Category Archives: Dr. Hussein Hamid Hassan

Unity in diversity? Shariah scholars and Islamic finance

Unity in diversity? Shariah scholars and Islamic finance
Source: http://www.themalaysianinsider.com/business/article/rock-star-scholars-a-risk-for-islamic-finance/

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Decades of parsing turgid legal documents have not dampened the enthusiasm of octogenarian Islamic scholar Sheikh Hussein Hamed Hassan. He gets agitated as he searches for a paper among piles of documents strewn across his posh Dubai office.

Wearing a dark grey suit with no tie, the Egyptian-born academic talks to a visitor for almost two hours about Islamic banking, which he has been instrumental in developing over half a century of writing and lecturing.

“Listen to me. You have to understand the basics of sharia, what’s allowed and not allowed in Islam. If you get it, then you’ll write it. And the whole world will understand,” he says.

Sheikh Hussein is one of the world’s most sought-after scholars in applying sharia or Islamic law to finance, chairing no fewer than 22 of the boards which rule on whether products and practices in the industry obey religious principles.

One position in particular stands out. As chairman of the sharia advisory board of London- and Dubai-based consultants Dar Al Istithmar, he is having to answer some searching questions on behalf of one of its most high-profile clients, US investment bank Goldman Sachs.

Last October Goldman announced it would issue as much as US$2 billion (RM6 billion) in sukuk or Islamic bonds, making it one of the first top Western banks to raise money in that way. But the plan has run into controversy among potential investors over whether it follows Islamic principles, as Dar Al Istithmar insists it does. There is also controversy over the fact that Goldman publicly named at least three Islamic scholars as potential advisers on the sukuk even though they had not even seen the prospectus.

“A copy of the Goldman Sachs sukuk prospectus was sent to these scholars for consultation but they never responded back,” Sheikh Hussein told Reuters. “They could be busy or did not approve the structure, but we didn’t hear from them. Their approval is not necessary anyway.”

The controversy over the Goldman sukuk illustrates some of the weaknesses of the Islamic finance industry. These are leading to growing pressure for reform of the scholar system, though the power of entrenched interests, and the difficulty of coordinating policy in an industry where authority is spread across the Middle East and Southeast Asia, may slow any change.

Scholars such as Sheikh Hussein command great influence but their opinions, lacking definitive legal sanction, are often challenged, creating an uncertain regulatory environment. And some scholars sit on scores of boards, leaving them open to charges of conflict of interest and making it hard for them to keep up with all areas of their work.

“The big problem is that there just aren’t enough of them,” said one Dubai-based banker in the industry, who declined to be named because of the sensitivity of the issue. “It’s a bit like being a rock star. They are disproportionately recognised, with people saying: ‘I want that name in Malaysia, I want that name in Bahrain.’“

Capacity

Islamic finance, based on principles such as bans on interest and pure monetary speculation, has grown rapidly over the last several years because it draws on pools of investment money in the oil-rich Gulf and Asia that have been relatively untouched by the global financial crisis.

The industry’s global assets are expected to rise 33 per cent from 2010 levels to US$1.1 trillion by the end of 2012, according to consultants Ernst & Young. Islamic finance will remain far smaller than conventional finance, with its tens of trillions of dollars, but the gap may continue narrowing; Ernst & Young expects Islamic banking in the Middle East and North Africa to expand over the next five years at a compound annual rate of 20 per cent, versus less than nine per cent for conventional banks.

Sharia scholars, with expertise in both religious and conventional law, are key to this growth. Investors will not buy instruments without believing they are religiously acceptable, so most wholly Islamic financial firms have their own board of sharia scholars which certifies products and monitors the firm’s business. “Independent” sharia boards also exist, offering their services to financial firms for a price.

There are over 400 sharia scholars worldwide but only around 15 to 20 prominent and experienced ones, which creates demand for scholars to sit on multiple boards. The top 20 scholars hold 14 to 85 positions each, occupying a total of around 620 board positions or 55 per cent of the industry, data compiled by investment research firm Funds@Work show.

The shortage of scholars is a capacity constraint for the industry, said Sheikh Muddassir Siddiqui, a sharia scholar and Harvard-trained attorney at law firm SNR Denton. He is a member of the sharia standards committee of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), a Bahrain-based body setting standards for the industry.

“If you engage a lawyer or a doctor you would naturally want someone with a big name and reputable,” said Siddiqui.

“But unlike a rock star who can entertain thousands of people at once, a sharia scholar’s role should be viewed more like a doctor’s — it is natural to ask how many surgeries a doctor can perform in one day. It is a question of capacity.”

The capacity problem is worsened by the fact there is no single, universally accepted interpretation of religious principles. So firms seek out the scholars who they think will carry the most weight with investors; in effect, a scholar’s reputation becomes a currency used in completing a deal.

“The reason the Islamic finance industry is still emerging is that governance standards are not as well established as in other industries,” said Murat Ünal, CEO of Funds@Work.

“It’s like a social network. People and their relationships play a very important role. If you have a prominent scholar on board, this increases trust and makes up for the lack of governance standards. Institutions sell their products via the reputation of the scholars, so you better make sure you have accepted scholars on board.”

And this leads to sky-high fees paid to the top scholars. A senior banker at an Islamic lender said some scholars could be paid US$1,000 to US$1,500 per hour of consultation — in addition to an annual bonus of between US$10,000 and US$20,000 per board seat.

Sheikh Hussein and other scholars strongly reject the idea that there is anything improper in the fee system.

“What’s wrong with getting paid for issuing a fatwa or reviewing the sharia compliancy of a financial instrument?” Sheikh Hussein said. “We’re just like auditors, lawyers. Each one of us has years and years of experience in sharia law. We do our job and get paid for it. Nobody is allowed to question our honour, integrity and truthfulness.”

