Adding social responsibility and accountability to the mandate of Shari’a advisory boards

INTRODUCTION
On the face of it, the 2008 to 2010 period should be a golden age for Islamic banking and finance. With the conventional sector licking its wounds after a year or two of high profile collapses, bail-outs and bruised egos, and the Islamic sector suffering only mild aftershocks, the sound of Western bankers and investors clamouring to board the Shari’a Express should be deafening. But the response has been one of curiosity and grudging acknowledgement rather than a wholesale signing up to the cause. Could it be that this relative newcomer to the global financial market still lacks a certain degree of credibility? And if so, why?
The conventional sector has hundreds, if not thousands, of years of experience, governmental regulation and business culture behind it, whereas the Islamic sector as we now know it is younger than the ATM. Since it’s fair to say that the inception of Islamic finance has not exactly been rushed, the reason why Western investors are still lacking trust in the system could be down to its idiosyncratic means of regulation at the hands of unaccountable Shari’a advisors.
By definition at least, Shari’a advisors are specialized jurists, particularly in Shari’a (Islamic Law), Fiqh al-mu’amalat (dealings), Islamic finance and economics. They are entrusted with the duty of directing, reviewing and supervising activities related to Islamic finance in order to ensure that they are in compliance with Shari’a rules and principles. However, they are not accountable for their actions. The management of a financial institution is responsible for its own organization and performance. Shari’a board members’ qualifications, responsibilities, ethos, commitment and social responsibility can therefore be questionable when ideally the members’ skills and actions should be identified, regulated and accountable both to the organization they represent and to the communities affected by their decisions. After all, their decisions can and do shape the Islamic finance system as a whole.
A particular problem has proved to be the manner in which advisors are appointed. The process is almost completely opaque, based as it is on recommendations, friendships and showing up at the right conferences; the idea that advisors should have any particular qualifications in either Shari’a or conventional banking is shrugged off in many jurisdictions as imitating a failed Western banking system.
But perhaps an even deeper problem lies in the small pool of advisors in an ever-expanding sector. Instead of training and bringing in new, young talent, the old guard is spreading itself thinly around the world’s boards, with single members splitting their time between numerous other boards – seventy-seven in one notable case. And it is a situation that they are unlikely to change from within; remuneration makes board membership a lucrative business and gives members something akin to celebrity status as they collect appointments around the world. The lack of incentive for the powers that be to broaden the pool of advisors inevitably means that the decision-making process is being squeezed in terms of time and commitment. It is likely that many life-changing decisions are simply being rubber-stamped out of necessity. Furthermore, financial institutions will use these top names in their marketing and PR materials, ostensibly affording the institution credibility but hiding the fact that the individuals probably spend little time actually making decisions on their boards.
Even if we ignore the effects of this lax attitude on efficiency, risk management and profitability, where does this leave the devout Muslim who is using the bank under the assurance that the strictest Quranic tenets are being stringently observed?
So, for all its faults, conventional banking is decades ahead in terms of transparency, due diligence and legal adherence. Less-than-angelic conventional bankers do of course exist, but eventually their excesses tend to catch up with them and they are forced to account for themselves either to their superiors or to government inquiries and courts; individuals’ careers and corporations’ futures can turn to dust because of their poor decisions. Their Islamic counterparts, however, need fear no such eventualities; they are accountable to no one and their decisions are final. In view of this, it becomes clear to see how Islamic banking as it is practised can appear amateurish, nepotistic and unreliable, regardless of the noble principles that reigned when it was first made real. When a notable body such as the Islamic Financial Services Board produces a very detailed draft on governance that has no mention of accountability in board members, potential investors versed in Western methods can be forgiven for saying “Thanks, but no thanks” to the investment opportunity.
The story is not a hopeless one, however. As with so many other Islamic matters, Malaysia is forging ahead while much of the Middle East’s bankers bury their heads in the sand. The nation has shown how placing limits on board members’ excesses, improving transparency and nurturing a constant supply of educated, impartial and enthusiastic advisors has made its Shari’a banking sector a world leader; indeed the country itself is a model of enlightened business practice within an Islamic framework.
There is still time to change the system throughout the rest of the world, perhaps even to start acting like a mature, serious business open to all of the brilliant financial minds that are distributed throughout the Islamic quarter of the world’s population. But it will take a massive shift in the mindset that has become the norm in much of the world’s Shari’a banking sector. This paper aims to identify the problems and suggest workable solutions that really could stoke the engine of Shari’a banking.

At its root is a very straightforward question:

“Are Shari’a board members immune from accountability?”

