{"id":2177,"date":"2024-01-15T11:00:00","date_gmt":"2024-01-15T11:00:00","guid":{"rendered":"https:\/\/cis.aaoifi.com\/knowledge-articles\/shariah-compliance-benchmarking-sofr-sonia-islamic-finance"},"modified":"2026-05-22T14:19:13","modified_gmt":"2026-05-22T14:19:13","slug":"shariah-compliance-benchmarking-sofr-sonia-islamic-finance","status":"publish","type":"kh_article","link":"https:\/\/cis.aaoifi.com\/ar\/knowledge-articles\/shariah-compliance-benchmarking-sofr-sonia-islamic-finance\/","title":{"rendered":"Navigating Shari’ah Compliance and Benchmarking: The Dilemma of SOFR and SONIA in Islamic Finance"},"content":{"rendered":"

Source:<\/strong> JOIFA (Journal of Islamic Finance and Accountancy), Vol. 9, Issue 1, 2024 | Author:<\/strong> Mughees Shaukat, Senior Manager \u2014 Capacity Building Programs, AAOIFI (article written in personal capacity)<\/em><\/p>\n

1. Introduction<\/h2>\n

The landscape of Islamic finance, rooted in Shari’ah principles, has encountered a complex dilemma with the integration of conventional benchmark rates such as the Secured Overnight Financing Rate (SOFR) and the Sterling Overnight Index Average (SONIA). This article explores the dynamics surrounding Shari’ah compliance of benchmarking and pricing challenges of Islamic financial products, posed by the inherent dilemmas rooted in SOFR and SONIA \u2014 introduced for transition from LIBOR to alternative risk-free rates (RFR).<\/p>\n

2. The Emergence of SOFR and SONIA<\/h2>\n

The 2008 financial crisis exposed vulnerabilities in existing benchmark rates, notably LIBOR. The Federal Reserve-sponsored Alternative Reference Rates Committee (ARRC) was formed in the United States to identify a suitable replacement. Hence the birth of SOFR \u2014 introduced in 2018, it is a broad measure of the cost of borrowing cash overnight collateralised by U.S. Treasury securities.<\/p>\n

Similarly, the Bank of England initiated a comprehensive review of sterling benchmark rates, leading to the reformulation and rebranding of SONIA in 2018. The reformed SONIA reflects the average interest rate paid on overnight unsecured deposits.<\/p>\n

3. Core Challenges Posed to Islamic Finance<\/h2>\n

3.1 Interest-Based Nature<\/h3>\n

The Islamic financial system carries the innate mandate of al-bay (risk-based finance), while promoting fairness, transparency, and shared prosperity, with no riba (interest). The continued absence of a dedicated Islamic benchmark rate and hence adoption of SOFR and SONIA akin to LIBOR has presented a unique set of challenges for Islamic finance practitioners.<\/p>\n

3.2 Secured Nature of SOFR<\/h3>\n

SOFR being secured and collateralised raises concerns within the Islamic finance community. The interest rates derived from SOFR may not fully capture the credit risk inherent in unsecured lending\/financing, potentially introducing a misalignment with Islamic finance principles as well as risk-return matching.<\/p>\n

3.3 Uncertainty and Speculative Elements<\/h3>\n

Shari’ah-compliant financial transactions emphasise certainty and predictability. SOFR’s reliance on market dynamics introduces speculative elements, as the rate is influenced by supply and demand conditions in the repurchase agreement (repo) market. SONIA, based on actual transactions, is also sensitive to changes in market forces including liquidity conditions.<\/p>\n

3.4 Transparency Challenges<\/h3>\n

One of the primary transparency challenges lies in the opaque nature of the calculation methodologies used to determine benchmark rates. The lack of clarity on how these rates are derived can lead to suspicions of manipulation and unfair practices \u2014 principles fundamentally at odds with Islamic finance requirements.<\/p>\n

