The Role of AAOIFI - the oldest standards setting organisation in Islamic Finance !!!

BAHRAIN-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is a pioneering institution that aims at standardisation and harmonisation of international Islamic finance practices and financial reporting in accordance to Shariah principles.

As a standard-setting organisation for the global Islamic finance industry, it has developed and issued 110 hundred standards and technical pronouncements, making a major impact on the industry, says Omar Mustafa Ansari, Secretary General of AAOIFI.

AAOIFI develops standards in five very specific areas—Shariah, accounting, auditing, governance, and ethics — which are all interlinked to form a bouquet of standards for the regulators trying to protect and enhance the integrity of the local Islamic finance industry, says Ansari in an exclusive interview.

Excerpts from the interview:

Briefly describe the vision, goals and objectives of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)?

The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), based in Bahrain since 1991, is the leading international not-for-profit organisation primarily responsible for development and issuance of standards for the global Islamic finance industry.

The vision of AAOIFI is to protect the integrity of the global Islamic finance industry through the means of standardisation of best practices in the areas of Shariah, accounting, auditing, governance, and ethics.

In addition to standardisation, AAOIFI also offers professional capacity building fellowship programmes and workshops to different levels of stakeholders, who include regulators, directors, Shariah scholars, and other practitioners, so as to promote knowledge about, and to encourage greater professionalism in, the implementation of its standards.

AAOFI has made great strides when it comes to regulations in the Islamic finance industry. What are some of its main achievements up till now?

AAOIFI develops standards in five very specific areas—Shariah, accounting, auditing, governance, and ethics—which are all interlinked to form a bouquet of standards for the regulators trying to protect and enhance the integrity of the local Islamic finance industry.

To begin with, the Shariah standards bring uniformity with respect to Shariah principles and rules, and this sets the foundation for other standards.

The governance standards ensure that the implementation of respective standards are true to their purpose i.e. it helps translate theory into practice.

Similarly, the financial accounting standards bring uniformity with respect to the reporting of the implementation of those standards, while the auditing standards assess the quality of the reporting. And the ethics standards exist to overall help Islamic finance professionals and institutions uphold the highest standards of excellence in their work activities.

Thus these standards collectively offer regulators and Islamic financial institutions the direction they need to ensure a high level of Shariah compliance and that they are following the highest benchmarks in best practices.

How big is AAOIFI’s impact on the global Islamic finance industry?

AAOIFI is supported by over 200 institutional members, including central banks and regulatory authorities, financial institutions, accounting and auditing firms, and legal firms, from over 45 countries. Its standards and technical pronouncements are currently followed by leading Islamic financial institutions across the world and have introduced a progressive degree of harmonisation of international Islamic finance practices.

As a standard-setting organisation for the global Islamic finance industry, AAOIFI’s 110 standards and technical pronouncements it has developed and issued over the last more than 27 years, has had the biggest impact on the industry.

To appreciate this fact, it is important to understand the standard development process, which involves 50 members of the technical boards (Shariah, accounting, auditing, governance and ethics) and more than 100 members of the various technical working groups who hail from different fields of regulation, Shariah, practice, research, consultancy, etc and who represent not less than 20 countries. To engage such key and varied decision makers, and that too for almost three decades while establishing a single line of thought (in the form of standards) is commendable, to say the least.

Presently, AAOIFI is conducting a footprint analysis study. So far we have found that its standards and technical pronouncements are being followed in about 30 countries and/or jurisdictions. These include countries or jurisdictions that have either adopted the standards fully or partially or have adapted it and are used as benchmark or guidelines.

In addition to setting best practice standards for the industry, AAOIFI is also actively engaged in the development of the human resource capital, particularly in the implementation of the AAOIFI standards. This is done through its offerings in the form of professional fellowship programmes such as the ‘Certified Islamic Professional Accountant’ (CIPA) and ‘Certified Shari’ah Advisor and Auditor’ (CSAA). It is important to note that these fellowships are recognised by the Central Bank of Bahrain (CBB) in the Rule Book as part of the fit and proper criteria for the key positions of an Islamic financial institution.

Moreover, AAOIFI has also launched several professional workshops such as the ‘Sensitisation Programme’ (aimed at directors, senior management, and Shariah scholars of IFIs), ‘Ethics Leadership Programme’, ‘Refresher workshops’, and ‘Crash Course’ (in fellowship programs). These workshops are available in multiple languages. The development of human resource in AAOIFI standards, we feel, will have tremendous impact on the growth and sustainability of the global Islamic finance industry.

