Achieving Shariah Compliance in Islamic Finance: A tale of two countries (2000 Words) I.

Introduction

Islamic banking and financial products are a growing sector in the finance industry. The annual growth of the sector averages 10-15% per annum and is forecasted to perform strongly.1 Singapore, with its position as a global financial center, coupled with its strong credit rating, rule of law and proximity to key Islamic nations is well poised to tap on the growth of Islamic finance.2 Nevertheless, it has much to catch up with Malaysia, a close neighbor and a developed Islamic banking hub with more than 20 years of history. This paper seeks to examine the legal framework surrounding Islamic finance in Singapore to ensure Shariah compliance on 3 levels: Regulatory; Firm based and; Consumer based. The first, explores the regulatory framework governing the industry on a governmental level. The next, explores internal measures utilized by Islamic finance firms for self-regulation. The last explores dispute resolution mechanisms which can be utilized by consumers to ensure Shariah compliance. Comparisons would be made to the framework in Malaysia due to the proximity of both nations and similarities in being based on a common law tradition with separate Shariah courts that handle Islamic civil and family matters. This paper would highlight that due to the different regulatory frameworks, Malaysia is much better equipped to ensure Shariah compliance. Nevertheless

recommendations would be made to improve Shariah compliance in Singapore.

1

Martin Cihak & Heiko Hesse, Islamic Banks and Financial Stability: An Empirical Analysis (Working Paper, International Monetary Fund, 2008), online: IMF <http://www.imf.org/external/pubs/ft/wp/2008/wp0816.pdf> 2 Harsha Jethnani, Spore can be key in Islamic banking push Straits Times (Singapore 25 March 2011) C27

II. A. (1)

The Legal Framework Regulatory Singapore

The main statutory provisions that govern Islamic Banking in Singapore are the Banking Act3 (BA), the Securities and Futures Act4 (SFA) and, the Insurance Act 5 (IA). Singapores approach towards Islamic banking modifies existing legislation to accommodate Islamic financial products along with conventional banking products. 6 Generally, Murabaha deposits and financings, Ijara wa igtina, Musharaka and Istina are managed under the BA; Sukuk are managed under both the BA and SFA and; Takaful are managed under the IA. It is pertinent to note that regulations related to Islamic financial products are crafted in secular terms. Hence, what results is a technical description of the transaction.7 The main regulator of financial products, the Monetary Authority of Singapore (MAS) does not profess to ensure Shariah compliance or acceptability of products.8 Instead, it highlights the problems of Shariah compliance risks to consumers, stating that the financial institution has to ensure that it is in compliance with Shariah rulings as [it] carries significant reputational risk to the bank. 9

3 4

(Cap 14, 2008 Rev Ed Sing). (Cap 289, 2006 Rev Ed Sing). 5 (Cap 142, 2002 Rev Ed Sing). 6 Monetary Authority of Singapore, Guidelines on the application of Banking Regulations to Islamic Banking (April 2010). <http://www.mas.gov.sg/resource/legislation_guidelines/banks/guidelines/Guidelines%20%20Islamic%20Banking%20May09.pdf> (MAS Guidelines), [2.6]. 7 Raj Joshua Thomas, Islamic Banking and Finance Regulatory Regimes in Malaysia and Singapore (2011) 29 Sing L Rev 166 (Thomas, Islamic Banking and Finance), 181. 8 MAS Guidelines, [2.7]. 9 Ibid.

Consequently, Shariah compliance appears to be a key concern on the regulatory level. Nevertheless, it is submitted that prudent and calculated regulation by the MAS would be unlikely to result in a sanctioned transaction falling foul of Shariah compliance. An examination of a Murabaha deposit under the BA would illustrate that despite its secular drafting, Shariah compliance is maintained. Traditionally, a Murabaha transaction involves a purchase of an asset by one party which is resold at a premium to the second party. The cost of acquiring that asset is then repaid in whole or in installments to the first party. In a Murabaha deposit, the consumer acts as the first party while the bank acts as the second party. The transaction essentially allows returns to be given on a deposit, avoiding the prohibition on riba. Regulation 23 of the Banking Regulations10 detail the steps involved in a Murabaha deposit. While there is no reference to the term Murabaha, the regulation has been explained to be targeted at Murabaha deposits based on guidelines issued by the MAS.11 The regulation permits banks to carry on the business of purchasing and selling assets on the conditions that: 12 (a) it is for the purpose of making available of customer funds to a bank for the purchase of existing assets; (b) money is advanced by the customer to the bank for the purchase of the asset;

