RESEARCH PAPER (No: 29/2011)

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION HAKIMAH YAACOB MARJAN MUHAMMAD EDIB SMOLO Researcher, ISRA

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION Hakimah Yaacob, Marjan Mohammad & Edib Smolo*

“I have no doubts that we shall succeed in drafting uniform rules which will lend themselves to adoption by legislatures, thereby creating a basis for the codification of private international law.” —Tobias Asser (1838-1913)

ABSTRACT Global Islamic finance is faced with many unresolved issues that demand urgent attention from all parties involved. One of the pressing issues is the lack of standardisation to face globalisation within the industry. An attempt is made herein to examine the subject with an aim to clarify the rationale for having an international treaty for standardisation. Uniformity and standardisation incorporated in a treaty form a basis for consensus among the state parties that will not only promote a sound and stable Islamic financial system but also prove its viability and credibility to the global financial world. This paper proposes that, as the global market continues to increase and as interest in Islamic finance grows around the world, there is a compelling need to make future development of the industry smoother by standardizing, at the very least, the basic financial instruments in order to avoid possible conflicts.

Keyword: International Convention, International Standardisation, Islamic Finance, Jurisdiction.

*

Treaties,

Globalisation,

The authors are researchers at ISRA; they can be contacted at [email protected], [email protected] and [email protected].

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1. INTRODUCTION Globalisation is the process through which the increasingly free flow of ideas, people, goods, services and capital leads to the integration of economies and societies.1 Globalisation is the process through which the increasingly free flow of ideas, people, goods, services and capital leads to the integration of economies and societies.2 Successive waves of globalisation, particularly from the 13th century onward, have resulted in the expansion of world trade, the diffusion of technology, extensive migrations of peoples and cross fertilisation between countries.� However, the dominance of Western corporations has resulted in not just the modernisation of nations, but also the importation of Western values, philosophies, and lifestyles (westernisation). These include democratic institutions, legal principles, free market principles, and increasing emphasis on commercial and material activities over other societal priorities. These factors seem to clash with traditional behaviours of many parts of the world, especially the Muslim world. During medieval times and earlier, the Middle East was a world leader in the global economy. Its medicine, mathematics, chemistry, astrology, and philosophy were the envy of the world, and the Silk Road and spice routes linking the region to Asia were the major trade routes in the world. Rice, sugar cane, cotton, tea, coffee and metals came from Asia and Africa. The world changed after 1500. European sea power and military prowess exerted itself, and although the Turkish Ottoman Empire continued as a diminishing world power until the 20th century, the Middle East languished until the discovery and popularity of oil gave the region a new lease on life in the rapidly industrializing world. According to Christophe Bernasconi,3 the existing Hague Convention on private international law is also applicable to SharÊÑah matters and applies to all SharÊÑah courts in countries which have ratified the Convention. With due respect to his view, the authors are of the opinion that commercial matters and civil matters defined in the context of the Hague Convention failed to specify the scope of SharÊÑah matters. The current Convention merely spelt out the definition of commercial and civil matters, whereas the SharÊÑah and its divisions carry different intricacies and distinctions. It 1

As per Eduardo Aninat, Deputy Managing Director of the IMF; adopted in John S. Hill, International Business: Managing Globalisation, India: Sage Publications, 2009, pp. 124-136.

2

John S. Hill, op. cit, pp. 124-136.

3

First Secretary of the Hague Conference on Private International Law, the Hague.

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

is for this reason that SharÊÑah matters and the international conventions cannot be harmonised. Indeed, when harmonisation has failed, it is time for us to recognise it.4 In general, the party autonomy rule applies in international contracts. It is the theory of freedom of contract known as autonomie de la volonte, or party autonomy. In cross-border practice, the parties are mostly free to choose the law applicable to their contracts at any time as provided in Art. 3 of the Rome Convention, which reads, “A contract shall be governed by the law chosen by the parties. The choice must be express or demonstrated with reasonable certainty by the terms of the contract or the circumstances of the case. By their choice the parties can select the law applicable to the whole or a part only of the contract.” This Convention guarantees the litigants will be judged according to the law of their choice. However, scrutinising the case of Mount Albert Borough Council v. Australasian Temperance & General Mutual Life Assurance Society Ltd,5 the proper law of contract was defined as the law which the English or other Court is to apply in determining the obligation under the contract. In the absence of comprehensive legislation in governing Islamic finance across the globe, the parties should be given the freedom to enter into a contract with their own choice of law. It means they may opt for that which is in their best interest and the best interest of the contract. Thus, where the parties have an agreement stating the manner in which they have chosen to resolve their disputes, it should be respected in every way possible. It is common to see in any agreement the governing law clause written as, “The Contract shall be governed by the law of England, and any dispute, question or remedy however so arising shall be Seminar on the Harmonisation of SharÊÑah and Civil Law in Malaysia in relation to the Convention on Taking Evidence abroad on Civil or Commercial Matters (CTEA), also known as the Hague Evidence Convention; Attorney General’s Chambers, Putrajaya Malaysia, 7-8 October 2010. This convention was signed by the United States (US) in March, 1970, and entered into force on October 7, 1972. The CTEA plays a vital role in sharing evidence among the signatory countries’ judicial authorities. The Hague Evidence Convention is currently in force in the following countries: Anguilla, Aruba, Australia, Barbados, Bulgaria, Cayman Islands, China, Cyprus, Czech Republic, Denmark, Djibouti, Estonia, Falkland Islands, Finland, France, French Guiana, French Polynesia, Germany, Gibraltar, Guadeloupe, Guernsey, Hong Kong SAR, Isle of Man, Israel, Italy, Jersey, Latvia, Luxemburg, Macao, Martinique, Mexico, Monaco, Netherlands, Norway, Poland, Portugal, Saint Pierre and Miquelon, Singapore, Slovak Republic, Sovereign Base Areas of Akrotiri and Dhekelia, Spain, Sweden, Switzerland, United Kingdom, United States, and Venezuela. The Hague Convention of 15 November 1965 on the Service Abroad of Judicial and Extrajudicial Documents in Civil or Commercial Matters (Hague Service Convention) provides for the channels of transmission to be used when a judicial or extrajudicial document is to be transmitted from one State Party to the Convention to another State Party for service in the latter. The Convention provides for one main channel of transmission (via the Central Authority of the requested State), and several alternative channels of transmission. For more information, see The Practical Handbook on the Operation of the Hague Service Convention (2006).

4

[1938] AC 224, 240; [1937] 4 All ER 206, 214 (PC).

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determined exclusively by the Courts of England.” This happens when the parties have not been given many choices in settling disputes involving their interests. Hence, they have opted for English court to decide on the validity of the contract. Referring to Re Herbert Wagg & Co. Ltd., it was held that “This Court will not necessarily regard the parties’ choice of law as being the governing consideration where a system of law is chosen which has no real or substantial connection with the contract looked at as a whole”. The views concluded that the courts should have residual power to strike off, for good reason, choice of law clauses totally unconnected with the contract. However, in this case, Re Herbert Wagg, it was also held that the parties may well contemplate that different parts of their contract shall be governed by different law. Is there any justification for excluding the intended terms of the agreeing parties in the contract, and merely applying English law for the execution of the contract? It is submitted that an effective legal framework at the international level is needed to ensure the resilient development of Islamic finance. This can be achieved by creating a framework that is accommodative, that facilitates the development of the industry and ensures the enforceability of Islamic financial contracts. This makes the establishment of a credible forum for settlement of legal disputes arising from the Islamic finance transactions a matter of pivotal importance. The industry and supervisory authorities should not hesitate to take the lead in spearheading the development of Islamic finance through the issuance of clear policy decisions and directions that will bring certainty to market players. This is to avoid any legal and SharÊÑah risks in the future. It may help in avoiding stigma at the international level. Indeed, such a convention needs to be carefully formulated to avoid causing any confusion in the industry. The purpose of such a provision would be to support the market, smooth out lingering legal anomalies with the conventional system and induce greater legal standardisation and convergence. This paper consists of six sections, including the introduction. Section Two deals with the global legal system in the countries where Islamic finance is practiced. Section Three discusses the issue of standardisation and its relevance for the future development of Islamic finance. Sections Four and Five elaborate the rationale for having an international convention for Islamic finance and propose a standard international convention for the industry. Finally, Section Six summarizes the conclusions.

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

2. THE GLOBAL LEGAL SYSTEM IN COUNTRIES APPLYING ISLAMIC COMMERCIAL TRANSACTIONS It is unclear at present to what extent Muslim business enterprises are willing to bind themselves to the decision of an individual SharÊÑah scholar or panel of such scholars, especially when faced with disputes worth millions of dollars and considering that awards in general cannot be appealed. The uncertainty is further heightened by the arbitrators’ possible lack of the stature that the civil courts possess. In the absence of any specific laws governing SharÊÑah laws in Islamic finance for international contracts, the proper law is the law which is most convenient to both parties along with adherence to SharÊÑah principles. In addition to this, there is no generally applicable connecting factor that can be used in English law to determine the proper law of the contract. This means the parties may opt for the contractual formula that best secures their interests. Thus, where the parties have an agreement stating the manner in which they have chosen to resolve their disputes, it should be respected in every way possible. In any agreement, it is common to see the governing law clause written as, “The Contract shall be governed by the law of England, and any dispute, question or remedy however so arising shall be determined exclusively by the Courts of England.” The parties may also include, “It is understood and agreed that all questions of interpretation, construction, and adjudication arising out of this contract shall be governed by the laws of Malaysia.” Alternatively, if an international convention or treaty for Islamic finance were available, it would be the definitive standardisation of law for referral. The issue of referring Islamic matters to English court would no longer arise. Shamil Bank of Bahrain v. Beximco Pharmaceuticals was the result of a problem that arose when the lawyer drafted two governing law clauses in one contract. The essential thought which determines the proper law of contract in private international law is that the two parties to the international contract are subject to the jurisdiction of their two countries and the municipal laws and courts of the two countries. International Islamic commercial law involves at least four distinct areas of law. The first is the law of contract. It provides the rules for interpreting the intention of both parties to the contract and fills in any gaps that the parties may have left out. The second issue is the payment system. By providing an alternative payment mechanism, the law in this area provides the choices for the parties as to how to minimize the risk of non-performance. The third area of concern is the security of the transaction. The fourth concern in international law is the bankruptcy law. It sets out various rights of

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conflicting investors when there is a business failure or financial distress and outlines the future deployment of the assets traded. There are two principal reasons why international trade has grown so rapidly. One is the liberalisation of trade and investment via reductions in tariffs, currency, controls and other impediments to the international flow of goods and capital. The second is the unprecedented shrinkage of economic space via improvement of communication and transportation technologies and consequent reductions in costs. English common law has been accepted as the most common legal system in the world, not only because it applies to the largest slice of the world’s population but also because it is used in 27% of the world’s 320 legal jurisdictions.6 American Common Law jurisdictions comprise mainly the 50 states of the United States and ten smaller territories and countries like Samoa (American), Puerto Rico and the Marshall Islands. The Napoleonic group comprises 82 jurisdictions, including Algeria, Belgium, Brazil, Egypt, France, Greece, Iran, Italy, Luxemburg, Mexico, Portugal and Spain, as well as many other countries in Sub-Saharan Africa and Latin America.7 Most Middle Eastern Islamic financial centres use the SharÊÑah as one element of their law. They also use other sources of law such as French law. The diagram below illustrates the general spread of legal systems around the world.8 Figure 1: World Legal Systems

Civil Law

Mixed Law

Common Law

Source: ChartsBin Refer to http://www.juriglobe.ca/.

