Islamic sharia is voluntarily practiced as governing law throughout the Muslim world in many aspects of personal and social life. Increasingly sharia is emerging as a choice of law in business and commercial practices as well. Islamic sharia law is based on long juristic deliberations and has evolved over nearly 1400 years.
Up until the middle of the last century, sharia law was extensively used throughout former Ottoman territories such as Syria and Jordan for business transactions and dispute resolution. In the modern context, sharia law should not be seen as a black box but should be regarded as another level of virtual jurisdiction to comply and accommodate.
The UK Treasury, the Financial Services Authority (FSA) and the English high courts have shown accommodation of sharia law in business and finance over the past few years and as a result, the UK is seen as a model by the rest of the secular world.
Panels of expert sharia scholars play a crucial role in the governance of Islamic financial institutions and banks. Shareholders of concerned institutions appoint them to ensure sharia adherence and compliance at all levels of business conduct and product offerings. The UK FSA decided not to regulate sharia boards as the FSA is a “financial regulator and not a religious regulator”.
Many central banks of the Middle East and south-east Asia have followed suit to treat Islamic financial institutions within the existing regulatory framework. Others, such as Malaysia, Bahrain and some Gulf states, have chosen to regulate Islamic financial institutions separately. Many regulatory and consumer protection issues emerge as controversial at formation stages of Islamic banks and institutions. Most European regulators are still deliberating on the issues.
The first issue has to do with regulatory law. This concerns institutions rather than individual transactions. Focusing on banks, supervision has developed according to internationally accepted standards.
How does Islamic banking fit in? According to William Blair of the UK Commercial Bar Association, the solution lies in convergence, and the accommodation of Islamic finance within current models of financial regulation. Michael Hanlon, the first CEO of Islamic Bank of Britain, says: “An incredibly constructive approach was taken by the regulator… to accommodate [Islamic] banking principles and fit the concept into the regulatory framework.”
Account protection
A practical example of such resolution has been the question of protecting the principle amount in deposit accounts of the customers at Islamic banks. British law does not allow funds invested in a savings account to be put at risk. However, this creates problems from a sharia perspective, as capital cannot be guaranteed in this type of transaction. A solution was found which involves giving sharia-compliant savings account holders the opportunity to choose sharia principles, and therefore incur losses.
The second issue relates to the respective roles of the sharia and the secular law in the context of financial transactions in Muslim countries and cross-border dealings. This only becomes a problem when a transaction goes wrong and the parties end up in dispute.
But transactions routinely do go wrong, and as Islamic finance grows, courts in different parts of the world will have to find an appropriate response to the possibility that the application of the sharia and that of a secular system of law will not necessarily produce the same outcome. The famous Riba judgment of the Supreme Court of Pakistan of December 1999 is rightly regarded as a valuable source of learning.
Standard process
The development of standards specific to the needs of Islamic finance is taking place within the process of convergence in global financial standards generally. The Islamic Financial Services Board (IFSB) is an international standard-setting organisation that promotes and enhances the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry. Many financial regulatory institutions are active members of the IFSB. In practical terms, this signals the growing maturity of the market and will help to bolster investor confidence, and therefore promote the growth of industry.
The Accounting and Audit Organisation of Islamic Financial Institutions (AAOIFI) of Bahrain rolls out sharia standards based on best practices and common agreement among a vast number of sharia supervisory panels and boards of Islamic institutions. Standards are not binding in themselves but they provide essential guidelines and a frame of reference. Standards must be translated into national legal systems to have mandatory effect. How this is done varies from country to country.
In Malaysia, the Islamic Banking Act 1983 and the Banking and Financial Institutions Act 1989 are enacted as separate statutes. The latter also governs Islamic banking by conventional banks. The Bahrain Monetary Agency has a long-standing supervisory history of Islamic banks and institutions by separate regulations directed toward fulfilling needs of the specific sector.
In contrast, when Kuwait adopted its new regulatory framework for Islamic finance in 2003, it did so by introducing a new section into the Central Bank Law of 1968. This approach places the emphasis on the regulation of Islamic finance within the established legal framework, seeking to minimise points of possible conflict and maximise a level regulatory playing field.
