The price of piety
GC explores the rise of the Islamic finance industry, and how legal teams, regulators and governments are responding to the ever-growing demand for Islamic financial products.
Banks the world around are subject to a level of supervision and regulatory scrutiny over and above almost any other entity. In certain parts of Asia, and in an increasing number of Western countries, banks have even more to contend with. In Southeast Asia, where Muslims number 240 million and over 40% of the population, the demand for financial products that adhere to Sharia legal principles is similarly high.
Ernst & Young estimates that Islamic banking assets grew at an annual rate of 17.6% between 2009 and 2013, and further estimates that they will continue to grow by an average of 19.7% up to 2018. A report by Thomson Reuters in 2017 projected global Islamic financial assets to be worth $3.2tn by 2020.
‘A credible Islamic finance offering is becoming one of the key differentiators among banks in Southeast Asia,’ explains Lee Chin Tok, group general counsel at CIMB, Malaysia’s second largest bank.
In 2015, 65% of the global assets were held by those based in Saudi Arabia, Iran and Malaysia. Another report by the Islamic Financial Services Board, an international body based in Malaysia, which is responsible for setting standards and giving guidance on Islamic banking and finance, reported that the total value of Islamic financial assets had grown from $1.4tn to $1.5tn in 2017.
Sharia on the ground
In many countries, Malaysia and Indonesia included, the demand for Islamic financial products has carved out an increasingly prominent role for Sharia within the traditional legal system. Naturally, this is felt by legal teams operating within these jurisdictions and this industry, where Islamic finance isn’t just a public relations issue, but a regulatory one, too.
‘We have a dedicated Islamic Legal team that covers Islamic finance. However, I also encourage my other legal colleagues who are not on that team to also have familiarity with the Islamic principles that we use for our Islamic products,’ explains Chin Tok.
‘Although we do have various specialist legal teams for a particular area of law or particular area of business and notwithstanding the fact that we have a dedicated Islamic legal team, the rest of our legal colleagues are encouraged to learn about Islamic finance because it is an important component for our business.’
Indonesia has begun to solidify the boundary between Sharia and non-Sharia offerings. The country introduced the so-called ‘New Insurance Law’ in 2014, which is intended to be the definitive source on insurance law in the country. One of the requirements it introduced was that all Sharia business units within conventional insurance companies must be segregated.
‘In terms of regulation, insurers have to be ready to spin off their Sharia units, as required by the 2014 insurance law. We have to submit the blueprint for the spinoffs by 2020, and they have to be spunoff by 2024, so this is becoming a hot topic of conversation everywhere in the industry. We have to be able to ensure that the process is running smoothly and successfully, ’explains Randi Ikhlas Sardoni, head of legal at Panin Dai-ichi Life.
‘Now, the issues relate to how to ensure that when the spinoff company is independent from the holding company or the conventional company, it will be competing with the other Sharia companies in Indonesia, and not with the conventional company.’
‘There will also be a lot of discussion about how to train the financial advisers. Currently, we have financial advisers that hold two licences, a conventional licence and a Sharia licence. But after the regulation takes effect, they have to advise just the conventional or just the Sharia businesses. So these will be several things that have to be taken care of and discussed properly.’
Pious Regulation in Malaysia
According to Thomson Reuter’s Islamic Finance Development Indicator, Malaysia is the best-developed Islamic Finance market by a significant margin, scoring 128.87, ahead of the next-best, Bahrain, by over 45 points.
The regulation of Islamic finance in Malaysia is sophisticated. Islamic financial products and services are regulated by the Central Bank of Malaysia, which regulates specifically for the Islamic finance market in the hopes of establishing Malaysia as a global hub. Islamic finance is specifically provided for in the Central Bank of Malaysia Act 2009, which states that ‘the financial system in Malaysia shall consist of the conventional financial system and Islamic financial system.’
the Islamic capital market in Malaysia accounts for over 60% of the total capital market.
‘The legal infrastructure in Malaysia, in the context of Islamic products, is generally quite well-established by the regulatory authorities. On the banking side, we have the Malaysian Central Bank (Bank Negara Malaysia) and on the capital markets side, we have our Securities Commission,’ says Lee.
‘Both Bank Negara Malaysia and the Securities Commission have their respective Shariah Advisory Councils to, amongst others, deliberate, provide guidance and issue rulings on all Sharia matters, including products and structures and therefore help the banks to structure their products in a Sharia-compliant manner.’
The Malaysian Central Bank, referred to as BNM, is empowered by statute to legitimise the duality of both Malaysia’s conventional and Islamic financial systems. It has a dedicated Shariah Advisory Council, to which all questions of Islamic finance under Sharia should be referred.
The Securities Commission is similarly mandated to regulate the Malaysian capital market, which includes the Islamic capital market. According to the Securities Commission, the Islamic capital market in Malaysia accounts for over 60% of the total capital market. To bolster this, the Securities Commission set up a dedicated Islamic Capital Market Department, mandated to carry out research and development aimed at strengthening the long-term prospects of the Islamic capital market in the future.