6

Ibid.

7

Ibid.

8

Muslim Law

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

Civil law systems also have other names such as Roman law, Continental law or Napoleonic law. The terms refer to a system in which laws are legislated by parliament or some other form of representative government and codified (i.e., brought together). They are distinguished from common law mainly because they come from parliaments, not from court cases. SharÊÑah refers to the laws, commandments, and way of life prescribed by Allah for humankind pertaining to their conduct in this world and salvation in the next. The SharÊÑah is frequently described as ‘Islamic Law’, but the boundaries of SharÊÑah extend beyond the limited horizons of law. SharÊÑah is a set of norms, values, and laws that make up the Islamic way of life. Table 1 below briefly describes the legal mechanism governing Islamic finance in each country. One can infer that the legal frameworks mentioned would be used to secure rights at the domestic level. Should a dispute occur, the parties would normally choose English courts to settle it. Table 1: Summary of Supervisory and Legal Frameworks in Countries Applying Islamic Finance Countries

Supervisory Authority/Regulation#

Algeria

The primary law governing FFSI is the Ordinance No. 0311 relating to credit and currency and addressing regulations, including the local currency, banking operations, required authorisations and approvals, control of banks, and exchange controls. The Ordinance is implemented by 80 regulations, which themselves are also complemented and implemented by notes and instructions. Supervisory authority is Banque d’Algerie.

#

Information in this table is extracted from Islamic Finance, Global Legal Issues and Challenges, Effectiveness of Legal and Regulatory Framework for IFS, Kuala Lumpur: Islamic Financial Services Board (IFSB), 2008, pp.43-45.

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Bahrain

Governed by the Central Bank of Bahrain. The law is Prudential Information and Regulations for Islamic Banks (PIRI) 2000. AAIOFI was established in 1991 to issue standards on accounting, auditing, governance, and SharÊÑah practices with which players in Bahrain are required to comply.

Bangladesh

Supervised by Bangladesh Bank. The applicable law is Banking Companies Act 1991, containing provisions for Islamic banking activities following an amendment in 1993.

Brunei

Governed by the Ministry of Finance Brunei. Islamic finance is only offered through full-fledged IFIs. A national SharÊÑah Financial Supervisory Council was established in 2006. Banking Act Cap 95, Emergency Order (Islamic Bank) 1992 and Emergency Order (Islamic Trust Fund) 1991; Insurance and Takaful, Third Party Risk Act, Cap 90. International Banking Order 2000 states, “International Islamic banking business contains provision for SharÊÑah law to override a conflicting provision in the order subject to good banking practice and imposes a requirement for the appointment of a SharÊÑah council. The restriction to local ownership which applies under the domestic Islamic Banking Act does not apply to the international regime.” This Order is governed under the segregated unit of the Ministry of Finance called Brunei International Financial Centre (BIFC)

Iran

Governed by the Central Bank of Iran (Bank Markazi Jumhuri Islami Iran). The ruling law is the Law for Usury-Free Banking 1983. There are no SharÊÑah boards for individual banks, only one at the central bank.

Kuwait

Supervised by the Central Bank of Kuwait. Ruled by Law No. 30 of 2003 on the addition of a specific section on Islamic banks to Chapter III of Law No. 32 of 1968 concerning currency, the Central Bank of Kuwait and the organisation of banking business. Disputes over SharÊÑah issues shall be referred to the Ministry of Awqaf.

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

Malaysia

The first Act enacted to facilitate the infrastructure of Islamic banking in Malaysia was the Islamic Banking Act 1983 (Act 276) IBA, i.e., to govern the operations of Islamic bank(s) in Malaysia. An amendment has also been made to the Government Investment Act (GIA) 1983 to facilitate both Statutory Reserves and Liquidity Reserve Requirements, which are to be interest-free. The Takaful Act 1984 (‘TA’) was enacted later on to allow the licensing and operation of Islamic insurance or takÉful companies in Malaysia. An amendment in 1996 to s 124 of the Banking and Financial Act (BAFIA) allowed banks licensed under the Act to introduce Islamic banking business. A new section (13A) has also been added to IBA in the 2003 amendment, which provides an Islamic bank may seek the advice of the ShariÑah Advisory Council on SharÊÑah matters relating to its banking business and the Islamic bank shall comply with the advice of the ShariÑah Advisory Council. In this section, ‘ShariÑah Advisory Council’ means the ShariÑah Advisory Council established under sub-s 16B(1) of the Central Bank of Malaysia Act 1958 (before the new Act 701 amended it in 2009). The amendment to the IBA in 2003 with the inclusion of section 13A enables Islamic banks to seek the advice of the ShariÑah Advisory Council (SAC) of Bank Negara Malaysia (BNM); and it is mandatory for the Islamic banks to comply with the advice given by the SAC pursuant to such request. This shows that the SAC has advisory powers over the Islamic banks, where liaison and common understanding between the SharÊÑah Advisory Board (SAB) of the bank and the SAC is expected.

Thailand

Monitored by the Ministry of Finance. Islamic Bank of Thailand Act 2002 was legislated. The Act provides laws relating to the establishment and capital of the bank, its purpose, governance structure, supervision, operation, control, audit, report, and inspection.

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Tunisia

Governed by the Central Bank of Tunisia. Law No. 200165 regulates the establishment and operations of banks in Tunisia, and banks offering Islamic financial products require approval under Law No. 33579.

Turkey

Regulated by the Central Bank of Turkey and the Banking Regulation and Supervisory Authority. Among the applied legislations are Bank Act No. 5411 and the Regulation on the Establishment and Operations of the Special Finance House pursuant to the Banks Act No. 4389.

United Arab Emirates (UAE)

Regulated by the Central Bank of UAE and the Dubai Financial Services Authority (DFSA).

United Kingdom (UK)

Monitored by the Financial Services Authority (FSA). The law applied is Financial Services and Markets Act 2000.

United States (US)

Governed by the Federal Reserve, State Reserve Banks, and Office of the Comptroller (OCC). The applicable legislation is the National Bank Act.

Yemen

Ruled by the Central Bank of Yemen via the Law on Islamic Banks 1996, which provides a regulatory framework for Islamic banking in the country.

Source: IFSB 2008 Thani and Othman (2008) published an important study that covers thirty countries where Islamic financial institutions are known to have a presence, covering all three types of major legal systems including the civil law systems, common law systems and SharÊÑah systems. Regardless of the outcome, the authors are of the view that approaches taken so far have been useful at the domestic level. When it comes to a legal framework at the global level, as proposed in this paper, standardisation and a specific legal framework are vital.

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

Table 2: Approaches Adopted by Different Countries in Relation to their Legal Frameworks for Islamic Finance Approaches to Legal Framework

Countries (in alphabetical order)

1.

Apply the same existing legal framework (as that used for conventional finance) to Islamic finance

Algeria, Australia, Canada, China, Egypt, Germany, Maldives, Saudi Arabia, Singapore, South Africa, Switzerland, Nigeria, Russia, UK, USA

2.

Adapt or amend the existing legal framework—mainly through subsidiary legislation or insertion of

Bangladesh, Bahrain, Djibouti, Jordan, Mauritius, Pakistan, Palestine, Qatar, Sri Lanka,

provisions under existing law—taking into consideration the specificities of

Turkey

Islamic finance, to accommodate this new area of finance 3.

Create a totally new and separate legal

Afghanistan,

Brunei,

Gambia,

framework, tailored specifically for Islamic finance.

Indonesia, Iran, Kuwait, Kazakhstan, Kyrgyz, Lebanon, Malaysia, Philippines, Sudan, Syria, Thailand, Tunisia, UAE, Yemen

Source: Islamic Financial System: Principles and Operations, p. 748, ISRA 2011 adapted and summarised from Thani & Othman (2008), updated 2010. How can Islamic finance be governed at an international level, and what would be the proper law to govern it? A proper law of contract was defined as “the substantive law of the country which the parties have chosen as that by which their mutually legally enforceable rights are to be ascertained”. 9 The main objective of the law is to assist in the structure, performance, and enforcement of rights and obligations under the contract. As per Lord Diplock, Amin Rasheed Shipping Corporation v. Kuwait Insurance Co. [1983] AC

9

50; Amin Rasheed Shipping Corporation v. Kuwait Insurance Co. [1984] AC 50. See Simmonds in Bonython v. Commonwealth of Australia [1951] AC 201, 219 (PC).

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He defined the proper law of the contract not as the law intended by the parties but as the system of law by reference to which the contract was made or that with which the transaction has its closest and most real connection.10 In Amin Rasheed’s case, P, a Liberian company resident in Dubai, insured a ship with D, the Kuwait Insurance Company. When a claim made by P under this policy was rejected by D, P sought an order to serve a writ on D under Rules of Supreme Court (RSC) O.11. There was no express choice of English law, nor was it clear as to what was the implied law: both Kuwaiti law and English law had claims to being the proper law of the contract. Favouring Kuwaiti Law, we may argue that the policy was issued in Kuwait; the insurers were Kuwaitis, and payment of claims was to be made in Kuwait. However, in favour of English law, one may argue that English language was used in the contract, the premiums were to be made in pound sterling, and the contract was made in English form. Moreover, the surrounding circumstances, as well as the terms of the contract itself, pointed ineluctably to the conclusion that the intention of the parties was that their mutual rights and obligations under the policy should be determined in accordance with the English law of marine insurance. A significant factor in reaching this conclusion was that at the time of making the contract, Kuwait had no law on marine insurance. Despite the above decision, Lord Atkin expressed his opinion on the controversy by stating, in R. v. International Trustee for the Protection of Bondholders A/G, “The proper law of the contract...is the law which the parties intended to apply.”11 His view would appear to apply in case of consensus ad idem. This view also reflects the party autonomy rule in determining the proper way of executing a contract. However, in Boissevain v. Weil,12 Denning LJ (as he was then) held, “I do not believe that parties are free to stipulate by what law the validity of their contract is to be determined. Their intention is only one of the factors to be taken into account.” Generally, there are two factors in determining the proper law for a contract, i.e., lex loci contractus (law of the place where the contract is made) and lex loci solutionis (law of the place where performance of the contract is due). Ibid.

10

R. v. International Trustee for the Protection of Bondholders A/G. [1936] 3 All E.R. 407 (C.A.);

11

[1937] A.C 500 (H.L.). [1949] 1 KB 482, 491.

12

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It is submitted that lex loci contractus may not be suitable for contracting parties from different countries (let us say one from France and the other from Malaysia) who agreed in London to buy property situated in Egypt. There is no closest connection to say that English law should prevail. It may not be appropriate to apply lex loci solutionis when the parties’ respective obligations may take place in different countries and would result in their respective obligations being governed by different laws. Lord Wilberforce, commenting on Amin Rasheed, held that “in the absence of a choice of law it is necessary to seek the system of law with which the contract has its closest and most real connection”, as opposed to the decision in Amin Rasheed that English law prevailed. It is submitted that the term “closest and most real connection” of the transaction should be determined by the law chosen by the parties and not by the law of the country where the case is being heard.13 In Vita Food Products Inc. v Unus Shipping Co. Ltd.,14 a choice of English law pertaining to an exemption clause in the contract was upheld, even though the contract had no connecting factor with England. Although the Vita Food case has been subjected to adverse criticism, it still represents strong authority for the proposition that the parties to a contract are free to submit the validity of their contract to any law of their own choosing. Lord Wright said, “...where there is an express statement by the parties of their intention to select the law of the contract, it is difficult to see what qualifications are possible, provided the intention expressed is bona fide and legal, and provided there is no reason for avoiding the choice on the ground of public policy.” The parties to the contract are entitled to make such an agreement; it is known as party autonomy rules. This was also confirmed by Lord Reid in Whitworth Street Estates (Manchester) Ltd. v. James Miller & Partners Ltd.15 According to the case, the parties are allowed to choose a law which has no obvious connection with the contract and still be bona fide and legal. If the choice of law was made for the “specific purpose of avoiding the consequence of the illegality”, then it is not bona fide and legal. Refer also to Shamil Beximco’s case.

