AMANIE ISLAMIC FINANCE CONSULTANCY AND EDUCATION LLC

By Jack Bunker (Dubai)

Thomson Reuters : Precedent Watch
APRIL 23, 2010

The kaleidoscope of Islamic finance gives every viewer a different picture. Four major schools of thought, set against two frequently diverse platforms of Far East and Middle East, along with the vantage points of Muslims and non-Muslims – all combine to keep many of the industry’s questions unsettled.

As part of a series of insider interviews, Westlaw Business Currents had occasion to speak with one of the industry’s most respected scholars. Now based in Dubai, Dr. Mohd Daud Bakar is a Sharia advisor for the Central Bank of Malaysia and a board member of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). As such, Dr. Bakar offers a unique perspective – that of a Malaysian-trained scholar working in the Gulf.

Dr. Bakar cites, perhaps surprisingly, a lack of human capital as one of the biggest challenges facing Islamic finance. “Lawyers, bankers, risk managers…we need to have qualified people to help the process moving forward. It will help by allowing to cut time and unnecessary delays in educating those involved – even regulators.”

He surmises, “In some cases, due to lack of knowledge, it may take longer to approve a product – which is good, but it affects the competitiveness of the industry.” The process, he says, “should be thorough and quick – otherwise costs accumulate unnecessarily. From the Shariah perspective, scholars have to educate further. To have to repeat education steps over and over slows down the fatwa process. Banks investing in human resources would be the potential winners.”

We asked Dr. Bakar, “With so little documentary information available and no binding precedents, how does the lawyer/banker/investor get to a level of confidence that a structure—especially a new structure will ultimately be found Shariah-compliant?”

“New products and structures won’t be offered unless they are valid and enforceable according to model law,” he explains. “First, they must be valid & enforceable; even before Shariah-compliant. In case of dispute, we have to fall back on legal documentation, as it is commonly accepted in industry. The issue of precedent is not that relevant. More relevant is certainty of clauses.”

As precedent undergirds the common law’s bedrock foundations, attorneys so trained may bristle at what seems a blithe dismissal. In reality, the underlying basis for the statement is far more conclusive than stare decisis.

“Since the beginning of Islam – for over 1,400 years,” emphasizes Dr. Bakar, “a new fatwa cannot make a previous judgment invalid. A legal opinion by a mufti or judge cannot make prior judgments invalid.” Thus, once a fatwa declares a structure Sharia-compliant, criticism by another scholar does not impact in the slightest the compliance of that particular deal. A fatwa can have only prospective, and not retrospective, application, he explains.

Asked what he considers to be the biggest misconceptions about Islamic finance, Dr. Bakar offers two. “First, that Islamic finance is exclusive to Muslims. That it’s exclusive and not inclusive.” He further suggests that many perceive the industry to be fundamentally just a semantic device, or in other words, “that Islamic finance is just a tweak of a term; that there’s no difference between profit and interest. This is the biggest misconception of the last 30 years,” he says, “that it’s basically a trick.”

All of these themes played out recently with real-world consequences in the British case of Investment Dar Co. KSCC v Blom Developments Bank SAL, (Dec. 11, 2009) (See the Westlaw Business Currents article Not Quite Cricket: High Court Drops Islamic Finance Ball?), a case involving a disputed wakala (agency) contract, in which one of the parties challenged the Sharia-compliance of the very structure itself. In declining to affirm summary judgment, the judge declared,

“I agree that the court should approach the matter with some circumspection, but that does not take anything away from what is essentially a simple point, albeit difficult to apply, namely, that where one finds . . . a device to enable what would at least to some eyes appear to be the payment of interest under another guise, that is at least an indirect practice of a non-Sharia compliant activity. I do not think it appropriate for me to go through the expert evidence in detail because I am satisfied that I cannot resolve which expert is correct on this application.”

This passage begs at least two questions: First, when does the illusion of interest cross over into a legal finding of non-compliance? And second, how can such a determination properly be made?

Dr. Bakar explains: “The basis of reference is legal documentation; the basis of contract and that to which the court might refer. However, terms might not necessarily be clear in all respects. Here judges have two options: (1) Decide on these based on their own legal training; or (2) call a Sharia expert. The expert must be an independent third party. The court still maintains an independent platform and is NOT bound.”

A jurisprudential chasm in the Blom decision fails to reconcile the difference between an agreement’s Sharia-compliance ex ante, and its continued compliance once perfected. In the former, if the statement of Dr. Bakar (and others) is correct – that once declared, a fatwa cannot be undone – no court should ever be able to declare a duly approved structure void ab initio. While a once-compliant structure may fall out of compliance – as in the case where an asset’s debt exceeds permissible levels – a court could entertain expert opinion from Sharia scholars to rule on the prospective application, but never on the retrospective. As Dr. Bakar observes, these cases seldom reach this stage.

Dr. Bakar sees several particular concerns for Islamic finance as an industry. “For all intents and purposes,” he says, “we’re working in an environment governed by a local/domestic/global regulatory framework. We’re not operating in a vacuum of existing standards issued by a central authority. The most effective product is Shariah-compliant and yet can suit the standard of local law and global requirements perfectly. You may have a good product from a Shariah perspective, but it could still prove a problem from a model standard.”

Competing with conventional finance poses additional hurdles for Islamic finance. “Scholars and economists have argued that the time has come for banks to depart from debt financing to equity financing. It’s very equitable, fair and square for both parties. However, introduction of this financing will require more capital.” Lacking the Sharia’s restrictions, conventional finance can employ leverage far more aggressively than Islamic.

“Equity financing requires higher capital for the bank,” says Dr. Bakar, “as compared to debt financing. Hence, equity financing is just not competitive with conventional. Until and unless there’s a change to the standard, we must be mindful of a product that can suit the model requirements best, while being compliant with Shariah principles.”

As for the future of Islamic finance, Dr. Bakar notes expanding penetration of the industry. “We could see new entrants into the field from Muslim and non-Muslim countries: (1) Australia; (2) China; and (3) India. The World Bank and IMF (and the whole world) should consider setting up [an Islamic] window… they should be able to give some attention to this way of doing finance.” The mainstream is now 100% conventional, he explains. The rest of the world should try to “think outside the box and be more contemporary to work together with Islamic countries.”

In the future, Dr. Bakar expects that “stakeholders will be more careful structuring and selling products because we don’t want to repeat what has happened in the West. Which is good – people will become more cautious and prudent.”

Dr. Mohd Daud Bakar is currently the Chairman of the Shariah Advisory Council at the Central Bank of Malaysia. Previously, he was the Deputy Rector (Student Affairs and Development) at the International Islamic University Malaysia. Dr. Bakar is a Shariah board member of various financial institutions, including the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) (Bahrain), The International Islamic Financial Market (Bahrain), The Securities Commission of Malaysia, Morgan Stanley (Dubai), and the Bank of London and Middle East (London) among many others..