Introduction

This Newsletter is directed at Gibraltar regulated firms intending to conduct Islamic financial services. Its purpose is to explain the FSC’s intended approach in respect of the offering of Islamic financial services in Gibraltar.

This Newsletter does not purport to establish requirements nor act as formal guidance. It aims to put forward the Commission’s approach to this area as well as matters firms should consider when offering such products or services.

The Newsletter is focused on those dealing with clients for such products/services.

Background

Islamic finance refers to financial transactions which are in accordance with the principles of Islam or Sharia.

Sharia is the legal framework within which the public and private aspects of life are regulated for those living in a legal system based on Islamic principles of jurisprudence and for Muslims living outside the domain.

These principles are applied to the provision of financial services. The Islamic financial framework mainly rests on the following principles:

● prohibition on payment or receipt of interest;

● prohibition of uncertainty or speculation;

● prohibition of financing certain economic sectors that are “haram” or prohibited  under the principles of Islam such as gambling, pornography, alcohol or armaments;

● principles of profit and loss sharing whereby the risk of all financial transactions must be shared and made aware at the outset;

● asset-backing principles whereby all financial transactions should be underpinned by identifiable and tangible underlying assets.

A number of countries most of which are traditionally non-Muslim have implemented legislation and established a series of regulatory measures to allow the introduction of Sharia compliant financial products and services.

FSC involvement with Islamic Finance Firms are reminded that where they intend to provide Islamic financial services in addition to their existing authorisation, they should first communicate such intention to the Commission prior to commencing this business line, as the offering of such services is considered by the Commission as a change to a firm’s business plan.

Firms which are not permitted to conduct financial services in Gibraltar should refer to the FSC website for further information relating to the provision of financial services in Gibraltar and the application process. At this point in time the applicant should also inform the Commission of its intention to offer Islamic products or services.

The FSC, in common with many other regulators, neither has nor professes any specific competence concerning Sharia compliant financial products and services. This Newsletter therefore focuses upon the principle of disclosure.

The principle of disclosure requires that investors and potential investors are provided with sufficient information to enable them to make an informed decision as to the suitability of the product or service for their own requirements.

To achieve this, the Commission expects that, as with other products or services, the promotion of the product or service provided by the authorised firm should be clear, fair and not misleading. This is vital as users may not be familiar with Islamic-related products and/or may be relatively inexperienced in financial services.

It should be noted that the comments contained within this Newsletter are supplemental to existing regulatory requirements and regulations and DO NOT replace them. Furthermore, the Commission would like to state that firms wishing to provide products or services which are Sharia compliant are authorised and supervised in exactly the same way as other firms and there is no separate licensing regime.

Nevertheless, where a firm seeks to hold itself out as providing Sharia products or services the Commission will expect the firm to:

● Evidence what systems and controls they have in place to ensure that the products or services they offer are Sharia compliant.

● Show that the role and responsibilities of any Sharia Supervisory Board (“SSB”) are advisory and does not interfere in the management of the firm to the extent it might be considered to be part of the mind and management of the firm. Likewise provide information pertaining to:

• The composition of the SSB.
• Brief details about the experience of each of the Board member.
• The frequency in which the SSB meets to review whether the product or service continues to comply with the requirements of Sharia law.
• The reporting lines between the SSB and the authorised firm

The FSC cannot and does not intend to give guidance on Sharia principles, nor on whether particular products are Sharia compliant as it would be inappropriate for the FSC to judge between different interpretations of Sharia law. Such a task lies with the Sharia Supervisory Board. Therefore, it is important for the FSC to know from a financial and operational perspective the exact role of the Board.

The Commission encourages firms seeking to provide Sharia compliant products or services to recruit more staff/advisers who possess a general understanding of Sharia law due to its complexity in its interpretation. Possessing the adequate knowledge of Sharia law would assist the firm in identifying a product’s potential non-compliance with Sharia at a much earlier stage.

Disclosures

Firms who provide Islamic financial services have to comply with the relevant requirements established by the necessary legislation under which it is authorised to conduct financial services. However it is expected, where there are no prescribed requirements specific to disclosures to clients, that the firm takes into consideration that the structure and set-up of the Islamic products or services vary from more conventional products. The following outlines a number of examples highlighting expectations as to the information firms are to make available to prospective clients.

However this is not exhaustive and therefore the firm should ensure at all times that the client is furnished with the necessary information to be able to make a well informed decision.

From the onset of the client relationship there is an overall principle, namely to ensure that the information provided is clear and not misleading, and in order to avoid any misconceptions the client should be made aware of any variations to the product set-up or service offered which differ form the equivalent conventional product.

Therefore a firm should provide clear information including any clauses which the client should be specifically aware of due to the different nature of the product when compared with more conventional ones. Again the emphasis is that the client should be in a position to make a well informed decision by understanding the product/service being offered prior to its purchase.

Furthermore firms should disclose to potential consumers the basis on which it claims its services and/or products are Sharia compliant and how the product is monitored on an ongoing basis to ensure continued compliance with Sharia throughout the product life cycle. This would most likely include details on the SSB and their involvement in the review and details of systems and controls to ensure ongoing monitoring of theproduct’s compliance with Sharia law. Where the SBB or scholars provide services to other institutions, the firm must assess whether such arrangements lead to a possible conflict of interest and, if so, ensure that this is disclosed appropriately.

Where the product/service offered is in compliance with the standards set by the International Islamic Setting Bodies such as AAOIFI, IFSB and IIFM1, this should also be disclosed.

Consideration must also be given to the fact that many of the products are still comparatively new, their structure different from more conventional products and the current level of consumer understanding may be lower than for conventional products.

Furthermore, by its very nature, Sharia products have more restrictive investment criteria than many conventional products. This reinforces how important it is when promoting Islamic financial products to include detailed information on the risks as well as the benefits.

Where a firm provides investment advice the client should be informed of any limitations which they may face by investing in the product. For example, where the number of Islamic products is still comparatively small, the client may not have the range of choices which might otherwise also be suitable to meet the client’s profile and investment objectives. Likewise consideration should be given to the level of potential risks (including liquidity risk where appropriate) involved as a result of extra limitations of a product and this should be communicated to the client accordingly.