An overview of the Paper prepared for the 2 nd AOSSG Meeting

1. Agenda-E-2 Financial Reporting Issues relating to Islamic Finance An overview of the Paper prepared for the 2nd AOSSG Meeting 2nd Meeting of the Asian-Oceanian Standard-setters Group Wednesday, 29th September 2010 Akihabara Convention Hall Tokyo, Japan Ms Mas Sukmawati Abu Bakar Associate Director, Islamic Research, Malaysian Accounting Standards Board

2. Part I: Introduction • What is Islamic finance? • Some statistics • Why should it be on AOSSG’s agenda?

3. What is Islamic finance? • Conventional finance may have Shariah-prohibited elements • Shariah compliant alternatives developed • Use of trade contracts, that date to (or pre-date) early Islam c. 600 AD – Bai’, Ijarah, Shirkah • But accompanied by other arrangements, e.g. wa’d • Economically, similar to conventional financing Financing alternatives that comply with Islamic religious law Based on trade contracts, rather than straight lending May be arranged to be economically similar to conventional financing [See Part I, paragraphs 1-12 of the Paper.]

4. 2002 - Islamic Financial Services Board (IFSB), was established. Islamic Bank of Britain, Britain’s first Shariah-compliant bank opens in London. Establishment of Mitghamir Bank in Egypt. Establishment of Pilgrimage Fund for haj pilgrimages in Malaysia. Pakistan, Iran and Sudan announce transformation of financial systems to comply with Shariah. 1960s 1970s 1980s 1990s 2000 – to date Establishment of the first commercial Islamic bank, Dubai Islamic Bank. Establishment of Islamic Development Bank. Pakistan, Bahrain and Malaysia began to promote Islamic banking system. World’s first takaful company was established. 1990 - AAOIFI was established. 1999 - Dow Jones Islamic Index was introduced. FTSE Index of Shariah-compatible stocks were developed. Al-Madina Fund was the first Islamic equity fund established in London. World’s first global sukuk was launched by Guthrie Berhad. 2010 - Germany’s first Islamic bank, a unit of Kureyt Turk Bank of Turkey, opens its doors in March. 2010 – ISDA/IIFM master agreement announced in March. Modern Islamic finance

5. Statistics Sources: (1) & (2) ‘The Banker’s Top 500 Islamic Financial Institutions Survey shows the Growth in Islamic Finance’, RIBH: Le Journal de la Finance Islamique. Available at: http://ribh.wordpress.com/2009/10/28/top-500-islamic-financial-institutions-2/ (3) ‘Islamic finance set to cross $1 trillion: Moody’s’, Reuters, 14 June 2010. Available at: http://www.reuters.com/article/idUSLDE65D19720100614 (4) ‘UAE: Global Islamic Banks Assets to touch US$4 trillion by 2020’, CIBAFI, 24 May 2010. Available at: http://www.cibafi.org/newscenter/english/Details.aspx?Id=8362&Cat=0

6. Statistics (cont’d) Top 10 Countries by Value of Shariah-compliant Assets, 2009 Source: The Banker, Top 500 Islamic Financial Institutions, November 2009, p.4

7. Statistics (cont’d) Source: (1) Assets of the largest 1000 banks in 2009 taken from Banking 2010, IFSL Research, February 2010. Available at: http://www.thecityuk.com/media/2372/IFSL_Banking_2010.pdf (2) Assets of the largest 500 Islamic banks in 2009 taken from ‘The Banker’s Top 500 Islamic Financial Institutions Survey shows the Growth in Islamic Finance’,RIBH: Le Journal de la Finance Islamique. Available at: http://ribh.wordpress.com/2009/10/28/top-500-islamic-financial-institutions-2/

8. How does it concern AOSSG? • 62% of Muslims live in the Asia-Pacific region. (Source: Pew Forum on Religion & Public Life, October 2009) • >90% of sukuk issued in Asia: 40% in Malaysia, 50% in West Asia. (Source: Islamic Financial Institutions Services, June 2009) • Key players are AOSSG members. Most Muslims are Asians. Asia has the biggest sukuk market. Key players are AOSSG members.

