Are Swap Dollar Sukuks Truly Islamic?

Author Credit:

This blog is adapted from an article by Muhammad Rizwan-ul Haque, Founding Chairman of Dawood Family Takaful, CEO of an Investment Bank, and Director of a Trust. The original article was published on January 19, 2016.

Introduction

Swap Dollar Sukuks are often presented as Shariah-compliant investment instruments. However, their structure raises an important question: are these transactions truly Islamic, or are they simply conventional loan arrangements presented in an Islamic form?

According to Muhammad Rizwan-ul Haque, the issue lies not only in the

name of the instrument, but in the substance of the transaction.

How Swap Dollar Sukuks Work

In market practice, governments may raise foreign currency from commercial banks against local currency. These transactions are usually carried out to meet a country’s foreign exchange requirements and support its balance of payments.

In simple terms, the government receives foreign currency, such as US dollars, while committing to repay the amount at maturity along with a predetermined return.

This return is often linked to prevailing interest rates, making the transaction similar in nature to a conventional loan.

A Balance of Payments Support Tool

Governments often enter into such arrangements because they need foreign currency to meet external obligations. When a country is spending more dollars than it earns, it may need to borrow additional foreign exchange.

These transactions therefore become a supporting structure for balance of payments. They help the government meet short-term foreign currency needs, but they also increase the country’s foreign currency liabilities.

The Main Concern

The concern raised by Muhammad Rizwan-ul Haque is that these Sukuk structures may not involve genuine Islamic trade, investment, or economic activity.

In a truly Islamic financial transaction, there should be real economic substance, asset-backed activity, and some form of business risk.

However, in many Swap Dollar Sukuk structures, the transaction may simply involve lending foreign currency against a promise of repayment with profit.

If the profit is predetermined and reflects the prevailing interest rate, then the structure becomes difficult to distinguish from an interest-based loan.

Is There Real Economic Activity?

One of the strongest criticisms of Swap Dollar Sukuks is the absence of real economic activity. These transactions do not necessarily create production, trade, asset development, or business participation.

Instead, the lenders mainly take credit risk on the government, just as they would in a conventional loan transaction.

This becomes problematic from a Shariah perspective because Islamic finance should not be based only on guaranteed returns and credit exposure. It should be connected to real assets, genuine risk-sharing, and productive economic activity.

The Issue of Artificial Structuring

According to the original article, some Sukuk structures are made to look Islamic by adding agents, trustees, and other formal parties. However, if these additions do not change the real nature of the transaction, then the structure remains questionable.

Islamic finance is not only about documentation. It is about the substance and purpose of the transaction.

If a transaction is effectively a loan on interest, then changing its legal form or adding extra parties does not automatically make it Shariah-compliant.

Why Are Such Sukuks Structured?

Swap Dollar Sukuks may provide Islamic banks with an opportunity to place excess liquidity in long-term investments. Since Islamic banks are restricted from investing in conventional interest-based instruments, these Sukuks may appear to offer an alternative.

However, if the transaction contains interest-like features and does not generate real economic activity, then it may not fall within the true ambit of Shariah.

The concern is that such instruments may give Islamic banks a way to achieve conventional financial outcomes while using Islamic terminology.

Living Beyond Means

Another important point raised in the article is that governments often need such foreign currency arrangements because they are spending more dollars than they earn.

This means the transaction is not necessarily helping create productive economic value. Instead, it may simply be helping the government manage a foreign exchange gap.

When new foreign currency loans are used to repay old commitments, the cycle of debt continues. This raises both financial and ethical concerns.

Conclusion

Swap Dollar Sukuks raise serious questions in Islamic finance. If they are structured as foreign currency loans with predetermined returns linked to interest rates, and if they do not involve real economic activity or genuine business risk, then their Islamic validity becomes doubtful.

The real challenge for Islamic finance is to move beyond labels and ensure that every transaction reflects the ethical, economic, and Shariah principles of Islam.

A Sukuk should not merely look Islamic on paper. It should support real economic activity, avoid interest-based outcomes, and remain faithful to the objectives of Shariah.

Credit: This blog is adapted from the article by Muhammad Rizwan-ul Haque, Founding Chairman of Dawood Family Takaful, CEO of an Investment Bank, and Director of a Trust.