Governance for Islamic mutual fund industry

Omar Mustafa Ansari Head of Islamic Financial Services Group Ernst & Young Ford Rhodes Sidat Hyder A member firm of Ernst & Young Global Limited

Outline

►

Governance for Islamic Financial Institutions

► Corporate governance – What and Why ► ► Fundamental pillars of corporate governance Corporate governance models – a comparison ► ► Islamic corporate governance model

Governance standards – AAOIFI and IFSB

► ► ►

Principles of governance Introduction to IFSB – 6: Guiding Principles on Governance for Islamic Collective Investment Schemes Key issues – points of focus

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By: Omar Mustafa Ansari

Governance for Islamic financial institutions

What is corporate governance?

Organization for Economic Cooperation and Development (OECD) “Corporate governance is the system by which companies are directed and controlled, in the interest of shareholders and other stakeholders, to sustain and enhance value”.

Cadbury Committee “It is a system by which companies are directed and controlled”. 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 4 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Why corporate governance?

► Corporate governance is a crucial part of financial institutions and banking industry as a whole.

► Banks and financial institutions play a significant role in the economy and they should adhere to strong corporate governance standards to: ► ensure stakeholders’ satisfaction; and ► confidence in the banking and financial system.

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By: Omar Mustafa Ansari

Impact of good corporate governance

It is all about having a better organization, a better socially responsible society and a better financial and economic system.

Increasing firm value On the organization Lowering cost of capital Enhancing capital efficiency Protection of shareholders' rights Safeguard of stakholders' interest Revitalizing market economy On the economic system Sustainable economic growth Positive development on capital market More globally competitve Increasing competitiveness through fair competition On the society Corruption prevention Rule of law: fair and orderly Promoting ethical wealth creation More open, transparent society 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 6 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Incentives for the financial services industry

Individual banks Banking Industry Shareholde rs • Adoption of Internationally accepted governance standards will help them to achieve their corporate aims.

• By increasing the compliance in the system the industry can attract depositors, borrowers, counter parties and the investors.

• To protect their sponsorship against all risks and ensure that wealth is multiplied.

Regulators • Strengthen banking sector and discourage fraud and misrepresentation.

Society • At large makes sure that social reward is maximized 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 7 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Fundamental pillars of corporate governance

1 2

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By: Omar Mustafa Ansari

Fundamental pillars of corporate governance

3 4

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By: Omar Mustafa Ansari

Corporate governance models – a comparison

Anglo Saxon or “neo liberal” approach • Principal – agent model • Relationship of managers vs. shareholders The European model • Stakeholders’ model • Relationship of managers vs. stakeholders Islamic corporate governance model • Stakeholders’ model + Shariah • Answerable to Allah Almighty 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 10 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Islamic corporate governance model

Allah SWT proclaims in Quran: “Men who celebrate the praises of Allah standing, sitting, and lying down on their sides, and contemplate the wonders of creation in the heavens and the earth, (with the thought): "Our Lord! Not for naught Hast thou created all this! Glory to Thee! Give us Salvation from the penalty of the Fire” (3: 191).

This verse provides fundamental principle of governance where everything created by Allah has a purpose and human being is created to be the world’s vicegerent. By putting a trust to mankind as a vicegerent, Allah plays actively roles to monitor and involve in every affairs of human being and He is aware and knowing everything all the times. 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 11 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Islamic corporate governance model – why different?

Corporate Governance Shariah Compliance Additional Fiduciary Responsibil ities Islamic Corporate Governance

Shariah compliance

Establishment of Shariah Board / Appointment of Shariah Advisor (SA) Establishing sound Shariah compliance mechanism

Fiduciary responsibilities

Additional governance committee 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 12 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

The enhancement in the role of BOD / Audit Committee / Shariah Board / Shariah Advisor

Governance standards – AAOIFI and IFSB

Governance standards issued by AAOIFI and IFSB

• • • • • • •

1: 2: 3: 4: 5: 6:

Shari’a supervisory board: appointment, composition and report Shari’a review Internal Shari’a review Audit and governance committee for IFIs Independence of Shari’a Supervisory Board Statement on governance principles for IFIs

7:

Corporate social responsibility conduct and disclosure for Islamic financial institutions • • • •

IFSB 3:

Guiding principles on corporate governance for institutions offering only Islamic financial services (excluding Islamic insurance (takaful) institutions and Islamic mutual funds)

IFSB 6:

Guiding principles on governance for Islamic Collective Investment Schemes

IFSB 8:

Guiding principles on governance for takaful (Islamic insurance) undertakings

IFSB 10:

Guiding principles on Shariah governance systems for institutions offering Islamic financial services 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 14 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Principles of governance

Principles of governance

Effective Shariah compliance Fair treatment of equity holders Equitable treatment of fund providers Appropriate governance structures Transparent interactions between SSB and management BOD is responsible for Shariah compliance Voting rights Communication with the IFI Appoint BOD and SSB members Ensure fair disclosure 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 16 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Equitable and unbiased treatment for all stakeholders Access to adequate and timely information Mechanism to safeguard against risk of inequitable treatment

Principles of governance

(Contd.)

