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Shariah governance Shariah

governance
practices at Islamic fund practices

management companies
Amiratul Nadiah Hasan, Aisyah Abdul-Rahman and Zaleha Yazid 309
Faculty of Economics and Management, The National University of Malaysia,
Bangi, Malaysia Received 23 March 2017
Revised 13 September 2017
29 October 2017
4 February 2018
19 March 2018
Abstract Accepted 16 April 2018
Purpose – The purpose of this paper is to explore the Shariah governance practices of Islamic fund
management companies (IFMCs) in Malaysia, with the principal goal of reviewing the need for a
comprehensive Shariah governance framework for the Islamic fund management industry.
Design/methodology/approach – The study was conducted using a qualitative approach via 14 semi-
structured interviews with three companies (i.e. Company A, Company B and Company C) involving face-to-
face interviews, telephone interviews and emails. Data from the interviews were recorded and later analysed
using content analysis.
Findings – The study finds that Shariah governance processes among the IFMC examined are well-
managed; and the current regulations issued by the regulators are sufficient to ensure the Shariah compliance
of Islamic fund management industry. In spite of the absence of a comprehensive Shariah governance
framework for the industry, most Shariah functions (i.e. Shariah risk management, Shariah review and
Shariah audit) are performed by the parent company, except for Shariah research. Nevertheless, Shariah
research is not an important function in Islamic fund management because the investment instruments are
generally selected from a predetermined list of Shariah-compliant investment options.
Practical implications – The study offers an overview of Shariah governance practices in the Islamic
fund management industry to policymakers and practitioners for the future development of Shariah
governance practices among IFMC.
Originality/value – This is the first paper to study Shariah governance practices in the Islamic fund
management industry in Malaysia.
Keywords Shariah governance, Islamic unit trust, Islamic fund management,
Corporate governance, Unit trust
Paper type Research paper

Introduction
The Islamic Financial Service Board (IFSB) Guiding Principles on Shariah Governance in
Islamic financial institutions (IFIs) (IFSB-10) defines a Shariah governance system as “A set
of institutional and organisational arrangements through which an institution offering
Islamic financial services (IIFS) ensures that there is effective independent oversight of
Shariah compliance [. . .]” [Islamic Financial Services Board (IFSB), 2009]; or may simply
refer to corporate governance affairs that are conducted in compliance with Islamic law

The authors gratefully acknowledge the financial support from the Centre for Research and Journal of Islamic Accounting and
Instrumentation Management (CRIM) of the National University of Malaysia under PNB-Yayasan Business Research
Vol. 11 No. 2, 2020
Tun Ismail (YTI) Grants (EP-2015-049). Besides, the authors are thankful to the team members of the pp. 309-325
PNB-YTI project, especially Prof Ben Jacobsen, the YTI-UKM Chairholder, for their helpful © Emerald Publishing Limited
1759-0817
comments and beneficial inputs during our group discussion. DOI 10.1108/JIABR-03-2017-0045
JIABR (Muneeza, 2014). In Malaysia, a structured and regularised practice of Shariah governance
11,2 has been developing in the Islamic banking and Takaful sectors, but not in the Islamic
capital market industry, which includes the Islamic fund management industry. In just
10 years, the total net asset value (NAV) of Islamic funds in Malaysia has increased from
RM8.5bn in 2005 to RM46.7bn in 2014; and Malaysia has become the largest Islamic fund
management centre in Asia (PricewaterhouseCoopers, 2009). In 2017, the Securities
310 Commission of Malaysia (SC) listed 36 fund management companies, and launched 644
funds, where 213 of them are Shariah-compliant investment funds. Total NAV of Shariah-
compliant funds as of 2017 is RM77.8bn (SC, 2017).
In spite of the tremendous growth of Islamic unit trust funds, a paucity of literature
exists that touches on the Shariah governance of Islamic unit trust funds. Kasim et al. (2013)
argue that all existing Shariah governance guidelines continue to focus on IFIs, such as
Islamic banks, Takaful and Retakaful operators. However, no specific Shariah governance
framework (SGF) exists for the Islamic capital market. Thus, in learning the importance of
good Shariah governance in the growing Islamic fund management industry, the present
research explores Shariah governance practices among Islamic fund management
companies (IFMCs) in Malaysia. The principal goals are to review Shariah governance
practices among IFMC, and determine whether a SGF is needed for the Islamic fund
management industry.
The present research is an exploratory study that analyses current practices by
interviewing several fund management companies. For each company, the researchers
interviewed personnel related to the management of the Islamic funds through face-to-face
interviews, telephone interviews and emails. Data from the interviews were recorded and
transcribed. The data were analysed using content analysis.
Islamic financial transactions are carried out in ways that do not conflict with the
conscience of Muslims and the religion of Islam. Shariah law, or Islamic religious law,
prescribes that the market should be free from activities prohibited by Islam, such as usury
(riba), gambling (maisir) and uncertainty (gharar). Additionally, Shariah-compliant finance
does not allow for speculation and prohibits financing of illicit activities (Beck et al., 2012).
Shariah-based unit trust funds or Islamic unit trust funds are defined as collective
investment funds that offer investors the opportunity to invest in a diversified portfolio of
Shariah-compliant securities that are managed by professional managers in accordance
with Shariah principles (Malaysia International Islamic Financial Centre, 2010). According
to SC, Islamic unit trust funds in Malaysia grew from just two Islamic unit trust funds
launched in 1993 to 188 funds in December 2014 (SC, 2015), which are managed by 29 fund
management companies. Among the categories of Islamic funds in Malaysia are equity
funds, sukuk (Islamic bond) funds, money market funds and balanced funds.
Similar to corporate governance, Shariah governance is a control system to ensure the
compliance with Shariah principles. This adds another responsibility to the board of
directors in IFIs to ensure that the whole Islamic finance industry is operating under the
guidance of Shariah (Kasim et al., 2013). Good corporate governance practices that comply
with Shariah guidance is crucial to sustain a well-functioning Islamic finance industry. The
objective of having such control is to ensure that the application and adherence to Shariah
principles are not compromised at any cost (Muneeza, 2014). Shariah governance becomes
more important as IFIs are exposed to additional risks, such as Shariah non-compliance risk
and the risks that depositors are exposed because of risk sharing, indicating that IFIs are in
dire need of a comprehensive governance structure (Chapra and Ahmed, 2002). A study by
Mersni and Ben Othman (2016) on 20 Islamic banks at Middle East countries emphasises the
importance of good corporate governance mechanism in financial reporting. The authors
find that the existence of an external sharia audit committee is a good way of preventing Shariah
earnings manipulation. Their results also show that Shariah supervisory boards with governance
smaller size and comprising scholars with accounting skills are found to be more effective.
Another recent study by Almutairi and Anwar Quttainah (2017), however, have a distinct
practices
finding. Its finding shows a positive relationship between size of Shariah supervisory board
and financial performance with regard to 82 Islamic banks sampled in 15 countries.
Nevertheless, both findings suggest the importance of a good corporate governance
311
mechanism.
At present, the Central Bank of Malaysia (CBM) and other international bodies, such as
the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and
the IFSB, have introduced SGFs, but these guidelines do not cater to the specific needs of the
Islamic capital market. The SC has provided guidelines for Islamic capital market products,
but a need continues to exist for a comprehensive SGF. By introducing the framework,
Kassim et al. (2013) believe that the framework would be able to overcome or at least
mitigate the issues faced by the Islamic capital market, such as Shariah non-compliant risk,
independence, conflict of interest and competency. Most of the literature concerning Islamic
unit trusts compare the performance of Islamic unit trusts with their conventional
counterparts, rather than focusing on the mechanisms and governance of Islamic unit trust
funds. Therefore, the present paper hopes to pioneer discussions regarding Shariah
governance practices in the Islamic fund management industry.
The study finds that Shariah governing processes among IFMC are well-managed and
the current regulations issued by the regulators are sufficient to ensure the compliance of
Islamic funds. In spite of the absence of a comprehensive SGF for the industry, most Shariah
functions (i.e. Shariah risk management, Shariah review and Shariah audit) are performed
by the parent company. However, Shariah research is not deemed to be an important
function in Islamic fund management because the investment instruments are generally
selected from a predetermined list of Shariah-compliant investment options. Because IFMCs
rely heavily on the guidelines and regulations of the SC, Malaysian regulatory bodies should
strengthen the enforcement and monitoring of the Shariah compliance of such companies.

