The development of an Islamic capital market requires many things: More issues, more liquidity and an industry-wide acceptance of ratings as a necessary benchmark. Paul McNamara reports
The traditional ratings agencies have a very important role to play in the analysis of conventional institutions and the instruments they issue. IIRA will provide "Entity Rating, Instrument Rating, Shari'ah rating, Sovereign Rating, and Corporate Governance Rating". Back in 2001, the Islamic Development Bank concluded that an agency that could rate Islamic debt instruments and Islamic institutions would help kick start the growth of the secondary Islamic capital market
The Islamic International Rating Agency (IIRA) was registered with the Bahrain Monetary Agency as a Bahrain Joint Stock Company in October 2002 with the objective of carrying on the business of rating, evaluating and appraising both institutions and instruments within the Islamic finance space.
The IIRA is sponsored by the Islamic Development Bank, several leading Islamic banks and rating agencies from different countries.
The structure of IIRA is geared to preserving its independence. It has a Board of Directors and a fully independent Rating Committee as well as a Shari'ah Board made up of experts in the field.
The agency provides an independent assessment and opinion on the creditworthiness of both Islamic finance institutions and the financial instruments that they issue. It also provides an independent assessment of compliance by the concerned entity or financial instrument with the principles of Shari'ah. In other words, the agency will rate both the financial aspects as well as the Shari'ah aspects of any instrument or bank.
In addition to this, the agency hope to introduce standards for greater disclosure and appropriate governance in Islamic and conventional banks, financial institutions and corporate and helping clients understand and manage risks in compliance with Shari'a principles.
According to IIRA their objectives are to:
Introduce a set of specific rating products and services, which will include Shari'a transparency for both the financial instruments to be introduced, and the concerned issuer of the instrument.
Contribute to the promotion of international financial Islamic capital market and Islamic instruments.
Carry on the business of research analysis, rating, evaluation and appraisal of the obligations, dues, and commitments.
Provide an independent assessment and opinion on creditworthiness of the rated entity or the financial instrument.
Provide an independent assessment of compliance by the concerned entity or the financial instrument with the principles of Shari'a.
Disseminate, sell and publish analytical data and ratings any media or means of information.
Provide an effective tool for encouraging the introduction of standards for greater disclosure and appropriate governance by way of representing the governance in Islamic and conventional banks, financial institutions and corporates.
As a profit making body, the agency works like its conventional counterparts and charges a set fee per piece of work. According to IIRA they acre currency working on three separate deals. In future their clients will include "a wide range of corporate and governmental issuers of securities as well as institutional investors, depositors, creditors, investment banks, commercial banks, funds managers, insurance companies and other financial intermediaries".
IIRA is owned by the Islamic Development Bank, Islamic Corporation for the Development of the Private Sector, Capital Intelligence, JCR-VIS Credit Rating (Pakistan), Kuwait Turkish Evkaf Finance House (from Turkey), Bahrain Islamic Bank, Arcapita, Abu Dhabi Islamic Bank, Takaful Malaysia, First Investment Company of Kuwait, Pakistan Kuwait Investment Company, Private, Arab Islamic Bank from Palestine, Dubai Islamic Bank, Bosna Bank International from Bosnia, Al-Baraka Banking Group, Jordan Islamic Bank and Bank Islam Malaysia.
The IIRA has a Shari'ah board that comprises 19 prominent scholars, which the IIRA uses for Shari'ah ratings.
They have chosen scholars from diverse geographic locations to accommodate different Shari'ah schools of thought. Each rating assignment is passed onto a Shari'ah committee of three members of the board. The committee members are chosen on the basis that none of them is in anyway linked with the rated entity and if possible at least one member is from the same country as the rated entity.
According to IIRA, the rating committee will meet the following criteria:
IndependenceThe committee member will not be under any influence of the rated entity or the Board of Directors and will perform their work independently. In case of any conflict of interest that may develop during the course of assignment the committee member will be replaced by another member.
Understanding of Islamic finance
The committee members have understanding of Islamic modes of finance which will be helpful to them in rating of banks, financial institutions and the Islamic instruments. Full details of the assets, liabilities and structure of the instrument will be studied through examination of actual documents of the transactions to enable committee to form its opinion.
Interview with Jamal Abbas Zaidi, chief executive officer of the Islamic International Rating Agency
What are the ranges of services that you offer or plan to offer?
