Islamic Finance: Introducing the Newly Launched (IASB) Consultative Group on Shariah-Compliant Instruments and Transactions

Ian MACKINTOSH

Chairman of the International Accounting Standards Board (IASB) Consultative Group on Shariah-Compliant Instruments and Transactions and IASB Vice-Chairman

 

By:

Nadi Mashni, Financial Management Specialist

Gabriella Kusz, Senior Financial Management Specialist

 

Mr. Mackintosh was formerly Chairman of the United Kingdom’s Accounting Standards Board (ASB). Originally from New Zealand, he has spent much of his career in Australia, first with Coopers & Lybrand, and later as a consultant with his own practice. In November 2000, he was appointed Chief Accountant of the Australian Securities and Investment Commission, and following that he was Manager, Financial Management, for the South Asia region of the World Bank.

Mr. Mackintosh has played an active role in standard-setting since 1983. He was a member, and later Deputy Chairman, of the Australian Accounting Standards Board, as well as chairing its ‘Urgent Issues Group’. Mr. Mackintosh has substantial public sector experience, having chaired both the Australian Public Sector Accounting Standards Board and the International Federation of Accountants Public Sector Committee.

Today Mr. Mackintosh is the Chairman of the International Accounting Standards Board (IASB) Consultative Group on Shariah-Compliant Instruments and Transactions (Consultative Group) and IASB Vice-Chairman. In his capacity as Chairman of the Consultative Group, he leads the Group’s efforts to engage with key stakeholders and practitioners in Islamic Finance. Specifically, he has worked to further the Consultative Group’s efforts to undertake research, open a dialogue and expand the degree to which Shariah-compliant instruments and transactions are being recorded properly and consistently using International Financial Reporting Standards (IFRS).

 

CV MENA: What is the objective / function of this Consultative Group? How has it come into being? What were the key triggers / motivating factors for developing this important grouping? What is the history behind it?

Mr. Mackintosh: The Consultative Group may trace it roots to a 2009 presentation made by the then Chairman of the Malaysian Accounting Standards Board (MASB), Mr. Dato' Mohammad Faiz Azmi, to the IASB on the subject of Islamic Finance. This presentation catalysed an internal conversation within IASB and among its stakeholders about how the organization might address this growing field and what if anything it could do to support the subject area of Islamic Finance.

To continue exploration of this important subject, in 2011, with the strong support of the MASB and then-Chairman Azmi, the IASB conducted a consultation about whether the topic of Islamic Finance should be included in its technical agenda. The responses to this consultation from countries where Islamic Financial activities were taking place was very positive. These countries were eager for the IASB to undertake activity and begin engagement on this important subject. As a result of this consultation, the IASB Board decided to enhance its exploratory efforts through the establishment of the Consultative Group on Shariah-Compliant Instruments and Transactions.

In July 2013, the Consultative Group held its first meeting with a focus on discussing Sharia-compliant instruments and transactions. The meeting, chaired by the IASB, was structured to draw those individuals and organizations working with Shariah-compliant instruments and transactions together to provide input as to how this Consultative Group could further this subject area and provide benefit and guidance to those in practice.  One outcome of this meeting, was the decision to undertake research and reflection upon the issues in the classification of Islamic financial instruments under IFRS 9 Financial Instruments.

This research culminated in the Paper entitled “Issues in the Application of IFRS 9 to Islamic Finance,” which posed a series of issues in the application of IFRS 9 to those products, and began discussion regarding what steps (if any) the IASB might take to clarify this standard. This Paper was preliminarily discussed during the second meeting of the Consultative Group held in Kuala Lumpur, Malaysia in 2014.

Ahead of its third meeting, the Consultative Group is still in an exploratory stage, seeking to answer the question: How can the Consultative Group further support organizations in applying IFRS to Shariah-compliant instruments and transactions? It is expected that after this third meeting, the Consultative Group will have a more focused direction in terms of areas of research and emphasis. 

CV MENA: How does the Consultative Group seek to position itself with regard to The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)1 and other leaders in the area of Islamic Finance and accountancy?

