Answer the questions and create presentaion

3321-Introduction to Islamic FinanceGroup Project – 15% and Presentations 5%
Submission Deadline – 16/07/2024
Prepare a summary assuming that you are involved in Islamic Fund Management.
Take cues from the questions given below:
1. What is the unique nature and fundamentals of Islamic asset and fund management
compared to the Non-Islamic Funds? Explain using real world situations/example;
2. Identify the criteria for the selection of Islamic stocks for
Islamic fund performances using an Example;
3. Examine the structure, marketing, and distribution of
investing and review
Islamic funds;
4. Understand the Sharī’ah governance for Islamic funds and
Islamic fund management; and
the
importance
of
5. Know the meaning and importance of risk management issues for Islamic funds,
including risk-reward profile, with specific analysis of the risk-reward profile of the
major Islamic finance products.
Note: Follow the guidelines provided in the group project.
In addition, ensure your presentation is clear, avoid reading, Graphical/figures/tables are included.
Marking Criteria Summary
Dear Students,
The following guidelines explains clearly the scheme of marking. Read carefully and work on
the Group Project (15%) and Presentations (5%) and prepare for your presentations (minimum 8
PPTs).
Grade
A+
A
B+
B
Objective
Conceptual
Understanding
Exceptional
Demonstrates the
Work. This work conceptual
is original, with understanding and
innovative ideas has ability to
and creative
link/apply to the
thinking
real-world
scenarios/evidence
Very Good
Shows the
Work. This work conceptual
is original,
understanding and
however there is has ability to
a scope for
link/apply to the
improvement to real-world
excel
scenarios/evidence
Good Work.
Shows the
This work is
conceptual
original.
understanding and
able to link/apply
to the real-world
scenarios/evidence
Practical
Implications
You are able to
show the
relevance of this
topic to the
Country’s
economic and
social stability
You are able to
show the
relevance of this
topic to the
Country’s
economic and
social stability
You are able to
show the
relevance of this
topic to the
Country’s
economic and
social stability
Indicates the
You are able to
conceptual
show the
understanding,
relevance of this
however, there is a topic to the
room for
Country’s
improving their
economic and
ability to
social stability
link/apply to the
moderately.
real-world
scenarios/evidence
Overall Quality
of Writing
Very clear,
concise and to
the point.
Interesting,
innovative and
creative.
Moderate Work.
This work is
original and
doesn’t involve
innovative ideas
and creative
thinking
Moderately
clear, concise
and to the point.
Clear, concise
and to the point.
Interesting.
Clear, concise
and to the point.
C+
C
Normal Work.
This work is
sometimes
original, but
largely drawn
from secondary
sources
Weak Work.
This work lacks
original
Moderately
understand the
concepts. Has
limited ability to
link/apply to the
real-world
scenarios/evidence
Weak in showing
conceptual
understanding and
ability to
link/apply to the
real-world
scenarios/evidence
Lacks conceptual
understanding
You are not fully Sometimes
able to show the moderate and
relevance of this few other times
topic to the
weak in clearly
Country’s
writing or
economic and
presenting your
social stability
responses.
D
You are not able Poor writing and
to show the
unclear.
relevance of this
topic to the
Country’s
economic and
social stability
F
Bad Work.
Unable to show Very careless in
the practical
presenting the
implications
work
Note: You will get a better score for using graphs, figures or tables where-ever required.
Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni
Chapter 5
Corporate Governance for
Islamic Financial Institutions
Learning Objectives
Upon the completion of this chapter, the reader should be able to:
1.Describe the meaning of corporate governance within the
Sharī‘ah framework as practiced in modern Islamic financial
institutions
2.Explain the models and key principles of corporate governance,
including Sharī‘ah governance
3. Understand the mechanisms of corporate governance and
control, including the different organs in Islamic financial
institutions
4. Understand the different models of corporate governance and
Sharī‘ah governance, and the different approaches adopted by
Islamic different financial institutions
5. Understand the dynamics of corporate governance in Islamic
insurance entities.
Learning Objective 5.1
Meaning of Corporate Governance
Describe the meaning of
corporate governance
within the Sharī‘ah
framework as practiced in
modern Islamic financial
institutions
•
There is no generally accepted definition for corporate
governance that can be applied to all contexts
•
Corporate governance has been defined in different contexts
and jurisdictions according to the goal it is designed to
achieve
Learning Objective 5.1
Meaning of Corporate Governance
Describe the meaning of
corporate governance
within the Sharī‘ah
framework as practiced in
modern Islamic financial
institutions
Defining Corporate Governance
“A set of relationships between a company’s management, its
board, its shareholders and other stakeholders. Corporate
governance also provides the structure through which the
objectives of the company are set, and the means of
attaining those objectives and monitoring performance are
determined”
(Organization for Economic Corporation and Development [OECD])
Learning Objective 5.1
Meaning of Corporate Governance
Describe the meaning of
corporate governance
within the Sharī‘ah
framework as practiced in
modern Islamic financial
institutions
Defining Corporate Governance
“Corporate governance is the relationship between corporate
managers, directors and the providers of equity, people and
institutions who save and invest their capital to earn a
return. It ensures that the board of directors (BoD) is
accountable for the pursuit of corporate objectives and that
the corporation itself conforms to the law and regulations”
(International Chamber of Commerce [ICC])
Meaning of Corporate Governance
Defining Corporate Governance
Learning Objective 5.1
Describe the meaning of
corporate governance
within the Sharī‘ah
framework as practiced in
modern Islamic financial
institutions
“Corporate governance is the system by which companies are
directed and controlled…”
(The Cadbury Report)
•
The definition and description given in the Cadbury Report
explains the interrelationship among stakeholders in corporate
entities and their responsibilities in ensuring the transparent
and fair management of the company based on accountability
Learning Objective 5.1
Meaning of Corporate Governance
Describe the meaning of
corporate governance
within the Sharī‘ah
framework as practiced in
modern Islamic financial
institutions
Common Features Shared by the Majority of Definitions
•
A system of relationships defined by structures and
processes
•
Relationships with different and in some cases contrasting
interests
•
Stakeholders’ involvement in the direction and control of the
company
•
Rights and responsibilities are properly distributed among
the stakeholders
Learning Objective 5.1
Meaning of Corporate Governance
Corporate Governance in Islam
•
Describe the meaning of
corporate governance
within the Sharī‘ah
framework as practiced in
modern Islamic financial
institutions
Sharī‘ah supervisory board:
– lays down Sharī‘ah-compliant rules and procedures
– supervises/ensures Sharī’ah compliance of new products
•
Sharī’ah scholars have both consultative and supervisory
functions
•
Sharī‘ah corporate governance structure of IFIs ensures
strict compliance with the Sharī‘ah in all activities carried
out by other stakeholders
Learning Objective 5.2
Models of Corporate Governance:
Stakeholder versus Stockholder
Explain the models and key
principles of corporate
governance, including
Sharī‘ah governance
Conventional Perspective: Two Basic Models
1. The Anglo-American model
•
Emphasizes interests of the shareholders
•
Aims at aligning manager’s interests with shareholders
interests
•
Applies various ways to accomplish aims, including
shareholder representation on the BoD, management
compensation scheme, and external market discipline
•
The Anglo-American model has a great relevance for Islamic
finance
Learning Objective 5.2
Models of Corporate Governance:
Stakeholder versus Stockholder
Explain the models and key
principles of corporate
governance, including
Sharī‘ah governance
Conventional Perspective: Two Basic Models
2.
