Fitch ratings methodology for sukuk

Fitch Ratings released several documents relating to Islamic finance and banking, which I am reading and summarizing. The first one is titled "Fitch's Approach to Rating Sukuk".

One of the first things to strike me in this article is the skepticism of Fitch Ratings towards sukuk being asset-based, secured borrowing. "Depending on the precise structure of the bond, the rating may be linked to the rating of the originator of the transaction or to the underlying assets if the bond satisfies the agency’s requirements for a true securitisation." It appears that the way Fitch's approaches the ratings process is to use the originator's rating as a default (or possibly lower if the originators have more preferential creditors than the sukuk holders) unless the originator demonstrates that the sukuk is a "true securitisation". Fitch's defines true securitization by laying down why most sukuk are not securitized:

"Unlike a true securitisation, the investors do not have any recourse to the underlying assets in the event of default. Default accelerates the purchase undertaking, which, if not fulfilled, would trigger a claim by the investors against the originator. This would be immediately due and payable, and would be pursued through the commercial courts. The assets within the Sukuk would be available for all senior unsecured credits of the originator, and the investors would ordinarily rank as senior unsecured creditors of the originator. They would rank pari passu with other senior unsecured creditors, except for any preferential creditors as determined by local law."

In the event of a default, sukuk holders would not have any higher claim on the assets backing the sukuk than other unsecured creditors and therefore the sukuk does not display the asset-based nature it claims. In some instances, the payments stream may not fluctuate, "The originator may provide a liquidity facility to match receipts to the contractual periodic distributions and eliminate any volitility in the cash flows deriving from the asset".

Even the ratings methodology, which bases sukuk ratings on the originator rating in most cases (treating the sukuk as a form of unsecured lending and not an asset-based certificate based on risk sharing) does not fully address potentially hidden risks involving the sukuk's Shari'ah-compliance.

At the end of the article, Fitch describes what sukuk lack that keep them from being classified as securitized directly (they have never reviewed a sukuk transaction that would meet these criteria: "In order to achieve a real securitisation, the transaction should [...] represent a true sale, ie the underlying collateral has been validly transferred to the SPV [...] In the event of the insolvency of the originator [...] the underlying collateral must remain completely separate from the assets of the originator/parent company [and sukuk] investors should have first priority over the underlying collateral."

The lack of sukuk issues meeting Fitch's requirements for securitization presents a difficulty for the sukuk markets, who claim that the product they trade is asset-based. Without meeting the criteria set down by Fitch's (or other similar criteria), sukuk are not asset-based in a meaningful, legally-enforceable way nor are most sukuk truly based on risk sharing between the originator and the investors.