Given that many jurisdictions are interested in Islamic
finance and have taken initiatives to develop the industry through reviewing
their legal framework to facilitate the introduction of a range of Islamic
financial products, including more recently France, Ireland, Australia, Jordan,
Japan, Hong Kong, Korea and Lebanon, this augurs well for sustainable global
growth of Islamic finance going forward.
However, one of the key determinants for the successful
development of Islamic finance in any jurisdiction is the existence of a
conducive legal framework that supports the operations and growth of the
industry. These were the strong sentiments of Muhammad Ibrahim, deputy
governor, Bank Negara Malaysia, the central bank, expressed at a workshop
titled "The Polemics of Governing Law in Islamic Finance: Recent
Developments and the Way Forward" in London last week, which was also
attended by Alderman Nick Anstee, Lord Mayor of the City of London,
Ibrahim stressed that it is no surprise that jurisdictions
that are able to quickly amend their legal framework have managed to achieve
significant growth in Islamic finance.
This is only partially true. Saudi Arabia for instance has
had significant growth in the sector but its legal framework is seriously
lagging. It has no dedicated Islamic banking law; and its mortgage law has been
pending for the last three years and is still not adopted. As such in the case
of the Kingdom, both banks and customers have lost huge opportunity costs
because of the lack of legal framework for the introduction of various Islamic
financial products.
However, the Malaysian legal framework for Islamic finance
is undoubtedly the most developed and holistic in its approach. The new Central
Bank of Malaysia Act 2009 explicitly codifies the duality of the Malaysian
financial system which comprises the conventional financial system and the
Islamic financial system. The important point is that the governing regulatory
laws for Islamic finance are separate from those for conventional finance.
“This approach,” confirmed Ibrahim, “has proven to be
successful and critical in instilling public confidence in the Shariah
integrity of the industry. Whilst enacting a separate governing law avoids the
trap of confining the scope and operation of Islamic finance within the mold of
conventional finance, this approach has proven in Malaysia to be the most
efficient way possible to regulate Islamic finance.”
Kuala Lumpur earlier this year also established a Law
Harmonization Committee with the main objectives to review existing Malaysian
Islamic finance laws and to propose necessary amendments to give legal
recognition to Islamic financial transactions under the law; and to provide a
facilitative legal framework for the Islamic finance industry and develop
Malaysian laws as the law of choice for international Islamic financial
transactions.
In conjunction with a supportive legal framework, it is
equally important to have a robust Shariah governance framework to preserve the
sanctity of Shariah in Islamic finance. This is inevitable given that Islamic
finance has its roots in Shariah. The overarching requirement for an Islamic
financial institution is to ensure that its objectives and operations are in
accordance with Shariah.
In Malaysia, the integrity and credibility of the Shariah
governance framework is supported by the role of Bank Negara’s Shariah Advisory
Council (SAC), a centralized referral body for Islamic finance community, which
is by law the Shariah Authority of Last Resort in Shariah matters relating to
Islamic finance.
The same applies to an effective adjudication system to give
customers, banks, and other stakeholders recourse to law. “An efficient and
authoritative adjudication system,” explained Ibrahim, “helps create certainty
and establishes the legitimacy of Islamic financial contracts. Islam places
great importance on contracts and on parties to a contract. The ability of
parties to enforce a contract is thus critical as it constitutes the core of
maintaining the confidence of the public at large. Therefore, there is a
crucial need for a dispute settlement mechanism that is able and competent to
dissect in a judicious manner Shariah matters in contracts, so that issues of
dispute in Shariah interpretation could be resolved and enforced accordingly.”
In Malaysia, for adjudication purposes, a dedicated judge in
the commercial division of the High Court in Malaysia has been assigned to
preside over litigations relating to Islamic banking and finance. The court’s
adjudication role in Islamic finance is reinforced by the support from the SAC
in its capacity as a consultative body to the Malaysian judiciary system.
Under the law, the Central Bank of Malaysia Act 2009
prevails, if a question concerning a Shariah matter arises in any proceedings
relating to Islamic financial business, where the court or the arbitrator shall
take into consideration any published rulings of the SAC or refer the matter to
the SAC for its ruling. The SAC’s rulings are binding on the courts and
arbitrators.
This referral system, explained Ibrahim, preserves and
enhances the sanctity of Shariah rulings and the consistency in the
interpretation and application of Shariah principles in Islamic financial
transactions. To complement the court system, specific arbitration rules for
Islamic banking and financial services have also been developed, enabling
disputes for both domestic and international cases to be dealt with by the
Kuala Lumpur Regional Centre for Arbitration (KLRCA).
Another important legal aspect in the conduct of Islamic
finance is in ensuring good documentation of contracts underlying Islamic
financial transactions, which forms an integral part of Islamic finance as it
provides a critical ‘bridge’ between Shariah and Islamic finance practices.
Given the faith-based nature of Islamic finance, documentation must conform to
Shariah in such a way that it enables the "operationalization" of
Shariah principles into legally enforceable Islamic finance contracts. This is
crucial to avoid legal risks arising from the failure to faithfully reflect the
principles of Shariah which could undermine public confidence in the industry.
The move toward greater standardization in the legal
documentation of Islamic financial transactions is also a major challenge. A
more standardized contract creates greater certainty and predictability about
the characteristics of the financial contracts.
Ibrahim extolled the value of diversity of Shariah opinion
in Islamic finance, which he called “the seed to harness innovation in Islamic
finance”. The best way to move forward in this respect is through the concept
of mutual recognition of the interpretations and decision of Shariah principles
reached by a recognized Shariah body across countries.
“We believe in the need for diversity as it is an impetus
for sustainable global growth of Islamic finance…But at another level,
facilitating the internationalization of Islamic finance would involve a
delicate balancing act in nurturing innovation and pushing for greater Shariah
convergence, harmonization and acceptance. One option is to standardize
contracts for mature and widely acceptable concepts and structures as it leads
to consistency and efficiency and in some instances promote inter-jurisdiction
transactions,” he added.