The Franco-German model
•
Emphasizes the stakeholder-value system
•
Incorporates interests of shareholders and nonshareholders with more emphasis on non-shareholders
considered to be stakeholders
Learning Objective 5.2
Models of Corporate Governance:
Stakeholder versus Stockholder
Explain the models and key
principles of corporate
governance, including
Sharī‘ah governance
The Islamic paradigm
Under the Islamic paradigm of corporate governance, all
stakeholders (including shareholders, employees and
executive management) should all serve on the board to
ensure transparency, accountability, fairness, and mutual
consultation
Learning Objective 5.2
Models of Corporate Governance:
Stakeholder versus Stockholder
Explain the models and key
principles of corporate
governance, including
Sharī‘ah governance
Role of Corporate Governance in Islamic Financial
Institutions
•
The inclusion of Sharī‘ah governance to emphasize the
compliance with the requirements of the Sharī‘ah
•
Accountability in business transactions to protect interests of
all stakeholders, particularly investors
•
Issues of competitiveness and globalization of IFIs prompted
some standard-setting bodies (IFSB, AAOIFI) to issue
specific guidelines intended to help such institutions
Learning Objective 5.2
Models of Corporate Governance:
Stakeholder versus Stockholder
Explain the models and key
principles of corporate
governance, including
Sharī‘ah governance
The role of corporate governance in IFIs include:
•
Establishing a harmonious relationship among concerned
parties
•
Promoting prudent and transparent practices in the
management of IFIs
•
Protecting the interest of all stakeholders
•
Ensuring proper discharge of corporate social responsibility
role of the IFIs
•
Promoting a sound, stable, and competitive Islamic financial
industry
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Principles of Corporate Governance in Islam
•
Concept of tawhid (unity of God)
•
Principle of shurah (mutual consultation)
•
Islamic legal rules on harmonious relationship and mutual
benefits in commercial transactions
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Figure 5.1:
Functional
Roles of
Corporations
in Islam
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Sharī‘ah Governance
•
Sharī‘ah governance and corporate governance are
inextricable in Islamic corporate entities
•
Sharī‘ah governance is missing in corporate governance
frameworks of conventional financial institutions
•
Sharī‘ah system of governance introduced to:
– complement adaptable standards of corporate
governance
– streamline non-compatible standards
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Guiding Principles
• Corporate Governance for Institutions Offering Only Islamic
Financial Services (Excluding Islamic Insurance (Takaful)
Institutions and Islamic Mutual Funds, 2006 (IFSB-3)
• Sharī’ah Governance Systems for Institutions Offering Islamic
Financial Services, 2009 (IFSB-10)
• Governance for Takâful (Islamic Insurance)
2009 (IFSB-8)
Undertakings,
• Governance for Islamic Collective Investment Schemes, 2008
(IFSB-6)
Mechanisms of Corporate Governance
and Control
Learning Objective 5.3
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Functions of Sharī‘ah Governance System in
IFIs
• Advising the Board of Directors on Sharī`ah-related matters
• Reviewing/endorsing Sharī`ah-related policies and guidelines
• Endorsing/validating documentation for new products and
services
• Overseeing computation/distribution of zakat and funds for
charity
• Assisting and advising relevant parties that serve the IIFS
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Major areas of the Sharī‘ah Governance System in IFIs
• Issuance of relevant Sharī`ah pronouncements/resolutions
• Dissemination of the
Sharī‘ah resolution to the
Sharī‘ah Review Unit
• The ISCU to record and
report its findings
• Preparation of an Annual
Sharī‘ah Compliance
Review Report
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Institutionalization of the Sharī‘ah
Governance System
•The first Sharī‘ah Board was established in 1976 by the Faisal
Islamic Bank of Egypt
•The institutionalisation carried out through:
– Pre-modern society model (hisbah model) – more
emphasis on Sharī‘ah-compliance
– Modern scholars model (collective ijtihad model) Sharī‘ah advisory and consultancy
• In modern IFIs, the Sharī‘ah Board is responsible for product
development, certification, and issuance of resolutions
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Fiqh
The whole corpus of Islamic jurisprudence. Fiqh may
also mean the jurists’ understanding of Islamic Law
Fiqh al-mu‘malat
The jurisprudence concerning transactions regulated by
Islamic law
Hisbah (market ombudsman)
An Islamic institution that guards against infringement
of the law in economic, social, and political domains
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Organs of the Sharī‘ah Governance System
1.
Sharī‘ah Supervisory Board at the micro level
2.
Sharī‘ah Supervisory Council of the Central Bank at the
macro level
3.