13

[1939] A.C. 277 (P.C.) per Lord Wright. Lord Wright took the view that the subjective intention

14

of the parties was not only of paramount significance but also conclusive. [1970) A.C. 583. “As long as the intention expressed is bona fide and legal, and provided there

15

is no reason for avoiding the choice on grounds of public policy, the intention of the parties as to the choice of law should prevail”, as per Lord Reid.

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Looking into the divergence of views above, it is submitted that it is timely for the world to recognise that Islamic finance should have its own lex merchantile. The dispute should be decided not merely according lex situs or lex loci but lex volii.

2.1 The Existing Institutions Established to Handle Disputes in Islamic Finance There are many institutions established to settle disputes, regardless of whether they are in conventional or Islamic finance. This was first initiated by AALCO. AALCO was initially known as the Asian Legal Consultative Committee when it was conceived on the 15th of November 1956 to serve as an advisory board of legal experts to deal with problems referred to it by its members. Initially, six countries took part in this committee, namely India, Indonesia, Iraq, Japan, and the United Arab Republic (now Egypt and Syria). African nations joined the committee in 1958, which led to its being renamed the Asian-African Legal Consultative Committee (AALCC).16 In its infancy, AALCO was intended to serve as a non-permanent committee for a term of five years.17 However, the organisation only changed its name to its existing name during its 40th session in 2001 in New Delhi, where its headquarters are located. At its 43rd session in Bali, in 2004, the texts of its Statutes were revised to bring it in line with other intergovernmental organisations around the world. Article 1 of its Statutes stipulates the objectives of the organisation: •

to serve as an advisory body to its Member States in the field of international law and as a forum for Asian-African cooperation in legal matters of common concern.

•

to consider and deliberate on issues related to international law that may be referred to the Organisation by the Member States and to make such recommendations to governments as deemed necessary.

•

to exchange views, experiences and information on matters of common concern having legal implications and to make recommendations thereto if deemed necessary.

Based on an interview with the Director of the Kuala Lumpur Regional Centre for Arbitration (KLRCA) conducted in 2009 and an informational brochure about the Asian-African Legal Consultative Organisation (AALCO). 17 Refer to http://www.aalco.int/. 16

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

•

to communicate, with the consent of the governments of the Member States, the views of the Organisations on matters of international law referred to it, to the United Nations, other institutions and international organisations.

•

to examine subjects that are under consideration of the International Law Commission and to forward the views of the Organisation to the commission, to consider the reports of the Commission and to make recommendations thereon, wherever necessary, to the Member States.

•

to undertake, with the consent of/or at the request of Member States, such activities as may be deemed appropriate for the fulfilment of the functions and purposes of the Organisation.18

At the Doha session in 1978, AALCO decided to establish two regional centres for International Commercial Arbitration that would function as international institutions under the care of AALCO and form a viable alternative to traditional ADRs that are currently being practiced in Western countries. These regional centres have the following objectives: i)

promoting international commercial arbitration in the Asian and African regions.

ii)

coordinating and assisting the activities of existing arbitral institutions, particularly among those within the two regions.

iii)

rendering assistance in the conduct of ad hoc arbitrations, particularly those held under the UNCITRAL Arbitration Rules.

iv)

assisting in the enforcement of arbitral awards, and

v)

providing for arbitration under the auspices of the two centres where appropriate.19

Ibid.

18

Ibid.

19

15

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Below are a few institutions established under AALCO: Table 3: ADR Institutions Established under the Auspices of AALCO

1

Institutions

Establishment

Kuala Lumpur Regional Centre for Arbitration, Malaysia (KLRCA)

It served as the first Regional Centre for Arbitration in Asia. It was established in 1978 and offers facilities and assistance for the conduct of arbitral proceedings. It also gives its decision awards in the proceedings under the control of the centre. The rule governing the arbitration is the UNCITRAL Arbitration Rules of 1976 with some modifications and adaptations. The Centre also provides mediation under its Conciliation Rules and is broadening its ADR mechanisms to cover emerging substantive areas of dispute such as intellectual property.*

2

Cairo Regional Centre for International Commercial Arbitration (CRCICA)

Established in 1979 by AALCO and the Government of Egypt for a trial period of three years. It was made a permanent centre in 1983.** The types of disputes that the Cairo Centre settles are trade and investment disputes.***

3

Regional Centre for International Commercial Arbitration – Lagos (RCICAL)

The AALCO initiative established a third regional centre for arbitration in Lagos, Nigeria, the first step being the signing of an agreement in 1980 between AALCO and the Government of Nigeria. The Centre was inaugurated nine years later, and in 1999, the Honourable Alhaji Abdullahi Ibrahim signed the agreement to put the Centre into operation.**** The Centre is currently operating based on its human resources and capital.

4

Tehran Regional Arbitration Centre (TRAC), the Islamic Republic of Iran

The Tehran Regional Arbitration Centre is an independent international institution established pursuant to an agreement between the Islamic Republic of Iran and AALCO.

* ** *** ****

For further details, refer to www.klrca.com. Information retrieved from http://www.crcica.org.eg/. Ibid. Retrieved from http://www.rcicalagos.org/.

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

2.2 Other International Institutions for Islamic Finance ADR around the World (Middle East/Europe/Asia/Regional) There are international institutions for Islamic banking which apply alternative dispute resolution in their mandate. The newly launched International Islamic Mediation & Arbitration Center (IMAC), based in Hong Kong, announced plans to organise a condensed basic training course on SharÊÑah and arbitration in Hong Kong starting January 2009. The Arab Chamber of Commerce & Industry (ARABCCI) and IMAC President Lord Edwin E. Hitti said the program aims at heightening the legal, legislative and arbitration-oriented awareness and stressing the importance of Islamic arbitration conceptually and in actual practice.20 The IMAC is an independent international institution established pursuant to the resolution by the ARABCCI signed on the 31st of July, 2008, in Hong Kong and pursuant to consultation with the International Chamber of Commerce. Its objectives are: 1.

conducting mediations and arbitrations;

2.

promotion of international commercial arbitration;

3.

coordinating the activities of, and offering assistance to, existing arbitration institutions in the region, providing assistance to ad hoc arbitrations, including acting as appointing authority, particularly in cases where they are taking place in accordance with the UNCITRAL Rules of Arbitration;

4.

providing assistance in the enforcement of arbitral awards;

5.

providing assistance in the settlement of disputes.21

The Hong Kong International Arbitration Centre (HKIAC)22 was founded in 1985. Its arbitration law is governed by the Hong Kong Arbitration Ordinance (Chapter 341 of the Laws of Hong Kong) and is accepted to be one of the most advanced arbitration centres in the world. The Ordinance incorporates the UNCITRAL Rules of Arbitration.

24-7 Press Release, Hong Kong, October 07, 2008. Retrieved from http://www.24-7pressrelease.

20

com/press-release/international-islamic-mediation-arbitration-center-imac-organizes-basictraining-courses-in-hong-kong-announces-its-president-lord-edwin-e-hitti-68366.php. 21 Ibid. 22 This is a conventional arbitration centre. The Arab Chamber of Commerce approached the chamber to set up a SharÊÑah arbitration centre. Based on an interview via telephone with Mr. Edward on the 25th of March, 2009.

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The Hong Kong Mediation Council was also set up in January 1994 and falls within the ambit of HKIAC. Its membership is solicited through invitations to volunteers who are interested in learning about mediation and in assisting in its development. Hence, the Mediation Council conducts training courses and talks to educate those interested to conduct mediation. The procedures applied are similar to those of the London Maritime Arbitrators Association in that the procedures are ‘documents only’ procedures and small claims procedures. Small claims procedures are suitable for arbitration where the claim is below HK$50,000. In certain circumstances, the Group may also handle larger claims when the dispute is a simple one and the hearing is unlikely to be complex. The Singapore International Arbitration Centre (SIAC) was established in 1991 and since then has administered over 1000 cases involving parties from various parts of the world.23 Arbitration is administered under its own rules and, when the parties agree, the UNCITRAL Rules of Arbitration. In 2007, SIAC introduced the new SIAC Rules 2007, which came into effect on the 1st of July. The salient features of the 2007 Rules are clarification of the rules of the SIAC in appointing arbitration, streamlining SIAC’s function as the institutional administrator, introducing the concept of memorandum of issues and formalising the use of practice notes. Initially known as the Centre for Commercial Conciliation and Arbitration, DIAC was established in 1994. In its current form, it is an autonomous, permanent and nonprofit organisation. Among the objectives of its establishment were to provide facilities for conducting commercial arbitration, to promote arbitration as a means of settling disputes and to provide training to arbitrators in the practice of international arbitration. Recently, Bahrain has been progressive in initiating the Islamic Financial Mediation and Arbitration Centre. It remains to be seen to what extent the initiative will be realized. The reality is that most of the institutions mentioned above have not heard any arbitration or mediation cases on Islamic finance. Despite the establishment of the centres, especially KLRCA, none has been involved in any Islamic finance cases.24 The expansion of Indian business activity, bilateral trade within the ASEAN region and a major

23

trade agreement signed between India and Singapore in 2005 have led to a surge in commercial disputes. Singapore International Arbitration Centre (SIAC) continues to report significant growth in Indian parties using the centre as a seat of arbitration. The number of cases involving an Indian party increased from four cases in 2006 to 24 last year, more than double the 2008 figure. Reported by Greg Bousfield - Thursday, 29 April 2010, Commercial Dispute Resolution News, retrieved from http://www.cdr-news.com/index.php?option= com_content& view=article&id= 706:stealing-from-singapore-lcias- indian-arbitration- mission&catid= 112:articles&Itemid =1, on 24th of March 2010. 24 Interview with the Director of KLRCA in May 2009. For comparative purposes, refer to

