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Mahyuddin Khalid emkay@salam.uitm.edu.

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ISLAMIC FINANCIAL LEGAL FRAMEWORK


SHARIAH ADVISORY COUNCIL (SAC)

CONTENT
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INTRODUCTION DEFINITION SAB/SSC BEFORE AMENDMENT OF CBA 2003 SAC OF BAFIA AMENDMENT OF CBA 2003 SHARIAH ADVISORY COUNCIL APPOINTMENT OF SAC SECRETARIAT OF SAC RULINGS OF SAC FUNCTIONS OF SAC ADMINISTRATION OF JUSTICE MEMBERS OF SAC PRODUCTS DEVELOPMENT AND ENHANCEMENT SHARIAH GOVERNANCE CONCLUSION

INTRODUCTION
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It is mandatory for every Islamic bank to have a SAC/SAB which plays a crucial role and responsibility in ensuring the Islamic banks compliance with the principle of Shariah in its operations. The scope of Shariah compliance is to comply with the concepts and operations of Islamic banks. The underlying concept of the products, structures, term sheets, documentations, accounting and operational procedures must comply with Shariah principles It is important to ensure the existence of a single

INTRODUCTION
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The establishment of the SAC/SSB in some jurisdictions is a statutory / legal requirement by the country. In countries where there is no specific Islamic banking law, the provision is made through IFIs articles of association without any force of law. The Higher Religious Supervisory Board of the International Association of Islamic Banks (IAIB) requests that all IFI to appoint a Religious Supervisory Board in order to render binding decisions in conformity with Shariah. Furthermore, the Board decrees that IFI which does not adhere to the rules will not be able to claim to be operating according to Shariah.

DEFINITION
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AAOIFI:

An independent body of specialised jurists in fiqh muamalat; may include a member other than those specialised in fiqh muamalat but who should be an expert in the field of Islamic financial institutions and with the knowledge of fiqh muamalat A Religious Supervisory Council whose members would be made up of Muslim religious scholars in the country to advise on the operations of its banking business in order to ensure that they do not involve any element which is not approved by the Religion of Islam

BIMB:

A group of Shariah experts whose responsibility is to monitor and supervise the operations of Islamic financial institutions in order to ensure that it does not contravene Shariah principles. It is clear that SAC/SSB is a body set up by the Islamic banks authorities to ensure the operations and activities of the bank are Shariah compliant.

SAB/SSC BEFORE CBA 2003


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Several types of SAB/SSC in Malaysia under various legal frameworks before amendment of CBA 2003:
Shariah

Advisory Board (SAB) of Islamic bank IBA 1983 Shariah Supervisory Council (SSC) of Takaful operator - Takaful Act 1984. Shariah consultant for Islamic Banking Scheme (SPI/SPTF) banks - BAFIA 1989 Shariah Advisory Board (SAB) of savings and development institutions which participated in the SPI - Development Financial Institutions Act 2002 (DFIA)

SAC OF BAFIA
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The Shariah Advisory Council (SAC) of the BNM was established under the BAFIA l989 to advise BNM and IBS banks. Since the SAC was set up under the BAFIA, its jurisdiction was limited to the banks and financial institutions under BAFIA. It is not applicable to Islamic banks, Takaful operators as well as savings and development institutions The SAB and the SAC were totally independent of each other and need to be regulated under a supreme SAC to avoid the divergence of opinions which might lead to confusion.

