Islamic finance debate: Shari’ah Scholars Under Fire Part 2

Maha Khan Phillips continues examining how the dominance of a few key Shari’ah scholars on advisory boards is being met with increasing criticism.

Networking Koran, Holy Book

Whether it is intentional or not, high profile scholars are also networking amongst each other. Murat Unal, author of the Funds at Work study, says the data compiled for the study was surprising, particularly when the firm began to look in to the networks between scholars. “You can see that there are companies that have virtually the same boards as one another and you ask yourself, how is this possible? One theory is that financial services companies are chasing scholars based on their prominence. But you may also argue that it is social capital, that there are some scholars who know each other very well through their ongoing interaction and that they tend to recommend each other for positions.”

He suggests that such networks can have negatives effects. “We know that people who have strong ties and work together tend to isolate themselves from other people and develop in-group thinking.” He also believes it is time for more transparency, and openness in terms of how a board is selected, and whether board members end up selecting each other. There should also be transparency on decision-making, he suggests, so that if a board makes a decision with one dissenting voice which is overruled, that becomes clear.

Rubber Stamping

Dr Ali Khorshid, the Islamic economist and former Shari’ah scholar, who presented a paper on conflicts of interest at the 9th Harvard University Forum on Islamic Finance, also believes it is time for Shariah boards to explain their selection criteria. He argues that the industry has been held hostage by a few scholar boards which are making it more difficult for others to join. “They are crippling the industry because they are unaccountable, and the conventional financial system is frightened to get in. They don’t let anyone attend their meetings, and they don’t want to train anybody.”

A former board member of the bank Al-Baraka, the first Islamic bank in the UK, Khorshid says that his responsibility on the board was to “prevent people from profiteering by putting the word “Islamic” to their name.” He believes that current boards are not taking this responsibility to heart. “Financial institutions are simply hiring scholars who will rubber stamp them, and the institutions do what they like.” If they are simply willing to rubber stamp anything, then Shari’ah boards are no longer needed, he suggests.

Khorshid insists that boards will become a thing of the past over time. “The industry is not as complicated as it used to be. Once the main products are established, you’ll find that the same products are being marketed by different banks and institutions. I don’t think it’s the product itself that is the issue anymore. It’s the auditing of the product that remains an issue.”

Consistency islamic_finance

However, consistency in approach does remain a problem. Two years ago, one fund of hedge funds manager, which had its product approved by its board, was stopped in its track during the distribution phase, because other scholars rejected the fund. It is, say market participants, frustrating that there is not one overarching authority to deal with, so that there is no question about whether a product is compliant or not.

Paul Wouters, legal counsel in the Bener law office in Turkey, believes that this is unrealistic. “Every market is different in composition and development. Universal solutions therefore hardly exist. Every jurisdiction is bound to respond to problem situations as they see fit. There is a need to tune back the unnecessary hype. I am confident that regulators, market players, and Shari’ah scholars will find their way forward,” he says.

Critics also express concerns about sustainability of rulings, however. When Sheikh Muhammad Taqi Usmani, on behalf of AAOIFI, suggested that 85% of sukuks were not Islamic, market participants began to ask why it had taken so long for someone to point this out.

One index provider says that having the same board in place over time, a board that has one homogenous view, has been very helpful. “From the perspective of an index provider, the homogeneity of opinion and ideas is a good thing. It can become very difficult if you have multiple scholars with multiple advice,” says Alka Banerjee, vice president for global equities in the index services group of Standard & Poors’. She also believes that a board which does not exhibit integrity would be quickly ousted from the market.

“We have never had any issues with our scholars taking the time to answer the questions that we have. Dr Elgari comes back to us very quickly. The board always explains why they make the decisions that they do, and that explanation is always logical.”


Market participants say that they are also frustrated by a lack of transparency of remuneration. Depending on whom you talk to, scholars charge annual retainers ranging from $100,000 to $400,000 to sit on a board. If a scholar holds multiple board positions then, they are potentially making millions of dollars. On top of this, scholars can also charge transaction fees, percentages on transactions ranging from 1% to 2.5% depending on the size and scope of a deal. On a murabaha transaction worth $1 billion for example, a scholar could stand to make a significant amount of money if a deal went through. It is worth noting that these figures have come from market participants who use scholar boards. Scholars approached declined to provide information on remuneration, although Siddiqui says the figures are most likely to be closer to $100,000 than $400,000, and that it is important to distinguish between how, and how much, a scholar is paid.

“If compensation is based on shares of the financial institutions, or how many products you approve, then of course there is a problem. But whether a doctor or a lawyer charges a $200 an hour legal fee or a $1000 an hour fee is irrelevant. They don’t have to disclose that to the public at large,” he says.

The industry disagrees, with many pointing out that if part of a role of a scholar is to act like an auditor, then they should be subject to the same checks and balances. “If you open up an annual report of a bank, the bank would disclose its auditor’s financial compensation. But it does not disclose its Shari’ah board payment,” says one critic.

Wouters suggests that a remuneration that is neither based on performance, nor a “no cure no pay” would be best. He also suggests that a split between the two roles scholars are involved in might help. “On one hand are the Shari’ah scholars post factum auditors and certifiers. On the other hand, are they on a non-executive level involved in daily compliance control and product design? Maybe there should be a split between the two levels of activity. It is a new jurisdiction and I presume that every jurisdiction will address the issue according to local requirements.”

