Sharia compliant finance


Several actions by the Government recently have revealed an intention to facilitate the expansion of the opportunities for Islamic finance in Australia.

On 15 January the Johnson Report (“Australia as a Financial Centre”) was released, and it included recommendations concerning the specific steps that need to be taken to enable Islamic finance in Australia.

On 12 February Trade Minister Simon Crean launched the Australian Government’s first-ever comprehensive publication on Islamic finance. (“Islamic Finance” can be downloaded from  The booklet provides a detailed explanation of the opportunities that Sharia compliant investment and banking offers Australia’s financial services sector.

On 27 April, Assistant Treasurer Nick Sherry gave an important speech in Qatar, in which he announced that he had directed the Board of Taxation “to undertake a comprehensive review of Australia’s tax laws to ensure that, wherever possible, they do not inhibit the expansion of Islamic finance, banking and insurance products.”

This follows on from movement elsewhere. Last year La Trobe University launched Australia’s first Masters Degree in Islamic Banking and Finance, and two Sharia compliant funds (the LM Australian Alif fund and the MCCA Income fund) were also launched.

Many of these initiatives are targeted at the large worldwide population of Muslims, which makes up almost a quarter of the global population. The most populous Muslim nation, Indonesia, is right on our doorstep, and with a rapidly growing middle class, it certainly represents a major opportunity for Australian financial services if we can develop sufficient expertise and infrastructure to take advantage of it. There are also around 340,000 Muslims living in Australia. Nearly 40% of these were born in here, almost 60% are under 30 years of age, and many of them would no doubt like to use financial planning services that align with their beliefs.

Of course the financial needs of Muslim clients are no different from those of any other clients. Like everyone else, Muslims need to earn a living, pay bills and taxes and worry about retirement. Like all of us, they face the risks of uncertain investment markets, unemployment, sickness, accident, mortality and longevity. The difference is that the solutions to these needs must comply with Sharia. All Muslims believe Sharia is God’s law, but there is a great deal of disagreement between the different schools of Islamic thought, cultures and geographic regions as to exactly what it entails.  Also, as with most religions, there is a great deal of variation in the degree of strictness with which the rules are observed.

The principles of Sharia are not overly complex and these are the main ones that bear on the provision of financial planning services. There are general prohibitions on riba (interest on monetary loans) and gharar (preventable ambiguity in contract essentials). Specific prohibitions apply to such things as alcohol and gambling, and so many businesses including breweries and casinos will not be suitable for investment, and many common financial products, including interest bearing investments and mortgages will not be compliant. Commercial insurance is problematical, as interest is earnint on reserves, and uncertainty and gambling aspects come into play. Nevertheless, mutual help and protection is a principle of Sharia (“takaful”) and so with careful design, compliant  insurance products can be created.

Apart from the prohibitions, there are some obligations, such as Zakat (sharing wealth with the poor) and Hajj (the pilgrimage to Mecca which must be undertaken at least once in the life of an able-bodied Muslim who can afford it.) These matters should be taken into consideration when planning.

Not every Muslim client will automatically want to pursue a purist approach that requires strictly compliant products and a client may be willing to consider conventional financial solutions where a suitable substitute is lacking or is uncompetitive. The important thing is to make enquiries about what is acceptable and to tailor the recommendations accordingly.

There will often be debate about what is or is not compliant. In many countries Islamic financial institutions have established structures and processes for ensuring Sharia compliance within the personal finance industry. Typically, the institution will have a board of religious scholars that issues religious rulings on whether a product or service complies or not. In Australia, however, not much infrastructure of this kind is in place, and there is a shortage of suitably qualified Islamic scholars equipped to do the work. There is no need for advisers or product providers to be experts in matters concerning Sharia, or to be Muslims. But realising the potential for Islamic finance will need the training of scholars that can advise on Sharia compliance regarding issues affecting personal financial planning.

Usman Hayat, director of Islamic finance and ESG at the CFA Institute in the UK has published widely on Islamic finance. He has identified five challenges that face a financial planning practice that plans to target and service Muslim clients This is what he says.

“First, the business model of a financial adviser may have Sharia-compliance issues of its own. If the financial adviser is employed by a conventional bank, the client seeking Sharia compliance may shy away from the bank’s advisory services because conventional financial institutions are deemed non-compliant with Sharia for reasons that include the prohibition on riba. Therefore, the adviser may choose to check the Sharia compliance of his or her business model and obtain a formal ruling from a scholar from whom clients may seek advice on Sharia-compliant products.

Second, the Sharia compliance of products branded Sharia compliant by their providers may not be foolproof, and sometimes such compliance may only be a change in form rather than a change in substance of a conventional product. On more than one occasion, Islamic finance has experienced situations where products approved by the Sharia supervisory board of an Islamic financial institution were later criticized for lacking such compliance. Recently, Sukuks (compliant securitised assets that behave in a similar way to interest bearing investments) came under intense criticism when prominent scholars condemned some instruments for being dangerously close to conventional bonds. A financial adviser need not take positions on issues of Sharia compliance but should explain to the client that there is room for a difference of opinion on Sharia compliance and that some of the common practices in the Islamic finance industry are not without their critics.

Third, the position of Sharia on a given issue, as stated by a Sharia scholar, may come in conflict with the law of the land. For instance, transfer of wealth under Sharia could come into conflict with civil law, particularly where the client dies without a will. Clearly, financial advisers cannot assist clients in violating the law. They may, however, simply state the facts and confine their advice to solutions that comply with the law.

Fourth, given the emphasis on risk–reward sharing in Islamic finance and the prohibition on interest-bearing monetary loans, advisers may have difficulty meeting the suitability criteria of the client who seeks Sharia compliance but displays high risk aversion or a low ability to withstand risk coupled with vulnerability to inflation. In such situations, the adviser may need to explain to the client that given the general lack of Sharia compliance of conventional fixed-income instruments, the client needs to understand the potential trade-offs between Sharia compliance and risk avoidance.

Fifth, the need to educate the client while remaining sensitive to his or her emotions is likely to be greater than in conventional financial planning. The client may have only a vague understanding of the scope and implications of Sharia compliance. Because these matters concern the client’s religion, he may feel embarrassed that he neither understands such matters nor finds confining himself to Sharia-compliant choices easy. This challenge, however, is not one that most advisers would find difficult to overcome because their profession trains them to deal with it.”

It does seem that the Australian Government is serious about boosting Australia’s capacity to service Muslim consumers of financial services, and given the amounts of money involved, that seems to be a sensible thing to do. Although Australia is short of capacity, the international system is well organised. Among other things, an Islamic Financial Services Board (IFSB) headquartered in Malaysia has been in place since 2002 and The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), based in Bahrain, has been in place since 1990.

The IFSB has issued 12 prudential standards and other publications covering  risk management, capital adequacy, corporate governance, supervisory review processes, transparency and market discipline, ratings, money markets, governance for collective investment schemes and governance for Takaful (quasi insurance) operations. This is a substantial body, with almost 200 members, including The World Bank and the International Monetary Fund.

The  AAOIFI  issues accounting and auditing standards within the Islamic finance sector which attempt to align with local Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).

The introduction of Sharia-complaint financial planning into an existing financial advisory business is possible because the financial needs of Muslim investors are the same as those of any other investors. However, while the usual financial planning process can be applied with little amendment, the design of fully compliant solutions will have its challenges.

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