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

Despite the noble intentions behind the establishment of all these institutions, the facilities are not fully utilised by contracting litigant parties. The approach of adopting English law as a way to settle disputes may block the growth of Islamic finance. From another angle, the levels of competencies among the judges are questionable. Islamic finance has its own unique features and requires someone with the proper background who understands its intricacies. Without understanding the nature of uÎËl al-fiqh, fiqh al-muÑÉmalÉt, ÍadÊth sciences, the rules of ijtihÉd and much more, arbitrators are unlikely to understand the nature of Islamic contracts. According to a former International Monetary Fund executive director and acclaimed economist, Professor Dr. Abbas Mirakhor, a comprehensive, legislatively-based, unified, and dynamic regulatory and supervisory framework needs to be set up. This is because Islamic finance operates uses its own transactions and a law (SharÊÑah) that governs them. Prof. Mirakhor states, “The regulatory challenge is far more serious within the framework of Islamic finance than in the conventional system. Regulation and supervision in the former system has to consider the risks of violation of financerelevant doctrinal precepts embedded in the institutional scaffolding in addition to violation of [a] strictly regulatory and supervisory framework ruling the latter’s financial system.”25 He also stated that for strong regulation of the Islamic finance sector, the regulatory authority “needs to have enough mandates to supervise and regulate the policy”.26

other institutions established to cater to disputes in international commerce such as: American Arbitration Association Rules: http://www.adr.org/sp.asp?id=22440; CIETAC China Arbitration Centre Rules: http://www.cietac.org.cn/epop_1.htm; International Centre for Settlement of Investment Disputes (ICSID) Rules: http://www.worldbank.org/icsid/basicdoc/CRR_Englishfinal.pdf; Stockholm Chamber of Commerce- Arbitration Institute (SCC) Rules: http://www. sccinstitute.com/_upload/shared_files/; regler/web_A4_vanliga_2004_eng.pdf; London Court of International Arbitration (LCIA); Permanent Court of Arbitration (PCA) Rules: http://www. pca-cpa.org/showpage.asp?pag_id=1064; NAFTA Claims Rules: http://naftaclaims.com/; http:// www.dfait-maeci.gc.ca/nafta-alena/chap11-en.asp UNCITRAL; Rules: http://www.uncitral.org/ pdf/english/texts/arbitration/; arb-rules/arb-rules.pdf; Singapore International Arbitration Centre (SIAC) Rules: http://www.siac.org.sg/rules-siac.htm; WIPO - World Intellectual Property Organisation Arbitration and Mediation Rules: http://arbiter.wipo.int/arbitration/rules/index.html; International Maritime Organisation (IMO) - ICC-CMI. 25 Abbas Mirakhor, “Recent Crisis: Lessons for Islamic Finance,” SC-UM Visiting Scholar Programme, transcript of public lecture, 29 Sept., 2009, p. 32. Retrieved April 14, 2010, from http://www.sc.com.my/eng/html/icm/SC_UM_DrAbbas_090929.pdf. 26 Interview with Professor Mirakhor, The Star, 30 Sept., 2009.

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3. STANDARDISATION OF ISLAMIC FINANCE There are many definitions of standardisation. According to Investopedia, standardisation can be defined as: A framework of agreements to which all relevant parties in an industry or organisation must adhere to ensure that all processes associated with the creation of a good or performance of a service are performed within set guidelines. This is done to ensure the end product has consistent quality and that any conclusions made are comparable with all other equivalent items in the same class.27 Many authors point out that there is an urgent need for standardisation within the Islamic finance industry (IFI). However, due attention has not been given to the topic as it remains one of the major issues faced by the IFI. Moreover, there are different views on whether we even need standardisation. Some hold that we do not, arguing that differences of opinion are part of the beauty of Islam and, as such, pose no threat to the IFI. Others, while acknowledging the validity of differences of opinion, argue that for the Islamic financial industry to prosper we need to standardize rulings on basic products to help the growth of Islamic banks and financial institutions. It is rightly pointed out that different opinions on similar issues given by different schools of thought may create confusion among the public as well as among practitioners of Islamic finance.28 Thus, standardizing the rulings would make it easier for both companies and ordinary people to better understand them. The lack of standardized religious decisions leads to uncertainty, confusion, and unease among scholars and investors. This situation restricts the industry from reaching its potential because a number of inefficiencies arise from the lack of standardisation. For example, different interpretations of SharÊÑah mean that one Islamic bank may not be able to accept or use as a model another Islamic bank’s products, which can stifle the integration of Islamic finance at both the national and international levels.29

Investopedia. (2010). “Standardisation.” Retrieved April 15, 2010, from http://www.investopedia.

27

com/terms/s/standardisation.asp. Khir, K., Gupta, L., et al. (2008). Longman Islamic Banking: A Practical Perspective, (Petaling

28

Jaya: Pearson Malaysia Sdn. Bhd.), p. 312. Shanmugam, B. and Zahari, Z. R. (2009). A Primer on Islamic Finance, (Charlottesville, VA: Research Foundation of CFA Institute), p. 93.

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INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

The lack of standardisation of Islamic banking products across the different jurisdictions creates obstacles at the international level. Apart from reducing confusion and increasing efficiency, standardisation would increase consistency and transparency, reduce costs, and provide more time for innovation.30 One of the suggested solutions (although it may not be a perfect one) would be to establish an International SharÊÑah Board that would consist of members from all schools of law and whose decisions would be mandatory for all jurisdictions.31 Without standardisation, the authors believe that the IFI will suffer in the long run. An example of a problem caused by the lack of standardisation is the plan by Japan Bank for International Cooperation (JBIC) to issue ÎukËk. JBIC was about to issue its first ÎukËk in May 2008. Two respective banks were selected to arrange the deal, namely Citibank of Dubai and CIMB Malaysia. However, due to the disagreement that existed between the SharÊÑah boards of the two banks on whether the ÎukËk were SharÊÑah compliant, the ÎukËk issue was delayed. As a result, the deal had to be restructured from the original murÉbaÍah structure to mushÉrakah. All of this created additional problems in terms of time, cost and frustration for the issuer.32 Similarly, the operations of Islamic banks worldwide differ greatly, and standardisation is urgently needed. Karina Robinson cited Nabeel Shoaib, global head of HSBC Amanah, the Islamic finance unit of the global bank HSBC as stating, “[S]tandardisation in Islamic finance is necessary to avoid fragmentation and to ultimately create a new asset class that can fully compete with conventional finance.”33 Differences of opinion among SharÊÑah scholars on what is and is not SharÊÑah compliant hinders the development of the IFI. This lack of standardisation—according to Marco Rochat—is due to the non-existence of a recognized body to oversee the IFI. A lack of standardisation or Al-Jassar, J. (2002). Islamic Finance: Successes, Prospects, and Neglected Areas, Islamic

30

Finance: The Task Ahead - Proceedings of the Fourth Harvard University Forum on Islamic Finance; Cambridge, Massachusetts: Center for Middle Eastern Studies, Harvard University: 173-176, Shanmugam, B. and Zahari, Z. R. (2009). op. cit.; Smolo, E. (2009). Sustaining the Growth of Islamic Financial Industry: What Needs to Be Done? Islamic Finance Bulletin (RAM) October-December(26): 15-23; Alvi, I. (2009, May). Standardisation of Documentation in Islamic Finance & Role of the International Islamic Financial Market (IIFM), Islamic Financial Sector Development (IFSD) Forum 2009, Ashgabat, Turkmenistan. 31 Kamal, R. M., (2008). Standardisation, the Password to Progress, Islamic Finance Asia, August/ September: 28-30, Shanmugam, B. and Zahari, Z. R. (2009). op. cit. 32 Kamal, R. M., (2008), op. cit., 28-30. 33 Robinson, K., (2007, November 5) Islamic Finance is Seeing Spectacular Growth. NY Times.

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harmonisation between the global markets (especially between the Middle East and Malaysia) makes it hard to set up a global or even regional regulatory body. Currently, different opinions and different practices are used even within a particular jurisdiction of a nation or a region. Some products that are accepted in Malaysia are not acceptable in the Middle Eastern region and elsewhere. We believe that standardisation of the practices and rulings would help these practices and rulings to transcend borders more easily. Hence, standardisation of practices across the globe may bring about further growth and strengthen the IFI. Standardisation of common agreements would save time, efforts and resources, giving the Islamic finance practitioners extra space to focus on much needed areas such as product development.34 Implementing standardized laws with regard to the IFI would definitely foster its prosperity. One of the biggest challenges that Islamic finance is facing today is that of its instruments and their documentation. The best example is the case of bayÑ bi-thaman Éjil (BBA), which is rejected by Middle Eastern scholars because it involves bay’ al-‘inah35 but is being widely practiced in Malaysia and some other countries. The case ruling which took place last year in Malaysia has changed the path of the IFI. As a result, BNM in its latest Central Banking Act 2009 directed that in all future legal disputes the courts should refer back to the resolutions of BNM’s SharÊÑah Advisory Council. Although there are no huge disagreements at the national level on the product structures, when it comes to the international scene, the differences and disagreements are obvious. As mentioned earlier, implementation of identical documentation in all financial institutions throughout Muslim countries (if possible) would be very difficult. However, there has to be some sort of standardisation with regard to financial instruments if we want to have an international Islamic financial system. This is especially true for establishing regulatory and supervisory frameworks for the industry.Smolo and Habibovic (2010) identified the key benefits of standardisation as being:36 Al-Jassar, J., (2002), Islamic Finance: Successes, Prospects, and Neglected Areas, Islamic

34

Finance: The Task Ahead - Proceedings of the Fourth Harvard University Forum on Islamic Finance. Cambridge, Massachusetts, Center for Middle Eastern Studies, Harvard University: 173-176. 35 BayÑ al-ÑÊnah is a sale contract with immediate repurchase. 36 Reproduced with permission. See Smolo, E. and E. Habibovic, (2010), Islamic Banking and Finance beyond Borders: Issue of Standardisation, International Conference on Islamic Banking & Finance “Cross-border practices & Litigations”, Kuala Lumpur, Harun M. Hashim Law Centre, IIUM.

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

i)

Greater transparency and consistency – It is believed that the development of proper regulatory standards and standardisation of documentation, certain products, and practices are essential to ensure sustainable growth of the Islamic financial industry. This will make the market fairer, more efficient and more transparent.37

ii)

Improves confidence of all stakeholders – Standardisation will increase confidence in the industry among stakeholders, as they will know the financial instruments, their documentation and mechanisms better.

iii)

Time and cost saving – By having standardized documentation and products (at least those that are most used), the time and costs involved in developing new products will be reduced. In this regard, Ijlal Alvi, CEO of the International Islamic Financial Market (IIFM), said, “…uniformity and standardisation… create cost reduction for all financial institutions, together with improved transactional security, as well as widely acceptable SharÊÑah interpretations or rulings.”38

Furthermore, this uniform approach will remove confusion and misperceptions about Islamic finance, reduce fragmentation, and lead to market integration. On top of that, it will allow more time for stakeholders, especially scholars, to innovate.39

3.1 Institutions Supporting the Standardisation Process in Islamic Finance A few internationally recognized bodies are developing common regulatory standards for Islamic financial institutions. They include the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), the Islamic Financial Services Board (IFSB), the International Islamic Financial Market (IIFM) and the International Islamic Rating Agency (IIRA).40

Alvi, I. (2009, April). Standardisation of Documentation in Islamic Finance. Leaders in Islamic

37

Finance 2009: Shaping the future of the Islamic finance industry, Doha, Qatar. Kamal, R. M., (2008). op. cit., 28-30. 39 Alvi, I. (2009, May). Standardisation of Documentation in Islamic Finance & Role of the International Islamic Financial Market (IIFM), Islamic Financial Sector Development (IFSD) Forum 2009, Ashgabat, Turkmenistan. 40 Bahrain takes pride in hosting several infrastructure institutions such as AAIOFI, LMC, CIBAFI, the International Islamic Financial Market and the International Islamic Rating Agency (IIRA), which inject more robustness into the Islamic finance market. Other jurisdictions may initiate similar outfits, although perhaps in a more localised manner. 38

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A brief introduction to these institutions follows: a)

Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) The Accounting and Auditing Organisation for Islamic Financial Institutions (hereafter referred to as AAOIFI) was established on the 26th of February, 1990 in Algiers as per the Agreement of Association signed by Islamic financial institutions and was later registered on the 27th of March, 1991 in Bahrain as an international autonomous non-profit corporate body. AAOIFI is supported by institutional members (200 members from 45 countries, so far) including central banks, Islamic financial institutions, and other participants from the international Islamic banking and finance industry worldwide. AAOIFI has gained support for the implementation of its standards, which are now adopted in Bahrain, Jordan, Lebanon, Qatar, Sudan and Syria, and by the Dubai International Financial Centre. The relevant authorities in Australia, Indonesia, Malaysia, Pakistan, the Kingdom of Saudi Arabia, and South Africa have incorporated AAOIFI’s standards and pronouncements into their national guidelines. 41 The main objective of AAOIFI is to develop accounting, auditing, governance and ethical thought relating to the activities of Islamic financial institutions, taking into consideration those international standards and practices consistent with the rules of the SharÊÑah. It also harmonizes the accounting policies and procedures adopted by Islamic financial institutions through the preparation and issuance of accounting standards and its interpretations of the same. AAOIFI’s most recent standards publications are SharÊÑah Standards 2010 and Accounting, Auditing, and Governance Standards 2010. As an international standards setter, AAOIFI develops, prepares and issues Financial Accounting Standards (FASs) and SharÊÑah Standards (SSs), and their relevant exposure drafts, through a system of due process that includes consultations with industry practitioners. AAOIFI also occasionally sponsors the publishing of books on general banking and finance knowledge. So far, only one book on banking operations has been published.