AMENDMENT OF CBA 2003


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CBA 1958 of the BNM was amended in 2003 to enhance the role and functions of the SAC of the BNM. The amendment included:
new section 16B which provided for the establishment of the SAC under the CBA for the purpose of advising the BNM concerning matters related to Shariah that affect all Islamic banking and financial matters. new section 13A after section 13, which enables Islamic banks to acquire advice from the SAC which Is established under subsection 16B(l) of the CBA and the advice given must be followed by the Islamic banks. subsection 16B (1) vests the authority to the BNM to establish the SAC and to clarify the jurisdiction and function of the SAC

AMENDMENT OF CBA 2003


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With the amendment of the CBA in 2003, the role of the SAB in IFI and its relation with the SAC need to be streamlined and rationalised. SAB would act as Shariah advisors for particular institutions only. It will play a complementary role to the SAC of the BNM. BNM has issued the Guidelines on the Governance of Shariah Committee for Islamic Financial Institutions. The Guidelines shall be applicable to all Islamic banks, IBS banks, development institutions and Takaful operators. The objectives of these guidelines are:

to set out the rules, regulations and procedures in the establishment of a Shariah Committee; to define the role, scope of duties and responsibilities of a Shariah Committee; and to define the relationship and working arrangement between a Shariah Committee and the SAC of BNM.

SHARIAH ADVISORY COUNCIL


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SAC is defines as the Shariah Advisory Council on Islamic finance established under section 51 Section 51(1) allocates the authority of the BNM to establish the SAC and clarifies its jurisdiction and functions as follows:

The Bank may establish a SAC on Islamic Finance which shall be the authority for the ascertainment of Islamic law for the purpose of Islamic financial business.

Section 52(1) provides that the SAC shall have the following functions:

to ascertain the Islamic law on any financial matter and issue a ruling upon reference to it in accordance with this part; to advise the Bank on any Shariah issue relating to Islamic financial business, the activities or transactions of the Bank; to provide advice to any Islamic financial institution or any other person as may be provided under any written law.

APPOINTMENT OF SAC
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According AAOIFI standard, the authority to appoint members of the SSB must be vested in the Annual General Meeting (AGM) of all shareholders of the institution. The reason for this is to ensure that the members of the SSB free from any undue influence of the management board because the latter does not have the authority to appoint or to dismiss them. It is acceptable for the management board to propose the names of prospective members of the SSB to the AGM for deliberation and endorsement . The rationale of AAOIFIS standard is, to prevent any undue influence of the management board on the Shariah advisers, which might exist if the former were to be given the authority to appoint.

APPOINTMENT OF SAC
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However, if the appointment of the SSB is now to be undertaken by the Supreme Shariah board in the country, the issue of undue influence by the management will cease to be relevant. The role and functions of the SAB and SAC are not mentioned clearly either by the IBA, BAFIA or the CBA.

APPOINTMENT OF SAC
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Section 53 (1) clarify the appointment and the qualifications of the SAC members: The YDPA may, on the advice of the Minister after consultation with the Bank. appoint persons who are qualified or have knowledge or experience in the Shariah and in banking, finance, law or such other related disciplines as members of the SAC Section 53 (2) enable the Judges of the High Court, Court of Appeal, Federal Court or Shariah Appeal Court to be appointed as members of the SAC after being consented by the Chief Justice or the Chief of the Shariah Court respectively.

SECRETARIAT OF SAC
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Section 54 (a) Provision to establish a secretariat and such other committees as it considers necessary to assist the Shariah Advisory Council in carrying out its functions Section 54 (b) To appoint any officer of the Bank or any other person to be a member of the secretariat or such other committees.

RULINGS OF SAC
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Section 55 provides that BNM should obtain advice from the SAC in all matters relating to the Islamic financial business. Section 55(1) : The BNM shall consult the Shariah Advisory Council on any matter:

relating to Islamic financial business; or the purpose of carrying out its functions or conducting its business or affairs under this Act or any other written law In accordance with the Shariah,

Section 55(2) : Any Islamic financial institution in respect of its Islamic financial business, may:

refer for a ruling; seek the advice, of the SAC on the operations of its business in order to ascertain that it does not involve any element which is inconsistent with the Shariah.

