Islamic Finance Made in Germany – A Case Study on Kuveyt Turk (KT Bank): Germany’s First Islamic Bank

Transcription

1. > Islamic Finance Made in Germany – A Case Study on Kuveyt Türk (KT Bank): Germany’s First Islamic Bank Matthias Casper / Asma Ait Allali 2017.15 Preprints and Working Papers of the Center for Religion and Modernity Münster 2017.15
2. Preprints and Working Papers of the Center for Religion and Modernity M ünster 2017.15 > Islamic Finance Made in Germany – A Case Study on Kuveyt Türk (KT Bank): Germany’s First Islamic Bank Matthias Casper* / Asma Ait Allali** The Working Paper was first published on: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3077366 (25.11.2017). * Dr. iur., Dipl.-Oec., Professor for Civil Law, Company Law, Banking Law and Law of Capital Markets, University of Münster. ** Dr.ssa., PhD in Business & Law, University of Brescia, Italy / Visiting fellow, University of Münster.
3. Abstract In recent decades , Islamic Finance has seen an interesting growth and spread, not only in the Arab or other Muslim, but also in Western countries. This article focuses on Islamic Finance in Germany, a European country characterized by strong economic growth and an increasing Muslim community, mostly of Turkish origin, which saw the opening of its first Islamic Bank in July 2015. After a very brief overview on the experience and the current situation of Islamic Finance in Germany, we will focus on the question whether within the German supervisory law, within the rules for corporate governance or within the civil and tax law legal obstacles can be found that hinder the establishment of Islamic Financial Institutions in Germany. As Islamic bank customers choose Sharia compliant products voluntarily out of respect for their faith, we will focus on the role of the Sharia Supervisory Board, which certifies whether a financial product is in accordance with the Islamic Law. The main part of this article will contain a case study on the KT Bank. We will discuss the current situation of the bank, examine some of their products and ask whether their Sharia Supervisory Board and their internal Sharia Compliance System can be brought in line with the German supervisory and company law. Afterwards we will analyze the position and role of the participatory depositors, especially those who invest their savings under the principle of profit and loss sharing, in the context of Corporate Governance. We will answer the question whether these stakeholders should have a possibility of participation within the bank. Finally, we will discuss Islamic Finance in the context of Corporate Social Responsibility and analyze the position of the KT Bank in this context.
4. Content 1 . Introduction .........................................................................................................2 2. Islamic Finance in Germany: An Overview ............................................................4 3. The legal framework for Islamic Banks in Germany ..............................................7 3.1. Supervisory Law: no special rule for Islamic Financial Institutions?............... 7 3.2. Corporate Governance as a legal obstacle for Islamic Institutions?............. 10 3.3. German Contract Law ................................................................................. 15 3.4. Double Tax in the case of a murabaha........................................................ 16 4. The German KT Bank: A case study ....................................................................17 4.1. Foundation, legal structure and financial background .....................................17 4.2. Products and services offered: what risks associated .....................................19 4.2.1. The self-presentation of the KT Bank...................................................19 4.2.2. KT Participation Account ....................................................................21 4.2.3. KT Real Estate Financing .....................................................................22 4.2.4. KT Instalment Loan, KT Car Financing, KT Business Loan ....................24 4.3. Internal Organization of KT Bank and Corporate Governance ...................... 27 4.3.1. A Sharia Supervisory Board called Ethical Council ..............................27 4.3.2. A Sharia Compliance Department named PrinzipienUmsetzungskomitee (Principles Implementation Committee) ......................30 4.4. The depositors and investors’ position in the context of Corporate Governance ...................................................................................... 31 4.5. The KT Bank in the light of Corporate Social Responsibility ........................ 35 4.5.1 The concept of Corporate Social Responsibility – an overview .............35 4.5.2. The KT Bank’s CSR view ......................................................................37 5. Conclusion ........................................................................................................39 References ............................................................................................................42 1
5. 1 . Introduction In addition to many scandals, such as the manipulation of exchange rates and the interest rates “EURIBOR”, 1 the global financial crisis of 2007/2008 and its aftermath have awakened the debate on new forms of finance. Unlike conventional finance, these forms tend to be more oriented towards ethical, moral and religious aspects. Although Islamic Finance has an ancient tradition, it can be named in this context. According to several studies, Islamic Finance growth in the recent decades was at an annual rate revolving around 10-20%, 2 and with a development that has reached various economic sectors. 3 This development started in the early 1970s after the end of colonialism of many Arab countries, which had marginalized the Islamic Finance. 4 Islamic Finance can be defined as follows: It encompasses all kinds of financial services that are conducted without breaching the rules of the Sharia, although the contract itself is subject to a secular (national) jurisdiction. There are nearly no known examples where Islamic religious law was chosen as the governing law of a contract or at least there this would be valid. 