Corporate governance from an Islamic perspective

The history of corporate governance in Islam can be traced back to the concept of hisbah,
which literally means “sum” or “reward.” In practice, hisbah was a state institution that
promoted proper conduct and sought to prevent all types of misdeeds or offences, with the
purpose of safeguarding the members of society from deviance; protecting their faith; and
ensuring the welfare of the people in both religious and worldly manners according to the
law of God (Saleh, 2009). At the time of Prophet Muhammad, the prophet appointed
individuals to perform the duty of maintaining the institution of hisbah, which was known
as muhtasib, where the duties of the muhtasib included controlling weights and measures;
preventing monopoly; and enjoining what was considered good and forbidding what was
considered evil. At the time of the four caliphates, the role of the muhtasib as a state
institution was expanded to include supervising the cleanliness of markets and mosques;
and monitoring civil servants to ensure compliance with Shariah law (Elsergany, 2010). The
hisbah system provides evidence that a governance system has long been embedded in
Islamic society. Islam encourages the use of an external governance system to ensure the
rights of all parties are protected; and to ensure that people act according to the law of God
in a manner similar to the way corporate governance frameworks act in contemporary
corporations.
JIABR Hasan (2009) classifies Islamic corporate governance into two models: the tawhid-based
11,2 approach and the stakeholders-based approach. Tawhid is defined as the oneness of Allah.
The tawhid-based approach has been discussed by Choudhury and Hoque (2006), where
they argue that tawhid should be used to develop the guiding rules of participation and
sharing in cost, profit and risk. Choudhury and Hoque (2006) propose two main institutions
in the process of corporate governance: a Shariah board and members of a Shura
312 (consultative participation), both of which are stakeholders in this context. While the
Shariah board ensures all corporate activities are consistent with Shariah, the members of
the Shura should have the objective of stimulating the social well-being instead of
maximising shareholder wealth. However, Hasan (2009) argues that the adaptation and
implementation of this approach is still unclear and finds that most IFIs tend to follow
conventional corporate governance models based on the episteme of rationality and
rationalism.
The second approach (i.e. the stakeholders-based approach) is highlighted by Iqbal and
Mirakhor (2004), who argue that the stakeholder theory of corporate governance is strongly
rooted in Islamic economic systems. The argument is based on two fundamental concepts of
Islamic economic system:
 the concept of property rights; and
 the contracts that govern the economic and social behaviour of individuals, society
and the state.

