ISFIRE Islamic Finance Review

ISFIREEpistemology of finance:MisreadingSmith

SufiContribution to IslamicEconomics

Interview with MohammedKateeb of Path Solutions

Equity screening inIslamic finance

Barrier to Entry:Shari’a Cost

Legal andFinancial MitigationSolutions forSukuk Legal Risks

Datuk Noripah Kamso

A Humble Visionary

Volume 1 • Issue 1 • November 2011 • £10

Islamic Finance Review

ISFIRE-Winter 2011_ISFR 09/11/2011 23:29 Page 1




Equity screeningin IslamicfinanceRizwan Malikpage 37

Barrier to Entry: Shari’a CostAsim Kamalpage 42

Legal andFinancial MitigationSolutions forSukuk LegalRisks Jhordy Kashoogiepage 44

contentsEpistemology of finance:MisreadingSmith (Part 1)Dr. Abbas Mirakhorpage 9

Sufi Contribution to IslamicEconomicsRizwan Rahmanpage 19

Profile: Datuk NoripahKamsopage 25

Interview withMohammedKateebpage 30


6 ••• ISFIRE

Editor-in-ChiefProfessor Humayon Dar (PhD,Cambridge University)

Associate EditorsAsim KamalRizwan Rahman

Contributors Dr. Abbas MirakhorRizwan RahmanAsim KamalRizwan MalikJhordy Kashoogie

International Editorial BoardDr. Sofiza Azmi (AsianInstitute of Finance)Dr. Mehmet Asutay (DurhamUniversity)Dr. Asyraf Wajdi Dusuki(International Shari’ahResearch Academy) Dr. Mian Farooq Haq (StateBank of Pakistan)

Designer Fareena Alam

Executive StaffNaveed IqbalAnse Rauf SheikhRaja Asif Niaz

Published by Edbiz Consulting Limited, 305 Crown House, North Circular Road, London NW10 7PN, UK T: +44(0) 207 709 3050E: [email protected]: www.edbizconsulting.com

Islamic Finance Review • Volume 1 • Issue 1 • November 2011 • ISSN 2049-1905


As the Islamic finance industrygrows, the need to support insti-tutions and disseminate ideas be-

comes even more pressing. Competingeffectively with conventional market in-stitutions both in terms of profitabilityand ideology is undoubtedly difficult.The conventional markets have evolvedover a period of 400 years; Islamic fi-nance, only 40. The conventional mar-kets are established in the psyche of theglobal population; Islamic finance is con-sidered a peculiar substrate and notenough is known about it, its principlesand its products.

Hence, it is necessary for those inthe industry to promote Islamic financeto the masses. One way to do such is togalvanise market agents, to encouragethem to think of the alternative perspec-tive. In this regards, this publication byEdbiz Consulting of the Islamic FinanceReview (ISFIRE) contains an expositionof ideas by those who wish to see Islamicfinance develop as a dynamic, flourish-ing and unique system offering a tangi-ble and real value proposition.

It therefore should come as no sur-prise that the first article in the ISFIREstarts by challenging the ideologicalprinciples of the current economic and fi-nancial system. Dr. Abbas Mirakhor, aleading Islamic economist and a shininglight in the industry, challenges com-monly held assumptions expounded byeconomists regarding Adam Smiths’ideas of the ‘invisible hand’ and ‘self in-terest’. While the current economic sys-tem has no room for the divine granddesigner, Smith was much more accom-modating. For Smith, the realisation ofan efficient allocation of resources andconsequently greater wealth for a nation,virtuous market agents were expedient.Rizwan Rahman takes this further focus-ing on how the general principles of Su-fism can contribute to a change inthinking about conventional economics.

However, the power of ideasshould not remain in abstraction, farfrom the events on the ground. The Is-

lamic finance industry started from ideasbut grew by the hands of practitioners.One leading figure in the industry, mak-ing strides in the Islamic asset manage-ment sector is Datuk Noripah Kamso,CEO of CIMB-Islamic Principal. A pro-file is provided showing how the focusand drive of a diminutive and humbleMalaysian woman is changing Islamicasset management for the better.

One can compellingly argue thatthe strength of the conventional financialservices industry owes itself to the explo-sive developments in technology over thelast 30 years, which take into account theparticularities of the products. Islamic fi-nance products are different and requirean alternative system. Path Solution canboast of a solution, having provided thefirst Shari’a compliant banking platform.Mr. Mohammed Kateeb, the charmingCEO of Path Solutions and ex-Microsoftofficer, sits with us to discuss the prod-uct, the industry, and the man himself.

The Islamic banking and financeindustry is comparatively a young in-dustry and is evolving slowly. The mar-kets are constantly changing and oneneeds to be adrift of the current situationand the challenges that arise. RizwanMalik looks at Shari’a stock screening, aconstantly developing field. Asim AnwarKamal focuses on the problem of Shari’acost in the Islamic finance industry,which is proving to be a constant effi-ciency concern while Jhordy Kashoogiereflects on the conflicting law issue thatconfronts Islamic finance.

Following the Global Islamic Fi-nance Report, Edbiz Consulting areproud to be publishers of another intel-ligence publication. Our commitment tothought leadership is staunch and wehope to encourage the development ofideas within the industry.

Professor Humayon Dar

Editor-in-Chief

ISFIRE ••• 7

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Before the inception of the Islamicfinance industry, there was whatcould be called a “market failure”

in the conventional financial system.There was substantial unmet demand forShari’a-compliant financial products. Is-lamic finance grew out of conventionalfinance to meet this demand. Muslimscholars writing mostly since the 1970sabout Islamic finance focused on devel-opment of an Islamic finance system;they not only emphasised elimination ofriba contracts but urged their replace-

ment with risk-sharing contracts. Thepractitioners, most of whom had beenoperating in the conventional financespace, were however interested in devel-oping ways and means of finance that,while Shari’a compatible, would be fa-miliar to and accepted by market playersin conventional finance. The former em-phasised Profit-Loss sharing (PLS), thelatter focused on traditional methods ofconventional finance centred on risktransfer and risk shifting. In doing so, allfinancial instruments of conventional fi-

nance became subject to replicating,retrofitting and reverse engineering forShari’a compatibility. This two partpaper argues that there are two ideal fi-nancial systems based on risk sharing,conventional and Islamic, and one actualconventional system focussed on risktransfer. Part One discusses the episte-mology of the conventional financial sys-tem and finds that there has been asubtle yet significant misunderstandingof Adam Smith’s vision. A closer inspec-tion of his views highlights palpable sim-

ISFIRE ••• 9

Epistemologyof Finance:

MisreadingSmithPart 1

Adam Smith is commonly regarded as the father ofmodern economics and advocate of the free markets.However, as Dr. Abbas Mirakhor argues there has been asubtle yet significant misunderstanding of Smith’s visionand closer inspection reveals similarities between theSmithian and Islamic conception of an economic system.



“could be regarded, in a well-definedsense, as superior to a large class of pos-sible alternative dispositions …” (Arrowand Hahn, 1971, pp vi-vii). These at-tempts focussed primarily on Smith’sidea of a decentralized market economybut in the process it abstracted frommuch of the well-spring of his thoughtsrepresented by the societal frameworkemphasizing moral-ethical values envi-sioned in The Theory of Moral Senti-ments.

The work of Arrow-Debreu (1954)is fundamentally about optimal risksharing in a decentralized market econ-omy. It addresses the question of howbest to allocate risk in an economy. Theanswer is that risk should be allocated tothose who can best bear it. The work ab-stracted from the underlying institu-tional structure envisioned by AdamSmith in The Theory of Moral Senti-ments and The Wealth of Nations. It ap-pears that Arrow-Debreu took forgranted the existence of such institutionsas property rights, contracts, trust, ruleof law, and moral-ethical values. Twokey assumptions of this work were com-plete contracts and complete markets. Bythe former it was meant that it was pos-sible to design contracts such that allcontingencies were covered. The latterassumption meant that there was a mar-ket for every conceivable risk. Crucially,all future pay offs were contingent onspecific outcomes. The Arrow-Debreumodel did not include a fixed, predeter-mined rate of interest as pay offs to debtcontracts. Subsequent to his seminalwork with Debreu, Arrow made it clearthat, while not stated explicitly in hiswork with Debreu and with Hahn, heenvisioned it “possible that the processof exchange requires or at least is greatlyfacilitated by the presence of several …..virtues (not only truth, but also trust,loyalty and justice in future dealings …..The virtue of truthfulness in fact con-tributes in a very significant way to theefficiency of the economic system … eth-ical behaviour can be regarded as so-cially desirable institution whichfacilitates the achievement of economicefficiency in a broad sense”. (Arrow,

1972, pp. 345-346). For example, if the in-stitution of trust is strong in an economy,the universe of complete contracts can bereplicated by simple contracts enteredinto by parties stipulating that terms andconditions of the contracts would be re-vised as contingencies arise. Arrow him-self was to place emphasis on trust as thelubricant of the economy. DespiteArrow’s attention to some important el-ements of the institutional structure thatwere integral to Smith’s vision of aneconomy, such as its value system, theeconomics profession developed its ownvision of that economy focussing prima-rily on two concepts of “invisible hand”and “self interest”. The first was men-tioned only once in The Wealth of Na-tions and the manner in which thesecond was used by economists has beenregarded by many as a misunderstand-ing of what Smith actually meant by“self interest”. Narrowing of Smith’sview has been subject to rather sharpcriticism by Amartya Sen who suggeststhat the misrepresentation of theSmithian view has caused major defi-ciencies in contemporary economy the-ory which has widened the gap betweeneconomics and ethics .

A careful reading of Moral Senti-ments and The Wealth of Nations pro-vides immense support for Sen’sposition. Even beyond Sen’s spirited crit-icism of economists’ misunderstandingof Smith’s self-interest motive is the lat-ter’s insistence on the need to complywith “general rules of conduct” that

align with the commands of a Deity whorewards for observance and punishes forbreach in the life hereafter.

Three observations can be made ofSmith’s view. First, this is the Smith thathas been ignored by the economics pro-fession. The Smith of economics is theauthor of the self-interest motive that isthe basis of utility and profit maximiza-tion at any cost to the society, includingthe impoverishment and exploitation offellow human beings. Even his most ar-dent of supporters, Amartya Sen, has ig-nored the Smith of the above quotation.Second, Smith makes clear in his Theoryof Moral Sentiments that compliancewith the rules prescribed by the Creatorand with the rules of the market was es-sential to his vision. Third, it is also clearthat Smith considers the internalizationof rules – being consciously aware ofever-presence of the Creator and actingaccordingly - as crucial to all human con-duct, including economics. Smith suc-cinctly and clearly shares some of thefundamental institutional scaffolding ofIslam: belief in the One and Only Cre-ator; belief in accountability on the Dayof Judgement; belief in the necessity ofcompliance with the rules prescribed bythe Creator; and belief that justice isachieved with full compliance of rules.To paraphrase Sen, no space need bemade artificially for justice and fairness;it already exists in the rules prescribedby the Law Giver.

