Shariah governance and corporate governance are unique institutional structures in Islamic banks and financial institutions. Their function is to ensure that the operations of such institutions are Shariah compliant. Shariah governance ensures that the industry is at all times in accord with the Shariah by ensuring the legitimacy of the products offered and supervising the products sold and applied in the market. PROF DR MOHAMAD AKRAM LALDIN and DR HAFAS FURQANI probe further.
The Shariah governance system is defined by the IFSB Guiding Principles on Shariah Governance Systems for Institutions Offering Islamic Financial Services (2009) as “the set of institutional and organizational arrangements through which an Islamic financial institution ensures that there is effective independent oversight of Shariah compliance”. Effective Shariah governance requires the setting-up of a clear and comprehensive framework to regulate the Islamic finance industry and guide its development.
The significance of the Shariah governance and corporate governance framework transpires via their role in ensuring the confidence of the Islamic finance industry in the eyes of the public. In conducting its business, Islamic finance has to address a number of problems, including those matters relating to credibility, regulatory enforceability and SharIah compliant issues. A proper governance framework is expected to be able to facilitate those concerns and guide the industry in order to ensure that the entire operations of Islamic financial institutions are SharIah compliant.
Review of 2016
For the Islamic finance industry, global Shariah governance and corporate governance have been mainly dominated by two multilateral standard-setters: AAOIFI and the IFSB. Both institutions continue to issue various standards that govern major Islamic finance jurisdictions. AAOIFI this year has issued three additional Shariah standards, increasing their Shariah standards to 57 with 26 accounting standards, five auditing standards, seven governance standards and two codes of ethics.
A major push for AAOIFI this year would be the gold standard in collaboration with the World Gold Council (WGC) and Amanie Advisors. AAOIFI has held three public hearing sessions on the gold standard with the third held in Kuala Lumpur in collaboration with International Shari’ah Research Academy for Islamic Finance (ISRA) and it has recently approved the Shariah standard for gold-based products.
Similarly, the IFSB continues to tighten its corporate and Shariah governance by issuing standards and guidelines. The IFSB has highlighted the components of a sound Shariah governance system that should be in place in any Islamic financial institution in order to facilitate a better understanding of Shariah governance issues and provide enhanced transparency in terms of the issuance of Shariah rulings and the audit/review process for compliance with those rulings.
It also provides a basis for the greater harmonization of Shariah governance structures and procedures across jurisdictions. Earlier this year, the IFSB issued a standard on re-Takaful (re-insurance) and it is expected to issue another standard, such as the Disclosure Requirements for Islamic Capital Market Products, by the end of the year.
A key component of Shariah governance that gained greater focus this year was the area of external Shariah audit as a means to ensure compliance and maintain credibility. Both Oman and Pakistan within their central bank guidelines have made external Shariah audit mandatory. A lack of qualified external Shariah auditors, an unclear scope of the external Shariah audit and a lack of public disclosure were among the issues and challenges associated with implementing an external Shariah audit as highlighted in the External Shariah Audit Report jointly produced by ISRA and UKIFC.
Shariah governance in various jurisdictions: observations in 2016
We have observed that in most jurisdictions, the framework for a Shariah governance system has been put in place. The Shariah governance framework in each jurisdiction is designed in line with the domestic legal and regulatory framework. In some countries, the Shariah governance framework has been designed also to be in line with international standards and best practices as envisaged by the IFSB and AAOIFI.
In general, the Shariah governance framework is designed with the following dimensions:
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A Shariah governance structure at the higher level by a centralized body or by independent bodies having differing areas of authority or a combination of both.
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A Shariah governance process in terms of the appointment and resignation of Shariah advisors; the composition of the Shariah advisory board; qualification requirements; restrictions, such as, whether there are any restrictions on a Shariah advisor being appointed to more than one financial institution and the effect of decisions made; and whether a Shariah advisor can be appointed to the board of directors of the Islamic financial institution and such, which will reflect the process of Shariah governance in Islamic financial institutions.
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A Shariah governance function which describes the roles and functions of Shariah advisors, management, the board of directors and other stakeholders in an Islamic financial institution.
Each jurisdiction has a particular position on those dimensions in a Shariah governance framework. With regards to the structure of Shariah governance across jurisdictions, we can classify it into three main models:
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A centralized Shariah governance authority, which refers to countries that have their own central body to govern Islamic banks and financial institutions, for example, Malaysia, Indonesia and Pakistan
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An exclusive central Shariah body, which refers to countries that have their own central body to govern Islamic banks and financial institutions but strictly restrict them to their central banks, for example, the UAE and Bahrain, and
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Self-regulatory Shariah governance, which refers to countries where Shariah decisions are made at the institutional level with no final authority (central Shariah committee at the central bank level) established such as Singapore, the UK and Kuwait. The Shariah committees are appointed at the institutional level, and their decisions only bind their respective Islamic financial institutions.
Preview of 2017
The level of development of the Shariah and corporate governance framework varies across jurisdictions in accordance with the level of Islamic financial industry development. Some countries have developed a well-structured Shariah governance framework such as Malaysia. However, in certain jurisdictions, such frameworks or guidelines are not well structured which creates some uneasiness among industry players and leaves Shariah advisors without clear guidelines to be followed.
Therefore, Islamic finance industry practitioners should push forward this agenda and request for a Shariah governance framework to be established. This is because a proper Shariah governance framework would not only support the development of the industry but would make the industry more effective and efficient in ensuring strict Shariah compliance.
Conclusion
For further development of the industry, it is recommended that a comprehensive framework of Shariah governance and detailed or explicit provisions on Shariah governance and corporate governance should be in place so that we can ensure a totally Shariah compliant industry.
Prof Dr Mohamad Akram Laldin is the executive director and Dr Hafas Furqani is a research fellow at ISRA. They can be contacted at [email protected] and [email protected] respectively.