Zeti Akhtar Aziz: Legal issues in the Islamic financial services industry
Speech by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the 4th IFSB
Seminar on Legal Issues in the Islamic Financial Services Industry, Kuala Lumpur,
28 September 2009.
* * *
It is my great pleasure to speak at this 4th IFSB Seminar on Legal Issues in the Islamic
Financial Services Industry that has brought together so many international experts and
industry practitioners to discuss legal issues in Islamic Finance. Such dialogue is important to
achieving a common understanding and solutions to issues in Islamic finance, thus
contributing to its overall development.
Islamic finance has continued to expand and demonstrate its resilience in the current more
challenging international financial environment. This advancement has been in terms of the
increased range of Islamic financial products and services, the development of the Islamic
financial infrastructure and institutions, the greater maturity of the Islamic financial markets
and the more comprehensive supporting legal and regulatory framework. More recently, the
international dimension of Islamic finance has gained significance with the move to further
liberalise domestic Islamic financial system and the strengthening of the international Islamic
financial architecture.
In Malaysia, Islamic banking assets at the end of the second quarter of this year, now
constitutes close to 19% of total banking assets. Total financing now amounts to RM118
billion and accounts for 20.1% of the total financing portfolio of the banking industry. Net
nonperforming financing remains low at 2.4%. Islamic securities has also maintained its
dominance in the Malaysian bond market, accounting for 58% of total bond market. And
almost two thirds of the equity market comprises Shariah compliant securities. Growth has
also been experienced in the takaful sector in which the funds asset has registered an
increase by 8.2%. This recent decade has also seen the increase in number of Islamic
financial institutions including full-fledged Islamic banks, development financial institutions
that engage in Islamic banking, takaful, re-takaful and capital market intermediaries. Several
of these players have strategic partnerships with foreign players. In April this year, as part of
the liberalization initiatives announced, new mega Islamic banking licenses and up to two
family takaful licenses will be issued this year. On the global front, Islamic financial assets
are projected to grow to USD1.6 trillion by 2012 while the global sukuk outstanding valued
to date at approximately
USD152.8 billion.
In the third series of this seminar in 2007, the vital role of a strong legal and Shariah
framework in the sustainable development of Islamic finance was extensively discussed. It is
key to providing certainty and predictability to financial transactions. The current international
financial crisis has demonstrated the importance of recognizing that the rapid transformation
of the functioning of the international financial system had to be accompanied by the need to
ensure that regulatory and legal framework was aligned with these developments. The
relevance of legal framework is essential to providing certainty and predictability to the
financial transactions and to the innovative products, thus promoting public confidence in the
financial system. This is equally important for the Islamic financial services industry in which
this recent decade has seen a rapid evolution in terms of the innovation and in terms of its
expansion.
Indeed, a robust legal framework in Islamic finance instills public confidence in the Islamic
financial system, provides an enabling platform for practitioners to develop more innovative
and complex financial products to meet the increasingly multifaceted consumer demands. In
addition, it provides the mechanism for dispute settlement that takes into account the distinct
features of Islamic financial transactions. This is where the legal services industry has a vital
role in providing sound legal solutions in Islamic finance. It therefore provides an important
"bridge" between Shariah and legal parameters, thus enabling the operationalisation of
Shariah principles into legally enforceable Islamic finance practices. In addition, by ensuring
that the legal parameters are in compliance with Shariah parameters and the regulations, it
also becomes a risk mitigator.
The legal aspects in Islamic finance represents an important "bridge" between the governing
Shariah principles and the practice of Islamic finance. The application of Shariah principles in
the light of the governing laws and regulations in each Islamic financial transaction are
interpreted through legal advice, in legal documentation of the financial transactions, and
dealing with disputes. In documenting financial transactions based on specific Shariah
principles that underlie a financial product, the legal documentation reflects the tenets of
Shariah and that it is in full compliance with the laws and regulations governing the financial
transactions. Varying interpretations of Shariah in particular between countries adds to the
complexity when cross-border transactions are involved.