An economy in which there arecontingent markets for all commodities

Despite Arrow’s attention to someimportant elements of the institutionalstructure that were integral to Smith’svision of an economy, such as its valuesystem, the economics professiondeveloped its own vision of thateconomy focussing primarily on twoconcepts of “invisible hand” and “selfinterest”.

ISFIRE ••• 11


ilarities between the Smithian conceptionof an economic system and that pro-pounded by Islamic economists. PartTwo will focus on the Islamic system, thepresent state, the challenges it faces, andprospects for the future .

An Ideal Conventional Financial System

An overall socio-political-eco-nomic system gives rise to an economicsystem out of which grows a system offinancing to facilitate production, tradeand exchange. The idea of the contempo-rary conventional economic system isusually traced to Adam Smith’s concep-tion of an economy as envisioned in hisbook, the Wealth of Nations. What hasbeen ignored until recently, however, isthe fact that, from an epistemologicalpoint of view, Smith’s vision of the econ-omy is embedded in his vision of amoral-ethical system that gives rise tothe economy envisioned in the Wealth ofNations. That moral-ethical system waswell-described in Smith’s book: The The-

ory of Moral Sentiments which precededhis Wealth of Nations by a decade

Whereas conventional economicsconsidered Smith’s notion of “invisiblehand” as a coordinator of independentdecisions of market participants, in bothThe Theory of Moral Sentiments and inthe Wealth of Nations the metaphorrefers to the design of the Supreme Cre-ator, where market agents seeking theirown advantage would produce the mostefficient allocation of resources and con-sequently the greatest possible wealthfor the nation. Smith contended that theobjective of the Divine Design must havebeen the happiness of humans. A majorcontribution of Smith in his Theory ofMoral Sentiments is to envision a coher-ent moral-ethical social system consis-tent with the Supreme Creator’s designand how each member of society wouldenforce ethical positions. Recognition ofhuman frailties led Smith to recognisethe need for an organic co-evolution ofindividual and society in a stage-wiseprocess of accumulation of ethical sytemof values from one generation to next.

While it is possible for any given societyto move forward or stagnate and evenregress, the benevolence of the invisiblehand of the “Author of nature” guidesthe totality of humanity in its movementtoward the ideal human society. Compli-ance with and commitment to a set ofvalues – virtues of prudence, concern forother people, justice and benevolence –would insure social order and cohesion

Smith and Arrow

It was not until the second half ofthe last century that attempts were madeto present a particular conception ofSmith’s vision of the economy. This con-ception saw the economy as a marketsystem guided by the “invisible hand”toward smooth functioning, coordinat-ing independent individual choices in aconnected world. Two such attemptswere the works of Arrow and Debrau(1954) and Arrow and Hahn (1971) thatsought to show “that a decentralizedeconomy motivated by self-interest”would allocate resources, such that it

12 ••• ISFIRE



– meaning that there are buyers and sell-ers who promise to buy or sell givencommodities “if any only if” a specifiedstate of the world occurs – is called anArrow-Debreu economy. In such aneconomy, it is the budget constraint ofthe participants that determines howmuch of each contingent commodity atprevailing market prices they can buy.Since these commodities are contingenton future states, they are risky. There-fore, the budget constraint of individualsdetermines the risk-bearing ability ofeach market participant. Arrow himselfrecognised such a market is unrealisticbut opined that securities on the modernmarket serve as partial substitute. Suchsecurities, referred to as Arrow Securitieswhose pay offs could be used to pur-chase commodities, would reduce thenumber of markets required while repli-cating the efficiency of risk allocation ofcomplete contingent markets. Associatedwith complete markets are complete con-tracts. These are agreements contingenton all states of nature. In the real world,not all contracts can cover all future con-tingencies. Therefore, they are said to beincomplete contracts and may indicateinefficiencies in exchange. However op-timal contracts can be devised providedthere is mutual trust between the partiesto the contract.

A compelling case can be madethat in so far as the financial instrumentsare Arrow Securities, i.e., their pay off iscontingent on the “state of nature”- that

is, dependent on the outcome that is notfixed, predetermined, and representsrisk sharing- this ideal system wouldhave many characteristics of an ideal Is-lamic system. However, not all ArrowSecurities would satisfy Shari’a require-ments as some may well represent con-tingent debt contracts to deliver a fixedpredetermined amount of money if agiven state of the world occurs. Thesemay not, therefore, represent an owner-ship claim either. Shares of commonstock of open corporations do meet theserequirements. They are residual owner-ship claims and receive a return contin-gent on future outcomes. Stock marketsthat are well-organized, regulated andsupervised are efficient from an eco-nomic point of view because they allo-cate risks according to the risk-bearingability of the participants. In essence, thisis the contribution of Arrow-Debreumodel of competitive equilibrium, ac-cording to which, efficient risk sharingrequires that the risk of the economy areallocated to market participants in accor-dance with their respective degree of risktolerance.

From ideal to actual: conventional finance

The spring that motivates the ac-tion of market agents in Smith’s storyhas been carried forward, but much ofthe rest of his insights has been forgot-ten. Smith’s vision of the institutional in-

frastructure (rules of behaviour) that isarticulated in the Theory of Moral senti-ments has not been correctly identifiedand executed, and, as such, abstractingfrom them would be unlikely to changethe outcome of the mathematical analy-sis of Arrow-Debreu and/or Arrow-Hahn. Furthermore, had actual financedeveloped along the trajectory dis-cernible from these works, i.e., stepstaken toward completion of markets andof contracts, keeping in mind the overallinstitutional framework for the economyas envisioned by Adam Smith, the resultmight have been emergence of conven-tional finance different from the contem-porary system. That system wouldinstead be dominated by contingent, eq-uity, risk-sharing financial instruments.

Perhaps the most influential factorin derailing that trajectory is the exis-tence and the staying power of a fixed,predetermined rate of interest for whichthere has never been a rigorous theoret-ical explanation. All, so called, theoriesof interest from the classical economiststo contemporary finance theories explaininterest rate as the price that brings de-mand for and supply of finance intoequilibrium. This clearly implies that in-terest rates emerge only after demandand supply forces have interacted in themarket and not exante prices. In fact, insome theoretical models there is no roomfor a fixed, exante predetermined rate ofinterest

Even though no satisfactory theoryof a positive, exante fixed rate of interestexists, all financial theory developmentpost Arrow-Debreu-Hahn assumed itsexistence in the form of a risk-free asset,usually Treasury Bills, as a benchmarkagainst which the rates return of all otherassets, importantly equity returns, weremeasured. These include theories suchas the Capital Asset Pricing Model(CAPM), Modern Portfolio Theory(MPT); and the Black-Scholes optionpricing formula for valuing options con-tracts and assessing risk. For all practicalpurposes, the assumption of a risk-freerate introduced an artificial floor into thepricing structure of the real sector of theeconomy, and into all financial decisions.

14 ••• ISFIRE

...Had actual finance developed alongthe trajectory discernible from these

works, i.e., steps taken towardcompletion of markets and of contracts,keeping in mind the overall institutional

framework for the economy asenvisioned by Adam Smith, the result

might have been emergence ofconventional finance different from the

contemporary system.


It can be argued that it is the existence ofthis exogenously imposed rate on theeconomy that transformed Arrow-De-breu vision of a risk-sharing economyand finance. The resulting system be-came one focused on transferring orshifting risk rather than sharing it. Sucha system needed strong regulation tolimit the extent of both. However, furtherdevelopments in finance theory pro-vided analytic rationale for ideologicallyaggressive deregulation. One was theModigliani-Miller Theorem of neutralityof capital structure of firms. In essencethis theorem asserted that the value of afirm is independent of its capital struc-ture. This implied that since firms wantto maximize their value and sinceModiglian-Miller showed that the valueof the firm is indifferent whether the firmdebt finances or equity finances its capi-tal structure, firms would prefer to incurhigher debt levels for the firm ratherthan issue additional equity. Hence, therisk of additional debt would be shiftedto other stakeholders.

Another was the development ofthe Efficient Market Hypothesis (EMH)that claimed that in an economy whichis similar to that of Arrow-Debreu, pricesprevailing in the market contained allrelevant information such that therewould be no opportunity for arbitrage.The implication was that if market effi-ciency is desirable, then markets shouldbe allowed to move toward completion,through innovation and financial engi-neering, in order to create a financial in-strument to allow insurance against allrisks. For this to happen, it had to bedemonstrated that it is possible to de-velop such a wide array of instruments,and that regulation had to become pas-sive or even regressive to allow an incen-tive structure to induce innovation. Thelatter was initiated in almost all indus-trial countries in the 80s and continuedwith an accelerated pace until the 2007-2008 crisis. The former had already beendemonstrated by the theory of spanningdeveloped in late 1960s and early 1970sshowing that one basic financial instru-ment can be spanned potentially into ainfinite number of instruments. These

developments coupled with the highmagnitude of leverage available frommoney-credit creation process character-istic of a fractional reserve banking sys-tem represented an explosive mix thatreduced the vision of Adam Smith to therubble of post crisis 2007-2008. TheArrow-Debreu vision of an economy inwhich risk was shared was first trans-formed into an economy in which thefocus became risk transfer but whichquickly transformed into one in whichrisks were shifted, ultimately, to tax pay-ers.

Conclusion

The economy-finance nexus de-fined by Arrow-Debreu-Hahn generalequilibrium models were risk-sharingconceptualizations in which securitiesrepresented contingent financial claimson the real sector. Equity share claimsrepresent first best instruments of risksharing and satisfy characteristics re-quired of Arrow Securities. It would ap-pear that had the financial markets inindustrial countries developed their fi-nancial sector along the lines suggestedby Arrow-Debreu-Hahn model, theycould have had much more efficient risksharing and, perhaps, avoided the crisesthat have plagued conventional financialsystem. A number of post-mortem analy-ses of the recent crisis have developed

constructive insights that may help steerthe conventional system away from highcredit, high leverage, and high debtwhich are the ultimate causes of all fi-nancial crises. Almost all of the manyrecommendations for reform of the con-ventional system – from the Stiglitz Re-port (2010), at one end, and The SquamLake Report (2010), at the other end ofthe spectrum of thought among finan-cial-economic scholars and practitioners– include some form of control, direct orindirect, on credit, debt, and leveragewithin the financial system, includinghigher capital adequacy requirement.Some have gone beyond these recom-mendations and have suggested reformof the fractional reserve banking systemand deposit insurance . It is likely that ifsuch reforms are implemented relianceon debt-creating flows within the con-ventional system will decline in favourof greater equity. Basel III has alreadytaken steps – albeit not as significant assome scholars demanded – to enhancecapital adequacy requirements, imposelimits on leverage and curtail proprietarytrading of the banks. Whether thesechanges are sufficient to induce the con-ventional system to move away from itsoverwhelming dominance by interest-based debt contracts, risk transfer andrisk shifting or it will take a more severebouts with crises before it does so re-mains to be seen.