WHY SHARI’A BOARD MEMBERS’ ACCOUNTABILITY IS VITAL

The accountability of Shari’a board members is vital for the following reasons:
• It gives worldwide credibility for the Islamic finance system.
• It creates confidence among investors and the public in the Islamic finance system.
• It demonstrates that Islamic financial transparency can be adopted by conventional finance institutions.
• It presents personal credibility to individual Shari’a board members.
• It demonstrates that the Islamic finance system is compatible with the conventional finance system.
• It introduces Islamic risk management tools into global finance.
• It reflects Islamic principles in the terms of transparency, ethics, fairness, justness, and honesty.
• It allows management and shareholders to seek advice on Shari’a matters.
• It allows the creation and structuring of new Shari’a-compliant products within the global internationally-developed market.
• It strengthens the global respect of fatawa issued for product development that is Shari’a-compliant.
• It introduces Shari’a auditing standards to the global financial market.
• It strengthens the corporate governance of Islamic financial institutions.
• It embeds the values of Islamic finance into the business operations and governance of financial institutions.
• It ensures Islamic ethical principles are preserved within the global market.
• It protects consumers’ rights from abuse and fraud found in the conventional finance monopoly
• It ensures the adoption of Basel II and Pillar II, particularly in regard to money laundering and capital adequacy issues, within Islamic finance institutions
SHARI’A FINANCE AND ACCOUNTABILITY
Muslims are accountable not only to a Supreme Being, but also to their families, their employers, their governments, their electorates, and each other. This accountability may be based on oath, such as marriage vows, or may originate from lawyers, doctors, judges, or other professionals providing services to the public. The accounting industry, brokerage firms, the legal community, and all of the business community are accountable for business ethics. This privilege comes with responsibility: with misconduct comes a punishment; with good conduct come rewards.
The public expects and deserves accountability from the businesses, professions, and other institutions that govern and influence our lives. The legal profession is not immune to this expectation; the members of the legal profession are accountable, both to their clients in the regular course of business and to the public when their services are used in the furtherance of a fraud.
Each business, profession, and institution must have effective leadership to ensure that their members are held accountable and to respond to public concerns with discernible, effective, and conscientious action. Likewise, promoters of Islamic finance should consider what it means to be a “good person,” both in business or as individuals – and should be personally accountable when advising or teaching the message of Islam.

CORPORATE GOVERNANCE IN ISLAMIC BANKING AND FINANCE

Islamic finance is a nascent industry, with a small share of the global market – about 1%. However, Islamic finance is benefiting from a number of favourable structural and cyclical drivers: strong growth in the GCC, Asia, and Africa; positive demographics of young and rapidly growing populations; and a growth in the preference of savers/investors towards Islamic finance in Muslim countries, partly due to a reawakening of cultural and religious identity. The rapid growth may have taken some by surprise, and the state of corporate governance might stand as evidence of this. Corporate governance:
• aims to provide institutions with a body of rules and principles to ensure that good practice guides the overall management of an institution;
• covers incentive structures to address principal–agent issues;
• ensures that executive management serves the long-term best interests of the shareholders; and
• ensures sustainable value of the company in conformity with the laws and ethics of the country.
Islamic banks are subject to an additional layer of governance since the suitability of their investment and financing must be in strict conformity with Islamic Law. For this purpose, Islamic banks employ an additional layer of governance, the Shari’a advisory board. All the complex factors involved in balancing power between the CEO, the board, the shareholders and the Shari’a board members can be considered parts of the corporate governance framework. Tasks include auditing, ensuring Shari’a compliance, selecting officers and advisors, remuneration of management and advisors, balance sheet and off-balance disclosure and ensuring transparency.
Islamic finance is based on ethics, fairness, and justice to all people as taught by the Holy Qur’an. Muslims have a moral responsibility to their parents, family, relatives, and to the entire community. No one is privileged or immune from accountability; even Prophets of Allah have been shown to be accountable to Allah for their words and actions. Consider this quote from the Holy Qur’an (Al-Maidah, 5/116):

And when Allah will say: O Isa, son of Marium! Did you say to men, Take me and my mother for two gods besides Allah he will say: Glory be to Thee, it did not befit me that I should say what I had no right to (say); if I had said it, Thou wouldst indeed have known it; Thou knowest what is in my mind, and I do not know what is in Thy mind, surely Thou art the great Knower of the unseen things.

It is very important that Muslim scholars who represent Islam in the most important issues affecting Muslims and non-Muslims alike, such as dealing with money, are shown to be accountable and equitable:

And from among you there should be a party who invite to good and enjoin what is right and forbid the wrong, and these it is that shall be successful. (Quran, Ala Imran 3/104)

The finance industry is no different from any other industry that provides professional services. Almost all professionals offering consultancy and advisory services are accountable to a code of ethics that regulates their industries and all members are accountable for their conduct. They can be prevented from offering their services and may be charged if proven incompetent or fraudulent. Shari’a advisory boards are a notable exception. In Islamic banking and finance, there seem to be no codes of ethics or accountability, no minimum qualifications required for members, and no requirement of specific experience in the field of finance or Islamic law. Above all, board members do not obey any regulations and are not responsible to regulators to ensure that Islamic finance is a credible system, compatible with the conventional finance system. We will deal with the conventional system’s ethical basis now.
ETHICS OF THE SHARI’A AND CONVENTIONAL FINANCIAL SYSTEMS

The conventional financial system has evolved greatly over the last two centuries and has contributed a great deal to the development of not only the Western world but also to that of a substantial number of developing countries. The mention of Islamic finance raises the question of whether there is a strong rationale for the establishment of a parallel system. The rationale would exist only if it could be shown convincingly that the Islamic system is capable of addressing successfully some of the problems that the conventional system has been unable to address. There is general agreement that every system must ultimately lead to the wellbeing of all people. One of the measures that Islam has adopted for ensuring greater justice for all is to introduce the principle of risk-reward sharing instead of interest in financial intermediation.
While the conventional financial system has generally been considered to be superior with regard to efficiency, certain conventionally structured capital market products (e.g. derivatives products) led to the financial crisis of 2008–09. The introduction of the minimal-risk Islamic financial system over the past 10–15 years has added a healthy dimension to the international financial system. In addition to injecting greater justice into the system it has also helped make the financial system healthier and more stable by adding greater disci¬pline into it.
A large number of Islamic financial institutions have been established worldwide and Islamic financial services are now available in most jurisdictions around the world. These institutions are playing an important role in catering to the financial needs of a wide spectrum of society. The innovative products they have provided have not only widened the coverage of financial services but also deepened the financial markets. Nevertheless, the system is still in its initial phase and thus has a long way to go before it can optimize efficiency and enable Muslims to be confident that these institutions have made headway in the realization of the maqasid al-Shari’a (the objectives of Islamic law).
The conventional financial system has a code of ethics and conduct to which all key personnel, including management, are accountable. Otherwise the system could not have survived and expanded to the level it has reached.
It is therefore imperative for the Islamic financial system to become institutionalized and properly regulated not only by institutions’ internal regulatory boards and authorities but also by external, accountable Shari’a boards. This makes it necessary to evaluate the performance of modern Islamic banking and Islamic financial institutions regularly and have the Shari’a board members transparent, accountable, and adequately qualified in terms of experience and ongoing education.
SHARI’A SCHOLARS
Shari’a scholars are the main component of all Shari’a advisory bodies. A Shari’a scholar is commonly referred to as a person with experience in Shari’a or who has a strong background in fiqh, usul fiqh, and particularly fiqh muamalat, which outline Islamic commercial law and contracts. However, the current trend requires scholars to have reasonable experience in and knowledge about the modern conventional banking and financial system, so that they are able to distinguish between the two systems.
The basic duties of Shari’a scholars in the Islamic finance institution include:

• Advising management and shareholders on Shari’a matters;
• Structuring new Shari’a-compliant products within the global internationally-developed standard;
• Issuing fatawa for Shari’a-compliant product development;
• Proposing Islamic risk management tools to management;
• Enforcing Shari’a auditing standards in the procedures of their institution;
• Strengthening the corporate governance of Islamic financial institutions;
• Instilling Islamic finance values into financial institutions’ business operations and governance;
• Conducting and/or supervising Shari’a audits to ensure compliance;
• Ensuring Islamic ethical principles are preserved within the institution;
• Protecting consumers’ rights from abuse and fraud;
• Ensuring the adoption of Basel II and Pillar II, particularly in regard to the prevention of money laundering and capital adequacy issues within their institution; and
• Ensuring management accountability to the shareholders and customers.

Shari’a scholars need to equip themselves with a good command of English and Arabic. This will enable them to study and discuss global financial market ethics and principles as well as the the Quran, in whose pages the solutions to all their tasks ultimately lie. They should be able to present and negotiate Shari’a-compliant products with conventional finance professionals to achieve a common understanding of the two systems.
The scholar must also possess “noble”, less tangible characteristics, such as trustworthiness, honesty, responsibility, and accountability. The scholar must be able to develop his knowledge and skills and equip himself with adequate exposure to the global financial market, and must be flexible, dynamic and prepared to face daily challenges.
Shari’a scholars are also responsible to the investors and the clients of Islamic financial institutions, as they are the principal stakeholders of the institutions. The scholars must also perform their roles with diligence, especially in ensuring that the products and services offered are in compliance with the highest Shari’a standards and requirements. Shari’a scholars also act as enablers for customer advocacy.
Modern Islamic finance practices require scholars to be alert to the different needs and ever-changing circumstances, be they legal, tax or regulatory requirements. They also need to be adept at assessing the economic implications of products and to be innovative in overcoming all obstacles to come up with competitive Islamic financial products. This is vital if Shari’a scholars are to play their role efficiently, to shape their advisory bodies well, and ensure the success of the industry. If they are successful, Shari’a applications will be extended into other areas of Islam, making it relevant to and competitive with the rest of the world’s industries. Shari’a applications must be seen to be viable and ethical as well as profitable.
A role that is harder to define, measure and monitor is their work towards the harmonization of fatawa and the global development of Islamic finance. This will happen over generations thanks to their comparatively small efforts, but this still brings us back to their competence and attentiveness to each board and each decision.
The above-mentioned roles of Shari’a scholars demonstrate the need for determination, vigilance, commitment, seriousness, and competency in Shari’a scholars. These individuals must not be mere rubber stamps, but professionals who endorse a product after full inspection and with the satisfaction that the product is Shari’a-compliant. Their role is nothing less than ensuring that the Islamic financial system develops in line with the Quran, and millions of Muslims rely on them to do a thorough job. But as Islamic finance expands into the non-Muslim markets, it is its financial soundness, rather than, say, its avoidance of pork and alcohol, that will determine its success or failure.
The rapid growth and advancement of Islamic finance has been underpinned by the desire to develop Shari’a standards and frameworks for product development. This has been initiated by international bodies such as Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the Islamic Financial Services Board (IFSB) or national bodies like the Shari’a advisory councils of central banks (e.g. in Malaysia, Pakistan, and Sudan), among other financial institutions. The task of those organizations within the Shari’a scholars’ framework is to ensure that the standards are maintained and followed, in order to protect the high level of integrity of Islamic finance ethics and principles.
SHARI’A ADVISORY BOARDS
A Shari’a advisory (or supervisory) board is composed of several Shari’a advisors. Shari’a advisors are defined as follows by the AAOIFI:

Shari’a advisors are specialized jurists, particularly in Fiqh Muamalah and Islamic finance, entrusted with the duty of directing, reviewing and supervising the activities related to Islamic finance in order to ensure that they are in compliance with Shari’a rules and principles. The views of the Shari’a advisors shall be binding in the Islamic Finance Institution area of supervision.
Therefore, unlike other advisory bodies, the decisions of Shari’a advisory boards are binding in relation to Shari’a matters. In this regard, they are not merely exercising an advisory role. Hence, because Shari’a is the backbone of the industry, in certain countries or institutions this body is called a Shari’a supervision body, as it better describes the actual and intended role of the body. For instance, the Shari’a Advisory Council of the Central Bank of Malaysia oversees and prevails over the Shari’a Advisory Committees of all other Islamic financial institutions in the country. It is the highest authority and must be referred to in any adjudication and arbitration process that involves an Islamic finance issue.