Internal Sharī‘ah Compliance Unit (ISCU)
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Sharī‘ah Supervisory Board at the Micro Level
•The Sharī‘ah Supervisory Board (“Sharī‘ah Board”)
– the highest organ of an Islamic financial institution
– the advisory and supervisory roles ensuring
Sharī‘ah compliance in all activities
– is based on the traditional concept of hisbah
•Hisbah – important organ of the Sharī‘ah governance system
•Institutionalization of hisbah led to introduction of the Sharī‘ah
Supervisory Board
•Utilization of collective ijtihad to establish the Sharī‘ah Board
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Sharī‘ah Supervisory Council of the Central Bank at the
Macro Level
• The establishment of Sharī‘ah Board at macro level:
– A national set up – Al Rajhi
– An international set up – HSBC Amanah
• Compliance of Sharī‘ah resolutions of the Sharī‘ah
Supervisory Boards of IFIs with general standards created by
the supreme Sharī‘ah Council of the Central Bank
• Resolution of Sharī‘ah Supervisory Council of the Central
Bank prevails if any conflict with the Sharī‘ah Board of an IFI
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
Internal Sharī‘ah Compliance Unit (ISCU)
• ISCU responsible for verification of processes, services, and
transactions ensuring compliance with the resolutions and
pronouncements of the Sharī‘ah Board
• ISCU tasked to report on its Sharī‘ah compliance audit
• The report is presented to the Sharī‘ah Board or at the AGM
for the stakeholders in the IFI
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
The Sharī‘ah Governance Process
The Sharī‘ah governance process in IFIs comprises of
•Appointment
•Composition
•Qualification
•Sharī‘ah Coordination
•Sharī‘ah Compliance Process
•The Sharī‘ah Resolution
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
The Sharī‘ah Governance Process: Appointment
• The appointment of Sharī‘ah scholars is either done by:
– the shareholders at the Annual General Meeting (AGM)
– the Board of Directors on behalf of the shareholders and
subject to their approval at the AGM
• The Board of Directors appoint members of the Sharī‘ah
Board
• The members of the Sharī‘ah Advisory Council are appointed
by the relevant government authority
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
The Sharī‘ah Governance Process: Composition
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
• Sharī‘ah Boards of IFIs generally put together by scholars who are
well-versed in fiqh al-mu‘amalat and usul al-fiqh
• Composition of Sharī‘ah Boards of IFIs determined by individual
institutions
• Composition of Sharī‘ah Boards of international financial
institutions vs. national IFIs
• Usually between 3 and 6 members in a Sharī‘ah Board
• Max number of the Sharī‘ah Board of AAOIFI is twenty members
(appointed by the Board of Trustees for four years)
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
The Sharī‘ah Governance Process: Qualification
• Practical knowledge and considerable expertise in the
application of fiqh al-mu‘amalat and usul al-fiqh in modern
financial transactions
• Non-experts in fiqh al-mu‘amalat and usul al-fiqh
– are experts in specific areas of banking and finance
operations
– may be appointed with the purpose of strengthening
the board in complex banking and finance operation
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
The Sharī‘ah Governance Process: Sharī‘ah Coordination
• Coordinate the Sharī‘ah governance process, consisting of
corporate interaction between:
– The Sharī‘ah Board and the ISCU
– External Sharī‘ah audit review and other organs of the IFI
• In some IFIs, there is no clear distinction between the Sharī‘ah
compliance officer and the Sharī‘ah coordinator
• The secretary of the Sharī‘ah Board or the Sharī‘ah compliance
officer may perform the task of Sharī‘ah coordination
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
The Sharī‘ah Governance Process: Compliance Process
1. Conducting a standard Sharī‘ah review that includes both
internal and external Sharī‘ah audits, to ensure total
compliance with the resolutions and specific instructions of the
Sharī‘ah Board
2. Carrying out the Sharī‘ah compliance process by an
independent division or part of an internal audit
3. Performing an internal Sharī‘ah audit to verify the extent of
compliance
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
The Sharī‘ah Governance Process: Compliance Process
4. Undertaking an independent Sharī‘ah compliance process by
an external Sharī‘ah auditor or Sharī‘ah firm
5. Producing a report indicating whether the IFI has complied
with the Sharī‘ah requirements in the financial year under
review
While the internal audit department of IFIs reports to the Audit
Committee, the internal Sharī‘ah audit reports to the Sharī‘ah
Board
Mechanisms of Corporate Governance
and Control
The Sharī‘ah Governance Process:
The Sharī‘ah Resolution
Learning Objective 5.3
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
• The Sharī‘ah Board is to produce a Sharī‘ah report periodically or
annually to explain its position on:
– The overall business and products of the IFI
– fatwa on matters brought before the board
•The Sharī‘ah report may be in any of the following forms:
1. a fact finding report
2. (an ex-ante) report in relation to product design and
development
3. (an ex-post) internal Sharī`ah audit/review report
on the products offered to customers
4. an annual Sharī`ah compliance report
Learning Objective 5.3
Mechanisms of Corporate Governance
and Control
Comprehend the
mechanisms of corporate
governance and control
including the different
organs in Islamic financial
institutions
The Distribution of the Sharī‘ah Report
1. The fact-finding reports and product design and development
reports are submitted to the management of the IFI
2. The internal Sharī‘ah audit/review report on the products
offered to customers is submitted to the Audit Committee
3.
The annual Sharī‘ah compliance report is submitted to:
–
The BOD to be distributed to the shareholders at the AGM
Members of the public including the investment account
holders (IAH)
4. The supervisory authority in the jurisdiction may also have
access to the report
Learning Objective 5.4
A Different Approach for Islamic
Financial Institutions
Understand the different
models of corporate
governance and Sharī‘ah
governance and the
different approaches
adopted by Islamic
different financial
institutions
•
As there is no universal standard for corporate governance
in IFIs, diverse approaches are adopted in different
jurisdictions
•
The Governance Standards for IFIs by IFSB and AAOIFI are:
– similar in many aspects
– complementary to other prudential standards issued by
international standards of corporate governance
Learning Objective 5.4
A Different Approach for Islamic
Financial Institutions
International standard-setting bodies include:
Understand the different
models of corporate
governance and Sharī‘ah
governance and the
different approaches
adopted by Islamic
different financial
institutions
•
The Organization of Economic Co-operation and
Development (OECD)
•
The International Organization of Securities Commission
(IOSCO)
•
The Basel Committee on Banking Supervision (BCBS)
International standards did not address the specifics of the
Islamic finance industry. Therefore, IFSB and AAOIFI
Standards are specifically meant for the IFIs
Learning Objective 5.4
A Different Approach for Islamic
Financial Institutions
1
Models of Sharī‘ah Governance from Selected
Islamic Countries
Understand the different
models of corporate
governance and Sharī‘ah
governance and the
different approaches
adopted by Islamic
different financial
institutions
• Malaysia
– Islamic capital markets are regulated by the Securities
Commission
– Legislation aims at harmonizing different Shari‘ah
interpretations on Islamic financial issues to strengthen
the regulatory and oversight framework
• Pakistan
–
The State Bank of Pakistan (SPB) has established a Shari‘ah
board at the macro level
–
At the micro level, all IFIs operating in Pakistan are
required to appoint a Shari‘ah advisor
A Different Approach for Islamic
Financial Institutions
1
Models of Sharī‘ah Governance from Selected
Islamic Countries
• Kuwait
– Provision for Shari‘ah boards in IFIs, but no Shari‘ah
board at the macro level at the Central Bank of Kuwait
– fatwa board in the Ministry of Awqaf and Islamic Affairs,
the final authority on Islamic banking business/financial
transactions
• Bahrain
–
The National Shari‘ah Advisory Board has no authority over
IFIs but the Central Bank of Bahrain has a board
–
At the micro level, all IFIs are required to establish a
Shari‘ah supervisory committee
A Different Approach for Islamic
Financial Institutions
1
Models of Sharī‘ah Governance from Selected
Islamic Countries
• UAE
–
Establishment of a Higher Shari‘ah Authority to supervise
Islamic banks and financial institutions – except in Dubai
– At a micro level, all IFIs establish a Shari‘ah supervision
authority, or simply a Shari‘ah board
• Qatar
– No Shari‘ah advisory board at the Qatar Central Bank (QCB)
but there is a Supreme Shari‘ah Council
– Two major regulatory frameworks for Shari‘ah governance in
IFIs, namely those of the QCB and the Qatar Financial
Centre (QFC)
Learning Objective 5.4
A Different Approach for Islamic
Financial Institutions
Figure 5.2 Sharī‘ah Governance Framework
under BNM
Understand the different
models of corporate
governance and Sharī‘ah
governance and the
different approaches
adopted by Islamic
different financial
institutions
Learning Objective 5.4
A Different Approach for Islamic
Financial Institutions
Understand the different models
of corporate governance and
Sharī‘ah governance and the
different approaches adopted by
Islamic different financial
institutions
Figure 5.3: A Model
of Sharī’ah
Governance
Framework for
IFIs
Learning Objective 5.4
A Different Approach for Islamic
Financial Institutions
Understand the different models
of corporate governance and
Sharī‘ah governance and the
different approaches adopted by
Islamic different financial
institutions
Table 5.2: Summary of the
Sharī‘ah Governance System
in Selected Countries
Learning Objective 5.5
Corporate Governance for Islamic
Insurance
Understand the dynamics
of corporate governance in
Islamic insurance entities
Major requirements for good corporate governance
within the context of takāful
•
1.