Based on the first principle, even though Islam recognises and acknowledges individual
rights, these rights are governed by a set of rules to protect the rights of the society and the
state. Thus, with regard to property rights, the private initiative and choice of an individual
or a corporation should not violate the rights and well-being of society. The second principle
(i.e. social and economic contracts) complements the first principle because of the emphasis
on the obligation to fulfil the rights of stakeholders bound by a contractual agreement,
irrespective of whether the contract is verbal or written; or formal or informal. In Islam, a
stakeholder is the one whose property rights are at stake or at risk because of voluntary or
involuntary actions of the firm (Iqbal and Mirakhor, 2004).
The basic concept of corporate governance does not differ much between the Islamic
approach and the conventional approach because both are inherently systems by which
companies are directed and controlled with the purpose of meeting the objectives of the
corporation. However, certain elements that are present in Islamic corporate governance
differ from their conventional counterparts. From the Islamic perspective, the central
concept that encompasses all aspects of life is tawhid or the unity of God (Mohamed Haneef,
1997). As Allah must be present constantly in a Muslim’s life, an Islamic corporation must
also regard Allah as its episteme, meaning that all activities performed by the entity should
be consistent with the will of Allah and the Maqasid Shariah should be the ultimate goal[1].
Another distinct feature is that Islam itself should be the most important stakeholder in an
Islamic corporation (Chapra and Ahmed, 2002). IFIs have the additional responsibility of
bringing the goodwill of Islam, because people will have the tendency to put the blame on
Islam if IFIs do not perform well. Islam places emphasis on being fair, honest and just
towards others. Such values should be upheld in any activities affecting stakeholders to
fulfil the Maqasid Shariah.
In an Islamic economic system, the interests of stakeholders may extend beyond
financial interests to ethical, religious and other values. Hence, it is important to ensure that
the rights of all stakeholders are respected. However, ensuring the rights of stakeholders are
protected is not simply the responsibility of the firm, but requires a moral consciousness and
commitment on the part of all the players of market. An enabling environment where society Shariah
is ethical and properly educated is another important aspect to ensure the effectiveness and governance
development of Shariah governance. Without social support, moral and legal norms hardly
can be effective (Chapra and Ahmed, 2002). We can conclude from the literatures that
practices
corporate governance in Islam is driven by faith-based rationalism along with social welfare
criterion (M. Larbsh, 2015). Faith-based rationalism serves as a guideline on how to perform
economic transactions within the framework of Islamic laws. In Islam, corporate governance
is geared towards protecting the rights of all stakeholders, including Islam, while at the 313
same time having the oneness of God, or tawhid, as its episteme, which determines how
business transaction are conducted. Last, but not least, another important role of corporate
governance from the Islamic perspective is to mitigate Shariah non-compliance risk by
placing emphasis on the important role of the Shariah supervisory board in every IFI.

Shariah governance practices in Malaysia

Malaysia is argued to favour a pro-active (Hasan, 2010) and regulation-based (Shaharuddin,
2011) approach. Proponents of this approach strongly believe that regulations are the key to
strengthening an SGF. Malaysia uses a centralised model with central financials authorities
(i.e. CBM and SC). The Shariah Advisory Council (SAC) of both the CBM and the SC provide
standards and rules concerning the conformity of products and activities of all the IFIs
under their respective purviews (Hamza, 2013). The centralised model has the advantage of
harmonising the divergent opinions of the Shariah boards between banks and regions,
which promotes consistency with regard to fatwas and interpretations. Grais and Pellegrini
(2006) argue that internal and external supervision can provide an effective framework to
monitor and assess Shariah compliance. Hamza (2013) also supports the finding and
believes that a centralised model could strengthen the position and independence of a
Shariah committee. The harmonisation of fatwas and interpretations could improve the
effectiveness and credibility of Islamic banks (Hamza, 2013). The internal Shariah
arrangement gives a sense of independency and flexibility to the company to design and
customise their Shariah compliant products while, at the same time, collaborating with
external supervisors to ensure whether their activities satisfy Shariah requirements.
The SGF 2011 issued by the CBM is the current framework to ensure that the overall
Islamic financial system operates in accordance with Shariah principles. However, this
guideline is only applicable to IFIs that are regulated by the CBM, such as Islamic banks,
Takaful and Retakaful operators. The framework adopts a two-tier Shariah governance
system composed of two vital components: the SAC at the CBM; and internal Shariah
committees formed by each IFI (Central Bank of Malaysia, 2011). A Shariah committee is a
key component of Shariah governance (Hasan, 2009), as such committees are charged with
the task of ensuring Shariah compliance (Grais and Pellegrini, 2006). Because of the
importance of the role played by Shariah committees, most extant literature focuses on the
roles and functions of such committees. In general, the main duty and responsibility of a
Shariah advisory body is to advise the IFIs on Shariah matters and to ensure that their
operations do not involve any elements that are prohibited by Islam. Shariah committees are
involved in three principal areas: issuance of fatwa, supervision and review (ISRA, 2011).
Another distinct element in the SGF by the CBM is that the Shariah compliance and
research functions are composed of review, audit, risk management and internal research
functions[2].
The new SGF issued by the CBM provides a robust foundation for the improvement of
the Islamic banking industry (Shaharuddin, 2011; Muhamad Sori et al., 2015). According to a
study by Muhamad Sori et al. (2015), exploring the effectiveness of the implementation of
JIABR SGF, the SGF is an important mechanism that provides assurance to the stakeholders that
11,2 the institutions conduct their operations in accordance with Shariah principles in the
interest of all stakeholders; and ensuring fairness through higher accountability and
transparency for the stakeholders. The study also suggests that the role of Shariah
committee could be enriched by putting the committee members in other boards, such as
risk management boards and audit boards. Placing members of a Shariah committee on
314 other boards and committees within a company could help facilitate a better understanding
of the vision and mission of the institutions, as well as the operations and the issues faced by
other boards, so that the Shariah committee can make more practical Shariah decisions.