5 Islamic Banking is not only interest-freebanking. In fact, in addition to the prohibition of riba (commonly translated as interest), there are several underlying principles of Islamic Finance in the Koran such as the prohibition of speculation (maysir) and of implementing elements of uncertainty in contracts (gharar), also called the prohibition of gambling. Moreover, trade or investment in goods and in any activity prohibited by the Koran (haram) is not accepted. As a consequence of these basic principles Islamic financial transactions are characterized by the method of profit and loss sharing (PLS) and the fact that nearly all financial transactions have an underlying real asset. 1 For more Details see Lehmann (2016), 207, 211 et seq. According to the ICD-Thomson Reuters Islamic Finance Report 2016, the global indicator of Islamic Finance development (IFDI) in 2016 was about 9% (8,828%). It is an indicator of the overall health and development of the Islamic financial industry worldwide that includes: Quantitative Development, Knowledge, CSR, Governance and Awareness. For more information see e.g.: http://www.zawya.com/islamic-finance-development-indicator/. 3 According to the latest Thomson Reuters report 2015/2016, “State Of The Global Islamic Economy Report", Muslim consumers in 2014 spent about 1.8 trillion dollars in the Islamic economic sector and it is estimated that this amount will reach up to 2.6 trillion dollars in 2020. It is a market with obvious potential development with regard to the core business Halal, strengthened by a predominant presence of young Muslim consumers (1.7 billion worldwide). The purpose of the Global Islamic Economy Indicator (GIEI) is to show the current development of Islamic economy sectors. The GIEI is a composite weighted index comprised of six sector level indicators (Halal Food, Islamic Finance, Halal Travel, Modest Fashion, Halal Media and Recreation, and Halal Pharmaceuticals and Cosmetics) across 73 core countries. The Indicator is not a ranking of current size and growth of each market, but evaluates the quality of the overall Islamic economy ecosystem including social considerations. For more information see: http://www.zawya.com/mena/en/story/ZAWYA20150810103426/. 4 Iqbal and Mirakhor (2011). p. 13 et seq. 5 Casper (2014), p. 41, 42; see also Warde (2000), p. 5. In the Beximco case of the Court of Appeal, 28 January 2004, [2004] All ER (D) 280 the court decided that Islamic law cannot be chosen as the governing clause. 2 2
6. The development of Islamic Finance has not only taken place in Arab-Muslim , but also some European countries, in particular in Great Britain, which today is considered a hub of Islamic Finance in Europe with five Islamic Banks operating in the British financial sector. Besides Great Britain, this development has taken place in France, Luxembourg and finally Germany, which has seen the opening of its first Islamic bank in July 2015. The establishment of Islamic Finance in the European context leads to some difficulties: The religious peculiarities of Islamic Banks make them differ from the conventional banks. Therefore, the integration of Islamic Banks into the different countries’ regulatory and tax environment is a significant challenge. The application of the PLS principle seems to leave some gaps in terms of the managerial powers’ equilibrium and the representation of interests in the Islamic bank management bodies. They are directed to ensure transparent management activity and to protect the interests of the stakeholders, especially those who take up the responsibility of investing their savings by sharing the risk of loss, the so-called participatory depositors. Notably, they do so without having effective managerial powers over the activities, not even over those supported by their financial contribution. Therefore, it is important to analyze Islamic bank’s corporate governance, its specificities and the approaches that can be taken in order to ensure compliance with the ethical-religious goals as well as with the law and the best practices provided by the mandatory law of the country in which it operates. In particular, we will take the following points into considerations: 1. The Islamic bank in the context of German supervisory and company law; 2. The Islamic bank’s corporate governance structure; 3. The bodies responsible for the Sharia supervision, their configuration in the Islamic bank’s corporate governance and their integration under the law; 4. The stakeholders’ protection, with particular emphasis on the case of the participatory depositors. Starting with a general overview on the development of Islamic Finance in Germany, we will examine German law regarding corporate governance and the possible integration of the Sharia supervisory function and finally conclude with the study of the case of Kuveyt Turk Bank, the first Islamic Banks operating in Germany. 3
7. 2 . Islamic Finance in Germany: An Overview In 2010, the former German Federal President Christian Wulf said that Islam belongs to Germany. Although the veracity of this statement is still discussed controversially today, 6 it cannot be ignored that Germany’s Muslim population has risen rapidly ever since Turkish workers immigrated during the late 1960s. By the end of 2015, the federal Statistics Office Germany had registered the highest net immigration rate of foreigners in the history of the Federal Republic of Germany. Many of the 1.1 million counted immigrants were Muslims. 7 According to the latest statistical data, the number of Muslims present in Germany amounts to 4.7 million (5.9% of the total population) 8. This number is expected to increase as a result of the refugee crisis and further migration waves. A lot of these people are potential customers of Islamic Banks. The beginning of Islamic Finance in Europe dates back to the 1980s, when the first branches of foreign Islamic Banks opened in the United Kingdom. In Germany, however, Islamic Finance was not offered for many years. German Muslims had predominantly come from Turkey, where Islamic Banking was not very popular until the 1990s. Until the AKP came to power, Turkey was a practicing secular state9 with a slow development of Islamic Banking. Therefore, German Muslims with Turkish background had little experience with Islamic Finance at all. Many of them had been educated in accordance with the philosophy of modern Turkey’s founding father, Atatürk, who once said: “I have no religion, and at times I wish all religions at the bottom of the sea.” 10 Consequently, Islamic Banks saw no market for Islamic financial products in Germany. This changed in the very late 1990s, when the first Islamic Funds - founded mostly under the law of Luxembourg - were offered in Germany. The absence of Islamic financial products in Germany definitely ended in 2004, when the first Islamic bond (Sukuk) was issued by the federal state Saxony-Anhalt. 