Frustrations

Nevertheless, the system is open to accusations of conflict of interest because scholars head or sit on the boards of the industry’s standard-setting bodies, such as AAOIFI, at the same time as they are being paid handsomely by the firms which are being regulated.

In some ways the situation is similar to that of credit rating agencies in conventional financial markets. The agencies are paid by the companies they rate, which may have made them slow to downgrade debt before the global financial crisis, allowing imbalances to build up that triggered the crisis.

“Certainly there is a need for improvement in the way sharia supervisory boards play their role,” said Sheikh Siddiqui.

“There needs to be some sort of enforcement body that stipulates who is qualified, how to protect against the conflict of interest, and other reasonable conditions for the conduct of a sharia board.”

Sheikh Siddiqui also advocates separating some of the duties of sharia boards so that scholars, who may now effectively act simultaneously as lawyers, product developers and auditors for instruments, do not end up “judging their own work.”

The impact of individual scholars on the Islamic finance industry can be huge. In late 2007 and early 2008, sukuk issuance slowed after Sheikh Muhammad Taqi Usmani, chairman of the board of scholars at AAOIFI, suggested that about 85 per cent of sukuk might not comply with Islamic law.

Haissam Arabi, chief executive of Gulfmena Investments, a Dubai-based asset management firm, says he has personally experienced the pitfalls of the scholar system: products have been approved for investment by his firm’s sharia board, only for their sale to be delayed by the boards of other firms.

“Here is a crack in the system which needs to be remedied,” he said. “When you can’t sell or distribute because your board is different from my board, you end up not being able to achieve scale and you’re left with a very expensive product. That’s what’s hindered the development of sharia asset management.”

Another area of frustration in the industry is the lack of transparency in the way that sharia boards reach their findings and communicate them, industry participants say.

“Sharia scholars’ opinions are not published and in some cases not even circulated,” said Oliver Agha, partner of Agha & Co, a sharia-compliant law firm in Dubai.

Mohammed Akram Laldin, executive director of Malaysia’s International Sharia Research Academy for Islamic Finance, said few boards disclosed their methodology. This is dangerous, he said, since as the industry grows and products become complex, investors need to be sure scholars understand the markets.

“Scholars are no doubt well-versed in Islamic law,” he said. “But sometimes they might not be as well-versed on the market side.” In other cases, he added, scholars may not even be fully informed of the ultimate purpose of a product — an important issue for them to consider when forming a judgment.

“They only see a half-cooked structure… Something is not being disclosed to the scholar, and some who have more disclosure might ask more questions.”

Reforms

There are signs that the industry is moving towards reform of the scholar system. The Goldman case is one impetus for reform, because it underlines the large amounts of new business that could be generated in the industry if Western financial institutions become heavily involved; they are likely to demand a more transparent and predictable environment.

The shortage of experienced scholars is unlikely to be remedied quickly, but proposals within the industry include setting minimum quotas for the number of young scholars on sharia boards, and introducing apprenticeships to give young scholars more experience. Some companies may begin adopting these measures even if the industry’s standards-setting bodies do not decide to recommend them universally.

“We do need more trained sharia scholars, but it’s beginning to happen because of demand pressures,” said Jasseem Ahmed, secretary-general of the Malaysia-based Islamic Financial Services Board (IFSB), another industry body.

Scholars are likely to face stricter guidelines for their behaviour from bodies such as AAOIFI. The organisation’s assistant secretary-general Khairul Nizam said it was discussing internally proposed new standards for scholars; they are expected to be issued by the end of this year as part of a strategic review of AAOIFI standards, he said. A draft is likely to be distributed to the industry at mid-year for consultation.

The new standards will try to give more guidance on scholars’ responsibilities, their relationship with banks, the issue of confidentiality, and the terms of reference of sharia boards, which should be similar to those that govern bank boards in conventional finance, Nizam said.

Regulations imposed by Malaysia’s central bank could provide one model for the AAOIFI reforms. Among other rules, scholars in Malaysia cannot sit on the board of more than one bank; sharia board members must attend at least three-quarters of the board’s meetings each year, and two-thirds of a board’s members must be present for the board to meet.

Pressure is also growing for action to reduce the differences of opinion and conflicting judgments between the sharia boards at individual companies.

The central bank governor of the United Arab Emirates, Sultan Nasser al-Suweidi, is among those who have suggested the creation of a global body that would provide legal guidance to boards around the world.

“The solution here may lie in the establishment of a supervisory or a control body that would issue fatwas or rulings on the general policy of Islamic banking,” he told Reuters.

Once again, Malaysia could be a model; a Shariah Advisory Council (SAC) established by that country’s central bank acts as “the apex authority for the determination of Islamic law,” helping to resolve differences of interpretation between scholars or companies.

Obstacles

Globally, however, the Islamic finance industry is unlikely to achieve the strictness and consistency of regulation seen in Malaysia any time soon.

A source familiar with AAOIFI’s review of standards, who declined to be named, told Reuters that the review would probably not look at restricting the number of board positions that scholars could hold, or at setting up a global version of Malaysia’s SAC to iron out legal disputes.

“Such steps are years away,” the source said.

The industry is so diverse that without the intervention of central banks and governments, it may be unable to agree on strict regulation of itself. And outside Malaysia, most central banks and governments have hesitated to take on the responsibility of setting standards for the industry.

Many in the industry are wary of inviting official intervention, arguing that it could curb their freedom to innovate and slow the market’s growth.