Shariah governance in the Islamic capital market

While most of the literature concerning SGFs focus on Islamic banks and Takaful operators,
Kasim et al. (2013) argues few studies exist that examine Shariah governance in the Islamic
capital market. The SGFs issued by regulatory bodies (e.g. CBM, AAOIFI and IFSB) do not
yet address the specific needs of the Islamic capital market. As of now, the Islamic capital
market is supervised under the SC and its SAC has the responsibility to advise the SC on
Shariah matters relating to the Islamic capital market (SC, 2015). Since 1997, the SAC has
had the responsibility of determining which companies and stocks are Shariah-compliant.
At that time, the screening criteria only focus on the core business element that is prohibited
by the Shariah requirements (Abdullah Sani and Othman, 2013). The current screening
criteria have been strengthened by including both business activities benchmarks and
financial ratio benchmarks[3]. The whole capital market is guided by Capital Market Service
Act (CMSA) 2007. With regard to the Islamic capital market, the SC has issued guidelines to
regulate and guide the operations of the industry, such as the Guidelines on Islamic Fund
Management and the Guidelines on the Offering of Islamic Securities.
The Islamic capital market is important as it provides a platform for Shariah-compliant
investments for Islamic banks and Takaful operators, as well as for Muslim investors. One
of the differences between the Islamic capital market and its conventional counterparts is
that the investors in the Islamic capital market will not get a fixed rate of return, which
makes it important for firms in the Islamic capital market to ensure a good return for
investors while remaining Shariah-compliant. Otherwise, investors might withdraw from an
Islamic capital market (Kasim et al., 2013). The Islamic capital market has more pressures
and is exposed towards Shariah governance issues and additional risks such as Shariah
non-compliance risk, independence, conflict of interest and competency. Thus, a need exists
for a comprehensive SGF for the Islamic capital market that will at least mitigate the
challenges (i.e. ensuring good returns for investors and pressure from additional risks) faced
by the firms. The mitigation of such issues is important in supporting the development of an
Islamic capital market.
In Islamic unit trust management, Shariah non-compliance risk basically focuses on the
risk of securities which are initially classified as Shariah-compliant securities and later
reclassified as Shariah non-compliant. Rectification of the non-compliance (i.e. disposal of
the Shariah non-compliant securities in a fund’s portfolio) may result in losses if the disposal
of the Shariah non-compliant securities is at a price lower than the initial purchase price and
affect the NAV of a fund. Furthermore, risk may arise from the failure of the company to
comply with guidelines issued by regulators. In such an event, the penalty issued by the
regulators may not just hurt the company financially, but may also taint the reputation of
the Shariah status of the Islamic funds of the company and cause investors to lose
confidence.
 To guide Islamic fund management activities in Malaysia, the SC issued Guidelines on Shariah
Islamic Fund Management under the CMSA 2007. The guidelines emphasise the governance
appointment of a Shariah adviser. An Islamic fund manager must appoint either an
individual or a corporation as an independent Shariah adviser; or appoint an Islamic bank or
practices
an institution licensed and approved by the CBM to carry out Islamic banking business as their
Shariah adviser. The guidelines also detail the roles of the Shariah adviser, requirements
relating to employee competency and the general guidelines on portfolio management. In
addition, the guidelines stress the responsibility of the compliance officer to ensure the business 315
complies with the guidelines; and to report any breach to the Shariah adviser, the board of
directors of the company and the SC. However, the CMSA 2007 guidelines are not as
comprehensive as the SGF 2011 issued by the CBM. A comprehensive SGF for the Islamic
capital market is expected to enhance the confidence of the investors and stability in the
industry, thus boosting the market and economy as a whole. Therefore, after outlining the risks
faced by the Islamic fund management industry and the importance of a comprehensive SGF,
the need for such a framework for the Islamic fund management industry must be investigated.

Research methodology
This study is an exploratory study that attempts to explore Shariah governance practice in
IFMC in Malaysia. A qualitative approach is used and interviews were conducted with three
IFMCs or Islamic windows (i.e. Company A, Company B and Company C). The companies
are selected based on their different approaches to Shariah governance practices in relation
to the appointment of the Shariah adviser. Such companies have the option of appointing
individual Shariah advisers to establish an internal Shariah committee, appointing a
corporate Shariah adviser or appointing an Islamic bank as Shariah adviser.
The data for this study are based on 14 semi-structured interviews conducted with the
respondents through face-to-face interviews, telephone interviews and emails. Four
interviews were conducted in Company A; four interviews were conducted in Company B;
and six interviews were conducted in Company C. The interviews were conducted with top
management related to the Shariah-compliant practice of the respective companies (e.g. head
of compliance unit; head of Islamic business operation division; and head of business
strategy and marketing support department). In addition, brochures, websites and
prospectuses were also examined to gain background information pertaining to the
companies, such as funds information, financial performance and Shariah adviser profiles.
The interviews were then transcribed and analysed. The analysis was conducted using
content analysis. Hsieh and Shannon (2005) define content analysis as “a research method
for the subjective interpretation of the content of text data through the systematic
classification process of coding and identifying themes or patterns.” In this study, the data
from the interviews and other sources such as websites and prospectus were categorised
according to the differing practices identified from the interview data, relating to Shariah
governance among the companies. This step was known as pattern coding, where data were
summarised into segments. Pattern coding is important as it chunks large amount of data
into smaller number of analytic units and it helps the researcher to get into analysis during
data collection so that the fieldwork could be more focused (Miles and Huberman, 1994). The
summary of all responses to the interview questions was divided into subsections as
presented in the next section.

