Shariah Governance Framework, IFSB and AAOIFI Standards

Legal Aspects ofIslamic FinanceLCA4592DR. ZULKIFLI HASAN

Contents Shari’ahah Governance framework AAOIFI IFSB

Section 13A (1) 13A. (1) An Islamic bank may seek the advice ofthe Syariah Advisory Council on Syariah mattersrelating to its banking business and the Islamicbank shall comply with the advice of the SyariahAdvisory Council. (2) In this section, “Syariah Advisory Council”means the Syariah Advisory Council establishedunder subsection 16B(1) of the Central Bank ofMalaysia Act 1958.

Sec 124 of the BAFIA 124. (3) Any licensed institution carrying onIslamic banking business or Islamic financialbusiness, in addition to its existing licensedbusiness may, from time to time seek the adviceof the Syariah Advisory Council establishedunder subsection (7), on the operations of itsbusiness in order to ensure that it does notinvolve any element which is not approved bythe Religion of Islam.

Pre-CBA 2009 Affin Bank v Zulkifli Abdullah : It is not aquestion of shariah law. It is the conclusion ofthis court. There is no necessity to refer thequestion to another forum. Arab Msian Merchant v silver concept: s 16Bdoes not make reference to the sac mandatory.Only binding to the arbitrator.

SAC S 51 (1) The Bank may establish a ShariahAdvisory Council on Islamic Finance whichshall be the authority for the ascertainment ofIslamic law for the purposes of Islamic financialbusiness (2) The Shariah Advisory Council maydetermine its own procedures

S 52 of the CBA S 52: (a) to ascertain the Islamic law on anyfinancial matter and issue a ruling uponreference made to it in accordance with thisPart; (b) to advise the Bank on any Shariah issuerelating to Islamic financial business, theactivities or transactions of the Bank;

S 52 of the CBA (c) to provide advice to any Islamic financialinstitution or any other person as may beprovided under any written law; and (d) such other functions as may be determinedby the Bank

Reference to SAC The court or arbitrator shall (a) take intoconsideration any published rulings of theShariah Advisory Council; or (b) refer such question to the Shariah AdvisoryCouncil for its ruling. (2) Any request for advice or a ruling of theShariah Advisory Council under this Act or anyother law shall be submitted to the secretariat.

Tan Sri Khalid Ibrahim v Bank IslamMalaysia Berhad [2009] 6 MLJ 416 Tan Sri Khalid Ibrahim v Bank Islam MalaysiaBerhad, , for the first time in the history of theMalaysian court that the High Court judge madereference to the SAC for confirmation of theShari’ahah status of the agreement. Bba is recognized form of transaction.

Bimb v lim kok hoe The ct will have to assume that the sac and thesc would have discharged their duty to ensurethat the operation of islamic banks are compliedwith the syariah. The judge should not have taken upon himselfto rule otherwise without having regard the viewof the sac.

Effect of Rulings S 57 Any ruling made by the Shariah AdvisoryCouncil pursuant to a reference made under thisPart shall be binding on the Islamic financialinstitutions under section 55 and the court orarbitrator making a reference under section 56. 58. Where the ruling given by a Shariah body orcommittee constituted in Malaysia by an Islamicfinancial institution is different from the rulinggiven by the Shariah Advisory Council, theruling of the Shariah Advisory Council shallprevail

Shari’ahah governance Framework for IFIs The SGF consists of two parts and one appendix withpart I consists of five sections and part II, six sections.Part I provides an overview of Shari’ahah governanceconsisting of objectives, scope of application, legalprovision, effective date and compliance deadline andapproach. Part II details out the Shari’ahah governancearrangements and these include general requirement forShari’ahah governance framework, oversight,accountability and responsibility, independence,competence, confidentiality and consistency andShari’ahah compliance and research functions. All IFIslicensed under the IBA, the BAFIA, the DFIA and theTA are required to comply with the SGF.