IIRA has been established to provide a wide range of services. The main purpose is to play a pro-active role in the development of financial markets by providing an assessment of the risk profile of entities and instruments that can be used as a basis for investment decisions. IIRA is a unique rating agency, in that it provides a Shari'ah Quality Rating in addition to the credit rating services. Our credit rating services will cover both Islamic banks and institutions and their products like Sukuk as well as conventional banks and financial institutions and their products like bonds and commercial papers. Our Corporate Governance rating assesses the governance system of banks, corporate and financial institutions against the international best practices and local regulatory requirements and thus provides a direction for the improvement in the governance systems.
IIRA will also carry out research, analysis and evaluation of sectors, industries and entities. For this purpose, IIRA is building a strong database of individual firms, as well as of industries. The impartial, independent and reliable credit rating issued by IIRA helps regional investors and other stakeholders of both the Islamic as well as conventional financial institutions. Whilst providing these services, IIRA maintains high standards of objectivity, independence, transparency and consistency. We believe that these attributes are essential to build investors' confidence and develop acceptance in capital markets and among lending institutions.
How do you go about pricing your services?
IIRA offers its services at prices that support our operating costs, which include highly skilled and professional employees, that are at the same time not as expensive as global rating agencies. We follow a structured fee scale for entities and for bonds and Sukuk. The fee is proportional to the value of bonds/Sukuk, while for entities we follow a scale of fees depending on the size of the entity.
When can we expect to see your first rating?
The operations at IIRA started in July 2005 with the induction of the CEO. The later part of 2005 was therefore devoted to building up the necessary infrastructure to deliver our services. This included building up a modern, well-equipped, functional office and hiring of appropriate qualified and experienced professionals for carrying out the highly skilled work of analysis and rating. We also devoted considerable time in carrying out research and developing rating methodologies.
IIRA started marketing its services and is encouraged by the response. We have obtained a few rating assignments and the work has commenced on them. It is expected that our first assignment will be completed by the third quarter of this year.
Do you anticipate any conflict between your Shari'ah Board conclusions and those of the issuing institution? How would you propose to deal with such conflict?
The Shari'ah Rating Committee of IIRA is selected from a panel of nineteen scholars. The criteria for selection of Shari'ah Rating Committee members is that none of the members should be related to the rated entity in any manner, all should have experience in banking and finance, and at least one of them should represent the geographical market where the rated entity is located. This selection process ensures independence of Shari'ah Rating Committee with knowledge of relevant subject and market. While doing the Shari'ah Quality Rating, IIRA's Shari'ah Rating Committee, which consists of scholars who are independent of the rated entity, look at a number of factors before arriving at rating assessment. These factors include the Fatwa issued by the Shari'ah Committee of the institution, the evaluation of the mechanism within the institution to comply with the Shari'ah Committee's Fatwa, the opinions of the Shari'ah Committee of the institution, and any dissenting opinion thereon is also carefully studied.
IIRA's Shari'ah Rating Committee also looks at the detailed structure of assets and liabilities, and a few executed agreements and documents to evaluate the degree of compliance with the approved scheme or product. We also look at the strength of the internal control and audit systems and the procedures and safeguard against co-mingling of funds (in case of Islamic windows in conventional banks). The level and quality of disclosure of information to clients, investors and other stakeholders is also evaluated. Importance is also given to presence, or lack, of code of ethics and its understanding and implementation among all the tiers of management and employees. Each of the above aspects is scored separately to arrive at an overall Shari'ah Quality Rating.
It is a standard practice that the initial ratings assigned by IIRA are first discussed with the management of the institution. If there were any conflicts, the management is given an opportunity to bring forth any new information or data that may have an impact on the rating, and this exercise completes the rating process.
However, the rating is an independent opinion of IIRA and the Rating Committee issues the final rating according to its own judgment.
How closely will you work with IIFM and LMC?
The rating of bonds, Sukuk and commercial papers will add value as the investors will be able to make more informed decisions based on the risk profile on the bonds and their own risk appetite. We will work closely with investment banks and institutions like LMC to provide the rating services for the issues managed or organized by these institutions. We will also work closely with AAOIFI and IIFM for review and improvement in accounting standards from time to time.
© Banker Middle East 2006
