Durham

 Islamic  Finance  Autumn  School  

2011  in  Istanbul  

Shariah  Governance  
in  Financial  Ins@tu@ons  
 
Mohammad  Farrukh  Raza  
Managing  Director  –  IFAAS  (UK,  France  &  Bahrain)  
 

Presented  at  the    

Durham  Islamic  Finance  Autumn  School  2011  
jointly  organised  by    
Durham  Centre  for  Islamic  Economics  and  Finance  and    
ISAR-­‐Istanbul  Foundation  for  Research  and  Education  
Istanbul  Commerce  University,  Istanbul  
19th-­‐22nd  September  2011  
©  2©  011  
2009  IIFAAS  
FAAS.   All  All  rights  
UK  Ltd.   reserved.        
rights  reserved.  

TABLE  OF  CONTENTS    

§ Shariah  and  financial  ins@tu@ons  
Ø Types  of  Islamic  financial  ins@tu@ons  
Ø Dual  Governance  model  
§ Shariah  Supervisory  CommiOee  “SSC”/Shariah  Board  
Ø Defini@on  
Ø Composi@on,  selec@on  and  dismissal  
Ø Morals  and  requirements  
Ø Roles  and  Responsibili@es  
Ø Example  of  SSC  at  work  
Ø SSC  mee@ngs  
Ø SSC  terms  of  reference,  powers  and  authori@es  
Ø Year  End  SSC  Shariah  report  
§ The  role  of  Shariah  Compliance  Officer  (SCO)  
§ Standardiza@on  in  Islamic  Finance  
§ Shariah  Standards  (AAOIFI)  
§ Controversies  &  Challenges  in  Shariah  governance  

Mohammad  Farrukh  Raza,  Shariah  

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Durham  Islamic  Finance  Autumn  School  
2011  in  Istanbul  

ABOUT  US  
IFFAS  UK  

IFAAS  France          

 IFAAS  Bahrain    

IFAAS  Offices  
IFAAS  Projects  

Government  of  Senegal  

SHARIAH  AND  FINANCIAL  INSTITUTIONS  

§ Islamic  financial  products  have  similar  objec@ves  as  
conven@onal  products  –  fulfilling  the  needs  of  customers  but  
in  a  Shariah  compliant  way  
§ Islamic  products  and  the  ins@tu@ons  providing  them  are  
subject  to  conformity  with  the  requirements  of  Shariah  
§ The  financial  ins@tu@ons  providing  Islamic  products  have  to  
conform  to  both  –  regulatory  and  Shariah  requirements  that  
vary  for  different  types  of  the  ins@tu@ons    

Mohammad  Farrukh  Raza,  Shariah  

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Durham  Islamic  Finance  Autumn  School  
2011  in  Istanbul  

TYPES  OF  ISLAMIC  FINANCIAL  INSTITUTIONS  

§ Windows  model  –  conven@onal  ins@tu@on  carrying  out  
Islamic  financial  transac@ons  which  are  segregated  from  the  
other  ac@vi@es  
§ Branches  –  dedicated  delivery  channel  just  providing  Islamic  
financial  services  
§ Subsidiaries  –  separate  legal  en@ty  owned  by  a  parent  
company  to  specifically  undertake  Islamic  financial  ac@vi@es  
§ Stand  alone  –  totally  independent  structure  
 

SHARIAH  REQUIREMENTS  FOR  FI’S  

§ Islamic  window  of  conven@onal  ins@tu@on  
Ø Segrega@on  of  funds  
Ø No  separate  balance  sheet  required    
§ Islamic  subsidiary  of  financial  ins@tu@on  
Ø Clean  funds  (may  be  provided  by  the  mother  company)  
Ø Separate  balance  sheet  required  (may  be  incorporated  into  the  group  
balance  sheet)  
§ Fully-­‐fledged  Islamic  financial  ins@tu@on  
Ø Shariah  fully  embedded  in  the  governance  model  of  the  FI  
§ All  models  need  a  Shariah  Board/Shariah  Supervisory  
CommiOee  (SSC)  to  supervise  the  Shariah  compliance  
§ All  models  operate  on  dual  governance  structures  