“If you have a central sharia board the government will be more involved, and as we know bureaucracy kills growth,” said Mohamed Elgari, a prominent scholar. “Centralised government entities should be concerned about risks but should refrain from sharia issues.”

Others believe that an industry based on the interpretation of religious principles is never going to achieve the same consistency and predictability as conventional finance.

“On the whole there is some convergence that has taken place, but we can never aim at 100 per cent. It is just the nature of Islam — people have different approaches,” said the IFSB’s Ahmed.

Dr. Hussein Hamid Hassan calls for supreme Shari’ah board

Dr. Hussein Hamid Hassan calls for supreme Shari’ah board

 

The call to institute a supreme Shari’ah board in the GCC has been taken up Dr. Hussein Hamid Hassan, a leading Shari’ah scholar.

Hassan made the call at a briefing session organized by Dubai’s Hawkamah Institute for Corporate Governance to publicize its launch of a policy brief on the corporate governance of Islamic financial institutions operating in Dubai.

Hassan said that he believed the industry needed a collaborative body encompassing the leading Shari’ah scholars from across the GCC, in order to streamline the process of issuing Fatwas and help speed up the development of products.

When Hassan was asked by The Islamic Globe, how he judges the Qatar Central Bank’s move to separate Islamic and conventional banking, he answered that this was: “A step in the right direction for more transparency,” as regulators should not be treating Islamic banks like conventional banks. Hassan also telegraphed that an Islamic Banking Academy was on the verge of being set up “in the near future” in Dubai.

Source: http://www.theislamicglobe.com/index.php?option=com_content&view=article&id=484:leading-scholar-calls-for-supreme-shariah-board&catid=16:article&Itemid=38

A Shariah scholar’s place on the board: Interview with top Shariah scholars

Gulf News: A Shariah scholar’s place on the board: Interview with top Shariah scholars

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Funds-at-Work, a research-based strategy consultancy focusing on the investment industry, recently released "Shariah Scholars – A Network Analytic Perspective," which links Sharia scholars to board positions. It is a more comprehensive study than previous Sharia scholar reports. Rushdi Siddiqui puts some challenging questions to four international Sharia scholars to get their view points:

  • Dr Hussain Hamid Hassan (HHH), eminent scholar and chairman of many Islamic financial institutions
  • Dr Mohammad Daud Bakar (MDB), international scholar and founder and managing director of Amanie Islamic Finance Consultancy and Education;
  • Yousuf Talal DeLorenzo (YTD), leading US scholar; and
  • Dr Mohammad Akram Laldin (MAL), Executive Director, ISRA, Malaysia.

Research is an important area in Islamic finance and you are well aware of the Funds-at-Work study, linking scholars to Sharia boards. What is your impression of the study?

HHH: The Islamic finance industry is young but growing. It needs specialists, not just in Sharia, but in law, accounting and feasibility studies.

There are very few scholars who combine the qualifications and experience needed for this field.

Therefore, it is only natural that they would carry a heavy load, for the industry is in need of development and the invention of new products which should be compliant with the Sharia, valid in civil law, and commercially viable.

There just aren’t a sufficient number of specialists in these areas in light of the rapid growth and remarkable development of this industry.

In time, the young will gain experience, and people will then seek them out, after the generation that preceded them has passed away; and they, in turn, will be succeeded by another generation of young practitioners. That’s the way of the world.

Furthermore, this study was lacking in precision, for it ignored a great number of up-and-coming scholars who are working as members of these same Sharia boards along with their teachers, in order to learn from them. Why didn’t the study focus on them?

It focused instead on the first generation, whose careers developed apace with the growth of the Islamic finance industry and the Islamic banking movement.

The number of these [young scholars] far exceeds the number of senior scholars, who are now well over 60 years of age.

How can the study demand that the new Islamic finance industry be led by the young to the exclusion of those with long experience, who are considered the fathers and theorists of the Islamic finance industry (IFI)?

MDB: What is lacking in this research is the clear hypothesis of the research and in what way the readers could actually benefit from the research, as the data presented is quite extensive (although not necessarily accurate), but the data analysis needs to be improved.

YTD: The goal of research is knowledge and its application. There are very likely a great deal of practical applications for the Funds-at-Work study and this is welcomed.

Networking aside, there are far more important considerations, or there should be, in evaluating Sharia scholars and their work: Published work? Academic background? Affiliation with one juristic school?

Experience and exposure to various financial products and instruments? Relationships with international legal firms? Ability to function effectively as team members and meet deadlines? Ability to represent, if necessary, IFIs in international or regional forums or even in informal situations?

All of these are factors that may have varying degrees of importance for IFIs.

MAL: I believe it is a good move to provide the market players with the information about their involvements.

It will definitely assist the market player to engage the suitable Sharia advisor so as not to hinder their progress. I also strongly believe that we are not in shortage of Sharia advisors in the market. We do have competent people but not many are given the chance to serve on Sharia boards as some market players prefer to have certain scholars on their board. As a result you can find that some scholars sit on many boards.

There is increasing conversation about scholars serving on multiple boards and how this might present a conflict of interest. Are you in agreement?

HHH: It has never happened in the history of the Islamic finance industry that the members of any Sharia board divulged secrets that damaged an Islamic bank or an Islamic financial institution.

They are the people most worthy of confidence and trust, for they are leaders and role models.

History has not conveyed to us a single report of a scholar who issued a fatwa that was a secret which only the mustafti (questioner) was privy to, such that the mufti could not issue the same fatwa to someone else.

This criticism is the result of ignorance about the nature of the duty of Sharia board members.

They explain the rule of Allah in the issues presented to them, and their fatwas are not considered the property of the mustafti who asks them, such that the rule of Allah cannot be given to someone else.

