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AAOIFI Shari’ah Standard on Gold

Andrew Naylor, Director of Central Banks and Public Policy at the World Gold Council.

 

The launch in 2016 of the AAOIFI Shari’ah Standard on Gold developed in collaboration with the World Gold Council opened a completely new asset class to the Islamic finance industry. Gold is now poised to power the growth of Islamic finance worldwide. The statistics are already very impressive. Islamic finance is expected to grow from USD 2trn assets under management to over 4trn over the next few years. Product innovation will be a major driver of this growth, and gold products will play an important role in the ongoing success of the industry. The gold industry will benefit too. A very conservative 0.5% allocation to gold would equate to an additional 250 tonnes of demand at today’s prices.

 

As Dr Mark Mobius said, the AAOIFI Shari’ah Standard on gold ‘will enable the foundation of what could be the most significant event for Shari’ah finance in modern times’.

Gold has always played a significant role in Islam but a lack of Shari’ah guidance on contemporary gold-based financial products has held back its use in modern Islamic finance. The launch of the AAOIFI Shari’ah Standard on Gold changes that – for the first time financial institutions and investors have very clear Shari’ah guidance on the use of gold.

 

Clarifying the Shari’ah treatment of gold will support the growth of Islamic finance only if the industry uses the Standard to develop Shari’ah-compliant gold products. This is why the focus of the World Gold Council in 2017 is to support and encourage the adoption of the Standard and the development of new products.

 

Since its launch last year, several products have been certified as compliant with the AAOIFI Standard on Gold. These products enable Shari’ah-conscious savers and investors to benefit from gold’s unique attributes as a diversification tool, as a risk-mitigating asset, and as a long-term preserver of wealth.

 

These products include a physical gold ETF, an exchange traded contract, and various online gold savings plans targeted at the retail market. More products are in the pipeline, and the World Gold Council has published a list of gold products compliant with the AAOIFI Standard on a dedicated webpage: www.shariahgold.com.

 

  

Five most important principles of the Standard:

 

  1. Gold must be traded on a spot basis (hand-to-hand).  This means that conventional forwards and futures are not permissible.
  2. Gold can be owned on a physical OR constructive basis, allowing structured gold products
  3. In the case of constructive possession, gold must be fully allocated. Unallocated gold is not permissible and no paper gold  products are allowed.
  4. Allocation can occur through either T+0 settlement OR the receipt of a certificate/email specifying bar ownership (this is because in Islamic finance you MUST own something before you are allowed to sell it).
  5. It is permissible to own gold jointly, where each partner owns an undivided beneficial interest in a trust. This is important for structuring purposes, such as for some physical gold ETFs. 

 

  Powering the global growth of Islamic finance

 

The Standard brings a number of benefits: 

 

·         Increases investor and consumer confidence in Islamic financial transactions and their compliance with Shari’ah principles. Applying the Standard will also ensure there is no riba within the financial transactions.

·         Increases product innovation, better satisfying consumer demand.

·         Supports the growth of Islamic finance by opening up an entirely new asset class to the industry.

 

As the Islamic finance industry grows in size it is essential that a diverse range of products and financial instruments are available to ensure market stability and resilience. In order for Islamic finance to reach its full potential, a broader range of Shari’ah-compliant financial instruments need to be available to savers and investors. Product diversity is key to ensuring the commercial success of Islamic banks, ensuring that consumer demand is met with a broad range of financial solutions, and new tools are available for portfolio diversification, risk management and liquidity management purposes.

 

Shari’ah-compliant gold instruments will support the growth of Islamic finance worldwide by increasing the size and depth of its investment universe. The AAOIFI Standard is the highest authority on the Shari’ah treatment of gold and gives confidence to the industry to develop contemporary Shari’ah-compliant gold products. Banks can have confidence to use gold as part of their operations, such as using it as collateral or for liquidity management purposes. It could also be used by sukuk issuers, potentially as a way of improving the credit quality of sukuk. The sukuk market has grown substantially recently, but high credit quality sukuk remain relatively scarce.

 

The importance of AAOIFI standards should not be underestimated. They help harmonise practice across borders and are the highest authority available to industry on Shari’ah compliance. Harmonising Shari’ah guidance acts as a catalyst for the internationalisation of Islamic finance and will help facilitate, for example, cross border investments by removing Shari’ah uncertainty.

 

Gold is considered by many to be the ultimate safe haven and wealth preservation asset. The reasons for this are well understood: it has almost no correlation with other main asset classes (including Shari’ah-compliant assets). It has no credit risk, and it is a physical, tangible asset.

 

Its distinctive behaviour as a financial asset makes it an excellent risk management tool. This is very important for Islamic investors, who have less tools available at their disposal. In conventional finance derivatives are used to manage risk – instruments not permissible in Islamic finance. Gold functions as a hedge against risk, including foreign exchange risk and tail risk events. Its inclusion in Islamic portfolios will help Islamic investors manage risk whilst at the same time boosting risk-adjusted overall returns.

 

Islamic institutional investors, pension funds and Hajj funds are all seeking to boost returns whilst mitigating risk. Gold is now available to these investors.

 

 Gold can support the growth of Islamic finance in four ways:

 

  1. It is a powerful investment tool – virtually any Islamic investment portfolio can be improved with some allocation to gold.
  2. Gold enhances the Islamic investment universe – Islamic finance lacks a true safe haven asset. Gold is the ultimate safe have asset and, as a large and liquid market, it will be accessible in times of need.
  3. Gold will support innovation in Islamic finance – a whole new asset class is now available to product developers. Product innovation will help satisfy consumer demand for Islamic financial solutions.
  4. Gold is a distinctive asset – gold historically played a very important role in Islamic finance and it is fitting that it will play an important role in the next phase of the growth of Islamic finance.

 

 The launch of the Standard last year is a major milestone in the development of Islamic finance. Gold is now more accessible to Islamic investors, and it can power the growth of the industry through greater product innovation. It is through greater product innovation that Islamic finance will reach its full potential, which is why it is pleasing to see gold playing a role in this, with a number of new products in the pipeline.

 

The World Gold Council has published a website hosting copies of the Standard, associated research and information, and a list of products compliant with the AAOIFI Standard. For more information please visit www.shariahgold.com

 

Disclaimer: Views are personal and not the views of the publisher.