Mohammad  Farrukh  Raza,  Shariah  

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Durham  Islamic  Finance  Autumn  School  
2011  in  Istanbul  

DUAL  GOVERNANCE  MODEL  

Shariah  Framework     Regulatory  framework  
“SSB/SSC”   “NaJonal  Regulator”  
e.g.  BDDK,  CMB  etc    

Shariah  Sales  Policy       Trea@ng  Customers  Fairly  

Ethical  Trading     Transparency  
Profit  sharing   Risk  control  
Fairness   Social  responsibility  
Mutual  coopera@on   Money  laundering  
Social  responsibility   Know  Your  Customer  
Profit  distribu@on    

Islamic    Bank  

DUAL  GOVERNANCE  MODEL  

There  is  a  lot  of  similarity  between  regulatory  and  Shariah  
requirements  
§ Capital  adequacy  (Shariah  does  not  define  any  monetary  
adequacy  but  requires  the  ins@tu@on  to  fulfill  its  promises  and  
obliga@ons  on  assets  and  liabili@es  sides)  
§ TreaJng  Customers  Fairly  (The  ins@tu@on  is  required  to  ensure  
that  the  product  is  designed  and  implemented  according  to  the  
needs  of  the  customer  and  is  not  being  miss-­‐sold)  
§ Disclosures  (The  ins@tu@on  has  to  ensure  that  all  systems  are  
working  correctly  and  no  misrepresenta@ons  are  being  made)    
§ Data  ProtecJon  (The  ins@tu@on  is  bound  to  preserve  the  privacy  
and  confiden@ality  of  the  customer’s  personal  informa@on)  

Mohammad  Farrukh  Raza,  Shariah  

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Durham  Islamic  Finance  Autumn  School  
2011  in  Istanbul  

ISLAMIC  BANK  -­‐  CORPORATE  STRUCTURE    

Nomina@ons  
Shariah   CommiOee  
Supervisory  
Board  of  
CommiOee   Directors  
Remunera@ons  
CommiOee  
Shariah  guidelines  

Audit  
Managing   CommiOee  
Shariah   Director  
Compliance  
Officer  

Marke@ng   Finance   Internal    

Opera@ons   Sales   Audit  

           IT          HR  

SSC  -­‐  DEFINITION  

§ The  SSC  is  an  independent  regulatory  body  of  specialised  Muslim  
scholars  entrusted  with  the  duty  of  providing  guidance,  supervision  
and  cer@fica@on  of  Islamic  financial  products  to  ensure  that  they  
are  in  compliance  with  Shariah  rules  and  principles  
 
§ However  the  onus  is  on  the  management  to  raise  maOers  with  the  
SSC  whose  role  is  more  akin  to  a  regulator  (such  as  BDDK  or  CMB)  
than  to  an  internal  department  or  management  commiOee  
 
§ The  SSC  may  also  include  other  experts  in  areas  of  Islamic  financial  
ins@tu@ons  with  knowledge  of  Islamic  jurisprudence  rela@ng  to  
commercial  transac@ons  

Mohammad  Farrukh  Raza,  Shariah  

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Durham  Islamic  Finance  Autumn  School  
2011  in  Istanbul  

SSC  -­‐  COMPOSITION  AND  SELECTION  

§ The  SSC  should  be  appointed  by  the  shareholders  in  their  Annual  
General  Mee@ng  upon  the  recommenda@on  of  the  BOD  taking  
into  considera@on  the  local  legisla@on  and  regula@ons  
§ The  SSC  shall  consist  of  at  least  three  members  of  whom  one  will  
be  elected  as  the  chairman  by  the  fellow  members  
§ The  SSC  should  not  include  directors  (execu@ve  or  non-­‐
execu@ve)  or  significant  shareholders  of  the  financial  ins@tu@on  
§ Islamic  financial  ins@tu@on  is  required  to  have  a  minimum  of  one  
officer,  preferably  a  person  with  knowledge  in  Shariah,  who  will  
serve  as  the  secretariat  to  the  Shariah  CommiOee  (this  func@on  
may  be  outsourced)  

