As the conflict in the Middle East drives sovereign spreads wider and disrupts capital flows, a deeper vulnerability is being exposed: the need to raise capital in an efficient manner. Association of Southeast Asian Nations and Gulf Cooperation Council economies have been affected by the conflict in different ways, with countries such as the Philippines and Indonesia suffering from rising oil prices, and the United Arab Emirates and Saudi Arabia sustaining physical damage to ports, hotels and infrastructure. Investing in energy diversification for the former, and reconstruction for the latter, requires market infrastructure that can deliver trusted capital.
Innovations in digital finance can provide a mechanism to meet this need when paired with traditional capital market instruments. Sukuk are used throughout the Muslim world as a Sharia-compliant complement to bonds, allowing those with religious restrictions to participate in market-based financing.
Already tested by the private sector, tokenised sukuk can offer a potential means for countries to mobilise capital for reconstruction and recovery, while simultaneously fostering deeper, more resilient local capital markets over the longer term.
Enhancing the sukuk market with tokenisation
Often described as ‘Islamic bonds’, Sukuk are certificates issued by governments, corporations and financial institutions that represent partial ownership in a project or an asset. They allow the certificate holder (the purchaser) to partake in profits generated by the underlying asset and are Sharia compliant as the returns are not generated through interest.
It is possible that, with maturity, tokenisation can enhance the sukuk market. Tokenisation is often used to fractionalise larger instruments, lowering the minimum denomination and thus enabling broader access. There is also a community, though fairly small at present, that may be inclined to buy securities available on a blockchain but not through traditional markets.
While the first deals are likely to entail additional complexity as new systems are developed, in the long run, smart contracts should be able to automate the lifecycle processes of the instruments. This automation should make digital instruments cheaper and easier to issue.
Although distributed ledger technology secondary markets do not have much liquidity at present, if tokenised sukuk are designed to be interoperable with existing markets, then they can make a positive contribution rather than fracturing liquidity, as well as adding a post-trade settlement system that is more efficient than traditional systems.
Sukuk markets have remained stable through the conflict
Rather than being seen as an alternative to traditional bonds, Sukuk have grown as an investment-grade asset class with a wide international investor base, particularly in GCC and Asean economies. Malaysia, the UAE and Saudi Arabia are leaders in sukuk issuance, which can be denominated in both local currency and in dollars.
In times of geopolitical stress, sukuk markets have remained resilient. While the US-Israel and Iran conflict saw dollar-denominated sukuk issuance slow down, local-currency issuance remained stable and consistent throughout the volatility. Fundamentals have also remained constant: Fitch Ratings reported that the majority of rated GCC sukuk remained investment-grade.
Maximising the Islamic finance opportunity through tokenisation
Investors are increasing allocations to Islamic financial products, particularly in Asean economies where the Islamic finance industry has surpassed $1tn. Sukuk remain the most popular product in this region, and headway has already been made into digitalising them, with Khazanah Nasional Berhad (Malaysia’s sovereign fund) successfully launching the country’s first tokenised Sukuk pilot in collaboration with the Malaysia Securities Commission.
Market participants in GCC economies are paving the way through live case studies in regulatory sandboxes and early-stage initiatives. These include INABLR’s innovative ‘Sukuk-as-a-Service’ in Bahrain, which operates on the Tezos blockchain and includes built-in Sharia checks, and Abu Dhabi Islamic Bank’s Smart Sukuk platform, which allows smaller-ticket investors to access sukuk. Private sector initiatives like these can provide the infrastructure for sovereign tokenised sukuk. Other Asean economies, like Singapore and the Philippines, are also looking to further develop their Islamic finance ecosystems.
As with most digital finance technologies, regulation and standardisation are the key challenges. Clear legal treatment of digital assets, alongside common standards for token design and smart contract execution, will be essential to support interoperability, cross-border transactions and broader market adoption. International co-operation will be critical to the development of tokenised sukuk markets. GCC Islamic banks already play a leading role in arranging, distributing and investing in Asean sukuk, providing a strong foundation for deeper collaboration. Major sukuk-issuing jurisdictions should leverage these relationships and work towards greater regulatory clarity and standardisation.
Financial architecture matters as much as the instrument and the investor
While tokenisation is not a complete solution to these regions’ financing needs, it could enhance capital-raising efforts for countries that already issue sukuk and should be a key consideration for those planning future issuances. Ultimately, tokenisation reflects a broader shift in how capital markets are conceived: the debate about finance is not only about who provides capital, but also about how it is structured and which architecture can move trusted capital quickly and efficiently across borders.
As sovereign debt markets become increasingly digital, tokenised sukuk may not simply digitalise Islamic finance; they may become the missing Sharia-compliant layer of the emerging sovereign debt stack.
Mariam Khan is an Economist at OMFIF.
Join OMFIF on 7 July for Global financial stability: digital assets and next-generation cross-border payments.
Interested in this topic? Subscribe to OMFIF’s newsletter for more.