A new Shari’ah Standard for Gold

(November 2, 2016 - by Commodity Online)

Gold investing has traditionally been fraught with challenges for Islamic institutional and individual investors. Now the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) has joined forces with the World Gold Council to create a new Shari’ah Standard for gold. Dr Hamed Hassan Merah, Secretary General of AAOIFI, and Natalie Dempster, Managing Director, Central Banks and Public Policy, World Gold Council explain why the collaboration took place and what it will achieve.

What is AAOIFI?

Dr Merah: AAOIFI is an Islamic, international, autonomous not-for-profit corporate body that develops accounting, auditing, governance, ethics and Shari’ah standards for Islamic financial institutions (IFIs) and the industry. As an independent, international organization, AAOIFI is supported by 200 institutional members from around 45 countries, including the Islamic Development Bank, central banks, Islamic financial institutions, and other participants from the international Islamic banking and finance industry, worldwide. AAOIFI standards have introduced greater harmonization of Islamic finance practices across the world.

And how do institutions adopt AAOIFI standards?

Dr Merah: AAOIFI standards are followed – as part of regulatory requirements or Islamic Financial Institutions’ internal guidelines – in jurisdictions that offer Islamic finance across the Middle East, Asia, Africa, Europe, and North America, as well as, the Islamic Development Bank Group. In addition, there are jurisdictions where the local set of regulations or Shari’ah requirements are based primarily on the principles setup by the AAOIFI standards. And there are numerous institutions across the globe that follow the principles set by AAOIFI standards, even if there is no regulatory pressure to do so.

Why did the World Gold Council decide to pursue a Shari’ah Standard on Gold?

Natalie Dempster: One of the World Gold Council’s roles is to make sure that gold is universally available to savers and investors. Our discussions with Islamic financial institutions indicated that there was considerable uncertainty about the Shari’ah treatment of gold as an investment and the compliance of contemporary gold products. This was, in turn, preventing households and institutions from reaping the benefits of investing in gold. It was clear that a global Standard on Gold was necessary to clarify the rules.

And why did AAOIFI take on the development of the Shari’ah Standard on Gold?

Dr Merah: The main consideration that prompted AAOIFI to commence work on this standard, following the World Gold Council’s proposal, was gold’s apparent use as an investment opportunity for Islamic financial institutions and their customers. However, when investing in gold, many factors must be taken into consideration. From the perspective of Islamic Fiqh and the Islamic economic system, gold has a specific significance. The original sources of Shari’ah, the Holy Quran and Sunnah have numerous moral and ethical warnings about the use and hoarding of gold. These include a few prohibitive uses, as well as general guiding principles against hoarding gold and silver.

Shari’ah provides specific guidance on gold and gold-based transactions, including several prohibitions. But gold has been a medium of exchange since ancient times so these prohibitions are primarily hurdles for opening the back door to Riba.

Today, gold trading is different and demand for gold has also changed. Newer demands include central bank needs and industrial needs, like electronics. Newer avenues include exchange traded futures and other, similar transactions.

When will the Standard be launched?

Natalie Dempster: An exposure draft of the Standard was launched on 9 October and following an industry review process, we hope that the Standard will be endorsed by AAOIFI’s Shari’ah Board later this year on 20 November and launched on 6 December at the World Islamic Banking Conference in Bahrain. AAOIFI and the World Gold Council will then hold a series of regional events, bringing together Islamic finance market practitioners, investors, product development teams and Shari’ah scholars to discuss how to apply the Standard, increase the role of gold in the Islamic finance system and develop new, Shari’ah-compliant gold products.

How do you think Islamic investors will respond once gold becomes a more investible asset class

Dr Merah: Islamic banks and investment firms are continuously looking for possible investment options, as most of the time they are deposit-heavy, and asset-building avenues are not always available. Additionally, considering the needs of their customers, they need, at times, to diversify either their own or their customers’ investment portfolios. Shari’ah-compliant investment options in the gold market (including physical as well as exchange based transactions) can provide IFIs and their customers with a great opportunity to diversify their investments.

Natalie Dempster: The Standard will bring all the strategic benefits of investing in gold to Islamic investors. These include gold’s role as a powerful diversification tool, a safe-haven asset and a hedge against extreme inflation. Indeed, the choice of assets is so limited for Islamic investors that the benefits of adding gold to a portfolio should be even more pronounced. It is also much more liquid than other common Islamic assets, such as property.

Additionally, World Gold Council analysis shows that, since reliable data became available eight years ago, gold has outperformed all major Islamic asset classes including REITs, the Takaful index, the Dow Jones Islamic Equities Index and the Dow Jones Sukuk Index. Gold has also performed better than major currencies used in the Islamic world. Since 2000, it has risen 367% in US dollar terms (Gulf Cooperation Council currencies are pegged to the US dollar), 393% in Malaysian Ringgit terms, and 762% in Indonesian rupiah terms. Gold can bring both strategic benefits and returns to an investor portfolio.

And what products will the Standard cover?

Natalie Dempster: Before the Standard was issued, there was only very limited Shari’ah guidance on gold bars and coins, and virtually no guidance at all on contemporary gold products. The Standard addresses this gap and has been written on a non-exclusive basis, meaning that it covers a wide range of potential gold products. These products cater to both the retail and wholesale markets and include vaulted gold, regular gold savings plans, gold certificates, physical gold ETFs and certain aspects of gold futures. All these products need to be physically backed by fully allocated gold, in addition to complying with the other Shari’ah rules and principles outlined in the Standard.

How will the Standard impact the gold market?

Natalie Dempster: We believe the Standard will have a direct and significant impact on gold demand. Our research and industry engagement suggest that demand will come from both individual and institutional investors looking to grow their overall wealth, diversify existing portfolios and hedge against tail risk through gold exposure. Given that Islamic finance is growing on average by 16% per year, and Islamic finance assets are projected to reach US$2 trillion by 2020, a very conservative 1% allocation to gold would increase gold demand by US$20 billion or around 500 tonnes 2020.

Perhaps the most often-discussed constraint on the growth of Islamic finance is the lack of liquidity and product diversity. Do you see gold as a solution to these constraints?

Dr Merah: Gold certainly offers a good alternative investment opportunity, which is highly liquid. However, it cannot be the only solution and the Islamic finance industry must work rigorously to find further solutions in this area. At AAOIFI, however, we would say that one of the reasons for making this standard a priority was to ensure that appropriate products are available to provide investment solutions to customers and allow them to manage liquidity within Shari’ah-compliant options.