ISFIRE ••• 15





The overriding problem economics,as an intellectual endeavour, seeksto reconcile is how to fulfill unlim-

ited demands in a world characterizedby limited resources. If scarcity is the abinitio, economic theory then exploresconsumer choice when confronted bylimited resources through the mechanicsof supply and demand. Prices are thenset by seeking an equilibrium throughintersection of the upward sloping sup-ply curve with the downward slopingdemand curve. In theory, scarcity func-tions as an ever present reality of thesupply, but when met with an exponen-tially increasing demand, the pliancy ofeconomic theory is tested.

Practically speaking, this scarcityof goods is not a consideration that gov-erns the demands of the average con-sumer. Consumer choice is continuouslysaturated with the quantity and range onoffer by the perpetual growth of suppli-ers. In this acquisition of goods, the tan-gible role of money is reduced asindividuals are able to procure wantedand required goods on credit. Thus,rarely will an individual realize the mul-tifaceted dimensions present behind thecreation of a single good, as well as its ef-fect on resources and the environment.

This modern age, characterizedby its gross materialism and excessiveconsumption, has led to a number of

problems including the gradual deple-tion of resources and poverty. Nature it-self has fallen into disequilibrium asfossil fuels are being exhausted and thescarcity of natural resources has becomea reality. Although this has forced gov-ernments to search and harness otherforms of energy, viable alternatives havenot yet been discovered, and in countrieswhere natural resources are abundant,exploitation due to the constraint of therule of law has led to war and civil un-rest. Although the corporation has beenmaligned and fallen into disrepute for itsless than ethical practices, in competitivemarkets, the incentive to build profits isparamount. The modus operandi has be-

Sufi contribution to Islamiceconomics

ISFIRE ••• 19

In these times of excess and its effects on the globaleconomy, there is a need to step back and consider amore prudential approach. Looking at the beliefs of theSufis, Rizwan Rahman finds that their austere ways mayact as a panacea to the current global ills.


come if there is demand, there needs tobe an equivalent supply.

However, problems of unbridledconsumption are not limited to the de-pletion of resources or the causation ofsedition. In the developed world, crip-pling effects of debt accumulation bothon a personal and institutional level haveled to the dethronement of both the indi-vidual and industry. This profligatespending of individuals has been mir-rored by government and has led to theparalyzing economic situations of manycountries. The unweaned desires of themasses has set the global trajectory to-wards a recession. Thus, a more tem-pered, less indulgent approach to theprocurement of goods is paramount.However, changing the utility functionof both entities and focusing on pru-dence will be an arduous task when theinternal economic culture is marked byprodigal consumption. Thus, externalparadigms of those with alternativeworldviews becomes indispensablewhen creating alternative notions of con-sumption. One such paradigm is pro-vided by Sufism.

Understanding the problem

Western economists have createdthe economic man, homo economicus,who is motivated by his own self inter-est. His focus is on fulfilling his desireswithin a budget constraint. In order tohave a sufficient budget, he will need tohave employment to generate income.The quantum of pay will be dependenton the type of occupation undertook.Generally, for higher paying and moresecure jobs, education up to a tertiarylevel is paramount. By going into highereducation there is a sacrifice of immedi-ate, lower wage packets, for an increasedsalary in the longer term. In order to en-sure security or to generate increasedwealth, individuals are likely to save aportion of their income or invest some oftheir income for profits in, for instance,pension schemes or in the stock markets.There is a hope that by doing so, idlemoney will beget a capital gain. To

achieve a higher capital gain will be de-pendent on the risk profile of the indi-vidual. Homo economicus can be ofthree types: risk averse, risk neutral andrisk taking. Each will have a certain ex-pectation but the latter will have agreater propensity for taking risks inorder to secure higher profits.

Therein is a simplified deconstruc-tion of the life of the homo economicus,one which needs to be followed closelyin order to understand the consumptionproblem. The main focus of the averageman is to maintain and sustain himself.Anything above a certain amount be-comes a luxary, which while not re-quired are instead desired in order togratify, maybe even gratiously. The con-sumption problem is precisely bornefrom this gratitious gratification. In theWestern world, people generally havebasic needs satisfied either through theirown efforts or through social welfare. In-dividuals look for more material benefitsand comfort and are desirous to spendmore income to achieve this.

Philsophy of Sufism

Sufism is commonly thought of asbeing the mystical, where adherents seekto explore and experience transcendentaldelights. Perceptions vary with somelooking at Sufism as a heretical sect ofIslam while others see it as a bohemiancult advocating a saccharine outlook tolife. Sufism is thus misunderstood, espe-cially as there are differences in the actsand practices of the variegated Sufi

groups. A closer inspection of the rootsof Sufism reveals certain principleswhich would define a Sufi. A Sufi’s focusis to devote himself absolutely to thetranscendent. They chose to forsake theworld, looking instead to lead an aes-thetic life. While the beginnings of Su-fism are not altogether clear, it is agreedthat some of the early Sufis used to leadsolitary lives wearing woollen garments(suf). Being woollen, the garments werecoarse and uncomfortable, especially inthe scalding heat of the desert. To wearthese garments was a deliberate meansto scourge any love for the world. Indeedlove for the transcendent was the raisond’etre for the Sufis; love for the worldneeded to be purged out. For the Sufis,their actions form a journey towards theafterlife and thus the mystical elementproceeds whereby Sufis aim to ‘experi-ence the transcendent’.

Looking into Sufism, one can de-rive five broad principles. These princi-ples can be regarded as part of thejourney; but for the purposes of thisessay, these principles offer an alterna-tive way of looking at the western basedeconomic system. These principles are asfollows:

1.) Seeking guidance2.) Disavowing the world3.) Trusting in the divine4.) Refinement of character5.) ‘Experiencing’ the transcendent.

For the purposes of this essay, wewill only look at the first four principles.

Seeking Guidance

The first point for an aspirationalSufi was to find the right teacher whowould help him ‘experience the tran-scendent’. The guide would provide himwith the necessary instruction and toolsto help him achieve this objective. Ini-tially Sufis were simply individuals whoadopted certain idiosyncratic practices intheir desire to experience. Over time, cer-tain Sufis gained repute. The scholaracted as a centrifugal force bringing in

20 ••• ISFIRE

Indeed love for thetranscendent wasthe raison d’êtrefor the Sufis; love

for the worldneeded to bepurged out.



students who wished to follow hismethodology. These students wouldthen disseminate their knowledge towilling students; and so began the tariqa,the word “tariqa” in arabic meaningpath. Mureeds would be trained by anexpert (sheikh) who provided a regi-mented system in order for them toreach this transcendental goal. Eachtariqa had a certain pedagogy and ap-proach and often times mureeds wouldhave to reside with their sheikh in insti-tutions known as khanaqahs. Khanaqahsserved as a college for the Sufis and wasthe epicentre for the development of theindividual tariqas.

Analogically in the modern day,guidance is found in schools and col-leges followed by university but the ed-ucation is secular in its nature. Subjectsare taught in relation to themselvesrather than in relation to the divine. Fol-lowing university, students are expectedto go into salaried jobs and thus princi-pally the education system is a means bywhich students can secure gainful em-ployment. The grading system estab-lished from an early age serve to informemployers the quality of the candidates,though not in an absolute way. Studentslooking for higher salaries and a betterquality of living aim for higher grades.For the majority of students, concern ismaterial from the outset and the guid-ance from teachers is, broadly speaking,about achieving grades.

For the Sufis, the guidance was tohelp them ‘experience the transcendent’and could be a lifelong process. It was

not about achieving material benefits.There was a close relationship betweenthe sheikh and the mureed, and thesheikh would be able to advise accord-ing to the needs of his student. The mainpurpose of the sheikh was to help thestudent refine his character in order to‘experience the transcendent’. Thus theirfocus was not on material gains; it wason personal development. Abstract, life-long and uncertain, it had significant im-pact on the worldview of the mureed.

Disavowing the World

The focus on the inward meant ageneral aversion to the outward, mani-fest world. Sufis lived quite austere livesshunning luxary in favour of simple, al-most monastic living. Metaphors in Sufipoetry alluded to the world as a prison,where escape was only possible throughcomplete devotion to the transcedent.Their concerns were not worldly as theyviewed the world as fleeting and thusthey did not desire from the world. Thispsychology is contrary to the dominantone of any era, where securing materialgain is encouraged and facilitated. Mostindividuals live to gain beneficially fromthe world and hence would like to con-sume the good things in life. The con-sumption of the Sufis was small andlimited in terms of choice. In economicterms, by consuming less, there is lessneed for just-in-time supply and overdistributing products. This diminishesthe impact on resource extraction and

counters the scarcity problem. On theother hand, the dynamism and creativityof the modern day economy would benegatively affected.

Reliance on the divine

Sufis had a strong belief on relyingon the divine to meet their needs. One’slife was assumed to be dictated by the di-vine and therefore anything that hap-pened to a person was part of the decreeof the divine and to be accepted re-signedly. They ascribed to the notionthat all power came from the divine.Some Sufis took this to mean adopting ahermetic life, seldom expending effort tomeet basic needs and assuming provi-sion would be provided for by the heav-ens. This was roundly criticised by manyother Sufis who, argued that reliance onthe divine did not necessarily meanadopting an apathetic view to suste-nance. They had to strive to meet theirneeds and not have to resort to begging.Yet by relying on the divine, they wereless concerned about future security andwere encouraged to have very few pos-sessions. Additionally, with menial in-comes, savings would be reduced.Pension schemes and developing ones fi-nancial portfolio would have been analien concepts. In the modern era, impe-tus has been placed on financial plan-ning – ‘saving for a rainy day’. Savingsin banks and investments in financial in-struments have provided the financialsector with much needed liquidity to oilthe mammoth machine. Reduced sav-ings, less investments and a country isconfronted with anemic financial mar-kets. Conversely, it reduces the opportu-nity for unbridled speculation andinextricable dependence of a country’seconomy on the financial sector.

