Islamic finance standardisation still a ‘significant constraint’


The lack of standardisation in Islamic finance is still a “significant constraint” on the industry’s growth, and progress is expected to be slow given the scale of the challenge, according to an international credit rating agency.

In a recent statement, Fitch Ratings Inc said greater harmonisation of Shariah codification within and between jurisdictions is often cited as a limiting factor.

“But we believe it is just one of five overlapping areas, where greater standardisation and codification will be needed if Islamic finance is to gain wider acceptance among regional and international investors,” it said.

However, it noted that Malaysia is the most standardised market in the Islamic finance community and remains one of the most innovative.

“Standards in regulatory and legal areas, which aim to describe rights and obligations under all circumstances, would support consistency, strengthen supervision and enable the industry to move to the next phase of its development.

“This would be particularly important for driving corporate sukuk issuance locally, regionally and internationally, which is dominated by sovereign issuance,” it said.

Fitch said the differences in interpretation can deter investors, especially when combined with similar variation in laws and their application, and the lack of legal precedence for effective enforcement of creditor rights in many jurisdictions.

“This is highlighted by Dana Gas PJSC’s court case, after the company said it had received legal advice that its sukuk in its present form is not Shariah-compliant, and is therefore unlawful under United Arab Emirates (UAE) law,” it said.

The Shariah-related debacle concerning a sukuk issued by the UAE-based Dana Gas would not have happened in the Malaysian sukuk market, due to the latter’s tight and well-functioning Shariah governance framework, according to an earlier report in The Malaysian Reserve.

“In Malaysia, a national body puts out resolutions, justified and clearly articulated in written form which become the guideposts for Shariah committees at the firm or bank level,” said International Centre for Education in Islamic Finance professor of finance Dr Obiyathulla Ismath Bacha.

Under Malaysia’s Islamic Financial Services Act 2013, he said individual Shariah committee members are held personally liable to ensure compliance with the national resolutions.

“This assures synchronicity in interpretation and execution of Shariah rules. Such a governance framework, however, is sorely lacking elsewhere,” he said.

As well as Shariah, Fitch Ratings sees product structure and documentation, supervisory and regulatory frameworks, law and dispute resolution, and financial and accounting reporting as the main areas where standardisation would be advantageous.

“In some cases, there is still little standardisation even at a local level, while in others, progress would be needed on a regional, or international, basis,” it noted. “One of the barriers to standardisation is the argument that it may limit innovation, but we do not believe this to be the case.”

Citing some statistics on new sukuk issuance with a maturity of more than 18 months from the Gulf Cooperation Council (GCC) region, Malaysia, Indonesia, Turkey and Pakistan, the report said it totalled US$49.6 billion (RM203.86 billion) in the first nine months of 2017.

This is 24% more than the US$40 billion issued in the whole of 2016, driven predominantly by increased sovereign issuance in the GCC. Sukuk’s share of total issuance in these markets has also risen to 30% this year, from 29% in 2016, it said.

While there is a broad agreement on key Shariah principles, the report said their interpretation and the process for assessing compliance can vary significantly.

For example, it cited the example where Malaysia’s centralised Shariah supervisory board warrants all sukuk are compliant with nationally accepted principles. GCC member states, on the other hand, leave the question of compliance to Shariah boards of individual financial institutions and sukuk stakeholders, which leave the door open to divergence in Shariah rulings and interpretation.

“There has been progress recently in some GCC countries, most notably Bahrain’s creation of a central Shariah board, which supervises Islamic finance product development and provides guidance to the central bank. However, there is still limited clarity on these initiatives’ mandate and influence,” it said. — TMR