Fit and proper conditions Oversight Audit and governance committee Criteria for appointment of BODs, SSB members, and management Transparent selection Based on predefined set of criteria BOD responsible for implementing and monitoring policies Set tone for risk, compliance and other control activities 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 17 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Implementation of governance framework Monitor governance framework

Principles of governance

(Contd.)

Committee’s composition Risk management Conflicts of interest Non-executive members of the BOD Maintain its independence from executive authority BOD involved in setting the risk appetite Policies and systems for risk: -identification -reporting - mitigation Management responsible for assessing and managing of risks 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 18 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Identify situations of potential conflicts of interest Appropriate governance structures

Principles of governance

(Contd.)

Compensation policy oversight Appropriate governance structures in relation to remuneration policies Compensation policies should be independent and transparent Disclosures Maintain high standards of transparency and market discipline Financial and other performance measures should be accurate, adequate and timely Code of conduct and 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 19 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

ethics Policies and procedures to be consistent with Shariah

Comparison of functions – Islamic and conventional financial institutions

Functions

Governance Control Compliance

Typical financial institutions

Board of Directors

Additions in IIFS

Shariah Board Internal auditor External auditor Internal Shariah review unit External Shariah review Regulatory and financial compliance officers, unit or department Internal Shariah compliance unit 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 20 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Summary of governance framework for Shariah compliance for IFIs

AAOIFI & IASB Islamic financial institution Shareholders Central Bank External Auditors BOD SSB IFSB Audit Committee / ACG Prudential Regulations / Standards Internal Shariah Audit / Shariah Review / Shariah Compliance

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By: Omar Mustafa Ansari

AAOIFI Standards

IFSB – 6 Guiding Principles on Governance for Islamic Collective Investment Schemes

Islamic Collective Investment Scheme (ICIS) – Definition

► Under the guiding principles, Islamic Collective Investment Scheme (ICIS) is defined as any financial scheme which

meets all

of the following criteria: ► investors have pooled their capital contributions in the fund where their share is divided into units and the right to share profit or losses in the pool; ► fund is established and managed in accordance with Shariah rules and principles; and ► it is a separate entity in terms of financial assets and liability.

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By: Omar Mustafa Ansari

Principles set out by the IFSB – 6

General Governance approach of ICIS • To establish a comprehensive governance policy framework ensuring appropriate governance structure and procedure are in place • Continuously adopt international best practices Transparency in disclosure • Accurate and timely disclosure of information to reflect the true picture of ICIS investment profile and its associated risks Compliance with Shariah rules and principles • Ex ante and Ex post Shariah Compliance controls are in place • Effective Shariah governance system • The review of Shariah compliance of ICIS by internal auditors / Shariah review Additional protection for ICIS investors • It focuses on the practices followed by ICIS operators to influence the movement or shuffling of funds • Appropriate precautions are undertaken that no such practice of funds movements are carried out 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 24 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Key issues – point of focus

Key issues : organs of governance and Shariah compliance controls at entity level

► BOD / Audit Committee – additional functions ► HR ► Hiring ► Training ► Shariah compliance function ► ► Resources Reporting line ► Independence vs. product development ► Shariah Audit ► ► Internal ► External ► Supervisory Policies, procedures and systems ► Shariah Rating ► Shariah compliance ► Fiduciary responsibility 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 26 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Key issues – focus required: SSB and SAs

► Right forum – board or advisor ► Right responsibilities ► Support ► Advise ► Supervise ► ► Judge and decide Report ► What to? ► How to?

► Independence ► Objectivity – state of mind / from the heart ► Influence ► Teachers / school of thoughts ► ► Peers Management ► Capability 23 April 2012 Al Huda CIBE – Conference on Islamic Funds & Investments Page 27 Governance for Islamic Mutual fund industry

By: Omar Mustafa Ansari

Thank you