10 11

(Cap19, Reg 5, 2004 Rev Ed Sing) MAS Guidelines, [4.4] [4.6] 12 Banking Regulations (Cap19, Reg 5, 2004 Rev Ed Sing), Reg 23(1)

(c) the bank purchases the asset from the customer at a price greater than the original and sells the asset; (d) the bank and customer do not experience loss or gain in the movement of the market value of the asset and; (e) the marked-up price need not be repaid to the customer until after the date of sale of the asset by the bank. The example illustrates a technical stipulation of the key elements of the Murabaha deposit. This allows little room for maneuverability, resulting in products likely to be rated Shariah compliant. (2) Malaysia

In contrast, the Malaysian approach crafts separate legislation under the Islamic Banking Act 198313 (IBA). A precondition to the licensing of an Islamic financial institution is that the business would not contain elements which are not approved by the Religion of Islam.14 Furthermore, existing financial institutions which seek to offer Islamic financial products can also be licensed for Islamic banking under the Banking and Financial Institutions Act 198915 In order to determine Shariah compliance of various transactions, reference is made to the Shariah Advisory Council (SAC) established under the Central Bank of Malaysia Act 200916 (CBM). The SAC operates under Bank Negara, the central bank of Malaysia and is the sole authority for Islamic finance. Generally the SAC issues resolutions on questions of Islamic law and can be consulted by courts or arbitrators on Shariah matters.
13 14

(Malaysia), 1983, Act 276. Ibid s 3(5)(a). 15 (Malaysia), 1989, Act 372. 16 (Malaysia), 2009, Act 701, s 16(b)(1).

Members of the SAC include Shariah scholars, jurists and market practitioners,17 possessing a range of expertise when ruling on complex financial products. The ruling of the SAC is final and binding 18 on all institutions offering Islamic financial products and all Islamic financial institutions are required to submit matters involving decisions of Islamic law to the SAC.19 It is submitted that the level of legitimacy accorded to Shariah compliance on the regulatory framework would be higher in Malaysia than in Singapore based on the proficiency and nature of the regulators involved. While controversies have previously arisen due to conflicting fatwas issued by state and national fatwa councils on whether certain government-run unit trusts were halal.20 Such disputes are unlikely to occur in the future with the rulings of the SAC.

17

See Bank Negara Malaysia, Shariah Advisory Council of the Bank <http://www.bnm.gov.my/index.php?ch=7&pg=715&ac=802> accessed 23 February 2012 for a list of the current members of the SAC. 18 CBM, s 57 19 CBM, s 55 20 Hazlin Hassan, KL-run unit trusts in 'halal' controversy Straits Times (Singapore 8 November 2011) There are no sources in the current document.

B. (1)

Firm based Singapore

In both nations, self-regulation by firms is a typical occurrence. Generally, each Islamic financial institution would set up a Shariah Board to advise and provide legitimacy to their financial products. For example, The Islamic Bank of Asia, an initiative by DBS Bank, a leading Singapore bank, has 4 members on its Shariah board who are all members of the Accounting and Auditing Organisation for Islamic Financial Institutions.21 Consequently, internal Shariah Boards perform checks to ensure compliance and the reputation of the board and consumer discretion acts as a second filter to ensure compliance. (2) Malaysia

While the internal regulations of an Islamic firm in Malaysia are largely similar, the IBA makes it mandatory for Islamic financial institutions to have within their articles of association a Shariah advisory body that is approved by the Central bank to advise on banking operations.22 The threat of licence revocation23 is likely to be an efficient deterrent in ensuring Shariah compliance. Furthermore, any act by the bank which is not approved by Islam is likely to be deemed ultra vires.24 Accordingly, a member of the bank, debenture holder or trustee can apply to the courts to set aside and restrain the ultra vires act.25 This allows

21

See Islamic Bank of Asia, Shariah Board <http://www.islamicbankasia.com/shariah/Pages/default.aspx> accessed 24 February 2012. 22 IBA, s 3(5)(b). 23 IBA, s 11. 24 Nik, Mohamed Ridza & Megat, Law and Practice of Islamic Banking, 2d ed (Selangor: Sweet & Maxwell Asia, 2010), 107 25 This is based on the Companies Act (Malaysia), 2009, Act 125, s 20.

members of the bank and shareholders to act as a second layer of check to ensure Shariah compliance. Again, Shariah compliance is much more likely to be achieved on the firm level in Malaysia than in Singapore.

C.

