(Bloomberg) -- A proposed change to the regime governing global sukuk risks transforming the asset class into an equity-like instrument that can’t be assessed by credit-rating companies, according to Bashar Al Natoor, head of Islamic finance at Fitch Ratings.
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The so-called AAOIFI Standard 62, aimed at strengthening compliance with Shariah, or Islamic religious laws, would require sukuk issuers to transfer ownership of the underlying assets to the investors. But sukuk-issuing nations can potentially adopt less disruptive ways to implement the rule that would leave the securities ratable, Al Natoor said in an interview.
The Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions, whose Shariah directives are followed by 18 sovereign and other issuers including the United Arab Emirates, plans to implement the rule this year, after consultations with stakeholders.
Currently, most sukuk is structured to give lenders access to revenue streams from an underlying asset, without requiring direct ownership of that asset. They are issued and traded like bonds.
The proposed rule could be interpreted in ways that would avoid alienating issuers and investors, Al Natoor said. But a purist approach that gives equity characteristics to sukuk would be disruptive to the market and could spell the end of the asset class as a financing tool for governments and companies, he said.
Governments may balk at turning over state assets to investors for money that could be raised via a traditional bond. Companies may be unwilling to shrink their balance sheets and give up revenue-generating assets. And given that sukuk buyers are typically looking for fixed-income cash flows, there may not be investor appetite for taking on business-related risk.
“The likelihood of this being transformed to an equity defeats the purpose,” said Al Natoor. “We are a credit-rating agency — we do rate debt, we don’t rate equity.”
An additional disincentive for sukuk issuers would be that removing assets from a balance sheet could affect their issuer default rating. However, AAOIFI’s standards typically offer plenty of room for interpretation and national regulators adopting them can implement them in their own ways, Al Natoor said.