We would like to ask: How many times in the history of Islamic banking — which is more than 30 years old — has an Islamic bank complained about a member of a Sharia board that he gave the same fatwa to another bank which he had already given to the first bank?

Indeed, the rule of Allah does not change just because the person asking about it has changed.

It is a principle of the Sharia that a scholar is not allowed to conceal knowledge; rather, he has to bestow it upon whoever wants it, based on Allah’s statement: "You shall make it clear to people and not conceal it" (3:187).

MDB: Conflict of interest is a term, albeit a technical one, which should be used in specific cases is often misunderstood.

For all intents and purposes it disallows a person to be in a position whereby his decision (of doing or not doing) may be influenced by his own interest.

Could a scholar sitting in various Sharia boards be perceived to be in that position? If established, then this practice should be avoided.

What is the interest that is applicable to a scholar when issuing a fatwa?

Perhaps, many understand that Sharia advisors are equal, or should be treated similar to board of directors, hence, the perception of conflict of interest. Scholars are essentially not in the position of serving as the board of director of a bank, for example.

They are similar to other professionals such as lawyers, accountants, auditors, and actuaries.

YTD: The problem I see is not a conflict of interest but one of capacity, in terms of both quantity and quality.

A scholar who serves on multiple boards in addition to a fulltime teaching position at a university, for example, will have to be careful to balance his schedule so as to allot ample time for each of his responsibilities.

That’s a matter of quantity; and each individual will have to make up his own mind as to what constitutes a reasonable workload. Some people simply have more energy than others. We have examples in our industry of scholars at advanced ages who serve on many boards; and continue to contribute in a positive manner. We also have examples of scholars who have cut back their commitments, or who have limited them to no more than a certain number.

Insofar as quality is concerned, I think the industry is beginning to demand a greater degree of specialisation, even from its Sharia scholars.

Thus, the concerns of equity fund supervision, of bank supervision, of takaful, leasing, real estate, infrastructure, private equity, home finance, commodity trading… all of these are different and require more than an introductory understanding, hence, the future will be toward specialisation because greater attention to detail will be required of scholars.

MAL: Yes there are many who sit on multiple boards and I have no objection to this provided that the respected scholars are able to discharge their duties in efficient manner. As for the conflict of interest, I do not see any issue for individual scholars sitting on different boards.

However, at present we see a number of scholars are operating Sharia advisory companies and if the person operates the company and at the same time provide advisory services, there might be some question regarding serving the interest of the company and providing independent Sharia views.

This conflict of interest may rise to Sharia compliance risk as not enough time to review all documents, hence, a real risk management issue for IFIs. Are you in agreement?

HHH: The Sharia boards undertake their duties regarding the transactions presented to them, based on their belief that all this is a religious duty which cannot be approached on the basis of whims. Rather, it requires penetrating and rigorous academic research.

Their conscience and sense of duty prevent them from deliberately issuing a fatwa opposed to the Sharia; as for mistakes, they do occur.

If one of them happens to make a mistake, he will be corrected by the other members of his own Sharia board or by another board altogether. At any rate, the Prophet Mohammad (Peace Be Upon Him) said that if someone makes ijtihad and is wrong he gets a single reward, and if he’s right he gets a double reward.

And where are these risks that the Islamic banks have faced due to hasty or erroneous fatwas?

Are they issued by the senior members rather than the junior members?

The claim that Islamic banks are facing dangers due to the inability of the members of their Sharia boards to properly carry out their duties is a claim that is not based on reality or evidence.

MDB: If this perception is established, it must not be restated as conflict of interest term, as its misleading.

The issue of quality of works by advisors is the issue of the performance and not of the policy of having scholar on various boards.

This issue should be addressed administratively and not from a policy and regulation perspective, unless the bad performance is rather a phenomenon in modern Islamic finance industry.

YTD: If scholars do not have enough time to review documents, or if they require months to review documents and then need to schedule and reschedule before they can meet and take decisions, then something is clearly wrong.

But the fault is not necessarily that of the scholars. When establishing a Sharia board, an IFI must be cognizant of the scholars’ other responsibilities.

Even the matter of time zones should be taken into consideration. And the IFI will need to be diligent and proactive in its management of the Sharia board’s affairs so that meetings are scheduled well in advance of deadlines and time is managed effectively.

Many problems can be avoided by making a realistic and practical selection of scholars for the IFI’s Sharia board.

MAL: I agree that if a person sits on too many boards, he might not be able to scrutinise all the details of the transactions, documents etc and it will lead to what is termed as "Sharia compliant risk" for the market player. On this issue, I am not blaming the scholars solely. The market practitioners are equally responsible as they are the ones who approach the scholars and appoint them.

With only a handful of scholars on so many boards, is there a risk to IF, especially looking at issues of age, health, and the travel demands of scholars?

HHH: This is not correct, for at this time we have specialised leadership in the Islamic finance industry and we have hundreds of young people who are members of Sharia boards. Therefore, the task is not limited to a handful of scholars.

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has a Sharia Council comprised of 18 members. There is also the Islamic Fiqh Academy that is part of the Muslim World League and the International Islamic Fiqh Academy of the Organization of the Islamic Conference (OIC).

Between them they have hundreds of scholars to whom issues of Islamic economics, Islamic finance and newly developed products are presented, and they issue fatwas and resolutions. So it is not true that those who undertake the issuing of fatwas in Islamic banks and institutions are a small handful of persons.

I totally disagree that those who are leading the Islamic finance industry and its institutions, including banks, takaful companies, and financing and investment institutions, are a small number.

MDB: The meaning of risk in this context is not clear. The risk is and should not be confined to the issues of age, health and travel commitments as these also apply to other sectors in life, be it financial or non-financial.

