9.2.1 Sharī‘ah Supervision

The sharī‘ah supervisory services offered by advisory firms are either broad such that they encompass the responsibilities of an in-house SSB, or limited to certain SSB duties. When Islamic banks outsource their SSB to an advisory firm, management and the Board of Directors (BOD) remain responsible before shareholders and other stakeholders for sharī‘ah compliance.

Regulatory guidelines may require banks to have their own SSB or allow them to appoint an external SSB.⁶ In either case, SSB responsibilities remain the same. When using the services of sharī‘ah advisory firms, banks ought to stipulate competency requirements for jurists that are set by their own nomination committee and agree to the scope of SSB duties. These requirements should be set in light of regulatory guidelines as well as AAOIFI and IFSB guidance.

Generally, advisory firms have their own group of experienced sharī‘ah jurists who supervise the sharī‘ah dimension of banks that contract with the firm. For instance, Shura Sharia Consultancy, a Kuwaiti firm inaugurated in 2007, lists eleven sharī‘ah jurists as consultants, and offers the following sharī‘ah supervisory services:

1. Examining the articles and memoranda of association and adapting them to sharī‘ah requirements.
2. Scrutinizing, modifying, and approving transactional contracts and agreements.
3. Contributing to the development of products and contracts.
4. Addressing questions posed by customers and employees.
5. Providing sharī‘ah consultations on transactions.
6. Assessing the extent of sharī‘ah compliance of activities and issuing the annual sharī‘ah compliance report.⁷

Shura lists on its website fatawa on the topics listed in Table 9.1:⁸

9.2.2 Internal Sharī‘ah Audit

Irrespective of whether a bank has its own SSB or arranges for an external SSB through a sharī‘ah advisory firm, these consultancies may be recruited to perform internal sharī‘ah audit tasks. As the key pillar of the internal sharī‘ah control system, the internal sharī‘ah audit function’s (ISAF) role in early identification of sharī‘ah non-compliant activity and in effectively supporting the bank to maintain sharī‘ah compliance cannot be overestimated. For this reason many banks opt not to outsource these responsibilities to an external entity, but rather house an internal function that fulfills these duties. Nevertheless, as the tasks of the ISAF become more specialized, develop in complexity, and banks face a challenge in recruiting competent individuals who can adequately perform these responsibilities, it will not be uncommon for banks to resort to these advisory firms in order to benefit from their internal sharī‘ah audit expertise. Making use of the services provided by these consultancies may be beneficial over the short term; however, in the long term banks should develop their own internal proficient talent in this field. Ethical principles outlined by AAOIFI that govern the work of auditors working in this function (whether in-house or outsourced) include righteousness, integrity, trustworthiness, fairness, honesty, independence, objectivity, professional competence, due care, confidentiality, professional behavior, and technical standards.⁹

9.2.3 External Sharī‘ah Audit

In most countries, external sharī‘ah audit is optional for banks engaged in Islamic banking. Several jurisdictions have, however, made recent changes to their regulations to make external sharī‘ah audit a mandatory activity. For example, the Islamic Banking Regulatory Framework issued by the Central Bank of Oman says: “External auditors shall present their Shari’a examination report on the Licensee’s system and controls with respect to Shari’a compliance to the Internal Shari’a reviewer who may present it to the SSB.” It further adds: “External auditors appointed for the purpose of examining the Licensee’s systems and controls to verify compliance with Shari’a guidelines issued by SSB shall report their findings to Central Bank.”¹⁰

In line with best practices in audit, external sharī‘ah audit provides an independent assessment of the extent of sharī‘ah compliance of the bank. This is necessary because of the importance paid to this dimension by shareholders and other stakeholders. The transparency provided addresses concerns that sharī‘ah compliance may at times be compromised as transactions increase in complexity and profitability goals override others.¹¹ External sharī‘ah audit differs from internal sharī‘ah audit with respect to its relationship to the bank, scope of the audit, and reporting. The audit and governance committee’s responsibilities in this regard include recommending to the BOD an independent sharī‘ah advisory firm that would conduct an external sharī‘ah audit and following up on the procedural aspects involved. Shareholders, however, appoint the firm and approve its scope of work and costs. External sharī‘ah audit would, therefore, be responsible to shareholders. Nevertheless, other stakeholders would also anticipate the results of its examination. This would include numerous tasks, such as:

1. Analyzing the bank’s sharī‘ah governance structure and procedures, in comparison to regulatory requirements (if any) as well as AAOIFI and IFSB recommendations.
2. Evaluating internal sharī‘ah controls developed to establish sharī‘ah compliance, including review of SSB and BOD meetings, policies and procedures, product manuals, selected job descriptions, reports prepared by the SSB, etc.
3. Reviewing executed transactions on a sampling basis to assess the extent of implementation of SSB decisions and fatawa.
4. Checking SSB approvals on products, contracts, etc.
5. Checking sharī‘ah training plans and their execution.

