The new SGF will officially be launched in 2010 but will become effective in 2011 and replaces the Guidelines on the Governance of the Shariah Committee for IFIs which was introduced by the Malaysian central bank in 2004 and which outlined the role, duties and responsibilities of the Shariah committee and its members and the relationship and working arrangement between the Shariah committee at individual institutions and BNM's Shariah Advisory Council (SAC) at the national level.

The SGF is effectively the next component of Malaysia's Islamic Finance Master Plan and part of BNM's on-going review of policy relating to the Shariah governance processes at IFIs in Malaysia.

Its timing is uncanny in that it will be introduced at a time of increasing concern about the Shariah advisory function in Islamic finance especially relating to issues concerning the relationship between IFIs and their Shariah advisories that have surfaced as a result of a number of court cases in the GCC (Gulf Cooperation Council) countries and the UK in recent months. However, the new SGF is totally unconnected to the above developments and more to do with the further modernization and natural updating of the Shariah compliance function at Malaysian IFIs.

Malaysian financial regulators including BNM; the Securities Commission of Malaysia (SC), the capital markets regulator; and the Labuan Financial Services Authority (Labuan FSA), the offshore regulator, have over the last decade or so spearheaded much-needed reforms in the Shariah advisory and compliance business.

Malaysia remains the only jurisdiction in which Shariah advisories have to be registered with the relevant regulator; must go through a "fit and proper" testing regime in terms of educational background and requisite skills sets; and where Shariah advisories are restricted to advise only one institution in a particular industry segment so as to pre-empt conflict of interest and to widen the base of Shariah advisories in the market.

Bank Negara Governor, Zeti Akhtar Aziz, confirmed in the central bank's Financial Stability Report 2010, which was published in March, that in line with efforts to further enhance the Shariah governance of IFIs, the new SGF will provide comprehensive guidance on the roles and responsibilities of the Shariah committee, and the board and management of IFIs in ensuring that their operations are in compliance with Shariah principles. In many respects it echoes the Shariah governance standard issued by the Islamic Financial Services Board (IFSB), the "Basel Committee" for global Islamic banking, in 2009.

The report stressed that although the current Shariah governance structure has increased the prominence of the role of the Shariah committee within the Islamic financial industry, further enhancements to the guidelines are needed to take into account the rapid developments in Islamic finance in the recent few years. These include "the enhancements relating to the governance arrangements of the board and management in respect to the Shariah compliance process, the independence and accountability of the Shariah committee in the decision making process, the strengthening of internal research capacity, compliance and the risk management processes".

The SGF, says Bank Negara,  aims to strengthen the Shariah governance process, decision making, accountability and independence of Shariah Advisories. The new measures require regular internal Shariah reviews and audits, supported by an appropriate risk management process and research capability. At the same time the board of directors are deemed to be responsible for the overall Shariah oversight of IFIs and the effective functioning of the Shariah governance structure, policies and processes.

This must be done without compromising the independence of the Shariah committee. The Shariah committee will also now be accountable for the implementation of decisions and opinions throughout the IFI. The SGF also requires IFIs to establish three functions that provide a system of checks and balances within the organization, which include: i) Shariah risk management control function that is able to identify all possible risk of Shariah non-compliance and, where appropriate, remedial measures to manage this risk; ii) a Shariah review function that continuously assesses Shariah compliance of all activities and operations; and iii) Shariah audit function that performs annual audits to provide an independent assessment of the adequacy and compliance of the Islamic financial institution with established policies and procedures, and the adequacy of the Shariah governance process.

BNM is confident that the effective implementation of the new Shariah governance framework will further promote stakeholders' confidence and the integrity of the Islamic financial industry thereby reducing Shariah non-compliance risks and, over the medium term, contribute toward maintaining financial stability.

"We believe this to be a crucial step in ensuring a clear and consistent development path for Islamic finance that ensures certainty whilst protecting investors," explained Anwar at the SC-OCIS inaugural forum which was held in March in Kuala Lumpur. The SC now also requires all Shariah advisers for the Islamic capital market activities in Malaysia to b e registered with the Commission. "This," explained Zarinah Anwar, the chairman of the SC, "gives us the opportunity as the regulator to conduct regular training programs to ensure that these Shariah advisers are apprised of latest developments and fully meet the standards as set forth by the SC Guidelines on the Registration of Shariah Advisers."

It is important to understand that the preceding measures are all based on enabling laws which have recently been introduced by the three financial regulators. Bank Negara, for instance, is governed by the new Central Bank Act 2009 which came into force in November 2009 and which has direct relevance to the Islamic finance industry in several areas including the institutionalization of BNM's Shariah Advisory Council (SAC) as the Shariah Authority of Last Resort for the Malaysian Islamic finance sector.

At the same time, the Securities Commission of Malaysia, the securities regulator, which will soon be enabled with the new Capital Market Services Act 2009, is also boosting its Shariah governance framework. According to Zarinah Anwar, the chairman of the SC, the new law will strengthen the commission's Shariah Advisory Council (SAC) by recognizing in law the SAC as the central authority for the ascertainment of Shariah principles for Islamic capital market. The new provisions also enable a licensed person, the stock exchange or a PLC or other persons to refer matters to the SAC for its advice and ruling which shall be binding on the person or entity concerned.

Similarly, the modernization of the legal framework of Labuan International Banking and Financial Centre (Labuan IBFC) with the enactment of 8 Acts consisting of 4 amended acts and 4 new laws, comprises a landmark Labuan Islamic Financial Services and Securities Act which streamlines procedures and requirements of all Shariah-related activities conducted in and via Labuan IBFC. "The enactment of this Islamic act makes Labuan IBFC the first common law international financial center to have a specific legislation governing Islamic financial services," said Labuan FSA Director General Azizan Abdul Rahman.