Refinement of the Self

Disavowing the world and relyingon the divine provides the mental under-pinnings for the aspirant Sufi and the basisfor the refinement of the self. Under the

22 ••• ISFIRE

The consumption of the Sufis was smalland limited in terms of choice. In

economic terms, by consuming less,there is less need for just-in-time

supply and over distributing products.On the other hand, the dynamism andcreativity of the modern day economy

would be negatively affected.


tutelage of the sheikh, the Sufi focus wasupon improving their character, on re-moving egregious aspects of their person-ality. These aspects broadly converge tothe seven cardinal sins of the CatholicChurch: lust, gluttony, avarice, sloth,wrath, envy and pride. Each sin wouldneed to be expunged by adopting certainpractices. It would typically involve me-diation, extra prayers over the canonicalfive, long periods of isolation, late nightvigils, constant fasting and recitation oflitanies.

The idea of refining the self is ca-sually disregarded in the modern age.Many believe developing good characteris abstract, personal and intuitive andany regimented system precisely for thispurpose is obsolete. The Sufis, on theother hand, saw that the loci for the evilsin the world was in the human individ-ual and therefore ‘sinful’ aspects of hischaracter had to be purged. This couldonly be accomplished by a long purifica-tion process overseen by a qualifiedsheikh who has undertook the purifica-tion process. He would be one who hasan understanding of his student and theperspicacity of potential failings. With-out his guidance, the aspirant may not beable to overcome his vices.

The credit crisis has been blamedon ‘greedy’ bankers and governmentshave been encouraged to pass laws toregulate their activities. However,regulation is a macro solution; there islittle focus on the micro elements, ergothe individual. Economics starts off withthe assumption that individuals are self-interested, and from this premise,economic theory has evolved. It isprecisely the self interested individualthat Sufism seeks to tackle as they seesins emanating from self interest.Working on sinful aspects of a characterwould therefore reduce self interest, notencourage it, leading to significanteconomic changes.

Sufi Economics

Sufism is regarded as being apeculiarity with extreme quietist and self

immolative tendencies. It is consideredimpractical and removed from thepractical needs of the world. Certainly,complete withdrawal from the worldwould be difficult for the majority butthere are principles of Sufism that havethe potential of tackling the worryingeconomic problems that are confrontingthe world today. Guidance on refiningthe character leads to more moral citizensand less of a focus on gaining materialwealth reduces the scarcity problem.Undoubtedly, a wholesale adoption of

ISFIRE ••• 23

Sufi practices would lead to a stagnantand less dynamic economy, but the Sufiswere never concerned with the macroand more concerned with the individual.The purpose of their institutions was toprovide the environment for therefinement of the individual. The focuswas on the transcendent, and from acapitalist point of view, this overridingpurpose is pointless. But for the valueproposition of Islamic finance, Sufismoffers a unique way of understanding theworld and how to act in it.



To redefine the rules of the game re-quires a visionary, one capable ofgoing beyond established bound-

aries and entering new frontiers of pos-sibility. As Islamic finance grows,expands and flourishes, stakeholders inits future health cannot simply reinventthe wheel but must continually be seek-ing new opportunities, to achievegrowth through a unique and nuancedforesight. It requires individuals and or-ganizations with the perspicacity to pushthe boundaries. Datuk Noripah Kamsois such an individual: wise, insightful,sharp and committed to the develop-ment of the global Islamic asset manage-ment sector. Taking the helm ofCIMB-Principal Islamic Asset Manage-ment Sdn Bhd (CIMB-Principal Islamic)in 2008, the global institutional house hassuccessfully demonstrated a convincingIslamic investment track record via cus-tomised investment capabilities.

Headquartered in Kuala Lumpur,CIMB-Principal Islamic is strategically lo-cated in a prime location for Islamic fi-

nance. Malaysia has firmly established it-self as a hub for Islamic finance, makingstrides in thought leadership, product de-velopment and institutional establish-ment. Its overall success in Islamic financeowes itself to the support of the govern-ment, who has taken gradual steps in cre-ating the right infrastructure for Islamicfinance to flourish. Today Malaysia is oneof the world’s most developed Islamic fi-nance jurisdictions and the world’s firstcountry to have a complete Islamic finan-cial system operating in parallel to theconventional system. This allows CIMB-Principal Islamic to leverage onMalaysia’s comprehensive Islamic finan-cial legal and regulatory infrastructure.

Noripah, who was previously theChief Executive of CIMB-Principal AssetManagement Berhad from September2004 to October 2008, has brought morethan 25 years of experience in corporatecredit and lending. Her commendablededication in creating awareness and ed-ucating the industry has deemed her atwo-time winner of the “Marketing Per-sonality of the Year” award (for 2005 &2006) by Asia Asset Management for theAsia Pacific region and CEO of The Yearfor Malaysia (2007). Due to her consis-tent thought leadership initiatives withglobal institutional investors, regulatorsand stakeholders, CIMB-Principal Is-

lamic has won numerous prestigiousawards – two time winner of the BestAsset Management Company awardedby Global Finance 2010 and 2011, MostOutstanding Islamic Fund Manager atthe 7th KLIFF Islamic Finance Awards2010. Previous awards also include theIslamic Fund House of The Year (2006,2007, 2008 & 2009) awarded by IslamicFinance News. Her focus stems from adeep conviction that Islamic finance ismore than just a capitalistic alternative.It is a complete system, one that ex-pounds an ethical and profitable ethos;and one that needs to cohere in the mar-kets. Noripah brings this belief to herwork, advancing the cause of Islamic fi-nance in Malaysia and the World.

Considering that CIMB-PrincipalIslamic aspires to be the most valued Is-lamic global institutional asset manage-ment house, Noripiah has ensured itsglobal recognition. Datuk Noripah takespride in this aspiration. Her primaryfunctions are to market and build up thefirm by securing institutional clientsfrom around the world through offeringglobal investment management capabil-ities. CIMB-Principal Islamic focuses onfour investment capabilities: Global Eq-uity, Global Sukuk, Regional Equity andRegional Sukuk. Whilst Noripah wasbased in London in the first half of 2009,

ISFIRE ••• 25

Leadership In Islamic Finance

Datuk Noripah KamsoChief Executive Officer, CIMB-Principal Islamic Asset Management Sdn Bhd

“Spearheadingnew businesscontinuouslydrives me.”



she was able to push forward its share-holder Principal Global Investors (PGI)model. She later interfaced the globalbusiness model with that of CIMB-Prin-cipal Islamic Asset Management. Thismove brought widespread attention andconsequently led to an increase in thecustomer base.

Not wishing to rest on her laurels,Noripah has broadened her attention,recognising the need to build up an in-ternational dimension to Islamic financefrom a regulatory and governmental per-spective. She has been working closelywith the Malaysian International IslamicFinancial Centre (MIFC) to bring in in-ternational capital into Malaysia andmake Malaysia the global hub for Islamicasset management.

CIMB-Principal Islamic is target-ing “low hanging fruits” in Malaysia,South East Asia, Gulf ConfederationCountries (GCC), the UK, Geneva andGermany. CIMB-Principal Islamic wasthe first company to obtain the MIFC-ini-tiated license, thereby allowing the pub-lic launch of its global Islamic fundmanagement operations in Malaysia.50:50 joint venture initiatives have deep-ened the existing relationship betweenits two shareholders: the MalaysianCIMB Group and Principal FinancialGroup of US, a Fortune 500 Company.This joint venture is very significant toboth shareholders as it houses their en-tire global Islamic asset managementbusiness. Following the establishment ofthis relationship, Noripah has been ad-vocating the development of Islamicasset management by meeting globalstandards. Noripah has been staunch inensuring that CIMB-Principal Islamic isin line with international best practices.By following the best practices of PGI, aglobally renowned asset manager whoseAsset Under Management approximatesUSD232 billion and who manages 6 outof the 25 largest pension funds in the US,CIMB-Principal Islamic is believed tohave become the first bank-ownedShari’a-compliant global Islamic assetmanagement house that is GIPS-compli-ant (Global Investment PerformanceStandards). This is an important pre-req-

uisite since CIMB-Principal Islamic of-fers Islamic investment solutions toglobal institutional investors namely,Sovereign Wealth Funds, PensionHouses, Takafuls, Waqaf and CentralBanks. It also manages sub-advised col-lective investment trust funds.

As of 31st March 2011, its share-holders group has a total combined Is-lamic Asset under Management ofUSD2.7 billion. A total of USD546 mil-lion worth of new mandates wereawarded to CIMB-Principal Islamic sinceAugust 2009 from South East Asian Cen-tral Banks and Pension Houses.

As the framework of Islamic assetmanagement is still taking shape, DatukNoripah continues to play an aggressiverole in educating and mitigating the mis-conceptions the mainstream investmentcommunity may hold with regards to Is-lamic investing. She has advanced thethinking revolving around Islamic in-vestments and its role on the global land-scape. She has contributed to a range ofglobal publications including the Lon-don-based Euromoney, the Global Is-lamic Finance Report, Financial Timesand Bloomberg. In the GCC, she haswritten for Dubai-based Islamic Businessand Finance and The Saudi-based Mid-dle East Insurance Review. Datuk Nori-pah has taken it as her responsibility toeducate global investors by participatingas a speaker in numerous internationalconferences and roundtable discussionsin London, Edinburgh, Dubai, AbuDhabi, Istanbul, Tokyo, Bahrain, Singa-pore, Hong Kong, Jakarta, Brunei, Syd-ney, USA and of course, Malaysia. In

2010, she chaired the Australian Businessto Business Roundtable in Islamic Fi-nance and also participated in the Istan-bul Roundtable, a platform identified asa gateway to market players and policymakers from the Russian and CIS coun-tries. Recently, in April 2011, she chaireda private roundtable with Bruneian Is-lamic banks and takaful operators, or-ganized by CIMB-Principal Islamic itself.

Through assessing the large 2ndgeneration resident-Muslims in the UK,Germany and France and based on Eu-rope’s strong conviction on ethical in-vesting, Noripah has recognized that thebest positioning for Shari’a investing tothese jurisdictions is to promote sociallyresponsible investments, values and eth-ical investing. To ensure an efficientcross-border global distribution modelfor its products, CIMB-Principal Islamicis planning to launch three Shari’a EquityFunds on a UCITS-compliant platform inDublin and Ireland.

With the burgeoning interest inShari’a investing and the comparable re-turns offered by conventional and Is-lamic funds over the last five years,Datuk Noripah believes Islamic financehas only scratched the surface. There arestill obstacles to overcome, doubters tobe convinced but Noripah knows thatonly through dedication and commit-ment to the Islamic finance propositionwill success result. It will be a long anddrawn out process, but Datuk Noripahis committed to setting the agenda forthe global Islamic asset managementlandscape with her years of expertiseand knowledge.

