Malaysia, the United Arab Emirates, Bahrain, Qatar, Kuwait, Turkey, etc.

Table 1 shows the most successful sukuk releases over the past few years.

Table 1

The most successful sukuk releases

Thus, the data in table 1 indicate a very successful experience in using sukuk to finance projects. Russia can benefit from this experience, which became possible thanks to the adoption of the federal law on partner financing. In addition, in addition to practical experience, foreign publications in the field of sukuk can provide Russia with new and unique material for research on economic phenomena relatively new to Russian reality, which are based on the principles and rules of partner financing.

The theoretical basis of the study

Sukuk has been studied in foreign literature for a long time.

More than 20 works on sukuk have been published by a group of researchers led by Ahmad W.M.W. and Hassan M.K. ^[1]. They cover almost all aspects of the issuance and circulation of sukuk, as well as monitor the dynamics of changes in issues in the capital markets.

The works of Al-Shammari B., Brown K. and Harris R. ^[2] are devoted to research on the placement and admission of sukuk to international stock exchanges and capital markets.

Research by Asutay M. and Rahim A.R.A. ^[3] concerns the determination of the possibilities of using sukuk to finance "green" projects. It was at their suggestion that a new term was introduced - "green" sukuk, which is used for financing in the field of ecology and ESG principles.

Azmat S., Skully M.T.H. and Brown K. ^[4] In their publications, they study the fundamentals of the functioning of global sukuk markets.

Dar H.A. and Srivastava D. ^[5] consider the impact of sukuk issues on economic indicators of economic development both within countries and in the whole world.

The article by Hasan M.Z., Alhabshi S.O and Haron R. ^[6] addresses the issues of economic growth due to sukuk issues and their role in the investment policy of states.

Studies by Khan M.F. and Porzio ^[7], C., Rahman, M.M. and Yusuf, Y.Q.M. ^[8] are devoted to the issues of compliance of sukuk issues with the principles and rules of Sharia, as well as the degree of customer confidence in issuers in terms of

The works of Saleem Q, Zaman U. ^[9], Zulkhibri M. and Sukmana, R. ^[10] analyze the current state of the capital market, as well as the evolution of approaches to sukuk issues.

Russian literature is still quite poor in research in the field of sukuk. But even here it is possible to single out the authors who publish on the topic under consideration.

Among them, of course, it should be noted the works of F.I. Kharisova ^[11] and co-authors ^[12], who not only published more than 15 works on sukkah, but also for the first time began to explore not only the economic essence of sukuk, but also the real possibilities of its reflection in the accounting and reporting of Russian companies.

Researchers such as Akhmetshin M.A. ^[13], Gafurov N.G. ^[14] and Ismagilova G.I. ^[15] attempt to comprehend the economic essence of sukuk, their classification and structure in relation to the Russian economic reality.

The works of Nasyrov I.N. ^[16], Pugacheva E.V. ^[17] and Shaidullina R.F. ^[18] explore the possibilities of introducing sukuk in Russia, as well as study the problems and prospects of using partner financing instruments in the country both in general and in particular sukuk.

Research by E.Z. Yakupova ^[19], A.A. Sklykapova ^[20] and R.R. Yusupova ^[21] is devoted to the development of partner financing in Russia, the problems faced by Russian organizations when implementing partner financing tools, their types, types and classifications, as well as release schemes.

Among the latest research in the field of sukuk, it is necessary to note the works of Abrorov S. ^[22], Sagiyeva R.K., Mahfudz A.A., Oteshova D.Y. ^[23], Jauida B., Chafiya K. ^[24], Mollaeva L.A., Kalimullina M.E. ^[25], which summarize modern practices and approaches to the issues of sukuk and development of the sukuk market in Russia and abroad.

Thus, the study of the above works allows us to draw a number of conclusions:

1) The above-mentioned authors have made a significant contribution to understanding the mechanisms of sukuk emission, especially in matters of theory, economic essence, classification, macroeconomic context, and management aspects in this area. In addition, the Russian school of scientists, represented by the above-mentioned works, also seeks to contribute to the adaptation of sukuk emissions to Russian realities, which enriches the theoretical understanding of sukuk. At the same time, many practical aspects of the introduction of sukuk in Russia remain unexplored: the mechanisms of its release, evaluation, rating, circulation, insurance, etc.