9. How does it work? • Sales – Murabahah, BaiInah • Fund management, venture capital - Mudarabah, Musharakah • Deposit taking – Wadiah, Mudarabah • Lease, services - Ijarah • Capital market – 14 types of Sukuk, according to AAOIFI • Protection - Takaful Avoid prohibited elements of riba, gharar, maisir IF transactions based on practices dating to, or pre-date, 1400 years ago Price differences – cash v. deferred; sale v. repurchase Participation Rental / fees [See Appendix C of the Paper.]

10. Part II: Accounting • The working group • Accounting standards for Islamic finance • Different opinions … • … which lead to different decisions • Notes for other AOSSG WGs

11. The Working Group • Work done: • Assess the extent of use of IFRS among member countries • Collate issues / concerns regarding use of IFRS to Islamic transactions • Findings: • IFRS, local GAAP, AAOIFI • Disagreement over some IFRS principles • Further work done: Understand reasons for the disagreement found • Purpose of Paper • Preliminary research • To educate Objective: Provide input and feedback on adequacy and appropriateness of proposed and existing IFRS to Islamic financial transactions and events. Framework: May refer / make reference to other standards. However, will undertake to make recommendations within the framework of IASB’s accounting standards. Shariah authority: Shall not be construed as a Shariahopinion.

12. What standards apply? • Shariah interpretations differ. • Some jurisdictions accept IFRS, others do not. • Why? • Time value of money • Substance over form • Why? • Similar to interest, which is riba • Disregards contractual form IFRS, in most jurisdictions But in some, ‘Islamic’ accounting standards [See Part I, paragraphs 13-33 of Paper.]

13. Differences of opinion … IFRS ‘Islamic’ standards Form important ‘Proportionate’ No discounting Operating lease only Separate ‘entities’ When ‘sale’ occurs When ‘sale’ occurs Substance prevails Effective interest rate Discounting Operating/finance Single entity When criteria met When criteria met SoF Cash flows Valuation Ijarah Takaful Derecognition Revenue [See Appendix E of the Paper, Comments from working group members.]

14. … which lead to different decisions. [See Part II, paragraphs 34-121 of the Paper, and Appendix D: IFRS with implications for the reporting of Islamic financial transactions.]

15. Points to note for other AOSSG WGs • Islamic sale and buy back • sale + wa’d to buy back • Derecognition • Revenue recognition • Ijarah: Most are currently reported as operating leases • Takaful • treatment of Qard • Takaful operator + funds a/c • FV – disapproval of discounting FI Revenue Leases – departure for Ijarah [?] Consolidation FS presentation Insurance FV measurement – no discounting [?] Islamic repurchase Takaful

16. Allowing departures from IFRS IAS 1, para. 19 “In the extremely rare circumstances in which management concludes that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements set out in the Framework, the entity shall depart from that requirement in the manner set out in paragraph 20 if the regulatory framework requires, or otherwise does not prohibit, such a departure.” IAS 1, para 16 “An entity whose financial statements comply with IFRSs shall make an explicit and unreserved statement of such compliance in the notes. An entity shall not describe financial statements as complying with IFRSs unless they comply with all the requirements of IFRSs.” For Against

17. Going forward… • Working Group • Look at impact of upcoming standards • Communicate findings to AOSSG / IASB • AOSSG • Improve cross-border comparability of Islamic financial transactions • Education, Outreach • Challenge: To understand and be mindful of Shariah interpretations which are less accepting of some IFRS requirements

18. Thank you. AOSSG Islamic Finance WG Secretariat c/o Malaysian Accounting Standards Board Suite 5.2, Level 5, Wisma UOA Pantai No. 11 JalanPantai Jaya 59200 Kuala Lumpur MALAYSIA Tel: +603 2240 9200 Fax: +603 2240 9300 Website: www.masb.org.myE-mail: masb@masb.org.my