Investing in Islamic funds : a practitioner’s perspective

  • Book Title:
 Investing In Islamic Funds
  • Book Author:
Noripah KamsoTsu Mae Ng
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We will now observe how regulatory authorities evolve and come together to address issues related to Islamic finance.

Effectiveness of Shariah Advisory Boards

The dominant market practice now is to appoint Shariah advisory boards comprising only scholars of Islamic law. The composition of a Shariah advisory board model could potentially evolve to a mix of these scholars, with Islamic finance professionals such as bankers, lawyers, and accountants.

This way, different views can be taken into account, resulting in practical and implementable decisions that bear in mind the Islamic fatwas. In addition to the effectiveness of an Shariah advisory board itself, integrating it into a regulatory framework can further increase its ability to make credible decisions.

In Malaysia, Shariah advisory boards must exist both at the capi- tal markets regulator level and at the individual company level. The Capital Market Services Act, which governs the Securities Commission Malaysia, confers its Shariah advisory board with the authority to establish the Islamic finance regulatory framework and guidelines (for companies) in accordance with Islamic law.

 The Shariah advisory board is solely dedicated to this singular role, and its members have the necessary expertise to integrate and balance Shariah interpretation with capital markets experience and knowledge. The Shariah advisory board of an individual company must then ensure that it complies with the relevant regulations.

 Therefore, in the area of Islamic investment management, the Securities Commission Malaysia’s Shariah Advisory Board Malaysia must then approve all Islamic investment products before they are offered to the marketplace, whether in Malaysia or around the world.

Importantly, the inclusion of Shariah advisory board responsibilities within the capital markets regulatory framework enables the admission of cases involving Islamic investment products into civil court, which importantly makes the judicial decision enforceable. This is not the case in some other countries. If this framework is not in place, it is hard, if not impossible, to adjudicate Islamic investment product issues and provide investors with the confidence in the under- lying law. Here are two examples:

  1. In some Muslim countries, the capital markets regulator must ob- tain approval for Islamic investment products from the nation- al fatwa council, which is not solely dedicated to Islamic finance regulation. It also typically has responsibility to render judgment in other areas—for example, divorce, inheritance, and custody is- sues. With this split focus, there are two consequences. First, it will take longer to obtain approval for Islamic investment products. Second, the Shariah scholars at the national fatwa council may make decisions solely on a faith-based perspective, without having the relevant capital markets experience and expertise. This may result in a decision that does not sufficiently take into account the interests of the capital markets. In addition, as the decision is made outside the capital markets regulatory framework, it is difficult to admit cases involving Islamic investing into civil court where decisions will have legal standing.
  2. Even more disconcerting, some countries only encourage Shariah advisory boards at the individual company level. Companies must then solely rely on the interpretation and judgment of their own Shariah advisory boards. There is no path to obtain approval for an Islamic investment product from a capital markets regulator or from a national fatwa council. As there is no Shariah regulatory framework at all, this makes enforceability even harder.

Therefore, investors should only consider Islamic investment products that are governed by a Shariah capital markets framework to protect their interests. Having a Shariah advisory board at the capital markets regulator level and at the individual company level will ensure that cases are admissible in court.

Islamic Financial Services Board

To match the international standards adhered to in conventional finance in the areas of risk management, capital adequacy requirements, and governance for Islamic collective investment schemes, the Islamic Financial Services Board (IFSB) was established in 2003.

Headquartered in Malaysia, the IFSB is an international organization that promotes and enhances the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry, broadly defined to include banking, capital markets, and insurance sectors.

To increase the international acceptability of Islamic cross-border transactions, the Islamic Finances Services Board Act 2002 provides IFSB with the privileges of an international organization. As of March 2012, the 187 members of the IFSB comprise 53 regulatory and supervisory authorities; 8 international intergovernmental organizations that include as International Monetary Fund, World Bank, Bank for International Settlements, Asian Development Bank, Islamic Development Bank; and 126 market players, professional firms, and industry associations operating in 43 jurisdictions.

Though IFSB has been established with particular needs to accommodate the regulatory needs of Islamic financial system, it complements the existing international regulatory bodies such as the Basel Committee on Banking Supervision and International Organization of the Securities Commissions.1

The IFSB has published 13 standards as of March 2012, a sum- mary of which is provided in Table 11.1.

In the area of Islamic investment, the 2008 Published Standard by the IFSB on “Guiding Principles on Governance for Islamic Collective Investment Schemes” specifies guiding principles that cover the areas of governance policy framework, accurate timely disclosure of information in an investor-friendly manner, effective monitoring systems and mechanisms for Shariah compliance, the movement of the Islamic collective investment scheme’s funds or assets, and transparency of fees.