Set of organisational arrangements
2.
Provision of proper incentives for the organs of
governance
3.
Compliance with the Sharī‘ah rules and principle
The compliance with the Sharī‘ah rules and principles is
ensured and sustained through an independent Sharī‘ah
Supervisory Board
Learning Objective 5.5
Corporate Governance for Islamic
Insurance
Understand the dynamics
of corporate governance in
Islamic insurance entities
IFSB Guiding Principles on Governance for Takāful
(Islamic Insurance) Undertakings
•
No single model of corporate governance that works well for
every country and all types of business
•
Good governance in securing/preserving public confidence in
takaful undertakings necessitated the development of
separate guidelines for the takaful industry
Learning Objective 5.5
Corporate Governance for Islamic
Insurance
Understand the dynamics
of corporate governance in
Islamic insurance entities
Objectives of the IFSB Guiding Principles on Governance
for Takāful (Islamic Insurance)
• To provide benchmarks for use by Takāful supervisors in
adapting/improving regulatory regimes or establishing new
ones
• To address regulatory issues, e.g. risk management and
financial stability for the Takāful industry
• To provide appropriate levels of consumer protection in terms
of risk and disclosure
• To support the orderly development of the Takāful industry
Learning Objective 5.5
Corporate Governance for Islamic
Insurance
Understand the dynamics
of corporate governance in
Islamic insurance entities
The IFSB Guiding Principles
•
Part I: Reinforcement of relevant good governance
practices for insurance companies, while addressing the
specificities of takāful undertakings
•
Part II: A balanced approach that considers interests of all
stakeholders and calls for their fair treatment
•
Part III: An impetus for a more comprehensive prudential
framework for takāful undertakings
Learning Objective 5.5
Corporate Governance for Islamic
Insurance
Understand the dynamics
of corporate governance in
Islamic insurance entities
Figure 5.4: Summary of IFSB Guiding Principles for
Takāful Undertakings
Learning Objective 5.5
Corporate Governance for Islamic
Insurance
Understand the dynamics
of corporate governance in
Islamic insurance entities
The IFSB Guiding Principles
Part I: Reinforcement of relevant good governance practices
for insurance companies, while addressing the specificities of
takāful undertakings
– Principle 1.1: Having in place an inclusive governance
framework appropriate for takāful business model:
(i) clear identification and segregation of strategic and
operational roles and responsibilities for each organ
governance
(ii) mechanisms for observing and addressing the
rights and interests of all stakeholders
(iii) a compliance mechanism
– Principle 1.2: The adoption of an appropriate code of
ethics and conduct
Learning Objective 5.5
Corporate Governance for Islamic
Insurance
Understand the dynamics
of corporate governance in
Islamic insurance entities
The IFSB Guiding Principles
Part II: A balanced approach that considers the interests of all
stakeholders (shareholders and the participants) and calls
for their fair treatment
Principle 2.1: Takāful Operators shall have in place an
appropriate governance structure that represents the
rights and interests of takāful participants
Principle 2.2: Takāful Operators shall adopt and implement
procedures for appropriate disclosures that provide
takāful participants with fair access to material and
relevant information
Learning Objective 5.5
Corporate Governance for Islamic
Insurance
Understand the dynamics
of corporate governance in
Islamic insurance entities
The IFSB Guiding Principles
Part III: A more comprehensive prudential framework for
takāful undertakings
Principle 3.1: Takaful Operators shall ensure that they
have in place appropriate mechanisms properly to
sustain the solvency of takāful undertakings
Principle 3.2: Takaful Operators shall adopt and implement
a sound investment strategy and prudently manage the
assets and liabilities of takāful undertakings
Key Terms and Concepts
•
AAOIFI
•
Actuary
•
Anglo-American
•
Arbitral tribunals
•
BNM
•
Corporate governance
•
Fatwa
•
Fiqh
•
FiqhFiqh al-mu‘amalat
•
Sharī’ah compliance
•
Sharī’ah governance
•
Franco-German
•
Hisbah
•
IFIs
•
IFSB
•
IFSB-10
•
Ijtihad
•
Islamic Finance
•
Maslahah mursalah
•
Muhtasib
•
Sukuk
•
Takaful
•
Zakat
Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed Umar A. Oseni
Chapter 6
Islamic Asset and Fund
Management
Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1. Understand the unique nature and fundamentals of
Islamic asset and fund management;
2. Identify the criteria for the selection of Islamic stocks for
investing and review Islamic fund performances;
3. Examine the structure, marketing, and distribution of
Islamic funds;
4. Understand the Sharī’ah governance for Islamic funds and
the importance of Islamic fund management; and
5. Know the meaning and importance of risk management
issues for Islamic funds, including risk-reward profile,
with specific analysis of the risk-reward profile of the
major Islamic finance products
Learning Objective 6.1
Review and Fundamentals of Islamic
Investing
Understand the unique
nature and fundamentals
of Islamic asset and fund
management
•
The Holy Qur’an emphasises necessity of financial planning
and asset management (Qur’an 12, verse 47-49)
•
Wealth in Islam considered as a means to an end
•
Wealth must be managed in such a way to cater for
interests of current and future generations
•
Fund managers and Islamic asset management firms must
be professional in the discharge of their responsibilities
•
Sharī’ah-compliant investing corresponds with the values of
socially responsible investing based on ethical dealings
•
Islam prohibits all forms of interest (riba) in Islamic
investing
Learning Objective 6.1
Review and Fundamentals of Islamic
Investing
Understand the unique
nature and fundamentals
of Islamic asset and fund
management
Islam prohibits unethical investments including investments
that deal with:
–
Gambling
–
Alcohol
–
Pork
–
Uncensored media/leisure
–
Pornography
–
Other activities that are explicitly prohibited under the
Sharī’ah
Learning Objective 6.1
Review and Fundamentals of
Islamic Investing
Understand the unique
nature and fundamentals
of Islamic asset and fund
management
Islamic investments must
–
Exclude all riba (interest-bearing) products
–
Avoid speculative investments
–
Be socially responsible
–
Ensure that contractual terms comply with Islamic law
Learning Objective 6.1
Review and Fundamentals of Islamic
Investing
Understand the unique
nature and fundamentals
of Islamic asset and fund
management
Non-Interest-bearing Products
•
Islam places special emphasis on ethical investing
•
Islam prohibits all forms of interest, whether fixed or
floating, simple or compound
•
“Nominal” or “excessive” interest amounts are prohibited
and they are treated alike under the prohibition rule
•
Fund managers must ensure that clients’ investments are
free from all forms of interest-bearing products and
investments are Sharī’ah-compliant
•
Financial returns must bear two inseparable features of
Islamic investing, i.e. profits and loss
Learning Objective 6.1
Review and Fundamentals of Islamic
Investing
Understand the unique
nature and fundamentals
of Islamic asset and fund
management
Avoiding Speculative Investments
•
Speculative investment may involve both uncertainty
(gharar) and gambling (maysir)
•
Islam prohibits:
•
–
Investment activities involving excessive risk,
speculation or uncertainty
–
Uncertainty and contingency in contracts such as short
selling and derivatives
–
Conventional insurance and derivatives
Fund managers must respect the wishes of their clients by
investing only in Sharī’ah-compliant products
Learning Objective 6.1
Review and Fundamentals of Islamic
Investing
Understand the unique
nature and fundamentals