SSC  -­‐  DISMISSAL  

§ The  dismissal  of  a  member  of  the  SSC  shall  require  a  
recommenda@on  by  the  board  of  directors  and  be  
subject  to  the  approval  of  the  shareholders  in  the  general  
mee@ng  

§ SSC  members  are  disqualified  if  they  have  acted  in  a  

manner  which  may  cast  doubt  on  their  fitness  to  hold  the  
posi@on  of  a  Shariah  CommiOee  member  

§ SSC  members  are  dismissed  if  they  have  failed  to  aOend  
most  of    the  mee@ngs  scheduled  for  Shariah  CommiOee  
in  their  appointment  period  without  a  reasonable  excuse  

Mohammad  Farrukh  Raza,  Shariah  

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Durham  Islamic  Finance  Autumn  School  
2011  in  Istanbul  

SSC  -­‐  MORALS  AND  REQUIREMENTS  

§ SSC  member  should  be  Muslim,  with  faith  and  belief,  
mature,  wise  and  fair  in  his  rulings  
§ SSC  member  should  not  agree  on  something  if  he  is  not  
sa@sfied  with  its  interpreta@on  
§ SSC  member  should  have  a  good  reputa@on  in  the  
community  
§ Members  of  the  SSC  should  have  wide  knowledge  and  
a  degree  in  Islamic  Shariah  and  especially  in  “Fiqh  Al  
Mu’amalat”  (jurisprudence  of  financial  dealings)  
§ They  should  have  knowledge  in  business,  economics,  
accoun@ng  and  finance  

EXAMPLE  OF  SSC  AT  WORK  

Product  Concept   Ini@al  review  of  the   Building  the  product’s  
prepared  defining   SSC  on  the  principle   documenta@on  
the    underlying   and  the  product’s   according  to  the  
Islamic  Principles  of   main  condi@ons   direc@ves  received  from  
the  product     the  Scholars    

Scholars  review  the   Product  documenta@on  

Product  Launch   final  documenta@on   reviewed    by  legal  and    
and  issue  their   compliance    
approval    

Regular  &  periodic  Sahariah  

Audit  for  ongoing  assurance  
throughout  the  product  life  
cycle  

Mohammad  Farrukh  Raza,  Shariah  

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2011  in  Istanbul  

SSC  -­‐  MEETINGS  

§ The  number  of  SSC  mee@ngs  will  differ  from  one  IFI  to  another,  
but  usually  they  will  have  3  to  4  mee@ngs  a  year  
§ Decisions  will  be  taken  by  majority  of  votes    
§ A  follow-­‐up  will  be  conducted  in  every  mee@ng  to  resolve  
pending  Shariah  issues  
§ The  SSC  issue  fatwas  (ruling),guidelines  and  approve  
investment  agreements  and  products  documenta@on  
§ It  is  recommended  that  the  IFI  publishes  the  fatwas,  rulings  and  
guidelines  
 

SSC    -­‐  TERMS  OF  REFERENCE    

§ The  SSC  Terms  of  Reference  will  be  very  similar  to  any  other  
commiOee  of  the  IFI  and  it  will  include  the  following:  
1-­‐  Objec@ves:  mainly  to  ensure  Shariah  compliance  of  the  IFI  
2-­‐  Du@es  and  responsibili@es:  defining  the  scope  of  work  
required  from  the  SSC  
3-­‐  Membership:  describing  the  requirement  of  each  member  
and  the  term  of  the  appointment  
4-­‐  Mee@ngs:  defining  the  minimum  numbers  of  mee@ngs  and  
the  procedures  of  each  mee@ng  
5-­‐  Authority:  defining  the  authority  of  the  SSC  and  tools  
available  for  them  to  implement  their  rulings  

