Ensuring the quality of Shariah Advice

1. Ensuring the quality of Shariah Advice MEFX Dubai June 1-3 , 2008 Dubai International Financial Center

2. Introduction • As most of you are aware any Islamic financial initiative without Shariah compliance is a non-starter. The Scholars do an admirable job considering the demand on time and the pressure to deal with more and more complex and innovative structures.A Scholar is expected to be a banker, accountant and lawyer besides his expert knowledge of Fiqh al Muamulat. • Shariah sources: - Primary: the Holy Quran; the Hadith (the sayings of the Prophet Muhammed pbuh); and the Sunnah (the practices and traditions of the Prophet Mohammed pbuh). • Secondary sources are Qiyas (analytical deductions and reasoning); Ijma (consensus of Shariah Scholars); and Ijtihad (legal reasoning). • Differences of interpretation between Shariah Scholars can create confusion, but fortunately these differences are narrowing.

3. Compliance Options • In house Shariah Board or Out sourced • Contracted Scholars or Advisory Firm • The benefits of a Shariah Compliance consultancy are many fold and have been welcomed by the institutions’ compliance departments, these include- institutions deal with one entity, - they have one contract and liaise with one point of contact,-       professional service-       timely delivery-       coordinated response-       coverage of different regional mindsets and attitudes-       knowledge of the market- Eminent, experienced and respected group of Scholars

4. Product Range • To a large degree, most of the products in use until very recently, were pre-Islamic and the development has been an adaptation of existing conventional products. The market, however, now demands that more innovative, relevant and even exotic products be made available. This is where Shariah compliance will come into its’ own. • Different asset classes and terms are covered by variations of the Ijara, such as Ijara Mawsufa F’il Dhimma; Ijara wa Iqtina (Lease to Purchase) this term refers to a mode of financing with an undertaking from the client to purchase the equipment or the facility, Ijara wa istisna (funding in stages at agreed levels of completion of the work in progress) etc. • A variety of tried and tested structures have been available in the Islamic financial market place and the documentation has evolved in acceptable form in many jurisdictions

5. Product Range • Now there are structured products, capital protected and even attempts at hedge funds, but with the confidence battering after the sub prime crisis and issues regarding Sukuks there is a form of stock taking going on. • Nevertheless, development is on going and we are witnessing the introduction of ETFs, private equity funds, etc., which are a conservative and equitable form of products for the Islamic investor.

6. Scholars • The investors look to see who comprises the Shariah Board of the initiative being offered. Younger Scholars must be encouraged and mentored by the principal Scholars active in the industry and we at Yasaar are putting that into practice by seeking and adding young and upcoming Scholars. • Taking into account the principles of supply and demand alone we know that the number of Scholars effective in this market is a handful. • The institutions must realize that besides a shortage of Scholars with the requisite knowledge of finance, banking and fiqh al muamulat , the Scholars are their marketing tools for the success of any initiative.

7. Conflicts of interest • The formation of an independent Shariah compliance consultancy helps in overcoming the prevailing perception of a conflict of interest; namely, the ability of a Scholar to provide an impartial opinion when employed and retained by a bank or financial institution. In the case of Yasaar, the institution contracts with a compliance services company that provides experienced and renowned Scholars who cover the different market mindsets and sensibilities. Therefore, an approved Shariah compliant structure is provided with a view of the major markets in which the product is likely to be launched

8. Future of Shariah Compliance • Regional and International DevelopmentsThere is a gathering momentum and awareness in Islamic finance and the availability of alternatives is driving the market where more and more Shariah compliant products are being demanded and provided. This demand is driven by both the Muslim communities in the West, as well as the customers in the Islamic regions themselves. Liquidity from the oil price boom is forcing the local banks to locate opportunities that are Shariah compliant. However, the international banks have capabilities that the regional banks do not always possess and these banks are not willing to give up their customers, they are therefore making moves into setting up Islamic banking operations of their own and making these options available to their clients. • Many financial centers are vying to become Islamic finance hubs.