YTD: Key man risk is always a problem in business. It is no different in our industry. Yet, at the same time, we all know that we need to do more to develop scholars for service in the Islamic financial services industry.

MAL: This is a real issue and if we look at present there are gap between the senior and junior scholars. Many senior scholars are ageing and there are no replacements.

There is a need to put a governance process to regulate the Sharia advisory services. In Malaysia we have started this process since 2005 when the Central Bank issues the guideline on Sharia Advisory services.

One scholar is only allowed to sit on one board as to allow the grooming of new generation of scholars. As a result, we now have more than 100 scholars on our list and the number is increasing especially with many young graduates who are interested in pursuing this career.

Should this type of study in IF be expanded to include law firms? Accounting/management consulting firms?

HHH: Yes. It will soon become clear that specialised expertise in Islamic banking is less expensive than that of firms that offer diversified services to hundreds if not thousands of clients.

Nor should we forget that our Arab and Islamic educational institutions have yet to concentrate on turning out graduates with qualifications and specialisations for careers in Islamic finance.

MDB: On one hand, the research should not be extended to other sectors unless the hypothesis and the benefits of doing this research are made vividly clear. Otherwise, this research may lose [credibility and] respect. Other hand, for comparative purposes, the investigation and examination should also be conducted on other similar services such as law firms, auditing firms, and actuaries, for example, so the industry will be getting a more comprehensive view on this perceived conflict of interest issue.

YTD: Yes.

MAL: Yes it is needed so as to give the information to the market players.

To address shortage of scholars, should scholars be compelled to have a junior (local) scholar (not well known) on the board so as to encourage apprenticeship and expand the supply of scholars?

HHH: This is the actual situation. A large number of up-and-coming scholars work on the Sharia boards along with their teachers. This process is due to the initiative of the elder scholars, who search for those with outstanding abilities in the new generation and nominate them.

However, we must emphasise one point: the danger of nominating an unqualified candidate. It is not appropriate, in the name of expansion, to appoint unqualified persons, for that will cause harm to the industry itself.

Graduating from a Sharia college is not enough by itself, for there are thousands of graduates. It requires experience, personal ability and the combination of knowledge of the Sharia, civil law and accounting.

MDB: In any industry, the practice of compulsion is not a healthy one. It is always about being passionate.

As much as the junior scholars are encouraged to be part of the service, they must demonstrate the minimum capabilities and professionalism required to undertake this task. The task of the scholar and consultant is different from other tasks, such as being an academic as it requires a bit of everything: research, original thinking, understanding of the current market, and it is time consuming.

YTD: I don’t think that compulsion is the solution. But I do think that IFIs should be encouraged to do so. And I also think that the junior scholar solution is a good one.

I have also recommended a rotating scholar solution for SSBs such that one seat may given to a new scholar after the previous scholar has served a term of one or two years.

MAL: Actually, it is not the scholars who should be compelled to do so, but the market player.

This is because the market players determine who sits on the Sharia board and it is their responsibility to ensure that there is mixed of senior and junior scholars in their board.

We have done this in Malaysia and it works as pointed earlier.

In a recent event in Malaysia, Dr Mohammad Elgari presented a paper on Sharia governance. Is this the need of the hour?

HHH: Governance, in the perfect sense of that term, does not exist outside of the Islamic financial system which is based on divine revelation as expressed in the Book (the Quran) and the Sunnah.

No one in the industry can ignore that, or the [AAOIFI] Sharia standards. In addition, there is a further guaranteed level of governance and that is the presence of the Sharia supervisory board itself, made up of three, five or even seven scholars who perform their duties and opine collectively rather than as individuals.

Beyond that, Islamic financial institutions adhere to their own standards, the fatwas issued by fiqh academies, and the teachings and rulings of the classical jurists.

And then there is the academic community that monitors the work of our Islamic banks such that if ever a fatwa is issued which contradicts an Islamic teaching or principle, as a result of faulty reasoning or legal process, our academics will raise a hue and cry until the matter is corrected.

MDB: This is a welcomed paper to address the quality of Sharia advisory services, applicable to both the scholars and the stakeholders of Islamic finance.

The Sharia governance, as presented in the paper, argues for more transparency of the fatwa process and deliberations.

As a matter of fact, this (the detailed process of fatwa issuance and its argument) should be the focus of research of modern researchers instead of the perceived conflict of interest by multiple board membership.

The superiority of any Sharia board is the quality of arguments that lead to a strong and defendable fatwa by the board.

YTD: His was a very important paper and it addresses a pressing need.

As the industry matures, it becomes more and more important to have systems in place that ensure greater transparency and accountability.

Such systems will play an increasingly important role of the future development of this industry and they must be promoted.

MAL: I am one of the commentators on his paper and in many forums I have express my views that it is very important to have a comprehensive Sharia governance framework for Islamic finance.

This shall be spearheaded preferably by the regulator. In Malaysia, ISRA have initiated the establishment of Association of Sharia Advisors (ASA) in order to regulate the Sharia advisory services.

We are in the process of setting up this association and its function will be similar to other professional bodies such as the Bar Council and Medical Association that regulate the practices of its members.

ASA will be the body that regulates the conduct and lays down the ethical code of the Sharia advisors and we will get the body to be the sole body that accredits Sharia advisors for them to practise in the market.

ASA will also provide licence for the scholars to practise in the market.

Funds-at-Work research is welcomed as it shows the landscape of scholars and boards, but needs expansion to include scholars’ total activities and work. And the study should be enlarged to include other stakeholders in the Islamic finance consulting role. Finally, Islamic institutions have not knowingly contributed to over-reliance on name-brand scholars, but must now actively contribute to governance and involve junior scholars to manage Sharia compliance risk, for expansion beyond natural borders.