of Islamic asset and fund
management
Social Responsibility
The Sharī’ah requires fund managers as well as their clients
to discharge their social responsibility from their investment
activities.
Mechanisms for fulfilling social obligation include
–
zakat (compulsory alms)
–
sadaqah (voluntary alms)
–
waqf (charitable endowment)
–
takāful (Islamic cooperative insurance)
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
•
The fund managers must ensure contractual terms conform
to the principles of Islam
•
Necessary certification by Sharī’ah experts (a panel or
Board) should be sought for all contracts
•
The Sharī’ah Board ensure compliance of all investment
funds
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
The Islamic Stock Market Index
•
Stock selection involves a process of screening to establish
Sharī’ah-compliance
•
An index is used to measure fluctuations in the performance
of stocks
•
Securities are traded in a place called the Stock Exchange –
buyers and sellers of securities trade here
•
Islamic indexes were introduced to set benchmarks for
Sharī’ah-compliant products
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Prominent Stock Exchanges
•
The Honk Kong Stock Exchange
•
The New York Stock Exchange (NYSC)
•
The London Stock Exchange
•
The Frankfurt Stock Exchange
•
The Kuala Lumpur Stock Exchange (KLSE)
•
Tokyo Stock Exchange (Nike)
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Prominent Islamic Indexes
•
The Dow Jones Market Index
•
FTSC Global Islamic Index
•
S&P Global Investable Sharī’ah Index
•
MSCI Barra
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Figure 6.1: Example of a Stock Market Index
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
The Dow Jones Islamic Market Index
– The Dow Jones Islamic Market Indexes are the most visible
and widely-used set of Shari´ah-compliant benchmarks
– Stocks are screened to determine eligibility for the indexes
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
Sharī’ah Supervisory Board
•
Established to advise Dow Jones Indexes on methodology
for screening securities (for inclusion in the Dow Jones)
•
The board consists of five eminent Shari´ah scholars from
around the world
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
The Process of Selection of Islamic Stocks
•
Ensure Sharī’ah compliance at every step of the investment
selection process
•
The selection process includes the following steps:
–
Sector screen or industry screen
–
Financial screen
–
Selecting Sharī’ah compliant transactions and
instrument
–
Purification of income distributions
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
Figure 6.2: The Sharī’ah Screening Process for Islamic
Funds
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
Sector Screen or Industry Screen
•
Evaluate and certify business activity of the potential
company to ensure its compatibility with Sharī’ah
restrictions
•
Exclude companies producing or selling prohibited goods or
services from Islamic funds investments
•
Scrutinize investments in large corporations that might have
more than one line of business
•
Analyze acquisition mode and target firms’ business focus
whenever a business conglomerate acquires a new
subsidiary business
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
Financial Screen
The firms under investment should be operating according to
Islamic financial norms. i, e., free of any prohibited financial
practice including:
–
riba (interest)
–
maysir (gambling and pure games of chance)
–
gharar (speculations and excessive risk)
–
any other prohibited element in commercial
transactions
Learning Objective 6.2
Contractual Terms and Certification
by Sharī’ah Experts
Identify the criteria for the
selection of Islamic stocks
for investing and review
the Islamic funds’
performances
AAOIFI Ratios For Financial Screening
•
Conventional debt / total assets < 30% • (Cash + interest-bearing deposits) / total assets < 30% • (Total interest income + income from non-compliant activities) / total revenues < 5% • Accounts receivable / total assets < 45% (AAOIFI Sharī'ah Standard No. 21) Learning Objective 6.2 Contractual Terms and Certification by Sharī'ah Experts Identify the criteria for the selection of Islamic stocks for investing and review the Islamic funds’ performances Selecting Sharī'ah Compliant Transactions and Instruments Conventional investment funds rely heavily on interestbased debt to finance their activities, thus they may invest in: - Interest-bearing debt securities - Preferred stocks - Warrants - Common stocks - Any other suitable instrument Learning Objective 6.2 Contractual Terms and Certification by Sharī'ah Experts Identify the criteria for the selection of Islamic stocks for investing and review the Islamic funds’ performances Selecting Sharī'ah Compliant Transactions and Instruments • Because of prohibition of riba, maysir, and gharar, Islamic investment funds cannot invest in fixed income instruments such as: - Corporate bonds - Treasury bonds and bills - Certificates of deposit (CDs) - Preferred stocks - Warrants - Some derivatives (such as options) Learning Objective 6.2 Contractual Terms and Certification by Sharī'ah Experts Identify the criteria for the selection of Islamic stocks for investing and review the Islamic funds’ performances Figure 6.3: Fund Results: Amana Trust Income Funds Learning Objective 6.2 Contractual Terms and Certification by Sharī'ah Experts Identify the criteria for the selection of Islamic stocks for investing and review the Islamic funds’ performances Selecting Sharī'ah Compliant Transactions and Instruments Islamic investment funds cannot trade on margin or get involved in any interest paying debt to finance their investments It is not permissible to engage in sale and repurchase agreements (i.e., repos or buy-backs) Islamic fund managers are not allowed to speculate or undertake any unnecessary risks Learning Objective 6.2 Contractual Terms and Certification by Sharī'ah Experts Identify the criteria for the selection of Islamic stocks for investing and review the Islamic funds’ performances Purification of Income Distributions • If the fund observes some part of its income is doubtful (income from interest-related dealings), then those earnings should be foregone • No consensus among Muslim jurists on the cleansing of capital gains: - Some observe that cleansing of capital gains earning is necessary - Others argue that no purification is required since selected firms belong to halal industries • Zakat may be used as a form of purification technique to dispose the portion of income resulted from interest-related dealings Learning Objective 6.2 Contractual Terms and Certification by Sharī'ah Experts Identify the criteria for the selection of Islamic stocks for investing and review the Islamic funds’ performances Issues of Non-compliant Stocks • Sharī'ah supervisory board keeps constant monitoring of the business operations of the Islamic fund • Sharī'ah compliance of firms that may engage in mergers, acquisition or divestures should be re-scrutinized periodically Learning Objective 6.2 Contractual Terms and Certification by Sharī'ah Experts Identify the criteria for the selection of Islamic stocks for investing and review the Islamic funds’ performances Issues of Non-compliant Stocks Degree of non-compliance : 1. Temporary non-compliance with Industry or Financial Screens 2. Short-term non-compliance with Industry or Financial Screens: - Fund manager should report to the supervisory board if stock becomes non-compliant for a longer period of time - Supervisory board should review the status of the noncompliant stocks at regular intervals - Fund manager should donate restricted earning to charity 3. Permanent non-compliance with Industry or Financial Screens: The Sharī'ah board may ask fund manager to divest from such stocks Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Islamic Investment