Yahaya Ismail Legal and Regulatory Issues in Islamic Banking and Finance Guiding Principles for Shariah Governance System Professor: Dr. Kazeem Yavari For Institutions Offering Islamic Financial Services (IFSB Standards) 25/05/2011 INTRODUCTION: The Islamic Financial Service Board is an international financial organization. It was founded in 2003 and issues guiding principles and standards within the Islamic banking and financial sector. It aims to promote stability and order in the Islamic financial industry. It also aims to promote the awareness of Islamic financial services.Among its duties is the issuance of Shariah-compliant standards, and provision of guidance and supervision for Islamic Financial Institutions.
The IFSB issued principles and standards regarding issues on Risk Management, Capital Adequacy Standards, Corporate Governance, Transparency and Market Discipline, Supervisory Review Process, Governance for Islamic Collective Scheme, Sukuk Securitization and Real Estate Investment, Takaful (Islamic Insurance) Undertakings, Conduct of Business, and Shariah Governance Systems1 for institutions offering Islamic financial services.The Board developed guiding principles in recent years to strengthen governance structures and processes in various segments of the Islamic financial services industry. These three guiding principles are ? Guiding Principles for Governance for Institutions offering only Islamic Financial Services (IFSB-3, 2006) ? Guiding Principles on Governance for Islamic Collective Investment Schemes (IFSB6, 2008) ? Guiding Principles on Governance for Takaful Operations (IFSB-8, 2009) In all three guiding principles, there were recurring issues of the functions of the Shariah boards2.Due to these recurring issues, the IFSB prepared other sets of guiding principles on Shariah governance system. The objectives of these guiding principles are to: I.
Complement other prudential standards issued by the IFSB by focusing on the importance of sound Shariah governance system with regard to competence, independence, confidentiality, and consistency of Shariah boards. II. Facilitate better understanding of Shariah governance issues in order to ensure that stakeholders are satisfied that an appropriate system is in place. III.Provide enhanced degree in terms of issuance, compliance and auditing for compliance with Shariah rulings. IV.
Provide greater harmonization of the Shariah governance structures and procedures across jurisdictions. There are nine guiding principles covered by the IFSB3. As we go further we will discuss each in details. This report is basically a summary of the guiding principle issued by the 1 2 This paper will focus on the guiding principles of Shariah Governance System. Shariah boards are the panel within any Islamic financial institution that certify the compliance of Shariah products. IFSB and has been divided in three subsections.
The next subsection will focus on the definition and scope of the Shariah governance system. The subsection after it covers the nine guiding principles and their best practices. I conclude by explaining the importance of adhering to these principles. Definition and Scope of Shariah Governance System: Shariah Governance System is a set of institutional and organizational arrangements that enable IIFS4 ensure effective independent oversight5 of Shariah compliance with regard to the following structures: ?Issuance of relevant Shariah pronouncements/resolutions: Shariah pronouncement refers to any juristic opinion on any matter relating to Islamic financial issues issued by the appropriate Shariah board. Any resolution issued must be critically scrutinized and deliberated upon. It must also be endorsed by the recognized Shariah board.
? Dissemination of information on Shariah pronouncements/resolutions: It is the duty of the Internal Shariah Compliance Unit (ISCU) to disseminate information of pronouncements to operative personnel of the IIFS that monitor compliance issues. The IIFS should equip ISCUs with relevant knowledge of Shariah.Also the ISCU should be an independent body. ? Internal Shariah Compliance review/audit: It is the duty of the Internal Shariah Review Unit (ISRU) to verify if Shariah Compliance has been satisfied. The audit team is also responsible for recording and reporting incidents of non-compliance.
? Annual Shariah Compliance review/audit: The Shariah board that issued the resolution should annually verify that internal Shariah compliance review/audit has been appropriately carried out and the results have been duly noted. The Guiding Principles: As mentioned earlier, there are nine guiding principles issued by the IFSB.They are divided into five parts: ? Part I: Relates to the general approach to Shariah Governance System. It covers processes that are essential to good governance such as the adoption of professional code of ethics, and proper record keeping among other things.
