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The legacy and hope of the pioneering Osun Sukuk in Nigeria

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Rauf Aregbesola


Lagos is the 5th largest economy in Africa and home to the continent’s 2nd largest stock exchange. It is no surprise then that Nigeria’s financial activity and innovation is heavily concentrated in Lagos. As always, there is an exception that proves the rule. On the 10th of October 2020, Osun State will pay down the final tranche of its ₦11.4 billion 7-year sukuk. In October 2013, the state sold the sukuk to over 40 domestic investors, a move which made the state the first issuer of a sharia-compliant bond in Nigeria, and the unlikely status of financial innovator. Let’s take a step back and see why this is important.

One of the most significant innovations of human civilisation is the creation of credit which grants us the ability to move money between the present and future. This simple innovation means that today’s spending is not constrained by today’s income; if I can borrow from the future, then I can spend a lot more today. It is not an exaggeration to say that credit has powered the global economy for the last millennia, and remains the bedrock of modern finance. Not all finance though. In Islam, traditional interest on money lending is forbidden as Sharia law says that all profit must come from work, and simple money lending is not work. So how do Islamic countries take advantage of the benefits of credit? An entire system of Islamic Finance has been created, with its own Sharia-compliant rules, with financial instruments that mimic conventional ones.

For example, one of the most important assets in conventional finance is a bond. Nigeria’s bond market is worth over ₦16 trillion, more than the size of the country’s stock market. A bond is essentially an IOU that guarantees an investor will receive a certain amount at the end of the period, and will be compensated with frequent interest payments before then. A sukuk is a sharia-compliant bond, and its distinguishing feature is that it is not a debt instrument as Sharia laws says that I cannot be entitled to interest just for lending you money.

Rather, when an investor buys a sukuk they essentially purchase ownership in an asset that then means they are entitled to periodic cash flows by virtue of their claim of ownership. This means that a sukuk must be backed by an underlying income-generating asset. In Osun’s case, the proceeds from the sukuk were ultimately used to build ten schools—three in Osogbo, and one each in Ila, Ikurun, Iwo, Ilesa, Ife, Ikire, and Ejigbo—so the underlying income-generating assets were the schools. In particular, the Osun sukuk was structured in this way: the state government set up a Special Purpose Vehicle (SPV) called the Osun State Sukuk Company which owned the schools and sold individual rights of ownership to the sukuk holders.

The SPV then turned around and leased the schools to the state government, and earned rent from this agreement, which was then used to pay the sukuk holders. Once the lease expired at the end of the 7-year period, the state government buys the schools outright and these funds are returned to the sukuk holders as principal. At the end of the day, investors got their money returned to them with profit on top, the government was able to build 27 schools, and the entire process was completely transparent. Few public projects in Nigeria can boast a comparable record.

The story behind sukuk in Nigeria
Sukuk have existed since the early Ottoman Empire issued financial certificates backed by tax revenues to the general public. Modern sukuk has its roots in Jordan, where the government was searching for sharia-compliant ways of raising financing to renovate property and decided to use revenues from specific projects to back the instruments. Since then, Malaysia and the Gulf Cooperation Council (GCC) countries have become leaders in a global sukuk market worth over $10 billion.

Osun cannot quite claim to be the pioneer on the continent as Sudan and Gambia launched sukuk from the late 2000s, mostly as a tool of central bank reserve management. But when Osun issued its sukuk in 2013, only a few African countries had sukuk and many did not even have a regulatory framework for sukuk issuances. Even in Nigeria, National Pension Commission rules drafted as recently as 2012 made not a single reference to sukuk as a form of investment in the country. It was only in the wake of the imminent Osun State issue that Nigeria’s Securities & Exchange Commission (SEC) introduced rules that created a framework for selling and investing in sukuk. The Osun State sale proved to be a ground-breaker on the continent as a number of countries subsequently launched their debut sovereign sukuk. Senegal kicked off proceedings with a 100 billion CFA franc 4-year sukuk in 2014, and Côte d’Ivoire upped the ante with consecutive 5-year and 7-year sukuk sales in 2015 and 2016, both worth 150 billion CFA franc. Meanwhile, South Africa became the first African country to launch a dollar-denominated sukuk when it sold a 6-year $500 million sukuk in 2014. Nigeria finally joined the fray, as, four years after the pioneering Osun issue, the Federal Government of Nigeria (FGN) sold a ₦100 billion 7-year sukuk to finance 25 major roads in the country. The FGN sukuk sale was so successful that the government quickly followed it up with another ₦100 billion 7-year issue in 2018. Five years after Osun State first tested the waters, Nigeria looked ready for sukuk.