Mohammad  Farrukh  Raza,  Shariah  

Governance  in  Financial  Ins@tu@ons   8  
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2011  in  Istanbul  

SSC  -­‐  POWERS  AND  AUTHORITIES  

§ The  SSC  fatwas  (rulings)and  guidelines  are  binding  on  the  
IFI  
 
§ Shariah  compliance  is  the  backbone  of  Islamic  banking  
and  finance  
 
§ The  SSC  gives  legi@macy  to  the  prac@ces  of  Islamic  
banking  and  finance  
 
§ The  SSC  boosts  the  confidence  of  the  shareholders  and  
the  public  that  all  the  prac@ces  and  ac@vi@es  are  in  
compliance  with  the  Shariah  at  all  @mes  

SSC  –  YEAR  END  SHARIAH  REPORT  

§ The  SSC  will  issue  an  annual  report  sta@ng  whether  the  IFI’s  
ac@vi@es,  opera@ons,  contracts,  documents,  financial  statements  
and  income  are  in  compliance  with  the  Shariah  rules  and  principles  
 
§ This  report  usually  forms  an  integral  part  of  the  IFI’s  annual  report  
 
§ The  Shariah  CommiOee  report    will  be  addressed  to  the  
shareholders  
 
§ This  repor@ng  structure  reflects  the  status  of  the  Shariah  CommiOee  
as  an  independent  body  of  the  Islamic  financial  ins@tu@on  

Mohammad  Farrukh  Raza,  Shariah  

Governance  in  Financial  Ins@tu@ons   9  
Durham  Islamic  Finance  Autumn  School  
2011  in  Istanbul  

ROLE  OF  SHARIAH  COMPLIANCE  OFFICER  (SCO)  

§ Independent  role  within  the  ins@tu@on    
§ Coordinate  closely  with  the  SSC  for  all  Shariah  related  issues  
§ Ensures  implementa@on  of  all  SSC  direc@ves  and  resolu@ons  
§ Assist  the  IFI  departments  in  carrying  out  their  daily  ac@vi@es  
according  to  Shariah  principles  
§ Carries  out  Shariah  audit  of  the  different  func@onal  areas  
§ Reviews  products,  policies  and  procedures  throughout  their  
lifecycle  
§ Reports  any  Shariah  non  compliance  ac@vity  directly  to  the  MD  
and  the  SSC  
§ May  be  outsourced,  if  required  
 

STANDARDISATION  IN  ISLAMIC  FINANCE  

OrganisaJon   AAOIFI   IFSB   IIFM  
Full  name   Accoun@ng  &  Audi@ng   Islamic  Financial   Interna@onal  Islamic  
Organisa@on  for  Islamic   Services    Board   Financial  Markets    
Financial  Ins@tu@ons  

Domain   Shariah  Governance,   Pruden@al   Islamic  financial  

Products,  Accoun@ng,   requirements   contracts  (Commodity  
Audi@ng  and  ethics   (Financial  stability,   Murabaha,  Forex  
Capital  adequacy  ,   Swaps  etc)  
Risk  management)  

Main  clients   Financial  ins@tu@ons   Regulators  &  other   Financial  ins@tu@ons  

authori@es  
Base   Bahrain   Kuala  Lumpur   Bahrain  
(Malaysia)  

§  All  organisa@ons  working  in  different  spheres  

§  No  conflict  or  compe@@on  between  them  
§  Mutually  complementary  services  overseen  by  individual  independent  SSC’s  

Mohammad  Farrukh  Raza,  Shariah  

Governance  in  Financial  Ins@tu@ons   10  
Durham  Islamic  Finance  Autumn  School  
2011  in  Istanbul  

SHARIAH  STANDARDS  (AAOIFI)  

