Governance Standard on Independence of Shari’a Supervisory Board Exposure Draft; Governance Standard on Independence of Shari’a Supervisory Board Prepared by; Alwin Yoga Mohd Edil Mohd Hairul Azrin Nuraishah REPORT FIN 6650 Accounting and Control of Islamic Financial Institution

Introduction Background Information Issued Early February 2006 Public Hearing 2nd March 2006, Manama Bahrain Purpose provide guidance for members of Shari’a Supervisory Board (SSB) of Islamic Financial Institutions pertaining to its independence, monitoring of such independence and ways to resolve issues of independence Need There is currently no specific standard on the Independence of SSB; To ensure the credibility of the financial Statements from Shari’a perspective Increasing confidence of the public in the Institution Arising concerns of the Independence of Shari’a Supervisory Board Date Effective Financial Period beginning 1 Muharram 1428 or 1 January 2007

Definition Exposure Draft The first rough sketch (preliminary version) of written composition, standard or law. This preliminary version is normally use for public feedback. Purpose To solicit comments from preparers, users, related institutions, members of organization and other interested parties particularly on the issue(s) concern Governance The system by which business corporations are directed and controlled. It is about promoting corporate fairness, transparency, accountability and equitable treatment of stakeholders. Independence An attitude of mind which does not allow the viewpoints and conclusions of its processor to become reliant on or subordinate to the influences and pressures of conflicting interests. It is achieved through organizational status and objectivity. The principle of objectivity imposes obligations on SSB members to be fair, intellectually honest and free of conflict of interests (neutral) – Para 2

Importance of Independence Opinion The perceived independence of SSB is important for the users of the financial statements who need reassurance that the bank (financial institution) has strictly adhered to such Islamic precepts. - Rifaat Ahmed Abdel Karim, The Independence of Religious and External Auditors: The Case of Islamic Bank. Effect Impairment of independence and objectivity can reduce the credibility of the SSB member which in turn reduce the confidence of the public/stakeholders in the respective Financial Institutions they seat.

Application General Guiding the meaning and clarification of Independence Providing outline to maintain independence Avoid impairment to make objective professional judgment Applicability of AAOIFI Code of Ethics for Accountants and Auditors and Code of Ethics for the Employees of IFI Outline ways to resolve independence Issue Malaysian Context GPS 1 (effective April 2005) had to some extend outline independence One seat per industry and members of SAC not allowed to be in any SSB Stringent process for election to SSB

Further Considerations Situations Subjectivity - determined by the members Events of collusion of members In the event of persisting independent issue leading to resignation, regulatory action Appraisal Should the SSB be assessed by independent entity such as a special board or regulators? Position Should SSB be an external party like external auditors? Acceptance Importantly adaptation/adoption of the Standard by Respective Regulators, IFI, members “For a true believer (mukmin), failure to keep Islamic Law should exact (cause) an unbearable moral cost, much greater than loss of economic revenue)” – Rifaat Ahmed Abdel Karim, The Independence of Religious and External Auditors: The Case of Islamic Bank.

Implication Benefits More compliant towards the Shari’a Standards Ensures the operations of such financial institutions are in favor of the public’s interests i.e. Maslaha Increases public’s confidence towards Islamic Financial Institutions Achieving the fundamental objectives of an IFI by enhancing independence and objectivity of its SSB Challenges Difficult to implement in reality Different SSB’s might have different views There is still some doubt in what action should be taken if collusion exists within the SSB Level of confidence in IFI Integrity of IBF Industry Level of SSB Independence INDIRECTLY EFFECT CAUSE

Summary Standard Laws Others Independence of SSB Integrity of IFI Public Confidence Best Practices Regulation

References 1 2 3 4 5 Governance Standard on Independence of Shari’a Supervisory Board - Exposure Draft, AAOIFI GPS 1 – Bank Negara Malaysia Rifaat Ahmed Abdel Karim, The Independence of Religious and External Auditors: The Case of Islamic Bank. Assoc. Prof. Dr. Abdul Rahim Abdul Rahman, Nur Barizah Abu Bakar, Ade Wirman Syafie, A Preliminary Study On The Responsibility & Independence Of Syari’a Advisors Of Islamic Banks Owen Matthews, How the West Came To Run Islamic Banks

Thank You

Definition of Sharia Supervisory Board “an independent body of specialized jurist in fiqh al-muamalat (Islamic commercial jurisprudence) that is entrusted with the duty of directing, reviewing and supervising the activities of the IFIs in order to ensure that they are in compliance with Islamic Syari’a rules and principles” - Article 2 Governance Standard , (AAOIFI) Shariah Supervisory Board: Appointment, composition and Report

Literatures 1 2 3 Rifaat Ahmed Abdel Karim, The Independence of Religious and External Auditors: The Case of Islamic Bank. Assoc. Prof. Dr. Abdul Rahim Abdul Rahman, Nur Barizah Abu Bakar, Ade Wirman Syafie, A Preliminary Study On The Responsibility & Independence Of Syari’a Advisors Of Islamic Banks Owen Matthews, How the West Came To Run Islamic Banks

Auditor’s Independence Independence in Fact / Mind (Real Independence) An attitude of mind which does not allow viewpoints and conclusions of its processors to become reliant on or subordinate to the influences and pressures of conflicting interest (Lee, 1986 p.89) Independence in appearance (Apparent independence) Normally taken to mean the “physical” location the auditor is in relation to the company and its management (Lee, 1986, p.89) The use of the term “independent audit” underlines the constitutional separation from the organizational entity which is audited and the “external” nature of the auditor’s position (Flint, 1988, p.55)

Resolving Independence Issue 1 2 3 4 Documenting the issue Review the issue internally within the SSB If the issue still exists after the internal review by the SSB, the SSB member with the issue of independence impairment must resign and General Assembly (the AGM - Shareholders) of the IFI must be notified. In all above levels of conflict resolution, consideration must be given to local law and regulations. Para 12

Situation Provided by the Standards 1 2 3 4 5 6 7 8 Financial involvement with, or in the affairs of, clients Personal and family relationships Fees Contingency fees Performance – Related Bonus Goods and Services (undue hospitality) Actual or threatened litigation Long Association of SSBs with IFIs