Sukuk set to adapt as markets move from IBORs to risk-free rates: Fitch

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The portion of the sukuk market which uses IBORs – the soon to be legacy interbank offered rates – is set to adapt to uncertainties ahead, said credit ratings firm Fitch Ratings in a research note.

Fitch said there will be uncertainties for the sukuk, or Sharia-compliant bond, market stemming from the finance industry moves from IBORs to risk-free rates (RFRs), but it is set to “adopt or adapt.”

“Where possible, we expect the sukuk market to adopt or adapt the initiatives that are taking shape in the conventional bond market,” said Bashar Al Natoor, global head of Islamic finance at Fitch Ratings.

“Key uncertainties relate to contracts that embed the legacy IBORs, but lack suitable fall-back provisions in the event of IBOR discontinuation,” Al Natoor added.

Fitch noted that the bulk of the sukuk market is fixed-rate, meaning the interest rate on the contract remains the same throughout its lifetime and is thus unaffected by the IBOR transition.

Sukuk also faces the additional challenge of Sharia-compliance with RFRs. As there is no central Sharia board that decides upon compliance, the difficulty of judging compliance is high.

“This comes to the chronic problem of standardization, harmonization, and centralization, which is not only a LIBOR issue, but is a chronic issue in this industry,” Al Natoor explained.

The London Interbank Offered Rate (LIBOR), the most dominate IBOR in the world, has been subject to various scandals involving collusion between major banks to rig rates and keep transactions at an artificially low level.

RFRs are the long-term alternative to IBORs. Whereas IBORs rely on expert judgement, RFRs are calculated using historical data.

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