AAOIFI also strongly believes in research and development and aggressively promotes a culture of innovation and productivity. Its own contribution in this respect is primarily in the form of two international conferences, which are held annually: one is the Shariah conference, and the other a technical conference held in cooperation with the World Bank. The conference is a platform to engage leading personalities of the industry and other practitioners in a dialogue for knowledge, insight, and experience sharing.

In addition to conferences, AAOIFI also publishes a bi-annual Islamic finance and accountancy journal/technical bulletin called ‘JOIFA’.

Briefly, how are accounting standards in the Islamic finance industry different from the conventional banking system?

The primary objective of accounting of either segment type (i.e. conventional or Islamic) remains the same, which is to meet the information needs of stakeholders with regards to the activities and position of a business. However, there are differences when we evaluate this objective in detail. Islamic accounting abides by the principles of Shariah in dealings and assesses whether the objectives of the organisation are being met. It also identifies and deals with socio-economic factors, religious activities and transactions.

There is a school of thought amongst accountants that views the substance of Islamic finance transactions different from their legal form. It needs to be re-emphasised that Islamic finance products are different in principle and shall be construed as such, as well as, they shall be implemented and executed in a manner consistent with their legal form. They must adhere to uniformity in substance and form, in line with Shariah.

There is also a view that for the purpose of better accounting, comparability and transparency, the concept of time value of money should be applied in accounting for Islamic finance. However, if the time value of money concept is accepted then Islamic banking may no longer be termed Islamic in its essence. In an interest free economic system the discount rate should always be zero and hence the present value of receivables should be equivalent to their par value.

Moreover, the needs of users of Islamic financial institutions is different and, therefore, a separate framework for accounting and disclosure is required to address areas like profit and loss distribution, investment accounts (restricted and unrestricted) and its treatment as quasi-equity off-balance sheet, disclosure of reserves created from profit attributable to investment account holders and disclosures of areas where investment is made.

Further, according to the International Financial Reporting Standards (IFRS), everything having a put option is an obligation and hence is a liability as it is a claim on the entity. In Islamic finance, participatory or profit and loss sharing arrangements are not a claim on entity. These represent claim on identifiable assets and meet the definition of equity. The only difference is they have a put option. So, the term redeemable capital or quasi-equity is more suitable to them.

For those who wish to develop a robust understanding of the differences between international standards (such as IFRS and GAAP) and Financial Accounting Standards (FAS), I would recommend reading our publication, “IFRS and the Shari’ah-based reporting: A Conceptual Study”. The book is available on our website (www.aaoifi.com) free-of-cost.

What is the need for Shariah standard setting bodies when every Islamic Financial Institution (IFI) has its own Shariah advisory board consisting of imminent scholars?

The greatest threat to the future of the global Islamic finance industry is the ‘reputational risk’, which is defined as that which ‘arises from negative publicity or perception associated with the activities of an Islamic financial institution, by the industry investors and customers’. This can be due to various reasons, such as poor levels of compliance or non-compliance with Shariah, unethical practices, or conflicting fatawas (opinions) of Shariah scholars sitting on Shariah supervisory boards of Islamic finance organisations.

It is quite possible to have different fatawas on the same product. Even if the two conflicting fatawas are acceptable, it will nevertheless create doubt in the minds of investors and customers and that will only impede the industry’s penetration and growth.

For example, fatawas on tawarruq-based deposits, mudarabah-based or cooperative (Ta’awuni) Takaful, Bai Inah, Islamic credit cards, etc, are seen to be controversial in one jurisdiction but acceptable in another. These cross-jurisdictional differences are a major threat to the future of Islamic finance.

Moreover, just because a fatwa is acceptable, it doesn’t automatically mean that it serves the overall maqasid (objective) of Shariah as well. In fact, we are all conscious of the fact that certain fatawas (though technically permissible) serve the short-term commercial goals of the industry at the expense of long-term benefit.

The aim of AAOIFI and its standards in this regard is to achieve conformity or similarity (to a possible extent) in concepts and applications among the Shariah supervisory boards of Islamic financial institutions so as to avoid contradiction and inconsistency between the fatwas and the applications by these institutions.