11 Subsequently, there has been an appreciable openness toward Islamic Finance. The German Federal Financial Supervisory Authority (BaFin) has promoted two international conferences in 2009 and 2012. They outlined the peculiarities of Islamic financial instruments and the potential economic benefits the country might gain from establishing an Islamic Finance industry in Germany. 6 See http://www.zeit.de/2015/09/christian-wullf-angela-merkel-islam-deutschland. See https://www.destatis.de/EN/PressServices/Press/pr/2016/03/PE16_105_12421.html. 8 For further information refer to the following link: http://www.bamf.de/SharedDocs/Anlagen/ DE/Publikationen/Broschueren/jahresbericht-forschungszentrum-2015.pdf?__blob=publicationFile. 9 According to Turkey’s current constitution, the country is still secular, but since AKP came to power this is no longer visible in everyday life. 10 Quoted after Mango (1928). 11 The Sukuk was subscribed by Gulf countries investors (Bahrain and United Arab Emirates) 60% and by European investors for the remaining 40% (France and Germany). In 2009 the entire amount of the Ijarah Sukuk (equal to 100 million euro) was repaid; see ECB Occasional Paper No. 146. Available at SSRN: http://ssrn.com/abstract=2251204. 7 4
8. Despite the absence of Islamic Banks in Germany , various conventional German banks, such as the Deutsche Bank, Unicredit (at that time still known as HypoVereinsbank), or the insurance company Allianz have offered Islamic Banking through branches or subsidiaries in different Arabic countries, mainly located in the Gulf States. 12 Primarily, this so-called “Islamic Window” offered Islamic investment banking, instead of Islamic retail banking, to German customers. Since 2008, the German financial market has experienced a considerable presence of Islamic investment funds like the Meridio Funds, which was founded under the law of Luxembourg. 13 Another milestone in the development of Islamic Finance was the foundation of the Institute for Islamic Banking and Finance in Frankfurt in 2006, a consulting firm in the field of Islamic Finance. 14 One more reason for the increasing popularity of Islamic Banking was the significant presence of non-Turkish Muslim immigrants and the growing heterogeneity of the Muslim community in Germany. 15 Hypothetically, the so-called re-Islamization of Turkey might have had an influence on some of the German Muslims with Turkish background. However, there is no empirical evidence to support this thesis. Although Islamic Finance developed significantly within the first decade of the millennium, it took until the summer of 2015 for the first Islamic bank to be established in Germany. In 2004, the Kuveyt Türk Katılım Bankası A.Ş. had established a branch in Mannheim, without a German banking license. In 2010 they got a license limited to the brokering of deposit business with undertakings domiciled in a state outside the European Economic Area (sec. 1 subsec. 1a sentence 1 No. 5 German Banking Act). However, without a full banking license, the range of products was limited. The KT Bank applied for a full license in 2012. But without a blue print, it took the German supervisory authority (Bundesanstalt für Finanzdienstleistungsaufsicht, in the following BaFin) nearly two and half years to make sure that Germany’s first Islamic bank was working in compliance with the German Supervisory Law. The reasons for this extraordinary long process remain unknown to the public. One reason might have 12 Schönenbach, R. (2011), „An Overview of Islamic Finance in Germany” available at http://www.citizentimes.eu/2011/03/04/an-overview-of-islamic-finance-in-germany/. 13 Funds, that had been available in Germany, are listed by Farhoush and Mahlknecht in Cattelan, 2013, p. 206, who rightly point out that the level was still low. For details of Islamic Funds under German Law see Casper (2016), p. 129-151 and Casper (2011c) p. 229-246. 14 For more Details see www.ifibaf.com and https://www.franz-hitze-haus.de/fileadmin/redakteure/ download/IFIBAF_Company_2014.pdf. 15 According to the study "Muslim Life in Germany", published in 2009 by the German Interior Ministry (http://www.bamf.de/SharedDocs/Anlagen/EN/Publikationen/Flyer/flyer-muslimisches-lebenkurzfassung-en.pdf?__blob=publicationFile), the Muslim population in Germany is today highly heterogeneous. The Turkish are still the dominant group, about 63 per cent (in absolute values from about 2.5 to 2.7 million people); but about 14 per cent (between 496,000 and 606,000 people) are from the southeast European countries (Bosnia, Bulgaria and Albania); from the Middle East about 8 percent with a number between 292,000 to 370,000 migrants; from North Africa around 7 per cent (between 259,000 and 302,000 people), most of whom came from Morocco and, finally, the rest is from Central Asia /CIS, Iran, South/Southeast Asia and other parts of Africa (about 8 per cent in total). 5
9. been that there was no rulebook for establishing an Islamic Bank in Germany . Another could be the unprecedented nature of the products of an Islamic Bank. Now one might argue, that the German law in particular and European law in general has been hindering the development of Islamic Finance in Germany as it is not familiar with contracts or even financial institutions governed by a religious law. But as further discussed under 3., this argument is not convincing at all. First of all, Islamic Finance is not governed by the Sharia in the sense that Islamic law is the applicable law of the contract of Islamic financial products. The contract is governed by the national secular law, and the parties simply try to stipulate it in accordance with Islamic law or its religious principles. Secondly, German law is neutral to the religions or ethical background of the content of a contract as long as the contract complies with mandatory German law. 16 The same is true for German supervisory law. As long as all requirements under German supervisory law are fulfilled, it does not matter whether the bank has an ethical, a religious, agnostic or a capitalistic background. In fact, it is the other way around. As the German society is – like most societies in Europe – an open-minded and liberal society, its law is also open to different religious or ethical business models of financial institutions. Another important factor that has effectively promoted and continues to support the development of the Islamic Finance and Islamic Banking sector in Europe is the European Union Directive 2004/39/EC on Markets Financial Instruments (MiFID) 17. It involves the so-called "Single European Passport" wherewith licensed banks operating in a EU country may expand their business to other member countries without having to repeat the authorization process. 