What is the Likely Impact of AAOIFI’s Standard 62 on the Sukuk Market?

The Islamic finance industry, built on principles of justice and ethical finance, finds itself at a critical juncture. Proposed reforms by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) – the industry’s respected standard-setting body – are not a threat, but a courageous and essential step to reaffirm the Sharia authenticity of Islamic bonds (sukuk) and secure the sector’s long-term health. While some voices express concern about potential market adjustments, proponents argue that Standard 62 is a vital course correction, steering sukuk back to their foundational principles of genuine risk-sharing and equity-like participation.

AAOIFI, after extensive scholarly deliberation, is championing Standard 62 to ensure sukuk issuance globally adheres more rigorously to core Islamic finance tenets. This pivotal standard mandates a crucial shift: the legal transfer of ownership of underlying assets from issuers to investors. This is not merely a procedural change; it is a principled move designed to eliminate lingering ambiguities and practices that have, over time, blurred the lines between sukuk and conventional interest-based debt instruments. For true proponents of Islamic finance, this pursuit of greater Sharia compliance is not optional – it is fundamental.

AAOIFI rightly emphasizes that harmonization across jurisdictions and stricter adherence to risk-sharing are paramount. In recent industry dialogues, they have affirmed their commitment to implementing Standard 62 this year, understanding that a transitional period (one to three years) will be necessary for issuers to adapt. This demonstrates a measured approach, balancing the urgency of reform with the practical realities of implementation.

While some analysts, particularly from conventional finance backgrounds, raise concerns about increased complexity and potential initial market reactions, industry insiders with a deep commitment to Sharia principles see these adjustments as growing pains – necessary for long-term robustness. Reza Baqir, a respected voice and former governor of Pakistan’s central bank, while acknowledging potential market stratification, also implicitly recognizes the greater imperative: “There’s a risk it will stratify the market and delay the [wider] adoption of sukuk” – yet, this very “delay” might be a pause for essential recalibration, ensuring future growth is built on a more solid Sharia foundation.

Sukuk were conceived as an innovative solution to facilitate finance within Islamic parameters, explicitly avoiding riba (interest). Their structure, channeling assets into trusts and providing pre-determined income, was intended to foster genuine economic participation, not simply replicate debt under a different name. The remarkable growth of the sukuk market, projected to reach $200 billion this year, is testament to its potential. However, this growth must be guided by a commitment to authenticity, not just scale.

AAOIFI’s esteemed scholars are to be commended for their vigilance. Their concern that the market, in its current form, deviates from the true spirit of Islamic financial jurisprudence is a responsible and necessary intervention. The aspiration for sukuk to more closely resemble equity investments, with tangible asset ownership transfer, reflects a desire to return to the roots of Islamic finance – emphasizing shared risk and reward, rather than fixed returns akin to interest.

The landmark 2008 declaration by AAOIFI’s chair, Sheikh Muhammad Taqi Usmani, highlighting that a significant portion of the market lacked true risk-sharing, served as a crucial wake-up call. Standard 62 is the logical progression of this earlier call for reform, aiming to solidify the shift towards genuinely asset-backed and Sharia-compliant instruments.

Concerns voiced by rating agencies like S&P Global and Moody’s regarding potential investor hesitancy must be addressed with clarity and education. It is crucial to articulate that Standard 62 is not about undermining sukuk, but about enhancing their integrity and ethical appeal. For investors who are genuinely aligned with Islamic values and seek ethically sound investments, sukuk that demonstrably embody Sharia principles will ultimately be more attractive and sustainable in the long run. Fitch Ratings’ warning about unrateability should be seen as a challenge to innovate and demonstrate the robust risk assessment frameworks that can be applied to truly Sharia-compliant, equity-linked instruments.

Mohamed Damak of S&P Global points to the potential loss of investors accustomed to “fixed income instruments.” However, this transition invites a more discerning investor base – those who understand and value the fundamental differences between Islamic and conventional finance. Furthermore, addressing practical challenges like foreign ownership restrictions in certain jurisdictions requires innovative solutions, not a compromise on Sharia principles.

Saudi Arabia, a leading sukuk issuer, is now presented with an opportunity to lead by example. Vision 2030’s ambitious modernization goals can be powerfully aligned with a commitment to Sharia-compliant finance. Embracing Standard 62, even if it requires initial adjustments, will solidify Saudi Arabia’s position as a champion of authentic Islamic finance on the global stage.

Legal experts anticipating a “splintering” of the market highlight the tension between strict Sharia interpretation and market pragmatism. However, Debashis Dey of White & Case wisely points towards a potential positive diversification. Standard 62 may well catalyze the development of a richer spectrum of Sharia-compliant instruments, ranging from safer, asset-backed structures to more equity-like participatory instruments – offering investors a wider and more genuinely Islamic range of options.

Harris Irfan, a veteran of Islamic finance, rightly emphasizes the need for sukuk to “move back to its roots, which is in trade not debt.” He acknowledges a “painful transition period,” but his concluding optimism – “there’s no reason why institutional investors can’t participate” – underscores the inherent viability and ethical strength of genuinely Sharia-compliant sukuk.

Standard 62 is not a threat, but an opportunity. An opportunity to reaffirm the ethical foundations of Islamic finance, to enhance the integrity of sukuk, and to cultivate a market that is not only large, but also truly reflective of Islamic principles. This is a necessary evolution – a bold step towards a more authentic and sustainable future for Islamic finance.