We believe the real solution is the global adoption of AAOIFI standards (which addresses the issues mentioned above). This will ensure harmony and uniformity among various practices. And this is an agenda that AAOIFI is serving well.

The other important component is the need for central Shariah supervisory boards. To streamline this objective, AAOIFI issued a governance standard (GSIFI No 8) titled “Central Shariah Board”, which aims at supporting regulators in establishing uniform practices for establishing and operating Shariah boards at jurisdiction level and which in turn will deliver uniformity at cross-jurisdictional, and ultimately, at the international level as well. We cannot emphasise enough that standardisation of best practices is the only way forward to secure the future of Islamic finance.

Are AAOIFI regulations reactionary, predictive or enablers of development in the Islamic finance industry?

Actually, all of the above; they are very much on standard-to-standard and case-to-case basis. AAOIFI has issued standards that have come about due to certain developments in the market. However, on the other hand since it is about laying the rules and regulations of conducting certain transactions, they have generally been predictive and enablers of the transactions as well.

We, in general, organise public hearings and roundtables, which is an opportunity for us to engage with industry stakeholders to receive their views and feedback on the exposure draft prior to issuing a standard. In addition, we use this opportunity to understand the needs and wants of the industry specific to the standard and in general and ensure those are incorporated within the remit of the standard.

In the last four years we organised more than 65 public hearings in different parts of the world. Recently, we concluded our ‘AAOIFI Strategy’ and one project of this was to establish a Public Interest Monitoring Consultative Committee (PIMCC) to look after public interest in line with international standard practices. Its functions include opining on the strategy and plan; and stating whether the exposure drafts produced by the Accounting Board and Governance and Ethics Board (and before being published) serve the public interest. The Committee will also review existing standards to ensure they are serving public interest.

Are AAOIFI and IFSB (Islamic Financial Services Board) complementary to each other’s efforts or competitors?

Surely, AAOIFI and IFSB complement each other. AAOIFI focuses on accounting, Shariah, governance and ethics standard; while IFSB focuses on soundness and stability of the Islamic financial services industry through the development of prudential regulations.

Both organisations have signed an MoU to collaborate in areas of mutual interest. Recently, both organisations initiated the process of developing a joint standard in Shariah governance framework and also organised a joint seminar on Islamic accounting in Bahrain.

Both organisations have agreed to complement each other’s mandate and activities so as to avoid duplication of efforts. They also invite each other to their conferences and events to share collective views.

As AAOIFI’s new Secretary General, how will your past experience help in shaping the organisation’s strategies? What is your vision for AAOIFI?

AAOIFI has in the last four years developed standards at an unprecedented pace and the credit goes entirely to its hard-working team. I, in particular, thank members of the technical boards who work tirelessly and on a voluntary basis.

To ensure we remain ahead of the curve, we continue to have a continuous engagement with industry players, understand the ground realities and develop standards that ensure harmonisation of best practices acceptable globally. 

During my career, I have worked with clients, partners and various global organisations in different fields and helped them achieve their underlying objectives. Prior to AAOIFI, I spent more than two decades in various managerial positions at EY including nine years as a Partner. Throughout, my career, I have focused on enhancing capacity of the institution to ensure it becomes self-reliant. For me, strengthening and enhancing of the institutionalisation aspect of AAOIFI is very important to ensure it moves forward and grows organically in a sustainable manner.

What strategies do you personally aim to implement in your new role?

For me partnerships with industry stakeholders and AAOIFI institutional members is very important. I personally, through active engagement and capacity building—by ensuring that our standards are well understood by our members and other industry participants—would like to enhance our relationships.

For this we have been working with central banks, other regulators, and multilateral institutions from around the world to ensure that the implementation and adoption rate of AAOIFI standards is increased.

AAOIFI standards are now published in various languages including English, Arabic, French, Urdu, Turkish and Russian, and we are keen on translating them into other languages as and when a need arises. Currently, we are working on translating the standards into Mandarin (which is almost complete) and Bengali.

We are also in the process of revamping our CSAA qualification and this should be completed in H1 2020. To date over 1,500 professionals have qualified from our capacity building programmes including CIPA and CSAA.

Mr. Omar Mustafa Ansari was appointed as the Secretary General of AAOIFI on April 7, 2019. This article was originally written for the Gulf Daily News' 'Tribute to Bahrain Annual Report 2019'.