The Islamic finance industry has witnessed healthy growth over the last two decades, with predictions that the industry assets will reach US$3.5 trillion by 2024. However, the absence of standardization and harmonization continues to be a recurring issue facing the industry and preventing it from reaching its full potential. This article examines the key developments witnessed in 2020 and the gaps that still need to be filled to take the industry to the next level.
Shariah is a broad term, representing a system of beliefs revealed in the Holy Quran and the Sunnah. While Shariah scholars generally agree on the main principles of Islamic finance, there remain differences in interpretation between the various schools of Islamic religious scholarship. There are also instances where Fatwas allowing a certain product could be accepted in one jurisdiction, but are seen as controversial in others. This lack of harmonization across jurisdictions hinders funding options and cross-border cooperation.
Increased standardization in the regulatory and legal areas, which aim to describe rights and obligations, would also support confidence and strengthen supervision. In the Sukuk market, standardization could lead to efficiencies and cost reduction in the drafting of voluminous Sukuk documentation for issuers and offer greater transparency of Shariah rulings and resolutions, which in turn builds investor confidence.
This would be particularly important for driving corporate Sukuk issuance locally, regionally and internationally; these segments are currently dominated by sovereign issuance. In more exotic products like Islamic derivatives and hedging (Tahawwut), the use of standardized documentation could help reduce cost and lead time for negotiations.
Fitch Ratings has produced a framework that helps demystify the issue of standardization and harmonization in Islamic finance, and notes the gaps that needs to be filled (See Diagram 1).
Review of 2020
Despite the coronavirus pandemic, various initiatives were launched by regulators in key Islamic finance jurisdictions to aid standardization. In February, the Saudi Arabian Monetary Authority issued a Shariah corporate governance framework for banks engaging in Islamic banking, aiming to establish standards for Shariah governance practices. While the outcome of the new framework is unclear, slower progress on this is likely as a result of lower oil prices and the coronavirus pandemic.
In Malaysia, which is the most standardized Islamic finance jurisdiction, the presence of centralized Shariah requirements has been a key driver in the evolution of Malaysia’s Islamic finance sector. As an example, Sukuk now represents about 60% of the country’s local debt markets. The country is not only working on Islamic finance, but also directing efforts toward developing and enhancing a comprehensive Halal ecosystem and pushing ahead with Halal Industry Masterplan 2.0 – recognition of Islamic finance as the pillar of a Halal economy.
The UAE also launched an initiative in May to create a unified global legal and legislative framework for the Islamic finance sector, in partnership with the IsDB and the Dubai Islamic Economy Development Centre. The initiative is in response to calls for greater standardization within the sector. This follows the establishment of the Higher Sharia Authority at the Central Bank of the UAE in 2018, which mandated that AAOIFI Shariah standards have to be followed in the country.
In October, the Central Bank of Kuwait also approved the establishment of the Higher Committee of Shariah Supervision to underpin the governance of Shariah supervision. Among its roles, the committee will propose general guidelines for products and services offered by Islamic banks in Kuwait. These efforts are also likely to deepen standardization efforts in Kuwait. Turkey is also reported to have launched the legal infrastructure for participation finance and this is likely to pivot standardization.
Additionally, AAOIFI launched the Governance Standards in January and the International Islamic Financial Market launched new Sukuk Ijarah documentation templates in October, adding on to hundreds of standards and guidelines from over the years.
Preview of 2021
We believe that standardization will continue to be driven by a top-down approach at the regulatory level, which we expect to continue in 2021 and beyond. Furthermore, industry standard-setting bodies will continue to contribute notably toward standardization. In the GCC region, Fitch Ratings’s research showed that standardization at a national level is starting to take shape. While we expect these initiatives to aid standardization efforts in the medium to long term, success will depend on their adoption by market participants and building a history of implementation. From a credit point of view, Fitch will continue to monitor how standardization in the Islamic finance industry progresses and comment on credit implications, if any, as they arise.
Notable strides were made in 2020 toward standardization, harmonization and centralization, despite the volatilities caused by the coronavirus pandemic and the oil price fall. However, the industry is not even close to achieving international or regional standardization, and in some cases, there is still little standardization even at the local level.
In 2020–21, the continued move by the regulators and industry bodies toward inclusive standardization will be vital for the future growth of the Islamic finance industry. AAOIFI, IFSB and a few other regional and international organizations have issued hundreds of standards and guidelines, but a full widespread, actual adoption continues to be limited globally.