Fitch Ratings-London/Dubai-07 June 2018: New rules governing sukuk offerings in the UAE could support market activity in tandem with other regulatory initiatives, although consistent adoption and implementation remains key to their success, Fitch Ratings says.
The UAE's Securities and Commodities Authority (SCA) said this week that issuers of Islamic securities should improve disclosure, including in key areas such as potential disputes relating to sharia compliance. Issuers should specify how transaction resources and revenues would be treated if a security were deemed no longer compatible with the provisions of sharia. Issuers should also specify whether the Islamic securities being issued are tradeable under sharia rules.
In addition, the SCA set out basic provisions for the composition and responsibilities of sharia boards. It also said that issuers should outline how inconsistencies between International Accounting Standards and those of the Accounting and Auditing Organization for Islamic Financial Institutions would be addressed.
The SCA regulation provides a general framework for disclosure around these issues, not a detailed template. Moreover, including this information would not eliminate the potential for conflicts with investors, given the lack of legal precedent regarding how sharia issues might affect UAE commercial court judgments in a distressed situation. This issue is likely to remain largely untested after Dana Gas reached agreement with sukuk holders on its restructuring and refinancing offer (the company had last year started court proceedings to have its mudaraba sukuk declared unlawful).
Nevertheless, the regulation is one of a number of initiatives that, over time, could support the UAE's sukuk market. International issuance is well established: according to the Dubai Islamic Economy Development Centre, of its 72 sukuk listings worth USD59.2 billion (AED217 billion), 33 are for companies and governments outside the UAE. The local market, however, is less well developed, partly due to the absence of a domestic government debt market.
As well as the SCA announcement, the inaugural meeting of the UAE's Higher Sharia Authority (HSA) was held in 1Q18. The HSA is mandated to establish and oversee standards to help sharia principles be more consistently applied across sukuk, banking activities and takaful in the UAE.
This could increase standardisation and reduce transaction costs, although again, the ultimate impact will depend on the extent of the HSA's involvement in the market, and its record in performing its role. It is not yet clear whether the HSA will become the sole authority on sharia matters relating to Islamic finance in the UAE, with courts and arbitrators required to refer to it, as is the case with the Malaysian Shariah Advisory Council. The impact of HSA rulings on UAE banks may vary, depending on whether they increase or limit a specific bank's product offering.
The HSA also has a remit to co-operate with sharia standard-setters internationally. Standardisation remains a significant challenge within and between major Islamic finance jurisdictions. In May, the IMF endorsed a proposal on the use of the Core Principles for Islamic Finance Regulation, developed by the Islamic Financial Services Board with the participation of the Basel Committee on Banking Supervision.
Fitch's sukuk ratings are based on our assessment of credit risk. The ratings do not imply any confirmation that the sukuk are sharia compliant, as this can be subject to differences of interpretation that Fitch would not be in a position to assess.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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