Standardization is indeed unlikely as there have always been, and will continue to be, different schools of Islamic jurisprudence. However, those seeking finance also want a choice of products, and differentiated products to suit their particular needs. Standardization eliminates choice and means financial contracts cannot be tailor made. The advantage of standardization is that it reduces cost and makes explaining the nature of the financial products more routine. The issue of standardization is different from transparency. There is no more reason why information should not be disclosed for differentiated products. Admittedly, the disclosure costs may be higher per client when the market is divided into many segments than if it is treated as a homogenous whole. However, the client may consider it worth paying extra for additional disclosure. For example, Islamic trade finance may be cheaper when the price the bank pays for a commodity is not disclosed. The supplier may not want the client to know the discounts being offered. However, in Murabahah both the purchase and sale prices must be disclosed, which may raise the cost to the bank, and this invariably gets passed on to the client. Knowledge has its costs, and the clients get what they pay for.
PROFESSOR RODNEY WILSON
In the conventional finance industry, we see a high level of standardization of contracts that are common across the industry. In addition, there are also regional and local deviations for a variety of contracts to cater for local practice and legal requirements. Although it is unlikely that all schools of thought will completely agree on transactions, what the industry should work towards is a common set of standard contracts with a list of clauses for known, generally accepted deviations. It will then be possible to construct a contract using a combination of these clauses based on the contract, jurisdiction and school of thought. Although it will not be able to cater for every single instance, it will enhance standardization and transparency in the Islamic financial industry. DR NATALIE SCHOON Head of product management, Bank of London and the Middle East
I agree that the global Islamic finance industry will not witness total standardization of agreements, largely due to the different interpretations of the rules of Shariah, and this is a necessary consequence of the diversity of opinion which has traditionally been supported in Islam in general. However, we will see certain kinds of contracts being used on a large scale (in terms of volume of transactions) among the majority of participants, and these should in time be suitable for standardization. One example is Commodity Murabahah, which most schools of thought find permissible. Indeed, some standardization of this agreement has already occurred, supported by IIFM (International Islamic Financial Market), and is available for use by market participants. We expect to find that differences in approach to such contracts to arise from two key areas: • Which party plays the role of agent in the commodity purchase and sale? • Some parties require full transfer of cash for each leg of the transaction, typically using a third party bank to manage the cash flows — this is used by some Islamic banks in Saudi for example. Notwithstanding this, the large number of similarities in the methodology of the component transactions enables such a contract to be standardized effectively. Where standardization is more difficult is in transactions that have not yet reached critical mass in terms of volumes in the market. This is because such agreements are still largely done on a bilateral basis, and there is typically more than one way of achieving the same outcome. In forex hedging, for example, there is more than one way to achieve the same economic protection as provided by conventional forex forwards, forex options and currency swaps, and the same applies to profit rate hedging. This part of the market is at a stage of growth and development and is probably not suitable for standardization quite yet. Indeed, we expect to see the preferred method(s) of structuring transactions to evolve and develop over time. Pushing for standardization (before a product has shown that it is being used by a wide range of counterparties in significant volumes) is not always helpful, and we could easily find that in these cases any standardized agreement could become out of date quite quickly and not achieve the widespread acceptance that is desired. The potential benefits of standardizing contracts include reduction of cost and resource in negotiating and executing agreements, ease of execution of transactions going forward, increased transparency in the market and greater dissemination of best practice principles amongst market participants. For these reasons the concept of standardizing agreements should always be considered. However, the concept needs to be applied at a time when the specific markets involved are ready for it. SAFDAR ALAM Executive director and head of Islamic structuring, J.P. Morgan
The idea of complete standardization is a fallacy in any field, particularly one with several well-established schools of thought. The divergence between schools of thought and scholars is healthy for the industry because it provides the engine for innovation. However, the resources available from a Shariah review perspective require some standardization of contracts in order to focus scholars’ energy on the controversial or innovative products. Currently in the Islamic finance industry, there is broad consensus on a number of “plain vanilla” financial products and creating a standard contract for these products will facilitate the efficiency of the industry in using these products. One of the added costs of Islamic financial services compared with their conventional alternatives is in the approval of each institution’s contracts by Shariah scholars. In addition to imposing a cost that will ultimately be borne by the consumers, the added costs favor larger institutions over smaller institutions because these costs can be spread across a greater number of consumers in larger institutions. Although the current focus is on developing larger, better-capitalized institutions (and this is important for other reasons), down the road it is likely that the Islamic finance industry will be forced to confront the “too big to fail” problem that has created systemic risks in more mature financial markets. An industry with the barriers to entry created by the absence of standardized contract will find the “too big to fail” problem more acute because there will be a greater concentration of assets in larger firms. BLAKE GOUD Principal, SharingRisk.org
It has been proved that lack of standardization of rules and principles in contracts in the business of banking brings with it numerous issues and problems. The least of these issues is customers’ confusion, difficulties in setting up regulatory requirements and the lack of comparability of competing financial institutions. In the case of Islamic financial institutions, lack of standardization is attributed to differences among Shariah scholars who follow different schools of interpretation of Shariah injunctions. The scholars now and then argue that differences among them are positive signs because the differences avail choices. Moreover, they argue, the recorded differences are very few and they do not merit this big row. In a survey conducted by Bahrain-based General Council for Islamic Financial Institutions in 2006 it was found that differences in a sample of Islamic banks accounted for only 6% of the total number of issues researched. Despite all of this the Shariah board of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), which issues Shariah standards, is trying to persuade Shariah boards serving Islamic financial institutions to follow their standards so that standardization can be achieved. However, AAOIFI has no enforcement power and even its member banks sometimes depart from its Shariah rules. The argument for a supreme Shariah board at the level of the central bank, as is the case in Malaysia, has not found support in the Middle East. Central banks do not want to get involved in details which need to be sorted out by the financial institutions themselves. For the Shariah scholars such an approach limits the scope for Ijtihad and innovation. However, legal professionals involved in the drafting of Islamic contracts have had a role in standardizing many products. For example, it has been noticed that contracts covering numerous corporate, Sukuk and treasury deals are almost standardized. DR TAHA ELTAYEB AHMED Senior vice-president, Shariah governance and documentation,
In Islamic finance, the goal of Shariah scholars, researchers and product development professionals is never to achieve comprehensive standardization as it could limit the scope of innovation and development of new solutions. However, the aim is to achieve a reasonable level of global acceptance that is required for transactions in the global markets. The platform provided by AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) is one such major initiative that appreciates the differences of view among the Shariah scholars and develops standards based on the present day consensus among these scholars. These standards not only provide guidelines for transactions and contracts but also ensure a greater level of Shariah compliance. Thus, today we need to promote and back such initiatives that aim to create a common platform for different schools of thought with the common objective of promoting Islamic finance and banking without restricting its growth. AHMED ALI SIDDIQUI Executive vice-president, product development and Shariah compliance, Meezan Bank
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