REFERENCE TO RULINGS OF SAC


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Similarly, Islamic financial institutions also may refer for a ruling or for a advice from the SAC in order to ensure their Islamic financial business do not contravene with the Shariah principles. CBA also provide allocation of reference to the SAC for Shariah rulings in court proceeding or arbitration tribunal . Section 56(1) state that if question arises concerning a Shariah matter, the court or the arbitrator, as the case may be, shall:

take into consideration any published rulings of the SAC refer such question to the Shariah Advisory Council for its ruling.

CBA also gives authority to the SAC to make rulings in any court proceedings and arbitration process for disputes on issues involving Islamic banking and financial institutions.

EFFECT OF RULINGS
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Section 57 provides effect of Shariah rulings by the SAC pursuant to a reference made by Islamic financial institutions under section 55 and the court or arbitrators under section 56. Section 57 : Any ruling made by the SAC shall be binding on the Islamic financial institutions under section 55 and the court and arbitrator making a reference under section 56. Section 57 clearly stated the rulings made by the SAC on any disputes relating to Shariah issues will be binding the civil court judges and arbitrators,.

EFFECTS OF RULINGS
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In case of contradict of opinion or ruling between Shariah body /Committee of Islamic Financial Institution and SAC of BNM In Shariah matters, the ruling given by the SAC shall prevail. Section 58 :Where the ruling given by a Shariah body or committee constituted in Malaysia by an Islamic financial institution its different from the ruling given by the SAC shall prevail. This section gives recognition to the BNMs SAC as the highest reference authority on Shariah issues for all Islamic banks and banks under the Islamic banking scheme. The SAC will be referred to by the courts or any arbitration tribunal in any disputes pertinent to Islamic banking and finance, and would assist judges in making decisions accurately and in line with Shariah principles.

FUNCTIONS OF SAC
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Section 52(1) provides that the SAC shall have the following functions:
to

ascertain the Islamic law on any financial matter and issue a ruling upon reference to it. to advise the Bank on any Shariah issue relating to Islamic financial business, activities or transactions to provide advice to any Islamic financial institution or any other person as may be provided under any written law.

FUNCTION AND DUTIES OF SHARIAH ADVISERS


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Article 20 of the Guidelines on the Governance of Shariah Committee for the Islamic Financial Institutions (BNM/ GPS 1) establishes the main functions and duties of the Shariah advisers:

To advise the management of the IFI on Shariah matters in order to ensure that its business operations comply with Shariah principles at all times. To endorse and validate relevant documentations such as the proposal forms, contract, legal documentations, product manuals, advertisements as well as brochures. To advise and provide assistance to the related parties of the IFI such as its legal counsel, auditor or consultant on Shariah matters upon request. To advise the IFI to refer to the SAC concerning matters which have not been resolved or endorsed. To assist the SAC by giving explanations on any Shariah matters that have been referred to and to ensure that all of the SACs decisions are implemented by the IFI.

ADMINISTRATION OF JUSTICE
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Another development in legal structure was the establishment of dedicated High Court to adjudicate all muamalat cases in the Commercial Division of the High Court Kuala Lumpur. Practice Direction was issued by the Chief Judge of Malaya to register Islamic banking and finance cases using a special code number (22A) effective from 1 March 2003 . All cases filled will registered and heard in the High Court Commercial Division 4 and this special High Court will only hear cases on Islamic banking. The above provisions also acknowledge the authority of the arbitration as one of the process in dispute resolutions in cases involving Islamic banking matters. The advice made by the SAC will be binding on the arbitration tribunal.

ADMINISTRATION OF JUSTICE
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Cases Registered from 1.3.2003 - 1.12.2005 = 656 Settled Cases from 1.3.2003 - 1.12.2005 = 497 Balance of Cases up to 1.12.2005 = 388 Percentage of Settled Cases from 1.3.2003 1.12.2005 = 75.7% The statistic shows a remarkable amount of cases settled by the court from the year 2003 to 2005. However, all of the cases are concerning defaulters of facilities payment taken action by the respective banks. None, from the statistics, is challenging the decisions of the Shariah Committees.