Banks should place a formal request to regulators asking for permission to appoint a particular appoint licensed sharī‘ah advisory firm for external sharī‘ah audit purposes. Such a procedure may apply in some jurisdictions but not others, depending on the approach that regulators adopt toward sharī‘ah governance. Appendix 9.1 provides a sample application form. Additionally, a formal engagement letter would document the details of the agreement between the bank and the sharī‘ah advisory firm, including confirming the firm’s acceptance of appointment, highlighting the objectives and scope of the audit, specifying the responsibilities of the firm to the bank, as well the form of reports to be furnished.¹²

9.2.4 Product Development and Transaction Structuring

Sharī‘ah advisory firms offer product development and transaction structuring services. It would be convenient for a bank to procure these services especially when it has already hired the advisory firm for its sharī‘ah supervision services, since the latter would be familiar with the views of its sharī‘ah jurists. Such information would facilitate the product/transaction approval process, as the advisory firm would from previous experience know the types of products or transactions that its jurists would approve or reject. Moreover, the firm would be capable of efficiently proceeding from the product development phase to the SSB review and fatwa issuance stages. Efficiency in transitioning between these different stages would result in shortening the product development/approval cycle and cost savings for the bank.¹³

Some Islamic banks currently offer consultancy services to other market players. For example, Meezan Bank Pakistan provides product structuring and other services to banks in return for a fee.¹⁴ While these banks undoubtedly have the required expertise to be able to advise others, one serious concern with this arrangement is the conflict of interest that arises when a bank (service provider) advises its competitor. There is a high probability that the former will not adequately fulfill its responsibility of offering sincere advice since the two banks compete against one another for market share.

9.2.5 Legal Document Preparation and Review

One service that has been predominantly provided by law firms is the preparation and review of legal documentation. In recent years, however, sharī‘ah advisory firms have competed for business in this terrain. They have hired lawyers and equipped them with the necessary sharī‘ah background to enable the advisory firm to make a strong value proposition to clients. Given the importance of sharī‘ah agreeableness of legal documentation, advisory firms have strategically positioned themselves well particularly for documentation concerning local market transactions. Once contracted to provide this service, the advisory firm prepares the legal documents in view of the SSB’s sharī‘ah rulings and approved product structures, policies and procedures, legal and regulatory provisions, and guidelines issued by standard-setters such as AAOIFI. Given that the advisory firm regularly interacts with sharī‘ah jurists and is quite knowledgeable about sharī‘ah market practices, it is capable of efficiently navigating its way through different phases of the process. When the advisory firm is also hired for its product/transaction development and sharī‘ah supervision services, the legal document preparation and review process becomes much easier to handle. However, a challenge in doing so is the risk associated with outsourcing the complete process to an external entity.

9.2.6 Sharī‘ah Training

Sharī’ah training is an important preventative measure that serves as a means for equipping employees with the necessary knowledge needed to correctly execute Islamic banking activities. The need for such training should not be underestimated since many individuals currently employed by the Islamic financial industry are recruited from conventional banks and are often unfamiliar with the rulings that govern Islamic transactions. Advisory firms are thus called upon to conduct sharī’ah training programs for employees. The human resources department outsources sharī’ah training when it determines that it is unable to internally provide such a service. Prior to conducting this training, advisory firms ought to ensure that they are sufficiently familiar with the sharī’ah rulings and decisions of the bank’s SSB in order to accurately communicate the SSB’s views to employees. This is important given the diversity of opinions found in the industry, and the risk of conveying views that the bank’s SSB do not subscribe to. While the primary method of delivery of such training has been in-person, some companies now deliver this training online. In doing so, they enable employees to proceed at their own pace and to choose the most appropriate time of day and location that would conveniently align with their schedule and needs.

9.4.1 Adherence to Directives and Guidance Issued

The services of sharī‘ah advisory firms need to comply with regulatory directives as well as guidance issued by key standard-setting bodies, such as AAOIFI and the IFSB. For instance, in providing sharī‘ah supervisory services to an Islamic banking institution, the firm must ensure that the SSB’s responsibilities as well as its code of ethics and professional conduct are in line with requirements. The sharī‘ah governance requirements set by authorities need not differ according to whether tasks are fulfilled in-house or outsourced. Nevertheless, a bank that opts to outsource some or all of its sharī‘ah governance functions has to keep in mind that certain restrictions will be in place to maintain the independence of the sharī‘ah advisory firm.

9.4.2 Competency

The jurists, auditors, lawyers, trainers, product and IT developers, and other service providers hired by sharī‘ah advisory firms need to possess the credentials, certification, and professional exposure necessary to provide the expertise for which they are sought out for by clients. Furthermore, they must stay abreast of developments via training and other means. Verification of credentials and experience is necessary to ensure that unqualified individuals do not practice in areas where they are not entitled to. Emphasizing the sharī‘ah guidelines governing the work of these different professionals is important, as the implications of hiring individuals who do not possess the necessary sharī‘ah understanding is problematic. In essence, it could lead to negligence of the sharī‘ah dimension or the development of artifices that conform to sharī‘ah in form but not in substance. Coming from experts who are sought out by multiple market players, these artifices could be particularly damaging, as their validity may not be questioned.

9.4.3 Monitoring

The quality of professional services provided by sharī‘ah advisory firms must be monitored to enforce regulations and verify that sound methodology is adopted. Such supervision is not currently in place but should be brought about. In doing so, it is essential to bear in mind pertinent lessons learned from regulating financial services firms.