By Bernardo Vizcaino
March 23 (Reuters) - Two top standard-setting bodies are proposing new guidelines for Islamic bonds that could increase investment in the instruments by making them more transparent and easier to structure.
Last week the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) published draft accounting standards for sukuk that aim to clarify how they should be treated on balance sheets and the information which issuers should disclose.
Bahrain-based AAOIFI, whose standards are followed in whole or in part by Islamic financial institutions around the world, said it had also formed a working group to overhaul its sharia standards for sukuk. Sharia standards cover the instruments' compliance with Islamic principles.
Late last year, the Malaysia-based Islamic Financial Services Board (IFSB) drafted its own guidelines for disclosure related to Islamic capital market products, mainly focusing on sukuk.
The new standards could make sukuk more popular because both issuers and investors have complained that the instruments, which seek to replicate conventional bonds without the use of interest payments, can be complex and time-consuming to design, and difficult for investors to understand.
Aligning the market around common, specific standards, and requiring all issuers to disclose the same information, could help to resolve these problems.
Conventional debt issuance nearly doubled in the Gulf Arab region during 2016, reaching over $140 billion, but sukuk issuance dropped by 6 percent and stood below $20 billion for a second year running, Standard & Poor's estimated.
"Muted issuance could push the market toward more standardisation as issuers and advisors realise that the lack of volume is due to the complexity of the process," said Mohamad Damak, global head of Islamic Finance at S&P.
The proposed AAOIFI standards cover the accounting treatment of sukuk by special purpose vehicles, which are often used in Islamic bond transactions. The standards say when sukuk should be classified as equity, quasi-equity or a liability.
This could help to resolve a longstanding source of confusion among investors over whether sukuk are asset-backed, giving them a share of the instrument's underlying assets, or asset-based, in which they may only have limited recourse to those assets.
"These two terms are too similar and can even mislead unfamiliar investors bewildered by sukuk jargon," said Khalid Howladar, managing director at Dubai-based advisory firm Acreditus.
The IFSB draft covers disclosures on the risks involved in certifying products as sharia-compliant, capital-boosting structures, underlying assets, limitations on how sukuk can be traded, and investors' rights in case of default or restructuring.
The new IFSB standards would allow exemptions from certain disclosure requirements for governments and multilateral bodies issuing sukuk, though some in the industry are challenging that.
The General Council for Islamic Banks and Financial Institutions, a lobby group, said such exemptions should be avoided as they could complicate cross-border sukuk offers.
"Identification of assets for sovereign or multilateral sukuk issuances is essential," the Manama-based group said in written comments to the IFSB. The Islamic Development Bank and the Malaysia-based International Islamic Liquidity Management Corp are the main multilateral issuers of sukuk. (Editing by Andrew Torchia and Gareth Jones)