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Roula Khalaf, Editor of the FT, selects her favorite tales on this weekly e-newsletter.
The author is an adviser on Islamic finance, a member of the Council on Overseas Relations and millennium fellow on the Atlantic Council
The worldwide sukuk marketplace for Islamic finance faces a pivotal second. A brand new framework from the Accounting and Auditing Group for Islamic Monetary Establishments threatens to destabilise a $1tn market that has turn into a significant funding supply for sovereigns and corporates throughout the Center East, Asia and past.
The religious crucial behind proposed modifications to AAOIFI’s Shariah Normal 62 is deeply revered. They search to make sukuk debt seem much less like debt with charged curiosity, one thing that’s prohibited below Islamic legislation.
Nevertheless, the real-world results may fracture a market that has flourished exactly due to its consistency and investor confidence. The stakes for international Islamic finance couldn’t be increased.
For many years, the sukuk market has operated on pragmatic foundations. Most issuances have been “asset-based”, permitting traders to carry useful pursuits in tangible property with out requiring formal authorized title transfers. This has enabled widespread adoption throughout various jurisdictions, whereas sustaining alignment with Islamic values.
The Normal 62 modifications suggest a shift to “asset-backed” sukuk, requiring full authorized possession to be transferred to traders. Underneath present standard observe, an asset towards which sukuk finance is being raised stays within the identify of its proprietor. The sukuk holder collects a revenue cost every interval (usually on a quarterly foundation) and is paid again the complete debt quantity at maturity. Thus sukuk holders, in impact, tackle credit score danger with no direct recourse to the asset in a default state of affairs.
Underneath Normal 62, the asset is more likely to be transferred to a particular objective automobile owned by the sukuk holders. They may obtain a revenue cost every month from that asset and at maturity the sponsor buys the asset again. Whereas this each makes the safety actually asset-backed and extra like fairness below Islamic legislation, its implementation could generally show unworkable in observe.
Key markets comparable to Saudi Arabia, the United Arab Emirates and Indonesia — which account for a major share of worldwide sukuk issuance — have various authorized frameworks and restrictions on asset transfers that may complicate compliance. For a lot of sovereign issuers, transferring possession of infrastructure or pure sources is not only operationally burdensome, however politically infeasible.
Extra regarding is the transformation of sukuk’s monetary profile. By introducing direct publicity to underlying property, sukuk could start to resemble fairness slightly than fastened earnings — undermining the attraction for traders who deal with them as Shariah-compliant bond equivalents.
Fitch Rankings has already warned that such devices may turn into unrateable below typical credit score frameworks. This could current a serious barrier for institutional traders ruled by ranking mandates — together with pension funds and sovereign wealth autos — a lot of which have solely lately begun allocating capital to sukuk markets.
One among Islamic finance’s nice achievements has been the rising standardisation of sukuk documentation and constructions. If the Normal 62 modifications are adopted inconsistently — as appears doubtless given jurisdictional constraints — it may fracture the market into incompatible regimes, every with its personal interpretation of Shariah compliance. This could introduce authorized uncertainty, scale back liquidity and improve the price of capital.
Strengthening the moral and non secular foundations of Islamic finance have to be a steady course of. However reforms should additionally mirror market realities. AAOIFI has signalled that trade suggestions is being thought-about with the ultimate customary anticipated to be issued in 2025. That presents a crucial alternative to make sure the usual achieves each Shariah authenticity and operational viability.
Three rules ought to information this course of. First, any transition have to be gradual, with current guidelines making use of to excellent issuances and Normal 62 to new issuances. Second, the framework should enable for jurisdictional flexibility, notably in authorized programs the place asset switch shouldn’t be easy. And third, AAOIFI ought to have interaction with credit standing companies to make sure sukuk stays suitable with institutional funding requirements.
The sukuk market has developed via principled flexibility, permitting Islamic rules to search out sensible expression in fashionable monetary programs. The trail chosen by AAOIFI will form the trajectory of this marketplace for a long time to return.