And Allah’s is what is in the heavens and what is in the earth, that He may reward those who do evil according to what they do, and (that) He may reward those who do good with goodness. (Quran, N-Najim 53/31)
Observations of the various Shari’a advisory boards around the globe indicate that there are discrepancies in the Shari’a governance systems. The variations include procedures, extent of power and levels of Shari’a advisory bodies, accountability, composition, stipulations of qualifications of Shari’a scholars, and the accounting standards applied.
In some countries there is a Shari’a advisory council at central level. The Shari’a scholars sitting at the central level are suitably qualified and accountable to the government. Since individual financial institutions employ in-house Shari’a advisory boards, the central Shari’a advisory council might also review the decisions or ijtihad made by its scholars in various financial institutions, but not their qualifications or their accountability. So although the central body might well filter out bad policies, it is an inefficient way of creating products.

No bearer of burden shall bear the burden of another. (Quran, Al Ana’m 6/164)

Such an arrangement is not applicable in some jurisdictions, for example, where the decisions (ijtihad) or the qualifications and accountability of the Shari’a advisory board at the institution level are binding and not subject to the review of higher authority. Such a predicament is based on the argument that an ijtihad cannot be invalidated by another ijtihad. In addition, the decisions of Shari’a advisory bodies do not constitute an ijmaa’ (consensus), the system operating on the basis of collective ijtihad, where Shari’a scholars decide as a group. However, in the event that they cannot reach a unanimous decision, the views of the majority will prevail.
Certain countries or institutions adopt the practice of including experts from other related fields of specialization in the Shari’a advisory board. Ideally, the composition of Shari’a advisory boards may include experts in Shari’a, legal, accounting, and finance matters. This will assist the Shari’a scholars in considering the macro and micro dimensions of the products and policies, and thus allowing them to reach better, more precise and more up-to-date decisions.
As for the question about the number of scholars on any board, there is no strict or fixed number of members. It depends on the need and extent of the services required. The IFI Standard recommends that there be at least three members.
The same is recommended by the Central Bank of Malaysia, through its Guidelines on the Governance of Shari’a Committees for Islamic Financial Institutions. It is pertinent for Islamic financial institutions to be aware in their selection of the members of a Shari’a advisory board that members should complement each other in terms of experience, knowledge, and qualifications to ensure the effectiveness of the institution and its decisions and to preserve its integrity.
THE DEMAND FOR SHARI’A BOARD MEMBERS
The Islamic finance industry, which is in desperate need of Shari’a scholars as board members, sometimes recruits without due diligence. In fact, there are no reliable references as to the process for the selection of scholars. The way they are selected is not in accordance with their qualifications and experience, but is determined simply by factors such as who attends conferences and seminars, who is popular (or has a louder voice), whether a candidate can convince influential people of his understanding of Islamic jurisprudence, and who sits more frequently on more Shari’a boards. One Shari’a board member will be asked to recommend two or three other members, and will generally recommend people with whom he sits on another organization’s board, or maybe a college friend. This friend will return the favor by recommending him to another board, and so on. Thanks to this system, one individual, Sheikh Nizam Yacobi, is seen to sit on 77 different boards, another on 72, another on 64, and so on. Table 1 shows the top 20 Shari’a board members and their engagements.
Having one Shari’a board member sit on 77 boards is neither efficient nor effective. If we assume that the average number of transactions per year for each Islamic finance institution (IFI) is 150, one member is responsible for 11,500 transactions per year. We would assume he needs time to eat, drink and attend to natural human needs and family commitments. How would he have the time to travel to and from one IFI, get time to see other clients for further sittings on other boards (either as a member or as the chairman of the board)? Where will he get time to pray and perform normal Islamic duties, to read the news, keep up to date with global financial developments, and monitor indices? How will he get time to do research and to develop new products?
A compelling drive for scholars to sit on quite so many boards is the attainment of individual wealth, power, and influence. But as we have seen above, the more boards a scholar attends, the less time each IFI is granted individually and there will almost inevitably be mistakes, something that Islamic finance can do without, particularly in its early stage. Whatever the individual scholars’ reasons are to sit on numerous Shari’a boards, it has gone way beyond an acceptable level, so far in fact that it damages the principles for which Islamic finance stands.
A client who wanted to raise money through Islamic finance for real estate development has consulted the author on this matter. The client had 50% of the total cost of the project and was offered the remainder by a well-known IFI, whose Shari’a board members include one of the top 20 from Table 1. They offered a Tawaroq deal (in fact it was a fixed-interest loan re-named as Tawaroq) whose multitude of hidden costs made the overall deal more expensive than a fixed-interest loan from a conventional bank. The bank confirmed that each transaction had been examined and approved by the Shari’a scholars, and obviously the bank manager used the names of the Shari’a board team to market the products. From this information alone it is clear that the most important deals the bank offers are not in accordance to the fatawa passed by the Shari’a board, because there is no way the Shari’a board would approve such deals. They are not aware of such practice, they are not consulted on any deal, and they do not have the time to do even a random audit of the transactions conducted by the IFIs. Because of the absence of accountability, Shari’a board members get engaged in many IFIs and become merely names used for marketing products. This is a failure in the basic meaning of “Shari’a compliant.” Is that the reason IFIs recruit Shari’a board members who are popular, busy, and do not have time to look carefully at the transactions and yet market products under the label of Shari’a compliant? If such practice were found to take place in the conventional banking system numerous people would be charged and possibly end up in prison – a Madoff every week.
EDUCATION
It has also become clear that there is no program in place for educating and training the new generation of Shari’a board members. Shareholders and clients of IFIs expect their investment to be protected by professionals adhering to strict standards of corporate governance. To protect the system from abuse and fraud there must be corporate governance in which the IFIs are directed, controlled, and forced to adopt structures and processes which incorporate the values of fairness, transparency and accountability.
The practical function of corporate governance is to put in place a system which will deliver a company’s business objectives to increase shareholder value and offer efficient, accountable services to clients and the public at large, whilst managing risk. IFIs share the same practical and business objectives, but are subject to an additional layer of compliance with Shari’a rules and principles. IFI objectives are not only to seek to offer Islamic finance services but also to make a profit, but only in a socially responsible manner.
Sitting on a board demands competence and an understanding of both complex mathematic concepts and immutable Quranic tenets. With the current generation of board members ageing, education of the next is therefore a vital and urgent step in the process.
DEVELOPMENT OF ISLAMIC FINANCE AND BANKING
The recent and rapid development of Islamic finance and banking is proof that it now constitutes a financial system able to compete globally with the conventional financial system. The recent global credit crunch has placed Islamic finance and banking in a position to become an alternative to the conventional system. The Islamic capital markets, Takaful, and Islamic money markets are regarded as fairer and more just schemes to investors and non-investors alike. Islamic finance is a system that rests on sharing profit and loss and sharing risk between all parties involved, which derives from the fairness inherent in Islamic principles. But to work effectively and legitimately, the system requires the assistance and advice from Shari’a scholars who understand and are able to translate the teachings of the Quran into the 21st-century financial and economic systems.
Islam is a way of life, and Shari’a scholars have struggled to create products, services, and an overall system that are strictly Shari’a compliant, and this has given birth to the Islamic banking and finance industry. Shari’a scholars throughout history who have discussed and elaborated on basic “Muamalah” concepts have assisted such efforts. Modern Shari’a scholars have continued their efforts by exploring this subject further and examining both Islamic Muamalah and the modern economic system.
Advisory services are common to all sectors, as they ensure healthy and successful operation, as well as preserving the integrity of the industry. Likewise, Shari’a advisory bodies are initiated to advise Islamic finance product/service providers on Shari’a compliance matters. These boards are normally composed of a number of Shari’a scholars who provide advice and guidance on matters within their specialist field of knowledge. It is impossible to overstate the importance of these bodies, as they not only set the distinction factor between Islamic and conventional banks but they also act as the bridge between individuals’ financial aspirations and the words and interpretations of the Quran.
SHARI’A ADVISOR CHALLENGES FOR THE INDUSTRY
As Islamic finance is still in its early stages compared to a conventional system that has had hundreds of years of developments and gained valuable experience, the situation requires Shari’a scholars to equip themselves well. They need to develop themselves quickly, in line with the rapid advancement of the industry in the increased liquidity and fast development of capital market products. There are still many challenges and weaknesses that need to be settled by contemporary Shari’a scholars:

1. There is a lack of knowledge and understanding among Shari’a scholars about the global economic system, along with insufficient understanding of the structure, objectives and implications of the products and policies.
2. There is the issue of the shortage of new and young scholars. The absence of new Shari’a scholars is one of the industry’s current concerns and has been caused largely by the nepotistic attitude prevalent since the emergence of the industry. To fix it will require all the relevant authorities to invest in developing and training Shari’a scholars, as well as maximizing the efforts of the existing and senior scholars as mentors to guide the young talents to assume their role as catalysts for the further development of the Islamic finance industry. One solution is to expose the young talent to the modern operations and the global practices of Islamic finance in conjunction with providing a solid Shari’a background. One of the suggested training methods is to allow a junior scholar to attend and participate in the meetings of Shari’a advisory bodies. However, to erode the culture of scholars serving on multiple boards, these young scholars should be encouraged to become deeply involved with and committed to a single board. There is an index issued by Filaka / Dowjones listing over 100 Shari’a scholars from different parts of the world with their qualifications and portfolio, and Funds@work issues a survey of 200 Shari’a scholars and their engagements.
3. Innovation of products is key to the development and survival of the Islamic financial system, both regulatory and legal. There is the increased challenge to balance between monetary and Shari’a objectives and financial and tax requirements in product development.
4. To ensure clear and transparent procedures of decision-making, as well as the independence of Shari’a scholars, and to ensure clear and transparent procedures of appointments, qualifications and accountability of Shari’a board members should be guaranteed.
5. Privacy and confidentiality must be assured, as the absence of full disclosure on the part of the financial institutions can prove to be detrimental to the legitimacy of products and can affect the rights of customers.

Not surprisingly, this all brings us back to accountability. Responsibilities should be realized and initiated by Shari’a scholars in the Islamic financial system. Such efforts will, however, fail without the firm support from investors and industry players.
Considering the importance of their role, particularly for devout Muslims relying on their interpretations and decisions to invest with complete peace of mind, one would have certain expectations of IFIs’ Shari’a scholars. Primarily, one would assume they were accountable and suitably qualified to be able to conduct their duties in a professional manner, in positions similar to judges, lawyers, accountants, physicians, bank managers, and financial managers whose roles are at the peak of their fields. When it is considered that Shari’a advisory bodies can effectively shape the Islamic financial system in a world where ripples of failure or even doubt can have globally catastrophic results, it becomes clear that solid personal qualification carries more safeguards than nepotism, back-room recommendations, and old school ties. In short, there is a wide gulf between what a reasonable observer would expect of the system and the reality on the ground.
The AAOIF recommended that Shari’a supervisors should serve under the company’s board of directors and not the management. It is highly desirable that Shari’a board members be elected by the shareholders in order to ensure the integrity of the board. It must also be assured that scholars are able to play their role free from fear of conflict of interest. It is important to highlight that the development of the banking system is closely associated with distribution and accuracy of information. It is vital that Shari’a standards are upheld by international bodies such as the AAOIF, the Islamic Financial Services Board (IFSB) and the Islamic Fiqh Academy. The IFSB released a draft document in December 2008 providing Guiding Principles on the Shari’a governance system, which is expected to:

