Shariah Non–compliance Risk Management and Legal Documentations in Islamic Finance

Shar`ah Non-Compliance Risk Management and Legal Documentation in Islamic Finance " Shar`ah Non-Compliance Risk Management and Legal Documentation in Islamic finance provides an in-depth explanation on how Shar`ah non-compliance risk should be understood and prudently managed within the Islamic financial institution to ensure proper compliance in theory, practice, and operation. The book offers help in understanding the legal documentation, the areas of risk along with some important Shar`ah and legal aspects considered for drafting legal documentation for products and services. In addition, the book offers helpful guidance and understanding for the legal departments of Islamic financial institutions, as well as lawyers, Shar`ah advisors, Shar`ah officers, and students studying Islamic finance. The book will be a significant contribution to the market and a useful reference for the Islamic finance industry in the area of Shar`ah non-compliance risk management and legal documentation." —Daud Vicary Abdullah, President & CEO, International Center for Education in Islamic Finance "This book is a welcome addition to the growing literature on the rapidly developing Islamic financial system. Elimination of riba is not the only criterion for Shar`ah -compliance. Many other factors need to be considered. A holistic approach must be adopted and the risks of non-compliance are grave, for the validity of the transaction and the legitimacy of the income will be in question. All these are clearly explained in the book which also discusses the 2013 Malaysian IFSA and documentation requirements. It should find a place on all Islamic banking practitioners' desks, from the Directors to risk managers, auditors, Shar`ah committee members and lawyers. Academia and students will find it illuminating." —Mohamed Ismail Shariff, Advocate & Solicitor Adjunct Professor, INCEIF "The book is a very good and useful addition to the literature of Islamic Finance. It offers both academicians and practitioners substantial exposure on Shar`ah non-compliance risk along with legal documentations, an area that is becoming increasingly crucial in Islamic Finance, and provides an in-depth explanation on how Shar`ah non-compliance risk should be understood and prudently managed to ensure proper compliance in theory, practice, and operation. It also gives readers an opportunity to understand the risks associated with drafting legal documentation for products and services to ensure Shar`ah rules and principles are preserved and implemented." —Datuk Dr Syed Othman Alhabshi, Chief Academic Officer, INCEIF

