The very success of an Islamic financial institution (IFI) will depend on stakeholders’ belief that the business of their financial institution is complying with Shariah principles. This is one of the main factors that intensifies the role of good governance to ensure that the trust of stakeholders is not compromised and that business grows according to their expectations. In order to maintain the highest standard of Shariah compliance, the IFIs should follow the guidelines and criteria of AAOIFI, failing which reputational risk will arise out of any uncertainty of Islamic business ethics compliance. Obviously, the issues related to Sukuk raised by AAOIFI need to be addressed. Furthermore, the issue of dual Waad-based financial products need to be taken up too. Vital components in this process are: Shariah compliant product, patient reputation building, high performance standards, a resilient infrastructure and a robust regulatory framework. While the virtues of Islam have always advocated good governance, the challenge to IFIs lies in its modern application.
DR ABUL HASSAN
It is good for the industry as it brings clarity. The issue on the majority of Sukuk being non-compliant is overstated and factually incorrect as the issues which scholars are concerned about don’t apply to 85% of all Sukuk. The media should research the statements rather than just sensationalizing issues. AFAQ KHAN CEO, Standard Chartered Saadiq
The AAOIFI ruling helps clarify the position on Sukuk issuance, but is not likely to be welcomed by issuers or investors. The problem is that investors are looking for a Shariah compliant substitute for debt instruments such as bonds or floating rate notes, and have little interest in the value of the underlying asset except in the case of a default. Sheikh Taqi Usmani thought that Sukuk should be more like equity than debt instruments, as Islamic finance is about sharing risk and participating in partnerships, but this is not how Sukuk have evolved. If investors want equity-like instruments with the possibility of capital gains and losses, then they will invest in these directly and not in Sukuk. Investors in Sukuk, including Takaful operators, want their capital virtually guaranteed. Helpfully, the AAOIFI ruling makes the distinction between Ijarah and Mudarabah and Musharakah Sukuk clearer as with the former, investors can get back the nominal value of their capital at the end of the period. This is no longer the case with Mudarabah or Musharakah Sukuk, where the money repaid must equal market or fair value, which will usually be different from the sum invested. In other words, with these Sukuk investors are exposed to market risk and not simply default risk. This ruling is likely to make Mudarabah and Musharakah Sukuk relatively unattractive, and will encourage most investors and issuers to opt for Ijarah structures. In my view, this is unsatisfactory, and more serious work is needed on Sukuk structuring to address these problems. The AAOIFI ruling should not be regarded as the last word on these important matters. PROFESSOR RODNEY WILSON Director of postgraduate studies, Durham University
In my view, the new resolution should not affect the Islamic finance industry negatively. In fact, I would view it as a positive development because it reflects that the authorities are serious in their efforts to ensure Shariah compliant products are not compromised. If there are any products that may be affected by this resolution, I believe that it can be further refined .The alternative would be to utilize other Shariah compliant products for the Sukuk issuance. MOHAMED RIDZA ABDULLAH Managing partner, Mohamed Ridza & Co
It should be clear that AAOIFI is first and foremost an accounting institution and does not ‘dictate’ Shariah law. Investors and market participants can defer to the wisdom of the scholars (AAOIFI or otherwise) but are not, and should not be, bound by their opinions. Shariah opinions are wide and varied; indeed, there is no earth-based authority that can ‘rule’ on Shariah compliance. The market is in its current form because that is what the ‘borrowers’ and many investors wanted. However, it is apparent that a proportion of investors are concerned about ‘compliance’ and this may have an effect on their future investment decisions. Moody’s strictly follows ‘substance’ over ‘form’ in its analysis of Sukuk credit risk. We think such an approach to Shariah, with more transparent disclosure will allow Islamic investors a better understanding of Sukuk ‘substance’ (i.e. the true asset backed, risk/profit-sharing characteristics) and make an informed investment decision. Some investors and borrowers may continue to be happy with the existing structures and that is wholly their choice. KHALID HOWLADAR Vice-president/senior officer, Moody’s Investors Service
The recent issuance of guidelines by the AAOIFI Shariah committee is a very welcome; a timely step as far as Islamic bankers and product developers are concerned. In fact, these clarifications in the existing guidelines were long awaited to ensure proper Shariah compliance. We believe these guidelines will help strengthen the industry on solid grounds and will put a stop to doubtful structures. With the rapid growth of Islamic finance and boom in the Sukuk market, the need to ensure Shariah quality was greatly felt. Some Sukuk structures present in the market were creating negative impressions of Islamic banking and causing discomfort among the Islamic banks; Islamic funds that were looking to invest their excess funds as well as among the common Shariah conscious investors. Now the time has come that we Islamic bankers must move forward to develop Sukuk and investment transactions that are clearly in line with the risk-taking, risk-sharing guidelines inherent in the Islamic modes and are not just technically Shariah compliant but also comply with the true spirit of Shariah rules. Another positive point highlighted in the guidelines was the role of Shariah boards and it was rightly pointed out the this role not only limits the approval of legal documentation or issuance of fatwas on these documents’ structure but also involves overseeing the actual implementation process including the calculations, timing, sequence of document execution as well as periodic review of its working and profit distribution. AHMED ALI SIDDIQUI Vice-president and manager, product development and Shariah compliance, Meezan Bank, Karachi, Pakistan
I believe that the context of denouncing some of the Sukuk was blown out of proportion and should have been handled more professionally and not emotionally as if the ISLAMIC FINANCE industry were the target. Nevertheless, there were some issues which crossed the border and misused certain Shariah rulings, therefore I believe that AAOIFI’s new ruling is much awaited and will ensure that issuing Sukuk is an industry and not “why not me too” approach. It will discipline the issuers and restore the confidence in the issues. JAMIL AL-JAROUDI CEO, Sokouk Exchange Centre (Tadawul)
As with any industry that innovates and expands, the key stakeholders take action to bring an industry back to its roots. The recent credit crisis is an example where credit criteria now again are strictly enforced. Similarly, with Islamic finance, the stakeholders are the Shariah experts and must be commended in bringing the industry in line with what they perceive in their expert opinion to be compliant. I fully believe this resolution will positively affect the industry and counter the arguments of Sukuk being wrappers to conventional bonds. OMAR KALAIR CEO and President, UM Financial Canada
The tightening of the rules on Sukuk issuance by AAOIFI will result in enhanced Shariah compliance for new Sukuk being issued. The following are the key points impacting Sukuk issuance: 1. Due to the fact that there is no longer a guarantee in the case of a default, Sukuk will rank pari passu with ordinary debt, with the main distinction that the Sukuk holder owns the asset and, therefore, is in a better position than unsecured debt. 2. The new rules allow for reserves to be built to cover shortfalls and hence leave the way open to tranching of the Sukuk according to risk level, which will in turn allow investors to decide the type of risk they would like to take. 3. A purchase undertaking to purchase the asset at maturity at a pre-agreed price is no longer allowed under the new rules for Mudarabah, Musharakah and Wakalah Sukuk. However, in case of a price decline, the investor does not get his capital back (which is not in line with the Sukuk manager’s fiduciary duty), and in case of an increase in the asset price, the investor takes all the profit, which is not in line with the overall risk levels he takes. Given that the borrower takes the business risk on the asset he should therefore be held responsible for the loss as well as benefit from the gain. DR NATALIE SCHOON Head of product management, Bank of London and The Middle East
Very positive development. Investment banks will have to do more research to customize solutions and move away from mimicking conventional structures. Finally, a bold statement from a major Shariah body. KHALID MAHMOOD BHAIMIA Managing director, Hong Leong Islamic Bank
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