Islamic financial institutions (IFIs) that are authorized by Bank Negara Malaysia (BNM), the central bank, and the Securities Commission Malaysia, the securities regulator, and have been operating in the country have six months to comply with all requirements of the new Shariah governance framework (SGF) for Islamic financial institutions which was introduced by Malaysia late last year and which became effective on Jan. 1.
According to Bank Negara, by the end of June 2011 each IFI authorized and operating in Malaysia is required to confirm the status of compliance with the framework, which was adopted pursuant to section 59 of the Central Bank of Malaysia Act 2009, section 53A of the Islamic Banking Act (IBA), section 69 of the Takaful Act (TA), section 126 of the Banking & Financial Institutions Act (BAFIA) and section 126 of the Development Finance Institutions Act (DFIA).
The SGF is the most comprehensive and unique legislation and guideline in the world, setting out the Shariah governance process for the Malaysian Islamic finance industry. It also supersedes the guidelines on the governance of Shariah committees of IFIs introduced by Bank Negara in 2004 and which outlined the role, duties and responsibilities of the Shariah committee and its members and the relationship and working arrangement between the Shariah committee at individual institutions and the BNM’s Shariah Advisory Council (SAC) at the national level.
According to the Malaysian central bank, the primary objective of the SGF is to enhance “the role of the board, the Shariah Committee and the management in relation to Shariah matters, including enhancing the relevant key organs that have the responsibility to execute Shariah compliance and research functions aimed at the attainment of a Shariah-based operating environment.”
The SGF is effectively the next component of Malaysia’s Islamic Finance Master Plan and part of BNM’s on-going review of policy relating to the Shariah governance processes at IFIs in Malaysia.
Malaysian financial regulators including BNM; the Securities Commission of Malaysia (SC), the capital markets regulator; and the Labuan Financial Services Authority (Labuan FSA), the offshore regulator, have over the last decade or so spearheaded much-needed reforms in the Shariah advisory and compliance business.
Malaysia remains the only jurisdiction in which Shariah advisories have to be registered with the relevant regulator, must go through a “fit and proper” testing regime in terms of educational background and requisite skills sets, and where Shariah advisories are restricted to advise only one institution in a particular industry segment so as to pre-empt conflict of interest and to widen the base of Shariah advisories in the market.
Bank Negara Gov. Zeti Akhtar Aziz confirmed in the central bank’s Financial Stability Report 2010, which was published in the end of March 2010, that in line with efforts to further enhance the Shariah governance of IFIs, the new SGF will provide comprehensive guidance on the roles and responsibilities of the Shariah committee, and the board and management of IFIs in ensuring that their operations are in compliance with Shariah principles.
The SGF further sets out the expectations of the bank on an IFI’s Shariah governance structures, processes and arrangements to ensure that all its operations and business activities are in accordance with Shariah; provides a comprehensive guidance to the board, the Shariah Committee and IFI’s management in discharging its duties in matters relating to Shariah; and outlines the functions relating to Shariah review, Shariah audit, Shariah risk management and Shariah research.
The SGF, says Bank Negara, aims to strengthen the Shariah governance process, decision-making, accountability and independence of Shariah advisories. The new measures require regular internal Shariah reviews and audits, supported by an appropriate risk management process and research capability. At the same time, the board of directors is deemed to be responsible for the overall Shariah oversight of IFIs and the effective functioning of the Shariah governance structure, policies and processes.
This must be done without compromising the independence of the Shariah committee. The Shariah committee will also now be accountable for the implementation of decisions and opinions throughout the IFI. The SGF also requires IFIs to establish three functions that provide a system of checks and balances within the organization, which include: A Shariah risk management control function that is able to identify all possible risk of Shariah non-compliance and, where appropriate, remedial measures to manage this risk; a Shariah review function that continuously assesses Shariah compliance of all activities and operations; and a Shariah audit function that performs annual audits to provide an independent assessment of the adequacy and compliance of the Islamic financial institution with established policies and procedures, and the adequacy of the Shariah governance process.
BNM is confident that the effective implementation of the new Shariah governance framework will further promote stakeholders’ confidence and the integrity of the Islamic financial industry thereby reducing Shariah non-compliance risks and, over the medium term, contribute to maintaining financial stability.
The Shariah governance arrangements in the SGF are indeed comprehensive and cover the general requirements of the Shariah governance framework; oversight, accountability & responsibility of advisories; independence of advisories; competency of advisories; confidentiality & consistency; Shariah compliance & research functions; Shariah review; Shariah audit; and Shariah risk management.
While it is not the brief of the Malaysian government to impose the SGF on the global industry, many Shariah scholars and bankers believe that given the systemic approach of Malaysia to develop its Islamic finance sector, the SGF is the best of its kind and could become a blueprint for other countries to follow. In this respect, the Malaysia International Islamic Financial Centre (MIFC) indeed has the responsibility of articulating the SGF well beyond its immediate community to all corners of the world where Islamic financial products are offered.