Legal Risks and Good Governance for the
Growing Islamic Finance Industry
Hamid Yunis
Partner
Karachi
December 2006
Contents
1.
Fundamentals of Islamic (Shariah Compliant) Finance
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2.
Overview of Islamic Finance Market
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3.
4.
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Background
Products and processes
Regulator/operator issues
Specific issues
International Guidance
Basel
IFSB Standards
General Principles
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6.
Types of Islamic Finance Products
Basic Assumptions
Additional Matters
Use of Islamic Finance in Different Market Sectors
Governance
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5.
Basic requirements and philosophy
Non executive functions
Conclusion
1
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Fundamentals Islamic (Shariah) Finance:
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Quranic (Shariah Law) principles;
Riba (“interest/unjustified rewards/unlawful gain”);
Gharrar (“uncertainty, risk, speculation”);
Halal (“religiously permissible”);
Haram (“not religiously permissible”);
Qard Hasan – (“good loan”);
Al-Wadia – (“safekeeping”).
2
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Basic Requirements and Philosophy
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true risk sharing;
no exploitation of a weaker position;
not socially unproductive;
not economically wasteful;
promotes economic and social development; and
charitable (“zakat”).
3
Overview of Islamic Finance Market
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Islamic and Dual Banking Systems
Retail Islamic finance products offered for a number of years,
some low key e.g. Middle Eastern banks, others high profile
e.g. HSBC
Islamic Windows in major Global Banks
Islamic Bank of Britain
Primary Market: initially basic finance products
Compatibility with conventional products
4
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Types of Islamic Finance Products:
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Equity;
Trade Financing;
Asset Financing
Lending;
Wholesale & Retail Products:
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loans;
partnership investments;
forex;
fund transfers;
letters of credit;
securities safe keeping;
investment management and device;
5
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Islamic Finance (Cont’d):
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Al-Wadia (safekeeping): usually not remunerated;
Takaful (Insurance);
Funds Work;
SUKUK/Securitisation (Capital & Secondary Markets); and
Derivatives/Funds Management.
6
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Basic Assumptions
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Underlying asset must be acceptable
 Different interpretations on what proportion of asset must not be
“haraam”
Proposed structure of transaction has to be acceptable
No prohibited activities (proportionate approach)
Need to account for regulatory requirements and comply with two sets
of law (Shariah and law of country)
7
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Additional Matters
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Zakat (specified amounts to be allocated from disposable income);
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Shariah Boards – competition, pragmatic approaches;
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Urf (custom);
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Darura (overriding necessity);
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Maslaha (general interest to justify);
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Hiyal (ruse)
8
Use of Islamic Finance in Different Market
Sectors
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Real Estate
Project Financing
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Co-financings (Power, LNG, Oil & Gas)
Retail Banking
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Depositors
 Investment Account Holders
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General Leasing
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Ijara
Asset Finance
Bond (SUKUK) Issuance
Private Equity Funds
Insurance (Takaful)
Capital Markets (Sukuk/Arboun/Salaam)
9
Governance
Background
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Developing, structuring and marketing Shariah compliant
financial products can be cumbersome and complex
IIFS needs to account for regulatory requirements and
comply with two sets of jurisprudence/law (Shariah and the
law and regulations of relevant jurisdiction)
10
Products and Processes
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Products and Processes need to be effective from the
following viewpoints:
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Understandable
Competitively priced
Tax effective
Available and transparent
Not administratively burdensome
Not “alien” to regulatory requirements
Governance of institution offering Islamic financial services
needs to be the same
11
Regulator/Operator Issues
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Scope for the continuing development of good corporate
governance in the field of Islamic finance
No inconsistency with Shariah
12
Specific Issues
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Islamic finance industry needs to, in particular, focus on
issues regulators will be concerned with
Remember that Shariah-compliance will not normally be an
issue for non-Islamic countries or where Shariah is not part
of a general legal framework
Shariah Supervisory Board presence and scrutiny therefore
essential
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Specific Issues (cont…)
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Islamic finance industry regulators need to consider
regulation of Shariah Supervisory Board
Islamic financing industry need for a unified front to
regulators
Standardisation of models used, terminology and treatment
Dissemination of codes of best practice
Practical Adaptability
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Guidance
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Many forms of International and National Guidance available
OECD principles
UK Stock Exchange Combined Code
 Cadbury Report
 Hempel Report
 Higgs Report
15
Guidance (cont…)
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France/Germany: different forms of governance models
US: Sarbannes-Oxley
Other/Corporate Governance Standards
 Country Specific
 Accounting and Industry Specific
IFSB guidance
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Principles outlined
“Comply or Explain”
16
Basel
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Basel Committee on Banking Supervision
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1999 paper
2006 paper
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General Principles
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Establish Good Governance Policy as a principle of Shariah
Monitoring and work of
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Board Committees
Executive Management
Shariah Supervisory Board
Internal and external auditors
Different Stakeholders
Mechanisms of balancing the roles of different stakeholders
i.e.) shareholders, management, IAHs
18
Non Executive Functions
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Role of non-executive directors/managers
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Guidance
Oversight
Compliance issues
Future compliance policy
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Contact:
HAMID YUNIS
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