ISFIRE ••• 27

Datuk Noripah believes Islamicfinance has only scratched thesurface. There are still obstacles toovercome, doubters to be convincedbut Noripah knows that only throughdedication and commitment to theIslamic finance proposition willsuccess result.



Noripah Kamso was born in Sep-ang, Selangor, Malaysia into amiddle/rural-class neighbor-

hood. The youngest of seven siblings,she was raised by her father who was amilitary-cum-police personnel.

She has four children; two of herdaughters are currently working, theeldest as a doctor and the second as aninvestment banker. The third child is inthe Australian National University,Canberra with the youngest still in sec-ondary School.

Honors Bestowed“Datuk” is a title awarded by Sul-

tans/State Governors in Malaysia to per-sonalities who have contributed tonation building through both the corpo-rate/professional world and alsothrough social contribution/causes. Shewas awarded her Datukship by the Stateof Malacca.

Education BackgroundMasters in Business Administration,1980, Marshall University, Huntington,West Virginia, USABachelor of Business Administration,1979, Northern Illinois University,Dekalb, Illinois, USA

Brief Career ProfilePrior to her appointment as Chief

Executive Officer of CIMB-Principal Is-lamic Asset Management, Datuk Nori-pah was the CEO of both CIMBPrincipal Asset Management Berhadand CIMB Principal Islamic Asset Man-agement. She eventually relinquishedher role in the conventional space andnow focuses entirely on the global Is-lamic space.

Prior to this she was Executive Di-rector of CIMB Futures Sdn Bhd fromOctober 1996 to September 2004. Sheserved as Deputy General Manager,General Manager, and then Director ofCorporate Banking at Commerce Inter-national Merchant Bankers Berhad(CIMB) from January 1993 to August2004.

From 1983 until 1993, Noripahrose through the ranks of CorporateBanking at Bank of Commerce (M)Berhad, starting off as a senior corpo-rate banker and ending her service atthe bank as Vice President of CorporateBanking.

Articles/BooksShe authored a book titled

“Credit Decision Making: The Qualita-

tive Credit Approach” which was usedby Institut Bank Bank Malaysia(“IBBM”) as a module for its CertifiedCredit Professional (“CCP”) exam. Shewrites articles for Euromoney, TheGlobal Islamic Finance Report, Institu-tional Investors, Asia Asset Magazine,Malaysian Business, Asia InvestorsMagazine, Islamic Business and Fi-nance Magazine, Middle East InsuranceReview and others.

Corporate ActivitiesShe has served on the Board of Direc-tors for:• Malaysian Derivatives ClearingHouse, Malaysia.• CIMB Futures Sdn. Bhd, Malaysia.• CIMB Nominees Sdn. Bhd, Malaysia.• Flowmore Engineering Sdn. Bhd,Malaysia. She has also served on Bursa Malaysia’sDerivatives Consultative Committee,Malaysian Stock Exchange.

Voluntary Organizations• Treasurer for the Association of BukitBintang Malay Women (PersatuanWanita Melayu Bukit Bintang),Malaysia • Secretary for the Alumni Associationof Northern Illinois University • Chairman of the women wing ofUMNO Bukit Bintang Division,Malaysia.

Professional andAssociation Membership

President of the Malaysian FuturesBrokers Association (“MFBA”) in 2003.Prior to that she served for four years asVice President of the Association. Shehas been active in developing the do-mestic derivatives landscape for the past6 years.

Products• Institutional mandates: Islamic GlobalEquity, Islamic Asia Pacific ex-Japan,Equity, Global Sukuk and Regional(Ringgit) Sukuk mandates. • Retail products: 26 Islamic retail unittrust funds ranging from Malaysian do-mestic to Asia capabilities.

Profile

Datuk NoripahKamso

ISFIRE ••• 29


What is the importance oftechnology in Islamicbanking and finance? Is it any different fromconventional banking?

In our current times, technologyhas become crucial for any industry todrive operational efficiency and enhancecustomer service. The Islamic financialindustry is no different from itsconventional counterpart. Importancehas been magnified by the financial crisiswhere declines in the profitability ofIslamic financial institutions and thetremendous increase of regulations havemade IT solutions critical for thisindustry to continue its growth. Thesecond point here is that Islamic financialinstitutions are in direct competitionwith conventional banks and they haveto acquire the same if not bettertechnology solutions than their

counterparts in order to effectivelycompete. I say better because in additionto conventional banks basic operationsthat have Shari’a-compliant equivalents,there is the complexity of Shari’a-compliant products structures, profitcalculations, etc.

Customers are becoming verydemanding of their banks regardless ofwhether they are conventional orIslamic. The world is changing andcustomer experience is continuouslybeing enhanced using technology. Newdelivery channels are putting customersin control through technology and bankshave to provide the 24/7 access thatcustomers’ need and the know-how thatthey demand.

What are your plans forPath Solutions for the next12 months?

Path Solutions is completelyfocused on the Islamic financial industry.Based on our extensive research webelieve this industry will continue togrow further over the next five years andthe number of financial institutions willreach 1000. Path Solutions is in a greatposition to capitalize on this. In the next12 months, we are focusing on perfectingexecution and building more agility intoour business. We will continue to expandour product line and geographycoverage. We want to solidify ourposition as the undisputed IT solutionleader in Islamic finance.

You are perhaps the onlyglobal technology firm thatexclusively specialises inIslamic banking & finance.When did you realise that

30 ••• ISFIRE

The importance of producing IT banking systems that accommodatesthe peculiarities of Islamic finance cannot be understated. The iMAL

system created by Path Solutions is a welcome solution that isproving to be useful, efficient and economical. In this exclusive

interview with CEO and Group Chairman, Mohammed Kateeb, wedelve further into the man, the vision and the product.


Islamic banking & financewas the niche you wouldlike to tap into ?

We started our company in 1992and during the 90s we built EnterpriseResource Planning (ERP) class solutions,did IT consulting and providedprofessional services to many financialand non-financial companies. Some ofthese companies were Islamic financialinstitutions. It was in the late 1990s thatwe realized the importance of thissegment and the tremendous growthexpected. We decided to focuscompletely on this segment and dropeverything else. It was a great decision.We decided to build a set of Shari’a-compliant fully integrated IT solutionsthat are designed to cater for all Islamicproducts, meet the increasing demand ofthis segment and be flexible enough toallow each bank to customize its own

products based on its Shari’a board’srequirements. In addition to that, thesystem should provide state-of-the-arttechnology and should becomprehensive to cover all businessneeds. Many of our customers run theircomplete banking operations using oursystem with no need for any additionalthird-party products. In addition to alarge portfolio of Islamic bankingsoftware solutions, we also offer otherservices, such as consulting, professionalservices, training and support.

What are the IT-relatedchallenges faced by theIslamic financial servicesindustry?

One of the main challenges facingthis industry is the masking of manyconventional IT systems and positioning

them to be Shari’a-compliant. Thesesystems do not comply with the Shari’afinancial regulatory requirements of therespective country. They are limited inflexibility and ease of use and don’tallow the building of customized Islamicfinancial products that can be bought tomarket in reasonable time. This industrystill lacks many standards, as a singlerigid solution will not meet Islamicinstitutions requirements. The solutionshould be designed to allow tremendouscustomization capabilities because this iscritical for the success of the Islamicfinancial institution’s operations.

Ambition or talent: whichmatters more to success? Inthe case of Path Solutions,what has contributed mostto the success of yourbusiness?

ISFIRE ••• 31

We believe in being closeto our customers.


Hard work! Ambition and talentare important and required for success,but hard work is what brings it alltogether. We had the ambition to be theleader for the Islamic finance IT solutionssegment; we brought in talented peopleto execute; but tremendous hard workon all stages of building these solutionsis what brought us to where we aretoday. I subscribe to the theory thatsuccess is 95% hard work.

What is the size of theIslamic financial technologymarket? What are thedriving factors in its furtherdevelopment and growth?

As per the Gartner February 2011Report, the Islamic banking systemmarket - that is, the market of thetechnologies that enable these financialproducts - is predicted to be a $1.2 billionmarket in 2011 and to grow at a 10.9%compound annual growth rate (CAGR)until 2014, while the external ITspending component will have a higherCAGR, at 18.1%. Thus, the total marketsize will grow from $1.2 billion in 2011to about $1.6 billion in 2014. That is aphenomenal growth largely driven bysome key market trends and theincreasing demand for such bankingsystems.

In addition there is tremendousinterest from conventional banks to offerShari’a-compliant financial services inthe form of Islamic windows which hasgiven a boost to this industry. Of coursethe evolvement of a more robustregulatory framework has also pushedthese financial institutions to deploybetter IT systems and drive a hugereplacement initiative of their existingsystems to systems that can help themachieve their objectives.

Customers’ requirements are alsoa key factor for technology growth.Institutions are asking for moresophisticated peripheral systems, forexample business intelligence, riskmanagement, regulatory reporting anddelivery channels: anything that helps

them run more efficiently, control theirbusiness better and gives them insightinto their business. IT solutions need toplay as a differentiator; we have to keepup with the most sophisticated bankingtechnologies, hence the need to continueto invest in R&D.

What is the culturaldifference between leadingthe Middle Easternoperations of a giant likeMicrosoft and working atPath Solutions?

When I was at Microsoft, thecompany had an interesting model inrunning its operations based ongeographies, which means the head ofgeography owns the complete Microsoftbusiness in that geographic location andwould be responsible for all decisions. Inmy last position at Microsoft I wasresponsible for 22 countries. This culturehas created the spirit of entrepreneurshipin many leaders who came out ofMicrosoft. Although it was a hugecompany, my experience at Microsoft inthe USA and the Middle East hasprepared me to run a company such asPath Solutions especially as they bothdevelop great software. Of courseMicrosoft is a much larger company thanPath Solutions and the supportinfrastructure in it for an executive ismuch stronger. The brand is also a strongbrand and the company is a strategicpartner to almost every business in theworld. This of course opens many doorsbut at the same time, makes the job atPath Solutions more challenging andmuch harder. As a medium size companywe have to work very hard to proveourselves to a bank in London orMalaysia. It’s not only that we have to bemuch better than the multinationals weare competing with, but we also need tohave a huge differentiator to even beconsidered.

Internally, I have tried to bring myvalue system, my work ethic and apersonal vision of a corporate culture toPath Solutions and recreate the company

to care about all the right things. I believewe have been building a great cultureinside Path that is as good as any of thelarge multinationals. The size of thecompany of course allows me personallyto know and influence directly most ofthe employees at Path Solutions.

