«Outreach on Shariah-Compliant Instruments and Project Transactions Issues in the application of IFRS 9 to Islamic Finance Paper topic A paper ...»
Comment One My following comments highlight issues arising from possible different points of views rather than saying one view is superior than others.
1) The use of interest rate.
Modern business is conducted with interest as the foundation in setting up pricing and valuation. Islamic law (syariah) prohibits the use of interest. This may have a pervasive effect on accounting for financial instruments, especially on recognition and subsequent measurement. The application of Capital Asset Pricing Model (CAPM) in pricing financial instruments contains parameter which is fixed, that is risk free interest rate which is regarded as riba. At the moment, at least from what I understand, alternative pricing model for Islamic Finance is still under study. The model must relates the instruments with underlying real business to avoid trading on papers only which many Islamic Scholars believe as a riba.
2) Financial Instruments (FI) In Islam, financial instruments must directly relate to underlying business. Price changes in the instruments are directly attributable to the changes in the value of underlying business and perhaps also changes in the value of competing assets. Theoretically, Islamic financial instruments will not change due to merely changes in interest rate since changes in interest rate are not necessarily driven by changes in the real sector or underlying business. FI in Islam is more a proof of ownership of a business instead of merely representing claim to cash flows. E.g. Islamic bond (sukuk)-Ijarah gives a fixed cash flows, since assets financed by the bond generates fixed rental revenue as well.
NCD (Islamic Certificate of Deposit) is only tradeable after initial offering after proven that the proceeds have been invested in a real sector. FI should relate directly to real sector to prohibit trading on papers only.
1. Due to the business model of an Islamic bank, it may be more appropriate to apply IFRS 9 rather than IFRS 15 to many of the bank’s sale-based transactions. This is
2. If an Islamic bank were to treat many of its sale-based transactions as sales of goods, this would result in a highly unusual presentation of the analysis of expenses, as the amount of revenue and cost of sales would be equal and cancel each other.
3. It is extremely rare for the underlying asset used to facilitate customer financing to be an output of the Islamic bank. This is in stark contrast to paragraph 6 of IFRS 15 which reads: “A customer is a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration”.
Comment Three All the Sukuk, however, do not fall in the category of debt-type instruments and rather a few may fall in the category of equity-type instrument (like Mudaraba Sukuk) in which case its fair valuation will be dependent on the underlying assets or resources.
There might not be any argument on the Sukuk based on trade-based transactions and they all shall fall in the category of debt-type instruments.
There can however, be an argument as to whether and to what extent the Sukuk on lease basis (which are the most common type) will fall in the category of debt-type instruments and at what stage it may be determined that the Sukuk-holder has the right to the access to the underlying assets, rather than merely the contractual cashflows.
It is also important to note that there is a debate within the industry initially raised by the rating agencies with regard to asset-backed and asset-based instruments. Mostly assetbacked instruments have a proper ring-fencing creating a direct linkage with the asset.
Most of the scholars, and AAOIFI’s Sharia board, have concluded that the Sukuk are permissible only in situation where there is a direct ownership link (maybe beneficial ownership in certain cases).
AAOIFI has commenced internally a larger project on Sukuk both on the Sharia and accounting standard setting.
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