From a domestic perspective, more jurisdictions are considering a central Shariah Council as
the ultimate decision making body on Shariah matters. Across jurisdictions, there has been
greater engagement thus bringing about increased convergence. Mutual recognition of the
interpretation of Shariah principles across countries will contribute to the sustained growth of
Islamic finance.
To promote consistent application of Islamic financial contracts in Malaysia, Bank Negara
Malaysia has issued "Shariah Parameters" aimed at promulgating a standard point of
reference on Shariah for Islamic finance practitioners. The Shariah Parameters outline the
main Shariah requirements in the contracts and provides examples, methods and models for
practical application of such contracts. The first Shariah Parameter on Murabahah that was
recently issued aimed to promote consistent interpretation and application of Shariah views
and opinions on Murabahah contracts.
In providing legal services, the industry has an important role of bridging the Shariah
parameter with the legal parameters of the Islamic financial contracts. This is in particular
important in preparing the legal documentation of Islamic financial transactions so as to avoid
ambiguity, inconsistency and to avoid the risk that the legal document be considered void by
a court of law on the grounds of contravention with Shariah.
Islamic financial transactions have their own unique risk characteristics that need to be
managed. Risk areas that are unique to Islamic finance transactions include the legal risk of
losses due in the event of lawsuits and non-compliance with relevant laws, the risks
associated with non-compliance of Shariah principles and the fiduciary risk arising from
failure to perform contractual obligations based on the underlying Shariah principles. The
introduction of new, more innovative and complex products and financial transactions
enables the disaggregation and repackaging of risks in ways that has not been explored.
Shariah advisors would require the collective expertise including legal practitioners, to
identify and understand the permissibility of a given structure. Islamic financial institutions in
turn would need to address the attendant implications.
In view of the importance for Islamic finance to be supported by a robust legislative
framework, the new Central Bank of Malaysia Act 2009 explicitly codifies the duality of the
Malaysian financial system which shall consist of the Islamic financial system and the
conventional financial system. This statement of law is supported by a comprehensive legal
framework already put in place for the regulation of Islamic finance in Malaysia,
encompassing the banking, takaful (Islamic insurance) and Islamic capital market industries.
The legal recognition of the distinct features of Islamic financial transactions and the
availability of a dispute settlement mechanism capable of applying these distinctive features
reduces the legal risks as well as risk of non-compliance with Shariah principles.
Institutional structure that is determined by the legal and administrative framework is the first
pillar of competitiveness. The ability to execute financial transactions efficiently, with
sufficient certainty and enforceability, and a clear process for resolving ambiguities and
possible breaches of the contract will enhance competitiveness, both at the institutional level
as well as for the financial system as a whole. In Malaysia, Islamic finance disputes are
adjudicated in civil courts and not the Shariah courts where the jurisdiction is limited to
matters relating to Muslim individuals. If the dispute concerns a point on the ascertainment of
Shariah, the courts and arbitrators are required to refer to the Shariah Council at Bank
Negara Malaysia to facilitate the ruling. The Shariah Council's authority is the ultimate body
responsible for Shariah in banking and financial matters that is within the purview of Bank
Negara Malaysia. This referral system provides an enabling platform for preserving
consistency and predictability in interpretation and application of Shariah principles for
financial transaction in Malaysia.
Concluding remarks
Allow me to now conclude my remarks. The inherent strengths of Islamic finance amid the
global financial crisis has heightened interest in Islamic finance across the world. The level of
innovation, scale and complexity of Islamic financial transactions is also increasing at a
tremendous pace. Going forward, it is envisaged that the legal services in Islamic finance will
become even more significant in the continued advancement and efficiency of Islamic
finance.
In this regard, your thought leadership in addressing the legal issues embedded in Islamic
finance holds important element in the continued growth of the Islamic financial services
industry. Here, I would like to take this opportunity to congratulate the Islamic Financial
Services Board for organizing this timely seminar. I trust it will continue to be a constructive
platform for the legal and industry practitioners to deliberate on effective and pragmatic
solutions to the legal issues in Islamic finance. On this note, I wish all of you a productive and
successful seminar.