The Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), an international autonomous non-profit organization that sets the standards in the Islamic finance space, is considering new guidelines on sukuk, Standard 62, that could transform how fixed-income sukuk are structured and distributed.
The market for sukuk—fixed-income instruments that comply with Sharia principles—has grown significantly over the past 15 years. According to Dealogic, issuance has risen from just under US$15 billion in 2010 to more than US$82 billion in 2024.
This growth is fueled not only by demand from core markets in the Middle East and Indonesia, but also increasingly from issuers in western markets. For governments, companies and banks in non-Islamic countries, sukuk can be a valuable financing alternative to traditional loans and bonds. Sukuk are now issued in various international currencies, attracting both Islamic and non-Islamic investors.
A potential shift in standards
The proposed Standard 62 could lead to profound changes in how sukuk are structured and treated in accounting and financial reporting processes, with potentially significant implications for issuers and investors.
The AAOIFI first published a consultation paper on Standard 62 in late 2023, focusing on how the assets underlying sukuk are treated for accounting purposes. Unlike western bonds and loans, which pay interest (prohibited under Sharia), sukuk generate returns through profit-sharing arrangements tied to tangible and intangible assets. To comply with Sharia principles, at least 51% of the sukuk’s value must be supported by tangible assets that generate revenue.
Under the existing system, sukuk are currently asset-based, but not asset-backed. This means investors are notionally exposed to the assets’ performance risk, but do not bear direct financial or legal risk tied to those assets. This structure ensures compliance with Sharia while providing issuers flexibility and mitigating risks for investors.
However, Standard 62 could change this dynamic by transferring full ownership and risk of the underlying assets to the investors or sukuk holders.
This seemingly technical shift could redefine the sukuk market. The instruments, which in their present form basically resemble bonds, would be treated more like securitized assets, fundamentally altering the risk dynamics for issuers and investors.
Currently, investors are protected from the specific performance of the underlying assets. The obligor or fund user of the sukuk purchases the assets back at maturity at the exercise price, which is typically an amount that covers the outstanding principal amount, accrued amount and the unpaid profit under the sukuk, thereby mitigating the non-performance risk of the underlying assets. Thus, the risk profile is tied to the obligor or fund user’s ability to pay the exercise price, which links the sukuk to the obligor’s credit risk.
For securitizations, this structure would no longer apply, and investors would bear the full risk of the underlying assets’ performance. For instance, in a real estate-backed sukuk, the focus would shift to the property’s market value at maturity. In the event of a default, investors would take control of the asset instead of receiving repayment from the issuer.
This reclassification could deter issuers who have traditionally relied on hybrid structures, reducing flexibility and potentially limiting the volume of capital raised in the sukuk market.
Next steps
There is still a long way to go before any final decision is made regarding whether sukuk will be treated as securitizations. The AAOIFI completed its first round of consultations on its Standard 62 draft at the end of June. The organization is now reviewing feedback from the industry and may release a revised draft or undertake further consultations given the significant changes that the new standard could bring about.
As with any accounting standard, much will depend on how the new rules are interpreted and implemented in practice. The role of Sharia scholars, Islamic financial institutions and accounting firms will be critical in determining the real-world application of Standard 62.
Whatever the outcome, these proposed changes are likely to have a lasting impact on the sukuk market. Both issuers and investors will need to closely monitor developments in the coming months.