Malaysia’s dual judicial system is supported by two separate courts: the Civil Court and the Sharia Court. Unlike the Civil Court, the Sharia Court only has jurisdiction over those professing the religion of Islam, and on select areas of Islamic law, including family law and the administration of trusts. Islamic banking and finance, while subject to Sharia law, are dealt with in the civil court system.
‘Here in Malaysia, we have the regular courts and then we have the Sharia courts. If you’re a Muslim and you want to get a divorce, you cannot go to the regular courts – you go to the Sharia courts. Sharia is very important, but where we don’t see it play a big role, is in business disputes,’ explains Harald Sippel, head of legal services at the Asian International Arbitration Centre.
‘For Islamic products which are being offered to bank customers in Malaysia, they come under the jurisdiction of the Malaysian civil courts, and not the Islamic courts. That helps in terms of making sure, in terms of the treatment of Islamic products, that they also follow the same principles in terms of enforceability,’ adds Lee.
‘That also helps to keep the wider public informed of any issues about Islamic products, as the cases are also litigated in the civil court system.’
This position has been affirmed on the basis that disputes over Islamic financial transactions still involve the application of civil law statutes; that Sharia courts hold few powers in terms of enforcement and remedies to function as a banking court; and that the Sharia courts are independent state courts with their own lines of appeal – making them a confusing source of authority on financial matters.
Despite this, the line between Sharia and civil law when talking about issues of Islamic finance, is not as well defined as it appears. Even in the civil courts, adjudicating on Islamic finance requires an application of both Sharia and the civil law. That Islamic finance cases are filed in the civil court at every level has muddied the procedural waters and has often left judges who are not sufficiently trained in Sharia law in the position of presiding over Islamic finance cases. Worse still, Islamic finance cases are often brought before lower courts who are not empowered to grant the kinds of remedies that would normally be appropriate in cases of non-compliance, leading to costly delays in proceedings.
The obvious answer may be to establish a dedicated court to hear matters of Islamic finance, but Malaysia’s legal architecture makes this difficult. In Malaysia, the courts are set up based on territoriality, with the intent of providing easy access to the legal system for citizens. This focus on geography would not lend itself to the establishment of dedicated Sharia courts, where the volume of Islamic finance cases will vary greatly depending on location.
A dedicated court, the Muamalah Court, was established in 2009 and is designated to hear all cases on Islamic finance. While viewed as a positive step, the scope of the Muamalah Court is limited and it still defers to Malaysia’s other commercial courts for execution proceedings. Further, appeals from the Muamalah Court follow the same path as appeals from other lower level courts, meaning that cases appealed will eventually end up before a panel of non-Sharia experts, despite their origins in the specialised Muamalah Court. Additionally, this court is resident only in Kuala Lumpur, meaning it can only hear cases filed in Kuala Lumpur. This renders citizens based in regional Malaysia without easy access.
While various figures within the Malaysian legal system have called for the establishment of the Mualamah Court at state level, citizens outside Kuala Lumpur have no option but to take the traditional route to justice. That means applying to non-expert commercial civil courts to rule on matters of Islamic finance, or seeking alternative methods of dispute resolution altogether.
Malaysia is one part of a tightly-knit collection of economies in Southeast Asia. Despite their geographic proximity and co-dependence, these countries are diverse culturally and, as a result, legally. Whereas a small niche of Sharia law sits alongside the civil code in Malaysia, some of its would-be trading partners see Sharia take a much more dominant part of their legal code. This, Sippel explains, can be a barrier to trade.
‘Now, there is a quickly growing volume of deals for halal product. That’s where we see a huge market for growth because these halal products are being traded more and more on an international scope. But the moment you have a second country involved, you will automatically have more disputes because of the cultural differences,’ explains Sippel.
The obvious answer may be to establish a dedicated court to hear matters of Islamic finance.
‘When it comes to halal products, for a Malaysian company to do business with an Indonesian entity, for instance, they would be reluctant to agree to be subject to anything other than Sharia experts, which is where the Asian International Arbitration Centre (AIAC) would come in.’
Malaysia has embraced the value of alternative dispute resolution methods, which has allowed entities such as the AIAC to thrive. Formerly the Kuala Lumpur Regional Centre for Arbitration, it looks to leverage its dominance in Malaysia and establish itself as Southeast Asia’s premier arbitration hub.
‘We were established 40 years ago, in 1978. What we don’t have to a great extent yet are the international arbitrations. Of around 150 arbitrations a year in total, 80% of that is domestic,’ says Sippel.
‘It’s something that we are trying to expand, because the AIAC is the only, or is one of the only arbitral institutions in the world that has Sharia-compliant arbitration rules.’
In 2012, the AIAC introduced a new set of arbitration rules for Islamic arbitration. Called the i-Abritration rules, they are the first adapted ruleset to cater exclusively to disputes arising from commercial contracts containing issues of Sharia law.
The rules were a necessary introduction for global legal frameworks, and form a big part of the AIAC’s vision to become the go-to arbitration service in Asia. The hope for the AIAC is that it can offer another avenue to international parties looking to do business in Malaysia or wider-Asia, specifically with regards to Islamic finance.