At the beginning of February, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) held a couple of public hearings on Sharia Standard 62. In S&P Global Ratings' view, this standard will shape the future of the sukuk market. The AAOIFI has reiterated that the purpose of this standard is to standardize and harmonize the requirements for sukuk issuances, particularly in jurisdictions where regulators have adopted the AAOIFI's Sharia standards.
What's Happening
The AAOIFI will likely give issuers more time to implement Sharia Standard 62. In its public hearing over the weekend, the AAOIFI mentioned that it is likely to approve Standard 62 in 2025, and that issuers will likely have between one and three years to implement the new requirements, depending on the AAOIFI's final decision.
The AAOIFI also mentioned that the retroactive application of the standard to existing sukuk is unlikely. We have previously commented that a retroactive application might be challenging. Changes to legal documents are generally subject to investors' consent, and, in our view, sukuk issuers are unlikely to obtain this consent if investors believe that they will be exposed to higher risks.
At the same time, we consider that sukuk issuers that are already under financial strain may use the adoption of Standard 62 as a reason to trigger the restructuring of their sukuk by declaring that they are not aligned with the new requirements.
However, this risk should be mitigated by the fact that the sukuk's legal documents generally have clauses that are designed to prevent the issuer from reneging on its contractual obligations on the basis of noncompliance with Sharia law. Therefore, depending on the standard's final content, we do not expect a significant number of sukuk restructurings when the standard is adopted.
Why It Matters
Sukuk structures could change. Depending on the final timeline that the AAOIFI gives the market, this development could give sukuk structurers more time to develop structures that strike a balance between complying with the new requirements and making the sukuk attractive to fixed-income investors, if this is still possible.
It remains to be seen if there will be any major changes to the standard compared with the current draft. The AAOIFI mentioned in the public hearings that some previous sovereign sukuk used the usufruct as the underlying assets. This could mitigate the difficulty of registering such assets.
At the same time, if the assets are registered to the investors and the investors pay the registration fee, the sukuk may ultimately be seen as an asset-management product, whereby the sponsor acts as an originator and asset manager rather than as an obligor. This could expose investors to the sponsors' fiduciary risk rather than their credit risk, and may cause sukuk to morph away from being fixed-income instruments.
What Comes Next
The adoption of the standard could cause a decline in sukuk issuance. If adopted as proposed, Sharia Standard 62 will, in our view, result in the sukuk market shifting away from structures in which the sukuk sponsors' contractual obligations underpin their repayments, to structures in which the underlying assets have a more prominent role.
Notwithstanding the fact that issuers will have more time to adjust to the new requirements, investors will likely face new risks relating to asset performance and value.
We continue to believe that if the standard is adopted as proposed, some investors and issuers may choose alternatives to the sukuk market, as issuing sukuk might become more onerous from a risk/reward perspective. This could also encourage some adopters to transition away from the standards if their ability to tap the capital markets is significantly restricted.
Related Research
- Sukuk Market: Strong Performance Set To Continue In 2025, Jan. 13, 2025
- Islamic Finance 2024-2025: Resilient Growth Anticipated Despite Missed Opportunities, April 29, 2024
This report does not constitute a rating action.
| Primary Credit Analyst: | Mohamed Damak, Dubai + 97143727153; mohamed.damak@spglobal.com |
| Secondary Contacts: | Tatjana Lescova, Dubai + 97143727151; tatjana.lescova@spglobal.com |
| Sapna Jagtiani, Dubai +971 (0) 50 100 8825; sapna.jagtiani@spglobal.com |
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