The evolving landscape of Islamic finance: regulatory developments


Muhammad Junaid
Younas Ghori

ISLAMIC finance is poised to become one of the most transformational value system touching all facets of business, banking, finance and commerce, the significance of Islamic finance throughout the global economy is growing apace and is more pronounced in countries with Muslim population. In Pakistan Islamic finance is widely believed to be the panacea for all economic ills.
Being the apex regulator of the corporate sector, capital markets and non-banking financial industry the SECP is fully cognizant of its role for development of Islamic finance in the country. Islamic finance assumes a center stage in the SECP’s policies and it has taken a number of measures on the regulatory front for effective regulation of Islamic financial services industry. The SECP has constituted a Shariah Advisory Board, consisting of renowned scholars, to advise it on all matters related to Shariah.
The SECP established a dedicated Islamic Finance Department (IFD),which is mandated to embed Islamic finance in corporate sector and capital markets for development of vibrant primary and secondary markets for Islamic financial products and services and to facilitate development of Islamic finance industry through enabling legal, regulatory and compliance framework. IFD has been entrusted with responsibility to achieve the highest standards in Islamic finance in building resilient and sustainable financial systems and to strengthen governance of the segments within the regulatory ambit of SECP to ensure that the business activities are in compliance with Shariah principles.
The SECP Act has been amended to empower it to regulate and facilitate the growth of Shariah-compliant financial products in the financial services market. Landmark provisions have been added to the newly promulgated Companies Act, 2017, for Shariah-compliant companies and Shariah-compliant securities. The concept of Shariah-compliant companies and securities is first of its kind in the corporate history of Pakistan. This concept extends the previous paradigm where Islamic finance was largely confined to Islamic financial institutions, Sukuk and Shariah screening of listed companies. The new concept provides an opportunity to companies or securities, irrespective of their size or line of business, to become Shariah compliant.
New regulations have been issued under the enabling provisions of the Companies Act. The SECP issued Draft Shariah Governance Regulations, 2018,which are a comprehensive set of regulations for governance of Shariah-compliant companies, Shariah-compliant securities and Islamic financial institutions under its jurisdiction. The regulations encompass different elements of Shariah governance such as Shariah compliance, Internal and External Shariah Audit, Shariah screening, Shariah related disclosures, Shariah advisor responsibilities, and provide certification mechanism for Shariah-compliant companies and securities.
Considering the need for a robust Shariah advisory function, to strengthen and improve the quality of Shariah advisors, and professionalize the Shariah advisory businesses, the SECP notified Shariah Advisors Regulations, 2017, whereby the individuals, firms, LLPs, and companies meeting the fit and proper criteria and registered with the SECP are allowed to provide Shariah advisory services.
In order to develop a vibrant Sukuk market and to encourage Sukuk issuances, Sukuk (Privately Placed) Regulations, 2017, and Public Offering Regulations, 2017, have been notified after extensive consultations with stakeholders, the Sukuk issuers have been exempted from the underwriting and rating requirements for privately placed Sukuk, minimizing the cost of issue. Tax neutrality has been provided to Sukuk vis-a-vis conventional securities through an amendment to the Income Tax Ordinance. Retail investors’ participation in the Sukuk has been encouraged by approval of a tax credit for investment in Sukuk.
Fiscal incentive to entice businesses to conform to Shariah principles in their business operations and financing has been offered. A tax rebate of 2% to Shariah compliant listed manufacturing companies has been approved with the consideration to lure businesses to move from conventional interest based investments and financing to Islamic investments and financing.
The SECP notified Futures Exchanges (Licensing and Operations) Regulations, 2017, under the provisions of the Futures Market Act, 2017. As per the licensing condition the Futures Exchanges shall endeavour to promote Shariah-compliant products and transactions. To facilitate and promote Shariah-compliant insurance business the SECP under section 167 the Insurance Ordinance, 2000, issued Takaful Rules, 2012. The Takaful sector comprise of five dedicated Takaful operators and 22 window Takaful operators. As of December 2017, Shariah-compliant Takaful business had total assets of Rs43 billion.
The NBFC Regulations have been amended to facilitate development of Shariah-compliant non-banking financial sector. The share of Shariah-compliant assets of the NBFI industry is steadily rising, Shariah-compliant assets account for 32.10% of the total assets of the NBFI industry by March 2018. The Shariah-compliant mutual funds registered a phenomenal growth. As of March 31, 2018, the share of Shariah-compliant funds reached 41% of the assets under management (AUM) of the mutual fund industry.
In the wake of technological advances, innovations in businesses, emergence of new risks, evolving fintech solutions, changes in governance, financial reporting and regulatory practices globally, and enhanced international focus on surveillance and compliance issues, the SECP felt compelled to align the old modaraba laws with the global legal and regulatory developments, the Modaraba (Companies and Modaraba Floatation) Ordinance, 1980,has been revamped, the Draft Modaraba Bill, 2018.has been presented to Ministry of Finance for onward approval of the Parliament.
Shariah compliance is the raison d’ etre for Islamic finance industry, the industry can achieve the highest levels of Shariah compliance by following the Shariah and governance standards issued by the leading standard setting bodies.
The SECP has been gradually adopting the accounting and Shariah standards issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) to achieve high degree of standardization in the operational and business practices of Islamic financial institutions. In February 2018,the SECP adopted three AAOIFI Shariah standards while in April 2018, the SECP issued draft notification for adoption of seven more AAOIFI Shariah Standards.
The SECP also implemented standards of Islamic Financial Services Board (IFSB) Malaysia through its Shariah Governance Regulations. It has plans to adopt more Shariah and accounting standards of AAOIFI for its stakeholders to benefit from improved Shariah and corporate governance in Pakistan.
The SECP and the three centres for excellence in Islamic Finance (LUMS, IBA and IM Sciences) have, in principle, agreed to join hands for the noble cause of promotion of Islamic finance education, training, research and development.
The initiative, the first of its kind, will go a long way in creating awareness among the academia, the public, training for stakeholders and capacity building of Islamic financial institutions through joint and collaborative efforts.
Islamic finance continues to evolve and accelerate. Innovations have led to development of new Islamic products and financial solutions and Islamic finance is emerging as an asset class of its own. Islamic finance due to its potential for bringing value to everyone, including vulnerable people has appealed to a wide variety of investors, who believe in gaining real value from the Islamic financial assets.
An obstacle-free regulatory regime that provides level playing field is a prerequisite for sustainable development and penetration of the Islamic corporate sector and capital markets. The SECP is providing its regulatory support to spur growth of the Islamic finance industry and has focus on scaling up Islamic finance regulations to provide enabling regulatory environment for the stakeholders in the sectors within the SECP’s regulatory ambit.
—The writer is Joint Director in the SECP’s Islamic Finance Department. He is a Chartered Islamic Finance Professional (CPIF) from the Chartered Institute of Islamic Finance, Malaysia.

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