18 16 For more details see Casper (2011a), p. 251-274 and fundamental on this aspect Huster (2017). Directive 2004/39/EC of the European Parliament and of the Council from of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC (http://ec.europa.eu/finance/securities/isd/mifid/index_en.htm). 18 The EU has just elaborated a new MiFID II. It still has to be incorporated into the national law of the member states with the aim of making financial markets more efficient, resilient and transparent, and to strengthen the protection of investors. For more details see: http://ec.europa.eu/finance/securities/ isd/mifid2/index_en.htm. 17 6
10. The European passporting clause is also valid for Islamic Banks already authorized in one of the EU member states and enables them to expand their activities throughout the European Union . This way, the Islamic financial institutes have an opportunity to also operate in EU countries with less willingness and openness to the development of this religious finance model in their national financial market. Future developments depend on a wide range of factors. The Turkish KT Bank can be considered a pioneer actor in the Islamic Finance field of Germany. Nonetheless, it would be helpful if other Islamic Banks entered the German banking sector in order to facilitate the development of Islamic Finance in a healthy competitive climate and to avoid a bank classified as Muslim becoming a mere ethnic bank. 3. The legal framework for Islamic Banks in Germany 3.1. Supervisory Law: no special rule for Islamic Financial Institutions? Similar to other European Countries, Germany has no special rules regarding its supervisory law for Islamic Banks or other kinds of ethical or religious Financial Institutions as it is known in countries like e.g. Bahrain or Malaysia.19 As mentioned before, the supervisory law in Germany naturally treats all religious or ethical firms equally. Therefore, the German law only asks whether an Islamic Bank meets all requirements for establishing a Bank in general. Before we go into a discussion of what difficulties an Islamic Bank has to be aware of during this process, the question whether the German supervisory law is at all applicable to Islamic Financial Institutions has to be answered. Different to the approach in many other countries, German supervisory law does not provide a general clause, which defines the nature of a Bank or Financial Institutions. Instead, sec. 1 of the German Banking Act (Kreditwesengesetz) contains an enumerative list of financial contracts. If a company offers one or more of these contracts regularly, it is required to hold a banking license for doing so. As this list was originally written in 1934 it only contains traditional contracts such as a loan with interest, saving or current accounts, leasing contracts, the collection of cheques or cashless payments such as a credit transfer 20. Although this list was extended several times since 1934, it does not include a mudaraba, a musharaka or a murabaha. If e.g. a company would only offer financing via murabaha contracts on a regular basis, one could argue that a banking license might not be necessary because a murabaha is 19 For Bahrain see an overview in Casper (2010a), p. 457, 462 et seq. with further references. Critical to this aspect Casper (2011b), p 21. 20 If one offers only credit transfers or credit cards he or she needs only a license under the German Supervisory Act for different forms of cashless payments (Zahlungsdiensteaufsichtsgesetz) and not under the German Banking Act (Kreditwesengesetz). But this makes no difference in our context. 7
11. not a loan . Among German Scholars it is controversially discussed whether a murabaha, due to a functional approach, can be considered a loan in the course of the German supervisory law because it allows the customer to finance goods without paying interest. 21 However, there is no doubt that an Islamic Bank which offers the typical variety of financial products such as deposit banking or the issuing of credit cards 22 is required to hold a license because this kind of services are clearly named in the list of sec. 1 of the German Banking Supervisory Act. Apart from this a bank should be interested in acquiring a license for its own account and benefit because a reasonable customer is unlikely to trust a financial services provider without a license. If an Islamic Financial Institutions (IFI) applies for a banking license, it has to meet all the requirements of the German Banking Act. It is not necessary to list and discuss all of these requirements here. But we are going to highlight some of the aspects that could be difficult to fulfill for an Islamic Bank. One main issue, which came up during the application of the KT Bank for a license, was the ultimate responsibility of the management board for all corporate actions and its independence from the Sharia Supervisory Board (SSB). Although the ultimate responsibility is not explicitly mentioned in the German Banking Act, it is a fundamental principle of Corporate Governance and the Supervisory Law because the Bank shall not be ruled from persons operating in the background. 23 Only registered managers who are monitored by the supervisory authority are allowed to take on responsibility. The German Financial Supervisory Authority already mentioned this aspect in a letter from June 8, 1989 concerning Christian Investment Funds. 24 The letter emphasized that the investment policy and the decision which assets may be bought must be made by the funds management and not by an external ethical board. More details on how to ensure the ultimate responsibility will be further discussed in sec. 3.2.; as this is mainly a question of Corporate Governance. 21 See for more details Casper (2010b), p. 345, 349 et seq with further references, who is supporting the functional approach and argues that the agio (the surplus) with that the Islamic Bank sells the product to its customer is similar to interest and the whole contract fulfill the same function like a loan. 22 See above footnote 20. 23 See for example Sorge (2010), p. 363, 365 et seq with further references. 24 BAKred letter dated 8 June1989 (Az. V 4/51) titled „Anforderungen an die Umschreibung der Anlagegrundsätze, Funktion von Anlageausschüssen“. 8
