Islamic Finance Into a new era
2016 should be the year when regulation and standardisation make their mark on the Islamic finance world
Regulation and standardisation have started to receive stronger attention, as the Islamic finance industry expands its international footprint and the range of products and services proliferates at an accelerating rate. National financial regulators and central banks are increasingly looking to establish a firmer sense of how to regulate the sector, with pressure growing for more uniformity across jurisdictions.
In early December 2015, the august institution that is the Bank of England joined the Islamic Financial Services Board (IFSB), one of the main standard-setting bodies for Islamic finance, the second western regulator to do so after Luxembourg.
The need for bolstering regulation is seen as pivotal in helping the industry resolve issues such as the lack of liquidity management instruments and applying more stringently its principle of profit and loss sharing. As ratings agency Standard & Poor’s (S&P) notes, standardisation of documents and sharia ruling could enhance industry integration and free stakeholders’ capacity to focus on innovation.
That’s the theory at least. But enforcing uniformity has been notoriously difficult in a global industry that has seen the culture of Islamic finance develop at sharply different tangents, from Malaysia’s traditionally more liberal interpretation to the stricter standards typically seen in the Gulf. Creating consensus across such cultural gaps has been beyond the industry’s capability until now.
Some changes will doubtless come as the regional Islamic finance industries look to adapt to global standards on financial services. S&P sees new regulatory developments in developed markets as a source of opportunities for Islamic finance. As Basel III helps the banking industry enhance its capitalisation and resilience to unexpected shocks, it will also tackle the lack of available liquidity management instruments for Islamic financial institutions.
S&P also sees Islamic finance as standing to benefit from standardisation of industry products and sharia opinions, helping to attract new issuers and free stakeholders’ capacity to focus on innovation and catering to specific issuers’ needs. A review of documentation used by some issuers in recent sukuk transactions illustrates movement toward increasingly standardised sukuk legal documents, such as those used for the sukuk issued by Luxembourg that closely resembled those used in the South African government’s issuance.
Yet the ratings agency notes that standardisation is not occurring at the market-desired speed. Bodies such as the International Islamic Liquidity Management Corporation (IILM), created to offer Islamic banks the necessary instruments for liquidity management by issuing short-term dollar denominated sukuk, have not proved up to the job of singlehandedly dealing with the weaknesses of a $2 trillion industry given the relatively small size of its own issuances.
At the same time, there is concern that regulation should not be imposed in an overzealous and arbitrary manner. While the solution to varied interpretation may be detailed common standards, some practitioners argue these should still leave flexibility of interpretation and development.
“While we appreciate the desire to have uniform standards that can adapt to and facilitate the trade and issuances in all matters related to Islamic finance, we’re concerned that it is being overdone. People should be careful what they wish for,” says one senior Gulf-based Islamic finance practitioner.
“Above all, we need to be careful in that we don’t stifle innovation and growth that the market still needs. The direction should be to achieve better transparency and governance by market participants, rather than try to achieve a set of standards that might be beyond what is possible, given all the different regulations in different countries and the different traditions of Islamic jurisprudence,” he says.
Some standards-setting bodies have already laid down a marker for improvement. In 1990, the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) was set up to issue issues guidelines that are followed wholly or in part by Islamic financial institutions around the world.
More recently AAOIFI , under its ambitious secretary general Hamed Hassan Merah, has become more active in its approach. AAOIFI has issued six new standards in the past 15 months alone. For example, in early December 2015 it announced it was revamping key standards and boosting its engagement efforts with the industry, part of an ambitious reform agenda. Merah said revised standards for sukuk and a new one covering the sale of debt are among major efforts planned for 2016. AAOIFI ‘s 13-year-old sukuk standards would be revised to take into account the considerable changes in the market for Islamic debt instruments. That revision would cover the asset-backed and asset-based nature of sukuk, capital boosting instruments, beneficial ownership and non-viability clauses.
One key change has seen AAOIFI ‘s division of its accounting and auditing board into two: one creating a board solely focused on governance and ethics. AAOIFI is seeking convergence with its counterpart in conventional finance, the International Accounting Standards Board.
Under the AAOIFI regime, the technical standards boards will consist of a sharia board responsible for the development and review of sharia standards and related materials including guidelines, researches and interpretations. It will also be responsible for general strategies relating to development and adoption of sharia standards. This board is intended to be the supreme authority for the Islamic finance industry worldwide, and the standards it issues are widely applied globally.
The Accounting Board will be responsible for carrying out development and review of accounting standards and all related materials including guidelines, research and interpretations. It will also be responsible for general strategies relating to development and adoption of the accounting standards. It will also co-ordinate with the Governance and Ethics Board to formulate strategies and standards work programme relating to auditing standards, including those on sharia auditing.
Finally, the Governance and Ethics Board will develop and review governance standards and codes of ethics, and all related materials including guidelines, researches and interpretations. It will also be responsible for general strategies relating to development and adoption of the governance standards and codes of ethics.
One important aspect that could shift the culture of regulation is AAOIFI ‘s appointment of 50 members across the three technical boards, drawn from 37 countries, which also marks an apparent shift away from a reliance on Gulf-based scholars.
For the sharia Board, AAOIFI has appointed 20 members from 17 nationalities, consisting of 16 sharia scholars who also serve on sharia Supervisory Boards of Islamic Financial Institutions and four sharia scholars who do not serve on sharia Supervisory Boards of any Islamic financial institution (but may serve central banks, regulatory authorities, governmental bodies or not-for-profit organisations). For example for the Accounting Board, AAOIFI has appointed 15 members from 13 nationalities.
These appointments reflect fresh thinking that will be welcomed. But many in the industry remain wary of bodies that seek to impose one world view on a sector that is still in a state of nascent development.
“Rather than achieve the impossible we should focus on principal standards which still leave room for market based supply and demand,” says the Islamic finance practitioner
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