Growing Pains

The Islamic finance industry is developing fast. But it is also an immature industry, which is still suffering from growing pains. Many of the misalignments in the industry will resolve themselves over time. Even still, market participants appear to have lost faith with their scholars. Qattan says that scholars do not advertise all the positive that they do. “Many scholars never ask how much they will get paid. Others pay their own transport costs. If a company doesn’t pay a scholar, the scholar will simply say, no problem, and leave it at that, but this is never advertised in the papers.”

In direct contrast to this, another banker claims to have been told it would cost him $10 million to get his product approved. The majority of asset managers and investment bankers approached for this story would not comment publicly, because one negative word from a scholar, in an industry that is so dependent on so few, would have negative implications for their careers, they insisted. “Well, somebody’s got to be a martyr, so it might as well be me,” laughs Khorshid ruefully.

It would be easy to dismiss market complaints as idle speculation, but when well respected industry figures say they fear to talk openly on the subject, than clearly scholars have a problem on their hands. In order to regain credibility, they must become more transparent. Otherwise, they leave themselves open to wide ranging criticism.

As one participant puts it: “When you see all these conflicts taking place in our industry, anyone who has a sense of shame is going to feel humiliated by this conspiracy of silence.”

100 years after the meeting at Jekyll Island, conspiracy theorists are still arguing about exactly what took place, and who said what. Nobody in this industry would want the same to be said about Shari’ah supervisory boards, one century from now.

A Regulatory Approach to Shari’ah Boards

With the exception of Malaysia, regulators seem to have no definitive approach to the issue of board concentration, and construction. A spokeswoman for the Dubai Financial Services Authority stated: “This is a complicated issue and one in which DFSA has no opinion on at the moment.”

Dubai is however, considering the matter. Rauf Mammadov, head of economic strategy in the Department of Economic Development for the Government of Dubai, began looking at supervisory boards while rating the competitiveness of the Dubai economy. “I started talking to a few practitioners about the key impediments to the economy and I was shocked when 60% of conversations were related to Shari’ah boards. Regulators feel like the issue does not reach them, but practitioners really do feel it is an issue. The second issue is that there is a lack of transparency of the review process. Clients will never be able to make an informed decision, when they don’t know if the product offered by Bank A was approved only after the 3rd time it went in front of a board.”

After multiple conversations, Mammadov has reached the following personal conclusions for reform, which he says are preliminary thoughts:

1. Compliance with Shariah must be observed at every stage of Islamic banking and not only when developing a new product. Thus, there is a need to scrap Shariah boards and transform them into the Compliance Department. This will help ensure that:

i) Bank’s structure and regulations are Shariah-compliant;    ii) products are Shariah-compliant (follow AAOIFI rules);

iii) the way they are launched/offered is Shariah-compliant;    iv) Bank’s internal practices (not just rules) are Shariah-compliant.

2. AAOIFI is to step up its role: it is to license Shariah advisory activities (both individual and firms). It should also monitor compliance of licensed individuals/firms with AAOIFI’s rules (license may be withdrawn in case of non-compliance).

3. Shariah advisers/firms to offer Shariah audit (no more need for product verification, which is taken care of by simply following the AAOIFI rules), which may initially be optional (just like CSR reports issued by the major firms). Hopefully, such reporting may be set as mandatory by the Central Banks (or AAOIFI).

Whether these conclusions are picked up by the industry in the future remains to be seen. Elsewhere however, it is difficult to tell where regulators stand. The Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg, and the Central Bank of Bahrain did not return calls for comment.

Dublin’s regulatory body points out that the directors of Irish funds are subject to a Fit and Proper Assessment, and that when a proposed candidate already holds directorships in excess of 25; they must show that the candidate is in a position to discharge his or her obligations in an effective and professional manner. Whether scholar board members are classified as directors however, remains unclear.

For its part, the UK’s Financial Services Authority stated its concerns in 2007, when it wrote: “…assuming that Sharia scholars are Directors, their role is more likely to resemble that of an Executive Director than a Non Executive Director as it might involve active participation in the firm’s business. In such cases, it would be very difficult to justify multiple memberships of Sharia Supervisory Boards of different firms because of significant conflicts of interest. This would put further constrains on an industry already facing a shortage of Sharia scholars with suitable skills.”

As yet however, there are no companies, which must demonstrate that their boards are advisory and that they do not interfere with the management of the firm, that have come foul on governance structures, reporting lines, fee structures, and other issues the FSA looks at.

Malaysia is the only nation with a proactive approach to potential conflicts.  “Malaysia has a very extensive regulatory and legal framework to deal with Islamic finance. Malaysian authorities require each Islamic financial institution to have a qualified Shariah board to ensure compliance of their activities. A scholar can only sit in one board only in specific segments e.g.: banks. In addition regulators are working to update the Shari’ah governance framework further,” said a spokesperson.

Related Article: Shari’ah Scholars Under Fire Part 1

One thought on “Islamic finance debate: Shari’ah Scholars Under Fire Part 2

  1. Shariyah Review Bureau, Dar Al Shariah are just a few examples of many specialized in the business of providing a complete Shariah solution ranging from product development, product approval and certification, regular shariah audits and so on. The industry is slowly realizing the importance of institutionalizing this important element of their business.