Fund Islamic investment fund can be defined as a joint pool to which investors contribute their surplus money for the sole purpose of investment in legitimate business from which they will earn permissible (halal) profits in conformity with the fundamental principles of the Sharī'ah regulating business transactions Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Islamic Investment Fund • The fund manager issues a certificate (may be called “shares”, “units” or “certificate” or “instrument” to the subscribers (investors) certifying their rate of subscription • Profits earned by the fund are distributed in accordance with subscribers respective investment portfolios after deducting the managerial expenses • Certificates commonly known as sukuk in Islamic finance • The validity of the subscribers' certificate is subject to: - No fixed return for the certificates Funds realized from the pool should be invested in Sharī'ah compliant activities Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Structure of Islamic Investment Funds Major Islamic investment funds commonly used by Islamic funds manager: • Islamic debt funds • Islamic equity funds • Alternative investments • Special asset classes Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Islamic Debt Funds An arrangement where the capital of an equity-based fund is invested in fixed-income yielding activity such as an operating lease which naturally involves a debt Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Insert Figure 6.4: The Five Steps in the Structure of Islamic Debt Funds Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Commodity Funds • Commodity funds involve murabahah operations or bai bithaman ajil (BBA): the fund manager uses the subscribed pool of funds to purchase different commodities for reselling at a profit (based on a deferred payment arrangement) • The amount of profit from the resale constitutes the main income of the fund • Profit is distributed among the subscribers based on their pro rata subscription to the fund Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Ijarah Fund • The ijarah fund is - Created through the pool of surplus financial resources - Managed by a fund manager - Used to purchase a leasable asset for establishing a lease agreement with a third party (the ultimate user) • The rentals that are charged from the lessee constitute the income for the fund • The income is distributed pro rata to the subscribers accordingly after deducting the managerial expenses Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Islamic Equity Funds • The most common and widely practiced portfolio among Islamic fund managers around the world • The structure of Islamic equity fund may either be based on a mudarabah contract, or a musharakah contract a mudarabah contract The two main parties are: a) The investors (rabb al-mal) assume the role of silent partners in the trust partnership b) The fund manager (mudarib) as the entrepreneur performs the managerial functions Structure Islamic Investments Funds Learning Objective 6.3 Examine the structure, marketing and distribution of Islamic funds. Islamic Equity Funds A musharakah contract (partnership financing): • The formation of partnership between the investor and the entrepreneur. Both parties share the assets of the business to the extent of the ratio of financing • Musharakah gives both the entrepreneur and the bank the opportunity to share the finances as well as the management of the business • Profit and losses are shared according to predetermined proportions after deducting the entrepreneur’s management compensations) Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Alternative Investments The three main forms of funds under the alternative investments are: - Private Equity Fund - Islamic Venture Capital Fund - Real Estate Funds or Real Estate Investment Trusts (REITs) Learning Objective 6.3 Marketing and Distribution of Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Private Equity Fund • Structured as private limited companies with a few numbers of stakeholders • Private equities usually - engage in non-exchange traded or illiquid investment strategies - embark on long-term investments in a portfolio of growth companies • Applying Sharī'ah compliance audit to boost the confidence of the investors in private equities Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Islamic Venture Capital Fund • The term “venture capital” - defined as the money and resources made available to promising startup firms and small businesses - encompasses managerial and technical expertise • Venture capital fund - is not traded on exchanges but engages in long term investments - is structured as an open-end fund • Venture capital investments may take place at any or a combination of different stages Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Islamic Venture Investments • Venture capital investments may take place at any or a combination of the following stages: - Seed-stage financing - Early-stage financing - Formative-stage financing - Later-stage financing - Expansion-stage financing - Balanced-stage financing Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Liquidating the Investment Venture capitalists liquidate their investment through any of the following procedures: • Initial public offering (IPO) • Company buyback • Trade sale • Write-off • Secondary sale • Reorganization of investee company Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. The Structure of Islamic Venture Capital Fund • Is based on a contractual arrangement between the fund manager and the institutional and individual investors • Individual and institutional investors are the passive investors and would act as the “limited partners” • Private equity experts are considered as the “general partners”; they undertake the management responsibility Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. The Structure of Islamic Venture Capital Fund • Analyzing the feasibility of possible ventures include: - Islamic venture fund performs Sharī'ah-compliance screening - Islamic venture fund conducts project feasibility analysis similar to the conventional venture capital fund Learning Objective 6.3 Structure Islamic Investments Funds • Examine the structure, marketing and distribution of Islamic funds. Analyzing the feasibility of possible ventures include: - Islamic venture fund performs Sharī'ah-compliance screening - Islamic venture fund conducts project feasibility analysis similar to the conventional venture capital fund Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Raising Funds for Islamic Venture Capital The Islamic venture capital fund draws its funds from a wide range of investors including: • Sharī'ah-compliant institutions such as: - Islamic banks and financial institutions - Takaful companies - Individual investors who prefer the Islamic finance products • Mudarabah contract Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Real Estate Investment Trusts (REITs) • The Real Estate Investment Trusts (REITs) structured as limited companies and are often listed in stock exchanges • REITs that are not listed or that are traded over-the-counter are known as Private REITs • Islamic Equity REITs basically replicates a fund structure that is similar to the Ijara fund • While Ijara Funds may have fixed maturity, the maturity of Islamic Equity REITs Funds may be long or ongoing Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Three Categories of REITs 1. Lending or financing activities in the real estate sector 2. Managing own real estate 3. Both financing others' and managing own real estate REITs are structured in such a way that allows the investors to replicate their target exposure for stock and real estate in a single contract Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Three Categories of Conventional REITs 1. Equity REITs: acquires and develops its properties primarily to operate them as part of its own portfolio - engages in a wide range of real estate activities such as leasing, real property and tenant services 2. Mortgage REITs: Extends credit facilities to real estate owners and operators 3. Hybrid REITs: A combination of the above two categories where the REIT acquires and develops properties and at the same time lends money to real estate owners and operators Learning Objective 6.3 Structure Islamic Investments Funds Special Asset Classes • Islamic Hedge Funds • Funds of Funds • Mixed Funds Examine the structure, marketing and distribution of Islamic funds. Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Islamic Hedge Funds Hedge funds are often set up as private investment partnerships open to a limited investors and requiring large initial minimum investments • Investments in hedge funds are illiquid • Hedge funds are acceptable in the Islamic investment sector if they are free from all forbidden elements • While some Sharī'ah scholars believe in the possibility of having Islamic hedge funds, others argue otherwise due to the speculative elements embedded in such portfolios Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Fund of Funds • Instead of creating its own portfolio, fund of funds applies a passive investment strategy where the investing fund invests in another fund with a different investment objective to diversify its exposure • The conception of fund of funds may be a less efficient technique for Islamic funds due to the number of Islamic funds as well as the higher commissions and fees involved Learning Objective 6.3 Marketing and Distribution of Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Mixed Funds • Invest in a pool of different assets • For Islamic funds, mixed funds require investment in both equity and debt instruments like equities, leases, commodities etc. • Islamic funds have preferred mixed funds investment style (during the declining global markets of 2001/2002) to protect their capital Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Distribution and Marketing of Islamic Funds • Islamic funds as an industry is: - still in its infancy stage - going through a transitional phase in terms of functional structure, marketing and distribution systems • The interrelationship between the Islamic investment funds and Islamic banks can partially be explained: - Islamic banks have preceded other Islamic financial institutions - Islamic banks were the pioneers for the Islamic investors’ demand for Sharī'ah-compliant alternatives to conventional investment funds Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Common Business strategies of Islamic Investment Funds • Joint Venture • Strategic Alliances • Franchising • Outsourcing Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Joint Ventures Islamic investment funds may enter into joint venture agreements with other Islamic banks or conventional banks to: - get higher market exposure and increase the investor network at a lower cost - create newer exposure to prospective investors in other geographical locations Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Franchising • Islamic investment funds may engage in franchising to promote their products in different markets • Franchising is preferred between Islamic funds and other Islamic financial institutions • The Islamic fund should make sure that the buying financial institution complies with the requirements of the Sharī'ah • Like a joint venture, an Islamic fund may seek investors beyond national boundaries Learning Objective 6.3 Structure Islamic Investments Funds Examine the structure, marketing and distribution of Islamic funds. Challenges in Marketing and Distribution of Islamic Funds • Lack of liquidity • Inadequacy in the number of Sharī'ah-compliant investment funds and investable securities • Segmented Islamic financial markets • Lack of appropriate management skills and difficulties in outsourcing of such skills • Lack of awareness of Islamic investment process entails assuming additional responsibility to create an educated investor base (to ensure customer loyalty) Learning Objective 6.4 Sharī'ah Governance of Islamic Funds Comprehend Sharī'ah governance for Islamic funds and the importance of Islamic fund management The Sharī'ah governance framework oversees that every aspect of the investment products, services and contracts is compliant with the fundamentals of the Sharī'ah. Learning Objective 6.4 Sharī'ah Governance of Islamic Funds Comprehend Sharī'ah governance for Islamic funds and the importance of Islamic fund management The Modern Practice of Islamic Wealth Management – Three Alternatives 1. To adopt the practice in the wider Islamic finance industry where standing Sharī'ah Boards are established 2. To employ the services of Sharī'ah consulting firms 3. To employ the services of independent Sharī'ah scholars on an ad hoc basis to review their investment processes, services, and contracts to ensure a full compliance with the requirements of the Sharī'ah Learning Objective 6.4 Governance of Shar framework Comprehend Sharī'ah governance for Islamic funds and the importance of Islamic fund management Composition of the Sharī'ah Supervisory Board •Islamic funds include members from different demographics •Whether an institution has a minimum of three members for the Sharī'ah supervisory board (as per the requirements of AAOIFI) or a single supervisor is its own choice •The composition of the Sharī'ah board should be included in the charter of the fund •The members of the board should possess: - Strong academic and professional background in Islamic jurisprudence - Understanding of the financial transaction and financial system Learning Objective 6.4 Sharī'ah Governance of Islamic Funds Comprehend Sharī'ah governance for Islamic funds and the importance of Islamic fund management Functions of the Sharī'ah Supervisory Board The responsibilities of the Sharī'ah board include: • monitoring the fund’s compliance with the Sharī'ah • overseeing the fund’s portfolio purification • reporting on the compliance status of the fund • assisting the fund management • advising on zakat (charity) and identifying the procedures for its distribution Learning Objective 6.4 Sharī'ah Governance of Islamic Funds Comprehend Sharī'ah governance for Islamic funds and the importance of Islamic fund management Independence of Sharī'ah Committee & Islamic Fund Infrastructure •The independence of the Sharī'ah supervisory from the management’s influence is more likely to: - impart better supervision - boost the confidence of the investors - ensure the best functionality of the Sharī'ah governance organ •Any prospective new product should be cross-checked for Sharī'ah compliance in the first place by the Sharī'ah board Learning Objective 6.4 Sharī'ah Governance of Islamic Funds Comprehend Sharī'ah governance for Islamic funds and the importance of Islamic fund management Compensation and Monitoring Fees •Compensation and monitoring fees for the Sharī'ah board members is based on professional expertise and academic qualifications •Transparency and consistency in the compensation system to avoid conflict of interest •The Sharī'ah board members may be compensated in the same manner as the Board of Directors on the basis of: - monthly remuneration - additional payment for meetings - out-of-pocket expenses - special allowance Learning Objective 6.4 Sharī'ah Governance of Islamic Funds Comprehend Sharī'ah governance for Islamic funds and the importance of Islamic fund management Compensation and Monitoring Fees •Compensation and monitoring fees for the Sharī'ah board members is based on professional expertise and academic qualifications •Transparency and consistency in the compensation system to avoid conflict of interest •The Sharī'ah board members may be compensated in the same manner as the