Findings
Company A is a subsidiary of one of the largest investment institutions in Malaysia. The
company is an Islamic window that offers both conventional and Shariah-compliant funds.
JIABR The internal Shariah committee of Company A was established by appointing a few
11,2 registered individual Shariah advisers to oversee Shariah matters pertaining to the Islamic
funds. Mr X, who is the head of business strategy and marketing support department, was
interviewed.
Company B is an Islamic fund management company and all of its operations and
products are Shariah-compliant. Company B is also licensed under CMSA 2007 as an Islamic
316 Fund Management Company and is a wholly owned subsidiary of an investment and asset
management company. Company B appoints corporate Shariah advisers to monitor both the
company and the funds. Ms Y, an executive from the compliance unit, was interviewed.
Finally, Company C is a subsidiary of a banking group. Because Company C is a part of a
banking group, the entity appointed as Shariah adviser for the funds is the Islamic Bank
which is a member of the banking group. Miss Z, the head of Islamic business operation
division, was interviewed.
Question 1: How does the company manage the Islamic funds in terms of guidelines,
Shariah adviser and Shariah governing units?
In Malaysia, IFMCs must be licensed by the SC. Therefore, all three companies examined
must observe the acts and guidelines issued by the SC, including the CMSA 2007, the
Guidelines on Unit Trust Funds, the Guidelines on Islamic Fund Management, the Licensing
Handbook and the Guidelines on Compliance Function for Fund Managers. As members of
Federation of Investment Managers Malaysia (FIMM), they must also observe the
guidelines and regulations issued by the FIMM.
All interviewees of the three companies stated that the each of the companies has their
own internal guidelines:
In relation to internal guidelines or policies, we established product approval process for
developing Shariah Funds to ensure that our funds are complied with the Shariah requirements.
Meanwhile for fund management activities, we outsourced the fund management activity to the
external investment managers as to manage our funds. Our company is leveraging on the
strength of the fund manager on the niche that they are better off. This include our Islamic funds
(Mr X, Company A).
Meanwhile, Company B has standard operating procedures that act as its internal
guidelines. The internal guidelines are based on the guidelines issued by SC and adapted to
the company operating system. While Company C stated that internal guidelines existed, no
further explanation was provided.
The main difference in the Shariah governance of the Islamic funds between the three
companies relates to the appointment of the Shariah adviser as required under the
guidelines provided under CMSA 2007. Company A established its own internal Shariah
committee composed of registered individual Shariah advisers and the appointment of the
committee members is based on the requirements stipulated in the Guidelines on Islamic
Fund Management and Registration of Shariah Advisers Guidelines.
Ms Y from Company B explains:
As an Islamic fund management company, company B appoints two different corporate Shariah
advisers; for the company and for the funds. Shariah adviser for the company will advise mainly
on the management of the company while Shariah adviser for the funds will advise on matters
pertaining to the funds only. These corporate Shariah advisers must be in the List of Registered
Shariah Advisers by the SC.
Because Company C operated within a banking group, the Shariah adviser function is
outsourced to the Islamic bank in the group. The Islamic bank is licensed under the Islamic
Financial Services Act 2013 and is an approved Shariah adviser by the SC to advise on
sukuk issuance, Islamic investment funds and all other approved Islamic capital market Shariah
instruments. The Shariah committee of the Islamic bank oversees all Islamic operations for governance
that banking group, including Company C. The committee members are Islamic scholars of
the industry and they are external members and independent to Company C. The
practices
appointment of the Shariah committee members complies with the SGF issued by the CBM.
The roles of the Shariah advisers in all companies are similar to the roles listed in the
guidelines.
With regard to Shariah governing units, information gathered during the interviews 317
indicates that no other Shariah-dedicated units exist within the three companies itself.
Instead, the companies rely on the shared resources of the group or parent company.
Because Company A and Company B are small companies, they delegated the risk
management, compliance and internal audit functions to their parent company under the
shared services of the group. As Company C operates within a banking group, it relies on the
shared resources of the group for Shariah audit, Shariah review and Shariah risk
management function. The role of each of the units is exactly as stipulated in the SGF issued
by the CBM.
Question 2: What is the process of developing and approving the Islamic funds?
The respondents agreed that the process of developing an Islamic fund is similar to
conventional fund with the exception of the Shariah requirements that must be met. In the
process of developing the Islamic funds, the company must ensure that every investment, as
well as the management of the funds generally, complies with Islamic principles enshrined
in the regulations from the relevant authorities. Additionally, they must ensure that the
documents drafted adhere to the requirements of Shariah principles in terms of the Shariah
screening methodology and Shariah terminology used under the purview of the SC and
other relevant regulators, if any.
Both conventional and Islamic funds must go through two stages of approval: internal
and external. However, Islamic funds require an additional internal approval from the
Shariah adviser of the fund alongside with the approval from management and the
directors. The fund proposal must be presented to the Shariah adviser to be reviewed
concerning Shariah compliance. External approval from the SC is required before launching
the funds. An application must be made to the SC, which includes the submission of various
forms and checklists by the company after obtaining all internal approvals.
Question 3: What is the internal monitoring process by the company to ensure that the
funds are Shariah-compliant at all time?
Each of the respondents reiterated that Islamic funds were invested in activities and
instruments that are allowed under Shariah Principles. No investments were made in
relation to activities and instruments prohibited by Shariah Principles based on the
parameters established by the SAC of the SC and the Shariah committee of the Funds.
All Shariah equity funds were invested based on the list of Shariah-compliant securities
issued by the SAC of the SC twice a year (i.e. May and November). In the case of companies
issuing Initial Public Offerings (IPOs) whose Shariah status has not yet been determined by
the SAC of the SC, all respondents agreed that their Shariah advisers adopt the Shariah
screening methodology of the SC as a temporary measure in determining its interim Shariah
status until the SAC makes a final determination of the Shariah status of the respective
companies. As for Shariah-compliant money market instruments, Company A explains that
the Shariah committee reviews any Shariah-compliant money market instruments to be
