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Monday, July 15, 2024

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AAOIFI keeps pace with sustainable financing developments

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is the leading international standard-setting body primarily responsible for the development and issuance of standards for the global Islamic finance industry. The specific characteristics of the Islamic financial transactions require standards that cater to the needs of the stakeholders. Therefore, 31 years ago AAOIFI was established to address challenges that face the Islamic finance industry. ZAHRA JASSIM writes.


AAOIFI’s vision is to safeguard the integrity of the Islamic finance industry. This is primarily done through the standardization of best practices in Shariah, accounting, auditing, governance and ethics.

This article provides an update on AAOIFI’s efforts and role in standardization and governance related to responsible financing, specifically, the progress and development of AAOIFI’s Governance Standard on Responsible Financing.

Governance Standard 7 ‘Corporate Social Responsibility, Conduct and Disclosure for Islamic Financial Institutions’
In April 2009, AAOIFI issued Governance Standard 7 (GS 7) ‘Corporate Social Responsibility, Conduct and Disclosure for Islamic Financial Institutions’. The Accounting and Auditing Standards Board started the standard development process in 2006 and multiple meetings were held to discuss the preliminary study and exposure draft.

The standard was developed to provide specific guidance to Islamic financial institutions (IFIs) to engage in productive corporate social responsibility activities and disclose the nature of these activities to their stakeholders. Given that there is no comparable standard specifically for IFIs, this standard is crucial for the preservation of the Islamic finance industry’s reputation.

AAOIFI is aware of the fact the IFIs need to keep pace with the recent market developments to persist and thrive. In this regard, the AAOIFI Governance and Ethics Board (AGEB/board) approved the initiation of a governance standard on sustainable financing in 2020. More details on the role of the AGEB and the update of the standard development process will follow.

AGEB — introduction, formation and role
The role of governance is essential in ensuring that the underlying principles are implemented in line with global best practices. At the end of 2015, AAOIFI’s General Assembly decided to establish a technical board for governance and ethics standards. The governance standards ensure that the implementation of respective standards is true to their purpose by translating theory into practice.

In January 2020, AAOIFI’s Board of Trustees announced the formation of its new technical boards and the names of the appointed members for a four-year term.

For AGEB, AAOIFI has appointed 15 members from 11 nationalities, consisting of representatives of Islamic financial institutions, central banks and regulatory authorities, accounting and auditing firms, governance-related professions and the academia.

The newly formed AGEB held its first meeting on the 24th and the 25th March 2020 via video conference. As the main agenda item, the secretariat presented and the members discussed at length the board’s strategy and the four-year plan related to development, dissemination and adoption of AAOIFI governance and ethics standards. The new plan included a number of new governance and ethics standards, as well as research projects within the scope of the board’s mandate. The members also reviewed the existing projects in the pipeline and approved the overall work plan in addition to its plan for the year 2020. Moreover, working groups were formed from among board members to carry out the development process on these projects. Also, experts in the industry were nominated to be part of the working groups. The approved plan included the development of a governance standard on sustainable financing.

The development of a governance standard on sustainable financing
The need for a governance standard on sustainable financing
As a standard-setting body, AAOIFI is mindful that it needs to promote sustainable development in the industry by supporting IFIs in integrating sustainability in their business models by considering environmental, social and economic objectives.
The growing awareness and the urgent need to address the global sustainability issues have driven increasing numbers of IFIs to integrate environmental and social considerations into investment and strategic decisions. The board was of the view that a governance standard is needed to play a fundamental role in harmonizing the relevant practices.

Development process preview — MoU with RFI
Following the approval of the AGEB, the secretariat initiated the development process. In March 2021, AAOIFI signed an MoU with the Responsible Finance and Investment Foundation (the RFI Foundation). The RFI Foundation acts as a catalyst to link together Islamic and responsible finance, bringing the most valuable perspective from each to advance the adoption of responsible finance. Over the last months, several meetings were held between AAOIFI’s secretariat and the RFI’s management represented by CEO Blake Goud to discuss the development process.

During the meetings, it was agreed that the standard should focus on financing and investment activities. In other words, the plan is to develop a focused standard on the activities and the disclosure. The standard should focus on:
a) What is sustainable financing?
b) What are the features of sustainable financing?
c) What is the role of Islamic finance in sustainable financing?
d) What should be the disclosure requirements of sustainable financing?

After due deliberations, the first draft of the preliminary study was prepared to be presented to the relevant working group and board.

Development process preview — working group input
The working group of the governance standard on sustainable financing is chaired by Ibtihal Al-Shamali, the head of corporate governance (governance manager) at the Capital Markets Authority of Kuwait. It consists of 17 members from more than eight countries including the UK, the US, Turkey, Kuwait, Syria, Malaysia, Pakistan, Bahrain, etc.

The preliminary study was presented to the working group on the 15th February 2022. The members thoroughly discussed the suggested name, scope and main structure of the standard.

Multiple names for the standard were suggested including ‘responsible finance’ or ‘sustainable finance’ or ‘impact investment’. After due deliberation, it was decided to use ‘responsible finance’. The members were of the view that the term ‘responsible’ has an additional aspect which is very specific to Islam and Islamic finance, which is the responsibility toward Allah.

With regards to the scope, given that GS 7 was issued in 2009, the members discussed whether the new standard should be comprehensive (includes content from GS 7) or replace GS 7. After lengthy discussions, it was agreed that this standard should be comprehensive.

The overall structure was also discussed. The members were of the view that social financing, UN Sustainable Development Goals and compatible financing should be considered. It was also agreed that the standard should cover investments, operations and strategies.

Other matters such as making sustainability reporting mandatory and adding requirements for auditors and rating agencies were briefly discussed.

The recommendations of the working group were minted to be raised and presented to the AGEB.

Development process preview — AGEB input
The preliminary study was presented to the AGEB in its 24th meeting held on the 3rd March 2022 via videoconferencing.

The secretariat presented two options for the members with regards to the development of the standard and presented the recommendations of the working group.

The board members agreed with the recommendation of the working group to turn GS 7 into a comprehensive standard that covers the existing content of GS 7 (and to update where necessary), in addition to the main aspects of sustainable financing.

AAOIFI’s approach in writing this standard is to observe developments of sustainable financing in the conventional finance industry closely and carefully. Afterward, AAOIFI may adapt the goals to the extent in which they align with Islamic values, and in case of any violation of such values, AAOIFI can make its own intervention.

Development process — way forward and timeline
The secretariat and the RFI are working together to develop the first version of the exposure draft. During the second quarter (Q2) of 2023, the exposure draft will be presented to both the working group and the AGEB to be reviewed for issuance to the public. It is expected that the final standard will be issued in Q2 2024.

Conclusion
There is no doubt in the genuine integration of Islamic finance with responsible finance. The need to integrate sustainability is transforming business models and strategies and the relevant considerations have come to dominate many decisions in the past years.

We believe that the development of a new and comprehensive standard on responsible financing by AAOIFI is a timely initiative and will prepare the IFIs for the new age Islamic finance.

AAOIFI as a standard-setting body has been and will continue to take the lead in developing standards that will cater to the growing needs of Islamic finance markets around the globe to harmonize and standardize the Islamic finance industry practices in compliance with Shariah principles and rules.

Finally, as the Islamic finance industry gradually makes inroads into global economies, it will be important for the regulatory bodies, multinational financial institutions and global audit firms to adapt to such changes and developments.

Zahra Jassim is the executive manager of the Professional Standards Development team at AAOIFI.

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