TABLE 11.1 IFSB Standards

2005 IFSB-1: Guiding Principles of Risk Management for Institutions Offering Only Islamic Financial Services (excluding Insurance Institutions)

IFSB-2: Capital Adequacy Standard for Institutions Offering Only Islamic Financial Services

(excluding Insurance Institutions)

2006 IFSB-3: Guiding Principles on Corporate Governance for Institutions Offering Only Islamic Financial Services (excluding Takaful and Islamic Mutual Funds)

2007 IFSB-4: Disclosures to Promote Transparency and Market Discipline for Institutions Offering Islamic Financial Services (excluding Takaful and Islamic Mutual Funds)

IFSB-5: Guidance on Key Elements in the Supervisory Review Process of Institutions Offering Islamic Financial Services (excluding Takaful and Islamic Mutual Funds)

2008 IFSB-6: Guiding Principles on Governance for Islamic Collective Investment Schemes

2009 IFSB-7: Capital Adequacy Requirements for Sukuk, Securitizations, and Real Estate investment

IFSB-8: Guiding Principles on Governance for Takaful Undertakings

IFSB-9: Guiding Principles on Conduct of Business for Institutions Offering Islamic Financial Services

IFSB-10: Guiding Principles on Shariah Governance Systems for Institutions Offering Islamic Financial Services

2010 IFSB-11: Standard on Solvency Requirements for Takaful Undertakings

2012 IFSB-12: Guiding Principles on Liquidity Risk Management for Institutions Offering Islamic Financial Services

IFSB-13: Guiding Principles on Stress Testing for Institutions Offering Islamic Financial Services

Source: www.if

The Accounting and Auditing Organization of Islamic Financial Institutions

For the Shariah community to standardize its accounting, auditing, governance, ethics, and Shariah standards for Islamic financial institutions, the Accounting & Auditing Organization of Islamic Finan- cial Institutions (AAOIFI) was registered in 1991. AAOIFI is an independent international organization supported by 200 institutional members from 45 countries, including central banks and financial institutions.2 AAOIFI standards are more comprehensive and entail 85 standards as of 2010, covering all five areas of accounting, auditing, governance, ethics, and Shariah individually.

AAOIFI has gained considerable recognition as regards setting standards, and these standards are now adopted by the Kingdom of Bahrain, the Dubai International Financial Centre, Jordon, Lebanon, Qatar, Sudan, and Syria. Other national authorities have also shown the initial recognition to AAOIFI standards by issuing guidelines conforming to AAOIFI standards. These countries include Australia, Malaysia, Indonesia, Pakistan, and the Kingdom of Saudi Arabia.


The Malaysian Framework

As part of the overall strategy to identify new sources of growth 30 years ago, Malaysia focused its efforts to build a niche to build a recognizable presence on the global financial landscape. As a country with a Muslim majority, Malaysia has long aspired to be a modern Islamic developed nation. In 2006, Malaysia embarked on a conscious strategic intent to internationalize its Islamic finance leadership to transform the country as a global financial hub for Islamic finance.

 It established a platform called Malaysian International Islamic Financial Centre (MIFC). The five pillars of focus for MIFC are Sukuk origi- nation, Islamic fund and wealth management, international Islamic banking, international Takaful, and human capital development. The universally accepted legal and regulatory frameworks offered to inter- national players are supported by a strong political will and market players.3 It is clearly articulated in the Economic Transformation Pro- gramme (ETP) to transform Malaysia into a developed nation by 2020.

Islamic finance is one of the national key economic areas (NKEA).4 The framework involves statutory authorities such as the Central Bank of Malaysia and Securities Commission, with the Ministry of Finance playing a pivotal role in ensuring the right regulatory and su- pervisory framework exists for the IBF (Islamic Banking and Finance) to flourish. The exchange authorities like Bursa Malaysia provided a platform to ensure liquidity of the Islamic financial instruments, a re- quirement in modern securities trading and liquidity risk management. The Shariah advisory board is at the heart of the Islamic regulatory framework. Malaysia identifies the imperative role of Shariah advisory and has realized the participation of finance-savvy Shariah advisers at the regulatory level. Shariah Council must endorse any Islamic financial instrument that is approved by Securities Commission. This structural plan ensures the validity and enforceability of the Islamic financial prod- ucts and services. This makes Malaysia an interesting case study com- pared to other Gulf Cooperation Council (GCC) countries, where the Muslim populations control the majority of the wealth.