? Part II: Relates to the area of competence. It covers processes that monitor and evaluate efficiency of reasonable expertise and skill sets in Shariah boards. ? Part III: Relates to the independence of the Shariah board. It covers processes that ensure that Shariah boards are independent especially with regard to management of IIFS.
The guiding principles cover; general approach to the Shariah Governance System; competence, independence, confidentiality, and consistency. 4 Institutions Offering Islamic Financial Services 5 The ability to exercise sound judgment without influence from management or inappropriate outside interest 2 ? ? Part IV: Relates to the issue of confidentiality. It covers processes that ensure the observation and preservation of confidentiality by organs of Shariah governance. Part V: Relates to the issue of consistency and professionalism among the Shariah board.
Part I: General Approach to the Shariah Governance System Principle 1. 1: The Shariah governance structure adopted by the IIFS should be commensurate and proportionate with the size, complexity and nature of its business. IFSB advocates that IIFS should adopt policies that are significant to their line of work. Shariah governance should meet the needs and requirements of different types of IIFS. The governance system may be similar in principle but must also be diverse in practice. The diversity of the governance system should take into consideration the nature and scope of the IIFS operation.
The Shariah board of an IIFS should be competent and experienced in issuing resolutions that fit the particular institution. Principle 1. 2: Each IIFS must ensure that the Shariah board has: ? Clear terms of reference regarding its mandate and responsibility: Shariah board members should be appointed based on professionalism and high ethical standard. The contract of appointment should document the form of relationship between IIFS and Shariah boards. It should also document the fiduciary duties of the board and the reporting structure within the organization.There should be a balance of power between the Shariah board and the IIFS; the limit of power and authority should be clearly stated to avoid unclear and bad governance.
Well-defined operating procedures and lines of reporting: IIFS should establish clear-cut rules and by-laws that guide the Shariah board in its operational procedures. The by-laws should include how and when meetings should be held, and how decisions should be implemented and recorded. The IFSB recommends that IIFS develop a dedicated ISCU comprised of Shariah officers with appropriate qualifications and experience.Good understanding of professional ethics and conduct: IIFS should establish appropriate codes of ethical conducts if there is no internationally recognized code of ethics. These codes should be reviewed and improved from time to time with full participation from the Shariah board. They should include the “do’s” and “don’ts”.
Some basic professional ethics and conduct include; moral, intellectual, and professional independence; personal responsibility for professional activity; care and conscientiousness for legal and ethical requirements of his or her profession; and confidentiality among others. ? 3 Part II: Competence Principle 2. 1: The IIFS shall ensure that any person mandated with overseeing the Shariah Governance System fulfills acceptable fit and proper criteria. ? Good character: Honesty, integrity, fairness, and reputation are qualities that are measured over time. However, at the time of appointment, IIFS should be in place a transparent process that evaluates appropriate factors of prospective board members past record.
Factors that should be considered include, but are not limited to: whether or not the individual has been convicted of criminal offence; whether or not he has been subject to any adverse findings in connection with financial business, misconduct or fraud; whether or not the person has been dismissed or asked to resign previously; whether or not he demonstrates readiness and willingness to comply with the requirements and standards of regulatory systems. Competence and capability: The IIFS should ensure that prospective Shariah board member possess appropriate knowledge and skill needed to understand the technical requirements of the business.Some factors to be considered when evaluating candidates include; qualification, experience, and responsibility. Shariah advisory firm: The Shariah advisory firm should possess adequate expertise and resources to undertake its duties. The IIFS should constantly monitor that the firm is equipped with the resources to perform duties effectively.
? ? Principle 2. 2: The IIFS shall facilitate continuous professional development of persons serving on its Shariah board, as well as i ts ISCU and ISRU, if any. Adequate training procedures should be provided to ensure and enhance rofessionalism and effectiveness. Policies should be established that ensure continuous professional development.