(a) Complement other prudential standards issued by the IFSB by highlighting in more detail, to the supervisory authorities in particular and the industry’s other stakeholders in general, the components of a sound Shari’a governance system, especially with regard to the competence, independence, confidentiality and consistency of Shari’a boards;
(b) Facilitate a better understanding of Shari’a governance issues and outline how stakeholders should satisfy themselves once an appropriate and effective Shari’a governance system is in place;
(c) Provide an enhanced degree of transparency in terms of issuance, and the audit/review process for compliance with Shari’a rulings; and
(d) Provide greater harmonization of the Shari’a governance structures and procedures across jurisdictions, especially since there are increasing numbers of IFIs with cross-border operations.

Two aims are missing:

(e) To establish a corporate governance framework for the Islamic finance industry, to build on and complement existing international standards and encourage institutions to view compliance as part of a general strengthening of good corporate governance culture.
(f) To include accountability. Accountability is the most important issue in the guide because the ISFB members are the institutions who offer Islamic financial services and it is in their interest to regulate the industry and make it accountable for the confidence of the general public and the industry.

Principles of good business conduct are desirable in terms of protecting investor interests and enhancing the integrity of the institutions concerned. It is also a requirement under Shari’a that companies observe principles of ethical business conduct. Furthermore, the principles of certainty and transparency strengthen the validity of a Shari’a-compliant contract.
TWO RECENT DRAFTS ISSUED BY THE IFSB
The IFSB has recently issued two important drafts: “Guiding Principles on the Shari’a Governance System” and “IFSB Exposure Draft on Conduct of Business.”
The guides focus only on the following issues:

1. General approach to the Shari’a governance system;
2. Competence;
3. Independence;
4. Confidentiality; and
5. Consistency.

The IFSB has issued nine Standards, Guiding Principles, and Technical Notes for the Islamic financial services industry. The published documents cover:

• Risk Management (IFSB-1);
• Capital Adequacy (IFSB-2);
• Corporate Governance (IFSB-3);
• Transparency and Market Discipline (IFSB-4);
• Supervisory Review Process (IFSB-5);
• Recognition of Ratings on Shari’a-Compliant Financial Instruments Development of Islamic Money Markets (TN-1);
• Governance for Collective Investment Schemes (IFSB-6); and
• Special Issues in Capital Adequacy (IFSB-7).

The IFSB is also working on three new standards. They are:

• Corporate Governance in Takaful Operations;
• Shari’a Governance; and
• Conduct of Business.
THE GUIDING PRINCIPLES ON THE CONDUCT OF BUSINESS
The Guiding Principles on Conduct of Business adopt a principles-based rather than a purely rules-based approach. It is intended that the seven principles outlined in the exposure draft will form the basis of a code of business conduct which is observed by all IFIs, and which complements existing standards.

Principle 1
Honesty and Fairness – IFIs should treat all shareholders fairly and aim for the highest standards of honesty and integrity in all dealings with shareholders.

Principle 2
Due Care and Diligence – IFIs should exercise due care, skill, and diligence in their dealings with all categories of investors. An IFI will be expected to carry out proper evaluations of risk in relation to any investment activity and undertake appropriate reviews of the process of obtaining Shari’a approval and of the Shari’a compliance of asset portfolios.

Principle 3
Capabilities – An IFI must ensure that its senior management, staff and representatives are capable of discharging their duties competently. In particular, it is expected that those parties will have an appropriate understanding of Shari’a and this principle must be continually kept under review.

Principle 4
Information about Clients – An IFI must undertake “know your customer” checks to ensure that an investor’s business and the purpose of any financing are consistent with Shari’a rules and principles.

Principle 5
Information to Clients – Reporting processes must be transparent and fair. An IFI must protect investors and potential investors by providing them with information that appropriately reflects the nature of its products and services and the associated risks.

Principle 6
Conflicts of Interest and Duty – As much as possible, an IFI should avoid situations that create a conflict of interest. When such a conflict cannot be avoided, the situation should be managed to ensure that all stakeholders are treated fairly and any issues are addressed in a transparent and open manner.

Principle 7
Shari’a Compliance – An IFI must adopt and implement appropriate Shari’a governance systems in order to monitor its Shari’a compliance. Since Shari’a compliance is of paramount importance in the context of IFIs, this issue is addressed more fully in a separate exposure draft as set out below.
GUIDING PRINCIPLES ON THE SHARI’A GOVERNANCE SYSTEM
Previous IFSB publications highlighted a particular concern over the role and function of Shari’a boards within the Islamic financial services industry. Shari’a boards play a key role in advising institutions on their compliance with Shari’a rules and principles. While other IFSB publications have contained recommendations for ensuring appropriate Shari’a governance systems are in place, the Guiding Principles on the Shari’a Governance System were a response to the industry’s need for greater clarity in this fundamental area.
“Shari’a Governance” is defined as the set of institutional and organizational arrangements through which an IFI ensures that there is effective independent supervision of the issue and dissemination of Shari’a pronouncements and internal and external Shari’a compliance reviews.

