Shariah Governance in Financial Institution

Durham
Islamic Finance Autumn School

2011 in Istanbul
Shariah Governance
in Financial Ins@tu@ons

Mohammad Farrukh Raza
Managing Director – IFAAS (UK, France & Bahrain)

Presented at the

Durham Islamic Finance Autumn School 2011
jointly organised by
Durham Centre for Islamic Economics and Finance and
ISAR-‐Istanbul Foundation for Research and Education
Istanbul Commerce University, Istanbul
19th-‐22nd September 2011
© 2© 011
2009 IIFAAS
FAAS. All All rights
UK Ltd. reserved.
rights reserved.
TABLE OF CONTENTS

§ Shariah and financial ins@tu@ons
Ø Types of Islamic financial ins@tu@ons
Ø Dual Governance model
§ Shariah Supervisory CommiOee “SSC”/Shariah Board
Ø Defini@on
Ø Composi@on, selec@on and dismissal
Ø Morals and requirements
Ø Roles and Responsibili@es
Ø Example of SSC at work
Ø SSC mee@ngs
Ø SSC terms of reference, powers and authori@es
Ø Year End SSC Shariah report
§ The role of Shariah Compliance Officer (SCO)
§ Standardiza@on in Islamic Finance
§ Shariah Standards (AAOIFI)
§ Controversies & Challenges in Shariah governance
Mohammad Farrukh Raza, Shariah

Governance in Financial Ins@tu@ons 1
Durham Islamic Finance Autumn School
2011 in Istanbul
ABOUT US
IFFAS UK
IFAAS France
IFAAS Bahrain
IFAAS Offices
IFAAS Projects
Government of Senegal
SHARIAH AND FINANCIAL INSTITUTIONS

§ Islamic financial products have similar objec@ves as
conven@onal products – fulfilling the needs of customers but
in a Shariah compliant way
§ Islamic products and the ins@tu@ons providing them are
subject to conformity with the requirements of Shariah
§ The financial ins@tu@ons providing Islamic products have to
conform to both – regulatory and Shariah requirements that
vary for different types of the ins@tu@ons

2011 in Istanbul
TYPES OF ISLAMIC FINANCIAL INSTITUTIONS

§ Windows model – conven@onal ins@tu@on carrying out
Islamic financial transac@ons which are segregated from the
other ac@vi@es
§ Branches – dedicated delivery channel just providing Islamic
financial services
§ Subsidiaries – separate legal en@ty owned by a parent
company to specifically undertake Islamic financial ac@vi@es
§ Stand alone – totally independent structure

SHARIAH REQUIREMENTS FOR FI’S

§ Islamic window of conven@onal ins@tu@on
Ø Segrega@on of funds
Ø No separate balance sheet required
§ Islamic subsidiary of financial ins@tu@on
Ø Clean funds (may be provided by the mother company)
Ø Separate balance sheet required (may be incorporated into the group
balance sheet)
§ Fully-‐fledged Islamic financial ins@tu@on
Ø Shariah fully embedded in the governance model of the FI
§ All models need a Shariah Board/Shariah Supervisory
CommiOee (SSC) to supervise the Shariah compliance
§ All models operate on dual governance structures

2011 in Istanbul
DUAL GOVERNANCE MODEL

Shariah Framework Regulatory framework
“SSB/SSC” “NaJonal Regulator”
e.g. BDDK, CMB etc
Shariah Sales Policy Trea@ng Customers Fairly

Ethical Trading Transparency
Profit sharing Risk control
Fairness Social responsibility
Mutual coopera@on Money laundering
Social responsibility Know Your Customer
Profit distribu@on
Islamic Bank
DUAL GOVERNANCE MODEL

There is a lot of similarity between regulatory and Shariah
requirements
§ Capital adequacy (Shariah does not define any monetary
adequacy but requires the ins@tu@on to fulfill its promises and
obliga@ons on assets and liabili@es sides)
§ TreaJng Customers Fairly (The ins@tu@on is required to ensure
that the product is designed and implemented according to the
needs of the customer and is not being miss-‐sold)
§ Disclosures (The ins@tu@on has to ensure that all systems are
working correctly and no misrepresenta@ons are being made)
§ Data ProtecJon (The ins@tu@on is bound to preserve the privacy
and confiden@ality of the customer’s personal informa@on)