Each Islamic bank must have an independent sharia supervisory board, comprised of not less than three members. The article provides an avenue for resolving disputes within the board, stipulating that in the case of a conflict of opinions among its members concerning a sharia rule, the bank may transfer the matter to the Fatwa Board in the Ministry of Awqaf and Islamic Affairs, which is the final authority on the matter.
Court intervention
In Malaysia, the high court has assigned a court to preside over matters relating to Islamic finance. Perhaps more importantly, the central bank has formed a committee to review common law legislation to assimilate sharia principles with the aim of removing impediments to the efficient functioning of the Islamic financial system. The Sharia Advisory Council of the central bank is positioned as the sole authority on sharia matters pertaining to Islamic banking and finance that fall under the purview of the central bank, therefore serving as the reference point for courts or arbitrators in disputes that involve sharia issues in Islamic banking cases.
Disputes arising between Islamic banks and their customers have been relatively straightforward to settle, as the first call of grievance has to be the sharia boards of banks themselves. In many instances, sharia boards managed to assert themselves as adjudicators and arbitrators. In a landmark case of gross misconduct by a bank employee causing a huge loss of funds, the loss was not allowed to be offset against profits of the bank but had to be offloaded to shareholders’ equity as profits belonged to bank customers.
Islamic finance is experiencing a cumulative 15% annual growth in the Gulf Co-operation Council region. A similar pattern is evident in international and cross-border transactions. The debate has centred on whether contracts governing international Islamic finance transactions should be governed by sharia law, English law or a combination of two. It is interesting to note that major multinational entities entering the Islamic finance deals choose English law as the applicable law of contract.
The judgment at the trial of Shamil Bank of Bahrain EC versus Beximco Pharmaceuticals Limited and others,
the largest Islamic finance dispute to be litigated to date, and upheld in a UK’s court of appeal, brings legal certainty to issues of liability in international Islamic finance transactions that are governed by English law. Antony Dutton of Norton Rose, the law firm representing Shamil Bank in the case, says: “The decision demonstrates that the English courts are content to leave issues of sharia compliance in the hands of the religious supervisory board of an Islamic financial institution, unless the parties have made a very clear choice to the contrary.”
Legal limitations
This case involved a consideration by the courts of a commonly employed method of Islamic financing and in particular the legal basis on which such agreements are founded. Due to the circumstances of the case and the fact that Beximco’s sharia defence was found to be a lawyer’s construct, the court’s scope to consider the applicability of sharia was limited.
Sharia defence
It would have been manifestly unjust for Beximco to avoid its liability to the bank by raising the sharia defence, having previously been indifferent to the form of the agreements or the impact of sharia on its validity. If the parties had wanted compliance with sharia to be a condition precedent, they should have said so.
Two points arise from the decision of the appeal court in September 2004. First, it would have been difficult for the court to resolve fundamental differences between scholars about sharia principles, but on the other hand, the courts are accustomed to dealing with controversy between experts. Parties looking to enter into agreements incorporating sharia principles should consider including a dispute resolution provision referring disputes about sharia and its applicability to a sharia expert chosen by the parties or by a suitable institution. This might help to streamline the resolution of disputes and avoid the need for court proceedings, which could be more costly.
Second, this case was decided on the construction of the governing law clause, which incorporated English law, and the court did not need to consider and apply sharia. However, the court said that had the relevant sharia principles been validly incorporated in this case, Beximco might have succeeded.
The decision of the two English courts gives strong support to sharia-compliant institutions and their religious supervisory boards. The decision also gives comfort to Islamic finance entities that provided their sharia supervisory boards have approved the form of such transactions and documentation for sharia purposes, the English courts will uphold them. The general confidence in international jurisdictions enjoyed by the global finance community can now be extended to Islamic financial institutions.
Mufti Barkatulla is a senior imam in London and a prominent Islamic sharia law scholar. He is a member of the sharia supervisory boards of several Islamic financial institutions and is sharia advisor to the UK’s Lloyds TSB Bank.
Michael Hanlon, Islamic Bank of Britain: UK regulator has taken a positive approach to Islamic finance