Objectives (i) sets out the expectations of the Bank on an IFI’sShariah governance structures, processes andarrangements to ensure that all its operations andbusiness activities are in accordance with Shariah; (ii) provides a comprehensive guidance to the board,Shariah Committee and management of the IFI indischarging its duties in matters relating to Shariah; ; and (iii) outlines the functions relating to Shariah review,Shariah audit, Shariah risk management and Shariahresearch

Framework (i) the board oversight on Shariah compliance aspectsof the IFI’s overall operations. (ii) a Shariah Committee w i t h qualified members (iii) effective management responsibilities in providingadequate resources and capable manpower (iv) an internal Shariah review (v) a regular Shariah audit, at least on an annual basis, (vi) a Shariah risk management process (vii) an internal Shariah research team (viii) issuance and dissemination of Shariah decisions

SGF In terms of appointment of the Shari’ahah board, , section3.8 mentions that the BOD of IFIs uponrecommendation of its Nomination Committee shouldappoint the members of the SHC and subject to theapproval of the BNM and the SAC. Appendix 2 onqualification requires the Shari’ahah board members to atleast either have qualifications or possess the necessaryknowledge, expertise or experience in Islamicjurisprudence or Islamic commercial law. To ensure that the SHC is able to function effectively,the SHC should consist of a minimum of five membersand its activities and functions will be coordinated bythe Shari’ahah secretariat of the respective IFIs (section2.3).

SGF With the purpose of mitigating the risk of potential ofconflict of interest and confidentiality issues, IFIs arenot allowed to appoint any member of the SC inanother IFI of the same industry (section 5.4). Appendix 2 on disqualification provides that an SHCmember may be disqualified if he fails to satisfy that heis fit for the position, fails to attend 75% of meetings ina year without reasonable excuse, has been declaredbankrupt, or a petition under bankruptcy laws is filedagainst him, was found guilty for any serious criminaloffence or any other offence punishable withimprisonment of one year or more, or is subject to anyorder of detention, supervision, restricted residence orbanishment.

SGF Appendix 4 of the SGF provides the clear dutiesand responsibilities of the SHC and theseinclude: to advise the BOD on Shari’ahahmattersinits business operations; to endorse Shari’ahahcompliance manuals; to endorse and validaterelevant documentations; to assist related partieson Shari’ahahmattersfor advice upon request; toadvise on matters to be referred to the SAC; toprovide written Shari’ahahopinions; ; and to assistthe SAC on reference for advice

SGF The SHC is legally required to produce a Shari’ahah reportexpressing their observations on IFIs’ compliance withShari’ahah principles as illustrated in Appendix 3 of theSGF. In this aspect, the BNM/GP8-i i specifies theminimum requirements of the Shari’ahah report. TheBNM/GP8-i i requires content of the Shari’ahah report tobe at least, declaration of Shari’ahah compliance endorsedby the Shari’ahah committee members. In terms of reporting structure, the SHC will reportfunctionally to the BOD as this reflects the status of theSHC as an independent body of the IFIs. . The BOD isbound by any decision of the SHC and they have toconsider their views on certain issues related tooperational matters, policy or business transactions.

IFSBGuidelines on CG for IFIs10 prudential standards for IFIs, , 2 forcapital adequacy requirements, 1 for riskmanagement and 7 for governance,disclosure and supervisory review processGuiding Principles on CG for InstitutionsOffering Only Islamic Financial Services(Excluding Islamic Insurance (Takaful(Takaful)Institutions and Islamic Mutual Funds)Guiding Principles on Governance forIslamic Collective Investment Schemes,Guiding Principles on Governance forTakaful (Islamic Insurance) UndertakingsGuiding Principles on Governance forTakaful OperationsGuiding Principles on Conduct ofBusiness for Institutions offering IslamicFinancial ServicesGuiding Principles on SG System forInstitutions offering Islamic FinancialServicesAAOIFI81 standards and guidelines whichinclude 25 accounting standards, 6auditing standards, 7 governancestandards, 41 Shari’ahah standards and 2codes of ethics.Shari’a Supervisory Board: Appointment,Composition and Report;Shari’a ReviewInternalShari’a ReviewAudit and Governance CommitteeIndependence of Shari’a BoardStatement on Governance Principles forIFIsCorporate Social Responsibility

AAOIFI(i)Governance Standard for IFIs No. 1: SharīʿahahSupervisory Board: Appointment, Composition and ReportIt consists of eight parts, namely introduction, definition,appointment, composition, selection and dismissal, basicelements of report, publication of the report, publication ofSharīʿahah rulings and guidelines, and the effective date. Section 2represents the most important provision in GovernanceStandard No.1. It has three elements which define the term‘Sharīʿahah board’. . Firstly, a Sharīʿahah board is an independent bodyof specialized jurists in fiqh al muāmalmalāt. . This section allows theappointment of Sharīʿahah board members who are not specializedin fiqh al muāmalmalāt but who are expert in the field of Islamicfinance. Secondly, it elaborates the role of the Sharīʿahah board toensure compliance with Sharīʿahah principles by having theauthority to direct, review and supervise the activities of IFIs.Thirdly, it indicates the binding authority of the Sharīʿahah boardupon the IFIs.

