Sukuk accounting proposal and standardisation

In an article called Sukuk Accounting Proposal Takes The Standardization Debate To A New Level, S&P Global Ratings says it believes the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)’s proposal for accounting and classification guidelines for Sukuk issued by Islamic financial institutions, if implemented, represents a boost for proponents of standardisation.

“In our view, this–coupled with AAOIFI’s recent proposal on centralized Shari’ah boards could help the market move forward with standardising the legal structure of Sukuk and Shari’ah interpretation,” said S&P Global Ratings’ global head of Islamic finance, Dr. Mohamed Damak.

In the recent past, the agency has observed some ambiguity in how legal obligations of Sukuk sponsors are worded, which according to our understanding was primarily in response to some Shari’ah scholars’ requests. However, if the AAOIFI’s proposal is adopted, lawyers and Sukuk structurers could have a basis for strengthening legal protection for Sukuk holders.

The AAOIFI’s latest proposal on Sukuk accounting states that Islamic financial institutions can report Sukuk as on- or off-balance-sheet instruments; the main determinant of the classification would be the effective control of the underlying assets. The proposal also recognises that issuers can report on-balance-sheet Sukuk as a liability, quasi equity, or equity. The agency believes that, if implemented, the proposal could lead to tighter legal documentation regarding the obligations of sponsors of Sukuk instruments categorised as a liability.

“We may refrain from rating a Sukuk transaction if the documentation doesn’t include sufficient contractual obligations for full repayment,” Dr. Damak added. “Under our methodology, our ratings on equity-type Sukuk would likely be lower than on liability-type Sukuk.”

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