Abdul Rasheed Ghaffour: Practical aspects of dispute resolution in
Islamic finance facilities
Remarks by Mr Abdul Rasheed Ghaffour, Deputy Governor of the Central Bank of Malaysia (Bank
Negara Malaysia), at the Association of Islamic Banking Institutions Malaysia (AIBIM) Law
Seminar on "Practical Aspects of Dispute Resolution in Islamic Finance Facilities", Kuala
Lumpur, 14 November 2017.
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"Past, present and future: Legal certainty and Islamic finance in Malaysia"
It is my honour to join all of you today in exploring this interesting topic on the practical aspects of
dispute resolution in Islamic finance. This seminar marks another significant step in fostering
dialogue between Islamic financiers, Shariah scholars and the legal fraternity. Gatherings such
as this serve as an important platform for Islamic finance practitioners to develop a better grasp
of legal issues, and for lawyers to gain a keener sense of Islamic finance. I am encouraged to
see the Association of Islamic Banking Institutions Malaysia (AIBIM) taking the lead in advancing
this mission.
Disputes in business transactions have been around for as long as commerce itself. It is
therefore no surprise that we come across judges and lawyers very early on in human history.
Earlier than bankers - and definitely long before we see the first central banker . Disputes are
bound to happen. One party may not be able or willing to honour their obligations. The other party
may be dissatisfied with how an obligation is performed. Still, there may be a fundamental
disagreement between the parties about what was agreed in the first place. It is the inevitability of
disputes that makes the existence of dispute resolution systems so universal.
Dispute resolution in Islamic finance is gaining more attention these days. I would take this to be
a good sign. In a legal system, disputes may be viewed as an indicator of vigour rather than
weakness - so long as they are resolved effectively and efficiently. The common law legal
system is exemplary in this regard. Today, common law systems are the most widespread in the
world, in terms of GDP generated under these jurisdictions . The large volume of commercial
disputes resolved by these jurisdictions are a reflection of the widely-accepted strength of the
common law legal system in providing certainty to business dealings.
Today, legal certainty is widely said to be central to the rule of law . It is important that the law be
accessible, clear and predictable. People should be assured that questions of legal right and
liability will be determined by rules that meet these characteristics. This is not just crucial for
social justice - this ensures a stable environment to facilitate sustained business growth. Of
course, legal certainty does not mean that the laws are inflexibly set in stone such that justice
and common sense are frustrated. In fact, dispute resolution in a healthy legal system will lead to
evolution in the law over time - often with positive knock on effects. For instance, landmark
judgments may not only re-shape policies, but also lead to improvements in risk management
practices or fairer outcomes to the customers. The series of legal cases involving the sale and
purchase contract (Bai' Inah) highlight several important lessons in this regard. For Islamic
banking institutions, the decisions have led to further enhancements to the legal documentations
for Bai' Inah contracts itself.
In the context of Islamic finance, the task of upholding legal certainty is even more complex, for
two reasons. First, Shariah principles and requirements must be infused into the law of the land
from the religious sources. Secondly, these prescriptions - written many centuries ago - must
be applied to the context of modern finance. For brevity, I will refer to these two aspects of legal
certainty as Shariah certainty.
My remarks today will focus on the importance of legal certainty in the development of Malaysia's
Islamic finance industry - with a particular emphasis on Shariah certainty. I will begin by
reflecting on the past, before sharing some thoughts about some considerations for the present
as well as future.
Looking at the past, Islamic finance has developed rapidly in Malaysia over the recent decades.
To a large extent, this progress is attributable to the certainty provided by the legal framework for
Islamic finance in Malaysia. This can be traced back to the enactment of the Islamic Banking Act
in 1983 and the Takaful Act in 1984 which facilitated the birth of the first full-fledged Islamic
banking institution and takaful operator. Prior to this, Islamic finance was very niche. Its relevance
was mostly limited to the provision of custodian services such as the pilgrimage fund as
managed by Tabung Haji. There was no appeal to the wider market, then.
Since the early 1980s, we have witnessed a significant transformation of Islamic finance in
Malaysia. Over the years, this sector began to offer a wider range of solutions to cater for the
evolving needs of the national economy and the local communities. Islamic finance now makes
up a significant and growing share of the domestic market. The share of Islamic banking assets
more than doubled from 12.9% in 2007 to 28% in 2016. Takaful penetration has now reached
14.6% of the population. Globally, Malaysia has established itself as a leading hub for Islamic
finance. In the global sukuk market, we hold a share of more than 50% of the global outstanding
sukuk.
To cater for the growing size and sophistication, the legal foundation for Islamic finance has
undergone several enhancements over the years. The Shariah Advisory Councils - or the SACs
- of the Securities Commission and Bank Negara Malaysia were established roughly twenty
years ago to promote greater Shariah certainty. They since have played an increasingly
important role in the ascertainment of Shariah for matters of Islamic finance. The Central Bank of
Malaysia Act 2009 formally established a "dual financial system" in this jurisdiction, setting the
pace for the progressive development of an Islamic financial system that is equally competitive
and sound as the conventional system. The Islamic Financial Services Act 2013 consolidated
and updated the earlier legislations on Islamic banking and takaful. Its focus was to elevate the
standards of Islamic finance regulation in Malaysia; drive greater innovation; and promote more
inclusive growth.
Today, Malaysia is internationally recognised for its comprehensive legal and regulatory
framework for Islamic finance. Many emerging Islamic finance markets now see Malaysia as a
model to emulate in this respect. Looking back, I believe that the certainty provided by our legal
and regulatory framework has contributed significantly to the development of a sound and
progressive Islamic financial system in Malaysia.