This information was taken from AAOIFI’s website: http://www.aaoifi.com/.

41

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

b)

Islamic Financial Services Board (IFSB)42 The Islamic Financial Services Board (hereafter referred to as IFSB), which is based in Kuala Lumpur, was established on the 3rd of November, 2002 and commenced its operations on the 10th of March, 2003. IFSB is an international standard setting body of regulatory and supervisory agencies that aims at ensuring the stability and soundness of the Islamic finance industry by issuing prudential global standards and guiding principles for the industry, including the banking, capital markets and insurance sectors. It is also active in conducting research on industry-related issues, as well as organizing roundtables, seminars and conferences for regulators and industry stakeholders. There are 195 members in IFSB comprising 52 regulatory and supervisory authorities, six international inter-governmental organisations, and 137 market players, professional firms and industry associations operating in 40 jurisdictions. The main objective of the IFSB is to develop a transparent and prudent Islamic financial services industry by introducing new, or adapting existing, international standards consistent with SharÊÑah principles. So far, the IFSB has issued 12 Standards, Guiding Principles and Technical Notes for the Islamic financial services industry, including the areas of Risk Management (IFSB-1), Capital Adequacy (IFSB-2), Corporate Governance (IFSB-3), Transparency and Market Discipline (IFSB-4), the Supervisory Review Process (IFSB-5), Recognition of Ratings on SharÊÑah-Compliant Financial Instruments (GN-1), Development of Islamic Money Markets (TN-1), Governance for Collective Investment Schemes (IFSB-6), Special Issues in Capital Adequacy (IFSB-7), Guiding Principles on Governance for Islamic Insurance (Takaful) Operations (IFSB-8), Conduct of Business for Institutions Offering Islamic Financial Services (IFSB-9) and Guiding Principles on the SharÊÑah Governance System (IFSB-10).

c)

International Islamic Financial Market (IIFM)43 The International Islamic Financial Market (hereafter referred to as IIFM) is another non-profit standard-setting body of the Islamic financial services industry. It was founded by the collective efforts of the Central Bank of Bahrain, Bank Indonesia, the Central Bank of Sudan, Labuan Financial Services

For more details, refer to the IFSB’s website: http://www.ifsb.org/.

42

For more details, refer to the IIFM’s website: http://www.iifm.net/.

43

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Authority (Malaysia), Ministry of Finance (Brunei Darussalam) and Islamic Development Bank (a multilateral institution based in Saudi Arabia). Besides the founding members, IIFM is supported by its permanent members, the State Bank of Pakistan and Dubai International Financial Centre Authority (UAE). IIFM is further supported by several central banks, government agencies and leading financial institutions as its members. The main objective was unifying the Islamic capital and money market sectors and standardizing products, documentation, and related processes. So far, IIFM has developed 2 standardisation initiatives, including the IIFM Master Agreement for Treasury Placement (MATP) and the ISDA/IIFM TaÍawwuÏ Master Agreement (TMA).44 This development is a breakthrough in Islamic finance and risk management since this is the first globally standardized document for privately negotiated Islamic hedging products.45 d)

Islamic International Rating Agency (IIRA) The Islamic International Rating Agency (IIRA)46 started operations in July 2005 with a mission to “facilitate development of the regional and national financial markets by delineating relative investment or credit risk, providing an assessment of the risk profile of entities and instruments”. Apart from the above bodies, there are some other international organisations which publish authoritative opinions that have been referred to by Islamic financial institutions and agencies across the globe; for example, the International Islamic Fiqh Academy of the Organisation of the Islamic Conference (hereafter referred to as the OIC Fiqh Academy).

The OIC Fiqh Academy47 was established during the Third Islamic Summit Conference, “Cycle of Palestine and Jerusalem”, held in Makkah, Saudi Arabia from 19-22 RabÊÑ al-Awwal, 1401 AH (25 to 28 January, 1981). Its brings together Muslim scholars, scientists and thinkers in various fields of fiqh, culture, science and economics from across the Muslim world to study the problems of contemporary life in order to provide solutions emanating from the Islamic heritage yet open to the evolution of Islamic It was jointly launched by IIFM and the International Swaps and Derivatives Association (ISDA).

44

See http://www.isda.org/newsletters/Issue2-2010/_access/Issue2-2010.html.

45

For more details, refer to IIFM’s website: http://www.iirating.com/.

46

More information about the OIC Fiqh Academy is available at www.fiqhacademy.org.sa.

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INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

thought. As of today, there are 47 countries participating in the Academy. The first OIC Fiqh Academy conference was held in Makkah on 26-28 ShaÑbÉn 1403 (7-9 June 1983). Since then, 19 conferences have been organized. In each session, decisions and resolutions are issued after a thorough discussion of the papers presented. In its last session held in Sharjah on the 30th of April, 2009, the OIC Fiqh Academy declared that organized tawarruq (also known as commodity murÉbaÍah) is impermissible. It is certain that these institutions can play a major role in developing Islamic finance and bringing it to a more standardized level, which will benefit this industry. However, although the abovementioned international standard-setting bodies have outlined, developed and published standards, fatwas and resolutions on Islamic financial matters, not all countries comply with these standards or resolutions. Hence, the divergence of opinions among Muslim scholars, particularly between Malaysia and countries of the Middle East, persists.

4. Battle of Principles The landmark Shamil Beximco48 case heard in 2004 caused significant apprehension in the industry. The English court ruled on the case of Shamil Bank of Bahrain (“Shamil Bank”), which professes to conduct Islamic banking business in line with the SharÊÑah. Beximco Pharmaceuticals Ltd. and the others (“Beximco”) are Bangladeshi companies involved in the manufacture, export and import of pharmaceuticals to and from Bangladesh. In 1995, the Bank agreed to provide Beximco with a working capital facility based on the Islamic contract of murÉbaÍah. The murÉbaÍah agreement contained the following governing law clause, “Subject to the principles of the Glorious ShariÑah, this Agreement shall be governed by and construed in accordance with the laws of England.” Beximco defaulted on the murÉbaÍah agreements. After the occurrence of various termination events under the agreements, Shamil Bank instituted formal court proceedings and made an application to the Court for summary judgment. Beximco contended that the governing law and jurisdiction clause in the agreements was worded to show that the murÉbaÍah arrangement must comply with the SharÊÑah as well as English law. Under their interpretation, the effect of the quoted clause was “to stipulate as a condition precedent (to the choice of English law) that the contract is only to be Beximco Pharmaceuticals Ltd v Shamil Bank of Bahrain E.C. [2004] EWCA Civ 19.

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enforceable insofar as it is consistent with the principles of SharÊÑah”. Beximco further claimed that the murÉbaÍah transactions in question were contrary to the SharÊÑah, as they were actually loans disguised as sales in order to circumvent the indisputable SharÊÑah prohibition of charging interest (ribÉ). Consequently, these murÉbaÍah agreements were invalid and unenforceable. The High Court dismissed Beximco’s defences and granted summary judgment in favour of Shamil Bank by concluding that the principles of the SharÊÑah did not apply to the murÉbaÍah agreements, principally because that had not been the intention of the parties. This was further affirmed by the Court of Appeal. The court held that the reference to the “Glorious ShariÑah” in the governing law clause was a mere reflection of the Islamic religious principles according to which Shamil Bank professed to be doing business. ShariÑah was not to be considered a system of law designed to supersede the application of English law as the governing law. Indeed the law was read in the eyes of Rome Convention, which does not allow two separate systems of law to govern a contract. England is a party to the Rome Convention on the Law Applicable to Contractual Obligations 1980 (“the Rome Convention”), which has the force of law in England by virtue of s.2 (1) of the Contracts (Applicable Law) Act 1990 (equivalent to Article 3.1 of the Rome Convention). This states that a contract “shall be governed by the law chosen by the parties”, and Article 1.1 of the Rome Convention makes it clear that the reference to the parties’ choice of law to govern a contract is a reference to the law of a country, not to a non-national system of law such as the SharÊÑah. Indeed, English law is perfectly open to the parties to a contract incorporating some provisions of a foreign law into an English contract, but only when the parties have sufficiently identified specific provisions of a foreign law, an international code, or set of rules. Then such foreign law, international code, or set of rules would prevail as the governing law, not SharÊÑah law. Both parties accepted that there were areas of considerable controversy and difficulty to applying SharÊÑah to matters of finance and banking.49 Consequently, it was “improbable in the extreme, that the parties were truly asking (the Courts) to get into matters of Islamic religion and orthodoxy”. The Court also accepted the points from the experts who were consulted that the transaction was not in accordance with SharÊÑah principles. Despite that, in the Court’s opinion, the SharÊÑah defence was “a lawyer’s Emphasis added: the difficulties faced by the litigants show that there is an important need to

49

standardize the practice at an international level.

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

construct”. Therefore, the Court inclined against the construction, which would defeat the commercial purpose of the documents. Therefore, the party autonomy rule was denied and English law was applied.

4.1.The Effects of the Decisions The decision is of importance to financial institutions that provide cross-border Islamic financing products and claim to be SharÊÑah compliant for the following reasons:50 i)

The decision in Shamil v. Beximco verified the problem faced in IICG v Symphony Gems.

ii)

The English courts will not allow a debtor to avoid or delay payment simply by claiming that the relevant contractual provisions are not SharÊÑah compliant.

iii)

The party autonomy rule, being the main principle to govern the international contract, was denied.

iv)

The intention of the parties was not taken into consideration.

v)

The governing law clauses in contracts should be drafted very carefully and appropriately.

vi)

No specific standard was named in the contract; e.g., the standards of AAIOFI or the OIC Fiqh Academy. General references to the principles of the SharÊÑah do not ensure the validity of the products.

vii) Based on the decision, a financial institution may require additional representations and warranties from SharÊÑah members regarding SharÊÑah compliance. viii) The decision creates legal uncertainty for parties who choose ShariÑah law in their contract to be applied in English court. ix)

The decision has implications for the parties’ choice of the appropriate law clause in agreements documenting all areas of international trade in which Islamic finance products exist.