Individual based

The last level where Shariah compliance can be achieved is based on the consumer. Consumer discernment aside, dispute-resolution tools available to the consumer would greatly enhance the degree of Shariah compliance. A preliminary point is that despite Shariah courts operating in both countries, Islamic financing disputes are outside the Shariah courts jurisdiction. In Singapore, the Administration of Muslim Law Act26 empowers the Shariah Court to only deal with matters relating to marriage & divorce27 and inheritance.28 In Malaysia, the position is less clear with conflicting Articles in the Federal Constitution.29 However, the matter has since been resolved with a declaration by the Malaysian High Court that the Shariah court does not have jurisdiction on Islamic finance matters.30 Another key issue is that both Malaysia and Singapore are common law countries. Therefore, common law conflict of laws principles apply in the secular courts. This is a significant difficulty when attempting to introduce Shariah principles into commercial contracts. While there have not been any cases from either jurisdiction that address the issue, English case law states that under the common law, the proper law of contract would have to be the law of a contract and the courts would not apply any other system of law. 31 Furthermore, English courts have rejected the

26 27

(Cap 3, 2009 Rev Ed Sing). Ibid s 52(1) 28 Ibid s 115. 29 For an in depth discussion of the issue, see Mohamad, Dato Adul Hamid bin Haji Mohamad, Civil and Shariah Courts in Malaysia: Conflicts of Jurisdictions in International Seminar on Islamic Law in the Contemporary World (Institute of Islamic Understanding, 2000), 9; Hassan & Yusoff, The resolution of Islamic commercial disputes in Malaysia: Courts, mediation and arbitration [2007] Asian J Mediation 17, 21. 30 Ismam Malaysia Berhad v. Adnan Bin Omar [1994] CLJ 735. 31 Musawi v RE International (UK) Ltd [2007] EWHC 2981.

application of Shariah law to contracts attempting to incorporate Shariah principles due to the uncertainty involved.32 (1) Singapore

The problem highlighted above demonstrates the difficulty in applying Shariah principles and achieving Shariah compliance through dispute resolution in Singapore. Consumers are given limited legal recourse on multiple fronts. First, the courts are only able to interpret Islamic principles insofar as they have been implemented in statute. Given the technical and secular manner in which Islamic financial products are authorized under the BA, this is hardly satisfying in achieving Shariah compliance. Furthermore, even if the financial institution was found to have breached the BA, the statute only provides for the imposition of penalties33 by the MAS and does not avail civil recourse to the consumer. Nevertheless, a limited recourse is available through the doctrine of illegality or breach of contract insofar as the provisions of the MAS are incorporated. A possible means of incorporating Shariah principles is through arbitration. The courts are obliged to refer matters to arbitration upon proof of an arbitration clause. 34 The restrictions on Islamic principles would no longer apply and parties would be free to determine the applicable law.

32 33

Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd [2004] EWCA Civ 19 BA, s 71. 34 Arbitration Act (Cap 10, 2002 Rev Ed Sing), s 6; International Arbitration Act (Cap 143A, 2002 Rev Ed Sing), s 6.

(2)

Malaysia

Given the explicit incorporation of Shariah principles in Malaysian statutes, the abovementioned conflict of laws issues are less likely to be less problematic in Malaysian courts. However, secular court judges are trained in the common law and seldom in the Shariah.35 While no cases have depended on the interpretation of Shariah law, it is an eventuality given the growth of the Islamic finance sector. Nevertheless, this situation is practically remedied by the presence of the SAC. The CBM provides that matters relating to Islamic financial business shall either take into account prior resolutions by the SAC or submit the matter to the SAC for a ruling. 36 Furthermore, rulings of the SAC are binding on the court,37 rendering the SAC the sole authority on Islamic financial matters, ensuring certainty and consistency in Shariah compliance. Furthermore, the courts are also able to set aside arbitration rulings if it is unjust and contravenes Shariah principles.38 This provides for a higher degree of consistency and certainty in achieving Shariah compliance. Again, the Malaysian framework, due to explicit incorporation of Shariah principles, is better equipped to ensure compliance.

35

Mohd Illiayas Seted Ibrahim, The Regulatory Framework and Legal Aspecs of Islamic Banking and Finance in Malaysia in Mohd Daud Bakar, Engku Ali & Engku Rabiah Adawiah, eds., Essential Readings in Islamic Finance (Malaysia: Cert Publications, 2008) 36 CBM, s 56. 37 CBM, s 57. 38 Hassan & Yusoff, The resolution of Islamic commercial disputes in Malaysia: Courts, mediation and arbitration [2007] Asian J Mediation 17, 25.