Overcoming the challenges Osun faced
Osun State paved the way and the Federal Government has followed, but are we likely to see more sukuk issues in Nigeria? One determinant would be regulation. Nigeria’s regulatory framework for sukuk issues was only developed in response to the Osun issue and it has barely evolved since then. The Osun and FGN sales may provide a template, but it is unclear whether others will follow as Nigeria does not have a specific roadmap for developing sukuk in the country. For example, Nigeria’s recently-elapsed medium-term debt management strategy identifies sukuk as one of the funding sources the government will use, but goes no further. Likewise, the 2018-2022 debt management framework does not specify how, when or where sukuk will be used. Meanwhile, existing SEC rules on sukuk are conservative and not as clearly defined as you would expect from investment regulation. One reason for the regulatory uncertainty is that there is still some controversy over which Sharia principles are relevant to sukuk. For example, some sukuk are considered tradeable by some Islamic finance bodies and others are not.

Meanwhile, although Malaysia is the global leader in sukuk, its rules are more liberal and sometimes clash with those provided by the Organisation of Islamic Cooperation. Osun State avoided this controversy by opting for the simplest and most recognisable sukuk structure (the ownership-leasing model called Ijara-sukuk) and the FGN followed suit. However, this is a sub-optimal long-term approach.

The debate over Sharia-compliance would hinder the development of the market by dissuading some people from investing in particular types of sukuk, fragmenting the supply as some countries issue one type while other countries issue another, and foster uncertainty and inconsistency in regulation. For example, SEC rules in Nigeria are intentionally open when it comes to Sharia-compliance and the commission places the burden of proof on the Shariah adviser appointed by the issuer. Again, it is likely that sukuk issues will only get more popular when the scholarly and regulatory landscape is clearer.

Finally, although the Osun State sukuk experiment has been vindicated by the Federal Government’s follow-up, the legacy would be permanently cemented once another issuercomes into the market. Crucially, research suggests that one key determinant of a thriving sukuk market is private sector participation. We see this in Malaysia where the private sector is responsible for more than half of outstanding sukuk. The challenge here is that even the conventional bond market in Nigeria is dominated by the Federal Government. As at February 2020, sub-nationals had under ₦350 billion in outstanding bonds and corporates had ₦550 billion; in contrast, the FGN had nearly ₦15 trillion outstanding. This discrepancy is caused by structural issues, such as high interest rates, low market liquidity, and weak sub-national IGR bases, that would need to be fixed before sukuk—or any type of bond—can really thrive at the subnational level.

How can sukuk help Nigeria?
Having said that, sukuk can help Nigerian states in a way that traditional bonds (or debt) cannot. It is no secret that the Nigerian government at all tiers has struggled to raise non-oil revenues in recent years. The difficult is partly as a result of leakages in the system (e.g. Billions of Naira in unremitted taxes by Federal and State Government agencies; low tax revenues highlighted by a low Tax to GDP ratio of 5.2% versus an ECOWAS average of 14.6%),generally because the average Nigerian is hesitant to fully trust governments with their finances, due to past disappointments.

This trust gap is why regular state bonds are backed by an Irrevocable Standing Payment Order (ISPO) which means that interest payments to investors are deducted directly from state FAAC allocations. The same is true for sukuk but sukuk have a crucial extra element: transparency. Perhaps the greatest appeal of the Osun sukuk offer is that investors knew the funds raised were tied to the school-building project and they could track the progress of construction. The same is true for the FGN sukuk as the issuer clearly indicates what roads the money will be committed towards.

In fact, this level of transparency is a legislative requirement as SEC rules state that the issuer must submit documents detailing what the proceeds will be used for and a schedule of how they will be used. In a time where governments are trying to win the people’s trust and raise revenues, sukuk are a natural fit because they show the government is willing to be open and they actually give people oversight on how the funds are used. Of course, not every project will be suited for a sukuk issue as the project needs to be Sharia-compliant (e.g. funds cannot be used to build a brewery) and the project ought to be income-generating to justify the sharing of profits. However, the second requirement is subject to interpretation as the FGN sold its sukuk even though the roads to be constructed are not directly income-generating. Therefore, it makes sense for Nigerian states to explore how they can use sukuk as atool for both income generation and social trust.

Alas, for all the potential sukuk holds for Nigeria, the biggest obstacle may be ignorance. When Osun State rolled out its sukuk, it received significant backlash from Christian organisations who were unhappy with the introduction of a sharia-compliant financial instrument. History repeated itself when the FGN first launched its sovereign sukuk as the Christian Association of Nigeria accused it of trying to Islamise Nigeria. The reality is that sukuk is like any other financial instrument; the only difference is that it conforms to Sharia principles. Any Nigerian can buy a sukuk and there is not religious component attached to it. However, religion is a sensitive issue in Nigeria so a lot of education must be done for people to understand these basic principles. After all, countries as diverse as the United Kingdom, Singapore, and Germany have all issued sukuk in the last decade.

When all is said and done, the success of sukuk in Nigeria may hinge on how willing Nigerians are to learn and accept it as a financial tool for development. The reality we cannot ignore is that Nigeria is in no position to be picky right now. Lower-for-longer oil prices have left the country’s finances in a bind and we need money however we can get it. It does not matter if it is from Sango or Ifa, as long as it can build schools and bridges.


In this article:
Rauf AregbesolaSECSukuk
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