United Arab Emirates: Comparing Sharia'a Governance Frameworks

Last Updated: 18 July 2017
Article by Samer Hijazi

Islamic financial products and services are distinguished from their conventional counterparts by their compliance with Sharia'a precepts and principles. Sharia'a compliance risk to an Islamic financial institution (IFI) is the risk that a financial service or product is not or will not be in compliance with established Sharia'a principles and standards as interpreted by the Sharia'a advisors to the IFI. The consequences of non-compliance with Sharia'a principles can be significant and pervasive – with the worst case scenario being that it could lead to depositors withdrawing their funds; loss of income; voiding of contracts; litigation; and ultimately lead to a diminished reputation and long-term damage to the IFI's business franchise.

The risk of Sharia'a non-compliance is present in all stages of the development and launch of an Islamic product, including the conceptualisation and structuring of Islamic instruments; legal documentation; contract terms governing default and late payment charges; sale and market conduct; execution and implementation; and accounting and disclosure.

In order to be able to address these risks, an IFI should establish a rigorous and comprehensive Sharia'a governance system. In this article, we discuss a number of governance models in place around the world based on a survey of reporting practices of IFIs in the UK, the Middle East and Malaysia. Typically, these comprise of internal and/or external assurance arrangements.

Internal assurance arrangements to achieve/demonstrate Sharia'a Compliance

Internal assurance arrangements are clearly the most prevalent governance model currently in place. An IFI's internal assurance framework to ensure Sharia'a compliance will usually consist of a Sharia'a Supervisory Boards (SSB) often supported by the IFI's internal audit function and, sometimes, by an internal Sharia'a Review Unit, however, other hybrid arrangements are also common.

The SSB is responsible for ensuring that an IFI has complied in all its activities with Sharia'a, as well as for directing, supervising and reviewing its activities. The SSB consists of scholars and industry best practice is for the members of the SSB to be elected by the shareholders of the IFI, in order to establish their independence from management who they are required to challenge.

However, we have noted some inconsistencies in the application of this model around the world. Firstly, while industry standards around Sharia'a governance have been developed and issued by the likes of AAOIFI and the IFSB, these standards are mandatory in only a few jurisdictions and barely referred to as best practice in other jurisdictions.

As such, some SSBs comprise several recognised scholars while others only include one or two. How each of these SSBs oversee the activities of their respective IFIs also varies with the members of some SSBs choosing to directly sample the IFIs transactions themselves on a periodic basis. Other SSBs make use of the services of the internal audit function and issue them with work programmes, however a handful of IFIs also employ their own internal Sharia'a review unit consisting of more junior scholars who perform compliance testing directly for the SSB.

To make matters even more perplexed, we have noted that the nature and scope of the assurance opinions issued by the various SSBs also differ. Most SSBs issue Sharia'a compliance opinions on the activities of the IFI for the year then ended based on the transactions sampling they would have carried out over the period. Most of these opinions give positive assurance on the compliance of the IFI. However, some SSBs state that they have reviewed all transactions and activities of the IFI as opposed to a sample while a minority of SSBs issue negative assurance opinions.

All of this is also compounded by the fact that there seems to be no industry accepted definition of the experience and qualifications needed to work as a scholar. This is obviously less of an issue when it comes to the big industry names such as Sheikh Nizam Yaqoubi and Dr Mohamed El Gari to name a few, who are practically household names now. However, arguably, this is potentially a barrier to entry for the next generation of leading scholars.

This leads us on to the next challenge, which sees many IFIs being advised by the same scholars. As one senior Islamic banker stated: "if you want to establish a high quality Islamic finance business with zero tolerance for compliance issues then there is a select group of scholars you have to use". Some industry commentators respond that this is no different to the Big 4 accounting firms being auditors to 99% of the FTSE 100, however, the Big 4 are subject to independent oversight by industry regulators around the world. With a few exceptions, there is little independent regulation of Sharia'a scholars currently in place.

External assurance arrangements to achieve/demonstrate Sharia'a Compliance

As noted, some jurisdictions (especially those that follow AAOIFI standards) require some form of external assurance around the IFIs' Sharia'a compliance arrangements and this is typically the responsibility of the IFI's external auditor. As such, an external audit of an IFI may entail not only a statutory financial audit, but also an audit of the Sharia'a compliance of the entity. Since IFIs are required to adhere to Sharia'a principles in all their business activities and operations, external auditors in some jurisdictions express an opinion as to whether all transactions and products entered into during the financial year are in compliance with the Islamic Sharia'a rules and principles, and fulfill the specific directives, rulings and guidelines issued by the SSB of the entity.

In addition, some jurisdictions, such as Malaysia, Pakistan, Oman and Nigeria, have set up a Centralised Sharia'a Board (CSB). The advantage of a CSB is that it brings consistency to financial products and services offered by IFIs. The disadvantage of a centralised structure is that it can inhibit the SSB's ability to provide solutions and innovations that are relevant to that particular IFI. Further to this, an IFI operating across different jurisdictions may find it difficult to adhere to guidelines set by different CSBs. Nevertheless, it seems that a CSB can complement the SSB function by providing clarification at a regional level over Islamic investment and accounting issues.

At the other end of the spectrum is the UK, which is typically accepted as the leading hub for Islamic finance in the Western world given the number of institutions (including standalone) offering Islamic financial products there together with the recent UK Government Sukuk issuance. However, the regulators over the years have taken a strictly secular approach to Sharia'a governance, preferring to let the industry itself arrive at what the right framework might look like. While this approach is understandable, it is also a little risky given that Sharia'a compliance is a fundamental aspect of operational risk in an Islamic financial institution. The result is that Sharia'a governance models range fairly widely across Islamic financial institutions in the UK.

Recent developments

It always needs to be remembered that while the wider conventional financial markets have been in place for hundreds of years, modern Islamic finance only really emerged on to the scene in the 1970s. As such, it has had a whole suite of issues to address as it developed over the past forty years from product development to convincing skeptical customers of the validity of its offering and Sharia'a governance has been only one of many challenges.

However, there is recent evidence to suggest that more and more stakeholders within the industry are recognizing the need for more regulation and standardization around forms of Sharia'a governance frameworks within the Islamic world.

In May 2016, the UAE Cabinet approved the launch of a new Sharia'a Authority, a national regulator to set standards for Islamic finance products, oversee the Islamic financial sector, approve financial products and set rules and principles for banking transactions in accordance with Islamic jurisprudence. Members of the new board will be selected by the UAE Central Bank and subject to its oversight. The UAE Sharia'a Authority will be modeled on the Malaysian version and will effectively act as a higher level of approval for products approved by individual Islamic finance SSBs which will continue to exist.

The Central Bank of Bahrain (CBB), in the meantime, has proposed new governance rules that would require Islamic banks in the Kingdom to conduct annual external Sharia'a audits of their operations which will be a significant shift away from the existing internal assurance arrangements. It is understood that this move is partially to placate concerns of some market participants and customers that the activities of some Islamic finance houses are sailing too close to the wind of conventional finance.


There does not seem to be a single accepted model of achieving and demonstrating 'Sharia'a compliance' to the market and the stakeholders of the IFI. The current structures and processes established within IFIs for monitoring and evaluating Sharia'a compliance consist of internal and, in some cases, external features. One of the defining lessons of the recent financial crisis has been around the need for better and more transparent corporate governance. We believe this should also apply to developing more consistent and rigorous Sharia'a governance models across the Islamic finance industry around the world and we welcome some of the recent moves to greater standardization around Sharia'a governance frameworks within the region, which will further fortify governance frameworks overall.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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