Board of Directors on the basis of: - monthly remuneration - additional payment for meetings - out-of-pocket expenses - special allowance Learning Objective 6.4 Sharī'ah Governance of Islamic Funds Comprehend Sharī'ah governance for Islamic funds and the importance of Islamic fund management Disclosure Issues •Better disclosure practices for all the investment funds •The disclosure of Sharī'ah compliance information •In addition to the annual Sharī'ah-compliance reports issued by the boards, Islamic investors might need to prepare additional Sharī'ah-compliance reports on a regular basis Learning Objective 6.5 Risk Management for Islamic Investment Funds Learn the meaning and importance of risk management issues in Islamic funds, including risk-reward profile, with specific analysis of the risk-reward profile of the major Islamic finance products • Islamic fund managers replicate some of the basic risk management strategies found in ‘normal’ investment funds • There are additional risk management issues associated with the uniqueness of Islamic funds and their products • Islamic fund managers consider the limitations of Islamic investments while forming risk management strategies: - the lack of investable securities - lack of liquidity - lack of Sharī'ah compliant derivatives Learning Objective 6.5 Risk Management for Islamic Investment Funds Learn the meaning and importance of risk management issues in Islamic funds, including risk-reward profile, with specific analysis of the risk-reward profile of the major Islamic finance products Risk-Reward Profiles of Islamic Investment Products •Risk-reward theory is a cornerstone of investment philosophy •Risk reward profile - a chart of the maximum profit or loss a particular investment can have in the portfolios of investors •Ratio used by investors to compare expected return on investment to the amount of risk undertaken to realize return •The funds managers are in the best position to adequately extend professional advice to clients on risk-reward profiles of available investment products Learning Objective 6.5 Risk Management for Islamic Investment Funds Learn the meaning and importance of risk management issues in Islamic funds, including risk-reward profile, with specific analysis of the risk-reward profile of the major Islamic finance products How to Calculate Risk-Reward Profile •Potential investors identify suitable finance products based on the chart •Ratio calculated by dividing the amount of profit the investor expects to make (i.e. reward) after the close of position by the amount such investor stands to lose if loss is recorded in such investment (i.e. the risk) $ Reward Risk-reward Profile Ratio ------------$ Risk Prospective investors must always aim at a ratio 1:2 riskreward profiles Learning Objective 6.5 Risk Management for Islamic Investment Funds Learn the meaning and importance of risk management issues in Islamic funds, including risk-reward profile, with specific analysis of the risk-reward profile of the major Islamic finance products The risk-reward profile of stock ownership is represented in the graph below ❖ The graph indicates that: ✓ a profit that is being expected to be gained does not have a maximum limit; it can continue to rise to infinity loss is limited to 0 (one's entire investment) Learning Objective 6.5 Risk Management for Islamic Investment Funds Learn the meaning and importance of risk management issues in Islamic funds, including risk-reward profile, with specific analysis of the risk-reward profile of the major Islamic finance products Risk-Reward Profiles of Islamic Investment Products •The most common financial instruments used in Sharī'ah- compliant investment funds are musharakah, mudarabah, murabahah, and ijarah •Knowledge of the risk-reward profile of each of these instruments will guide potential investors in identifying a better product for investing •The fund managers must guide potential investors on the best product according to the prevailing market indices Learning Objective 6.5 Risk Management for Islamic Investment Funds Learn the meaning and importance of risk management issues in Islamic funds, including risk-reward profile, with specific analysis of the risk-reward profile of the major Islamic finance products Risk Management Strategies for Islamic Funds 1) Market Risk Management • Market risk for investment funds arises from price volatility of the securities under investment • Islamic fund managers adopt two main strategies to manage market risks: a) Portfolio diversification, and b) Portfolio protection a) Portfolio Diversification Islamic fund managers engage in portfolio diversification as a strategy to minimize their risk exposure Learning Objective 6.5 Risk Management for Islamic Investment Funds Learn the meaning and importance of risk management issues in Islamic funds, including risk-reward profile, with specific analysis of the risk-reward profile of the major Islamic finance products Challenges for Islamic fund managers •They need to diversify their portfolios within a limited range of Sharī'ah compliant asset classes •The Islamic market may be more volatile compared to conventional markets b) Portfolio protection Fund managers engage in the following strategies in order to minimize their risk exposures - SWAPs - Options (Call and Put Options) - Futures Forwards - Other investment strategies Learning Objective 6.5 Risk Management for Islamic Investment Funds Learn the meaning and importance of risk management issues in Islamic funds, including risk-reward profile, with specific analysis of the risk-reward profile of the major Islamic finance products Risk Management Strategies for Islamic Funds 2) Liquidity Risk Management •Most of the investors prefer investment in more liquid assets •Despite surplus of liquidity in the Islamic fund market, there is low return rate on liquid assets managed by Islamic financial institutions •One important liquidity issue that Islamic fund managers face is the investment exit strategy Learning Objective 6.5 Risk Management for Islamic Investment Funds • Learn the meaning and importance of risk management issues in Islamic funds, including risk-reward profile, with specific analysis of the risk-reward profile of the major Islamic finance products As there is no secondary market in a conventional sense, fund managers may have to depend on: - sponsor principal - nominated liquidity agent - asset management company • Islamic fund managers are wary of balance sheet mismatches and exposures to assets that cannot be sold easily • Fund managers should be prepared for higher cash out-flow possibilities during the downward markets when individual investors may wish to liquidate their position Learning Objective 6.5 Risk Management for Islamic Investment Funds Learn the meaning and importance of risk management issues in Islamic funds, including risk-reward profile, with specific analysis of the risk-reward profile of the major Islamic finance products Managing Liquidity Crunches •Fund managers may cautiously enter into agreements with other financial institutions or other liquidity provider •As an immediate measure, fund managers may leave some of the short-term cash balances in interest-free current accounts Key Terms and Concepts • Arbun • Hedge funds • Economies of scale • Ijarah fund • Ethical investing • Interest-bearing (riba) • Exchange-traded derivatives • Investable securities • Islamic debt funds • Legitimate investment • Leverage • Liquidity • Maysir • Nisab • Fiduciary relationship • Firm-specific risk • Fund managers • Gharar • Halal industry Key Terms and Concepts • OTC derivatives • Screen • Portfolio diversification • Stock exchange • Portfolio protection • Stock market index • Portfolios • Takaful • Private equities • Venture capital • Pro-rata profits • Waqf • Real estate investment trust (REIT) • Zakat • Risk-reward profile • Sadaqah