How difficult is it to managea company with globaloperations, headquarteredin Kuwait, a Research &Development Centre in

32 ••• ISFIRE


Lebanon, and clients spreadall over the world?

I believe technology has changedall the rules regarding geographicdistribution. Almost all multinationalcompanies have their operations officesspread across the globe and if weconsider the outsourcing and off shoringand the makeup of a virtual company itgets much more complicated.Technology enables all of us to achieveintegration. We believe in being close toour customers and we believe in havinga direct presence in their countries. We

also believe in having R&D offices whereaffordable talent is. We have a R&Doffice in Beirut, one in Egypt and thethird one is of course in ourheadquarters in Kuwait. The office inKuwait allows us to mix manynationalities and bring talent from India,other Middle Eastern countries and evenEurope and the USA. There areadvantages in having a centralizedmodel but we believe the advantages weare getting from the distribution modeloutweigh the disadvantages and wealways have technology to make all this

work!

If someone says thattechnology is technology,nothing is Islamic about it.What would you say?

We, of course, disagree on this, andwe have built a very successful companybecause we disagree. We also have over75 Islamic financial institutionsworldwide who agree with our point ofview. Actually, whenever we have a

ISFIRE ••• 33


chance to debate this point and presentour solutions to any potential customerwe usually win. Islamic finance hasdifferent processes governed by differentregulations, different policies andprocedures and unique documentationswhen compared with conventionalfinance. Profit and the way it iscalculated is completely different tointerest; investment and financingproducts are also different, and of courseall these fundamental differences lead tothe need to have an IT solution that isdesigned based on a comprehensiveunderstanding of Islamic finance.

What distinguishes PathSolutions from itscompetitors?

The answer is execution on avision, comprehensive solutions, fastdeployment of these solutions and greatsupport for our customers. This alltranslates to great total cost of ownershipand tremendous value delivered tocustomers.

We realized early that Islamicfinance is unique and different toconventional finance and we strived tobe the IT leader for the segment. Wedesigned and built our solutions to caterfor Islamic finance needs. We partnerwith key organizations and thoughtleaders in the industry. We are the firstAAOIFI-certified software firm. Thecertification covers all Islamic bankingmodules, business processes, contracts,Islamic accounting principles,implications and behavior.

We built our solutions to becomprehensive, modular, integrated setof solutions that offer functionality asgood if not better than any conventionalsystem out there. We offer modules thatperform Core Banking, Investment,Financing, Treasury, Trade Finance,Retail and Corporate Banking inaddition to Delivery Channelsmanagement and integration.

A very strong competitiveadvantage we have is the speed of ourdeployment and bringing our customers

live. While many of our competitorsstruggle to bring their customers live, wehad new banks live in two to threemonths and have existing large banksmigrated off their legacy systems in justnine months. This is unparalleled in ourindustry.

Of course we have a great modelfor supporting our customers andcontinuously updating them to thenewest version of our solutions at noadditional cost. Customers continuouslyget the most updated solutions as part oftheir maintenance contract.

In your observation andopinion, what has been theimpact of the on-goingfinancial crisis on Islamicbanking & finance?

I believe the financial crisishighlighted the strengths of Islamicfinance concepts. Tying assets totransactions is of critical importance.Pure economies based on Islamic financewould never have had such a crisis, butwe all know such economies don’t exist.The future impact of this crisis on theindustry would be decided based on thebehavior of market agents in the nextfew years. If the Islamic finance industrycapitalized on this crisis by halting thetranslation of conventional products andfinancial instruments to Islamic productsand by returning to the spirit of Islamicfinance and addressing theshortcomings, I believe it would havehad tremendous positive impact. If wecontinue to do what we have done in thepast years, this segment will continue togrow, but also will continue to be a subsegment under conventional financeimpacted by all the forces ofconventional finance. It will never realizeits full potential.

Which country is the mostinteresting from theviewpoint of your business?

We serve our segment in markets

from as far as Malaysia in the East all theway to the United Kingdom in the West,and with Islamic finance emergingstrongly in Africa, Central Asia and evenChina, we are excited by the newopportunities they bring.

We are in fact very enthusiasticabout the development of Islamicfinance worldwide. Malaysia continuesto lead in Islamic finance with manyinteresting initiatives, e.g. TheInternational Islamic LiquidityManagement initiative and others arestarting there. Similarly countries likeSudan where Islamic finance is the onlyform of finance; Oman announcing theopening up of Islamic banks to curb fundoutflows, positive developments inEgypt as well, Qatar and the UAEleading different initiatives; seeingcentral banks representatives fromcountries like South Korea and Japanattending Islamic finance conferences isalso a positive sign. Of course seeingIslamic finance reaching Moscow,Central Asia, and North America andfurther development in Europe is allvery exciting stuff for us!

Where would you like to seeyourself personally in thenext 10 years?

The world is changing so fast, it’sso hard to see three years ahead, but I ama person with a very strong value systemand professionally always focus on beinga contributor who adds value towhatever I do. I would be happy if Icontinue to be just that in ten years andthat I am not driven to irrelevance.

What do you do when youare not working?

I am a very hardworking person,so when I am not working I spend timewith my family; I enjoy helping my kidswith school work, traveling with them,and educating them about life. I alsoenjoy reading and research.

34 ••• ISFIRE




Everything is permissible in Islamunless it is clearly prohibited,meaning unless something contra-

dicts the guidelines of the Shari’a, it isdeemed Shari’a compliant. Islam is a re-ligion which guides its followers in everyfacet of life, be it be how to pray, or howto invest your funds in accordance withguidelines set out in the Shari’a. The Is-lamic investor needs to consider not onlythe structure of the investment but alsothe type of organisation the investmentis in.

When an investor gets involved inequity investment he technically be-

comes a part- owner of the company. Asa result, in the case of equities traded onthe stock exchange, an investor needs toconsider whether the company is in-volved in non-Shari’a compliant activi-ties. Some Shari’a scholars are of theview that a minimal amount of haramactivity is acceptable, as long as the pri-mary activities of the company remainsShari’a compliant. However, strict opin-ion states that even a small amount ofHaram activity undertaken by the com-pany is deemed as unacceptable. Shari’aScholars in the past had completelyruled out investing in listed companies;

however with time this has changed anda more balanced approach is beingadopted. More informed scholars haveconceded that all companies in the mar-ket have to go through or transact withconventional finance and therefore, areaffected by interest based financing.

Hence, consensus is moving to-wards accepting some degree of compro-mise. Shari’a boards of a number ofIslamic banks and Islamic financial reg-ulators like the Accounting and AuditingOrganizations for Islamic Financial Insti-tutions (AAOIFI) have agreed upon var-ious criteria, which would ensure that

ISFIRE ••• 37

Screeningin Islamic Finance

How does the Islamic investor gain certainty that their investments are being used in Shari’a compliant companies? In this article, Rizwan Malik looks into Shari’ascreening methodologies developed and how funds deter-mine whether a stock is compliant or not.

EquityISFIRE-Winter 2011_ISFR 09/11/2011 23:29 Page 37

the stock in question would be regardedas acceptable under the Shari’a. Thenorms or benchmarks set out by the likesof Dow Jones, S&P, AAOIFI, MSCI, Rus-sell Jadwa are listed towards the end ofthe paper.

Guidelines underpinning the Shar-i’a assessment of stocks are provided bythe Shari’a Scholars who have delvedinto Islamic legal principles and prece-dents to determine the boundaries of in-vestment. These guidelines regardingthe activities of the company are there toprevent an investor being part of some-thing which is deemed Haram or imper-missible. In assessing whether certaininvestment is Shari’a compliant or not, itneeds to be examined from two differentangles, namely:

•Business Screening•Financial Screening

Business Screening

Business screens focus on the com-mercial activities of the business. If thebusiness is involved in activity consid-ered by the Shari’a as being forbidden,then the Shari’a sensitive investor is pro-hibited to invest. Non- Shari’a compliantactivities (which differ from institutionto institution) include alcohol, gambling,conventional financial institutions, adultentertainment (including cinema, musicetc), pork-related products, weapons anddefense. However, today’s companiessell a range of goods and services, mix-ing both what is considered under theShari’a as acceptable and forbidden.

Shari’a scholars have elaboratedupon on how the investor should ap-proach this dichotomy. They have per-mitted investments in companies whosemain product and/or service offeringsare Shari’a compliant but contain only asmall percentage of non-compliant activ-ities. In value, if over 5% (the percentagediffers amongst scholars but is generallyquite low) of the firm’s revenue is de-rived from non- Shari’a compliant invest-ments or activities deemed unacceptable,it is prohibited to invest in these compa-nies. Question arises as to where the 5%

figure comes from. The 5 per cent toler-ance is not based on the Quran or Sun-nah; instead it is based on the consensusmade between contemporary Shari’aScholars. This income received from thenon-Shari’a compliant activities is subjectto purification where 5 per cent of therevenue is donated to a charity or an-other similar good cause.

The threshold test may sound sim-ple. However, in most cases, in depthanalysis into the company activities is re-quired in order to accurately decidewhether the stock would be consideredcompliant or non- compliant. It is a diffi-cult process and a few examples wouldsuffice to explain the problems.

If we take an example of a com-pany which produces alcohol and otherbeverages, or invests heavily in conven-tional financial activities, these types ofcompanies will be immediately re-moved. This is a simple example butwhat about if there is a company produc-ing IT software which is used by conven-tional financial institutions as well asothers? What about a Compact Discmanufacturing company whose CDs isused for music production? The under-lying concern over both these productsis that they facilitate a non-Shari’a com-pliant activity. IT software is used byconventional banks for Riba transactions.The troubled dialectic that arises is thata riba transaction can only occur due tothe utilisation of the software. If the soft-ware is facilitating a ribawi transaction,then its modus operandi is inextricablylinked to that which is consideredharam.

Shari’a scholars have proposed abroad based solution. In the case of thetwo companies mentioned above thecompanies are actually producing some-thing which can be used for both Shari’acompliant and non- Shari’a compliant ac-tivates. So unless or until it is found thatthe software company or the CD manu-facturing companies produces exclu-sively for non-Shari’a compliantactivities then the company is deemedShari’a compliant. A further problem isthat business focus changes. It maybethat initial analysis of the company

showed that the company had less than5% of the income in Shari.a non compli-ant activities. However, over time, thispercentage increases over the threshold.Consequently, Shari’a auditors have tobe constantly vigilant as to the activitiesof the company.