invested by the funds based on the data available at Bond Info Hub (www.bondinfo.bnm.
gov.my) and the Fully Automated System for Issuing/Tendering (www.fast.bnm.gov.my).
The other respondents state that the funds must be placed in Shariah-compliant institutions
JIABR and it is critical to not be involved with conventional financial institutions. As for sukuk
11,2 (Islamic bond), the companies will only invest in sukuk approved by the SC.
The Shariah adviser will monitor the Shariah compliance of investments from time to
time to ensure that the funds maintain their Shariah-compliant status. The Shariah
committee of Company A and the Shariah adviser of Company B attend formal meetings at
least once every three months to review the compliance of funds with Shariah principles.
318 Meanwhile, in Company C, the Shariah adviser of the group holds a meeting at least once
every two months to discuss any Shariah issues that may arise from the operations of the
group that include the Islamic funds. The Shariah adviser screens the Shariah status of the
investments on monthly basis and, if there is any status change, they will immediately
inform the fund managers in Company C to take necessary steps to ensure the Shariah
compliance of the funds. The Shariah advisers of each company set investment guidelines in
compliance with Shariah principles and monitor the funds’ activities to ensure adherence to
the above guidelines. The Shariah advisers are also required to present a report in the
manager’s annual and interim report in addition to reviewing the compliance and
transactions report to ensure investments are consistent with Shariah principles.
The compliance officer, as required in the Guidelines on Islamic Fund Management,
plays an important role in ensuring that the company and its funds comply with Shariah
regulations and guidelines. In addition to the Shariah adviser, the compliance department
also shares the responsibility to ensure the business complies with Shariah principles and
guidelines. The compliance function is involved with the funds before and after they are
launched. In Company B, it was explained that the compliance department examines the
funds’ investments on a weekly basis to ensure that the investments are in accordance with
Shariah principles based on the Shariah parameters of SC and with the investment strategy
promised in the funds’ profile.
Question 4: What is the external monitoring process by the regulator, i.e. the SC?
Company B explained that the monitoring performed by the SC as the regulator is
primarily accomplished through periodical reports submitted by the company to the SC.
Company C also explained that the company will submit a compliance report every month to
the SC. From the report, the SC will supervise the compliance of the funds and, if there is any
breach or non-compliance issue, the SC will detect compliance issues based upon the reports.
From the interviews, it is understood that the SC rarely performs physical audits at a
company and, if it does, the SC audits all operations of the company, not simply Shariah-
compliance matters. The interviewee also indicated that the SAC at the SC releases public
documents, such as guidelines and resolutions on Shariah matters, but no follow-up
inspection is performed, aside from the monitoring on the reports submitted by the company
and the Shariah adviser. It can be deduced that the SC heavily relies on the compliance
department of companies to ensure the operations and the funds of the company are in
accordance with the regulations and guidelines.
In terms of the rectification process in the event of Shariah violations in relation to
investments, all companies follow the guidelines issued by the SC. Based upon the
guidelines, two types of violations of Shariah-compliant investment status were found:
wrong investment and reclassification of Shariah status. Wrong investment refers to a
Shariah non-compliant investment inadvertently made by the manager. The said
investment will be disposed/withdrawn with immediate effect. Any revenue gained in the
form of capital gains or dividends received during or after the disposal of the investment is
to be channelled to Baitulmal or any other charitable bodies as advised by the Shariah
committee. If the disposal of the investment results in loss to the fund, the loss is to be borne
by the company.
 Reclassification of Shariah status, on the other hand, refers to equities which were Shariah
initially classified as Shariah-compliant equities that are subsequently reclassified as governance
Shariah non-compliant because of emerging issues, such as changes in the companies’
operations. If at the time the announcement is made, the value of the equities held exceeds
practices
the original investment cost, such non-compliant equities will be liquidated. Any capital
gains arising from the liquidation of the non-compliant equities made at the time of the
announcement could be kept. However, any excess capital gains made from the disposal
after the announcement day will be channelled to Baitulmal or any other charitable bodies
319
as advised by the Shariah committee. If the market price of the said equities is below the
original investment cost, the fund may hold the non-compliant equities and keep the
dividends received during the holding period until such time that the total amount of
dividends received and the market value of the non-compliant equities held equal the
original investment cost. At this stage, the fund will dispose of such equities.
Regarding the action from the SC if the company fails to rectify the situation, the
respondents from Company A, Company B and Company C stated that, so far, their companies
have observed all the guidelines issued by the SC pertaining to Shariah fund offerings. If stock
is held that is being reclassified as non-Shariah-compliant stock, the fund manager will follow
the rectification process as required by the SC. The company will ensure that this exercise is
done in a timely and correct manner. All of the companies are fully aware that any breach of
the Shariah screening methodology will have severe impacts on the company in relation to
reputational risks, because investors will lose confidence in their ability of the company to
manage Shariah funds. Furthermore, the companies diligently monitor their activities to ensure
compliance with mandatory guidelines of the SC because of the risk of incurring severe
penalties if the regulations are determined to have been breached.
Question 5: In your opinion, is there any need for Shariah-related units and Shariah
governance framework for IFMC?
Company A, Company B and Company C agreed that no need exists for dedicated
Shariah-related units and that they can generally operate without them:
In our opinion, the company can operate generally without any dedicated Shariah Related Units in
place, but such company needs to have an effective governing process and escalation procedure
and monitoring the latest development of Shariah Practice in Malaysia, like what the company
has been doing. At a certain degree, we can safely assure that the company is in good shape in
governing their business activities and observing the Shariah Guidelines. Furthermore, for any
Shariah Compliant Funds, each Fund will have a dedicated Shariah Committee to ensure that the
fund is managed and administered in accordance with Shariah Principles (Mr X, Company A).
Company B is an Islamic fund management company by licensed by the SC. Its operations and
