Should financial reporting for Islamic Finance be different?

1. IFRS and AAIOFI – Convergence or Harmonisation? Nik Mohd Hasyudeen Yusoff INCEIF Intellectual Discourse – 22 May 2009 Competitiveness Through Innovation and Strategy

2. 1. Read! In the Name of your Lord, Who has created 2. Has created man from a clot 3. Read! And your Lord is the Most Generous 4. Who has taught by the pen 5. Has taught man that which he knew not. Al Alaq 1 to 5

3. Agenda Overview A brief about AAOIFI A brief about IASB IASB-FASB Convergence agenda G20 Position on IFRS Checkpoint 1 Transaction – From Concept to Reporting Checkpoint 2 Convergence or Harmonisation? Thoughts for Malaysia

4. Overview There is no doubt that Shariah compliant financial products and services (Islamic finance) are gaining acceptance globally There are a number of epicentres which promotes Islamic finance particularly in Muslim majority jurisdictions such as the United Arab Emirates and Malaysia The establishment of the Islamic Financial Services Board is a testimony of the promoters of Islamic finance to move this sector into the main stream of the global financial market

5. Overview Some interesting observation on Islamic finance: Promotes different types of risk-sharing methods, supported by emphasising on equity and asset backed financing The lender supports transactions that are real and backed by tangible assets with profits linked with the risk taken Greater reliance on profit and loss sharing enables IF to structure equity partnerships which carry identifiable risks and discourage speculation (Dr. ShamshadAkhtar, Governor, State Bank of Pakistan)

6. Overview Some interesting observation on Islamic finance: The objectives of globalisation and Islamic finance is to achieve maximum risk sharing...in the long run they would both expand and their convergence would be feasible (AbbasMirakhor, Executive Director, IMF)

7. Overview Some interesting observation on Islamic finance: ...the international dimension of Islamic finance... has been a catalyst for increased financial innovation and resulted in a wider range of Islamic financial products and services. This has ignited interest from conventional global players from Non-Muslim countries largely in the form of increased participation in Islamic financial markets and in acquisition of strategic stakes in domestic Islamic financial institutions (Tan Sri Dato’ Sri Dr ZetiAkhtar Aziz, Governor of the Central Bank of Malaysia )

8. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) An Islamic international autonomous non-for-profit corporate body that prepares accounting, auditing, governance, ethics and Shariah standards for Islamic financial institutions and the industry AAOIFI was established in accordance with the Agreement of Association which was signed by Islamic financial institutions on 1 Safar, 1410H corresponding to 26 February, 1990 in Algiers. Then, it was registered on 11 Ramadan 1411 corresponding to 27 March, 1991 in the State of Bahrain

9. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) The objectives of AAOIFI are: to develop accounting and auditing thoughts relevant to Islamic financial institutions; to disseminate accounting and auditing thoughts relevant to Islamic financial institutions and its applications through training, seminars, publication of periodical newsletters, carrying out and commissioning of research and other means; to prepare, promulgate and interpret accounting and auditing standards for Islamic financial institutions; and to review and amend accounting and auditing standards for Islamic financial institutions.

10. International Accounting Standards Board Established on 1 April 2001, IASB’s mission is to develop, in the public interest, a single set of high quality, understandable and international financial reporting standards (IFRSs) for general purpose financial statements IFRSs are set by the IASB, the independent standard-setting body of the International Accounting Standards Committee (IASC Foundation) The Trustees of the IASC Foundation are responsible for its governance and oversight, including funding.

11. International Accounting Standards Board The Trustees are publically accountable to a Monitoring Board of capital market authorities IFRSs are developed following an international consultation process, involving interested individuals and organisations from around the world and with the support of an external advisory council, the Standards Advisory Committee (SAC). The International Financial Reporting Interpretations Committee (IFRIC) develops guidance to promote consistent practice.