MEMBERS OF SAC
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Another amendment in CBA in 2003 relating to the SAC as well as the Shariah Committee was Section 16B (6) It limits the involvement of SAC members of BNM from becoming members of any SSB in other IFI, unless they have a written consent from BNM. This is to preserve independence SAC and to avoid conflict of interest. However, the provision was taken out from the CBA 2009. Similarly, a member of the Shariah committee of any IFI is not allowed to be appointed in any other Shariah committees of the same industry. This is to comply with the corporate governance policy in terms of confidentiality and secrecy provisions. A company or an institution is no longer allowed to be a Committee member as the Guidelines restrict the members of the Shariah Committee to individuals only.

PRODUCT DEVELOPMENT AND ENHANCEMENT


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Product development is an exercise to create a new product or instrument to meet specific requirements. The creation of a new product, other than for diversification purposes, is to satisfy the needs of customers under certain circumstances. In the conventional banking industry, all of those developments are more of a product enhancement rather than product development. But in Islamic banking business, a new product must be fundamentally based on a new concept or contract. Product enhancement is to add more value to an existing product so that it becomes more viable and more appealing.

ISLAMIC BANKINGS PRODUCT DEVELOPMENT


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Some new product is created by reference to existing contracts that being combined or consolidated to form a new instrument. Product development takes the form of putting existing contracts into new structure in order to suit the banking environment. The common methodology of product development is based on a few fatwas which are very much peculiar to a specific mazhab though this has no support from the overwhelming majority of jurists. It is merely to seek some legal justification to reinforce the Islamicity of the products that are deemed to be feasible and viable without considering status of the fatwa.

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SAC ROLES IN PRODUCT DEVELOPMENT

The involvement of the SAC/SSB in product development and approval is not at the initial stage of product development, but in the middle or at the end of the process. All the technical parts of the product development are normally prepared by the banks management. Most of the IFI prefer to present their almostready product to the SAC/SSB for approval as far as Shariah compliance is concerned.

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SAC ROLES IN PRODUCT DEVELOPMENT

In the deliberations, the SAC/SSB may endorse or may suggest some changes to achieve Shariah compliance, or may suggest new features or a new product or contract altogether. The responsibility to modify into a new workable product still lies with the management. This new product will he brought back for discussion at the Shariah meeting to get the final Shariah endorsement .

SHARIAH GOVERNANCE
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BNM has issued the Guidelines on the Governance of Shariah Committee for IFI Among the duties of the Committee are to:

advise the Board of Directors on Shariah matters regarding the banks business operations to ensure that they comply with Shariah principles at all times endorse Shariah compliant manuals endorse and validate relevant documents provide written Shariah opinion or decision provide necessary assistance to the Committee refer all Shariah issues to the Committee for advice and adoption ensure that product documents containing Shariah matters be endorsed and validated by the Committee provide access for the Committee members to the relevant records, transactions, manuals or other relevant information provide sufficient resources, independent expert consultations, reference materials and training.

IFI are responsible to:


SHARIAH GOVERNANCE
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The composition of the Committee shall be a minimum three members. In addition to the Shariah Committee, an IFI is also required to designate at least one officer, preferably with the knowledge of Shariah, to serve as the secretary to the Committee. The Committee will report to the board of directors of the IFI. This reporting structure reflects the status of the Committee as an independent body of the IFI.

CONCLUSION
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The SC plays very important roles in ensuring good Shariah governance. The setting up of a special High Court in Commercial Division, the issuance of BNM/GPS1 and also the amendment of section 16B of the CBA shows positive indication by the government in providing more comprehensive and effective Shariah governance. An effective Shariah governance framework requires involvement of the Shariah Committee as the key player, the government as the regulatory body, the Islamic financial institutions as the implementer and also to other persons relevant to the business such as auditors, accountants, lawyers.

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END OF CHAPTER