Don’t fear the riba: Sheikh Yusuf Talal DeLorenzo criticizes the Wa’d scheme promoted by Dr. Hussein Hamid Hassan

Don’t fear the riba: Sheikh Yusuf Talal DeLorenzo criticizes the Wa’d scheme promoted by Dr. Hussein Hamid Hassan

There has always been room for disagreement within Islamic finance, but one issue has caused particular controversy in the past months.

At the recent Islamic Funds World conference held in Dubai, two top industry figures put forward opposing views on the wa’ad swap – the promise agreement with which returns from one basket of assets are swapped with returns from another. Increasingly, this mechanism is being used to give Shariah compliant investors exposure to returns from haram, or non-Shariah compliant, assets.

Supporters of the technique say that it is no different to issuing a sukuk, for example, against the LIBOR (London Inter-Bank Offered Rate) benchmark, which is widely used in pricing Islamic bonds even though it is an interest rate.

Shaykh Yusuf Talal DeLorenzo, chief Shariah officer and board member, Shariah Capital, is a staunch opponent of the wa’ad swap with haram returns.

“The purpose of this swap is to bring returns that are not compliant to Shariah investors – and everyone knows it,” he told the audience.

“It is a mistake to say that the haram basket is no more than a benchmark. All that happens is the non-Shariah basket of assets sets a benchmark and it’s no different from LIBOR – wrong.”

He said that the comparison with LIBOR was inappropriate, since the interest itself, rather than the benchmark rate, is the forbidden part.

“As a mere benchmark it has nothing to do with the transaction,” DeLorenzo said. “In a wa’ad swap it is what creates the returns, and that is the problem.

“LIBOR for ijara is totally unrelated to the ijara transaction. With the haram basket of assets, its performance is directly related to the return. The funding, whether it’s direct or indirect, is there.”

He pointed out that LIBOR has been approved by Shariah boards for use as a benchmark for Islamic returns.

“There is no participation by Muslim investors in LIBOR – it’s the business of the London banks,” he added.

DeLorenzo argued that a Muslim investor taking part in a wa’ad swap is implicated in every investment decision the bank subsequently takes with his funds.

“When you accept this investment product, you accept the whole series, whether you know it or not,” he said. “As the money moves, its character changes.”

DeLorenzo concluded by saying: “If you’re going to swap returns of one basket of performing assets for another, then you must insist that the assets in both baskets are halal.

“Only then can you be sure of receiving returns that are halal.”

Taking a slightly different view was Dr Hussein Hassan, director of Islamic finance structuring for Deutsche Bank UAE, which has pioneered Shariah compliant products that give Islamic investors exposure to non-Shariah returns.

Dr Hassan told the assembled delegates that Deutsche Bank keeps Islamic investors’ assets isolated from haram assets, something that is demonstrated in the regular Shariah audits carried out on the bank.

In the specific mechanism outlined in the white paper issued by Deutsche Bank last year, the wa’ad swap is an agreement between the bank and the investor to swap the returns from two baskets of performing assets, which are kept entirely separate and do not interfere with each other. When the assets are deposited with the bank, it agrees with the investor to hand over the return from the basket of haram assets at the due date, in return for the return from the basket of Shariah compliant assets. The Islamic investor therefore takes the risk that the Shariah compliant assets he deposited with the bank could outperform the haram returns he will receive when the swap is conducted. For this reason, two agreements need to be signed to ensure that both sides carry out their obligations on the due date.

Deutsche Bank is confident that the transactions it conducts are entirely compliant with Shariah law, regardless of what assets make up the haram side of the swap.

“We had discussions with Shariah scholars to discuss if we need to change anything we do,” said Dr Hassan. “They explained we don’t need to resort to blocking the means.”

He said that he expected a greater range of benchmarks to be available to the Islamic finance industry in future, making it easier to create Shariah compliant investment products that are linked to other assets.

Alka Banerjee, chairperson of Standard & Poor’s index committee, also argued that more Islamic benchmarks were necessary to develop the industry.

“Commodities is one that’s really crying out for indices,” she said. “That’s a no-brainer. They are a big source of revenue for most Islamic countries and we do not have a commodities index right now. All commodities indices are based on futures pricing and futures are not Shariah complaint, so until the scholars come up with an acceptable form of pricing that index, it’s waiting to happen.”

Banerjee added: “We are working with Islamic scholars to find a way, but we don’t have anything yet.”

She predicted that Islamic ETFs (exchange traded funds) would take off in the next two years, and called for more breadth and depth in the Islamic funds industry, something that was echoed by other participants.

Mohammad Shoaib, CEO of Al Meezan Investment Management in Pakistan said that the high levels of liquidity in the region meant that there was not necessarily an incentive for the industry to come up with innovative types of funds.

“There is lots of liquidity in the system, so it is very easy to come up with plain vanilla products and bring in a lot of money,” he said.

Syed Tariq Husain, CEO of Pakistan’s Emirates Global Islamic Bank, agreed. “We’re growing rapidly, but in terms of value rather than product diversification,” he told the audience. “We probably need to do more in terms of funds and Islamic investment opportunities available.

“In the GCC we have an excessive amount of liquidity chasing too few assets. The rate at which liquidity is coming into the system is so great that assets can’t keep up with it.”

He said that, having used negative screening to rule out assets that are not Shariah compliant, there may now be a case for fund managers to apply positive Shariah screening to assets.

However, other participants argued that product innovation should not come at the cost of customer relations.

Umer Majid, director, Halal Investment Bank in the UK, said that British Muslim investors were becoming distrustful of Shariah compliant investment products. “They feel they’re being conned,” he said. “They feel they are being given conventional products with Islamic labels.”