12. Another concern , regarding in particular Islamic Banks, is the policy of refinancing. As the traditional market for refinance is based on interest, a fully flagged Sharia compliant bank cannot use this source of refinancing. The Islamic Bank must constantly ensure the Financial Supervisory Authority of sufficient liquidity for debt payment. Refinancing of Islamic Banks is one of the black boxes within academic discussion of Islamic Banking. One way to comply with the German Supervisory Law is to show superior equity in comparison to other banks or the possible participation in a Sharia compliant, interest free refinance market based on sukuks and other kinds of Islamic Finance. Alternatively, a potent liquidity sponsor such as a treasury house organized and supported by a state that promotes Islamic Finance meets the requirements of the German Supervisory Law. We are not aware of the details on how this question was solved in the KT case. 25 To our knowledge, the KT Bank in Germany works with a high equity rate and deposits of its customers. Another issue in the context of the supervisory law is the protection of deposits. Under German and European law, a bank has to be part of a deposit guarantee scheme. This scheme, normally a fund, guarantees the deposits up to a certain sum in the case of an insolvency of the bank. In Germany this sum goes up to 100.000 Euro. 26 Some Islamic Scholars argue that this kind of an absolute promise to pay back the deposit is not compatible with Islamic Law and should be modified for Islamic Banks, as it is not in accordance with the principle of profit and loss sharing. 27 However, investor protection is guaranteed by German law to all investors and is therefore mandatory. The German Act of the protection of the deposits (Einlagensicherungsgesetz) also forbids the depositor to waive this privilege. 28 In Germany, the KT Bank accepted this requirement and is ever since a member of the deposit protection scheme of the private banks in Germany. 29 However, KT Bank is not a member of the voluntary deposit protection scheme which grants deposit protection beyond the 100.000 Euro threshold of the mandatory deposit guarantee scheme. 25 Therefore, we will not come back to this aspect in our case study under 4. See Einlagensicherungsgesetz dated 28 May 2015 (BGBl. I S. 786) and DIRECTIVE 2014/49/EU OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 16 April 2014 on deposit guarantee schemes, http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014L0049&from=DE. 27 Archer and Karim (2007), p. 330 et seq; Hassan and Lewis (2007), p. 344 et seq. 28 A different perspective from British law takes Wilson (2012) p. 116. 29 See https://einlagensicherungsfonds.de/banks/kt-bank-ag and https://www.kt-bank.de/wpcontent/pdfs/Informationsbogen_fuer_den_Einleger.pdf. Therefore, there is need to come back to this point in details under 4. 26 9
13. 3 .2. Corporate Governance as a legal obstacle for Islamic Institutions? When talking about Corporate Governance and Islamic Financial Institutions, two different approaches may occur. One perspective is the traditional western view of Corporate Governance. It asks how an Islamic Financial Institution, given its different structure, can be successfully integrated into this traditional system, which is based on three different theoretical approaches: the agency theory, the stakeholder theory and the stewardship theory. 30 The other point of view is advocated by Islamic Scholars who focus on what they can learn from the traditional debate on Corporate Governance in order to develop an autonomous system of Corporate Governance for the IFI, helping to ensure these Institutions work in compliance with the Islamic Law and its Principles. 31 In the following and once more in 4.3, we will argue from the perspective of a traditional, western point of view on Corporate Governance. Furthermore, we will discuss whether this view – or to be more precise – whether the mandatory German company law can be a legal obstacle to build up an Islamic Bank in Germany. Subsequently in 4.4. and 4.5, we are going to switch the argumentative perspective and address the issue, whether the participatory depositors should be treated as a shareholder from a Corporate Governance for Islamic Financial Institutions point of view. To the traditional debate on Corporate Governance, a religious supervisory body such as a SSB seems to be a clear alien element. This can evidently be seen in the German Company Law. Sec. 76 subsec. 1 of the German Stock Corporation Act can be translated as the following: “The management board shall have direct responsibility for the management of the company.” 32 Among German Scholars it is widely accepted that this direct responsibility has to be interpreted as the above-mentioned ultimate responsibility. This can also be seen in sec. 119 subsec. 2 of the German Stock Corporation Act, which emphasizes that even the shareholders’ meeting may only decide on matters concerning the management of the company if required to do so by the management board. Thus, a strong influence of the SSB on the management has to be avoided. In the following, we are going to discuss how this can be ensured. From a German point of view, a SSB can be qualified as an advisory council (Beirat), which is, however, unfamiliar to the German Stock Corporation Act (AktG). Due to sec. 23 subsec. 5 AktG, the majority of the German literature assumes the prohibition of the establishment of an advisory council as there is no room for another supervi- 30 See the overview by Obid and Naysary, Towards a Comprehensive Theoretical Framework for Sharia Governance in Islamic Financial Institutions, in: Harrison/Ibrahim (2016) p. 10, 12 et seq. 31 For this approach see e e.g. Obid and Naysary (footnote 30), p. 10, 20 et seq. 32 This translation was taken from Norton Rose (ed), German Stock Corporation Act (Aktiengesetz), available under http://www.nortonrosefulbright.com/knowledge/publications/147034/german-stockcorporation-act-aktiengesetz. 10