An added problem is that in somecases information might not be availablemaking the work of Shari’a auditor morechallenging. Take for example a propertydeveloper that rents space out to busi-nesses. Along with the Shari’a Compliantbusinesses renting, he has leased theproperty to non-Shari’a compliant busi-nesses i.e conventional financial institu-

38 ••• ISFIRE


Shari’a compliancy of the companies toinvest in. Information is available onscreening criteria used by AAOIFI, DowJones, MSCI, FTSE, Russell Jadwa andNasdaq etc. The criteria used by these or-ganizations are listed below:

AAOIFI

According to Shari’a standardslisted in AAOIFI Standards book, thefundamental rule is that of prohibition ofacquiring shares of and transactions inthe shares of corporations that some-times undertake transactions in riba and

Islamic index like Dow Jones Islamic,FTSE, S&P and MSCI etc, as these stocksare already screened for Shari’a compli-ancy. There is no added work requiredfrom the investor or fund manager.However, the ease comes at what we cancall an opportunity cost of limiting theinvestments to that specific index portfo-lio and thus narrowing the Shari’a com-pliant stock universe.

Financial ScreeningAs mentioned above different Is-

lamic banks and Islamic financial institu-tions including regulators have agreedfor a certain criteria in assessing the

tions or pork-meat shops. Shari’a schol-ars are of the view that if the propertydeveloper generates more than 5 per centof the rent revenue from these leaseesthan the stock of the property developerbecomes prohibited to invest in. Theproblem is that sometimes the breakdown of revenue is not publically avail-able, making it difficult for the auditor toassess the Shari’a compliancy of the com-pany. In which case, the auditor wouldhave to directly contact the company inorder to request for the revenue break-down.

Instead of independent research, itis easier to pick stocks that are from an

ISFIRE ••• 39


All of the following must be lessthan 33%:• Total debt divided by trailing 24-month average market capitalization.Total debt includes: Short term debt plusCurrent portion of Long Term Debt plusLong term Debt.• The sum of a company’s cash and in-terest-bearing securities divided by trail-ing 24-month average marketcapitalization• Accounts receivables divided by trail-ing 24-month average market capitaliza-tion. Receivables include CurrentReceivables plus Long Term Receivables.

Companies which pass and fallwithin the above criteria are deemed ascomponents of the Dow Jones IslamicMarket Index.

MSCI Islamic Index Series:

Shari’a investment principles donot allow investment in companieswhich are directly active in or derivemore than 5% of their revenue from thefollowing activities:

Business Screening• Alcohol: distillers, and producers of al-coholic beverages, including producersof beer and malt liquors, owners and op-erators of bars and pubs. • Pork related products• Tobacco: cigarettes and other tobaccoproducts manufacturers and retailers. • Conventional Financial Services• Defense/Weapons• Gambling/Casionos• Music• Hotels and Cinemas• Adult entertainment

Financial ScreeningShari’a investment principles do

not allow investment in companies de-riving more than significant income frominterest or companies that have excessiveleverage. MSCI uses the following threefinancial ratios to screen for these com-panies:• Total debt over total assets should notbe more than 33.33%

• Sum of company’s cash and interest-bearing securities over total assetsshould not be more than 33.33%• Sum of company’s accounts receiv-ables and cash over total assets shouldnot be part of 33.33%.

FTSE Shari’a Global EquityIndex Series:

Companies involved in any of thefollowing activities will be filtered out asnon-Sharia compliant:

Business Screening• Conventional Finance (non-IslamicBanking, Finance and Insurance, etc.)• Alcohol• Pork related products and non- halalproduction• Entertainment including casinos andgambling• Tobacco• Weapons, arms and defense manufac-turing

Financial ScreeningThe remaining companies are then

further screened on a financial basis. Thefollowing financial ratios must be metfor companies to be considered Shari’acompliant:• Debt is less than 33% of total assets• Sum of company’s cash and interest-bearing securities over total assetsshould not be more than 33.33%• Accounts receivable and cash are lessthan 50% of total assets• Total interest and non compliant activ-ities income should not exceed 5% oftotal revenue.

Russell Jadwa Shari’a Index:

Business Screening The business activity screens eliminatescompanies whose activities are related tothe following:• Financial Institutions• Alcohol, tobacco or weapons• Production and distribution of meatnot slaughtered according to Shari’a

other prohibited things even when theirprimary activity is lawful,but for thisrule subscription and transactions are ex-empted with the following conditions:• That the corporation does not state inits memorandum of association that oneof its objectives is to deal in interest, orin prohibited goods or material like porkand the like.•That the collective amount raised onloan as interest – whether long-term orshort-term debt – does not exceed 30% ofthe market capitalization of the corpora-tion.• That the total amount of interest- tak-ing deposits, whether short, medium orlong- term shall not exceed 30% of themarket capitalization of total equity,knowingly that interest-taking depositsare prohibited whatsoever the amount is.• That the total amount of income gen-erated from prohibited component doesnot exceed 5% of the total income of thecorporation irrespective of the incomebeing generated by undertaking a pro-hibited activity, by ownership of a pro-hibited asset or in some other way. If asource income is not properly disclosedthen more effort is to be exerted for iden-tification therof giving due care and cau-tion in this respect.• For the determination of these percent-ages, recourse is to be had to the lastbudget or verified financial position.

Dow Jones Islamic IndexScreening Criteria (DJIMI):

The DJIMI Shari’a SupervisoryBoard established the following broadcategories in industries as inconsistentwith Shari’a percepts and stocks arescreened to ensure that each meets thestandards set out in the methodology.

Business Screening• Alcohol• Pork-related products• Conventional financial services• Entertainment• Tobacco• Weapons and defense• Financial Ratio Screens

40 ••• ISFIRE


assets that are real and tangible.• This gearing ratio screens outcompanies that excessively depend onthe debt to finance their businessactivities compared to the total value ofthe company. The ratio used is total debtdivided by market cap which should notbe more than certain per cent (normally30% or 33.33%), meaning that the totaldebt of the company should not be morethan one third of the total company’svalue. Total debt include: bankoverdrafts, loans, credit facilities, financelease and advance from suppliers etc.• The ratio screens out companies thatexcessively invest in interest bearingassets as part of their businesscompanies meaning all the investmentthat the company makes and the interestreceived on it. These normally includedeposits, cash, loans given out,receivables, finance lease, advances tocustomers. The ratio uses to measure isinterest income divided by Totalrevenue, which should not be more thancertain per cent (normally 5 per cent).

As one can see, 33% seems to bean important proportion. The rationalefor selecting or considering one third ispartly based on the following hadith: “It is narrated by Saad bin Abu Waqqasthat The Prophet SAW came visiting mewhile I was sick in Mecca (‘Amir) HEsaid, “May Allah bestow His mercy onIbn Afra”. I said,“Oh Allah’s apostle!May I will all my property (in charity)?”He said, “No.” I said,“Then may I willhalf of it?” He said “No”. I said, “Onethird?” He said: “Yes, one third, yet evenone third is too much. It is better for youleave your inheritors wealthy thanleaving them poor begging others, andwhatever you spend for Allah’s sake willbe considered as a charitable deed eventhe handful of food you put in yourwife’s mouth. Allah may lengthen yourage so that people may benefit by you”.

In conclusion, different bodieshave different interpetations of theparamenters of Shari’a compliance. Thisis does not obviate the importance ofensuring Shari’a assessments of thestocks to ensure compliancy.

rules• Gambling and adult entertainment• Restaurants, hotel and places of enter-tainment that provide prohibited serv-ices• Trading of gold and silver as cash on adeferred basis• Stem call/ human embryos and geneticcloning

Financial ScreeningThe financial based screens ex-

clude companies with excessive expo-sure to interest and other forms ofprohibited income, as well as prohibitedinvestments. Companies are excluded if:• Total cash, deposits, and receivablesdivided by the immediately preceding12-month average total market capital-ization, exceeds 70%.• Interest bearing debt divided by theimmediately preceding 12-month aver-age total market capitalization, exceeds33%.• Total cash, deposits and interest bear-ing securities divided by the immedi-ately preceding 12-month average totalmarket capitalization, exceeds 33%.• The sum of interest earned and rev-enue from prohibited activities dividedby total income (defi ned as total revenueor sales) exceeds 5%.

Nasdaq 100 Shari’a:

Business Screening• Conventional Finance (non-IslamicBanking, Finance and Insurance, etc)• Alcohol• Pork related products and non- halalproduction• Entertainment including casinos andgambling• Tobacco• Weapons, arms and defense manufac-turing

Financial Screening:• The sum of company’s cash and shortterms investments divided by the marketcap should not be more than certain percent meaning the norm is to screen outcompanies do not have major portion of

ISFIRE ••• 41

Purification

The profits are normally gener-

ated either through dividends

distributed by the relevant com-

panies or through appreciation in

the prices of the shares known as

Capital gain. If the profits are

earned through dividends, a cer-

tain proportion of the dividend,

which corresponds to the pro-

portion of the interest earned

must be donated to charity. This

practice is derived from the fol-

lowing Quraniv verse:

"O you who believe, fearAllah and give up what remainsdue to you of interest if you areindeed believers. And if you donot, then be warned of war(against you) by Allah and HisMessenger, while if you repentyou shall have your capital, Donot do wrong and you shall notbe wronged. (2:278-279)"

So, it is through the purifi-

cation process that the elements

of non-permissible income are

removed from the portfolio via

dividend cleansing.

Shari’a screens agreed by

different Shari’a boards or Shari’a

scholars are very subjective and

can change overtime. According

to International Shari’ah scholar,

Sheikh Yusuf Talal DeLorenzo,

"four important points need to

be kept in mind.

Firstly, that the screens de-

veloped by scholars are prelimi-

nary attempts to deal with issues

of interest and should in not be

considered the final word on any

of these matters.

Secondly, that these apply

only to non-Muslim owned/oper-

ated companies.

Thirdly, that this is not to

be understood as an endorse-

ment of corporate practices.

And, fourthly, that all im-

permissible income must be cal-

culated and cleansed."


Barrier to entry

Shari’a CostThere is growing need for affordable yet authentic

Islamic finance advice in the industry. In an everevolving Islamic finance system with more entrants

to the market and technological developments,prices are indeed falling. Asim Anwar Kamal

investigates further.


ISFIRE ••• 43

Islamic finance is expected to continueits rapid growth despite the recent un-rest in the Middle East. New frontiers

are currently being explored all over theworld, from Europe through to the FarEast. Governments facing political insta-bility are turning to Islamic finance as apossible means for social & economic re-form. In the West, Islamic finance hasbeen viewed as a tool for the financial in-clusion of the growing local Muslimpopulace. Furthermore for many coun-tries Islamic finance is as a way to attractfunds from the oil rich GCC and FarEast.

