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

1. Read! In the Name of your Lord, Who has created2. Has created man from a clot3. Read! And your Lord is the Most Generous4. Who has taught by the pen5. Has taught man that which he knew not.Al Alaq 1 to 5

AgendaOverviewA brief about AAOIFIA brief about IASBIASB-FASB Convergence agendaG20 Position on IFRSCheckpoint 1Transaction – From Concept to ReportingCheckpoint 2Convergence or Harmonisation?Thoughts for Malaysia

OverviewThere is no doubt that Shariah compliant financial products and services (Islamic finance) are gaining acceptance globallyThere are a number of epicentres which promotes Islamic finance particularly in Muslim majority jurisdictions such as the United Arab Emirates and MalaysiaThe 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

OverviewSome interesting observation on Islamic finance:Promotes different types of risk-sharing methods, supported by emphasising on equity and asset backed financingThe lender supports transactions that are real and backed by tangible assets with profits linked with the risk takenGreater 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)

OverviewSome 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)

OverviewSome 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 )

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 industryAAOIFI 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

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; andto review and amend accounting and auditing standards for Islamic financial institutions.

International Accounting Standards BoardEstablished 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 statementsIFRSs 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.

International Accounting Standards BoardThe Trustees are publically accountable to a Monitoring Board of capital market authoritiesIFRSs 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.

IASB-FASB Convergence AgendaJoint IASB-FASB MOUs were signed in 2002 and 2006 on convergence of their standards – this would shape future developments of IFRSMay 2006 IASB issued exposure draft of “Improved Conceptual Framework for Financial Reporting”Objective of Financial ReportingEntity perspectivePresent and future capital providers as primary user group for general purpose financial reportingBroad enough to encompass all decisions that equity investors, lenders and other creditors make

IASB-FASB Convergence AgendaQualitative characteristics and constraints of decision-useful financial reporting informationRelevance and faithful representation are fundamental qualitative characteristicsComparability, verifiability, timeliness and understandability are enhancing qualitative characteristics Materiality and cost are pervasive constraints

G20 Position on IFRSG20 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 accountingReduce 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

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

Transactions -From Concept to ReportingConceptualisationof productsContractualobligationsestablishedand performedFinancialReportingAuditingPrudential Requirements

Transactions -From Concept to ReportingShariah compliant financial transactionsFinancialInstitutionsAccountingStandardsAuditingStandardsShariah CouncilConceptualisationof productsContractualobligationsestablishedand performedFinancialReportingAuditingPrudential RequirementsShariah-based prudential standards

Transactions – From Concept to Reporting

Transactions – From Concept to ReportingGiven 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 IFRSThe key is that the contracts entered into by the parties should ensure the principles of Shariah are properly crystallisedThe consequences on prudential requirements should be managed accordingly

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

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

Need for a Merger?This does not mean that IFRS is perfect and the accounting standards developed by AAIOFI are inferiorSerious 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

Thoughts for MalaysiaThe FRSIC model in facilitating IFRS implementation could be replicated in applying IFRS on Islamic finance transactionsGiven 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 areaA voluntary structure would provides flexibility in modes of operation, especially at the developmental stageThe establishment of such structure would support the Malaysian government initiatives in positioning Malaysia as the centre for Islamic finance

Thoughts for MalaysiaWe 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 financeLow 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. TakafulIncluding Islamic finance dimensions when responding to IASB exposure drafts

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