The precursor to the Malaysian model of Islamic Banking and Finance (IBF) was the enactment of the first Islamic Banking Act in 1983. Ever since then, Malaysia has evolved into a leading hub for IBF through various developmental phases. With diverse ethnic demo- graphics, Malaysia adopted a dual-banking system in which the Islamic system grew side by side with its existing conventional counterpart. This may lead to an important remark regarding the existence and enforceability of Shariah-based system vis-à-vis conventional system.

Unlike Pakistan and Iran, the jurisdictions that tried to convert their respective financial systems to completely comply with the Shariah principles, Malaysia introduced the Shariah-based system to coexist with the conventional and has managed to become a leading inter- national financial player in IBF.

Malaysia today has a comprehensive Islamic financial system that coexists within its financial system. It has a diversity of play- ers and a wide range of products supported by legal, Shariah, and regulatory framework. This resulted in Malaysia being one of the favored jurisdictions for Islamic fund domiciles, totaling to date 170 unds as at end-June 2012, and its AUM is the second largest after Saudi Arabia.

The Malaysian model presents international investors with a platform that adheres to global standards and best practices. This comprehensive framework provides the governance that will enable market players and investors to have confidence, for it ensures admis- sibility in court and enforceability of all cases involving Islamic finance and investing.

Legal and Regulatory To ensure the diverse players and wide range of products are supported by enforceable legal Shariah and regula- tory framework, Malaysia has instituted the Islamic Banking Act, the Takaful Act, the Government Funding Act, and the Capital Market Services Act.

Shariah Advisory Council There exist two Shariah advisory councils at the national level. One is at the central bank and the other is at the Securities Commission. The Shariah Advisory Council at the central bank makes decisions under the local standards of the Central Bank- ing Act. The Shariah Advisory Council in the Securities Commission makes decisions based on the Capital Market Services Act.

Dispute Resolution In the interest of protecting investors’ interests and the Islamic finance community as a whole, Malaysia has a judicial system that offers a dedicated high court to resolve Islamic finance cases. It also established the KL Regional Centre for Arbitration. The Financial Mediation Bureau was established to further inculcate a speedy resolution to challenges confronted in an infant industry.

On top of this, as Malaysia progresses to establish its international recognition as a global hub, it has also domiciled international centers for the use of international players.

International Centre for Education in Islamic Finance (INCEIF) was established in 2006 as a subsidiary of Bank Negara, the Central Bank of Malaysia. INCEIF represents a global university that spe- cializes in providing various qualifications in Islamic finance ranging from certification to doctorate programs. Equipped with the highly recognized academic staff across the globe, INCEIF has attracted and equipped the bright students from all continents to participate actively and contribute to the Islamic financial industry.

International Shariah Research Academy for Islamic Finance (ISRA) was established in 2008 to serve as the repository of knowl- edge through intensive research and scholarly discourse in the corpus of Shariah with a focus on the Islamic jurisprudence on transactions, a discipline that covers all the areas related to Islamic finance. ISRA provides a platform of exchange among scholars, academicians, regu- lators, and practitioners to arrive at appropriate fatwas pertaining to issues in Islamic finance through multiple perspectives.

The Islamic Financial Services Board (IFSB) is an international standard-setting organization that promotes and enhances the sound- ness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry, broadly defined to include banking, capital markets, and insurance sectors. The IFSB also conducts research and coordinates initiatives on industry-related issues, as well as organizes roundtables, seminars, and conferences for regulators and industry stakeholders.

The International Islamic Liquidity Management Corporation (IILM) is an international institution established by central banks, monetary authorities, and multilateral organizations to create and is- sue short-term Shariah-compliant financial instruments to facilitate effective cross-border Islamic liquidity management. By creating more liquid Islamic financial markets for institutions offering Islamic finan- cial services (IIFS), IILM aims to enhance cross-border investment flows, international linkages, and financial stability.

Established on October 25, 2010, IILM has 14 founding members consisting of the central banks or monetary authorities of Indonesia, Iran, Kuwait, Luxembourg, Malaysia, Mauritius, Nigeria, Qatar, Saudi Arabia, Sudan, Turkey, the United Arab Emirates, and two multilateral institutions, the Islamic Development Bank and the Islamic Corpor- ation for the Development of the Private Sector.

Membership of IILM is open to central banks, monetary author- ities, financial regulatory authorities or government ministries or agen- cies that have regulatory oversight of finance or trade and commerce, and multilateral organizations. IILM is hosted by Malaysia and head- quartered in Kuala Lumpur. As an international institution, IILM en- joys a range of privileges and immunities conferred by the IILM Act 2011 of Malaysia.

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