One of the requirements for any in-stitution looking to enter the Islamic fi-nance space is the establishment of areputable Shari’a board on which tier 1Shari’a scholars sit. Names such asSheikh Nizam Yaqubi and Dr.MohamedElgari serve an important function in theoverall marketing of the Islamic financialservice on offer. Scholars such as theseare no doubt knowledgeable enough tooffer advice and thus their services comewith a premium.

In the nascent stages of the Islamicfinance industry, the high cost of Shari’aadvice was attributed to demand andsupply factors. This means that therewere high levels of demand for Shari’aadvice and very few well versed Shari’ascholars on the supply side. It was ex-pected that as the industry grew and ma-tured, the supply of skilled Shari’ascholars would increase which in turnwould cause a reduction in the Shari’acosts facing institutions.

Over a decade has passed andShari’a costs continue to remain higheven though the number of Shari’a schol-ars in the industry has increased. One ofthe reasons for this is that established fi-nancial institutions want establishednames and therefore the premium fortheir services has remained. For these es-tablished institutions paying this pre-mium is justifiable as there is no doubtthat tier 1 scholars deserve the fees theyreceive for their high quality service.

However it cannot be denied thatthere is a growing need for affordableShari’a advice for new players looking to

enter the Islamic finance space, espe-cially less established institutions. Manyof these institutions, particularly in thewest, are reluctant to take the plunge dueto the high initial Shari’a cost and thushave decided to avoid Islamic finance orbide their time. Thus Shari’a cost has in-advertently served as a barrier to entryand has ultimately stopped the industryfrom growing even more than it couldhave.

Notwithstanding this constraint,demand and clamour for cheaper Shari’aadvice has been steadily increasing asseen by developments in the industry.For Fund managers looking to cut downon Shari’a costs, there are now softwareproviders who for an annual or monthlysubscription, pre-screen a universe ofstocks and then allow fund managers tohave access to the results enabling themto form a Shari’a compliant portfolio.This saves the fund manager from hav-ing to hire external parties to conduct the

Shari’a screening on their behalf and thusreduces its costs.

Another way of saving on theShari’a cost for some institutions offeringIslamic financial services has been theappointment of a Shari’a advisory firm.These particular firms can substantiallyreduce Shari’a costs for an institution. In-stead of the new player setting up theirown Shari’a board, the firm can representthem and present the service to the endclient’s Shari’a board. The reason thatthis is sometime more viable and effi-cient is that if for example an institutionsets up their own Shari’a board for a par-ticular service it is offering, whilst itsown Shari’a board may approve the serv-ice, when they go to the end client tomarket it, the end client’s Shari’a boardwill also need to approve it and mayeven pass the service as Shari’a repug-nant. In such a scenario the initial Shari’acost of setting up the institutions Shari’a board is a huge sunk cost.

Whilst the appointment of Shari’aadvisory firms may save an institutionsome Shari’a cost, it is still a fairly costlyoption for a player who is still unsureabout Islamic finance and is just dippingits toe in the water.

A recent initiative by Edbiz Con-sulting, a London based firm, seems tobe the way forward. For a nominal fee,small institutions looking at entering Is-lamic finance can have access to qualityShari’a advice on a daily basis. Thiswould be appreciated by clients whoneed initial Shari’a advice with regardsto an Islamic financial service they arelooking into. This would be helpful forinstitutions looking at plain vanilla prod-ucts that have become standard in themarket such as commodity Murabahafor example. Instead of undergoing ahigh Shari’a cost the institution can havean informal opinion as to whether theirproposed offering meets Shari’a stan-dards such as AAOIFI’s and whether ornot the service is likely to be approvedby a Shari’a scholar.

Initiatives such as this would en-able more institutions to have access toaffordable Shari’a advice and this in turnwould help the industry grow in future.

There is a growingneed for affordableShari’a advice for

new playerslooking to enter

the Islamic financespace. Many of

these institutions,particularly in thewest, are reluctantto take the plungedue to the high

initial Shari’a costand thus have

decided to avoidIslamic finance.


There have been 21 sukuk defaultsrecently in the Islamic capital mar-ket space, with the Nakheel sukuk

and the East Cameron Gas sukukamong the most publicized. These sukukdefaults reveal severe legal risks whichare inherent in the sukuk contract.Specifically, the risk with regards to asukuk contract’s enforceability i.e.whether or not the sukuk can be en-forced in order to protect the rights of thesukuk holders in the event of a default.

Sukuk default cases are increasingwith adverse impacts on the legal rights,and compensation of the sukuk holders.Therefore, in this article, the issues sur-rounding the enforceability of sukukcontracts are discussed in an attempt togive possible legal and financial mitiga-tions to the problem of sukuks legal risksin the Islamic capital market. Before as-sessing issues surrounding the enforce-ability of sukuk, it is imperative tohighlight the kind of conflicts occurringin the Islamic finance sphere due to thedual law system that governs sukuktransactions.

actually a conventional debt contract. With respect to sukuk structures in

jurisdictions where Shari’a concepts arefollowed, this is, to a certain degree,more straightforward from a legal per-spective, although the process does com-pose more layers since it requirescompliance with Shari’a as well as locallaw. Realising that in most sukuk is-suances there are cross-border transac-tions, there is a problem with which lawwould be enforced. This enforceabilityissue causes legal impediments due tothe inability to obtain satisfactory legalopinions, which emanate from the sale ofassets between the originator and in-vestors through the SPV, and also due tovarious bankruptcy law matters. Hence,there is a confusion about which law canbe enforced and to what extent that lawcan be enforced in some sukuk is-suances.

There are two crucial aspects ofsukuk operations that affects the enforce-ability of a sukuk contract . Firstly, truesale execution. Executing a true sale is acrucial element in a sukuk operation, asit constitutes a real transfer of ownershipfrom the originator to the sukuk holdersvia the SPV. Nevertheless, some sukukissuances do not execute a true sale, inthe case of asset-based sukuk issuance,due to the absence of property law andbankruptcy law under civil law regimes.Secondly, a SPV is a bankruptcy remotefirm, which is independent from theoriginator. The SPV is established basedon trust law in which the sukuk’s origi-nator (the transferor) transfers the assetsto the sukuk holders (beneficiaries) viathe SPV (a trustee) with good faith.Therefore, trust law plays an important

Common law and civil law eachpresent distinctive problems when theycollide with the Shari’a. The nationnallaw always prevails over Shari’a lawwhen there are disputes. In the case ofShamil Islamic Bank of Bahrain VS Phar-maceutical Company, the defendant wasunable to repay his loan to the bank, andthe court judged based on English lawinstead of Islamic law. The defendantsargued that the contract was so wordedwith Shari’a principles as not to clashwith English law. However, the judgeruled that there cannot be two separatelaw systems governing a contract, andthat English law will prevail especiallysince the parties had stated that the gov-erning law of the contract was Englishlaw. The Courts will only look at theShari’a so far as it adheres to the com-mercial purpose of the contract and willnot look at it as the governing law. Fur-thermore, the conflict between commonlaw and Shari’a leads to paradoxes. Inthe aforementioned case, the verdict wasdecided based on sale contract law,while the substance of the contract was

Legal and FinancialMitigation Solutions for

Sukuk Legal Risks

44 ••• ISFIRE

With the combination of both theShari’a and conventional law in

Sukuk contracts, there were alwaysgoing to be conflicts. This increases

the risk facing potential investors.However, as Jhordy Kashoogie

opines, there can be a harmonious relationship between the two systems of law.



market seriously consider these legaland financial mitigation tools, sukuk is-suances can become more transparentand predictable enough so that sukukcan be enforced to protect the sukukholders’ rights. Sukuk holders wouldhave more valuable information as wellas financial assurances in order to makean informed decision for sukuk invest-ment. Thus, closer engagement betweenkey players, regulators, Shari’a advisers,and scholars in the industry is urgentlyneeded to discuss and improve the fea-sibility of these legal and financial miti-gation tools.

which have lower financing costs, inorder to settle the sukuk holders’ resid-ual payments. These two suggestionscan be done only if the sukuk was in astrong financial position. Lastly, convert-ible equity sukuk in which sukuk’s as-sets values are converted into the issuer’sequity value based on a pre-determinedformula in the event of default. These in-novations would give assurances to thesukuk holders before the purchase un-dertaking is executed, and hence their fi-nancial rights would be fully protectedfrom legal uncertainties.

If key players in the Islamic capital

role in governing the SPV’s establish-ment. These two aspects indicate thatproperty law, bankruptcy law, and trustlaw are pivotal in governing rules to fa-cilitate a true sale transaction in the eyesof both western law and the Shari’a.

True sale execution and an inde-pendent SPV, however, are not in exis-tence in most sukuk structures, whicheventually leads to a lack of legal protec-tion for the sukuk holders. There are twoidentifiable legal mitigations arisingfrom these sukuk enforceability issues.Firstly, the rating agency should incor-porate additional proxies for sukuk rat-ing, which take into account complianceas well as legal uncertainties of sukuk.Secondly, sukuk urgently need to bestandardised and streamlined in terms oflegal documentation and Shari’a stan-dards. AAOIFI Shari’a standards forsukuk have been set properly, but theproblem is that the standards are notbinding among key players in the Is-lamic financial industry. Therefore, en-forcement of the standards is critical tohaving Shari’a compliant and jurisdic-tionally accepted sukuk in the market.Besides this, there should be uniformityof methods in resolving the issue of con-flicting legal systems that govern sukukissuances across. The goal would be that,in a case of default, the case could be re-solved in pursuant to a standardisedlegal documentation. Hence, therewould be predictability, certainties, andShari’a convergence through sukuk stan-dardisation.

Alternatively, possible Shari’acompliant financial innovations can besuggested in order to give financial pro-tection to the sukuk holders from legaluncertainties. The following are sugges-tions made by scholars such as Mo-hammed Khnifer. Firstly, sukukmaturity extension in which the sukukcontract is extended until the issuer’slegal dispute is resolved by compensat-ing sukuk holders through higher rentalpayments in the case of ijarah sukuk, andincreasing the agreed profit sharing ratioin the case of musharakah sukuk. Sec-ondly, sukuk refinancing in which sukukare refinanced with another sukuk,

46 ••• ISFIRE

Realising that in most sukuk issuancesthere are cross-border transactions,there is a problem with which lawwould be enforced. This enforceabilityissue causes legal impediments due tothe inability to obtain satisfactory legalopinions, which emanate from the saleof assets between the originator andinvestors through the SPV, and alsodue to various bankruptcy law matters.




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ISFIRE Islamic Finance Review