Governance Standard for IFIs No. 2: SharīʿahahReview It consists of eight parts with eighteen sections. Section3 explains the Sharīʿahah review as an examination of theextent of the IFIs’ Sharīʿahah compliance. section 5 putsthe responsibility for compliance upon themanagement. The Sharīʿahah board is only responsible for forming andexpressing opinions on the extent of Sharīʿahahcompliance. Sections 7–137detail the Sharīʿahah reviewprocedures, which involve planning, designing,executing, preparing and reviewing. The Sharīʿahah reviewreport should be submitted to the AGM.

Governance Standard for IFIs No. 3: InternalSharīʿahah Review It consists of eleven parts and thirty sections whichcomplement Governance Standard No. 2. Standard No.3 aims at establishing standards and guidance on theinternal Sharīʿahah review. As the management of IFIs is responsible for the extentof Sharīʿahah compliance, it is incumbent upon them tohave a proper mechanism of internal Sharīʿahah review.While the AAOIFI requires IFIs to carry out aninternal Sharīʿahah review, it does not specify therequirement of establishing a separate internal Sharīʿahahaudit department. The internal Sharīʿahah review can be carried out by eitheran independent department or part of the internal auditdivision.

Governance Standard for IFIs No. 4: Audit andGovernance Committee To complement the corporate governance frameworkfor IFIs, , the AAOIFI strongly recommends theestablishment of an Audit and Governance Committee(AGC) at the board level. The AGC should consist of a minimum of threemembers, appointed by the BOD from its non-executive and independent board members, who areknowledgeable about the affairs of the institution andapplicable regulations and laws, including Sharīʿahah rulesand principles.

Governance Standard for IFIs No. 5:Independence of Sharīʿahah Board guidelines for its independence and mechanisms toresolve issues of independence. The state of independence of the Sharīʿahah board is ofthe essence in enhancing public confidence on theaspect of Sharīʿahah compliance. Section 3 restricts theSharīʿahah board to subordinating their judgment onSharīʿahah supervision to third parties. The Sharīʿahah boardis not recommended to consist of employees of thesame IFIs or be involved in managerial decisions andoperational responsibilities. The Sharīʿahah board isrequired to conduct continuous assessment of the IFIsand do anything necessary to resolve any issues ofindependence impairment.

IFSB-10SG:The set of institutional and organizational arrangements:This refers to the Sharīʿahah board and its relatedinstitutions, such as an internal audit department andSharīʿahah division.Effective independent oversight of Sharīʿahah compliance:This indicates the aims and objectives of the Sharīʿahahgovernance system to provide efficient mechanisms forthe purpose of Sharīʿahah compliance.Sharīʿahah pronouncements, dissemination of informationand an internal Sharīʿahah compliance review: Thisinvolves the overall Sharīʿahah governance processes thatcover both ex ante and ex post aspects of the Sharīʿahahcompliance framework.

Key ElementPrincipleKey ElementsOperational FrameworkCompetenceIndependenceConfidentialityConsistencyFit and proper criteriaProfessional trainingFormal assessmentAdequate capability toexercise objectivejudgmentComplete, adequate andtimely informationStrictly observe theconfidentialityFully understand thelegal and regulatoryframework strictlyobserves the saidframeworkEx ante: Screening processEx post: Review and assessmentEx ante: Appointment, disclosure and fullmandateEx post: Review and assessmentEx ante: Undertaking secrecyEx post: Review and assessmentThere must be consistency in all ex ante andex post Sharīʿah governance processes

Thank YouZulkifli Bin HasanFaculty of Syariah & LawE-mail:zulkiflih@admin.kuim.edu.myE-mail:zul361977@yahoo.com.Tel. No: 06-7988455H/Phone No: 016-3379776