Islamic securities in Kyrgyzstan: an overview

Islamic securities, also known as sukuk, are unique financial instruments that provide holders with income derived from a specific business or asset. These securities differ from conventional ones in that the businesses or assets they support must comply with Sharia law. As a result, Islamic securities have gained popularity in recent years, particularly in Muslim-majority countries and regions.

The primary tenets of Sharia law pertaining to investments include:

• Prohibiting guaranteed interest to investors: Traditional interest-based investments are forbidden under Sharia law, as they are considered usury (riba). Instead, Islamic securities focus on profit and loss sharing arrangements, which emphasize the ethical aspect of investments.
• Mandating that investors and recipients share project risks to varying extents: Sharia law promotes the concept of shared risk in financial transactions, ensuring that both parties involved in the investment contribute to the risk and reward of the project.
• Disallowing speculative or gambling-like activities: Sharia law prohibits investments that involve excessive uncertainty (gharar) or resemble gambling (maysir). Consequently, Islamic securities must be transparent and backed by real assets or projects.
• Refraining from financing businesses or assets subject to religious prohibition (haram): Islamic securities cannot support businesses or assets that conflict with Islamic principles. This includes industries such as alcohol, interest-bearing loans, gaming activities, and pork products.

While Kyrgyz law has recognized Islamic securities since 2016, their issuance only gained traction recently. Issuing Islamic securities involves a distinct legal structure, wherein a dedicated intermediary, the Islamic Special Finance Company (ISFC), is established. The ISFC collects funds from securities issuance and transfers them to the “originator” or the investment recipient. It also distributes income from the originator’s business to investors.

Key features of Islamic securities issuance include:

• Establishing a Sharia Council to ensure compliance with Sharia norms: A panel of Islamic scholars and financial experts is formed to oversee the issuance process, review the structure and documentation, and ensure that the securities adhere to Sharia principles.
• Appointing a licensed market participant to safeguard the interests of Islamic securities holders: To protect investors’ interests, the issuer hires a professional participant in the securities market with brokerage and dealer licenses (representative of the holders).

Public issuance of Islamic securities mandates registration of the prospectus with the State Financial Supervision Authority. Closed placements, however, only require state registration and the securities’ terms can be included in the issuance decision.

Trading publicly offered Islamic securities occurs on the stock exchange, while private offerings can be conducted over-the-counter. The Kyrgyz Republic permits the issuance of five types of Islamic securities to finance various businesses and share profits:

• Islamic rental certificates: These securities finance rental businesses and provide investors with a share of the rental income.
• Islamic project finance certificates: Investors finance the creation of an asset and participate in the profits generated from its operation.
• Islamic equity certificates: Investors provide funds to manage a business in exchange for a share of the profits.
• Islamic certificates of an investment agency: These securities are similar to a mutual investment fund but in the form of a security, allowing investors to pool their funds for investment in Sharia-compliant assets.
• Islamic partnership certificates: Investors finance the business alongside its organizer and share the profits.

Although considered a financial novelty in the Kyrgyz Republic, Islamic securities have secured their position in the Asian and Middle Eastern financial markets over the past 30 years. The total value of Islamic securities issued globally amounts to hundreds of billions of dollars. By issuing Islamic securities, Kyrgyz projects can tap into investment opportunities from Gulf countries where Sharia rules dominate.

While the legal structure of Islamic securities may appear complex to those unfamiliar with them, they offer unparalleled flexibility from a business perspective. Neither stocks nor bonds, these securities can accommodate various financial agreements within an issuance. Essentially, Islamic securities enable businesses to raise financing without surrendering a share in company capital or incurring fixed interest obligations. This process, sometimes referred to as “Islamic securitization,” enables the packaging of diverse assets and businesses into securities issuances.

The benefits of Islamic securities extend beyond their flexibility. These instruments promote ethical investing and social responsibility by aligning investments with Sharia principles. Consequently, they appeal to a broader range of investors, including those who prioritize environmental, social, and governance (ESG) factors in their investment decisions.

Moreover, Islamic securities can contribute to financial inclusion by attracting investors who were previously deterred by non-Sharia-compliant investment options. This creates a more diverse investor base and fosters economic growth in regions where Islamic finance is prevalent.

As global interest in Islamic finance continues to grow, countries like the Kyrgyz Republic can leverage Islamic securities to foster economic development and diversify their financial markets. Additionally, the increased adoption of Islamic securities can lead to greater cross-border investments and collaboration between countries in the Asian, Middle Eastern, and African regions, where Islamic finance is particularly influential.

Despite their potential advantages, challenges remain for the widespread adoption of Islamic securities. For instance, a lack of standardization in Sharia interpretations can create inconsistencies in the issuance and trading of these instruments. Regulatory frameworks and market infrastructures also need to be further developed to accommodate the unique features of Islamic securities, ensuring their seamless integration into the global financial system.

To address these challenges, countries can learn from the experiences of leading Islamic finance hubs like Malaysia and the United Arab Emirates. Adopting best practices and collaborating with international organizations can help harmonize regulations, improve market infrastructure, and promote the growth of the Islamic securities market.

For further information on Islamic securities issuance, a dedicated website operated by Interstan Securities, a Kyrgyz investment company, provides a comprehensive overview of the key aspects involved in various types of Islamic securities.