This brings me to my second point, - which is the present. We are faced with both opportunities
and challenges as we move forward.
Global Islamic financial assets stood at USD1.9 trillion in 2016 - and is estimated to reach
USD3.2 trillion by 2020. Muslims now make up 24% of the world's population . This is a very
large and rapidly expanding market. The potential is enormous. Islamic financial institutions and
legal professionals in Malaysia stand to gain -from this, only if we position ourselves well enough
to serve this boom. Doing this will require a variety of measures, and it is beyond the scope of
my address today, to talk about all of them now. But one thing is clear - in order to remain as a
leading Islamic financial hub, Malaysia must uphold legal certainty for effective dispute resolution.
As I mentioned earlier, Shariah certainty entails two unique challenges - Shariah prescriptions
must both be infused into law, as well as applied to contemporary settings.
These challenges are augmented by the fast-changing times in which we live. Business is
constantly evolving, and finance is likewise far from static. The expectation now for our legal
system is to apply the principles of Shariah to novel products and approaches in a timely manner
- while remaining clear, sufficiently flexible to innovation and yet faithful to the tenets of the
religious sources. This is a tall order, and the jurisdiction which succeeds in doing this most
reliably, will stand in good position, to ride the wave of the Islamic finance boom.
Certainty around the Shariah rules applicable to a particular Islamic finance facility is crucial.
Equally important is certainly on the legal enforceability of obligations in the event that there is
non-compliance to the relevant Shariah requirements. Uncertainty in any of these areas may lead
investors to view such facilities as high risk instruments, and in extreme cases even destabilise
the Islamic finance market more generally. An interesting case in point is the one involving Dana
Gas, which is now being considered by the High Court in London. The UAE-based energy
company declared that its USD700 million sukuk was no longer Shariah-compliant - and thus
unenforceable - because the scholarly consensus was said to have shifted since issuance in
2003.
Now, let's move on to the future - we need continued certainty. We have come a long way in
setting in place the strong foundation of a legal framework. The law review and harmonisation
committees have done good work in ensuring that Shariah principles can be imported into
Malaysian law in a way that is effective and seamless. The progress of the past has positioned
us with both opportunity and challenge at present. To navigate these well, we need to promote
continued certainty as we move into the future. This will require excellence at both the
institutional and individual levels.
Institutional excellence
At the institutional level, the judiciary plays a vital role in upholding legal certainty. Judges - along
with arbitrators - ensure that disputes are settled by the application of the law, rather than
unbounded discretion. The courts also ensure that these laws are intelligible, clear and also
predictable.
For Islamic finance, the Shariah Advisory Councils (SACs) of Bank Negara Malaysia and the
Securities Commission play a complementary role to the courts - by providing Shariah certainty.
It is important to note that this role does not [in any way] substitute the function of the judiciary in
upholding legal certainty. Rather, the SACs support the courts - by providing predictability and
uniformity in the interpretation of Shariah rulings that are applicable to Islamic financial business.
Unlike a scientific question, a Shariah question can be answered by reference to at least four
different schools of thoughts, all of which provide valid answers from a Shariah perspective.
Having the SACs as central authorities for providing finality of Shariah rulings - helps the court
apply the rulings to the specific circumstances of a particular case with full certainty. This will
then inform the final judgment by the courts.
A clear process has been set out to facilitate judges, arbitrators and Islamic financial institutions
to refer matters which require the ascertainment of Islamic law to the SACs for their ruling or
advice. Matters beyond the ambit of the SACs' authority will be left for the courts to adjudicate.
The composition of the SACs, which includes former judges, ensures it functions well within the
boundaries of its purview. To promote procedural legitimacy, efforts have been also directed
towards ensuring that the reasoning of the SACs are well-documented and accessible to the
public.
Other than the courts and the SACs, another important institutional arrangement for our path
forward will be the financial regulators. In particular, Bank Negara Malaysia and the Securities
Commission will continue to play a proactive role in identifying pertinent Shariah issues that need
to be clarified for the domestic market. By the end of this year, Bank Negara Malaysia will have
completed a compendium of regulatory standards to provide clarity on the Shariah and
operational requirements for 14 Islamic finance contracts. This endeavour began in 2013, and
incorporates the interpretation of the SAC. The task for the regulators is to come up with similar
standards in the future - especially as the market ventures into novel and more innovative
approaches. This will provide an invaluable resources in helping Islamic financial institutions and
their lawyers in structuring Islamic finance products as well as identifying the necessary legal
documentation.
Individual excellence
At the individual level, the promotion of legal certainty will require a strong base of legal and
Islamic finance professionals. As the domestic industry and global market for Islamic finance
grows, so must our talent pool. Lawyers involved in product structuring, for example, can provide
value-added advice to their clients on the parameters of Shariah requirements and legal rules,
which helps in the design and developing the documentation of the products. Litigation experts
with sound understanding of Shariah requirements can reason better in courts. Certification
programs and targeted seminars such as today's will be important in equipping legal
practitioners with a solid understanding of both applied Shariah knowledge and the necessary
legal expertise.
In conclusion, the world of modern finance is in need of anchoring principles to ensure that
intermediation serves rather than enslaves the real economy. Islamic finance, ingrained with the
values of socio-economic justice and the spirit of cooperation, has the potential to provide an
answer to this quest. Already, it is gaining much traction around the globe. "For Malaysia to
remain a central part of this solution", we must build on our experience and continue to promoting
legal certainty for Islamic finance - especially in importing and applying Shariah requirements to
the Malaysian law. I certainly believe we can. I wish you all the best in your interesting
discussions on dispute resolution today, and also in the days to come.