2011 in Istanbul
ISLAMIC BANK -‐ CORPORATE STRUCTURE

Nomina@ons
Shariah CommiOee
Supervisory
Board of
CommiOee Directors
Remunera@ons
CommiOee
Shariah guidelines
Audit
Managing CommiOee
Shariah Director
Compliance
Officer
Marke@ng Finance Internal

Opera@ons Sales Audit
IT HR
SSC -‐ DEFINITION

§ The SSC is an independent regulatory body of specialised Muslim
scholars entrusted with the duty of providing guidance, supervision
and cer@fica@on of Islamic financial products to ensure that they
are in compliance with Shariah rules and principles

§ However the onus is on the management to raise maOers with the
SSC whose role is more akin to a regulator (such as BDDK or CMB)
than to an internal department or management commiOee

§ The SSC may also include other experts in areas of Islamic financial
ins@tu@ons with knowledge of Islamic jurisprudence rela@ng to
commercial transac@ons

2011 in Istanbul
SSC -‐ COMPOSITION AND SELECTION

§ The SSC should be appointed by the shareholders in their Annual
General Mee@ng upon the recommenda@on of the BOD taking
into considera@on the local legisla@on and regula@ons
§ The SSC shall consist of at least three members of whom one will
be elected as the chairman by the fellow members
§ The SSC should not include directors (execu@ve or non-‐
execu@ve) or significant shareholders of the financial ins@tu@on
§ Islamic financial ins@tu@on is required to have a minimum of one
officer, preferably a person with knowledge in Shariah, who will
serve as the secretariat to the Shariah CommiOee (this func@on
may be outsourced)
SSC -‐ DISMISSAL

§ The dismissal of a member of the SSC shall require a
recommenda@on by the board of directors and be
subject to the approval of the shareholders in the general
mee@ng
§ SSC members are disqualified if they have acted in a

manner which may cast doubt on their fitness to hold the
posi@on of a Shariah CommiOee member
§ SSC members are dismissed if they have failed to aOend
most of the mee@ngs scheduled for Shariah CommiOee
in their appointment period without a reasonable excuse

2011 in Istanbul
SSC -‐ MORALS AND REQUIREMENTS

§ SSC member should be Muslim, with faith and belief,
mature, wise and fair in his rulings
§ SSC member should not agree on something if he is not
sa@sfied with its interpreta@on
§ SSC member should have a good reputa@on in the
community
§ Members of the SSC should have wide knowledge and
a degree in Islamic Shariah and especially in “Fiqh Al
Mu’amalat” (jurisprudence of financial dealings)
§ They should have knowledge in business, economics,
accoun@ng and finance
EXAMPLE OF SSC AT WORK

Product Concept Ini@al review of the Building the product’s
prepared defining SSC on the principle documenta@on
the underlying and the product’s according to the
Islamic Principles of main condi@ons direc@ves received from
the product the Scholars
Scholars review the Product documenta@on

Product Launch final documenta@on reviewed by legal and
and issue their compliance
approval
Regular & periodic Sahariah

Audit for ongoing assurance
throughout the product life
cycle

2011 in Istanbul
SSC -‐ MEETINGS

§ The number of SSC mee@ngs will differ from one IFI to another,
but usually they will have 3 to 4 mee@ngs a year
§ Decisions will be taken by majority of votes
§ A follow-‐up will be conducted in every mee@ng to resolve
pending Shariah issues
§ The SSC issue fatwas (ruling),guidelines and approve
investment agreements and products documenta@on
§ It is recommended that the IFI publishes the fatwas, rulings and
guidelines

SSC -‐ TERMS OF REFERENCE

§ The SSC Terms of Reference will be very similar to any other
commiOee of the IFI and it will include the following:
1-‐ Objec@ves: mainly to ensure Shariah compliance of the IFI
2-‐ Du@es and responsibili@es: defining the scope of work
required from the SSC
3-‐ Membership: describing the requirement of each member
and the term of the appointment
4-‐ Mee@ngs: defining the minimum numbers of mee@ngs and
the procedures of each mee@ng
5-‐ Authority: defining the authority of the SSC and tools
available for them to implement their rulings

