DUBAI: The $1 trillion Islamic finance industry needs to improve asset quality, risk assessment and regulation to meet growing demand from investors looking to diversify their portfolio, a top scholar says. Islamic bonds or sukuk, the biggest component of the industry, are structured as profit-sharing or rental agreements and their returns are derived from underlying assets instead. The lack of a single regulatory framework and consensus on investment ratings, as well as the debate over the definition of sukuk have hampered the growth of the industry. The rating and the quality of the assets are challenges. We have to review the core methodology of rating, particularly for sukuk, Mohd Daud Bakar, who advises the globally recognized Accounting and Auditing Organization for Islamic Financial Institutions, told Reuters in an interview earlier this week. We cannot piggyback on the old system, you have to be courageous enough in quantifying the risk of Islamic assets. Daud, one of the influential scholars who decide whether investment products adhere to Sharia law, said the industry must improve transparency through better ratings. So investors need to be updated, that s why disclosure is very important, the rating is very important, Daud said. Standard & Poor s has long term foreign currency ratings on 25 sukuk issues globally. Industry debate Sukuk issuance received a double blow last year from the global liquidity freeze and a debate on the compliance of most of its structures. Scholars say the majority of sukuk adhere to Islamic principles only in form, but not in substance, as ownership rights are typically not transferred to sukuk investors. Prominent scholar Sheikh Muhammad Taqi Usmani ruled in late 2007 that most sukuk did not comply with Islamic law, as their repurchasing agreements at maturity violated the principle of sharing risks and returns. This unleashed a debate about the lack of consistent regulations and standardization in sukuk financing. Scholars are also divided whether to define sukuk as bond or equity based instruments depending on its structure. Technically its not a bond because that is a debt instrument, Daud said. Sukuk represents more a certificate of investment by investors pooling the money together in a specific project or venture to share profit and loss.
