The Islamic finance industry continues to grow exponentially worldwide, with the latest estimates showing global sharia-compliant assets crossing the $500bn (£250.67bn) mark. Since its modern-day re-emergence almost 40 years ago, this religion-based financial system has positioned itself as a growing force to be reckoned with. According to current estimates, there are around 300 Islamic financial institutions (IFIs) operating in more than 75 countries worldwide, and this number is rising sharply.
The level of good governance required by sharia principles arguably transcends that of conventional financial systems, as Islamic financial principles categorise an IFI as a trustee of its investors. As such, the IFI must be transparent, act fairly and be held accountable to the investors. Considering the significant amount of wealth currently entrusted to IFIs and their role as the trustees of their investors, is it time for the introduction of more robust corporate governance practices tailored specifically for IFIs?In general, regulators responsible for supervising IFIs have taken a non-prescriptive approach. Rather than setting criteria and standards which IFIs must comply with to be authorised and licensed to carry out sharia-compliant activities, the onus is placed on the individual IFIs to put adequate measures in place to ensure that the services and products they offer accord with Islamic principles. Both the Dubai Financial Services Authority and the Qatar Financial Centre Regulatory Authority have taken this approach.
The UK Financial Services Authority (FSA), however, takes a different stance. It makes no distinction between IFIs and conventional financial institutions regarding regulation, based on the principle that all financial institutions should expect the same treatment and standards. Among the ‘potential difficulties’ the FSA has identified in relation to the authorisation and regulation of IFIs is the role of the sharia scholars’ boards (SSBs). The FSA’s view is that, as a secular rather than a religious regulator, it should not concern itself with the different interpretations of sharia principles.
Nonetheless, it is arguable that to regulate the industry properly, regulators must fully understand the SSB’s role in each authorised IFI and, in particular, whether the role is executive or advisory. The implication is that if it is an executive role the SSB should be subjected to the usual standards for directors, including the ‘fit and proper person’ test. However, there is a shortage of sharia scholars adequately experienced in modern-day Islamic finance practices and so further regulation could potentially lead to capacity problems for IFIs.
There are two key standards-setting organisations in the Islamic finance industry: the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB). Both have recognised the growing need for more specific governance for IFIs and have issued certain standards and guidelines on corporate governance practices.
AAOIFI has issued numerous standards on accounting, auditing, governance and sharia – including standards on, among other things, the appointment and composition of SSBs, the objective monitoring of sharia-compliance by audit and governance committees, and a general statement on governance principles for IFIs. Increasingly, regulatory authorities are relying upon AAOIFI standards for the specific regulation of IFIs.
In December 2006, the IFSB issued far-reaching guiding principles on corporate governance for IFIs, intended to help IFIs establish and improve their corporate governance frameworks and assist regulators in assessing such frameworks. The IFSB’s view is that there is no single model that suits all IFIs globally. Rather, the effectiveness and soundness of a corporate governance framework will depend on the specifics of individual IFIs.
Considering the non-prescriptive approach taken by regulators in regulating IFIs, the importance of the SSBs’ role in helping to apply and monitor good governance frameworks cannot be underestimated. Discharging this role to the best of their abilities and according to the relevant religious precepts requires sharia scholars sitting on SSBs – particularly those on governance committees – to be fair, impartial, unbiased and objective.
If a conflict of interest arises, the AAOIFI governance standards state that the affected sharia scholar should review the issue with the SSB and if it is not resolved the sharia scholar concerned should resign and no longer take part in the functions of the relevant SSB.
Key Islamic finance industry players feel that although IFIs should be able to compete on a level playing field with their conventional counterparts and demonstrate that they can meet the same regulatory standards, there is also a need to continue to develop more tailored regulations for IFIs. Addressing concerns such as the role and operation of SSBs will help to grow the level of trust and confidence increasingly being placed in the Islamic finance industry. nMuneer Khan is a partner and global head of Islamic finance and Omar Shariff an associate in Islamic finance at Simmons & Simmons Dubai