2011 in Istanbul
SSC -‐ POWERS AND AUTHORITIES

§ The SSC fatwas (rulings)and guidelines are binding on the
IFI

§ Shariah compliance is the backbone of Islamic banking
and finance

§ The SSC gives legi@macy to the prac@ces of Islamic
banking and finance

§ The SSC boosts the confidence of the shareholders and
the public that all the prac@ces and ac@vi@es are in
compliance with the Shariah at all @mes
SSC – YEAR END SHARIAH REPORT

§ The SSC will issue an annual report sta@ng whether the IFI’s
ac@vi@es, opera@ons, contracts, documents, financial statements
and income are in compliance with the Shariah rules and principles

§ This report usually forms an integral part of the IFI’s annual report

§ The Shariah CommiOee report will be addressed to the
shareholders

§ This repor@ng structure reflects the status of the Shariah CommiOee
as an independent body of the Islamic financial ins@tu@on

2011 in Istanbul
ROLE OF SHARIAH COMPLIANCE OFFICER (SCO)

§ Independent role within the ins@tu@on
§ Coordinate closely with the SSC for all Shariah related issues
§ Ensures implementa@on of all SSC direc@ves and resolu@ons
§ Assist the IFI departments in carrying out their daily ac@vi@es
according to Shariah principles
§ Carries out Shariah audit of the different func@onal areas
§ Reviews products, policies and procedures throughout their
lifecycle
§ Reports any Shariah non compliance ac@vity directly to the MD
and the SSC
§ May be outsourced, if required

STANDARDISATION IN ISLAMIC FINANCE

OrganisaJon AAOIFI IFSB IIFM
Full name Accoun@ng & Audi@ng Islamic Financial Interna@onal Islamic
Organisa@on for Islamic Services Board Financial Markets
Financial Ins@tu@ons
Domain Shariah Governance, Pruden@al Islamic financial

Products, Accoun@ng, requirements contracts (Commodity
Audi@ng and ethics (Financial stability, Murabaha, Forex
Capital adequacy , Swaps etc)
Risk management)
Main clients Financial ins@tu@ons Regulators & other Financial ins@tu@ons

authori@es
Base Bahrain Kuala Lumpur Bahrain
(Malaysia)
§ All organisa@ons working in different spheres

§ No conflict or compe@@on between them
§ Mutually complementary services overseen by individual independent SSC’s

2011 in Istanbul
SHARIAH STANDARDS (AAOIFI)

§ AAOIFI (Accoun@ng & Audi@ng Organisa@on for Islamic Financial
Ins@tu@ons) is an independent body established in 1990 under an
agreement between a number of Islamic Financial Ins@tu@ons and is
now based in Bahrain
§ AAOIFI’s objec@ve is to formulate and issue Shariah, accoun@ng,
ethics and governance standards for the interna@onal IFIs and
standardise the Islamic financial industry
§ There are 30 Shariah Standards issued (to date) covering all known
Islamic financial principles yet the work is s@ll in progress
§ The standards are released by consensus of AAOIFI Shariah Board
consis@ng of Shariah scholars from all major schools of thought and
regions of the world
§ AAOFI is a member of the Interna@onal Accoun@ng Standard Board

DIFFERENT MODELS OF SHARIAH GOVERNANCE

§ Malaysian Model – centralised Shariah governance
Ø Shariah Advisory Council of Bank Negara Malaysia
Ø Highest and ul@mate authority on Islamic financial maOers in the country
(BNM Act 2009)
Ø Guidance, valida@on, and arbitra@on (by ruling) on all Islamic finance
maOers
Ø Shariah Supervisory CommiOee required at each Islamic Financial
Ins@tu@on to complement SAC
§ Bahrain Model -‐ ins@tu@onal Shariah governance
Ø Each ins@tu@on is required to have its own SSC
Ø AAOIFI Shariah standards are compulsory
§ UK Model – ins@tu@onal Shariah governance
Ø Each ins@tu@on has its own SSC
Ø FSA being a secular body does not involve in Shariah
§ Other Models

