* AAOIFI to address flaws in scholar system
* Certification, governance may be strengthened
* Follows appointment of new secretary-general
* Debate to bring in wide range of industry players
* But vested interests within AAOIFI may block change
By Bernardo Vizcaino
DUBAI, April 29 (Reuters) – Islamic finance may face its
biggest shake-up in years as a top standard-setting body seeks
to reform the way the industry does business, including the role
of highly paid scholars in enforcing religious principles.
Khaled Al Fakih, the new secretary-general of the
Bahrain-based Accounting and Auditing Organisation for Islamic
Financial Institutions (AAOIFI), outlined plans for a sweeping
review of its guidelines in an interview with Reuters.
Some of AAOIFI’s reforms may prove controversial by
challenging entrenched interests in the fast-growing business.
Islamic financial assets hit $1.3 trillion globally last year, a
150 percent rise in the past five years as the industry expanded
beyond core markets in the Middle East and Malaysia, financial
lobby group TheCityUK estimates.
“We would like to see insightful debate…that can help us
develop standards that can benefit the industry,” Fakih said by
email from Bahrain, ahead of AAOIFI’s annual meeting there on
May 7 and 8.
His organisation plans to start consultations on reforming
the operations of sharia boards, the groups of Islamic scholars
which rule on whether financial institutions’ activities and
products are religiously acceptable, by the middle of this year.
A final draft of the reforms is not expected to be ready before
the end of next year at the earliest.
AAOIFI will also work on a new framework for disclosing
financial data, and will look at revising standards for takaful
(Islamic insurance), investment accounts and other products.
Fakih, a Lebanese-born commercial banker who took over at
AAOIFI in February, said basic elements of Islamic finance such
as murabaha, mudaraba and ijara – structures designed to permit
investment while obeying religious bans on paying interest and
pure monetary speculation – would be reviewed next year.
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CONTROVERSY
For many in the industry, AAOIFI’s review cannot come too
soon. Although far smaller than conventional banking, which has
tens of trillions of dollars of assets, Islamic finance has
grown much more quickly in the last few years, so its flaws
could start to affect banking systems and economies.
Much of its growth has occurred because it can count on the
support of large pools of sharia-compliant funds in the booming
Gulf and southeast Asia, which have not pulled back during the
global financial crisis as Western funds have.
Last year’s Arab Spring uprisings in the Middle East promise
a fresh wave of growth; new, Islamist-led governments want to
promote the industry after their authoritarian predecessors
discouraged it for ideological reasons.
But the growth has exposed weaknesses in Islamic finance.
One is the lack of a clear consensus on what products and
procedures are permissible; the sharia boards of individual
banks and investment firms can issue conflicting rulings.
This can create big controversies. When Goldman Sachs
announced last October that it planned a $2 billion sukuk issue,
which would make it one of the first top Western banks to raise
money in that way, its own sharia advisors approved the plan.
But some other scholars criticised it; six months later, the
sukuk has not been issued and it is not clear when it might be.
The sharia board system is open to accusations of conflict
of interest because scholars are paid handsomely – in some
cases, with hourly fees of $1,000 or more – by the very firms
whose behaviour they are supervising.
The ambiguity in regulation has let some Islamic financial
institutions, such as Kuwait’s Investment Dar, argue in court
that contracts into which they had entered were not valid
because they were not sharia-compliant in the first place.
AAOIFI plans to improve the operations of sharia boards by
strengthening the certification process for scholars, Fakih
said. The organisation currently offers scholars two
professional credentials, but they have been criticised as not
sufficiently rigorous and too easy to obtain.
In addition, AAOIFI is developing new guidance on the
relationship between Islamic financial firms and their sharia
boards, “similar to international best practices on terms of
reference for financial institutions’ board of directors”.
One way to reduce conflicts of interest might be to limit
the length of scholars’ tenure at individual firms, to prevent
them from forming excessively close relationships with their
employers that might compromise their objectivity. However,
Fakih did not mention this idea. Current AAOIFI standards
acknowledge “engagement over a prolonged period of time may pose
a threat to independence”, but do not prescribe specific limits.
AAOIFI will also look at ways of fostering the rise of a
new, younger generation of Islamic scholars, through steps such
as training courses, Fakih said. This could remove a bottleneck
to growth in the industry by loosening the dominance of about
two dozen veteran scholars who have practiced for decades and
hold multiple board positions.
RESISTANCE
It is not yet clear whether reformers in AAOIFI will be able
to push through changes over the potential opposition of many
veteran scholars and financiers who profit from the status quo.
Yasser Dalhawi, chief executive of Syariah Review Bureau, an
Islamic finance advisory firm in Saudi Arabia, said change would
be difficult. But he added that many people in the wider
industry would support change as a way of ensuring growth and
bringing Islamic finance closer to its religious principles.
A survey of customers’ attitudes to sharia boards, conducted
a few years ago by a Gulf financial firm, found widespread
dissatisfaction which was expressed in some cases with
expletives, one prominent scholar told Reuters, declining to be
named because of the sensitivity of the issue.
To balance opposition to change within AAOIFI, Fakih seems
to want to involve the widest possible range of industry
interests in the debate; he called for “rigorous and meaningful
discussions…not only among scholars but also with all
participants of Islamic finance.”
His plans to release a series of draft proposals for public
consultation mark a change from AAOIFI’s past style, which
relied more on decisions made behind closed doors.
ENFORCEMENT
In its review, AAOIFI is also expected to discuss
strengthening enforcement of its standards across the globe.
They are not backed by any legal sanction, so national financial
regulators decide whether to enforce them.
Currently only a small number of countries, including
Bahrain and Qatar, have adopted AAOIFI standards wholesale;
others use them as references without making them compulsory.
“Unless you have a global rule, it is not really going to
work as it creates arbitrage opportunities,” said Murat Unal,
board member at Funds@Work, a German-based consultancy. He added
that in some cases, scholars had avoided strict local regulation
by offering their services in countries with looser standards.
At an Islamic finance seminar in Dubai this month, Muddassir
Siddiqui, a prominent scholar from Malaysia, pressed his fellow
panellists on who could strengthen global enforcement. There was
no concrete response except for the vague idea of an
international body of some sort.
AAOIFI might conceivably work around this by requiring all
scholars, regardless of the country where they are located, to
adhere to a code of conduct that would effectively transcend
legal or territorial boundaries. But powerful figures inside
AAOIFI might oppose anything which limited their room for
maneouvre so drastically.
In any case, the 21-year-old organisation is likely to have
to grapple with such issues as it tries to preserve its status
in the industry. So much money is now flowing into Islamic
finance that other bodies, such as national regulators, may jump
in if AAOIFI does not solve problems.
Some are already doing so. Last year Qatar’s central bank
banned Islamic windows, which allow conventional banks to offer
sharia-compliant products. AAOIFI already had standards which
let Islamic windows function if their funds were segregated from
the banks’ conventional operations. But Qatar decided those
standards were not sufficient – a warning sign for AAOIFI as it
tries to win industry support for its reforms.
(Additional reporting by Anjuli Davies; Editing by Andrew
Torchia)