14. sory body besides the regular Supervisory Board (Aufsichtsrat). 33 Nonetheless, from our point of view, the SSB is no subject to this discussion. A SSB can be embedded in the German understanding of Corporate Governance, if there is a clear separation between the responsibilities of both supervisory bodies, and if the management board is still responsible for all decisions regarding the bank. Therefore, there is no reason to qualify an SSB as an advisory council (Beirat) competing with the Supervisory Board. As shown before, the ultimate responsibility of the management board is a key principle of German law on stock corporation companies as well as of supervisory law.34 Hence, the SSB’s decisions cannot be binding for the company. Even if its decisions may be factually binding, according to the law the ultimate decision has to be made by the management board of the respective bank, which bears the sole responsibility for a company’s business policy. The AAOIFI, Governance Standard for Islamic Financial Institutions No. 1, sec. 2 which demands that the SSB’s opinion shall be binding on the Islamic bank, is not in accordance with German and European Law. Also the former British Financial Services Authority (FSA), the predecessor of today’s Financial Conduct Authority (FCA), demands proof from IFI that, in case a SSB is installed, it only exercises an advisory function and does not interfere with the management of the institution. In an explanatory paper this is stated as follows: „The key point from the FSA’s perspective is that firms can successfully show that the role and responsibilities of their SSB are advisory and that it does not interfere with the management of the firm.” 35 An IFI based in Germany needs to take precautionary measures in order to avoid any SSB decisions to become formally or factually binding. One way to do this is to have the internal regulation of the SSB and/or the management board state clear responsibilities and declare the decisions of the SSB as not binding. Another possibility is to have the SSB adopted by the managing and not by the supervisory board or the shareholder meeting, so the management board may release the SSB when it tries to influence the management board. Furthermore, it should be highlighted that after the SSB has objected specific financial products or work processes within the Islamic bank, due to their non-Sharia-compliant nature, it must propose various problemsolving solutions to the management board. The Managing Board may then choose between different alternatives. 36 33 Mertens, in: Kölner Kommentar zum AktG Vor § 76 Rn. 28; Habersack, in: Münchener Kommentar zum AktG § 95 Rn. 6; Hoffmann-Becking, in: Münchener Handbuch zum Gesellschaftsrecht, tome 3: AG, 3rd ed. 2007, § 29 Rn. 19a. 34 See for example Sorge (2010): 363, 365 et seq with further references. 35 FSA, Islamic Finance in the UK: Regulation and Challenges, November 2007, www.fsa.gov.uk/pubs/other/islamic_finance.pdf, p. 13. 36 For more Details see Sorge (2010): 363, 367 et seq. 11
15. On the other hand the independence of the SSB from the management board is also an important aspect of the Corporate Governance of Islamic Financials institutions (IFSB Guiding Principles on Sharia Governance Systems for Institutions offering Islamic Financial Services, December 2009, No. 3.1. margin number 40 et seq.; AAOIFI Governance Standard for Islamic Financial Institutions No. 1 sec. 2, No. 5, sec. 2-7). 37 As long as the act of protection against unfair competition is not triggered, the neutral, secular German or European law neither bothers whether this aspect is ensured by the Islamic Bank, nor whether the SSB works well or whether the financial product offered by an Islamic bank is eventually Sharia compliant or not. The same applies for the qualification of SSB members. 38 When seats in different SSBs are hold by one and the same person, conflicts of interest must be avoided. According to a survey by funds@work, Nizam Yaqubi, one of the most popular scholars, is a member in 85 SSB at once. 39 Although the German and European law contains several provisions regarding the avoidance of conflicts of interest, there is no rule for the SSB in particular. This has to be changed, not only from the perspective of the debate on Corporate Governance for IFI, but also from the traditional western viewpoint on Corporate Governance. From the German perspective, one could refer to the rules for the Supervisory Board (sec. 100 subsec. 2 German Stock Corporation Code). Due to this rule a person is not allowed to hold more than 10 mandates in different Supervisory Boards. Many German Scholars suggest reducing this number to six. 40 We agree that the discussion regarding sec. 100 German Stock Corporation Code does not hold the same weight with regard to the SSB. The workload of members of an SSB is not as extensive as the one of a regular Supervisory Board member. However, holding 85 mandates is undoubtedly an excessive workload; even for hardworking and efficient people. More importantly, a clear rule regarding the prevention of conflicts of interest must be added to German Supervisory Law. If a scholar within the SSB is only concerned with the certification of Islamic financial products or the business process of an IFI, there is no need to ban him from holding a membership in the board of a competing Islamic financial institution. However, if the advisory function of the SSB plays an important role, rules of incompatibility in regard to a membership in SSBs of competing institutes need to be established. The advisory function should primarily be fulfilled by the internal Sharia Compliance Department or Officer and not, or at least not primarily, by the external SSB. 37 For more details see Casper (2014), p. 41, 53 et seq. For more details on this aspect, that an is an important point from the view of Corporate Governance for IFI, see Casper (2014), p. 41, 51 et seq. 39 See report by funds@work, The Small World of Islamic Finance - Sharia Scholars and Governance, 19 January 2011, http://www.funds-at-work.com/uploads/media/ShariaNetwork_by_Funds_at_Work_AG.pdf_03.pdf. 40 See e.g. Deutscher Juristentag (ed.), Beschlüsse der wirtschaftsrechtlichen Abteilung des 69. DJT No. 18, available under www.djt.de. 38 12