Foreword ix Acknowledgments xi About the Author xiii Introduction 1 Chapter 1: Fundamental Concept of Shari′ah and Shari′ah Non– Compliance Risk 5 1.0. Introduction 5 1.1. Concept of Shari′ah 5 1.2. Compliance in the Islamic Financial Institutions: An Overview 6 1.3. Concept of Risk 11 1.4. The Concept of Shari′ah Non–Compliance Risk 12 1.5. Review of the Concept of Shari′ah Non–Compliance Risk 17 1.6. Features of Shari′ah Non–Compliance Risk 19 1.7. Shari′ah Non–Compliance Risk Events 19 1.8. The Shari′ah Basis for Shari′ah Compliance 25 Chapter 2: Shari′ah Compliance in IFSA 2013 and Classification of Shari′ah Non–Compliance Risk 29 2.0. Introduction 29 2.1. Provisions Unique to Islamic Banks in IFSA 2013 29 2.2. Shari′ah Compliance in IFSA 2013 31 2.3. Classification of Shari′ah Non–Compliance Risk 41 Chapter 3: The Major Risk Elements of Shari′ah Non–Compliance Risk and Its Causes in Islamic Finance Operations 43 3.0. Introduction 43 3.1. The Major Risk Elements of Shari′ah Non–Compliance Risk 43 3.2. The Causes of Shari′ah Non–Compliance Risk in Islamic Finance Operations 68 Chapter 4: Tools and Techniques to Identify Incongruence in Shari′ah Compliance 73 4.0. Introduction 73 4.1. Tools 73 4.2. Techniques 83 Chapter 5: Understanding the Shari′ah Requirements for Mitigating the Shari′ah Non–Compliance Risk in Islamic Finance 85 5.0. Introduction 85 5.1. The Fundamental Islamic Principles in Islamic Contracts 85 5.2. The Fundamental Islamic Financial Transactions Used in Islamic Finance 90 Chapter 6: Lines of Defences for Shari′ah Non–Compliance Risk Management 101 6.0. Introduction 101 6.1. The First Line of Defence: Product Owner 101 6.2. The Second Line of Defence: Management of the IFI 107 6.3. The Third Line of Defence: Shari′ah Risk Management 109 6.4. The Fourth Line of Defence: Shari′ah Management 112 6.5. The Fifth Line of Defence: Shari′ah Committee/Board 112 6.6. The Sixth Line of Defence: Board of Directors 123 6.7. The Seventh Line of Defence: Shari′ah Advisory Council (SAC), Bank Negara Malaysia (BNM)/Authorities 129 6.8. The Eighth Line of Defence: Shari′ah Review 130 6.9. The Ninth Line of Defence: Shari′ah Audit 144 6.10. The Tenth Line of Defence: Public 154 Chapter 7: Shari′ah Non–Compliance Reporting 157 7.0. Introduction 157 7.1. Objective 157 7.2. Applicability 158 7.3. Legal Provisions 158 7.4. Reporting Requirements 159 7.5. Reported as Potential Shari′ah Non–Compliance Event 159 7.6. Submission of Reports on Actual Shari′ah Non–Compliance Events 160 7.7. Timeline for Actual Shari′ah Non–Compliance Reporting 160 7.8. Potential Shari′ah Non–Compliance Event 161 7.9. Timeline for Potential Shari′ah Non–Compliance Reporting 161 7.10. No Shari′ah Non–Compliance Event Is Detected 162 7.11. Process Flow for Authentication or Confirmation of Shari′ah Non–Compliance in the IFIS 163 Chapter 8: Legal Documentations in Islamic Finance 165 8.0. Introduction 165 8.1. Introduction to Legal Documentation 165 8.2. Law Related to Islamic Banking 166 8.3. General Principles in Legal Documentation 167 8.4. Legal Documentation: Definition and Shari′ah Concern 167 8.5. Incorporation of Shari′ah Requirements into Legal Documentation 167 8.6. The Main Functions of the Legal Documentation 169 8.7. Areas in Legal Documentation under Consideration and Review 169 8.8. Potential Area of Shari′ah Non–Compliance Risk 190 Chapter 9: Drafting Legal Documents 209 9.0. Introduction 209 9.1. Structure of the Legal Agreement/Contract 209 9.2. Tips for Drafting Text and Additional Clauses 230 9.3. Legalistic Style 231 Chapter 10: Useful Information and Samples of Legal Documentation 233 10.0. Introduction 233 10.1. Sample of an Agreement (Musharakah Agreement in Sukuk Issuance) 233 10.2. Sample of an Offer Letter 241 10.3. Sample of Legal Document Structure 243 10.4. Master Agency Agreement (AIBIM) 246 10.5. Corporate Wakalah Placement Agreement (AIBIM) 253 10.6. Corporate Murabahah Master Agreement 272 10.7. List of the Top Common Audit Shortcomings in Shari′ah Non–Compliance 300 Appendix The Impact of Non–Shari′ah–Compliance Risk on the IFI, and Checklist 303 A.1. The Impact of Non–Shari′ah–Compliance Risk on the IFI 303 A.2. Major Aspects Governing the Checklist for Non–Shari′ah–Compliant Risk 304 A.3. Checklist for Shari′ah Non–Compliance Risk 305 List of Abbreviations 317 Glossary 321 Bibliography 327 Index 329

Associate Professor AHCENE LAHSASNA PhD, CIFP, ACIP, RFP, Shar`ah RFP, Shar`ah Advisor is currently a lecturer at the International Centre for Education in Islamic Finance (INCEIF) Malaysia, known as the Global University of Islamic Finance. He is also the Graduate Studies academic advisor at the same university. He received his bachelor's degrees in Islamic law and Islamic jurisprudence from Algeria, and his Master's and PhD degrees in Islamic law and Islamic jurisprudence from IIUM (Malaysia). Dr. Lahsasna is equipped with industry qualifications as follows: Certificate Islamic Capital Market Shar`ah Advisor (I Advisor), offered by the Securities Industry Development Corporation (SIDC), Securities Commission Malaysia; Certificate Islamic Capital Market (sukuk and structured products), offered by the SIDC, Securities Commission Malaysia; Chartered Islamic Finance Professional (CIFP), offered by INCEIF; Registered Financial Planner (RFP) and Shar`ah RFP, offered by MFPC. Dr. Lahsasna is also a member of the ACIFP, Association of Islamic Finance Professionals, and National Council of Malaysian Financial Planning. Currently, Dr. Lahsasna is a registered Shar`ah advisor at Bank Negara Malaysia and Securities Commission Malaysia; serves as Shar`ah board member of Maybank Islamic, Etiqa Takaful in Malaysia, and RGA Re-Takaful based in Labuan; is on the Shar`ah Advisory Council of MFPC; and is chairman of Takaful and Shar`ah RFP at MFPC, Malaysia. Dr. Lahsasna has been appointed by the Finance Agency Accreditation as FAP (FAA Accreditation Panel).