When we were asked for an article about the IASB and its work on Islamic finance, we were reminded of the perhaps-overused metaphor of a journey. It has been a journey of discovery for us, and it remains unfinished.
The journey began in 2009 when IASB representatives attended a presentation by Dato’ Mohammed Faiz Azmi, Chairman of the Malaysian Accounting Standards Board (MASB), on the topic of Islamic finance. At the end of his presentation, many in the audience voiced the opinion that the IASB should “do something” to address the financial reporting issues in this growing industry. Then IASB Chairman David Tweedie assigned the task to Wayne.
The task turned out to have two paths. First, we had to learn the complexities of Islamic finance. Second, we had to determine what “something” might entail.
FINDING “SOMETHING”
Let us begin with the second, more difficult, path. One can learn about Islamic finance from books and conversations, and that is what we have done. Determining what the IASB should do in response has proved more difficult. The IASB usually has a host of experts to draw upon, and they usually have well-developed ideas. Here, the situation was different. There are many experts in Islamic finance and many in financial reporting standards. The population that can claim expertise in both is small.
An example from early in our journey is useful here. In 2010, KPMG and the Association of Certified Chartered Accountants (ACCA) conducted roundtables on Islamic finance in Kuala Lumpur, Bahrain, and London. Wayne attended the Kuala Lumpur and London sessions and accumulated a list of over 20 suggestions. They ranged from “do nothing” (either because nothing was necessary or because nothing was possible) to issuance of a special International Financial Reporting Standards (IFRS) on Islamic finance.
In 2011, the IASB launched its first consultation on the makeup of the technical agenda. Recognising our need for help, the IASB listed Islamic, or Shari’a-compliant, instruments and transactions as a possible project. Reactions from those commenting on the consultation were perhaps predictable.
Those from countries with relatively small Muslim populations and little or no Islamic finance industry questioned whether the IASB should devote resources in this area. Those from countries with large Muslim populations and a growing industry thought otherwise, but unfortunately offered little new insight on the subject of “something.”
It is good to have an end to journey toward; but it is the journey that matters, in the end. — Ernest Hemingway.
The IASB has recognized two important realities from our experiences. First, the IASB as a body has little grounding in the principles and transactions of Islamic finance. Second, there are 1.6 billion Muslims in the world. An international body cannot ignore them.
We addressed those realities with the formation of a Consultative Group. In 2013, the IASB held the first meeting of its consultative group on Shari’a-Compliant Instruments and Transactions (the Consultative Group). Members of the group were drawn initially from the jurisdictions of the AOSSG and the group was expanded later to include members from banking and public accounting (see the appendix for a list of members). The group’s name is perhaps a bit misleading. The Consultative Group takes no view on whether a particular transaction is compliant with Shari’a law. It recognizes that Shari’a scholars hold differing opinions about some transactions.
Instead, the group focuses on financial reporting implications.
The Consultative Group first decided to solicit papers from academics and others on selected topics. Wayne prepared invitations on implications of IFRS 9 Financial Instruments and on Ijarah (leasing) transactions. We received no substantive response on either.
Clearly we needed to follow a different plan.
The Consultative Group met again in September 2014. It settled on two areas for work:
First, it should consult with the Joint Transition Resource Group on IFRS 15 Revenue from Contracts with Customers. Many transactions in Islamic finance are structured as a sale with deferred payment. The question is whether those transactions fall within the scope of IFRS 15. This consultation happened at the transition group’s January 2015 meeting.
Second, it should work on possible materials that would help Islamic finance institutions understand how IFRS 9 applies to their transactions. It also suggested that the IASB hold additional outreach meetings during early 2015 to solicit views on the topic.
In December, Ian met with representatives of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). The staffs of the IASB and AAOIFI have had cordial relations for some time now, but the meeting set a start to active work between our two organisations. Indeed, we hope to coordinate the outreach meeting with AAOIFI.
FINANCIAL REPORTING AND ISLAMIC FINANCE
Now we turn to the first path mentioned at the opening. Learning the ins and outs of Islamic finance is a daunting task for someone trained in the instruments and terminology of “conventional” or “western” finance. Transactions in Islamic finance have a sometimes-bewildering array of names. The structures of transactions take different forms than those found in conventional finance.
Experts sometimes differ on the necessary elements of a transaction and whether a particular transaction is, in fact, Shari’a compliant. A particular transaction that can be documented in a single conventional contract might require multiple contracts in an Islamic finance setting.
Two principles relevant to financial reporting emerge though:
- Transactions in Islamic finance arise from “real” as opposed to “financial” assets. We find it useful to group those transactions into five broad categories:
- mark-up in purchase and sale contracts with deferred payment— murabaha and other contracts;
- profit-share in venture and other partnership-like contracts— musharaka, mudaraba and other contracts;
- rent in lease contracts—ijara;
- fees from agency contracts —wakala;
and
- profit, profit-share, rent or fees from undivided pro-rata ownership contracts—sukuk.
- The instruments resulting from those transactions typically meet the definitions found in IFRS for financial instruments, leases, or fee-for-service contracts. An institution should, thus, be able to apply IFRS.
Indeed, a large number of Islamic finance institutions have reached that second conclusion. Wayne’s in-depth study of about 20 institutions showed that a number of jurisdictions have adopted IFRS. Saudi banks have used IFRS for several years now. We found three institutions, one in Saudi Arabia and two in the United Arab Emirates have already adopted IFRS 9. A broader study conducted by the AOSSG found that about 50 percent of Islamic finance institutions assert compliance with IFRS.
CONCLUSION
For now, then, “something” means the kind of on-the-ground implementation work that the IASB has always done:
We will try to be sure we recognise the Islamic finance implications of new and existing IFRS and work with our constituents to deal with those implications. This need not, it seems to us, take the form of special reporting standards.
We will work with AAOIFI, our colleague standard-setter, to bring their standards closer to IFRS and to leverage on their knowledge of Islamic finance.