16. Another point in the debate on Corporate Governance for IFI is the role of the internal Sharia Compliance or Review . According to the AAOIFI Standards “the internal Sharia review shall be carried out by an independent division/department or part of the internal audit department, depending on the size of an IFI. It shall be established within an IFI to examine and evaluate the extent of compliance with Islamic Sharia rules and principles, fatwas, guidelines, and instructions issued by the IFI’s Sharia supervisory board” (No 3. sub 2 part 1).” From the German or European Perspective there is no such obligation. But every IFI located in the EU has the obligation to establish a regular Compliance Department as governed by Art. 13 MiFID, sec. 25c para 1 KWG German Banking Act or section 33 German Securities Exchange Act (WpHG). As regular Compliance and an internal Sharia Compliance are not the same, the crucial question is whether the Sharia compliance function can be embedded in an existing regular Compliance Department. To answer this question one has to be aware of three basic requirements for a regular Compliance Department stipulated in section 33(1) cl. 2 no. 1 of the WpHG. This section calls the Compliance Department a “compliance function” without drawing a distinction. Thereafter, the Compliance Department of investment services companies must meet three criteria: independence, effectiveness and permanence. 41 Today it is widely accepted that independence does not mean independence from the management board, but only from other persons within the company as Compliance is a task of the management.42 The management board is responsible for the whole enterprise including compliance to all legal duties and therefore to the Compliance Department as well. Consequently, the question about the role of an internal Sharia Compliance Department and its influence on the management board must be brought up. If the SSB’s decision has no binding effect and no direct influence on the Sharia Compliance Department and if this is subordinated to the management board, there is no reason why the internal Sharia Compliance Department cannot be embedded into the regular Compliance Department. Yet this question can only be answered with respect to the specific circumstances and guidelines of the Islamic Financial Institution (IFI). Therefore, another rule within the AAOIFI Governance Standards could be problematic: “The primary objective of the internal Sharia review is to ensure that the management of an IFI discharges their responsibilities in relation to the implementation of the Sharia rules and principles as determined by the IFI’s SSB.” (No. 3 sub 2 part 2). “They shall have direct and regular communications with all levels of management, SSB and external auditors, which shall enhance the organizational status of the internal Sharia reviewers.” (No. 3 sub 7). This statement could potentially conflict with the independence of the management board from the SSB. On the other hand, the principles of the AAOIFI clarify: “The head of the internal Shari’a review shall be re41 With regard to the general debate on Corporate Compliance and Corporate Governance see Casper (2017), p. 477 et seq. 42 Casper (2017), p. 477, 481 et seq. 13
17. sponsible to the board of directors .” (No. 3 sub 7). And further it is pointed out that “[t]he head of the internal Shari’a review shall discuss conclusions and recommendations with appropriate levels of management before issuing a final written report.” (No. 3 sub 20). This report has to be written four times a year and is addressed to the SSB as well. To our understanding, these last two statements of the AAOFIF confirm that, even according to the principles of the AAOIFI, the internal Sharia Compliance Department falls under the responsibility of the Board of Directors or the two boards in the two-tier system. As long as the Sharia Compliance Department does not function as the SSB’s extended arm and as long as it does not automatically report potential breaches of Islamic law directly to the SSB before having informed the management board, both kinds of Compliance Departments may be merged together. However, clear guidelines for the Compliance Department ought to be written down as a precautionary measure. They shall set out the differences between actions triggered by a breach of public and religious law as well as the reporting structure and the relationship between internal Sharia Compliance Department and the SSB. This section’s subject matter was whether German Corporate Governance might be a legal obstacle for Islamic Banks in Germany. As long as the aspects mentioned above are taken into account, a SSB as well as an internal Sharia Compliance Department may be brought in line with the German requirements for good Corporate Governance. Therefore German Company Law is no legal obstacle for IFI. 14
18. 3 .3. German Contract Law As mentioned before, financial contracts between an IFI and their customers are not governed by Islamic Law. From the perspective of German International Private Law, this would not be possible either. At least the wide majority of German Scholars argues that only the parties may choose the state made law of another state, but not religious law. 43 Therefore, the IFI have mutually agreed upon German Contract Law as the jurisdiction to govern the interpretation and enforcement of the terms of their contracts. German Contract Law is neutral to the beliefs and the religious or ethical background of of the contracting parties. But due to German Civil Law’s principle of freedom of contracts the parties are free to implement this background into the contract, in particular if they use contract templates issued by the AAOIFI or the IFSB, as long as these provisions are in accordance with the mandatory civil law. 44 Since there is no uniform interpretation of the Sharia a product might be tested on its Shariaconformity (so called Sharia Risk). This question has also been widely discussed under the catchphrase “Sharia Trap”. There is no need for this article to go into more details. We leave it at summarizing the results of studies of Co-Author Casper. The religious background of a contract is not necessarily the basis of the transaction in terms of sec. 313 German Civil Code. 45 The interpretation of the contract must take the religious background of the parties into account. Oftentimes, this shows which party bears the risk of the contract’s potential nonconformity with Islamic Law. In this context, it is generally not appropriate for only one party to bear this risk on its own. In case of financial products, e.g. a sukuk, prospectus liability can be triggered. If a costumer blames his Islamic Bank for the financial product’s lacking alignment with Islamic law following the signing of the contract, prospectus liability should be confined to extreme cases of obvious breaches of the Sharia principles. An indemnification clause or alternatively a disclaimer may be acceptable if the classification by the SSB is a legitimate interpretation within the commonly accepted boundaries of Islamic law. Prospectus liability does not apply when the assessment of a product’s Sharia compliance changes during the duration of the contract. In this case the IFI is only liable for a breach of contract if the change was predictable and if the investor suffers a financial loss from this exact change. 