Legal Risks and Good Governance for the Growing Islamic Finance Industry

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Legal Risks and Good Governance for the Growing
Islamic Finance Industry
Hamid Yunis Partner

• Karachi
• December 2006

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Contents

• Fundamentals of Islamic (Shariah Compliant)
  Finance
• Basic requirements and philosophy
• Overview of Islamic Finance Market
• Types of Islamic Finance Products
• Basic Assumptions
• Additional Matters
• Use of Islamic Finance in Different Market
  Sectors
• Governance
• Background
• Products and processes
• Regulator/operator issues
• Specific issues
• International Guidance
• Basel
• IFSB Standards
• General Principles
• Non executive functions
• Conclusion

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• Fundamentals Islamic (Shariah) Finance
• Quranic (Shariah Law) principles
• Riba (interest/unjustified rewards/unlawful
  gain)
• Gharrar (uncertainty, risk, speculation)
• Halal (religiously permissible)
• Haram (not religiously permissible)
• Qard Hasan (good loan)
• Al-Wadia (safekeeping).

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• Basic Requirements and Philosophy
• true risk sharing
• no exploitation of a weaker position
• not socially unproductive
• not economically wasteful
• promotes economic and social development and
• charitable (zakat).

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Overview of Islamic Finance Market

• Islamic and Dual Banking Systems
• Retail Islamic finance products offered for a
  number of years, some low key e.g. Middle Eastern
  banks, others high profile e.g. HSBC
• Islamic Windows in major Global Banks
• Islamic Bank of Britain
• Primary Market initially basic finance products
• Compatibility with conventional products

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• Types of Islamic Finance Products
• Equity
• Trade Financing
• Asset Financing
• Lending
• Wholesale Retail Products
• loans
• partnership investments
• forex
• fund transfers
• letters of credit
• securities safe keeping
• investment management and device

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• Islamic Finance (Contd)

• Al-Wadia (safekeeping) usually not remunerated
• Takaful (Insurance)
• Funds Work
• SUKUK/Securitisation (Capital Secondary
  Markets) and
• Derivatives/Funds Management.

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• Basic Assumptions
• Underlying asset must be acceptable
• Different interpretations on what proportion of
  asset must not be haraam
• Proposed structure of transaction has to be
  acceptable
• No prohibited activities (proportionate approach)
• Need to account for regulatory requirements and
  comply with two sets of law (Shariah and law of
  country)

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• Additional Matters
• Zakat (specified amounts to be allocated from
  disposable income)
• Shariah Boards competition, pragmatic
  approaches
• Urf (custom)
• Darura (overriding necessity)
• Maslaha (general interest to justify)
• Hiyal (ruse)

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Use of Islamic Finance in Different Market Sectors

• Real Estate
• Project Financing
• Co-financings (Power, LNG, Oil Gas)
• Retail Banking
• Depositors
• Investment Account Holders
• General Leasing
• Ijara
• Asset Finance
• Bond (SUKUK) Issuance
• Private Equity Funds
• Insurance (Takaful)
• Capital Markets (Sukuk/Arboun/Salaam)

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GovernanceBackground

• Developing, structuring and marketing Shariah
  compliant financial products can be cumbersome
  and complex
• IIFS needs to account for regulatory requirements
  and comply with two sets of jurisprudence/law
  (Shariah and the law and regulations of relevant
  jurisdiction)

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Products and Processes

• Products and Processes need to be effective from
  the following viewpoints
• Understandable
• Competitively priced
• Tax effective
• Available and transparent
• Not administratively burdensome
• Not alien to regulatory requirements
• Governance of institution offering Islamic
  financial services needs to be the same

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Regulator/Operator Issues

• Scope for the continuing development of good
  corporate governance in the field of Islamic
  finance
• No inconsistency with Shariah

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Specific Issues

• Islamic finance industry needs to, in particular,
  focus on issues regulators will be concerned with
  
• Remember that Shariah-compliance will not
  normally be an issue for non-Islamic countries or
  where Shariah is not part of a general legal
  framework
• Shariah Supervisory Board presence and scrutiny
  therefore essential

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Specific Issues (cont)

• Islamic finance industry regulators need to
  consider regulation of Shariah Supervisory Board
• Islamic financing industry need for a unified
  front to regulators
• Standardisation of models used, terminology and
  treatment
• Dissemination of codes of best practice
• Practical Adaptability

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Guidance

• Many forms of International and National Guidance
  available
• OECD principles
• UK Stock Exchange Combined Code
• Cadbury Report
• Hempel Report
• Higgs Report

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Guidance (cont)

• France/Germany different forms of governance
  models
• US Sarbannes-Oxley
• Other/Corporate Governance Standards
• Country Specific
• Accounting and Industry Specific
• IFSB guidance
• Principles outlined
• Comply or Explain

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Basel

• Basel Committee on Banking Supervision
• 1999 paper
• 2006 paper

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General Principles

• Establish Good Governance Policy as a principle
  of Shariah
• Monitoring and work of
• Board Committees
• Executive Management
• Shariah Supervisory Board
• Internal and external auditors
• Different Stakeholders
• Mechanisms of balancing the roles of different
  stakeholders i.e.) shareholders, management, IAHs
  

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Non Executive Functions

• Role of non-executive directors/managers
• Guidance
• Oversight
• Compliance issues
• Future compliance policy

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• Contact

HAMID YUNIS Taylor Wessing Carmelite 50 Victoria
Embankment Blackfriars London EC4Y 0DX Tel 0207
300 7000 Fax [phone] Direct 0207 300
4088 E-mail h.yunis_at_taylorwessing.com Web
www.taylorwessing.com
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