The ratings landscape in Islamic finance is continually adapting to changing economic conditions, regulatory developments, and an increasing emphasis on environmental, social, and governance (ESG) factors. The 'Big Three' credit rating agencies predominantly assess the sector: Moody’s Investors Service, S&P Global Ratings, and Fitch Ratings. These agencies provide crucial evaluations for sovereign entities, Sukuk issuers, and Islamic finance projects. Complementing these global players are domestic agencies such as RAM Ratings and MARC Ratings in Malaysia, PACRA and VIS in Pakistan, and Indonesian agencies like PEFINDO and PIFRA. The Islamic International Rating Agency also remains the sole provider of Shariah-specific ratings.
Economic context
According to S&P Global, the Islamic finance industry is projected to continue its growth trajectory, with high single-digit expansion expected for 2024–25. This follows an 8% growth in 2023, driven by robust performance in core markets such as the UAE and Saudi Arabia. However, the sector faces challenges including regulatory hurdles and the need for new standards, which could affect Sukuk issuance volumes in the coming years.
Key developments
A significant regulatory update came from Fitch Ratings in June 2023, clarifying the impact of Shariah rulings on Sukuk ratings. This addressed complexities related to investor rights and recoveries upon issuer default, particularly when repurchase prices must reflect fair market value rather than a fixed amount. This has significant implications for the ratability of certain Sukuk structures under Fitch’s criteria.
Moreover, the adoption of AAOIFI Standard 62 is set to transform the Sukuk market by transferring ownership and risks related to underlying assets to Sukuk holders. While this may facilitate the development of residential mortgage-backed Sukuk, it could make other forms of Sukuk more challenging to structure and rate, especially those backed by sponsors’ contractual obligations.
Developments in Turkiye
Turkiye's participation finance sector is poised for significant advancements with the introduction of the Participation Finance Act, the establishment of an Islamic megabank, and the launch of a new Participation Finance Rating System. These initiatives aim to strengthen Turkiye’s position as a global hub for Islamic finance. The Participation Finance Rating System is designed to assess the financial performance and compliance with participation finance principles of financial institutions and real sector companies.
Updated ratings methodology
In March 2024, Fitch updated its interactive sovereign rating model to better capture the complexities and unique characteristics of sovereign ratings. Additionally, Fitch revised the debt-level naming convention for sovereign debt instruments to enhance clarity and consistency in ratings reporting. Following this update, all rated short- and long-term sovereign senior unsecured debt instruments will be labeled based on whether they are linked to Fitch’s foreign currency or local currency issuer default rating.
Moreover, Moody’s has simplified its hybrid capital criteria, potentially opening new opportunities for issuers. This move is expected to positively impact the Islamic finance sector by providing clearer guidelines and broadening the market for hybrid capital instruments within Islamic finance structures.
Challenges and opportunities
The current economic landscape presents complexities, with a notable divergence in risk assessments between bond markets and banks. While bond markets exhibit optimism, banks remain cautious due to tighter lending conditions. This divergence could affect future credit conditions.
Despite these challenges, the Islamic finance ratings sector offers opportunities for market participants. Staying informed about regulatory updates, market dynamics, and ESG trends is crucial for investors and issuers to make strategic decisions in this evolving environment.
The Islamic finance ratings landscape is transforming, influenced by economic challenges, regulatory updates, and the growing importance of ESG factors. Understanding these trends and their implications is essential for navigating the complexities of this market.
The author is the Managing Director & CEO of National Bank Limited. He is a fellow member of the Institute of Cost & Management Accountants of Bangladesh (ICMAB) and the first Certified Sustainability Reporting Assurer (CSRA) in Bangladesh. He is also a post-graduate diploma from the Institute of Islamic Banking & Insurance (IIBI), United Kingdom.
Messenger/EHM
