The Shariah and Legal Framework of Islamic Financial System

SUSTAINING FINANCIAL STABILITY THROUGH SHARIAH GOVERNANCE FRAMEWORK

Assoc. Prof. Dr. Rusni Hassan Deputy Dean IIUM Institute of Islamic banking and Finance International Islamic University Malaysia [email protected]

ISLAMIC FINANCE INTELLECTUAL DOSCOURSE Organised by: IRICIEF KUIS & MARA Novotel Hotels & Resots, Melaka (18 -19 October 2016) 2 The Outline

 Islamic Finance: A Recap  The Regulatory Aspects  The Shariah Governance Framework

Shariah principles are the foundation for the practice of Islamic finance through the observance of the tenets, conditions and principles espoused by Shariah.

Product Documentation Departure from development and requirement of conventional innovation guided Islamic products practice in by principles of that reflect product, legal Shari`ah, fiqh and “islamicity” of its requirement, tax ijtihad terms & conditions and accounting

Islamic Finance is to adopt Shariah principles Iqtidadiyyah (Belief)

Amaliyyah Islamic Finance is to reflect Shariah (Dealings components or aspects in all its activities COMPONENTS OF SHARIAH

Islamic Finance is commercial transactions based on prescribed principles of Fiqh al- Akhlaqiyyah Ibadah Muamalat (Morality) (Worship)

Muamalah Islamic Finance is to uphold the objectives of (Dealings) Shariah (Maqasid al-Syariah)

Dual-Banking / Financial System

Leveraging on Conventional Banking/Financial Conventional System Framework Banking/Financial Business Model Operating Environment of Islamic Finance

Debt-based, Collateral Based & Fractional Reserve Risk Averse Banking

Fiat Monetary System

Application of Shariah compliant contracts eg: Murabahah, How is Shariah Musharakah, Ijarah etc Compliance being Offer Shariah compliant products & services which satisfy translated in form & legal technicalities the Contemporary Operating Finance & invest in Shariah compliant business portfolio Environment of IBF? Apply/use majority of conventional banking rules & products which are consistent with Shariah

Fitting-in Conventional THUS … banking/finance features has resulted the following: Expose IFIs to Shariah Non- Compliance Risk & THE NEED for Shariah Compliance and Governance Framework

The growth and development of Islamic finance industry are supported through good governance and its comprehensive legal frameworks

2010 Strengthening regulatory 2005 framework 2000 Maturing & globalization Broader & deeper • 2009 : Enactment of Central Bank of market especially sukuk Malaysia Act 2009 1990 • Rule on full fledged (CBMA) Islamic subsidiaries 1980 Accelerated growth in • 2010 : Shari’ah • Islamic bank licenses to Governance market size & players • Introduction to sukuk foreigners (2005): Introduction & Framework (SGF) market • Guthrie Sukuk al • KFH, Al Rajhi, • 2012 : Enforcement Ijarah (2001) QIB, etc of the Takaful familiarization • Islamic windows (1993) st • 1 Malaysian Global • Moving towards globally Operational - BAFIA Sukuk al Ijarah (2002) accepted products: Framework (TOF) • Accelerated growth in • Experimenting new • Ijarah, Istisna’, • 2013 : Islamic • Development of market size & players product structures: Mudarabah, Financial Services Act markets, players & • Additional products Musharakah • BBA, Murabahah, 2013 products features: Ijarah, Istisna’, • “Pilot project”: • BBA, Murabahah, Mudarabah, • BIMB – IBA 1983 Ijarah, Wadiah, Musharakah • STMB – TA 1984 Mudarabah • More facilitative legal/tax • Limited products: • Intro of Islamic Capital regime – exemptions etc. • BBA, Ijarah – Market: financing • Equity, bonds, • Mudarabah, money market Wadiah – deposits

Central Bank of Malaysia Act 2009 “ Any financial business in ringgit or other Implementation of Legal & currency which is subject Regulatory to the laws enforced by Islamic Finance is to the Bank and consistent support be supported by with Shariah” effective regulatory framework to ensure Shariah compliance

aspects of the Islamic Financial Legal & overall operations Services Act 2013 Regulatory “An institution shall at all support times ensure that its aims and operations, business, affairs and activities are in compliance with Shariah”

4 Birth of IFSA

Royal Assent : Gazetted : Effective Date : 18 March 2013 22 March 2013 30 June 2013

Sec 6 IFSA : “The principal regulatory objectives of this Act are to promote financial stability and compliance with Shariah”