He added: “There was one sukuk fund very well promoted as halal by certain investment funds, but if you looked closely at the small print it promised a guaranteed return and that is haram,” said Majid.

“This has created a lot of mistrust and what I’m worried about is that the Islamic finance experiment might fail before it’s begun because people are trying to mimic conventional products.

“There needs to be something done about the legal documentation – it needs to be standardised.”

Majid called for an Islamic ombudsman which could authenticate even Islamic investment products that had already been approved by a Shariah board, and which could handle complaints from the public.

Generally, though, the outlook for the Islamic funds industry seemed to be bright, as long as the supply of new products is able to keep up with demand from a huge Muslim investor base.

Oliver Agha, global head of Islamic finance, DLA Piper Middle East, gave some perspective of the Shariah compliant investment opportunities that will be available. “There are $690 bn of projects expected in KSA in the next decade, most of which will be Islamically financed,” he told delegates.

Booming Islamic bond market embroiled in debate over religious compliance: Mufti Taqi Usmani’s criticism of contemporary sukuk issues

Booming Islamic bond market embroiled in debate over religious compliance: Mufti Taqi Usmani’s criticism of contemporary sukuk issues

The booming market for financial products that comply with Islamic law was thrown for a loop recently by criticism from a leading scholar, who has set off a debate about whether the industry has sacrificed religious principles for the sake of growth at a time of surging Mideast oil revenue.

Shariah, or Islamic law, prohibits charging or paying interest, so bankers and lawyers have developed a rapidly growing financial market by restructuring conventional products like bonds to make them compliant with Islam. Shariah-compliant products attempt to replicate the concept of interest through cost-plus transactions, leasing arrangements or by linking payments to returns on underlying assets. The process is normally blessed by a board of religious scholars affiliated with a bank.

However, one of the world’s leading Shariah finance scholars recently rattled the market by saying 85 percent of Islamic bonds, or sukuk, are not Shariah-compliant. Sheik Mohammed Taqi Usmani argued that, in essence, they were structured too much like conventional bonds.

Many industry participants say Shariah scholars knew the bonds had structural issues but approved them to jump-start market growth — raising questions about how the gatekeepers of the Islamic banking industry weigh potential profit versus religious principles.

Others downplay the controversy, saying debate was expected given the rapid evolution of the market and the nature of Islamic law, which encourages multiple viewpoints from different scholars.

The influential Shariah board headed by Usmani at the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions, one of the leading groups trying to establish standards for the market, is scheduled to meet Jan. 15 with the hope of resolving the dispute and mitigating its impact on the industry.

Some say the race to grow the market has led to questionable religious rulings — a problem that is hard to police because of the lack of standardization across Shariah approval boards and the shortage of Islamic scholars well-versed in finance.

“Increasing the market in volume or numbers with false product that is against Islam is not a big success. It should be according to Shariah, that is the main thing,” said Sheik Saleh Abdullah Kamel, chairman of the Bahrain-based General Council for Islamic Banks and Financial Institutions, one of several organizations attempting to monitor the industry.

Islamic banking assets outside Iran totaled $400 billion to $450 billion in 2006 and are projected to rise to $1 trillion by 2010, according to a recent report by McKinsey & Co. Total assets, including those in Iran, totaled $750 billion in 2006, a small fraction of global financial assets, but one that is growing quickly.

Experts say growth has been driven by booming Persian Gulf oil revenue, Muslims’ growing preference for an expanding range of Shariah-compliant products and increasing acceptance of Islamic banking practices by financial regulators around the world.

The development of the sukuk market has been particularly important because previously there was a scarcity of Islamic products that could provide mid- to long-term investment and potentially be traded in the secondary market.

Sukuk issuance has grown almost 85 percent per year since 2001, with the total value of Islamic bonds issued in 2007 reaching $39 billion as of October, according to McKinsey.

“There has been this perception in the past that Islamic finance doesn’t lend itself to overly complicated structures, but sukuk rebuts that view,” said Nadim Khan, a Dubai-based lawyer who specializes in Islamic banking.

“It’s a real demonstration from the perspective of the Islamic financing industry that it is possible to structure widely acceptable, quite sophisticated Sharia compliance structures,” he added.

Islam prohibits interest based on the belief that money alone should not be used to generate profit and the returns are seen as riskless gain. So most sukuk are structured with a profit-sharing arrangement where returns are based on the value of the assets purchased with the initial investment.

However, many sukuk have been sold with a repurchase agreement, stipulating the borrower will pay back the face value at maturity, mirroring the structure of a conventional bond.

Usmani, the Shariah scholar, estimates 85 percent of sukuk have been sold with these repurchase agreements and believes the promise to pay back the capital runs counter to Islamic law.

“This is against the risk sharing principle of Shariah,” said Usmani.

Sheik Nizam Yaquby, another renowned scholar on the Shariah board chaired by Usmani, agreed that bonds with repurchase agreements should be made more Shariah-compliant.

“We need enhancement, improvement, innovation and we need more risk taking,” said Yaquby. “Many scholars have reluctantly approved such (sukuk) structures to take us away from the conventional bond market, but that stage has ended, so we should start creating more innovative structures.”

Kamel, who monitors the market, criticized this willingness to approve sukuk structures based on the assumption that they could be made more Shariah compliant once the market had grown, saying it was dangerous for the industry.

“The golden rule of Islamic banking is if you want a profit, you should accept the losses,” said Kamel. “If this rule is broken in any of the product, it is not according to Shariah.”