12. IASB-FASB Convergence Agenda Joint IASB-FASB MOUs were signed in 2002 and 2006 on convergence of their standards – this would shape future developments of IFRS May 2006 IASB issued exposure draft of “Improved Conceptual Framework for Financial Reporting” Objective of Financial Reporting Entity perspective Present and future capital providers as primary user group for general purpose financial reporting Broad enough to encompass all decisions that equity investors, lenders and other creditors make

13. IASB-FASB Convergence Agenda Qualitative characteristics and constraints of decision-useful financial reporting information Relevance and faithful representation are fundamental qualitative characteristics Comparability, verifiability, timeliness and understandability are enhancing qualitative characteristics Materiality and cost are pervasive constraints

14. G20 Position on IFRS G20 2 April London Declaration on Strengthening Financial the System (among others): Accounting standard setters should improve standards for the valuation of financial instruments, while reaffirming the framework of fair value accounting Reduce the complexity of accounting standards for financial instruments Improve accounting standards for provisioning, off-balance sheet exposures and valuation uncertainty Make significant progress towards a single set of high quality global accounting standards

15. Checkpoint 1 Shariah compliant financing is growing, has wider market penetration than just Muslims, promotes risk-sharing and a beneficiary of globalisation AAOIFI is focusing on Islamic financial institutions and industry, established during pre-convergence era IASB’s mission is to develop a single set of global financial reporting standards and convergence with the US GAAP would shape the standard setting agenda Financial reporting standards is an important component of global trade warranting the focus of G20

16. Transactions -From Concept to Reporting Conceptualisation of products Contractual obligations established and performed Financial Reporting Auditing Prudential Requirements

17. Transactions -From Concept to Reporting Shariah compliant financial transactions Financial Institutions Accounting Standards Auditing Standards Shariah Council Conceptualisation of products Contractual obligations established and performed Financial Reporting Auditing Prudential Requirements Shariah-based prudential standards

18. Transactions – From Concept to Reporting

19. Transactions – From Concept to Reporting Given that Islamic finance transactions are backed by productive assets, structured through contracts within the same legal framework with conventional transactions, there is no likelihood that such transactions could not be accounted for using IFRS The key is that the contracts entered into by the parties should ensure the principles of Shariah are properly crystallised The consequences on prudential requirements should be managed accordingly

20. Checkpoint 2 The key to compliance with Shariah principles in financial transactions are the contracts which should reflect the financial models approved by the Shariah Council Contracts could be accounted for using IFRS and this will ensure there is no divergence with global practice The profit and risk-sharing concept promoted though Islamic finance transactions would have prudential implications

21. Need for a Merger? The IFSB concept and operational model demonstrates the ability of Shariah compliant structure to co-exist with conventional framework While the effort of AAIOFI so far is commendable, it should consider working with and compliments IASB in ensuring the convergence incorporates Islamic finance agenda This would also support the effort in promoting Islamic finance in to the main stream

22. Need for a Merger? This does not mean that IFRS is perfect and the accounting standards developed by AAIOFI are inferior Serious participation in the development and enhancement of IFRS by promoters of Islamic finance could influence the acceptance of the values and principles promoted by Islamic finance into IFRS

23. Thoughts for Malaysia The FRSIC model in facilitating IFRS implementation could be replicated in applying IFRS on Islamic finance transactions Given that we have institutions such as INCEIF and ISRA (education and research), MIA and other global accounting bodies, MASB and other parties which share the common interest, the consolidation of these resources and knowledge-based would facilitate further understanding and development of solutions in this area A voluntary structure would provides flexibility in modes of operation, especially at the developmental stage The establishment of such structure would support the Malaysian government initiatives in positioning Malaysia as the centre for Islamic finance

24. Thoughts for Malaysia We should position ourselves as one of the key stakeholders to IASB when dealing with Islamic finance matters In the long term, this committee could be internationalised by inviting experts from other countries in positioning Malaysia as one of the thought leaders in IFRS for Islamic finance Low hanging fruits could be projects such as: Stock taking of IFRS which have implications on Shariah compliant financial transactions, Identifying gaps between IFRS and the characteristics of Islamic finance for sharing with IASB e.g. Takaful Including Islamic finance dimensions when responding to IASB exposure drafts

25. Thoughts for Malaysia International experts (Global dimension) Accounting firms (Technical input) BNM, SC and IFSB (Regulatory perspective) Committee on IFRS application in Islamic finance Global accounting bodies (Global view & link to IASB) INCEIF, ISRA and academicians (Education and research) MASB (Technical input & link to IASB)