Principle 1
General Approach – Various different Shari’a governance structures have been adopted in different jurisdictions. The systems adopted should be proportionate to the size, complexity, and nature of the business. Shari’a boards should have a clear mandate and be equipped with operative procedures and reporting lines to provide effective Shari’a governance.

Principle 2
Competence – The choice of the scholars and other individuals whose role is to provide Shari’a advice should be made on the basis of an individual’s honesty, good character, and possession of the necessary qualifications to understand the technical requirements of the business. The need for ongoing professional development of such individuals is also crucial to ensure that they are kept up to date with legislative changes. Shari’a boards should be regularly assessed in relation to objective performance criteria and be accountable to the board of directors, shareholders and the public.

Principle 3
Independence – No individual member of a Shari’a board should be “connected” with the company or serve another function within the company. Each member should be capable of exercising independent judgment. The management of the IFI should ensure that all relevant information is supplied to the Shari’a board promptly and in such a manner that enables the board to discharge its duties properly. This will involve giving the Shari’a board independent access to senior management and providing for any further enquiries that may be made.

Principle 4
Confidentiality – Members of the Shari’a board will inevitably be exposed to commercially-sensitive inside information in the discharge of their duties. As part of its broader risk management processes, an IFI should ensure that adequate confidentiality clauses are included in each member’s service contract. There should also be a procedure for dealing with leaks of inside information, which may include some form of disciplinary action.

Principle 5
Consistency – Decisions of Shari’a boards should be consistent and, as far as possible, follow the pronouncements of the central Shari’a authority in the relevant jurisdiction where applicable. Where no such authority exists, it is recommended that the Shari’a board use best efforts to conform to any previous rulings and to publish its decisions so that they may be openly and transparently assessed.
MODELS OF SHARI’A GOVERNANCE FROM UNITED ARAB EMIRATES (UAE) AND MALAYSIA

United Arab Emirates’ Model
• Establishment of “Higher Shari’a Authority” to supervise Islamic banks, financial institutions and investment companies (Art. 5, Federal Law no. 6 of 1985)
• These authorities shall be accorded the final authority in Shari’a matters in Islamic banking and finance
• Formation of Shari’a supervision authority at the financial institution level (Art. 6 of the same law)
• Nothing is mentioned about any restrictions, appointments, duties, qualifications, accountabilities or ethics.
Malaysian Model
The establishment of Shari’a Advisory Council (SAC) at Bank Negara Malaysia (BNM) was by virtue of Section 16B of the Central Bank of Malaysia Act 1958 (CBA).

• The SAC is the final authority in matters relating to:
o Islamic banking business
o Takaful business
o Islamic financial business
o Islamic development financial business
o Any other business which is based on Shari’a principals and is supervised and regulated by Bank Negara Malaysia
• The court or arbitrator in disputes involving Shari’a issues in Islamic banking and finance and Takaful will refer to the SAC of BNM
• In the case of the court the SAC resolution shall be taken into consideration on the court (advisory)
• BNM also issued “Guidelines of the Governance of Shari’a Committees for Islamic Financial Institutions (BNM/GPS1)” which provides that:
o A Shari’a body which is to be known as a “Shari’a Committee” is to be established by each and every Islamic bank, Islamic window and Takaful operation
o Relationship of all Shari’a committees play a complementary role to the SAC of BNM
o Members of SAC of BNM are not allowed to serve in the Shari’a committee of any financial institutions
o One Shari’a advisor can only serve as a member of a Shari’a committee in one financial institution in the same industry (Islamic banking and Takaful are considered to be different industries)

Appointment of members of a Shari’a committee
• The Board of Directors of an Islamic financial institution upon recommendation of its Nomination Committee shall appoint the members of the Shari’a Committee.
• Written approval from Bank Negara Malaysia must be obtained prior to the appointment and reappointment of a Shari’a Committee member.
• The appointment shall be valid for a renewable term of two years.
• In approving the appointment and reappointment, Bank Negara Malaysia may impose any necessary conditions it deems fit in addition to the requirements
• The failure to comply with any of such conditions shall nullify the approval.

Qualification
• A member of a Shari’a Committee must be an individual
• The proposed member shall at least possess necessary knowledge, expertise in the areas of Islamic jurisprudence (Usul al-Fiqh); and/or Islamic transaction/commercial law (Fiqh al-Mu’amalat).

Disqualification
The members of the Shari’a Committee shall be persons of acceptable reputation, character, and integrity. Bank Negara Malaysia reserves the right to disqualify any member who fails to meet the requirements. In particular, any member may be disqualified due to any of the following breaches of corporate governance:

• He has acted in a manner which may cast doubt on his fitness to hold the position of a Shari’a Committee member.
• He has failed to attend 75 per cent of meetings scheduled for the Shari’a committee in a year without reasonable excuse.
• He has been declared bankrupt, or a petition under bankruptcy laws is filed against him.
• He was found guilty for any serious criminal offence, or any other offence punishable with imprisonment of one year or more.
• He is subject to any order of detention, supervision, restricted residence, or banishment.
• Upon the discovery of any of the aforementioned situations, the Islamic financial institution shall terminate the appointment of the Shari’a member.

Resignation and Termination
An Islamic financial institution shall notify Bank Negara Malaysia of any resignation or termination of a member of the Shari’a Committee within fourteen days of the date of resignation or termination. The notice shall state the reasons of such termination.

Restrictions on the Shari’a Committee
The members of the Shari’a Committee are subject to the following restrictions:

• To avoid conflict of interest and for reasons of confidentiality within the industry, an Islamic financial institution is not allowed to appoint any member of the SAC (Shari’a Advisory Council for Islamic banking and Takaful) to serve in its Shari’a Committee.
• An Islamic financial institution shall not appoint any member of a Shari’a Committee in another Islamic financial institution of the same industry.

