The new UAE banking law and its impact on Islamic Finance

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1. IFN SECTOR CORRESPONDENT The new UAE banking law and its impact on Islamic ϐinance LAW By Dr Nicolas Bremer In late 2018, Federal Law 14/2018 Regarding the Central Bank and Organization of Financial Institutions and Activities entered into force. The new law includes regulations for both the conventional and the Islamic financial industries. With respect to the Islamic finance industry, the most significant aspect of the new law is the establishment of the Higher Shariah Authority (HSA), which will oversee Shariah compliance in the UAE. As such, the authority’s designated purpose is to foster greater transparency and standardization in the UAE Islamic finance market. The new law applies to Islamic finance institutions regulated by the central bank and does not apply to the free zone entities. Thus, the law does not regulate financial institutions that operate within the financial free zones such as the Dubai International Finance Centre and Abu Dhabi Global Market. Pursuant to the new law, all Islamic financial institutions operating on the UAE mainland must establish an independent internal Shariah supervision committee. These committees shall set procedures for their institutions and supervise their activities to ensure that they comply with Shariah principles and the standards established by the HSA. As part of its duties, an institution’s independent internal Shariah supervision committee shall prepare an annual report at the end of the fiscal year of the institution, which shall review the institution’s activities with respect to their compliance with Shariah principles. In particular, the report shall address: (1) the extent of the committee’s independence, (2) the institution’s policies and procedures and their compliance with Shariah principles, (3) the distribution of profits and losses and their compliance with the opinions issued by the committee, (4) any breaches of Shariah principles, and (5) any measures imposed by the HSA in respect of such infringements. The new law addresses the constitution, operation and powers of the HSA. As © a regulatory authority, it determines the rules, standards and principles governing Islamic finance institutions and their activities. Furthermore, the authority supervises the independent internal Shariah committees of Islamic finance institutions. Fatwas and opinions issued by the authority are binding on Islamic finance institutions and their internal Shariah committees. To date, the HSA has issued relevant resolutions for Islamic finance institutions operating on the UAE mainland. In particular, the authority has taken steps to standardize Shariah compliance standards in the country. One of its first resolutions was to compel Islamic finance institutions to conduct their business in line with Shariah standards as issued by AAOIFI. While AAOIFI standards are widely known in the industry, prior to this resolution of the HSA, UAE-based Islamic finance institutions were free to evaluate and determine the Shariah principles that they would abide to through their Shariah boards. The mandatory application of AAOIFI standards is a much appreciated step toward standardization and increased transparency that may aid in building trust in the Islamic finance industry. Furthermore, the HSA passed two resolutions addressing bulk financial products, thus products are offered without the option to individually negotiate their terms. New financial products have to be approved by the authority prior to their issuance. Existing financial products will have to be brought in line with AAOIFI standards by the end of 2020 and Islamic finance institutions will have to prepare a report on the variations made to existing products to comply with AAOIFI standards. Hence, UAE-based Islamic finance institutions will have to review and revise their financial products with respect to AAOIFI standards, thereby raising the standard of Shariah compliance throughout the industry. These steps will likely build further trust in Islamic finance products issued in the UAE, since these will now be verified 20 and approved by a central supervisory body instead of by independent Shariah boards only. The negative impacts of practices such as Shariah shopping will be significantly limited. Individualized offerings, which are individually negotiated — such as syndicated Islamic financing and Sukuk transactions — do not require approval by the HSA. Still, Islamic finance institutions must ensure that the structure and documentation of any transaction are compliant with AAOIFI standards. While this requirement of AAOIFI compliance will raise the standards for individualized Islamic financing transactions, it should be noted that AAOIFI standards are not prescriptive in nature but rather provide guidance and principles which should be followed. Thus, with respect to individualized offerings, Islamic finance institutions still retain considerable freedom to shape their products. This is somewhat disconcerting since Sukuk in particular have been highly criticized for their low standards of Shariah compliance. While the full impact of the new law cannot be assessed at this stage, its regulations will significantly raise transparency and Shariah compliance in the (onshore) UAE Islamic finance industry, at least with respect to bulk financial products. Furthermore, UAE-based Islamic finance institutions must revise their existing product offerings, governance regulations, documentation, current and forthcoming transactions and also their auditing and reporting standards. Overall, the new law marks a significant step toward professionalization and sound regulation of the onshore Islamic finance industry in the UAE. It remains to be seen how the financial free zones will react to this new development. Dr Nicolas Bremer is a partner at Alexander & Partner. He can be contacted at nb@ alexander-partner.com. 19th June 2019