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Islamic Finance

Varied adoption of AAOIFI Standard 62 could spur market fragmentation


Disparate adoption of the AAOIFI’s (Accounting and Auditing Organization for Islamic Financial Institutions) Shariah standard no. 62 could crank up market fragmentation.

The adoption and implementation of the standard, if varied by jurisdiction or entity, could increase market fragmentation, Fitch Ratings has said. 

The impact will hinge on the finalised standard, which jurisdictions and entities adopt it, and how it is reflected in sukuk documentation, it adds. 

While the draft texts of the standard have revealed provisions that would entail transfer of legal ownership of the underlying sukuk assets as well as related risks to sukuk holders, the timeline to finalize the standard remains unknown. 

AAOIFI Shariah standards are adopted as mandatory regulatory requirements in many countries and jurisdictions across the globe such as Bahrain, Jordan, Krygyz Republic, Mauritius, Nigeria, Qatar and Qatar International Financial Centre (QIFC), Oman, Pakistan, Sudan, Syria, the UAE and Yemen. They are also followed by numerous Shari’ah consultancies, auditing firms, Takaful/insurance companies, non-banking finance companies, capital market institutions, and Shariah scholars and professionals worldwide. 

“A full assessment of Standard No. 62 will depend on the exact requirements and stipulations of the finalised text, and the resulting changes in sukuk documentation. Introducing asset-backed or quasi-equity structures could expose sukuk investors and issuers to additional credit, market, legal, operational, and liquidity risks compared to conventional bonds,” Fitch said in a statement.  

The standard could affect the credit profiles of new sukuk and may entail assessing potential implications for an obligor’s issuer default rating (IDR) and debt ranking, it said. However, the rating agency doesn’t believe that its adoption would have automatic implications for existing sukuk ratings, as the amendments usually require the consent of sukuk holders.

Big guns
Whether major sukuk issuers such as sovereigns would be open to transfer sovereign assets to certificate holders remains unclear. This could be due to multiple factors, including foreign-ownership restrictions. 

Corporates and financial institutions may also consider asset transfer impractical if this materially affected their balance sheet and credit profile. This does not arise with asset-based sukuk, which do not typically involve removing assets from the obligor’s balance sheet, Fitch added. 

Industry stakeholders posit that the new standard, if implemented in its present form, could potentially convert sukuk into a complex financial instrument, dampening issuances, Salaam Gateway reported in July. 

Besides credit implications, there may be an impact on sukuk issuance trends, and on market access for some issuers, Fitch adds. 

“Disruption could be minimal if the adoption of the new standard ultimately results in most sukuk continuing to be senior unsecured pari passu obligations of the issuer without asset recourse.”

Bashar Al Natoor, Islamic finance head at Fitch Ratings told Salaam Gateway earlier this year that the Islamic finance market has previously demonstrated the capacity to adapt to changes, as this is not the first time sukuk has experienced challenges.