2011 in Istanbul
CONTROVERSIES IN SHARIAH GOVERNANCE

§ Conflicts of interest
§ Confiden@ality
§ Fees (scholars for dollars?)
§ Scarcity of scholars VS high
demand
§ Finding problems or finding
solu@ons?
§ Dialogue between the deaf?
Source: Funds @ work § Consistency issues
A study in 2010 demonstra@ng that a § Who takes the blame?
small minority of scholars is sipng on
the majority of the Shariah Boards / § Expecta@on management
Supervisory CommiOees triggered a § Resource planning
widespread debate over the issue of
Shariah governance.
CHALLENGES IN SHARIAH GOVERNANCE

§ The scholars of different schools of thought (Madhabs) with
different interpreta@ons and opinions
§ The number of scholars qualified in the jurisprudence of dealings
(Fiqh-‐ul-‐muamalat) rela@vely limited
§ The level of familiarity of the scholars with modern day financial
services is limited
§ Most of the management of IFI’s coming from conven@onal
backgrounds with no or very liOle understanding of Shariah
§ The expecta@ons of the stakeholders (regulators, shareholders,
customers and the management of IFI’s) from Islamic finance are
very unrealis@c
§ More emphasis is required on training and Shariah audit

2011 in Istanbul
THANK YOU
IFAAS France IFAAS UK IFAAS Bahrain

Tour AREVA 2nd Floor Level 22 -West Tower Building
92 084 Paris 3 Brindley Place Bahrain Financial Harbour
La Défense Birmingham B1 2JB Manama
TEL : +33 820 20 41 21 TEL : +44 8444 821 941 TEL : +973 17502876
www.ifaas.fr www.ifaas.com www.ifaas.com
farrukh.raza@ifaas.com


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Durham

Islamic Finance Autumn School

Presented at the

TABLE OF CONTENTS

Mohammad Farrukh Raza, Shariah

Government of Senegal

SHARIAH AND FINANCIAL INSTITUTIONS

Mohammad Farrukh Raza, Shariah

TYPES OF ISLAMIC FINANCIAL INSTITUTIONS

SHARIAH REQUIREMENTS FOR FI’S

Mohammad Farrukh Raza, Shariah

DUAL GOVERNANCE MODEL

Shariah Sales Policy Trea@ng Customers Fairly

DUAL GOVERNANCE MODEL

Mohammad Farrukh Raza, Shariah

ISLAMIC BANK -­‐ CORPORATE STRUCTURE

Marke@ng Finance Internal

SSC -­‐ DEFINITION

Mohammad Farrukh Raza, Shariah

SSC -­‐ COMPOSITION AND SELECTION

SSC -­‐ DISMISSAL

§ SSC members are disqualiﬁed if they have acted in a

Mohammad Farrukh Raza, Shariah

SSC -­‐ MORALS AND REQUIREMENTS

EXAMPLE OF SSC AT WORK

Scholars review the Product documenta@on

Regular & periodic Sahariah

Mohammad Farrukh Raza, Shariah

SSC -­‐ MEETINGS

SSC -­‐ TERMS OF REFERENCE

Mohammad Farrukh Raza, Shariah

SSC -­‐ POWERS AND AUTHORITIES

SSC – YEAR END SHARIAH REPORT

Mohammad Farrukh Raza, Shariah

ROLE OF SHARIAH COMPLIANCE OFFICER (SCO)

STANDARDISATION IN ISLAMIC FINANCE

Domain Shariah Governance, Pruden@al Islamic ﬁnancial

Main clients Financial ins@tu@ons Regulators & other Financial ins@tu@ons

§ All organisa@ons working in diﬀerent spheres

Mohammad Farrukh Raza, Shariah

SHARIAH STANDARDS (AAOIFI)

DIFFERENT MODELS OF SHARIAH GOVERNANCE

Mohammad Farrukh Raza, Shariah

CONTROVERSIES IN SHARIAH GOVERNANCE

CHALLENGES IN SHARIAH GOVERNANCE

Mohammad Farrukh Raza, Shariah

IFAAS France IFAAS UK IFAAS Bahrain

Mohammad Farrukh Raza, Shariah

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ISLAMIC BANK -‐ CORPORATE STRUCTURE

SSC -‐ DEFINITION

SSC -‐ COMPOSITION AND SELECTION

SSC -‐ DISMISSAL

SSC -‐ MORALS AND REQUIREMENTS

SSC -‐ MEETINGS

SSC -‐ TERMS OF REFERENCE

SSC -‐ POWERS AND AUTHORITIES