A lthough there is general agreement on what is meant by the term “Shariah compliant” there is no single definition of what is meant by being “Shariah-based”. Some believe that the products offered by exclusively Islamic banks are Shariah-based, whereas those offered by conventional banks can merely be Shariah compliant. A second view is that products approved by national Shariah bodies such as the Shariah council of Bank Negara Malaysia are Shariah-based, whereas those approved by boards at the commercial bank level are merely Shariah compliant. A third view, and one to which I subscribe, is that Shariah-based refers to products based on Islamic structures such as Murabahah, Ijarah, Musharakah and such, whereas conventional instruments such as equities, which are halal for investment purposes are Shariah compliant. Investment in traded stock of public liability companies was not a concept which was found in traditional Fiqh, but which nevertheless can be regarded as permissible. Whether Shariah-based is institutionally or functionally defined, there is no reason why the industry should demand products exclusively categorized in this way. Private and public investment in equity which is Shariah compliant should be legitimate for Islamic investors and they should not simply be confined to more restrictive structures such as Mudarabah or Musharakah.
PROFESSOR RODNEY WILSON:
To undertake Islamic finance, the basis must always be Shariah compliant. What does it mean actually? One has to ensure that the transaction complies with the main sources of Islamic law. Anything other than that for the sake of ensuring competitiveness or to be commercial would be categorized as cloaking a product to be Shariah compliant. My short response is that the industry should demand for products which are Shariah compliant. They may be Shariah-based as long as it is consistent with Islamic law. MOHAMED RIDZA: Managing partner, Mohamed Ridza & Co
T he question is somewhat disingenuous, because industry participants merely follow the requirements of their clients. The sad fact is that clients typically have an appetite for risk and reward which can only be satisfied by leverage, and there is no such thing as Shariah compliant leverage. So, while the industry undoubtedly should be demanding Shariah-based products, unless there is a sea change in clients’ expectations, they are unlikely to do so. CHRIS COOK: Principal, Partnerships Consulting
People who are debating the terms “Shariah compliant” versus “Shariah-based” have too much time on their hands, and may not even understand the fundamental premise of Fiqh al Muamalat,which is permissibility unless proven otherwise. ABDULKADER THOMAS: CEO and President, SHAPE ─ Financial Corp
T ake Malaysia for example. Each (Shariah) product must be endorsed by Shariah advisors or scholars before it can be rolled-out. Granted that most of these products were “copied” from their conventional peers, such as Sukuk, Islamic hedging/derivative products and Islamic home financing — even though the end result is the same, the features of the Shariah products are visibly different. For instance, a customer wishing to obtain an Islamic financing to purchase a house will get his or her wish if he or she qualifies, the qualifying criteria of which are the same as that of a conventional home loan. Another customer who has an existing Islamic facility and feels that the market “interest” rate will likely go up may want to consider entering an Islamic profit rate swap to hedge his or her position. Shariah practitioners have been calling for true (or truer) Shariah compliant products not because the current ones are merely the concealed version of conventional products. Sukuk structure is a good example — the purchase undertaking (or put option) feature is embedded within most Sukuk issues that carry a fixed income element to create an explicit obligation on the part of the obligor. Sukuk issues utilizing Mudarabah and Musharakah principles may be best suited for non-fixed income structures, which a carry floating rate return. The Islamic finance industry is still very young and its growth is, and will continue to be, focused on the Middle East and Asia. The last couple of years has seen growing interest for Shariah-based products in new areas such as Europe, China, Hong Kong, Japan and the US. The global financial meltdown has further pushed for a new and better financial system which is based on, amongst others, proper (and transparent) sharing of risk and reward and ethical conduct of tangible and productive business. MOHAMAD SAFRI SHAHUL HAMID: Deputy CEO, MIDF Amanah Investment Bank
T he Islamic financial industry as we currently know it is still relatively young compared to the financial industry as a whole. The challenge that has faced, and still is facing, Islamic financial institutions is largely associated with their integration in a mature and long established financial market. The regulatory infrastructure is generally focused on conventional finance and Shariah compliant instruments do not always easily fit within this. Where possible, products should be enhanced to ensure that they become Shariah-based. It is generally easier to achieve this from a practical starting point, such as a product in use than from a theoretical basis. It is now up to the industry to come up with products that can be accepted by regulators and find a more solid basis in the Shariah framework. DR NATALIE SCHOON: Head of product management, Bank of London and the Middle East
H aving Shariah-based products is the ideal and ultimate objective that any Islamic banker and anyone else involved in Islamic banking and finance would aim for. But given the existing global riba-based financial order, which has evolved over many centuries and has been embraced by all economies, creating the ideal Islamic economic order would take time. The inter-twining of the economies cannot be unraveled in the short term, however much one would want to do it. In the interim, therefore, realistically one has to be content with Shariah compliant products. The consolation is that now, at least there are Shariah compliant products available when only 30 years or so ago there were none. MOHAMED ISMAIL SHARIFF: Partner, Skrine