For comparison, refer to a write up in: http://www.gtreview.com/global-trade-reviewmagazine/2008/June/LEGAL-ISSUES-Clarifying - Islamic -law_ 6011/; retrieved April 20, 2011. Norton Rose’s Antony Dutton, partner specialising in commercial and banking litigation, and Neil Miller, partner and global head of Islamic finance, explain why the case is so important. 50

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This case was decided on the construction of the governing law clause, which incorporated English law; thus, the Court did not need to consider or apply SharÊÑah. However, the Court said that had the relevant SharÊÑah principles been validly incorporated in this case, Beximco might have succeeded in their application. The problem is Islamic Finance does not have any fixed principles that are viable and acceptable internationally. A standard legal framework is needed for the maÎlaÍah of the practice.

4.2 SharÊÑah Validity and Risks The latest Islamic finance case to date in an English court is The Investment Dar Co. KSCC v Blom Developments Bank SAL [2009] EWCH 3545 Ch. The Investment Dar Co. KSCC (“TID”) is a Kuwaiti holding company with diverse business interests that include commercial and consumer finance, real estate and asset management. At issue in the litigation was an investment by Blom Development Bank SAL (“Blom”), a Lebanese bank, pursuant to a master wakÉlah agreement with TID. The agreement provided that Blom deposit a certain amount of money with TID, appointing TID as its wakÊl (agent) to manage the money as an investment. The wakÉlah appointment was for TID to invest the money in its treasury pool (which included moneys of other depositors). Among the salient terms of the agreement was that the choice of law and jurisdiction for the transaction would be English law, and the contract was determined by TID’s SharÊÑah committee to conform with the SharÊÑah—a determination that the agreement specifically precluded TID from challenging. In addition, each time Blom made a deposit, an individual wakÉlah contract was to be signed. At the end of every wakÉlah period, TID would pay 5% profit to Blom. Under this arrangement, Blom deposited over USD10 million with TID.51 TID is currently negotiating with its creditors to restructure the debts, and its motive for defending against Blom’s application for summary judgment may be to prevent other creditors from doing the same. TID claimed that the Article of Association (AOA) and the Memorandum of Association (MOA) of the company do not allow non-ShariÑah compliant practices. Therefore, interestingly, TID claimed that the products approved by its own SharÊÑah committee were not SharÊÑah compliant and ultra vires the company’s constitution. Ethics is an issue here. The liability and obligation of the ShariÑah advisers may create criticism. For more details refer to ISRA Research Paper 19, entitled “Islamic Finance Cases in English

51

Court” by Yaacob, H.

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

The parties engaged in SharÊÑah-compliant financing transactions with Islamic finance institutions have been sensitive to SharÊÑah risk, being the risk that an executed transaction will later be viewed by a SharÊÑah advisor as not being compliant with the SharÊÑah, thus affecting the ability of the financier to syndicate the financing or its obligation to honour the terms of the financing. To have an Islamic financial institution itself use non-compliance with SharÊÑah as a defensive weapon, claiming that a transaction it entered into with full knowledge of the transaction’s terms is not SharÊÑah compliant and therefore not binding on the financial institution, increases the magnitude of so-called “SharÊÑah risk” by several orders of magnitude. Moreover, the willingness to make such an argument damages the credibility of Islamic financial institutions in general. Investors determining whether to enter into a SharÊÑah-compliant transaction may now be reticent if they believe there is a risk their counterparty may in the future try to avoid its obligations by claiming the investment arrangement does not comply with the SharÊÑah. They may be more sceptical when an Islamic financial institution argues that certain transaction terms are necessary because of SharÊÑah considerations.52 The parties could also finalise the contract to ensure the contractual clauses dealing with choice of law and jurisdiction provide the best possible protection against anticipated default or enforcement issues.

4.3 Contentious Cases and Decisions US Court has decided Re East Cameron Partners L.P. inj 2006. Comparing the decision of the two courts in dealing with Islamic finance cases is material to understanding the level of recognition given to Islamic finance at an international level. The decision by a US court in 2006 was a landmark case on ÎukËk issuance. Following the subprime crisis in the United States, which burst into a full-blown financial crisis affecting the rest of the world in 2008, the risk of defaults continues to unfold. It is believed that investors and market players will become more aware of the issue of credit risks attached to ÎukËk, as seen in the case of Re East Cameron Partners L.P. [2008] Bank, LEXIS 3918. The East Cameron L.P. ØukËk offering (“the ECP ØukËk”) was launched in July 2006 in the US to raise USD165.67 million, using a mushÉrakah structure. It was a multiple-award winning ÎukËk, which was once the spotlight of the media. For additional information, refer to Michael Rainey, who claimed that the SharÊÑah was used as

52

a tool to avoid paying debt. Refer to http://www.cpifinancial.net /v2/Magazine.aspx ?v=1&aid =2327&cat=IBF&in=52.

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It was not until October 2008 that East Cameron Gas Co. (“East Cameron”) filed for bankruptcy protection after its offshore Louisiana oil and gas wells failed to yield the expected returns, partially because of hurricane damage. The main issue in this case was whether the ÎukËk-holders actually own a portion of the company’s oil and gas or, in other words, if there was indeed a true sale from the special-purpose vehicle (“SPV”) to the ÎukËk-holders. East Cameron argued that there had been no real transfer of ownership of production revenues, known as royalties, into the SPV that was formed to issue the ÎukËk. Instead, the company claimed the transaction was merely a loan secured on those royalties, meaning that ÎukËk-holders would have to share the royalties with other creditors in the event of liquidation. Robert Summerhays, J, rejected the company’s contention and ruled that the ÎukËkholders “invested in the Sukuk certificates in reliance of the characterization of the transfer of the royalty interest as a true sale”. The judge then gave East Cameron leave to find further arguments to support its case. It is highly significant that the US court here respected the arrangement of Islamic ÎukËk and refused to treat the issue in line with US laws on conventional bonds. The court was not inclined towards its own set of rules and laws, but instead delved into the legal commitment of the parties to the ÎukËk arrangement and upheld the intentions of the parties in entering into the contract and implications thereof. Having analysed the cases directly related to Islamic finance heard in English and US courts, a comparison with other cases is vital. Even though the cases are not directly related to Islamic finance, they are related to concepts of muÑÉmalÉt law such as ijÉrah, takÉful and issues of SharÊÑah compliance. It appears that the court applied party autonomy and interpreted the contract accordingly.

4.3.1 IjÉrah Contract In the case of Riyad Bank & Others v Ahli United Bank (UK) Plc [2006] EWCA Civ 780, the Islamic contract involved was ijÉrah (leasing). The Court applied English law, and it ignored the intention of the parties as stated in the agreements and ignored what transpired from the actions of the parties in relation to the SharÊÑah-compliant investment fund. Although the judgment in essence supports the validity and operations of an Islamic investment fund, it is saddening to see how the legal issue has been tackled to the exclusion of the SharÊÑah principles.

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

4.4 Regulatory and Supervisory Frameworks The global financial crisis revealed the importance of sound and prudent regulatory and supervisory frameworks for proper and efficient operation of a financial system in general. Islamic finance is not an exception.53 Many believe that regulatory and supervisory frameworks are “the most vital component of a sound operating framework for Islamic finance.”54 However, the growth of, and demand for, Islamic finance is not adequately matched with development of prudent regulatory and supervisory frameworks.55 The market witnessed a huge influx of new players entering this lucrative market, mainly motivated by its promising growth. As a result, many conventional banks and financial institutions started offering Islamic financial services. However, there is a need to monitor the industry to avoid any bubble in the future. This monitoring task should be carried out by various parties in the market; from governments to regulatory bodies, from financial institutions to the SharÊÑah scholars. In fact, there is a need for SharÊÑah scholars to continuously monitor and oversee the market in order to develop “regulatory rules based on the realities in a given market”.56 The task of regulating and supervising the IFI is even harder when we take into consideration the divergence of practices and opinions. Thus, standardisation may improve the regulation and supervision of the industry by smoothing the process.

4.5 Financial Reporting The quality and transparency of financial reporting differs across many different jurisdictions. While almost all of the Gulf Cooperation Council (GCC) countries follow the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) standards for financial reporting and disclosure, Malaysia follows its own standards Smolo, E. (2009). Sustaining the Growth of Islamic Financial Industry: What Needs to Be Done? Islamic Finance Bulletin (RAM) October-December(26): 15-23. 54 Ebrahim, A. I. (2004). Achieving Sustainable Growth in Islamic Finance. In S. Jaffer (ed.) Islamic Asset Management: Forming the Future for Shari’a-Compliant Investment Strategies, (London: Euromoney Books). 55 KPMG International, (March 2007), Growth and Diversification in Islamic Finance. Retrieved 05 April, 2010, from http://us.kpmg.com/microsite/FSLibraryDotCom/docs/Growth%20and%20 Diversification%20in%20Islamic%20Finance.pdf. 56 Eldin, S. E. T. and M. K. Hassan, (2007), Islam and Speculation in the Stock Exchange. In M. K. Hassan and M. K. Lewis (eds.) Handbook of Islamic Banking, (UK: Edward Elgar Publishing Ltd.). 53

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(Malaysian Accounting Standards Board), which are modified and adjusted to its current market structure and dual financial system. Many standards have been published, but much more has to be done in each country to bring their domestic regulations in line with them. Once again, standardisation of products and procedures may help in producing a unified reporting system that will be easily understood by all financial players. On this matter Standard & Poor’s, in its report Enhancing Financial Reporting and Transparency: Keys to the Future of Islamic Finance, stated, “Standardisation of financial reporting is a key challenge for the rapidly growing Islamic finance industry.”57 4.6 Accounting Standards Many consider accounting standards as the biggest challenge in implementing the Islamic financial system. Currently, there are two main standard setting bodies for accounting practices, namely AAOIFI, whose accounting standards are followed mostly by GCC countries, and the Malaysian Accounting Standards Board (MASB), whose standards are followed in Malaysia. The treatment of a deposit as a liability, the treatment of muÌÉrabah, zakÉh disclosure and many other differences need to be addressed and resolved in order to bring this industry to the next level. However, this task will not be easy as the products vary from one country to the next. The authors believe that this problem could at least be minimized by having standardized products all over the globe.

5. ISLAMIC FINANCE SHOULD GO FOR A LEX MERCATORIA IN THE FORM OF AN INTERNATIONAL CONVENTION The creation of many international model laws for commercial transactions has been Eurocentric for the last hundred years. It is timely to have our own caucus on lex standardisation. The purpose is not to ensconce any particular school of thought as the standard but to facilitate the implementation of Islamic finance worldwide. It is timely for Muslim countries, perhaps through the OIC, to stand up and have their own convention on Islamic finance.

KPMG International, (March 2007), op. cit.

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The UN’s Declaration of Human Rights was rejected by Islamic countries, due to its non-compliance with SharÊÑah values on certain points. The response of the OIC was the Cairo Declaration on Human Rights in Islam. If a convention for that purpose was possible, then it is also possible for a convention to resolve issues related to crossborder transactions in Islamic finance. It is timely for us to have our standard guidelines and rules to be followed. To make that possible, one supervisory body needs to be on board. There is a need for a World Islamic Bank to centralize the process and make the relevant laws uniform. Even though international law is “soft law”, it at least gives options to the parties in Islamic finance to deal with their problems. Having said that, Islamic finance needs an international convention, not only in the form of contract law that recognises and enforces Islamic financial contracts, but also other law components that are harmonious with its business model. These include, among others: i)

banking and finance law that provides for the licensing, regulation and supervision of Islamic finance business by a credible financial authority;

ii)

tax law that provides incentives to undertake financing in a SharÊÑah-compliant manner or at least neutrality in tax treatment when it comes to Islamic finance documentation and process-flow;

iii)

business law that permits an Islamic financial institution, notwithstanding its fundamental role as a financial intermediary, to participate in specific economic activities such as trading and investing without being subject to normal restrictions imposed on conventional financial institutions;

iv)

property law that empowers an Islamic financial institution to hold properties as assets or receive properties as collateral;

v)

insolvency law that enables Islamic financial institutions to enforce their claims against debtors and defend themselves against creditors, as the case may be;

vi)

securities law that allows parties to offer or trade capital market instruments that are SharÊÑah compliant;

vii) employment law that accommodates and facilitates the flow of international talents to meet the industry’s demand for highly qualified human capital; and viii) A dispute resolution framework that is well equipped with lawyers, judges and other experts who are competent and knowledgeable in Islamic finance.