46 To put it in a nutshell, German contract law poses no legal obstacle for Islamic Finance in Germany. 43 Form the German Perspective Bälz (2005), p. 44, 45 with further references; from the international Perspective Junius (2007), p. 537, 546 et seq. 44 For more Details see Casper (2011a), p. 251, 256 et seq. 45 For more Details see Casper (2011a), p. 251, 260 et seq. 46 For more Details see Casper (2014), p. 41, 55 et seq. 15
19. 3 .4. Double Tax in the case of a murabaha German Tax law is equally neutral to the religious or ethical background of a contract. But due to the structure of a murabaha, which can be described as a double purchase transaction47, taxes may pose a reason to hinder a murabaha or make it at least much more expensive. To some extent, this problem can be solved in the context of the value added tax (VAT). If the net price of the financed good the bank has to pay for on first purchase is e.g. 1.000; the bank has to pay a VAT of 19% to the seller (190). By selling the same good to its costumer with a surplus of – let’s say – 200 to the net price, the customer has to pay VAT on 1.200, which means 228. The bank may deduct the VAT it had to pay to the seller from this sum, the so-called value added tax on input (Vorsteuer). Therefore additional VAT due the structure has only to be paid on the surplus. In our example the additional VAT is 38. Therefore the VAT presents no serious obstacle to financing goods with a murabaha instead of the conventional loan with interest, although the debtor does not have to pay VAT on the interest of a loan. However, this system does not work in the context of the stamp duty land tax for real estate (Grunderwerbsteuer). The German Act on land transfer tax knows no deductible input tax. In our example above the bank would have to pay the full stamp duty land tax on the 1.000 and the costumer then again on the 1.200. 48 This problem does not only accrue in Germany. The British legislator has solved this problem in 2003. Ever since, the stamp duty land tax in a murabaha transaction has to be paid only once by the customer of the bank. 49 The German Legislator has not recognized this problem yet or at least has seen no reason to act and exempt the murabaha from the double stamp duty land tax. But as we will show in the further course of our case study, this double taxation can be legally avoided by using a diminishing musharaka in form of a partnership under German civil law. 47 Ayub (2007), p. 217 et seq; El-Gamal (2006), p. 65 et seq; Thurner in: Ebert/Thiessen (2010), p. 146 et seq; Casper (2010b), p. 345, 354 et seq. 48 The rate of the stamp duty land tax in Germany varies in the different federal states between 3.5% and 6.5%. 49 For details see Nethercott and Eisenberg (2012), recital 4.157; Ercanbrack, Regulation financial institution in the UK, in: Cattelan (2013), p. 157, 165. 16
20. 4 . The German KT Bank: A case study 50 2015 was a crucial year for the development of the Islamic Finance industry in Germany. It was marked by the debut of the first Islamic bank, the Kuveyt Turk Bank AG (in the following KT Bank). Authorized by the BaFin as a credit institution subject to the German supervisory law, the KT Bank aims to offer complete financial products and services compatible with the principles of the Islamic Law (the Sharia) and the principles of good management. As the KT Bank is pointing out on its website, it aims to be one of the Eurozone’s leading banks by offering services to everyone, regardless of religious faith. The KT Bank presents itself as a bank for the Muslim community and for all those who wish to invest in a sustainable and socially responsible manner.51 In a long run, the KT Bank wants to offer “Islamic Finance made in Germany”. 4.1. Foundation, legal structure and financial background The “KT Bank AG” was founded as a stock corporation under German Law (Aktiengesellschaft, AG) in November 2014. It is a 100% subsidiary of Kuveyt Türk Katılım Bankası A.Ş. located in Istanbul, which has been operating for nearly 30 years. The majority of the parent company’s shares are owned by the Islamic Bank Kuwait Finance House (KFH), which was founded as the first Islamic Bank in Kuwait in 1977. As mentioned before (see above 2.) the Kuveyt Türk Katılım Bankası A.Ş. had already opened a representative office in Mannheim in 2004, offering ethnic services related to the transfer of money from the Germany Turkish community to their families in Turkey and was eventually granted a limited license for non-EEA deposit broking in 2010. The incorporation of the KT Bank as a fully flagged Sharia compliant bank took place after overcoming several difficulties, mainly related to the corporate governance specificity characterizing the Islamic Banking model (in particular the presence of the Sharia Supervisory Board) and their subsequent integration in the German regulatory framework. Regulatory difficulties and specificities of the Governance structure will be discussed in the section about the KT Bank’s corporate governance structure (4.4.). Moreover, the different product categories on the assets and liabilities side have been subject to scrutiny by the regulator. 50 Our case study is based on questionnaires and an interview administered to the KT Bank AG Frankfurt’s Branch and on information can be found on the bank’s website. The authors are very thankful to Mr. Ibrahim Bilgin, Head of AML & Compliance at KT Bank AG for answering the questionnaire and additional questions. 51 See https://www.kt-bank.de/ueber-uns/kt-bank/. 17