T his is clearly a valid point, and central to the positive development of Islamic finance, and has been raised as such for some time now by concerned practitioners and investors. The solution, however, is one that requires clear understanding of the cause behind the current situation. Products that demonstrate Shariah compliance rather being Shariah-based are a symptom of the issue, and not the underlying cause. If we look at one particular area, which is benchmarking to LIBOR (London Interbank Offered Rate), or other interest rate benchmarks, we see, for example, Sukuk and interbank liquidity products fitting this definition. If you are an Islamic institution that raises funds from the capital markets, and thus are paying a LIBOR-based cost of funding, in order to efficiently service these liabilities, it almost becomes necessary to invest in assets that have a higher return than the cost, and generally also linked to LIBOR. That is why you would require your Sukuk investments to deliver a LIBOR-based return. If that is the demand being articulated by a large range of Islamic financial institutions (FIs), then quite naturally Sukuk will be structured and priced along those lines to service investor requirements. Non-Islamic FIs that invest in Sukuk will also clearly have requirements that Sukuk delivers LIBOR-based returns. Similarly, for interbank liquidity, banks typically have a clear requirement to raise liabilities, place assets and earn a spread on this activity, and this is one of the reasons that all such activity is again benchmarked to LIBOR. It is very difficult for a single institution to effect a change from such Shariah compliant products to Shariah-based products as long as one side of its balance sheet has LIBOR related liabilities. In order to invest in any meaningful way in Shariah-based assets, it must first make sure its liabilities are not LIBOR-linked. And, in order to raise liabilities that are not LIBOR-linked, investors must be prepared to accept non-LIBOR-linked returns. So quite quickly it becomes a circular problem. This means that several banks working together may achieve this, but a single bank on its own will find it exceedingly difficult. Meaningful progress can only be made if Islamic FIs work together to ensure that they can raise liabilities (from among themselves, initially) that are not linked to LIBOR but to the profitable and enterprise-linked activity of those financial institutions. Once such interbank activity is realized, then it can position the Islamic FIs in terms of facing external investors and look to raise liabilities that are also non-LIBOR linked. Islamic FIs must develop a functioning interbank system (not linked to LIBOR or any variant thereof) first, before expecting other investors to be willing to place funds at non-LIBOR-linked profit rates. This will have a knock-on effect in terms of Sukuk demand as FIs, which are the majority investors in Sukuk, will no longer have a binding requirement that their Sukuk assets deliver a LIBOR-based return. Sukuk issuers will need to react to such change in demand, and we will then see a shift in the Sukuk market to more Shariah-based products, delivering enterprise linked returns. Once the Islamic interbank and capital markets develop a practice of no longer linking to LIBOR, this will necessarily see much greater use of Shariah-based products, and provide a sound platform to enable this philosophy to extend to the wider Islamic investment market. SAFDAR ALAM: Executive director and head of Islamic structuring, J.P. Morgan
I find that the discussion of such terms as Shariah compliant, Shariah-based and “cloaking” to be confusing not only for first time investors in Islamic products but seasoned ones as well. I believe that a product is either compliant or not. Obviously, someone will have to make the call as to whether a product is compliant and this is where Shariah advisors come in. The industry and Islamic players need to assume a more proactive role than merely demanding Shariah-based products by investing in research and development (R&D) type efforts to develop products that truly address the needs of the Islamic communities where those players are active. Eventually, there are lessons we all need to learn from the current economic turmoil: the industry should stick to the basics of transparency, economic fairness and a focus on what is ethical. This should be supplemented by a study of what Islamic investors truly need. If there is one thing that has hindered the industry more than any other, it is the reverse engineering of conventional products into Islamic ones. Some of the early efforts of the late 1990s and early 2000s involved a high degree of innovation but at some point in the process, the focus seemed to have shifted to Islamically packaged (“wrapped” for a more technical term) products that smell and taste like conventional ones AYMAN H A KHALEQ: Partner, Vinson & Elkins
Y es, the Islamic finance industry should demand genuinely compliant Islamic products — the industry has a duty to the public to proffer genuine not sham products. Many products that have been offered are based on the replication of conventional banking products. Neither the industry nor the consumers benefit from such products or structures. In fact, the industry suffers as people lose faith in the Islamic finance industry. For Islamic finance to serve its goal — such as the fulfillment of an egalitarian society that has at its core synergistic partnerships, not exploitative and contentious lender/borrower constructs — it must move to genuine Islamic products not replicated conventional banking products. OLIVER ALI AGHA: Managing partner, Agha & Shamsi
T o ensure that all Islamic products offered by the bank are Shariah compliant, we use the advice of our Shariah Board to ensure that we are following the Shariah correctly, and obtain from them a pronouncement to that effect. On top of that, there is also a responsibility to ensure that the products you propose also follow the spirit of the Shariah. Much responsibility lies with the parties conducting the transaction to ensure that they follow the spirit as well as the letter of the Shariah. SIMON EEDLE: Global head of Islamic banking, Calyon
T he product mix right now in Islamic finance is largely focused on replicating conventional financial products and there has always been a divide between the theory-of profit-and-loss sharing products and the reality that most products are fixed payments through either Ijarah or Murabahah. These products will and probably should remain the mainstay for the Islamic financial industry because their fixed returns promote stability in the Islamic banking industry. Stability should always be the top priority. That said, the “Shariah compliant” versus “Shariah-based” discussion should focus on the direction of innovation in Islamic finance. Currently, the main thrust of new innovations comes from replicating more complex conventional financial products. Creating Islamic hedge funds and principal-protected notes with returns based on another investment’s performance seem to be the frontier of innovation in the last year. It would be more beneficial if there was more focus placed on two areas:
Innovation can be positive, but it is not always positive. Innovation should be judged on the merits of the innovation on its own, as a part of the broader financial industry and how it affects the development of the Islamic financial industry. BLAKE GOUD: Principal, Sharing Risk dot Org
The retail Islamic finance market has not matured over a few percentage points in many markets due to many factors which include the Shariah-based nature of products As the market matures the demand for more Shariah-based products will occur and you will see a trend towards more Shariah-based products. The current Shariah compliant products are simply a first step towards the ideal of the industry — the rise of truly just, equitable and trade-based transactions. OMAR KALAIR: President and CEO, UM Financial Canada
What about a focus on the standardization of Islamic products first, before trying to copy products! RODNEY J RINGROW: Senior vice-president and managing director, State Street Corporation Middle East North Africa
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