The lack of standardisation in Islamic finance is a significant constraint on the industry’s growth and we expect progress to be slow given the scale of the challenge, Fitch Ratings says. Greater harmonisation of sharia 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.
As well as sharia, we see 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.
One of the barriers to standardisation is the argument that it may limit innovation, but we do not believe this to be the case. 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. New sukuk issuance with a maturity of more than 18 months from the Gulf Cooperation Council (GCC) region, Malaysia, Indonesia, Turkey and Pakistan totalled USD49.6 billion in the first nine months of 2017. This is 24% more than the USD40 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.
While there is broad agreement on key sharia principles, their interpretation and the process for assessing compliance can vary significantly. Malaysia’s centralised sharia supervisory board warrants all sukuk are compliant with nationally accepted principles.
GCC member states, on the other hand, leave the question of compliance to sharia boards of individual financial institutions and sukuk stakeholders, which leave the door, open to divergence in sharia rulings and interpretation. There has been progress recently in some GCC countries, most notably Bahrain’s creation of a central sharia 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.
These 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’s court case, after the company said it had received legal advice that its sukuk in its present form is not sharia compliant and is therefore unlawful under UAE law..
Industry groups, such as the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), are expanding and have developed standards to try and drive harmonisation in several areas, including sharia and financial reporting. AAOIFI recently admitted Saudi Arabia’s central bank as a member and also issued a new standard that encourages the creation of central sharia boards and sets out common principles for establishing them. However, implementation of standards like this has been slow and patchy, and we expect this to remain the case.