investment activities are Shariah-compliant. Our audit, compliance and risk management operate
within the Shariah principles and parameters. As such, there is no need for a unit or units
specifically looking into its Shariah status. Unlike fund management companies who operates
under both conventional and Islamic investment regimes, such units may be required for them, to
ascertain that the operations or investments under the Islamic investment regime comply with the
Shariah principles and/or requirements (Ms Y, Company B).
In my opinion, presently there is no urgent need to have dedicated Shariah related units within
our company set up. Within the company, all these Shariah related units have been established at
the Group level and the mandate given to these units is extended to cover Company C as well. As
for other non-bank backed Islamic asset management company, I do believe there should be some
form of personnel specialization to cater for Shariah related matter but not to the extend of
establishing a dedicated Shariah related units where different personnel shall be employed to look
after Shariah Audit or Shariah Risk Management or Shariah Review (Ms Z, Company C).
JIABR Ms Z added that dedicated Shariah-related units are unnecessary because the products and
11,2 operations of a fund management company are less diverse when compared to Islamic
banks or Takaful. For example, it is sufficient to have a dedicated Shariah officer looking
after Shariah matters and acting as liaison with the Shariah adviser. Meanwhile, the actual
audit, review and risk management functions can still be performed by the existing team.
However, a comprehensive set of internal guidelines and standard operating procedures
320 must be established for the relevant general functions to monitor Islamic operations. For
example, the existing audit guidelines and standard operating procedures should be
extended to cover audit activities for Islamic funds, which can assist the existing audit team
to perform the Shariah-related audit.
Regarding the need of a comprehensive SGF, the respondents have different opinions on
the issue. The respondents from Company A believe that a need exists to have a
comprehensive SGF in place to govern Islamic capital market activities in Malaysia.
Mr X from Company A explains:
Shariah governance framework will bring into focus the measures that need to be taken by all
the market players in order to strengthen the regulated activities of Islamic capital market in
Malaysia. In addition, Shariah governance framework will improve the Islamic Shariah
capital market images and build brands in the Islamic Market space globally. Shariah
governance framework will further regulate the conducts of Islamic Capital Market Players,
thus enhancing the investors’ confidence and bring the stability towards our Islamic Capital
Markets. Eventually a proper governance practice will boost the market activities and bring
about a positive spill over effect towards the economy growth. Additionally, since Shariah
governance framework bring more transparency and efficiency to the markets, when it comes
to the social life, the impact is that it will bring betterment to all human being where it grants
fairness and justice to all affected parties. This will eventually improve the operational
performances of corporations and the relationship with stakeholders and ultimately
attracting more participation of investors.
Meanwhile, Company B and Company C believe that a proper SGF for the Islamic fund
management industry seems to be unnecessary for the time being.
It is wonderful, but not necessary, to have Shariah Governance Frameworks for IFMC. To be
qualified as an Islamic fund management company, its establishment objective, structure and
whole operations must be in line with the Shariah principles. There are adequate guidelines
issued by the authority body governing the matter. The Islamic investment instruments offered
currently are mostly straight forward. For equity market, the stocks have been classified by the
Shariah Advisory Council of the SC as either Shariah-compliant or non Shariah-compliant.
Similarly to debt securities, it is either sukuk or bond. Same goes to money market instruments
where it is apparent whether it’s Shariah-compliant or otherwise (Ms Y, Company B).
In my opinion, for Company C or other unit trust management company operated within a
banking group that have Islamic banks, there is no requirement for a separate Shariah
Governance Framework as the existing one issued by the CBM would have been sufficient.
The existing SGF issued by the CBM have covered all Shariah based operations within the
Group including fund management activities. Additionally, I also believe that at the present
time, there is no urgent need for fund management industries as a whole to have a proper
SGF similar to the one issued by the CBM. This is because the products and operations of
fund management company are less diverse compared to Islamic banks or Takaful. It is a
more direct agency arrangement (Wakalah) where the Shariah focus is more on the
investment activities. Hence, the existing regulations issued by Securities Commission
Malaysia would have been sufficient to ensure proper governance from the Shariah
perspective (Ms Z, Company C) (Table I).
 Company A Company B Company C
Shariah
governance
Shariah Individual Shariah advisers Corporate Shariah Islamic Bank as Shariah practices
adviser Sets up its own internal Shariah advisers adviser
committee comprising Appoint two corporate Outsource to the Islamic bank
registered individual Shariah Shariah advisers; for in the group that is licensed
advisers the company and for under the IFSA 2013 and is an
The appointment of the the funds approved Shariah adviser by 321
committee members is based on Shariah advisers must the SC
the requirements stipulated in be in the List of Following the BNM SGF for
the Guidelines on Islamic Fund Registered Shariah the Shariah committee
Management and Registration advisers by the SC requirements
Availability of No other Shariah-specific units in the company Relies on the shared services
Shariah units Delegated the risk management, compliance and internal of the group for Shariah audit,
audit functions to their parent company under the shared Shariah review and Shariah
services of the group risk Management function.
Process of Similar to conventional fund with the exception of the Shariah requirements that must be
Islamic funds met
development Two stage of approvals: internal and external. Islamic funds require an additional internal
and approval approval from the Shariah adviser of the fund alongside with the approval from
management and the directors. External approval from the SC is required before
launching the funds
Internal Investment portfolios: ensure that all portfolios are Shariah-complied based on the
monitoring guidelines and resolutions issued by SC and BNM
process Compliance officer to ensure that the company and its funds comply with Shariah
regulations and guidelines
Internal Roles as per Guidelines on Islamic Fund Management Roles as per BNM’s Shariah
monitoring Meets at least once every three months (four times a year) governance framework
process – Meet at least once in every
Shariah two months and screen the
adviser Shariah status monthly
External The monitoring performed by the SC is primarily accomplished through periodical reports
monitoring submitted by the company to the SC
process (by SC) The SC rarely performs physical audits at a company, especially on Shariah compliance