9. Secondary Market • The secondary market is ripe for the regional banks to concentrate and focus on and, to make concerted efforts to develop. There are very few products and too much liquidity and so offerings are being held rather than being traded, hence all the enormous over- subscription of most initiatives. Here, there is a twofold advantage for the regional banks; first, to be able to maintain an involvement in the process and secondly, earn fees from trading. • The success of Islamic finance depends on the development and standardization of a secondary market and for its global acceptance, but this in turn relies on grass roots spread and a critical mass. For that we need awareness programs to educate the target markets. • Could sub prime have happened in Islamic finance, this is a question asked over and over. The chances are slim as high debt ratios and debt trading is not permitted.

10. Retail Banking • The retail sector is the future as a broad based clientele is essential and this exists in the Islamic regions. Here also, the distribution capabilities of the regional banks outstrip the reach of large western banks. This is a perfect match for the two arms of Islamic banking to be working together and, in time, there will be a balance reached with the development of expertise and credibility of the local regional institutions. The regional banks are smaller compared with the Western giants but provide a much needed capability and here the perception held of the Western banks will, in due course, be overcome.

11. Clientele • The clientele is growing as more institutions start to offer more products. Also the Muslim communities in Europe are demanding these products and this demand is driving the institutions to respond. France and Germany both have large and growing Muslim populations.

12. Regulatory Authorities requirements • The demands and constraints of the regulatory authorities have to be taken into account in all the different jurisdictions. Here the Shariah Scholars have to work closely with the law firms to define the product’s acceptability in the legal context of the jurisdictions in which the product is to be marketed, as well as the Shariah compliance aspect. • Recently it was highlighted that some jurisdictions are placing hurdles in the field of Shariah compliance by demanding that Scholars should not advise more than one client in any given jurisdiction, with conflict of interest being cited. Can you imagine if these rules applied to Banks, lawyers and accountants. As it is there is a shortage of Scholars with the all the requisite expertise necessary to operate in the field of Islamic banking and finance.

13. Proposed Initiatives • If any one is planning on launching an Islamic finance initiative of any kind then they should ensure that they acquire good advice and by that I mean what I feel are the essentials for a successful and competitive product. Lawyers, Bankers and predominantly Shariah Scholars, all of whom must be competently familiar with Islamic Finance. • The drafting of the documentation based on the Shariah Scholars’ approved structure is very important and it must be recognized in the jurisdiction in which it is to be marketed, subject to the relevant and applicable laws. This is where the lawyers and Shariah Scholars have to work closely so that the local laws are integral to the structure as well as being compliant with the strictures of Shariah.

14. Next Steps • The appointment of a Shariah Board as early as possible in the initiative is highly recommended. • It cannot be impressed strongly enough how much a recognized and experienced Shariah Board comprising of at least three Scholars as per AAOIFI and other regulators requirements is essential to the success of the products acceptance. • The customers are going to look for Shariah Scholars of repute and standing in the market place who have established their expertise from many years of learning and acquisition of knowledge of Fiqh al Maumulat , Shariah law relating to financial transactions. Once the product has been developed with the Shariah Scholars, the Fatwa (or legal opinion) is then signed.

15. Next Steps cont. • The documentation and marketing materials must also be reviewed to ensure that they are Shariah compliant. Then only can the product be launched. The Scholars need to monitor the on-going Shariah compliance of the product by random review of the application of the terms agreed with the financial institution. • Matters such as early repayment, default, repossession etc, are all incorporated within the documentation but a random review would be required for an annual Shariah audit sign off stating that Shariah compliance has been maintained with the product over the preceding period. • Distribution capabilities are essential to the success of any product. These need to be backed up by through understanding of the target market. The target market here is predominantly Muslim customers, but also ethical ones. In Malaysia the take up of Islamic financial products is more or less even between Muslims and non- Muslims.

16. Conclusion • In conclusion, I would like to again state that you must ensure that you get a good Shariah Board with the experience and knowledge of Financial products along with Lawyers and Bankers who are familiar with Islamic Finance. The market is growing rapidly and needs a commitment from financial institutional entrants with relevant products.

17. Thanks Majid Dawood CEO Yasaar Limited DIFC Gate Building P.O. Box 121208 Level 12 Dubai, U.A.E. www.yasaar.org