IIFS should endeavor to maintain continuous training of the Shariah board, ISCU, and ISRU on relevant new laws, regulations and changing commercial risks. These training should equip the relevant board with industry specific knowledge in areas like banking, collective investment schemes (CIS) and takaful. Principle 2. 3: There should be a formal assessment of the effectiveness of the Shariah board as a whole and of contribution by each member to the effectiveness of the Shariah board.The IIFS should establish performance assessments that monitor the effectiveness and productivity of the Shariah board members.
Some assessments that should be measured include but are not limited to; demonstration of effective organizational accountability; effective communication with other organs of the governance; proper identification and evaluation of the organization’s exposure Shariah non-compliance risk; promotion of ethics and values; and promotion of continuous improvement of an organization’s Shariah control processes. 4 Part III: Independence Principle 3. : The Shariah board should play a strong and independent oversight role, with adequate capability to exercise objective judgment on Shariah-related matters. No individual or group of individuals shall be allowed to dominate the Shariah board’s decision -making. The IIFS should formalize the independence of the Shariah board by clarifying and recognizing the roles and mandates of the Shariah board.
The Shariah board should be able exercise independent judgment without outside influence or duress. To be considered independent, Shariah board members should not have any intimate relationship with the IIFS to avoid conflicts of interest.There should also be a transparent process employed in settling differences of opinion between the BOD and the Shariah board. Principle 3. 2: In order to fulfill their responsibilities, the Shariah board should be provided with complete, adequate and timely information prior to all meetings on an ongoing basis. The IIFS is obliged to supply the Shariah board with relevant, accurate and adequate information whenever it is needed.
On a frequent basis, the Shariah board should be provided with information such as copies of disclosure documents, financial statements and risk assessment reports.Information provided should assist the Shariah board in analyzing the issues brought before them in form and substance. Part IV: Confidentiality Principle 4. 1: Shariah board members should ensure that internal information obtained in the course of their duties is kept confidential.
Information that IIFS authorize not to be made public should be kept confidential by the Shariah board. It is a matter of professional ethics that any confidential and sensitive information obtained by any member of the Shariah board should not be used in any way that affects the IIFS negatively.Examples of confidential information include; information on development of new products and services; internal memoranda; decisions of the BOD or senior management among other things. To ensure compliance with confidentiality agreements, every Shariah board member should sign a non-disclosure agreement to observe confidentiality and secrecy with respect to delicate market information. Part V: Consistency Principle 5.
1: The IIFS should fully understand the legal and regulatory framework for issuance of Shariah pronouncements/resolutions in the jurisdiction where it operates.It should ensure that its Shariah board strictly observes the said framework and, wherever possible, promotes convergence of the Shariah governance standards . The IIFS should ensure that the Shariah board follows appropriate procedures in dissemination of resolutions. Intellectual property of resolutions should be protected and 5 Shariah board should provide necessary details as to why certain resolutions for the permission or non-permission of transactions were issued. Shariah boards are also encouraged to make resolutions understandable by the general public.Best efforts should be exercised in documenting and publishing resolutions so that stakeholders in the industry can have easy access to it.
Conclusion: This paper provides a short summary of IFSBs suggested guiding principles for Shariah governance in Islamic Financial Institutions. There are nine principles grouped into five parts; General approach to Shariah governance; Competence; Independence; Confidentiality; and Consistency. These parts cover basic procedures in setting up and establishing Shariah boards in IIFS. The principles encourage IIFS to employ best practice procedures in establishing their Shariah boards.
Shariah boards must be competent and able to deliver required resolutions about Islamic financial contracts and services. The board should also be independent in making decisions, IIFS should not interfere and conflicts of interest should be avoided at all cost. Confidentiality should also be practiced by the board; information that is deemed private and not of public interest should be divulged by the board. Appropriate procedures should be maintained in issuing resolutions. IIFS should ensure that the board makes resolutions easily understandable by providing necessary details to interested stakeholders.
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