Legal Risks and Good Governance for the Growing Islamic Finance Industry Karachi December 2006 Hamid Yunis Partner

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 6. Conclusion Contents 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

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 Overview of Islamic Finance Market 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

Al-Wadia (safekeeping): usually not remunerated; Takaful (Insurance); Funds Work; SUKUK/Securitisation (Capital & Secondary Markets); and Derivatives/Funds Management. Islamic Finance (Cont’d): 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

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) Use of Islamic Finance in Different Market Sectors 9

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) Governance Background 10

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 Products and Processes 11

Regulator/Operator Issues Scope for the continuing development of good corporate governance in the field of Islamic finance No inconsistency with Shariah 12

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 Specific Issues 13

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 Specific Issues (cont…) 14

Many forms of International and National Guidance available OECD principles UK Stock Exchange Combined Code Cadbury Report Hempel Report Higgs Report Guidance 15

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” Guidance (cont…) 16

Basel Committee on Banking Supervision 1999 paper 2006 paper Basel 17

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 General Principles 18

Role of non-executive directors/managers Guidance Oversight Compliance issues Future compliance policy Non Executive Functions 19

Contact: HAMID YUNIS Taylor Wessing Carmelite 50 Victoria Embankment Blackfriars London EC4Y 0DX Tel: Fax: Direct: Web: 20

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