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Column by Masroor Haq, Managing director and Head of Middle East and Africa at VTB Capital, for Islamic Finance News

18 May 2011

Islamic Finance News, 18.05.2011, Islamic Finance: More Standardization Means Less Chaos

By Masroor Haq, Managing director and head of Middle East and Africa at VTB Capital

The growth and development of the Islamic finance market continues to be impacted by the lack of standardization across the sector. The conflicting views among scholars about the structure of Islamic finance and its products need to be resolved to help boost the Shariah compliant market.

Standardization process

The Shariah scholars, accountants and practitioners have been successful in devising standards on the line of international accounting standards (IAS) for Islamic contracts. The framework ensures compliance, ease in interpretation and practical applicability.

Given the pace of development which Islamic finance has witnessed, it was important to establish adequate controls and guidelines. What is equally critical is to achieve consistency among the views of leading scholars and global standardization in Islamic finance.

Types of standards

The standardization process for Islamic finance started in the early 1990s with the formation of AAOIFI. AAOIFI has gained support for the implementation of its standards, which are now adopted in Bahrain, Dubai International Financial Centre, Jordan, Lebanon, Qatar, Sudan and Syria. The relevant authorities in Australia, Indonesia, Malaysia, Pakistan, Saudi Arabia, and South Africa have issued guidelines that are based on AAOIFI’s standards and pronouncements.

To adopt or not to adopt AAOIFI standards

Despite the efforts of scholars and implementers alike to furnish the industry with a set methodology to conduct transactions, some IFIs have not been following these standards. There are various reasons for this, one being that certain institutions find it extremely difficult to change. They consider implementation of these standards as submission to an approach suggested by someone else.

Some institutions find it more convenient to get approval fr om their globally renowned Shariah scholars than to comply with the standards. There is also a general sentiment that certain IFIs are reluctant to change their ways since subscribing to AAOIFI will mean the inability to tailor things to their own advantage. Among others, the key followers of AAOIFI standards increasingly include Malaysian and Indonesian IFIs who deserve credit for significantly developing the Islamic finance industry. DIFC also subscribes to the AAOIFI and all institutions within its jurisdiction, by law, must follow the standards. This is an encouraging sign as Dubai wants to play an important role in the development and promotion of Islamic finance.

The future

It is important that all Shariah experts and Islamic bankers realize the immediate need for standardization in the Islamic space. If not, we will continue to see a Sukuk or Islamic finance product considered halal to investors in UAE and Kuwait but not accepted in other countries such as Saudi Arabia. Even if this particular product deserves credit for significantly developing the Islamic finance industry, it is possible that it will have been stamped by a particular scholar and rejected by another — despite both scholars being equal in their reputation.

The industry therefore needs to create an institutional framework in terms of judgments around Shariah. It will grow much faster once there is consistency among the scholars and a product is established to be globally acceptable by Islamic investors. 
New promising regions wh ere Islamic finance can be used such as in Russia and CIS (US$1 trillion investment needed in infrastructure/ regions abundant in natural resources, with a Muslim population of more than 20 million) can very quickly adopt the standardized framework.

Benefits of standardization

Standardization is likely to reduce costs, improve liquidity and reduce execution times which are critical for the sector. The reduced execution costs and increased issuance will most likely reduce any price diversion between conventional and Islamic structures.

While some standardization bodies have emerged, adherence to standards varies from country to country. One critical aspect to achieve this would be to have an authoritative centralized body to frame the rules. Hence greater dialogue is needed between the different segments — Malaysia, Saudi, and the Middle East countries. Malaysia is already making a concerted effort to achieve standardization. The central bank, Bank Negara Malaysia is at the forefront with its initiative in issuing a series of ‘Shariah parameters’ for several major Shariah contracts.

A dedicated judge in the Malaysian high court has been assigned to preside over litigations relating to Islamic banking for adjudication purposes.

The Malaysian Investment Banking Association members will also be adopting the Interbank Murabahah Master Agreement, Corporate Murabahah Master Agreement and Wakalah Placement Agreement for Interbank and Corporate developed by the Association of Islamic Banking Institutions Malaysia.

The view that Shariah interpretation should be considered a strength, as it leads to innovation, is one shared by many scholars and bankers. However, these varying interpretations can lead to confusion and complexity of transacting among international financial institutions and the wider investor community, particularly when in the same market.

VTB Capital is working closely with domain experts and leading IFIs to facilitate the development of Islamic finance in Russia and CIS. It is important that any debut structure introduced for issuers from this region ensures best practice and structuring expertise.

Masroor Haq has experience structuring Shariah compliant transactions for oil financing, aircraft financing and leasing for the Middle East / emerging markets’ clients and private equity funds.

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