§ AAOIFI  (Accoun@ng  &  Audi@ng  Organisa@on  for  Islamic  Financial  
Ins@tu@ons)  is  an  independent  body  established  in  1990  under  an  
agreement  between  a  number  of  Islamic  Financial  Ins@tu@ons  and  is  
now  based  in  Bahrain    
§ AAOIFI’s  objec@ve  is  to  formulate  and  issue  Shariah,  accoun@ng,  
ethics  and  governance  standards  for  the  interna@onal  IFIs  and  
standardise  the  Islamic  financial  industry  
§ There  are  30  Shariah  Standards  issued  (to  date)  covering  all  known  
Islamic  financial  principles  yet  the  work  is  s@ll  in  progress  
§ The  standards  are  released  by  consensus  of  AAOIFI  Shariah  Board  
consis@ng  of  Shariah  scholars  from  all  major  schools  of  thought  and  
regions  of  the  world  
§ AAOFI  is  a  member  of  the  Interna@onal  Accoun@ng  Standard  Board  
 

DIFFERENT  MODELS  OF  SHARIAH  GOVERNANCE  

§ Malaysian  Model  –  centralised  Shariah  governance  
Ø Shariah  Advisory  Council  of  Bank  Negara  Malaysia  
Ø Highest  and  ul@mate  authority  on  Islamic  financial  maOers  in  the  country  
(BNM  Act  2009)  
Ø Guidance,  valida@on,  and  arbitra@on  (by  ruling)  on  all  Islamic  finance  
maOers  
Ø Shariah  Supervisory  CommiOee  required  at  each  Islamic  Financial  
Ins@tu@on  to  complement  SAC  
§ Bahrain  Model    -­‐  ins@tu@onal  Shariah  governance  
Ø Each  ins@tu@on  is  required  to  have  its  own  SSC  
Ø AAOIFI  Shariah  standards  are  compulsory  
§  UK  Model  –  ins@tu@onal  Shariah  governance  
Ø Each  ins@tu@on  has  its  own  SSC    
Ø FSA  being  a  secular  body  does  not  involve  in  Shariah  
§ Other  Models    

Mohammad  Farrukh  Raza,  Shariah  

Governance  in  Financial  Ins@tu@ons   11  
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2011  in  Istanbul  

CONTROVERSIES  IN  SHARIAH  GOVERNANCE  

§ Conflicts  of  interest  
§ Confiden@ality  
§ Fees  (scholars  for  dollars?)  
§ Scarcity  of  scholars  VS  high  
demand  
§ Finding  problems  or  finding  
solu@ons?  
§ Dialogue  between  the  deaf?  
Source:  Funds  @  work   § Consistency  issues    
A  study  in  2010  demonstra@ng  that  a   § Who  takes  the  blame?  
small   minority   of   scholars   is   sipng   on  
the   majority   of   the   Shariah   Boards   /   § Expecta@on  management    
Supervisory   CommiOees   triggered   a   § Resource  planning  
widespread   debate   over   the   issue   of  
Shariah  governance.    

CHALLENGES  IN  SHARIAH  GOVERNANCE  

 
§ The  scholars  of  different  schools  of  thought  (Madhabs)  with  
different  interpreta@ons  and  opinions  
§ The  number  of  scholars  qualified  in  the  jurisprudence  of  dealings  
(Fiqh-­‐ul-­‐muamalat)  rela@vely  limited  
§ The  level  of  familiarity  of  the  scholars  with  modern  day  financial  
services  is  limited  
§ Most  of  the  management  of  IFI’s  coming  from  conven@onal  
backgrounds  with  no  or  very  liOle  understanding  of  Shariah  
§  The  expecta@ons  of  the  stakeholders  (regulators,  shareholders,  
customers  and  the  management  of  IFI’s)  from  Islamic  finance  are  
very  unrealis@c  
§ More  emphasis  is  required  on  training  and  Shariah  audit  

Mohammad  Farrukh  Raza,  Shariah  

Governance  in  Financial  Ins@tu@ons   12  
Durham  Islamic  Finance  Autumn  School  
2011  in  Istanbul  

THANK  YOU  

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Mohammad  Farrukh  Raza,  Shariah  

Governance  in  Financial  Ins@tu@ons   13