Dollars for Scholars
Islamic finance could be a fruitful, thoughtful and even moral alternative to Western banking, says Sophie McBain — if it can overcome its scholar problem
IT MAY BE an unusual career move, but becoming a shariah scholar for an Islamic bank is nice work if you can get it. A quick poll of bankers, lawyers and academics working in Islamic finance revealed unanimous agreement that shariah scholars — who approve every new Islamic banking transaction to certify its compliance to Islamic shariah law — are paid ‘a lot’, but few volunteered figures. Welcome to the opaque world of Islamic finance, and the fledgling industry’s ‘scholar problem’.
Among those who did give figures on shariah scholar salaries, there was considerable variation. Professor Rodney Wilson, a member of the Durham Centre for Islamic Economics and Finance, says that the most in-demand shariah scholars are paid $2,000 a day. Reuters has quoted an unnamed banker as saying that some scholars charge around $1,000-$1,500 per hour of consultation — in addition to an annual bonus of between $10,000 and $20,000 per board seat.
Dr Murat Ünal, CEO of Funds@Work, an investment consultancy and Islamic finance specialist, says that remuneration for a fixed shariah board membership can exceed $200,000 a year plus fees, while advising on a large transaction such as a sukuk (Islamic bond) can generate commission running into millions of dollars. If this still doesn’t sound generous enough, consider that Funds@Work’s pioneering research into shariah scholars and their networks has found that the top twenty shariah scholars in the world hold between fourteen and 85 board memberships each.
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There’s a reason for the inconsistency of these accounts: shariah scholar payments don’t have to be made public. And while conventional bankers have found themselves the target of a forceful backlash against bonuses, the quieter but equally insistent voices calling for limits to the influence and payment of shariah scholars struggle to find a platform.
The concerns of those campaigning for changes to the current shariah scholar system are critical to a fast-growing industry, which has the potential to bring millions of Muslims into banking for the first time and which offers a thoughtful critique of mainstream finance. The Islamic finance industry is predicted by Deutsche Bank almost to double to $1.8 trillion by 2016, but its economic potential may never be fulfilled because of its serious governance problems, with power concentrated in a small, ageing and reticent elite.
Islamic finance differs from conventional finance because of its prohibition on the charging of interest, speculation, investing in haram industries such as alcohol, pork products and gambling, and gharar — loosely translated as ‘uncertainty’ in contracts, including selling items you don’t yet own. All Islamic banks or mainstream banks offering Islamic services have to appoint their own shariah board, which determines whether transactions are Islamic — and, in the absence of a powerful central regulatory authority, this places a huge amount of power with the board members.
Goldman Sachs’ registering of a sukuk last October has the distinction of illustrating both the increasingly broad appeal of Islamic finance and its fundamental flaws. The banking giant’s $2 billion sukuk programme met with early controversy after several Islamic scholars said it was not shariah-compliant. This problem became much bigger after it was reported — following a monumental mistake that has spawned many competing explanations — that at least three of the eight scholars quoted in Goldman’s provisional prospectus as endorsing the transaction said they had never even seen the document.
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The incident flagged up one of the major pitfalls with the current shariah board system: when one group of scholars declares a transaction shariah-compliant and another group disagrees, there is no higher authority to appeal to. Such disagreement hasn’t only happened during sukuk issuance; it has also been a line taken by defaulting parties. A famous example of this was when Kuwaiti investment firm Investment Dar argued over repaying a debt to Blom Bank on the basis that it was not shariah-compliant, and an English court surprised many by saying that Investment Dar had an ‘arguable case’ (it did nevertheless lose).
These disputes are something ‘that unfortunately happens quite a lot’, says Paul Holland, a partner at SNR Denton, although he says the defaulting party is unlikely to succeed. ‘It’s not an argument that the industry is happy with, and thankfully as far as I’m aware, all those arguments to date have failed,’ he adds. However, he does believe that arguments over shariah-compliance are inevitable, and not necessarily a bad thing. ‘Islamic finance has a large degree of subjectivity — that’s an occupational hazard. Scholars will take different views from one another, as will shariah boards and different schools,’ he says, but this illustrates that Islamic finance is a ‘thoughtful process’ where scholars ‘look at the merits of each case and take a view on a case-by-case basis’. Many today will welcome a more considerate, personalised finance industry, but the absence of any higher authority to appeal to in case of a dispute increases the power of individual scholars.
It hasn’t increased the power of all scholars equally — rather it has benefited a select handful as banks compete to appoint the most famous and established shariah scholars to their boards to increase their Islamic credibility and reduce the chances that their boards’ verdicts will be challenged. As a result, the top ten scholars in the world make up 40 per cent of all board memberships, sharing 450 board positions between them, according to research by Funds@Work.
ALL THIS HAS not only helped inflate the salaries of a small coterie of scholars, it has also given these individuals tremendous influence over an industry. ‘Take the top five scholars, who make up around 25 per cent of the entire boards across the globe — we’re talking about 350-plus boards. Just imagine if they flew in one plane together and that plane crashes. Of course we hope this will never be the case, but can you imagine what impact that would have on the system as a whole, on succession and stability?’ says Ünal of his research. It doesn’t help that there are no formal accession plans in place, or apprenticeship programmes for aspiring young scholars, or even any formal recruitment procedures: once a chairman is appointed, he will usually appoint the rest of the scholars on the board. As a result, scholars often come to boards in groups. Funds@Work research shows that the top two scholars share 51 per cent of their board memberships.
