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					Legal Risks and Good Governance for the
Growing Islamic Finance Industry




                                 Hamid Yunis
                                 Partner



Karachi
December 2006
Contents
1.   Fundamentals of Islamic (Shariah Compliant) Finance
          Basic requirements and philosophy
2.   Overview of Islamic Finance Market
          Types of Islamic Finance Products
          Basic Assumptions
          Additional Matters
3.   Use of Islamic Finance in Different Market Sectors
4.   Governance
          Background
          Products and processes
          Regulator/operator issues
          Specific issues
          International Guidance
          Basel
          IFSB Standards
5.   General Principles
          Non executive functions
     Conclusion
6.
                                                           1
   Fundamentals Islamic (Shariah) Finance:
       Quranic (Shariah Law) principles;
       Riba (“interest/unjustified rewards/unlawful gain”);
       Gharrar (“uncertainty, risk, speculation”);
       Halal (“religiously permissible”);
       Haram (“not religiously permissible”);
       Qard Hasan – (“good loan”);
       Al-Wadia – (“safekeeping”).




                                                               2
   Basic Requirements and Philosophy
       true risk sharing;
       no exploitation of a weaker position;
       not socially unproductive;
       not economically wasteful;
       promotes economic and social development; and
       charitable (“zakat”).




                                                        3
Overview of Islamic Finance Market
 Islamic and Dual Banking Systems
 Retail Islamic finance products offered for a number of
  years, some low key e.g. Middle Eastern banks, others high
  profile e.g. HSBC
 Islamic Windows in major Global Banks
 Islamic Bank of Britain
 Primary Market: initially basic finance products
 Compatibility with conventional products




                                                        4
   Types of Islamic Finance Products:
       Equity;
       Trade Financing;
       Asset Financing
       Lending;
       Wholesale & Retail Products:
        •   loans;
        •   partnership investments;
        •   forex;
        •   fund transfers;
        •   letters of credit;
        •   securities safe keeping;
        •   investment management and device;
                                                5
   Islamic Finance (Cont’d):
       Al-Wadia (safekeeping): usually not remunerated;
       Takaful (Insurance);
       Funds Work;
       SUKUK/Securitisation (Capital & Secondary Markets); and
       Derivatives/Funds Management.




                                                                  6
   Basic Assumptions
       Underlying asset must be acceptable
         Different interpretations on what proportion of asset must not be
           “haraam”
       Proposed structure of transaction has to be acceptable
       No prohibited activities (proportionate approach)
       Need to account for regulatory requirements and comply with two sets
        of law (Shariah and law of country)




                                                                       7
   Additional Matters
       Zakat (specified amounts to be allocated from disposable income);
       Shariah Boards – competition, pragmatic approaches;
       Urf (custom);
       Darura (overriding necessity);
       Maslaha (general interest to justify);
       Hiyal (ruse)




                                                                   8
Use of Islamic Finance in Different Market
Sectors
   Real Estate
   Project Financing
       Co-financings (Power, LNG, Oil & Gas)
   Retail Banking
     Depositors
     Investment Account Holders
   General Leasing
       Ijara
   Asset Finance
   Bond (SUKUK) Issuance
   Private Equity Funds
   Insurance (Takaful)
   Capital Markets (Sukuk/Arboun/Salaam)       9
Governance

Background
   Developing, structuring and marketing Shariah compliant
    financial products can be cumbersome and complex
   IIFS needs to account for regulatory requirements and
    comply with two sets of jurisprudence/law (Shariah and the
    law and regulations of relevant jurisdiction)




                                                          10
Products and Processes

   Products and Processes need to be effective from the
    following viewpoints:
       Understandable
       Competitively priced
       Tax effective
       Available and transparent
       Not administratively burdensome
       Not “alien” to regulatory requirements
   Governance of institution offering Islamic financial services
    needs to be the same
                                                              11
Regulator/Operator Issues

   Scope for the continuing development of good corporate
    governance in the field of Islamic finance
   No inconsistency with Shariah




                                                         12
Specific Issues

 Islamic finance industry needs to, in particular, focus on
  issues regulators will be concerned with
 Remember that Shariah-compliance will not normally be an
  issue for non-Islamic countries or where Shariah is not part
  of a general legal framework
 Shariah Supervisory Board presence and scrutiny therefore
  essential



                                                          13
Specific Issues (cont…)
 Islamic finance industry regulators need to consider
  regulation of Shariah Supervisory Board
 Islamic financing industry need for a unified front to
  regulators
 Standardisation of models used, terminology and treatment
 Dissemination of codes of best practice
 Practical Adaptability




                                                       14
Guidance

 Many forms of International and National Guidance available
 OECD principles
 UK Stock Exchange Combined Code
   Cadbury Report
   Hempel Report
   Higgs Report




                                                        15
Guidance (cont…)

 France/Germany: different forms of governance models
 US: Sarbannes-Oxley
 Other/Corporate Governance Standards
   Country Specific
   Accounting and Industry Specific
 IFSB guidance
       Principles outlined
       “Comply or Explain”

                                                         16
Basel

   Basel Committee on Banking Supervision
       1999 paper
       2006 paper




                                             17
General Principles

 Establish Good Governance Policy as a principle of Shariah
 Monitoring and work of
       Board Committees
       Executive Management
       Shariah Supervisory Board
       Internal and external auditors
       Different Stakeholders
   Mechanisms of balancing the roles of different stakeholders
    i.e.) shareholders, management, IAHs

                                                           18
Non Executive Functions

   Role of non-executive directors/managers
       Guidance
       Oversight
       Compliance issues
       Future compliance policy




                                               19
Contact:


                     HAMID YUNIS
                    Taylor Wessing
                       Carmelite
                50 Victoria Embankment
                       Blackfriars
                         London
                       EC4Y 0DX

                  Tel: 0207 300 7000
                  Fax: 0207 300 7100
                 Direct: 0207 300 4088

           E-mail: h.yunis@taylorwessing.com
             Web: www.taylorwessing.com


                                               20
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