Compliance Officers Key Issues - Islamic Finance

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Compliance Officers Key IssuesIslamic Finance Brought to you by

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This document is provided for guidance only and is not intended to be advisory in anything other than generic advise. Advice should be sought from a compliance professional.

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To the uninitiated Islamic finance can appear something of a mystery. With its complex and unfamiliar trade structures, alien vocabulary, unknown concepts, and everything set against the backdrop of the daunting-sounding Shari’ah law it can all seem somewhat confusing. This is indeed still a very specialist area of finance, although it is becoming more and more mainstream and is looking set to increase in popularity for the foreseeable future.

Diversity/Complexity Islamic finance is fairly complex and there is a seemingly never ending array of products to learn about. Compliance Officers should get to grips with the basics in terms of the vocabulary and trade structures used. You can never be expected to become an expert in the principles of Shari’ah law in an instant, although you may find yourself having to liaise with the Shari’ah Supervisory Committee for want of anyone else to do so. Remember also that there is a distinct difference between an Islamic finance product and a client who simply wants to ensure that his trading or portfolio is more or less in accordance with the tenets of the Shari’ah. Such clients may be happy to undertake transactions in conventional products as long as the underlying activity is acceptable, for example, no shares in companies involved in brewing.

Regulatory Environment The regulatory environment for Islamic finance is extensive and complex because of the requirement to comply with Shari’ah Law.

Regulated Status Sukuks and home finance products are regulated by the FCA. Other than that, Islamic finance tends to involve lending and is thus subject to a lighter FCA regime than other products such as equities and insurance. Compliance Officers and relevant Front Office staff should know the difference between regulated and non-regulated business so that the relevant rules can be applied where required. Regulatory Status of Staff Front and Back Office staff involved in the provision of services relating to sukuks may need to be Approved Persons/Senior Management Functions covered by the training and competence rules, depending on the exact nature of their activities. However, as much of Islamic finance activity involves lending, staff working in this field may not need to be authorised in any specific way. Senior Management Functions maybe required for oversight.


Conduct of Business Sourcebook (COBS)Rules Such staff should be very clear about the activities that they could potentially encroach on areas that do require a particular regulatory status and should avoid undertaking such activities until relevant rules have been satisfied. The relevant FCA Conduct of Business Sourcebook rules will apply to regulated Islamic finance products such as sukuks and home finance arrangements. You may also consider it best practice to monitor for suitability in its broadest sense under Sharia’ah law. Remember, whether or not a product is covered by FCA suitability requirements, some areas are prohibited for Islamic Finance such as transactions involving casinos, breweries, or ‘conventional’ futures and other derivatives.

Money Laundering/Counter Terrorist Financing As Islamic finance is unfamiliar to many, Compliance Officers should not be tempted to spend so much time trying to get to grips with a complex transaction that they lose sight of their responsibility to ensure that all of the parties involved have been identified and that the transaction itself makes sense, has a clear purpose and is not being used to facilitate money laundering: it can at first be difficult to determine who is a customer and what the relevant cash flows are. Hawala brokers represent a clear risk in terms of money laundering and terrorist finance as they do not require customer identification records, origin of funds information, etc., thereby allowing their customers to operate outside the framework of the legitimate banking and money transfer system. While it cannot be said that all or even many Hawala brokers are involved in illegal activity, any customers who appear to be involved with activity of this kind should be treated with extreme caution.

Exchange controls As the Hawala system operates outside the official financial system it may be used to breach exchange controls. Documentation The issue of exchange traded sukuks requires the preparation of a prospectus and any subsequent secondary market trading will necessitate the despatch of confirmation notes. There is also an ISDA master agreement for the use of Shari’ah compliant derivatives.

Industry Associations Further information can be obtained from a few organisations focusing on Islamic finance including: -

Arab Bankers Association Arab Bankers Association of North America Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) - Institute of Islamic Banking & Insurance International Islamic Financial Market Arab Academy for Banking and Financial Sciences (AABFS) UK Islamic Finance Experts Group (UKIFS)


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Union of Arab Banks Loan Market Association

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