Although not accountable to shareholders, the decisions of the shariah board can overrule those of the executive committee and have a decisive impact on an organisation’s strategy. ‘Shariah scholars are still perceived by many market participants — and this has been indicated in research from Malaysia — to be more influential than the CEO,’ explains Ünal. ‘You can have a situation where the shariah scholar can take a decision which is entirely negative to the development of the organisation, and where management can’t do anything about it.’ Shareholders may consequently be concerned that fewer than ten of the top 100 Islamic scholars have degrees in finance.
Unlike the decisions of the executive board, it’s also difficult to scrutinise shariah decisions because they’re not made public: minutes are rarely kept, and if they are they’re not shared. Even in widely reported disputes, scholars tend not to discuss their personal opinions publicly, for reputational reasons. ‘All the arguments around the Goldman Sachs sukuk haven’t been the scholars arguing, it’s been various commentators,’ says Nigel Denison, director and head of markets and wealth management at Bank of London and the Middle East (BLME). ‘The scholars themselves try not to get into that situation. There’s a relatively small group of scholars, so often you would find yourself criticising the board that has one of the top scholars on it.’
THERE HAVE BEEN moves towards strengthening Islamic standard setters and regulatory authorities (note the plural) — and all those interviewed felt optimistic that the industry was making considerable strides in the right direction, even as they disagreed as to which authorities were most relevant. Professor Wilson of Durham University says global standards existed to ‘some extent’ because of the Islamic Financial Services Board (IFSB), which advises central banks and other regulatory authorities about the regulation of Islamic finance. Paul Holland of SNR Denton, on the other hand, drew attention to AAOIFI, the Bahrain-based body whose standards he said are ‘now fairly well recognised within the industry’.
More important, however, is whether their recommendations are binding or independent. Here the ‘scholar problem’ looms again, because, according to Funds@Work, the seventeen scholars who are linked to AAOIFI make up around half of all board members around the world. ‘The reputation that comes with being on the standards-setting boards, as a substitute for the lack of sufficient governance standards in an emerging sector, basically is reason enough for many market participants to say, “We definitely need this guy,”’ says Ünal.
Similarly, the recommendations of AOOIFI and the IFSB are not binding in the case of a dispute between two bodies over shariah compliance. Malaysia has broken new ground in appointing a national shariah board with the power to make binding recommendations — but at present there has been little indication that other countries will follow suit. A national shariah board may be more practical in Islamic countries, but it’s hard to imagine the UK government, for instance, endorsing a national shariah committee.
There are further proposed reforms designed to overcome Islamic finance’s scholar problem — and Malaysia has pioneered most of them. They include opening up shariah boards to include other Islamic finance experts and limiting the number of boards that scholars can sit on. Ensuring that boards appoint one or two junior scholars, to introduce fresh blood into the industry, would help too. And greater transparency — whether it’s publishing minutes of shariah board meetings, setting up a central database of scholars or making scholars’ salaries public — would be welcome.
IN MANY WAYS the Islamic finance industry has reached a crossroads. It has expanded sufficiently to attract the interest of corporate giants — but if the industry is to increase its market share now, it will need serious reform. And not everyone will agree that it ought to expand: there is a tension within the industry because the larger it becomes, the more it interacts with non-Islamic financial institutions, and the more it’s structured to mimic conventional financial products, the less it will appeal to purists.
One of the reasons that Goldman Sachs’ sukuk was opposed by several scholars was a concern that Goldman would use the proceeds to fund interest-based activities (which the bank denies) and a feeling that the bank’s vampire squid reputation didn’t fit with Islamic finance’s ethos. At an Islamic finance conference in London in February, much of the discussion was devoted to whether Western banks’ involvement in Islamic finance is undermining the industry. In Qatar, authorities have taken the landmark step of banning conventional banks from offering Islamic services; conventional and Islamic financial services now have to be offered by separate entities.
That said, for Muslims and non-Muslims alike, there are grounds for hoping that Islamic finance is able to expand its horizons and overcome its scholar problem. At root, Islamic finance’s rulings on interest rates, gharar and halal investments reflect an overriding concern with ensuring that the financial sector is just and non-exploitative. And while Islamic products are not risk-free, the prohibitions on investing in over-leveraged companies, on short-selling or on complex derivatives have all proved financially shrewd.
Denison of BLME says that ‘the majority’ of the bank’s customers are non-Muslims, who are disaffected with mainstream finance. BLME’s model, he says, is ‘not dissimilar to an old-style merchant bank’ — and already offers the kind of high-street bank model that the Independent Commission on Banking is hoping to revive through its proposed ‘ring-fence’.
A forgiving critic would conclude that Islamic finance’s governance problem is inevitable in a relatively new industry, but this doesn’t mean it isn’t in critical need of reform. Like many of the Middle Eastern countries that are its natural home, Islamic finance’s economic potential is at serious risk of being lost because of its inability to distribute power beyond a small and ageing elite.
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