35

5.1 International Conventions There are currently thirty-nine (39) conventions for the harmonisation of rules of private international law and for the promotion of international judicial and administrative cooperation in civil and commercial matters. However, OIC can take the lead to propose a specific international convention for Islamic finance. This is vital in order to cope with market growth. Recognising the capacity of the member states, the authors are of the view that the OIC should promote the issue at The Hague. This lobbying process must be supported by AALCO. International law can be defined as the body of rules that nations recognize as binding upon one another in their mutual relations. Sources of international law include treaties, customs, general principles of law, resolutions and declarations of international organisations, equity, and the writings of judges and legal scholars. All countries that agree to apply uniform laws can solve the conflict of laws problem by applying the laws in cross-border financial investment and international trade. An international agreement may be given different designations beside treaty, namely covenant, convention, charter, statute, final act, protocol, agreement, exchange of notes or letters and modus vivendi.58 Today, Islamic finance involves international transactions that involve a number of different areas of law. A treaty is regarded as a legally binding agreement created between two or more subjects of international law who are recognised as having treaty-making capacity. It is an instrument governed by international law and once it enters into force, the parties thereto have legally binding obligations in international law.59 Art. 2 of the Vienna Convention on the Law of Treaties defines a treaty as an international agreement concluded between states in written form and governed by international law, whether embodied in a single instrument or in two or more related instruments, and whatever its particular designation. Different countries can make bilateral or multi-lateral treaties among themselves to facilitate international business and cross-border financial investment. In a treaty, the signatory countries may decide to choose a particular country’s law to be applied in the case of cross-border business transactions and financial investment. Thus, the conflict of laws issue in cross-border financial investment can be resolved.60 Dixon, M. (2000). Textbook on International Law, 4th ed., (London: Blackstone Press Ltd.), p. 52.

58

Ibid.

59

Refer to Case Concerning Delimitation and Territorial Questions between Qatar and Bahrain

60

(Jurisdiction), decided by the International Court of Justice, reported in (1994)ICJ Rep.112.

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Recommendations are not open for ratification and, therefore, are not binding. They provide further details or give guidelines for setting higher standards that go beyond the minimum standards set in the conventions; in other words, they provide a certain direction towards improvement. When a member state or state party61 ratifies62 a convention, it agrees to two important things: i)

It agrees to implement the convention. Thus, national legislation must be reviewed vis-a-vis the provisions of the convention. A country that ratifies is allowed to choose parts of the convention as it wishes (reservation). In the long term, all of the provisions must be applied in national law and practice.

ii)

It must report at regular intervals to the supervisory mechanisms of the authoritative body.

It is of pivotal importance for Islamic finance to have a separate lex mercatoria. Lex mercatoria is a Latin expression literally meaning “merchant law”. The term was used for a body of trading principles used by merchants throughout Europe in the medieval era. International commercial law today owes some of its fundamental principles to the lex mercatoria as it was developed in the medieval ages. This includes choice of arbitration institutions, procedures, applicable law and arbitrators, and the goal to reflect customs, usage and good practice among the parties. 5.2 Model Law of Arbitration Recurrent inadequacies and the absence of a proper framework may prejudice the practices of the Islamic finance industry. The absence of any legislative procedures and proper mechanism to handle disputes according to the ShariÑah may expose the practice to risks. It is therefore necessary to have a model law of arbitration that is based on sulÍ and taÍkÊm. Keeping these points in mind and due to the inadequacy of domestic laws or international laws, a model law needs to be developed at the United Nations level in order to suit the needs of merchants for international trade law. The model law is intended to reduce State party means a country that agreed to be bound by the treaty under the international law, i.e.,

61

ratified the treaty. Ratification is a definitive act undertaken at an international level whereby a state establishes its consent to be bound by a treaty that it has already signed.

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the risk of possible frustrations, difficulties or surprises. AALCO might be the best platform to initiate a model law on Islamic finance, the reason being that forty-seven countries are members of the organisation. Furthermore, should the members agree to adopt a model law on arbitration in Islamic finance, it would be a step toward having our own lex mercatoria in the future. It is quite possible to have a convention that is ratified by most of the countries involved in Islamic finance. This initiative could also be taken up by the Organisation of Islamic Countries (OIC). Alternatively, the United Nations could be lobbied; this would be more difficult, but there is no harm in trying.

6. CONCLUSION

The dominant trend in cross-border Islamic finance transactions seems to be agreements with the peculiar blend of an English or United States choice of laws and jurisdiction clause along with a statement that the operations must comply with the requirements of the Glorious SharÊÑah. The reason for this trend is not explained in the literature. Whatever it may be, the cases that have already been decided by the courts in England and the United States do not show any consistency in upholding Islamic laws. With due respect to the vast development in the legal systems of the United States and England, it is not advisable for the benefit of the true SharÊÑah spirit of international Islamic finance contracts to appoint the laws of those nations to govern them. As an alternative, it is recommended to have a unified Islamic banking and finance law to be implemented in all countries that are commercial centres in order to facilitate Islamic banking and finance dispute resolution. It is advisable to create an international convention or treaty that is recognised worldwide. Otherwise, if the laws of England and other Western countries are designated as the governing law of an Islamic finance contract in conjunction with SharÊÑah law, the transaction may be converted from an Islamic finance to a conventional Western financial transaction by default, as the governing law will most likely be construed according to the legal tradition of the country whose law is chosen. In other words, Islamic finance contracts may be subject to the laws and courts of a jurisdiction inexperienced in Islamic law, and this is not something to be welcomed by the Islamic banking fraternity. As emphasised, cogent and well-argued laws need to be formulated to avoid operating within the conventional framework legally. Implementing the true spirit of SharÊÑah law in financial matters will be realised only if we have a good legal framework acceptable to all relevant venues. There

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

should be a comprehensive reform of the judicial system. Even in the Middle East, where the legal system is much more sensitive to SharÊÑah, other issues arise. In Saudi Arabia, which uses SharÊÑah as the only basis for its legal system, Islamic banking disputes are dealt with by a central bank panel, not a SharÊÑah court. This is because of a view that the court may be expert in SharÊÑah but judges are often not expert enough in banking. The authors of this paper suggest that a greater consensus on standards and products in Islamic finance is necessary before this industry can mature. In order for this industry to become stronger and to compete with the conventional counterpart, the barriers to growth, which have been discussed earlier, will have to be resolved first. If these issues and challenges are addressed properly, Islamic finance will, ceteris paribus, grow further and faster. In brief, the paper can be concluded as follows: i)

The existing legal framework for international trade is ill suited to Islamic finance and, consequently, inappropriate for efforts at harmonisation.

ii)

The Islamic finance framework has its own intricacies and principles and is different from commercial or trade law, which has been Eurocentric for the last century.

iii)

The existing convention may serve as a platform to leverage the freedom of contract from an Islamic point of view.

iv)

The authors are of the view that the OIC should promote an Islamic finance convention at The Hague with the support of AALCO. This is due to the fact that Islamic finance is practiced worldwide and not merely in Islamic countries.

According to many, standardisation is the issue on which the entire Islamic finance industry depends. The standardisation of products in this industry is the prerequisite for this industry to go to the next level in its development and to be able to make changes in the banking industry in general. Cross-border transactions will be stuck with differences of opinions among SharÊÑah scholars until and unless we sit together and come up with a unified position. Standardisation of the practices across the globe may bring about further growth and strengthen the Islamic financial industry. This task is being partially tackled by some Islamic financial institutions such as AAOIFI, IFSB, IIFM and IIRA, but this task is far from over. However, it is the authors’ view that the OIC should take the lead. Having

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properly harmonized and standardized products across the globe will benefit the industry as a whole and will lead to economies of scale. Fortunately, these institutions are currently aware of these problems and the need for a greater standardisation of products along with better and more consistent regulatory and supervisory frameworks that will improve the position and credibility of the industry. In short, the Islamic financial industry will prosper more with standardisation than without it. Allah knows best!

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APPENDIX 1: Alphabetical Index of Political Entities and Their Corresponding Legal Systems POLITICAL

LEGAL SYSTEMS

ENTITIES

MIXED SYSTEMS COMPONENTS

POLITICAL

LEGAL SYSTEMS

MIXED SYSTEMS COMPONENTS

ENTITIES

AFGHANISTAN

Muslim

LUXEMBOURG

Civil law

 

ALBANIA

Civil law

MACAU (CN)

Civil law

 

ALGERIA

Mixed

MACEDONIA (FYROM)

Civil law

 

ANDORRA

Customary

MADAGASCAR

Mixed

Civil law/Customary

ANGOLA

Civil law

MADEIRA (PG)

Civil law

 

ANGUILLA (UK)

Common law

MALAWI

Mixed

Common law/ Customary

ANTIGUA AND BARBUDA

Common law

MALAYSIA

Mixed

Muslim/Common law/Customary

ARGENTINA

Civil law

MALDIVES ISLANDS

Muslim

 

ARMENIA

Civil law

MALI

Mixed

Civil law/Customary

ARUBA (NL)

Civil law

MALOUINES/ FALKLAND ISLES (UK)

Common law

 

AUSTRALIA (AU)

Common law

 

MALTA

Mixed

Civil law/Common law

AUSTRIA

Civil law

 

MAN ISLE OF (UK)

Common law

 

AZERBAIJAN

Civil law

 

MARIANA (USA)

Common law

 

Common law

 

Civil law/Muslim

AZORES (PG)

Civil law

 

MARSHALL ISLANDS

BAHAMAS

Common law

 

MARTINIQUE (FR)

Civil law

 

BAHRAIN

Mixed

Muslim/Civil law/ Common law/ Customary law

MAURITANIA

Mixed

Muslim/Civil law

BANGLADESH

Mixed

Muslim/Common law

MAURITIUS

Mixed

Civil law/Common law

BARBADOS

Common law

 

MAYOTTE ISLAND (FR)

Civil law

 

BELARUS

Civil law

 

MEXICO

Civil law

 

BELGIUM

Civil law

 

MICRONESIA

Mixed

Common law/ Customary

BELIZE

Common law

 

MOLDOVA

Civil law

 

BENIN

Civil law

 

MONACO

Civil law

 

BERMUDA (UK)

Common law

 

MONGOLIA

Mixed

Customary/ Civil law

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

Customary/ BHUTAN

Mixed Common law

MONTSERRAT (UK)

Common law

 

BOLIVIA

Civil law

 

MONTENEGRO

Civil law

 

BOSNIA AND HERZEGOVINA

Civil law

 

MOROCCO

Mixed

Muslim/Civil law

BOTSWANA

Mixed

Civil law/Common law

MOZAMBIQUE

Mixed

 

MYANMAR

Customary/ Civil law Common law/

BRAZIL

Civil law

Mixed Customary

BRITISH INDIAN OCEAN TERRITORY (UK)