However, Afaq Khan, the head of Saadiq, Standard Chartered Bank’s Islamic banking arm, does not believe sukuk currently in the market can be considered counter to Shariah because they were blessed by their respective approval boards.

“Nobody comes to the sukuk market without a Shariah fatwa (religious ruling), so at least some Shariah scholars approved it,” said Khan.

Nevertheless, Khan said the current debate was productive. “Anytime a new industry evolves, it will try to test the boundaries,” he said.

“It is very healthy for the industry to take a breath, review and then move on,” said Khan. “Hopefully some consensus will evolve and it will be beneficial for the industry.”

Dr. Hussein Hamid Hassan: All Arabs will prefer Islamic banking

“All Arabs will prefer Islamic banking”: Interview with Dr. Hussain Hamid Hassan

Hussein Hamid Hassan is considered as the father of Islamic finance. He received his PhD from the faculty of Sharia at the Al Azhar University in Cairo in 1965 and holds two degrees in law from the International Institute of Comparative Law, University of New York. He chairs the Sharia Supervisory Committee of many Islamic banks in the Middle East, and has advised several governments.

An expert in Law, he had been the attorney general for the government of Egypt between 1969 and 1970. He has advised several governments in the Middle East and CIS countries on establishment of Islamic Finance Institutions. According to Mr Hassan, Islamic financing is the most equitable form of financing since it enables the creation of wealth without fuelling inflation or stoking a financial crisis.

In order to do away with the concept of interest rates, Islamic banking entails structuring products in different ways. If it is primarily to acknowledge that there is a price of money, how is it different?

The function of conventional banks is to receive deposits with fixed interest rates and to lend the same to borrowers at a fixed rate. The difference will be the revenue of the bank to meet expenses and distribute profits to shareholders. Conventional banks are not permitted to invest deposits at all, but can only lend it to investors.

Islamic bank doesn’t receive deposits with fixed interest rates. Rather, the deposits are in the form of equity from depositors to be invested, along with shareholders’ equity in one common pool. On the asset side, conventional banks have, since inception, had only one product, that’s loan with interest.

Sharia has unlimited products to suit every customer and every project under any circumstances. For instance, if you need to buy an aircraft or vessel or plant, you come to me for financing. If you want to buy an aircraft for $300 million, I will buy and transfer it you after 10 years after collecting installments with a profit margin. It can be fixed or floating like any benchmark or any index.

This is called Murabahah, to buy with agreed margin. Then there is Mudarba for financing project, where the businessman has full freedom to invest; the bank has no right to interfere in the project. According to Sharia, if something happens beyond your control, a force majeure event like war than I lose the capital 100% and you will lose your share in this limited liability venture. Your share is the expertise that you bring in.

Conventional banks sell loans through securitisation to raise resources. Can Islamic banks do something similar?

Sharia does not allow trading of loans. But if you have a combine, which has up to 30% tangible assets and 70% receivables, you can securitise the portfolio, where you take the assets from the balance sheet and sell them. This I have done it for Islamic banks in Abu Dabhi, Sharjah, and the UAE which have issued Sukuk bonds for several billion.

There is a real estate company called Amlak, which has securitised its portfolio in this manner. I am working on sukuk bonds for Morgan Stanley for $5 billion, but we are fighting with them. They want to make it Sharia-compliant, but they want bondholders to be pari passu with creditors of the company. But I have said no. This kind of bonds cannot be Sharia-compliant. But Morgan Stanley says that according to the American law, they have to make bondholders similar.

This is also what we have been telling central banks for 25 years on capital adequacy. Central banks treat Islamic banks on par with conventional banks and ask for 8% capital. I have been saying this is not correct because depositors of Islamic banks are equity investors and if you treat their money as equity, capital adequacy of Islamic banks will be 90%.

Today, when people want investment avenues to multiply their wealth, can Islamic products generate same returns?

The Sharjah government had asked me to convert Sharjah’s national bank into Islamic bank in 2002. Before they were paying interest of 1.2 to depositors. On June 30, we closed the conventional bank books. The share of the bank was quoting at three dirhams. Overnight from July 1, the share price went up to seven dirhams. After six months, the bank distributed profit of 3.5% for six months.

A lot of money is going to non-dollar assets, which is reflected in euro’s rise, do you think this shift is permanent or temporary?

I think this will continue, they were waiting for this. They are re-evaluating their currency. Kuwait has already gone from the dollar.

Would you advise others to drop the dollar peg and shift to euro?

For the present circumstances I would. Why? because the dollar is coming down and why should I lose. Business is business. Everyone has a right to protect themselves. If after 25 years, things come back to where they were, we can move back. One should mitigate his risks. For any risk, it is compulsory that you mitigate for yourself. This is not religion. Religion does not prescribe what currency one should select. This means that fortunately, every country should look at its own interest.

Given the rise in revenues of the Arab world, one would have expected Islamic banking to grow faster.

Not everyone invests in Islamic banks. But every week and every day, conventional banks are converting into Islamic banks. This is happening gradually. I can guarantee that all Arabs will move and prefer only Islamic banks. This is my personal belief as I have my own analysis and research on this. When we built the first Islamic bank in 1975, it was easier to say Islamic whisky than Islamic bank. I myself could not imagine that the Islamic banking industry would grow that fast.

Are there bankruptcy laws in Islamic banking for recovery from defaulters?

We have in Egypt a proverb, “giving the keys of the food store to the cat”. Conventional banking does that. In Islamic banking, I am not giving money to you to buy equity in your name or your wife’s name. Instead, I will buy an aircraft and lease it to you for 10 years. In return, I will get fixed rental and I will also get variables as a percentage of your profits. If you default, the lease is terminated and the asset is leased to someone else. Under Islamic financing, default means to commit financial suicide.