IFIs shall at all times ensure Shariah compliance

IFSA 2013 Shariah compliance refer to compliance to rulings of SAC Enhances shariah governance aspects of IFIs by Procedure for Sharian non-compliant activities codifying the (c) report to BNM (a) notified to SC (b) cease the activities shariah compliance within 30 days requirements and enforcement of penalties for non- compliance Penalty for non-compliant with the above liable to imprisonment not exceeding 8 yrs or fine not exceeding RM25 mil or both

Bank Negara Malaysia places great importance in ensuring that the overall Islamic financial system operates in accordance with Shariah principles. This is to be achieved through the two-tier Shariah governance infrastructure comprising two (2) vital components, which are a centralised Shariah advisory body at the BNM and an internal Shariah Committee formed in each respective Islamic financial institution (IFI).

Key Features of Shariah Governance

“Shariah Governance system is a set of institutional and organisational arrangements through which Islamic financial institutions ensure that there is an effective independent oversight of Shariah compliance over the issuance of relevant Shariah pronouncements, dissemination of information and an internal Shariah compliance review.”

IFSB-10 Guiding Principles on Shariah Governance Systems for Institutions Offering Islamic Financial Services

PROCESS PURPOSE FUNCTIONS  SG aims to ensure Shariah

compliance in actuality i.e. SHARIAH CONCEPT Shariah legitimacy of ADVISORY products and/or Shariah compliant operations of IFIs

SHARIAH

STRUCTURE SUPERVISION  SG is essential to gain confidence and trust of OPERATION SHARIAH stakeholders i.e. REVIEW/AUDIT

perception of the INSTRUMENTS INSTRUMENTS PRACTICES & outsiders and reputation/ COMPLIANT SYARIAH TRULY public confidence Shariah Compliance aspects are to be observed throughout the process in developing/constructing the products/framework and to be supported by proper Shariah governance functions

Shariah Compliant Functions Oversight, Accountability Professionalism & Responsibility Sound and Robust Shariah Governance Structure

Confidentiality Independence & Consistency

Competency

• Effective • BODs communication • Shariah • Rigorous & Committees efficient process; • Management • Disclosure • Employees

Oversight role in ensuring Shariah compliance & due regards to SC’s decision BOD

Oversight role to assist BOD & senior Oversight & management for prudent advisory role on management of TO by Actuary SC Shariah matters to ensuring/safeguarding ensure Shariah interest of takaful compliance participants

Ensure business Enhanced statutory operations meet Shariah reporting obligations (Audit Auditors CEO requirements & & Shariah Audit) Reporting obligations to BNM & SC

The Shariah governance structure shall be robust & supportive to the IFIs internal infrastructure to ensure effective overall Shariah compliant process

Two layer of Shariah Advisory Board to ensure Shariah Compliance and harmonisation of Shariah decision

 Shariah Advisory Council at the Central level (BNM) established under Sec 51 of CBMA 2009 SAC  Highest authority to decide Shariah matters in Islamic Finance in Malaysia

 Shariah Committee at the respective IFIs  Appointed by Board of Director SC  Upon recommendation/approval of BNM

Establishment of Shariah Advisory Council • To ascertain the Islamic law on any financial matter Sec 51 (1) of CBMA & issue a ruling upon reference made to it

• “The Bank may establish a Shariah Advisory Council • BNM shall consult SAC on any matter relating to on Islamic Finance which Islamic financial business for the purpose of carrying out its functions or conducting its shall be the authority for the business or affairs in accordance with Shariah ascertainment of Islamic law for the purposes of Islamic financial business”.

• Any ruling made by SAC shall be binding on IFI, Court and/or arbitrator

Establishment of Shariah Committee • Accountable & responsible for (Sec 30 IFSA) Shariah decisions • Ensure Shariah compliant • A licensed person shall operations of IFIs establish a Shariah committee for purposes of advising the licensed person in ensuring its •BoD shall give due regards to SC business, affairs and activities decision comply with Shariah. SG & Financial Stability

SG ensure end-to end SG ensure consistent Shariah compliant market practices in view aspects which is the of differences of views essence of IF of scholars

SG enhance SG supports Corporate accountability of Governance principles stakeholders

SG ensure the public expectations are met

 Shariah governance framework as mechanism to ensure Shariah compliance of Islamic Finance  Effective enforcement of Shariah governance  Transparent deals - disclosure, accounting & auditing.  Good Shariah governance practice for global acceptance and recognition.