The SC heavily relies on the compliance department of companies to ensure the operations
and the funds of the company are in accordance with the regulations and guidelines
Need of other No need exists for dedicated Shariah-related units and that they can generally operate
Shariah- without them
dedicated units
Need for a There is a need for a proper Believe that a proper Shariah governance framework
proper Shariah Shariah governance framework for the Islamic fund management industry seems to be
governance It will bring into focus the unnecessary for the time being
framework measures that need to be taken There are adequate guidelines issued by the authority
by all the market players to body governing the matter
strengthen the regulated The products and operations of fund management
activities of Islamic capital company are less diverse compared to Islamic banks or
market in Malaysia Takaful. It is a more direct agency arrangement
Could improve the Islamic (Wakalah) where the Shariah focus is more on the
Shariah capital market images investment activities
and build brands in the Islamic Table I.
market space globally, besides Summary of
bringing more transparency interviewee
and efficiency to the markets responses
JIABR Discussion
11,2 Good corporate governance practice that complies with Shariah guidance is crucial to
sustain a well-functioning Islamic finance industry. Shariah governance becomes more
important as IFIs are exposed to the additional risk of Shariah non-compliance. In Islamic
unit trust management, the Shariah non-compliance risk basically focuses on the risk of
securities that were initially classified as Shariah-compliant securities and later reclassified
322 as Shariah non-compliant. Rectification of non-compliant securities in a fund’s portfolio may
result in financial loss. Failure to comply with the guidelines may also cause reputational
loss. Realising the importance of good practice associated with Shariah governance to
ensure the Shariah compliance of Islamic products, this study selected the Islamic fund
management industry to review the Shariah governance practices in this sector. The
findings are presented based on Shariah governance practices in three IFMCs distinguished
by the appointment of the Shariah adviser (i.e. appointing an individual Shariah adviser,
appointing a corporate Shariah adviser or appointing an Islamic bank as the Shariah
adviser).
Based upon the interviews with the representatives of the companies, the management of
the Islamic funds does not appear to vary much when compared against conventional funds,
except that the management of Islamic funds should be in accordance with Shariah
principles and the Islamic funds should only be invested in Shariah-compliant investments.
All companies rely primarily on the decisions of regulators, such as the SC and the CBM,
when determining the Shariah status of the investment. Based on the discussions with the
respondents, the Shariah governance process in IFMC is found to be adequate and the
current regulations issued by the regulators are sufficient to ensure the compliance of
Islamic funds. All respondents are confident with the current practices of their companies to
ensure the Shariah compliance of their Islamic funds. Most of the IFMCs in Malaysia are
subsidiaries of financial institutions groups. Thus, functions, such as compliance, audit and
risk management, are shared with the parent company and other subsidiaries in the group.
With regard to sharing the responsibilities of ensuring the Shariah compliance of Islamic
fund management, the respondents believe that they are well-equipped to handle such
functions and, as a result, dedicated Shariah units in the IFMC are unnecessary for the time
being.
Furthermore, it is also found that a comprehensive SGF for the Islamic fund management
industry is unnecessary as the current guidelines are adequate to ensure the Shariah
compliance of the funds. Existing Islamic fund products are straightforward because they
rely primarily upon the decisions of regulators regarding the Shariah status of investment
options. The contract underlying the Islamic funds is a more direct agency arrangement
(wakalah) where the Shariah focus is more on the investment activities. In spite of the
absence of a comprehensive SGF for the industry, in practice, all Shariah functions are
performed by the parent company, except for Shariah research. Shariah research functions
are not performed by either the company or the parent company. However, Shariah research
is not an important function in Islamic fund management because the investment
instruments are generally selected from a predetermined list of Shariah-compliant
investment options provided by regulators.
Even though the current Shariah governance practices among IFMCs appear to be well-
managed, the Malaysian regulator bodies, specifically the SC, need to strengthen their
supervisory functions. Because the IFMCs rely heavily on the guidelines and regulations of
the SC, improvements could be made in relation to monitoring as well as the development of
comprehensive guidelines. Supervisory actions, such as physical visit to the IFMC, should
be performed more frequently alongside the compliance reports submitted to the SC by the Shariah
IFMC. governance
The responsibility to promote good Shariah governance practices does not rest
solely with the regulators or management. Rather, it involves all players in the
practices
industries, including shareholders, employees and investors. It is also important for
them to realise that the first and utmost responsibility to comply with Shariah is to
Allah – not to the regulators, the management or the customers. The strong sense of
accountability to Allah and to Islam strengthens ethics and good conduct, including
323
justice, transparency and competency. After all, Shariah governance should go beyond
complying with the regulators’ regulations, but rather to uphold the Maqasid Shariah
of protecting the rights of the society.
This study is able to pioneer more discussions on Shariah governance in Islamic fund
management industry. From the interview sessions, the respondents shared some
suggestions which can be adopted to strengthen the Shariah governance mechanism in the
industry. The suggestions include improvement through training and knowledge and
improvement in standard operation procedures and internal guidelines. As for the
contribution to the society, this study aims to educate public about the measures taken to
ensure the Shariah compliance of Islamic unit trusts, especially to the investors and future
investors.

Notes
1. Maqasid Shariah (objective of Shariah) explains “the wisdoms behind rulings” (Auda, 2008). The
objectives are classified into three levels of importance which are necessities (daruriyat), needs
(hajiyaat) and luxuries (tahsiniyyat). Necessities objective is further classified into preserving
one’s faith, life, intellect, property and lineage. Ibn Ashur (1907) explains in his book “Treaties on
Maqasid al-Shariah” one of the higher objectives of Shariah is to preserve social order of the
community, which can be achieved by blocking the sources of discord and aggression.
2. Refer to Shariah Governance Framework Model (The Central Bank of Malaysia, 2011).
3. Refer to www.sc.com.my/frequently-asked-questions-on-revised-Shariah-screening-methodology/

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Corresponding author
Amiratul Nadiah Hasan can be contacted at: amiratulnadiah@gmail.com

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