Thou shalt not vs thou shalt: the positive influence of Shariah Finance

Stewart Place, Marketing Director, Argyll Investment Services discusses the ideology and the affect of Shariah Finance on society

Ask the average person what they know about Islamic finance, if anything. Ordinarily the response will show knowledge of the Qu’rānic prohibitions – no excessive lending, no investing in alcohol, nothing forbidden (haraam) under Shariah Law. It seems that the aspects of what is haraam therefore dominate the understanding of Shariah practice for most business people, and Shariah product providers have done little to balance this understanding. What is not always appreciated is the constructive side: that Shariah Law intentionally creates an ethical framework within which factors such as risk management, fairness, impact on wider society play an important part in the doctrine, and these can be beneficial to all participants, with or without the them being ideologically committed to Islam.

What, then, are the benefits of the Shariah approach; to the customer, the service provider and greater society? With only a little understanding, a picture emerges of a positive approach to some of the systemic problems in deploying capital. This writer makes no claim to Islamic scholarship, nor to representing adherence to Shariah methods being a solution to the world’s problems, but with Argyll and SFM having recently launched the Guernsey-listed World Shariah Funds, thinks there are some valuable insights to be explored, even replicated.

This article will look at some simple but practical examples that result from the ideology behind Shariah financial businesses, and will identify some micro and macro benefits arising from what is – after all – a form of apolitical regulation. The conclusion is a modest, but unconventional proposal regarding the adoption of Shariah principles as a ready-made framework for retail fund products as a socially responsible method of meeting investors’ needs in difficult territories irrespective of their prevailing religious allegiance.

Finding common agreement between Islamic scholars, codes and territories in order to set the standards for this regulation is a relatively new process. As Islam has no magisterium (such as the Vatican for Roman Catholicism), codes of conduct have in very recent years been negotiated by Islamic-dominated financial bodies under the auspices of the Islamic Financial Services Board. The various publications of the IFSB are a good guide to the “shoulds” as much as the “should nots” and form a good corpus of guidance to product providers trying to meet the needs of conscientious Mulsims. More usefully, the guidance notes give clear insight to the layman of the fundamentally ethical aims that are at the heart of Shariah practice.

Take the December 2009 publication of the IFSB, for example. Its wide scope is suggested in the title: Guiding Principles of the Conduct of Business for Institutions Offering Islamic Financial Services and the seven principles are listed as follows:

·         Principle 1: Truthfulness, Honesty and Fairness

·         Principle 2: Due Care and Diligence

·         Principle 3: Capabilities

·         Principle 4: Information about Clients

·         Principle 5: Information to Clients

·         Principle 6: Conflicts of Interest and Duties

·         Principle 7: Shariah Compliance

With the exception of the last item, the main thrust (and any detail provided in the Guiding Principles) is drawn from regulation and legislation familiar to any practitioner within a well regulated jurisdiction. Indeed, each of the sections describing the above Principles includes short illustrations of best practices. The ‘best practices’ sections hold little that would be controversial in a non-Islamic context, but the illustrations – unusually for a quasi regulatory ordinance – give practical case studies that demonstrate the prevailing spirit of meeting Shariah objectives. We will now have a look at some examples.

Let us start with the opening to Principle 7, which states that in order to be compliant, a financial business must not only have an effective system of Shariah governance, but also that it conduct “its business in a socially responsible manner”. There is no prescription for how this is to be achieved, except for reference to obligations “including appropriate charitable activities.” Charitable works being a theme of the Holy Qu’rān and the utterances of the Prophet as recorded in the Hadīth, these activities are understood to be first and foremost Islamic charities, however recent debate suggests that global responsibilities, such as ‘green’ efforts from the environmentalist lobby also qualify, as they are focused on the management of finite resources given to Mankind from the biblical Creation. Given that there is a growing industry in environmentally friendly, ethical and Shariah funds, the combination of all three implies that – given traction – a new and responsible investment product sector may be developing as a consequence of demand from hitherto unsatisfied customer bases.

One of the illustrations given under Principle 2 (Due Care and Diligence) examines practical concerns about social responsibility, and acknowledges there is a tension between Shariah objectives and running a competitive financial services business. It also makes clear, however, that if commercial motives are at odds with Shariah best practice, the latter always takes precedent. Take, for example, the excessive lending in the private sector for mortgages that have themselves played a part in artificially inflated domestic property prices to bubble proportions in some regions of the world. The strictures of Shariah lending are driven by corporate responsibility over profitability in unacceptable sectors, and as a consequence no Islamic financial services group or product would be able to participate in such a business as taking on sub-prime mortgages or issuing “liars’ loans” to the socially disadvantaged, as had become sadly prevalent in the UK and USA until the credit crunch, and remain Shariah compliant.

A requirement for competence (expressed under Principle 3) means that ignorance of the wrongness of such behaviour, or its potential wider social consequences, is no defence under Shariah practice. In fact, the practitioner’s responsibility goes wider, in that exploiting price advantage as a consequence of the other party’s innocence is unacceptable. This was illustrated by the Prophet Mohammed (PBUH) stating that “A town dweller should not sell the goods of a desert dweller” (Bukhari, no. 2006) as there can be no certainty that one party will not have an advantage of privileged information such as local prices for goods. Naturally, in regulated fund products and indeed all financial transactions, legislation now covers insider trading, misrepresentation and aggressive sales methods. Within Shariah practice, though, this condition must be explicitly performed beyond the letter of statute, whether it be for the good of an individual making a contract or for its societal impact. Compliance has not only to be in place but has to be seen to be in place.

Although the Shariah guidelines of the IFSB are intended to be complementary to, rather than a replacement of, international standards and local regulations (such that the language and structure are drawn from publications by the OECD, IOSCO etc), the Shariah aspect frequently goes beyond commonly accepted good practice. For instance, the legal defence of caveat emptor would not apply under Shariah Law; as with the desert and town dwellers being prohibited from profiting as a consequence of advantageous price information, so a seller or promoter of a financial service must exhaust all means to be unexploitative, not reasonable means to be so.

There are still parts of the world where very immature investor protection law is afforded financial services customers, or if the legislation is in place, the regulator there has too little influence over applying best practice. Notwithstanding the IFSB’s intention to complement local law, we suggest that where such law is ineffective, the standards of Shariah compliance could apply as a substitute and create a competitive advantage for a business in winning customers. Whilst some of the tools open to conventional financial businesses would be unavailable (such as certain derivative contracts), and would thus limit the product range, there is certainly a case to be made for Shariah standards being applied to retail products as well as for those investors looking to meet ethical objectives.

As more Shariah products become available to the man in the street and as both financial institutions and regulators tackle the problems of excess that have built up in the capitalist system, Shariah doctrines offer at least part of a suitable move to greater responsibility being taken by customers and product providers. Expect to see more influence from this sector in the coming years: there are constructive solutions that can help to the common good.