3.5 Static and Retrospective Characteristics<\/h3>\n

The challenges in using SOFR and SONIA in Islamic finance are compounded by their static and retrospective characteristics while pricing Islamic finance products and assessing risks. It is creating a compromising situation for Shari’ah compliance, especially in fixed-return products where the price, once fixed, cannot be changed or applied\/adjusted in retrospect.<\/p>\n

4. The Quest for Shari’ah-Compliant Benchmark Rates<\/h2>\n

To address the fixed nature of benchmark rates and in adherence to risk sharing, Shari’ah-compliant financial products can incorporate variable components in profit-and-loss distribution structures. Benchmarking could be done either on:<\/p>\n

    \n
  • Real Economy Based Macro Benchmark:<\/strong> e.g., Expected real GDP growth + expected inflation rate, growth rate as function of (fund demand\/fund supply) + premium, or the seasonally adjusted output price index<\/li>\n
  • Real Economy Based Micro Benchmark:<\/strong> rental rates from rental indices, asset price and commodity price indices, and\/or implied profit rate on commercial contracts<\/li>\n<\/ul>\n

    Collaboration with standard-setting bodies, such as AAOIFI, is vital in establishing benchmarks that adhere to Islamic finance principles. AAOIFI’s guidance can play a pivotal role in shaping the industry’s approach to interest-free benchmark rates.<\/p>\n

    5. Conclusion<\/h2>\n

    The ongoing efforts within the Islamic finance industry to develop Shari’ah-compliant benchmark rates reflect a commitment to ethical finance, transparency, and the core principles of Islamic finance. As collaborative initiatives gain momentum, the industry moves closer to establishing benchmark rates that not only align with Shari’ah principles but also contribute to the broader evolution of ethical financial practices on the global stage.<\/p>\n

    The journey towards a harmonious integration of Islamic principles and global financial standards requires strategic vision, persistence, and a collective commitment to preserving the authenticity and integrity of Islamic finance. The pursuit of an Islamic financial benchmark rate emerges not only as a necessity but as a catalyst for ensuring the continued growth, integrity, and global acceptance of Islamic finance.<\/p>","protected":false},"excerpt":{"rendered":"

    The transition from LIBOR to SOFR and SONIA presents a unique set of challenges for Islamic finance, given that these conventional benchmark rates carry interest-based components that raise Shari’ah compliance concerns.<\/p>","protected":false},"author":1,"featured_media":2179,"comment_status":"open","ping_status":"closed","template":"","meta":{"footnotes":""},"kh_category":[103,102],"kh_tag":[280,278,126,277,279,275,276],"kh_content_type":[105],"kh_audience":[112,113],"class_list":["post-2177","kh_article","type-kh_article","status-publish","has-post-thumbnail","hentry","kh_category-articles-blogs","kh_category-insights","kh_tag-benchmark-rates","kh_tag-benchmarking","kh_tag-islamic-finance","kh_tag-libor","kh_tag-shariah-compliance","kh_tag-sofr","kh_tag-sonia","kh_content_type-article","kh_audience-practitioners","kh_audience-researchers"],"_links":{"self":[{"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/kh_article\/2177","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/kh_article"}],"about":[{"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/types\/kh_article"}],"author":[{"embeddable":true,"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/comments?post=2177"}],"version-history":[{"count":1,"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/kh_article\/2177\/revisions"}],"predecessor-version":[{"id":2180,"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/kh_article\/2177\/revisions\/2180"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/media\/2179"}],"wp:attachment":[{"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/media?parent=2177"}],"wp:term":[{"taxonomy":"kh_category","embeddable":true,"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/kh_category?post=2177"},{"taxonomy":"kh_tag","embeddable":true,"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/kh_tag?post=2177"},{"taxonomy":"kh_content_type","embeddable":true,"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/kh_content_type?post=2177"},{"taxonomy":"kh_audience","embeddable":true,"href":"https:\/\/cis.aaoifi.com\/ar\/wp-json\/wp\/v2\/kh_audience?post=2177"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}