III.

Evaluation and Conclusion

Overall, the Malaysian framework is much more robust and better equipped to ensure Shariah compliance. This is hardly surprising given that Islam is the state religion of Malaysia with the population being predominantly Muslim. This is in contrast to Singapore, a secular nation which maintains the secularity of its banking system. Singapore has taken a different path from Malaysia in achieving Shariah compliance. Consequently, a proposal to bring legislation closer to that of Malaysias would be unrealistic. It is submitted that arbitration be advanced as the chief dispute resolution method for Islamic finance contracts. Furthermore, it is recommended that the Legal Committee of the Islamic Council of Singapore, Maijlis Ugama Islam Singapura (MUIS), be consulted on matters pertaining to Islamic finance. Given that MUIS currently handles matters pertaining to halal certification and matters of the Muslim religion, 39 this would be a logical extension of its pre-existing duties. These measures, coupled with prudent regulation of eligible Islamic financial products bolster the Shariah compliance framework in Singapore.

39

For a list of the roles and responsibilities of MUIS, see MUIS, Background, Roles and Functions <http://www.muis.gov.sg/cms/aboutus/overview.aspx?id=44> accessed 23 February 2012.

Bibliography Cases (UK) Musawi v RE International (UK) Ltd [2007] EWHC 2981. Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd [2004] EWCA Civ 19 Cases (Malaysia) Ismam Malaysia Berhad v. Adnan Bin Omar [1994] CLJ 735. Legislation (Singapore) Arbitration Act (Cap 10, 2002 Rev Ed Sing) International Arbitration Act (Cap 143A, 2002 Rev Ed Sing) Banking Act (Cap 14, 2008 Rev Ed Sing). Securities and Futures Act (Cap 289, 2006 Rev Ed Sing). Insurance Act (Cap 142, 2002 Rev Ed Sing). Banking Regulations (Cap19, Reg 5, 2004 Rev Ed Sing) Administration of Muslim Law Act (Cap 3, 2009 Rev Ed Sing). Legislation (Malaysia) Islamic Banking Act (Malaysia), 1983, Act 276. Banking and Financial Institutions Act (Malaysia), 1989, Act 372. Central Bank of Malaysia Act (Malaysia), 2009, Act 701, s 16(b)(1). Companies Act (Malaysia), 2009, Act 125, s 20.

Secondary Sources Bank Negara Malaysia, Shariah Advisory Council of the Bank <http://www.bnm.gov.my/index.php?ch=7&pg=715&ac=802> accessed 23 February 2012 Cihak M & Hesse H, Islamic Banks and Financial Stability: An Empirical Analysis (Working Paper, International Monetary Fund, 2008), online: IMF <http://www.imf.org/external/pubs/ft/wp/2008/wp0816.pdf> Hassan & Yusoff, The resolution of Islamic commercial disputes in Malaysia: Courts, mediation and arbitration [2007] Asian J Mediation 17. Islamic Bank of Asia, Shariah Board <http://www.islamicbankasia.com/shariah/Pages/default.aspx> accessed 24 February 2012. Jethnani H, Spore can be key in Islamic banking push Straits Times (Singapore 25 March 2011) C27 Mohamad, Dato Adul Hamid bin Haji Mohamad, Civil and Shariah Courts in Malaysia: Conflicts of Jurisdictions in International Seminar on Islamic Law in the Contemporary World (Institute of Islamic Understanding, 2000) Mohd Illiayas Seted Ibrahim, The Regulatory Framework and Legal Aspecs of Islamic Banking and Finance in Malaysia in Mohd Daud Bakar, Engku Ali & Engku Rabiah Adawiah, eds., Essential Readings in Islamic Finance (Malaysia: Cert Publications, 2008) Monetary Authority of Singapore, Guidelines on the application of Banking Regulations to Islamic Banking (April 2010).

<http://www.mas.gov.sg/resource/legislation_guidelines/banks/guidelines/Guidelines %20-%20Islamic%20Banking%20May09.pdf> MUIS, Background, Roles and Functions <http://www.muis.gov.sg/cms/aboutus/overview.aspx?id=44> accessed 23 February 2012 Nik, Ridza M & Megat, Law and Practice of Islamic Banking, 2d ed (Selangor: Sweet & Maxwell Asia, 2010). Thomas R J, Islamic Banking and Finance Regulatory Regimes in Malaysia and Singapore (2011) 29 Sing L Rev 166 (Thomas, Islamic Banking and Finance).