Common law

BRITISH TERRITORIES OF ANTARTICA (UK)

Common law

 

NAURU

Common law

BRUNEI

Mixed

Muslim/Common law/Customary

NEPAL

Mixed

Common law/  

NAMIBIA

Mixed Civil law

 

Common law/ Customary

BULGARIA

Civil law

 

NETHERLANDS (NL)

Civil law

 

BURKINA FASO

Mixed

Civil law/ Customary

NETHERLANDS ANTILLES (NL)

Civil law

 

BURUNDI

Mixed

Civil law/ Customary

NEW CALEDONIA (FR)

Civil law

 

CAMBODIA

Civil law

 

NEW ZEALAND (NZ)

Common law

 

CAMEROON

Mixed

Civil law/Common law/Customary

NICARAGUA

Civil law

 

CANADA (CD) (minus QUEBEC)

Common law

 

NIGER

Mixed

Civil law/ Customary Common law/

CANARY ISLANDS (SP)

Civil law

 

NIGERIA

Mixed

Muslim/ Customary

CAPE VERDE

Civil law

 

NIUE ISLAND (NZ)

Common law

 

CAYMANS- (UK)

Common law

 

NORFOLK ISLAND (AU)

Common law

 

CENTRAL AFRICAN REPUBLIC

Civil law

 

NORTHERN IRELAND (UK)

Common law

 

CHAD

Mixed

Civil law/ Customary

NORWAY

Civil law

 

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Muslim/ CHILE

Civil law

 

OMAN

Mixed

Customary/ Civil law

CHINA (CN) (minus H-K and MACAU)

Mixed

COLOMBIA COMOROS

Muslim/

Civil law/ Customary

PAKISTAN

Civil law

 

PALAU

Common law

 

Mixed

Civil law/Muslim

PALESTINE

Mixed

Civil law/Muslim

CONGO

Mixed

Civil law/ Customary

PANAMA

Civil law

 

CONGO, POPULAR DEMOCRATIC REPUBLIC OF

Mixed

Civil law/ Customary

PAPUA NEW GUINEA

Mixed

COOK ISLANDS (NZ)

Common law

 

PARAGUAY

Civil law

 

COSTA RICA

Civil law

 

PERU

Civil law

 

COTE D’IVOIRE

Mixed

Civil law/ Customary

PHILIPPINES

Mixed

CROATIA

Civil law

 

PITCAIRN (UK)

Common law

 

CUBA

Civil law

 

POLAND

Civil law

 

CYPRUS

Mixed

Common law/Civil law

PORTO RICO (ASS. USA)

Mixed

Mixed Common law

Customary/ Common law

Common law/ Civil law

Civil law/ Common law

CZECH REPUBLIC

Civil law

 

PORTUGAL (PG)

Civil law

 

DENMARK (DK)

Civil law

 

QATAR

Mixed

Muslim/Civil law/ Common law/ Customary

DJIBOUTI

Mixed

QUEBEC (CD)

Mixed

Civil law/Muslim/

Civil law/

Customary

Common law

DOMINICA

Common law

 

REUNION ISLAND (FR)

DOMINICAN REPUBLIC

Civil law

 

ROMANIA

Civil law

 

EAST TIMOR

Mixed

RUSSIA

Civil law

 

 

RWANDA

Mixed

Muslim/Civil law

SAINTBARTHELEMY (FR)

Civil law

 

Civil law/Muslim/ Customary Civil law/ ECUADOR

Civil law

Customary EGYPT

Mixed

Civil law

 

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

EL SALVADOR

Civil law

EQUATORIAL GUINEA

Mixed

  Civil law/ Customary

SAINT HELENA (UK)

Common law

 

SAINT KITTS AND NEVIS

Common law

 

SAINT LUCIA

Mixed

Civil law/ Civil law/ ERITREA

Mixed

Customary/

Common law Muslim ESTONIA

Civil law

ETHIOPIA

Mixed

  Civil law/ Customary

FAROE ISLANDS (DK)

SAINT MARTIN (FR)

Civil law

 

SAINT PIERRE AND MIQUELON (FR)

Civil law

 

 

SAINT VINCENT Civil law

 

AND THE GRANADINES

Common law

Common law

 

SAMOA

Mixed

Common law

   

Common law/ FIJI ISLANDS

Customary FINLAND

Civil law

 

SAMOA, AMERICAN (USA)

FRANCE (FR)

Civil law

 

SAN MARINO

Civil law

FRENCH GUYANA (FR)

Civil law

 

SAO TOMÉ AND PRINCIPE

Mixed

FRENCH POLYNESIA (FR)

Civil law

 

SAUDI ARABIA

Muslim

F R E N C H SOUTHERN AND Civil law A N TA R C T I C LANDS (FR)

 

SCOTLAND (UK)

Mixed

Civil law/ Customary

Civil law/ Common law Civil law/

GABON

 

Mixed

Civil law/ SENEGAL

Mixed

Customary

Customary

Muslim/ GAMBIA

Mixed

Common law/

SERBIA

Civil law

SEYCHELLES

Mixed

 

Customary Common law/ GEORGIA

Civil law

 

Civil law GERMANY

Civil law

 

SIERRA LEONE

Mixed

Common Customary

law/

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Common law/ GHANA

Mixed

GIBRALTAR (UK)

Common law

GREECE GRENADA

Common law/ SINGAPORE

Mixed

 

SLOVAKIA

Civil law

 

Civil law

 

SLOVENIA

Civil law

 

Common law

 

S O L O M O N Mixed ISLANDS

Customary

Muslim

Common law/ Customary Muslim/Civil law/

GREENLAND (DK)

Civil law

 

SOMALIA

Mixed

Common law/ Customary

GUADELOUPE Civil law (FR)

Civil law/  

SOUTH AFRICA

Mixed Common law

GUAM (USA)

Common law

 

S O U T H GEORGIA AND Common law SANDWICH ISLANDS (UK)

GUATEMALA

Civil law

 

SPAIN (SP)

Civil law

 

  Civil law/

GUERNSEY (UK)

Customary

 

SRI LANKA

Mixed

Common law/ Customary

Civil law/ GUINEA

Mixed

SUDAN

Mixed

Muslim/Common law

SURINAME

Civil law

 

SWAZILAND

Mixed

Customary Civil law/ GUINEA-BISSAU

Mixed Customary Common law/

Civil law/

GUYANA

Mixed

HAITI

Civil law

 

SWEDEN

Civil law

 

HAWAII (USA)

Common law

 

SWITZERLAND

Civil law

 

HONDURAS

Civil law

 

SYRIA

Mixed

Civil law/Muslim

TAIWAN

Mixed

Civil law

HONG (CN)

KONG

Customary

Common law/ Mixed

Civil law/

Customary

Customary

HUNGARY

Civil law

 

TAJIKISTAN

Civil law

ICELAND

Civil law

 

TANZANIA

Mixed

  Common law/ Customary

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

Common law/ INDIA

Mixed

Muslim/

THAILAND

Civil law

TOGO

Mixed

 

Customary Civil law/ Civil law/ INDONESIA

Mixed

Muslim/

Customary Customary IRAN

Mixed

IRAQ

Mixed

Muslim/Civil law

TOKELAU (NZ)

Common law

 

TONGA

Common law

 

TRINIDAD AND TOBAGO

Common law

 

TUNISIA

Mixed

Civil law/Muslim

TURKEY

Civil law

 

SWAZILAND

Mixed

Civil law/ Muslim  IRELAND

Common law

  Civil law/

ISRAEL

Mixed

Common law/

ITALY

Civil law

GUYANA

Mixed

HAITI

Civil law

 

SWEDEN

Civil law

 

HAWAII (USA)

Common law

 

SWITZERLAND

Civil law

 

HONDURAS

Civil law

 

SYRIA

Mixed

Civil law/Muslim

TAIWAN

Mixed

Jewish/Muslim   Common law/

Civil law/

Civil law

HONG (CN)

KONG

Customary

Common law/ Mixed

Civil law/

Customary

Customary

HUNGARY

Civil law

 

TAJIKISTAN

Civil law

ICELAND

Civil law

 

TANZANIA

Mixed

  Common law/ Customary

Common law/ INDIA

Mixed

Muslim/

THAILAND

Civil law

TOGO

Mixed

 

Customary Civil law/ Civil law/ INDONESIA

Mixed

Muslim/

Customary Customary IRAN

Mixed

Muslim/Civil law

TOKELAU (NZ)

Common law

 

TONGA

Common law

 

Civil law/ IRAQ

Mixed Muslim 

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IRELAND

Common law

 

TRINIDAD AND TOBAGO

Common law

 

TUNISIA

Mixed

Civil law/Muslim

Civil law/ ISRAEL

Mixed

Common law/ Jewish/Muslim

ITALY

Civil law

 

TURKEY

Civil law

 

JAMAICA

Common law

 

TURKMENISTAN

Civil law

 

JAPAN

Mixed

TURKS AND Civil law/Customary CAICOS (UK)

Common law

 

JERSEY (UK)

Customary

 

TUVALU

Common law

 

UGANDA

Mixed

Civil law/ Common law/ JORDAN

Mixed

Muslim/

Customary Customary KAZAKHSTAN

Civil law

KENYA

Mixed

  Common law/ Customary/ Muslim

UKRAINE

Civil law

UNITED ARAB EMIRATES

Mixed

  Muslim/ Customary

Common law

 

U N I T E D K I N G D O M (UK) (minus Common law SCOTLAND, GUERNSEY AND JERSEY)

 

KOREA NORTH

Mixed

UNITED STATES OF AMERICA Civil law/Customary Common law (USA) (minus LOUISIANA)

 

KOREA SOUTH

Mixed

Civil law/Customary URUGUAY

Civil law

 

KUWAIT

Mixed

Muslim/Civil Customary

UZBEKISTAN

Civil law

 

KYRGYZSTAN

Civil law

 

VANUATU

Mixed

KIRIBATI

law/

Civil law/Customary/ Common law LAOS

Civil law

 

VATICAN/HOLY

Civil law

 

LATVIA

Civil law

 

VENEZUELA

Civil law

 

LEBANON

Mixed

Civil law/Muslim

VIETNAM

Civil law

 

Common law/ LESOTHO

Mixed

Civil law/

V I R G I N Common law ISLANDS (USA)

 

V I R G I N Common law ISLANDS (UK)

 

Customary Common law/ LIBERIA

Mixed Customary 

INTERNATIONAL CONVENTION FOR ISLAMIC FINANCE: TOWARDS STANDARDISATION

LIBYA

Mixed

Muslim/Civil law

WALLIS AND FUTUNA (FR)

Civil law

  Muslim/Civil law/

LIECHTENSTEIN

Civil law

 

YEMEN

Mixed

Common law/ Customary Common law/

LITHUANIA

Civil law

 

ZAMBIA

Mixed Customary Civil law/

LOUISIANA Mixed (USA)

Civil law/ ZIMBABWE

Mixed

Common law/

Common law Customary

Source: http://www.juriglobe.ca/eng/sys-juri/index-alpha.php

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(Footnotes)

1.

Information in this table is extracted from Islamic Finance, Global Legal Issues and Challenges, Effectiveness of Legal and Regulatory Framework for IFS, Kuala Lumpur: Islamic Financial Services Board (IFSB), 2008, pp.43-45.

2.

For further details, refer to www.klrca.com.

3.

Information retrieved from http://www.crcica.org.eg/.

4.

Ibid.

5.

Retrieved from http://www.rcicalagos.org/.

Notes

Notes

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