2) Abroad, sukuk is a widespread, widely used in practice and deeply researched partner financing tool. It is important to note the difference in the approaches of foreign authors, which consists in the wide availability of information about sukuk, developed sukuk markets, both domestic and international. In addition, in eastern countries, data on sukuk are available to researchers in the context of many aspects.

3) In Russia, interest in sukuk has increased dramatically with the introduction of the federal law on partner financing in 2023. The economic essence of sukuk has been sufficiently studied both in Russia and abroad, but certain aspects of its release, circulation, and introduction into Russian reality remain relevant for modern scientists.

4) Here, an important point in conducting a sukuk study is that the authors face the need to turn to international sources of information, English-language websites, statistical reports, most of which are generated in foreign languages. In addition, the authors are faced with the lack of a sukuk market in Russia. There were only two real releases.

5) When describing sukuk lending methods, almost all authors refer to the approaches used by leading rating agencies such as Moody's, Standard & Poor's and Fitch. However, as it will be said below, there is a specialized credit rating calculation document for sukuk prepared by AAOIFI. Thus, when rating sukuk, rating agencies should rely on it.

6) Another important point is the uniqueness of sukuk as an Islamic financial product that requires a special approach to risk assessment, therefore, it is impossible to base sukuk credit rating methods on the same principles as rating ordinary corporate bonds. It is necessary to take into account the unique characteristics of sukuk as an instrument of Islamic financing. Sukuk are securities issued in accordance with the principles of Sharia law, which imply the division of income from the ownership of assets, and not the payment of interest. Therefore, when evaluating sukuk, special attention is paid to the structure of assets secured by these securities and the reliability of the issuer, which is traditionally not done by researchers.

However, we will focus specifically on sukuk credit ratings, since sukuk, like any security, needs to be rated in order to be represented on international capital markets (and there is no sukuk market in Russia).

Research methodology

The purpose of the study is to identify more advanced approaches to the formation of a credit rating of operations with sukuk. To achieve this goal, we will set and solve the following tasks:

1) Identify approaches to the formation of sukuk credit ratings.

2) Compare two documents concerning the formation of the sukuk credit rating. This is the AAOIFI Management Standard (GS) 17 "Sharia Compliance and Ratings of sukuk and Other Islamic Financial Instruments Trust Management" and published by the Analytical Credit Rating Agency (ACRA) "Methodology for assigning credit Ratings to Islamic Finance Financial Instruments – sukuk".

3) To test the results obtained on a specific example of the release of sukuk.

To achieve these goals, we use the following methods:

1) Analysis and synthesis to identify approaches to the formation of sukuk credit ratings.

2) Comparison and comparative analysis to compare two documents concerning the formation of the sukuk credit rating.

3) Analogies and similarities for testing the results obtained on a specific example of the release of sukuk.

The results of the study

AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) – an international organization that develops international standards for management, accounting, control, ethics and auditing based on the principles of partner (Islamic) financing. The study of these standards is necessary, since in order to enter the international eastern capital markets (for example, the Persian Gulf countries) in order to attract investments, Russian partner financing companies must submit their reports according to AAOIFI standards and sukuk issues must also comply with AAOIFI standards. Currently, AAOIFI standards consist of 60 Sharia standards, 47 accounting standards, 6 auditing standards, 17 corporate governance standards and 2 codes of ethics. Only Sharia standards have been translated into Russian. There is no translation of the other standards. Nevertheless, Russian researchers Kharisova F.I. et al. ^{[26, 27, 28]} have prepared and published reviews of management, auditing and ethics standards as teaching aids for graduate and postgraduate studies in disciplines related to partner financing.

Among the AAOIFI sukuk standards, the following are dedicated:

Sharia Standard:

Sharia Standard AAOIFI No.17 "Investments in sukuk"

Management standards:

AAOIFI Management Standard No. 12 "Sukuk Management"

AAOIFI Management Standard No. 17 "Sharia Compliance and Ratings of Sukuk Trust Management and Other Islamic Financial Instruments"

Accounting standards:

AAOIFI Financial Accounting Standard No. 33 "Investments in sukuk, Stocks and similar Instruments"

AAOIFI Financial Accounting Standard No. 34 "Financial Statements for Sukuk Holders"

Auditing standards:

AAOIFI Audit Standard No.1 – Purpose and principles of Auditing

AAOIFI Audit Standard No.2 – Audit Opinion

AAOIFI Audit Standard No.3 – Terms of Audit Assignments

AAOIFI Audit Standard No. 4 – Review of Sharia Principles and Rules by an independent auditor

Audit Standard No. AAOIFI No.5 Auditor's responsibility to review fraud and errors during the audit of financial statements

Of these, let's consider the AAOIFI Management Standard No. 17 "Compliance with Sharia Law and ratings of sukuk trust management and other Islamic financial instruments", since it concerns sukuk credit ratings.

