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With the emergence and rapid growth of the Islamic finance industry, Malaysian Rating Corporation (MARC) has witnessed a proliferation of Islamic financial products in terms of depth, breadth and sophistication. MARC lays claim to being the first rating agency that has a specific set of rating symbols and definitions for the ratings of Islamic capital market instruments. Soon after its inception, MARC established its own Shariah advisory panel to advise on Shariah aspects of Islamic financial instruments as well as review and endorse new variations to Islamic rating products and definitions.
The main driver behind this initiative is the fact that conventional rating symbols should only be appropriate for interest-bearing instruments. Islamic bonds, meanwhile, generate profit payments in place of interest — a distinction that is fundamental to Shariah compliant investing. Apart from the absence of interest-based (riba) transactions, the avoidance of economic activities involving speculation (gharar), the elimination of exploitation of either party and the prohibition of financing the production of goods and services that contradict Islam (haram) are also fundamental to Shariah compliance. While scholars agree on these main principles, there are differences in interpretation between various schools of Islamic religious jurisdictions.
From MARC’s experience of rating Islamic financing instruments, we find that the issue of Shariah compliance is generally adequately addressed by the appointed Shariah panel of lead arrangers and financial advisers. If MARC is the appointed rating agency for the transaction, issuers and investors would also have the added validating endorsement of the Shariah compliant from MARC’s own Shariah advisory panel.
In recent years, however, it has become apparent that the evolution of Islamic finance has progressed beyond a replication of conventional products to the development of real Islamic financing alternatives. The foregoing has taken place within the context of the increasing amounts of Shariah compliant capital and accordingly, the demand for Shariah compliant financial products and services.
MARC has kept pace with the evolution of Shariah compliant financial products and services and responded thereafter by introducing new rating products and rating symbols.
MARC currently provides ratings for Islamic bonds and Islamic Sukuk issuances. The analytical framework for rating Islamic bonds is broadly similar to that used in rating conventional bonds. There are no major differences in MARC’s rating approach for debt-based Islamic financing instruments. These ratings specifically assess the likelihood of full and timely payment of obligations to holders of the instrument issued under the various debt-based Islamic financing contract(s), which can be likened to the concept of probability of default in conventional debt ratings.
MARC assigns Islamic bonds ratings on long- and short-term rating scales that are comparable to its other credit ratings. The scale ranges from “AAAID” to “DID” for a long-term rating (with maturity of more than one year), and from “MARC-1ID” to “MARC-DID” for a short-term rating (maturity of up to one year).
Since 2001, MARC has also been assigning Islamic Sukuk ratings to fixed income Sukuk issuances. Similar to MARC’s conventional debt and Islamic debt rating scales, the long-term Sukuk rating scale comprises eight rating categories ranging from “AAAIS” to “DIS”, while the short-term rating scale ranges from “MARC-1IS” to “MARC-DIS”. The introduction of a different set of symbols for Sukuk obligations recognizes the fundamental difference between Sukuk and other fixed-income Islamic debt obligations. Sukuk are asset backed, Shariah compliant investment certificates, usually used in conjunction with an Ijarah (lease rentals) or a Musharakah (profit sharing) structure. Again, the rating focus for fixed-income Sukuk is on timely payment with added analytical emphasis on the “beneficial interest” conferred by holding a Sukuk. This “beneficial interest” represents a proportional ownership of the underlying asset as well as the income that is generated by the asset. The analytical framework employed in rating Sukuk broadly resembles that of asset backed securities. In the case of Ijarah-based Sukuk rated by MARC to date, the rating has been typically driven by the credit risk of the lessee (who is usually the originator or an entity related to the lessee).
Mohd Razlan Mohamed is CEO and Milly Leong is deputy head of ratings at MARC |