Mr. Mackintosh: The IASB is very aware of AAOIFI, and from the beginning has invited the organization to participate in Consultative Group meetings. Recently, there has been an increase in dialogue between the Consultative Group and the AAOIFI – including a face-to-face meeting between our organizations in December 2014. At this point, we have reached preliminary agreement on how to work separately as well as together. The AAOIFI will remain the prime source regarding the degree to which transactions meet Sharia law. Our [Consultative Group] role will be to determine how these transactions may comply with IFRS standards. As a demonstration of our cooperation, the AAOIFI will be hosting the 3rd meeting of the Consultative Group which will take place on April 9th in Manama, Bahrain. This meeting’s agenda will focus on discussing the “Issues in the Application of IFRS 9 to Islamic Finance” paper. The joint Consultative Group-AAOIFI invitation recently went out and it is our hope that we will be able to invite and attract participation by people who are interested in providing input into the further development of this Paper and its key research themes.

CV MENA: One of your early projects focused on a call for papers and exploration about whether Islamic products typically owned by Islamic banks qualify for amortized-cost classification.  Can you tell us a bit about how this project has unfolded? What were the findings and any impacts (or future impacts anticipated) of this research and dialogue on IFRS 9?

Mr. Mackintosh: In preparation for our first Consultative Group meeting held in 2013, we sought to engage with those persons involved in Shariah-compliant transactions to garner their perspectives and input regarding how they are accounting for these transactions with IFRS, as well as their challenges, difficulties and needs for additional guidance. To facilitate this engagement, we issued a formal call for papers. However, the responses were minimal. In order to jump-start the dialogue, the Consultative Group decided that in this circumstance, we would begin efforts by developing the paper “Issues in the Application of IFRS 9 to Islamic Finance.”

This Paper addresses issues in the classification of financial instruments under IFRS 9 Financial Instruments.  It provides background, sets out what Islamic Banks are doing in regard to IFRS 9, and provides a summary of some of the more challenging or interesting points related to IFRS 9 and its application to Islamic transactions (for example, how the question of interest is being addressed). In addition to a summary overview, this Paper also undertakes research into the financial statements of 17 Islamic Banks, demonstrating the relative importance of Islamic products in their assets, highlighting similarities and differences in treatment, and providing discussion on the types of transactions. Finally, it poses a series of issues in the application of IFRS 9 to these products and what steps the IASB might potentially take to clarify this standard. As noted, the Consultative Group has decided that the questions posed in this Paper will be the topic of the next jointly hosted Consultative Group-AAOIFI meeting to be held in April 2015. Strong efforts have been undertaken to reach out and invite interested accounting professionals, academics, and bankers to participate and share their perspectives on this issue. What will be the outcome of these discussions? This will depend on the nature of the proceedings; however, there will likely be another paper drafted to outline the main points of the meeting discussion, and potential recommendations on whether the IASB needs to do anything to enhance clarification in the application of IFRS 9 to Shariah-compliant transactions.

CV MENA: Today, what do you see as the three most pressing issues / questions of accounting and application of IFRS for Shariah-compliant instruments and transactions? How is the Consultative Group working to address these issues?

Mr. Mackintosh: I believe at this point the most pressing issue we face is that of financial instruments. Most Islamic financial transactions involve financial instruments of one sort or another, and this is where Shariah law brings about the greatest potential for differences in financial reporting and application of standards. Other than this issue, we have not heard very much in regard to significant challenges in applying IFRS to Shariah-compliant instruments and transactions. For example, the Kingdom of Saudi Arabia has been successfully implementing IFRS with small modifications in order to comply with Shariah law. Areas of modification are slight, for example, inclusion of requirements for additional disclosures on certain relevant issues. Modifications of standards for additional disclosure are not a key concern to the Consultative Group as they do not change the nature of the application of the standard. The main issues the Consultative Group will be directed toward are financial instruments and will likely seek to answer the following three questions:

·         Are purchase and sale contracts with deferred payment “contracts with customers” within the scope of IFRS 15?