In order to develop the sukuk market, in particular, publicly offered instruments, the trust of stakeholders in sukuk is necessary. Although the same concept applies to traditional financial instruments, the expectations of the relevant stakeholders may vary. The stakeholders' trust in traditional financial instruments is primarily based on the creditworthiness of the issuer, the stakeholders of Islamic financial instruments look at compliance with Sharia law and protection of the underlying asset, as well as its ability to generate expected profits. These expectations fundamentally change the approach that should be applied to the independent rating of these instruments. Therefore, AAOIFI has developed the AAOIFI Management Standard No. 17 "Compliance with Sharia Law and ratings of trust management of sukuk and other Islamic financial instruments". This standard sets out the principles that should be applied by rating agencies to comply with Sharia and fiduciary rating of sukuk and other Islamic financial instruments. It provides basic guidance on responsibility, acceptance, process, accountability, and quality assurance for such services. Rating agencies are free to develop their own detailed methodologies for such ratings, including rating scales, provided that they comply with the requirements of this standard.

Elements of Sharia compliance and fiduciary ratings include Sharia compliance (i.e. compliance with Sharia principles and rules), Sharia governance, appropriate corporate governance, transparency and disclosure, ethics and values, and fiduciary efficiency.

The rating of compliance with Sharia law and trust management reflects the combined assessment of the instrument in two aspects:

1. The relative state of compliance with Sharia law and governance, duly reflected in the rating scale (or assessment) with standards, rules and best practices (collectively referred to as benchmarks) in relation to:

- compliance with the principles and rules of Sharia;

- Sharia governance structures;

- Corporate governance practices related to Sharia governance;

- transparency and disclosure of information; and

- ethics and values.

2. The relative state of fiduciary efficiency and capabilities, including:

- asset quality and profitability; and

- the creditworthiness of the originator.

In order to determine the appropriate volume and rating scale for a specific type of sukuk or other Islamic financial instruments, the instruments are classified into the following types:

1) equity or quasi-equity type instruments (without warranty or obligation to purchase);

2) quasi-auction type instruments (with a guarantee or obligation to purchase);

3) debt-type instruments;

4) equity-type instruments.

Table 2 shows the proposed AAOIFI weight distribution for comparative parameters.

Table 2

Weight distribution for comparative parameters (source AAOIFI standard)

Thus, according to Table 2, it can be concluded that a single set of parameters and a single approach to assigning weights to various parameters may not work for all such tools. Accordingly, it is important to divide all instruments into four broad types and provide guidance, as appropriate, for each such type in order to properly assess the scope of the rating service and the rating scale for each specific type of sukuk or other Islamic financial instruments, as well as the significance of the control parameters for classifying each instrument compared to the rating of the institution.

It should be noted that in this article, when allocating weights for comparative control parameters, the weights proposed by the AAOIFI management standard No. 17 "Compliance with Sharia and ratings of trust management of sukuk and other Islamic financial instruments" were taken into account. At the same time, ACRA applies the following methodologies:

– Methodology for assigning credit ratings to non-financial companies according to the national scale for the Russian Federation;

– Methodology for assigning credit ratings to non-financial companies on an international scale;

– Methodology for assigning credit ratings to banks and banking groups according to the national scale for the Russian Federation;

– Methodology for assigning credit ratings to banks and banking groups on an international scale;

– Methodology for assigning credit ratings to structured finance instruments and liabilities according to the national scale for the Russian Federation;

– Methodology for assigning credit ratings to the repackaging of financial claims on a debt instrument.

Thus, the key difference between the AAOIFI methodology is the determination of what the key control parameters and the weights assigned to each control parameter will depend on. The AAOIFI approach depends on the type of instrument being evaluated, and the approach of other rating agencies depends on the rating of the issuer itself. This is a significant difference. Therefore, we consider it advisable to give recommendations to Russian rating agencies to rely on the AAOIFI standard when rating sukuk, rather than traditional approaches applied to other financial instruments.