Duties and Responsibilities of the Shari’a Committee
All Shari’a Committee members are expected to participate and engage themselves actively in deliberating Shari’a issues put before them. The main duties and responsibilities of the Shari’a Committee are as follows:

• To advise the Board on Shari’a matters in its business operation
• To endorse Shari’a Compliance Manuals
• To endorse and validate relevant documentations
• To assist related parties on Shari’a matters for advice upon request
• To advise on matters to be referred to the SAC
• To provide written Shari’a opinion
• To assist the SAC on reference for advice
• To refer all Shari’a issues to the Shari’a Committee
• To adopt the Shari’a Committee’s advice
• To ensure that product documents be validated
• To have a Shari’a Compliance Manual
• To provide access to relevant documents
• To provide sufficient resources
• To remunerate the members of the Shari’a Committee accordingly.
CONCLUSION
As the Islamic finance industry develops further, there is a growing need for standardization and professionalism across the industry. Coupled with this is the importance of adopting internationally recognized and robust corporate governance systems that incorporate transparent, fair, and ethical working practices. Islamic financial institutions are well placed in this context, since at the heart of Islamic law is a vision of social development which requires all individuals and businesses to conduct themselves ethically and in a socially responsible manner. The Guiding Principles demonstrate how closely aligned the basic principles of corporate governance are with Shari’a rules and doctrines, and consequently how IFIs are well placed to offer shareholders opportunities to participate in a broader goal of corporate social responsibility.
The prospects for the Islamic banking and finance industry are very bright but the task ahead is challenging. It requires not only the active participation of the Shari’a advisors, but also that of the regulators, practitioners, economists and legal experts if a complete and comprehensive system is to be developed. Islamic finance, as one aspect of human life, is a form of ibadah (worship) if it is conducted in accordance with the rule of the Almighty and as such, has to be upheld by all players in the Islamic finance industry. The ultimate reminder is this Prophetic saying: “Every one of you is guardian and each of you is responsible for the things or people that are under your care.”
The IFSB guide fails to include accountability and qualifications for Shari’a board members, even though accountability is the most important issue. Since the IFSB members are the institutions who offer Islamic finance services, it is in their interest to regulate the industry and gain the confidence of the general public and the industry.
The selection of Shari’a board members by IFIs should be made on the basis of suitable qualifications in Islamic finance studies, requiring at least Masters, but preferably doctoral, degree. They should be experts with a Shari’a background or who possesses good knowledge of fiqh and usul fiqh (Islamic Law), legal, accounting and finance matters. The scholar should possess good command of English and Arabic, and possess characteristics such as trustworthiness, integrity, honesty, and responsibility. The scholar must have had adequate exposure to the global financial market, be flexible, dynamic, and prepared to face additional challenges. To ensure full attention to each institution, the scholar should not be engaged in many other Islamic financial institutions, and preferably he should sit on just one board. This will also help resolve confidentiality and conflicts-of-interest issues. A scholar should accept personal accountability for his expertise to the organization, its shareholders, and the customers of the organization he represents. In short, the Shari’a board member should be an individual of the highest caliber, both professionally and personally.
The approach by Bank Negara Malaysia must be considered as an example of best practice because of their experience in operating an Islamic finance system parallel to the conventional system for over 25 years. They recommend that the appointment of Shari’a board members must have the approval first of the Bank Negara Malaysia. The bank will then ensure that the members are not sitting in several Shari’a boards. It will also scrutinize the proposed member’s qualifications, experience in Islamic jurisprudence (usul-al-fiqh) and Islamic commercial law (muamalat), and check if the member is unfit to serve or has been disqualified, and check that there is no conflict between the Islamic finance institutions.
The effects of Shari’a board members who sit on a more than acceptable number of IFIs are detrimental and numerous:

• It gives no credibility worldwide for Islamic finance
• It creates no confidence amongst investors
• It create no confidence among the general public
• It gives no personal credibility to individual Shari’a board members
• It makes the Islamic finance system incompatible with the conventional system on equal terms
• It makes Islamic principles inferior in terms of transparency, ethics, fairness, justice, and honesty
• It puts Shari’a board members under extreme pressure. This could lead to very expensive mistakes being made, both in their fatawa and auditing which may lead to its self-destruction.

Conversely, achieving accountability will have far-reaching advantages:

• Those IFIs whose aims are to profit from a “new” and “ethical” system by engaging Shari’a boards merely to act as rubber stamps for the sake of PR and publicity will find it difficult to maintain credibility; to make their institutions credible they will be forced to take extra care to engage Shari’a board members who are accountable and qualified.
• The authenticity, credibility, seriousness, and trustworthiness of Shari’a board members themselves will be enhanced.
• It strengthens global respect of fatawa issued for product development compliant with the Shari’a.
• It introduces Shari’a auditing standards to the global financial market.
• It strengthens the corporate governance of Islamic financial institutions.
• It embeds Islamic finance values into financial institutions’ business operations and governance.
• It ensures Islamic ethical principles are preserved within the global market.
• It protects consumers’ rights from abuse and fraud from the conventional finance monopoly.
• It ensures the adoption of Basel II and Pillar II, particularly money laundering and capital adequacy issues within their institutions.
• The conventional financial system has a code of ethics and conduct, which all key personnel including management are accountable; therefore, for the Islamic financial system to compete with the conventional financial system, it is imperative to have a code of ethics and conduct.
• It necessitates evaluation of the performance of Islamic financial institutions regularly, and ensures that Shari’a board members are transparent, accountable, and adequately qualified.

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