Centre stage: The kingdom considers the advantages of establishing a single sharia authority to oversee the whole sector


The global Islamic finance industry is a rapidly growing but relatively new phenomenon, and therefore the approach of national regulators varies from one jurisdiction to the next. Almost all regulatory frameworks, however, fall within two broad models: a centralised system, with some form of higher sharia authority to pronounce upon regulatory issues, such as those operated by Indonesia and Pakistan; or a self-regulation model, where Islamic finance institutions turn to their own sharia supervisory boards (SSBs) for rulings on new products and services.

The advantages and disadvantages of these systems have long been matters of debate within the global Islamic financial services (IFS) industry, and in recent years Bahrain has propelled itself to the fore of this discussion. The kingdom has, to date, operated the self-regulation model, but it is currently considering the possibility of introducing a centralised sharia board to oversee its increasingly diverse IFS sector, a move which it hopes will help maintain its position as home to one of the most advanced regulatory frameworks in the region.

CURRENT STATUS: While Bahrain already has a sharia board situated within the Central Bank of Bahrain (CBB), its mandate has so far been confined to vetting the bank’s own products. The sharia compliance of Islamic banks, insurers and investment houses operating in the kingdom is, therefore, overseen by the individual SSBs, as is the case with other Islamic finance markets around the world that have adopted the self-regulation model.

Bahrain’s current framework does offer some benefits over a more centralised system. Islamic banks and other sharia-compliant financial institutions frequently cite the advantage of speed that in-house SSBs give them when it comes to gaining approval for new products and services, for example. Being able to submit their latest innovations to their own sharia board is usually quicker than gaining permission from a centralised board – an important factor within the context of an industry competing with conventional institutions, which have a historical advantage in terms of product development. It might also be argued that the proliferation of SSB’s in a non-centralised sharia regulatory system provides more possibilities for ijtihad (the process of interpreting Islamic law and coming to a legal decision), by encouraging an intellectually richer environment more conducive to product innovation.

A STRONG CASE: However, in the view of a large number of market observers the disadvantages of a decentralised system outweigh the gains Islamic institutions make from running proprietary sharia boards. Chief among these is the issue of harmonisation. Proponents of a centralised system point out that the absence of an a presiding sharia body in any given jurisdiction limits the standardisation necessary for the running of an efficient industry, as interpretations of some of the finer points of Islamic law differ from one institution to the next.

This charge has been levied at Islamic banks for years, and their usual response has been to point out that as the majority of sharia scholars sit on multiple boards, it is easy to achieve a level of harmony between new products being developed in the market. There is some validity to this argument. A 2008 study of sharia scholars in the GCC by investment industry strategy consultant Funds@Work found that 68% of all sharia board positions throughout the region were shared by only 21% of active scholars, and that Bahrain’s Sheikh Nizam Mohammed Saleh Yaquby, and Saudi Arabia-based Sheikh Abdul Sattar Abdul Karim Abu Ghuddah and Mohammed Eid Elgari alone made up 26% of the total number of board memberships in the GCC region.

However, while the concentration of sharia board positions may be useful in the context of harmonisation, some sections of the IFS industry have voiced their concerns regarding the phenomenon. One issue that is frequently cited by opponents to the system is the possibility for conflicts of interest to arise, as sharia scholars on proprietary boards are effectively paid by the bodies on whose products and services they are ruling on.

MAKING MOVES: In 2012 the Bahrain-based international standard-setting body, the Accounting and Auditing Organisation for Islamic Institutions (AAOIFI), acknowledged that the “engagement [of scholars] over a prolonged period of time may pose a threat to independence.” To remedy this, AAOIFI and other market participants have suggested a number of proposals, including placing limits on a scholar’s tenure at individual firms to prevent them from establishing close relationships which might compromise their objectivity, and providing training courses which are designed to foster a new generation of Islamic scholars to diversify board positions.

The involvement of AAOIFI in the debate is important, as the standards it sets have been fully adopted by the Bahraini IFS industry. However, a major change to the AAOIFI standards applied to individual sharia boards would bring problems of its own.

Qatar is the only other jurisdiction that has fully adopted AAOIFI standards, with other markets around the world utilising them only as a guide in the administration of their own sharia-compliant markets. Unless all the national regulators overseeing IFS activity can be persuaded to implement a new set of sharia board standards, there will be opportunities for regulatory arbitrage.

Until now, therefore, there has been little regulatory change in the area of global standards, while just two national regulators have addressed the issue: Malaysia, which has placed a limit on the number of sharia boards any given scholar can sit on; and the UAE, which has introduced similar caps for its takaful (Islamic insurance) sector.

IMPLICATIONS: Establishing a centralised sharia board would certainly place Bahrain at the forefront of the regulatory movement in the eyes of the majority of observers. Oman is the only other country in the GCC region to have established such a body, and by the close of 2016 it had yet to involve itself in a number of fundamental areas, such as product approval, instead restricting its activities to discussing general IFS market matters.

In February 2015 the international press reported that the CBB was drafting legal documentation to set up a sharia board of scholars to oversee the IFS sector as a whole. While the CBB has released few details about the proposed central sharia board, its pronouncements on the matter to date have made it clear that it will have the final say on product approval, although there is likely to be a mechanism by which the differences between the central sharia board and the individual boards of financial institutions can be reconciled. “This will give us an edge over other markets, allowing more products to be attractive,” Najla M Al Shirawi, CEO of Securities & Investment Company, told media in 2015, when the proposal was first announced by the CBB.

Whatever the final form and functions of the council, the development of the IFS market in Bahrain makes its introduction a near inevitability. The argument for a transition from the current framework to a centralised system has gathered significant momentum in recent years, as a result of the increasingly complex nature of sharia-compliant instruments that the boards of banks and investment houses are faced with.

As the IFS market matures, there is a sense that all of the straightforward banking operations have been successfully translated into the sharia context, and suitable equivalents are universally accepted. More recently, however, tools like sharia-compliant repurchase agreements and profit rate swaps have had a somewhat uneven implementation, and the need for IFS clients to clear transactions with every institution involved in multi-institution deals is a labour intensive and time-consuming process.

THE WAY AHEAD: Bahrain is not the only GCC jurisdiction to come to the conclusion that a centralised system is the solution to the challenge of a rapidly evolving market. As well as the anticipated ramping up of the activities of Oman’s board, the UAE has also said that it plans to introduce a new Sharia Authority to improve the consistency of sharia rulings in its IFS industry. The UAE Cabinet gave its approval for the new body in May 2016, stating that while the authority would not replace individual boards operated by Islamic financial institutions, it would be given the final say on new products and services, which is the same model already deployed by Malaysia and soon to be implemented by Bahrain.

The trend then seems clear: centralisation of sharia regulation is likely to remain a key theme in the regional IFS industry over the coming years, and Bahrain is likely to play a leading role within in it.