AAOIFI Management Standard No.17 "Sharia Compliance and Trust Management Ratings of sukuk and Other Islamic Financial Instruments" offers the following rating scale (as a combined scale) for sukuk and other similar Islamic financial instruments (in particular, for joint-stock and quasi-stock (without guarantee or obligation to purchase) sukuk and other instruments), presented in table 3.

Table 3

Rating scale

Thus, the data in Table 3 represent AAOIFI's complete and unified approach to the rating scale (as a combined scale) for sukuk and other similar Islamic financial instruments (in particular, for equity and quasi-equity (without guarantee or obligation to purchase) sukuk and other instruments).

According to the specialized resources Islamic Finance News or Sukuk Market Insight, it is possible to collect information on the volume of issue of sukuk with different ratings. Let's form Figure 1 based on this data.

Fig. 1. The volume of sukuk output with various ratings, in billions of US dollars

Thus, according to Figure 1, it can be concluded that the AAOIFI approach to sukuk rating is widely used, which means that the technique has already been tested on international sukuk issues. Let's apply it to Russian reality using the example of the release of sukuk-ijar.

To test the results obtained, let's consider an example of assigning a sukuk credit rating.

Sukuk-invest company plans to issue sukuk in the amount of USD 750 million for a period of 15 years. Sukuk is based on the lease of production facilities owned by the company. The rental income will be distributed among the sukuk holders.

Analysis Steps:

1. Analysis of the transaction structure:

Asset type: leased production facilities.

Yield: 8% per annum.

Term: 15 years.

2. Assessment of the issuer's credit risk:

Sukuk-invest has the following financial indicators:

Revenue for the last year: $10 billion.

Net profit: $150 million.

Debt/EBITDA: 4x.

Interest Coverage Ratio: 4.5x.

3. Analysis of the legal structure:

The deal was approved by the Sharia Council, confirming its compliance with Islamic financial standards.

4. Assessment of liquidity and market demand:

The current market shows an average demand for such assets, which indicates an average liquidity.

5. Forecasting cash flows:

The annual rent is $60 million (8% of 750 million).

Expected rent growth: 3% annually.

Calculations:

1. The cash flows from the lease will be:

1 year – $60 million.

Year 2 – $61.80 million

...–...

Year 14 – $77.20 million

Year 15 – 79.56 million dollars.

2. Interest Coverage calculated by dividing

EBIT on interest expenses will amount to 4.44

This is a good indicator showing that the company has the resources to service its debt obligations.

3. Debt to Equity, calculated by dividing the total debt by the amount of equity, will be 0.75

This is a fairly high debt burden, although it is still within the acceptable level.

4. Risk of default:

The risk of default is assessed based on the financial stability of the company, the stability of the industry and macroeconomic conditions. In this example, we assume that the risks are average, given the average liquidity of the market and some volatility in the industry.

5. Additional calculations:

You can also perform additional calculations of the weighted average term to maturity (WAL) and Duration (Duration).

For our example, let's get 12.5 and 11 years, respectively.

Taking into account all of the above factors, including good financial performance, average interest expense coverage, high but manageable debt burden, Sharia-compliant transaction structure and average liquidity, the agency may assign sukuk an A+ rating. This rating reflects the relatively high chances of the company successfully fulfilling its obligations, despite some risks associated with the debt burden and the market situation.

Conclusions

Thus, based on the results of the study, a number of conclusions can be drawn:

1) Sukuk is a fairly new, but very interesting economic phenomenon for Russia. More and more Russian scientists are choosing sukuk as the object of their research. There is already the first domestic experience of producing sukuk.

2) In order to enter the international eastern capital markets (for example, the Persian Gulf countries) in order to attract investments, Russian partner financing companies must issue sukuk in accordance with AAOIFI standards, which have not yet been fully translated into Russian.

3) In matters of assigning a sukuk credit rating, rating agencies should rely on the AAOIFI Management Standard No. 17 "Compliance with Sharia Law and ratings of sukuk Trust Management and other Islamic financial instruments."

4) It is fundamentally important when forming a sukuk credit rating in accordance with the AAOIFI management standard No. 17 "Compliance with Sharia and ratings of trust management of sukuk and other Islamic financial instruments" to take into account the dependence of key control parameters and weights assigned to each control parameter on the type of instrument being evaluated.

5) The considered methods can be used by rating agencies in the formation of sukuk credit rating methodologies, as well as by capital market regulators in the preparation of uniform requirements for sukuk rating.