·         Do some of the instruments common to Islamic Finance meet the characteristics-of-the-instrument test in IFRS 9?

·         How will income from Islamic Finance instruments be described and measured?

 

CV MENA: Can you please discuss with us any upcoming projects / calls for papers which the Consultative Group intends to focus on? What has been the rationale behind this focus?

Mr. Mackintosh: At this point, the Consultative Group will be delving deeper into the issues related to financial instruments. It is anticipated that following the April 2015 Consultative Group meeting, we will have a better idea of where we are headed with regard to strategic priorities, a work plan, and upcoming research and projects.

CV MENA: The expansion of Islamic finance and banking outside of the MENA region has been increasing in recent years. In July 2014, Britain became the first country outside of the Islamic world to issue sovereign Sukuk.2 In September of the same year, Goldman Sachs raised $500 million with its debut sale of Islamic bonds, becoming the first conventional U.S. bank to issue Sukuk. As Islamic finance and banking grows outside of the MENA region, what role does the IASB see itself playing to ensure that high quality global accountancy standards are applied to transactions of all shapes and sizes— and that they are acceptable to countries around the world?

Mr. Mackintosh: Presently, the IASB notes that more than 114 countries around the world are applying IFRS standards. At the same time, Islamic Finance and Shariah-compliant transactions are also taking on a global nature. Not only does global interest continue to develop and expand in Indonesia, Malaysia, large parts of Africa and the Middle East, but now we are also seeing interest and the emergence of these products in the West. As such, we view the issue of application of IFRS to Islamic Finance as we view all other important global issues, that is, through the lens of ensuring the consistent application of IFRS standards. In response, we have created a globally representative Consultative Group on the subject, and undertaken preliminary research. We will continue to work to address the sub-topics and issues of relevance.

It is also important to note that the IASB maintains no enforcement rights — or ability to compel adherence and appropriate application of IFRS standards. In this regard, we rely on regulators (Central Banks, Capital Markets Authorities, and so on) to ensure proper and consistent application. As such, we are always interested in working with regulators to ensure that these standards are applied appropriately. Indeed, we are actively seeking their participation and input to our Consultative Group.

CV MENA: Does the Consultative Group envision at any point a role for itself in judging the degree to which a transaction could be considered to be Shariah-compliant?

Mr. Mackintosh: Absolutely not. The Consultative Group’s point of view is that there is a transaction that is taking place. Our role is to support IFRS users in answering the question: ‘How do you financially report that transaction?’

As the Consultative Group is still in its early stages, we are still seeking to answer this question and to understand what we may need to do to support the proper and consistent application of IFRS standards with regard to Shariah-compliant instruments and transactions. It may be that the Consultative Group discovers that there needs to be additional guidance to ensure consistent application around the world. Or, it may be that we discover that there is no need for additional guidance — that financial reporting activities are operating effectively as they are. We do not know yet, but this is something that the Consultative Group will continue to focus on in the future. 

CV MENA: Are there any key messages you would like to share with the readers of CV MENA Magazine?

Mr. Mackintosh: I would like to emphasize that our Consultative Group is still in its initial stages. As such, we are actively seeking individuals and organizations interested in the topic of IFRS application in Islamic Finance transactions to participate and provide input into our meetings. We welcome those with an interest to contact the IASB and our Consultative Group for further information.

 

1 The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an Islamic international autonomous non-for-profit corporate body that prepares accounting, auditing, governance, ethics and Shari'a standards for Islamic financial institutions and the industry. For more information on this important organization, please see the following website: http://www.aaoifi.com/

2 “Sukuk commonly refers to the Islamic equivalent of bonds. However, as opposed to conventional bonds, which merely confer ownership of a debt, Sukuk grants the investor a share of an asset, along with the commensurate cash flows and risk. As such, Sukuk securities adhere to Islamic laws sometimes referred to as Shari’ah principles, which prohibit the charging or payment of interest.” Islamic Development Bank. See: http://thatswhy.isdb.org/irj/go/km/docs/documents/IDBDevelopments/Internet/thatswhy/en/sukuk/what-is-sukuk.html