Published date01 December 2020
Date01 December 2020
AuthorMohd Zawawi SALLEH LLB (Hons) (Mal), LLM (Bristol); Judge, Federal Court of Malaysia. Mohd Johan LEE2 LLB (Hons), MCL (International Islamic University Malaysia), MA (Econs) (King's College London), PhD (Monash); Advocate and Solicitor (Malaya); Syarie Lawyer; Advocate and Solicitor (Brunei).

Since the introduction of Islamic finance in Malaysia three and half decades ago, the Malaysian judiciary has been confronted with various legal issues involving Islamic finance. While it is not the purpose of the article to provide an exhaustive list of decided cases1 in chronological order, the aim is to highlight the main issues impacting the practical aspects in the Islamic finance industry, namely, the issues of ibra' (waiver), late payment charges, reference to the Shariah Advisory Council, enforceability of non-Shariah-compliant contracts and sukuk default. This is done through an analysis of reported court cases by the Superior Courts. It is found that the courts have adopted a pragmatic approach in dealing with Islamic finance matters of practical importance, hence providing clarity and certainty to the industry players.

I. Introduction

1 Since its introduction in the 1980s, Islamic finance3 in Malaysia has continuously developed into a sophisticated sector, providing

a competitive and resilient component of the global financial system. Founded on Shariah principles, the central feature of Islamic finance is the prohibition of payment and receipt of riba (interest). Other distinctive features are the prevention of ambiguity (gharar) in contracts, the prohibition of gambling (masyir),4 the prohibition of conducting economic or investment activities which are ethically and socially unacceptable (such as casino, pornography, alcohol and prostitution), the introduction of alms-giving (zakat)5 and the sharing of risk and profit by parties in the transaction.6

2 Compared to conventional banking and finance where the banker/financier–customer relationship is a creditor/lender–debtor/ borrower relationship, the banker/financier–customer relationship in Islamic finance can take different forms based on the contracts entered into by the Islamic financial institution (“IFI”) and the customer. These contracts may take the form of bai' al 'inah (sale and buy-back agreement), bai bithaman ajil (“BBA”) (deferred payment sale), mudharabah (profit-sharing loss-bearing), murabahah (cost plus), musharakah (partnership/ profit and loss-sharing), ijarah (leasing), wakalah (agency) and sukuk (Islamic bond).7

3 Such an approach, much as it might seem unsustainable in the complex world of modern finance, proves to be otherwise. According to the 10th Global Islamic Finance Report 2019, the estimated figure for the

global Islamic financial industry at the end of 2018 was US$2.6trn after recording a growth of 6.58%.8 Domestically, Islamic finance is reported as continuing to anchor the growth of the overall Malaysian banking sector, expanding at a much faster pace than conventional loans in 2018 at 11.0% (2017:10.3%) in contrast to the latter's 3.3% growth. As of January 2019, Islamic finance comprised some 32% of the overall system's loan.9 In the area of capital market, Malaysia continues to be the main driver for the sukuk market and represented 49.7% of the total global outstanding sukuk which stood at US$466.8bn, as at the end of 1H2019.10 The nation's sukuk market is largely driven by corporates and government-related entities at 66.8% and has been a viable funding tool for various mega infrastructure projects.11 By numbers of funds, Malaysia ranked first (28.3%) with 430 of the total global number of funds, followed by Saudi Arabia (203), Luxembourg (202), Pakistan (180) and Indonesia (174).12

4 Ranked as a leader among 56 countries for Islamic finance institutions,13 Malaysia has successfully established a mature and robust Islamic regulatory framework and pioneered the dual banking system, wherein both Islamic and conventional financial systems operate and co-exist within a single regulatory framework. This has partly generated a vibrant business environment for financial institutions, intermediaries, investors, issuers and service providers alike.

II. Legislative and regulatory framework on Islamic finance

5 There are three major categories under Islamic finance, namely, Islamic banking, Islamic capital market and takaful (Islamic insurance). Each of these businesses is regulated by a separate written law.

A. Islamic banking and takaful

6 The first legislation enacted to facilitate the infrastructure and operations of Islamic banking in Malaysia was the Islamic Banking Act 198314 (“IBA 1983”). In compliance with the interest-free principle, an amendment was also made to the Government Investment Act 198315 to facilitate both statutory reserve and liquidity reserve requirements, which are to be interest-free. The Takaful Act 198416 (“TA 1984”) was enacted to allow the licensing and operation of Islamic insurance or takaful companies in Malaysia. In 1996, s 124 of the Banking and Financial Institutions Act 198917 (“BAFIA 1989”) was amended to allow conventional banks licensed under the Act to introduce Islamic banking business.

7 In 2003, the IBA 1983 was amended by inserting s 13A which provided that an Islamic bank may seek the advice of the Shariah Advisory Council (“SAC”) of the Central Bank of Malaysia (“BNM”) on Shariah matters relating to its banking business and that the Islamic bank shall comply with the advice of the SAC. The inclusion of s 13A enables the Islamic banks to seek the advice of the SAC and it is mandatory for the Islamic banks to comply with the advice given by the SAC pursuant to such request.

8 Another important piece of legislation in Islamic finance was the Central Bank of Malaysia Act 195818 (“CBMA 1958”). In 2003, an amendment to the then CBMA 1958 was made and through s 16B(1), the SAC was established under the aegis of BNM. The SAC functions as a body that ascertains the matters relating to Islamic banking business, takaful, Islamic finance business, Islamic development finance business or any other business based on Shariah principles.19

9 In 2009, Parliament passed a new Central Bank of Malaysia Act 200920 (“CBMA 2009”). The new CBMA 2009 deals in detail with the establishment and roles of the SAC and fills the lacunae in the previous CBMA 1958 where only one section dealt with the SAC. Section 52 of the CBMA 2009 outlines the functions of the SAC when reference to it is made by bodies other than the bank, including the court and arbitrators. The new ss 56 and 57 of the CBMA 2009 substitute the word “may” with

the word “shall” which makes it compulsory for the court or arbitrator to refer to the decision of the SAC as expert evidence in court under s 45 of the Evidence Act 1950.21 Section 57 of the CBMA 2009 expressly provides that any ruling made by the SAC pursuant to a reference by the court or arbitrator shall be binding.

10 Further development in the legal framework of Malaysia's Islamic financial system is seen in the enforcement of the Islamic Financial Services Act 201322 (“IFSA 2013”). This legislation replaced the IBA 1983, the TA 1984 and the BAFIA 1989. In concert with the needs of the industry, this law provides BNM with the necessary regulatory and supervisory powers to fulfil its broad mandate within a more complex and interconnected environment, given the regional and international nature of financial developments. The law is expected to place Malaysia's financial sector on a platform for advancing forward as a sound, responsible and progressive financial system. In describing the whole idea of the IFSA 2013, Datuk Nor Shamsiah Mohd Yunus, (the then) deputy governor of BNM,23 who was instrumental in the development of the IFSA 2013, summarised the key features of this Act as follows:24

The emphasis on governance framework for an end-to-end Shariah compliance for Islamic financial institutions under IFSA 2013 is a key additional dimension of the regulatory framework for Islamic finance and substantially increases the level of transparency required. In particular, IFSA provides a comprehensive legal framework that is fully consistent with Shariah in all aspects of regulation and supervision, from licensing to the winding up of Islamic financial institutions. More importantly, IFSA provides the statutory foundation for a Shariah contracts-based regulatory framework in a manner that would facilitate the next level of Islamic banking business, transcending beyond financial intermediation to include real economic sector participation, complete with the consequent regulatory checks and balance. Such a distinctive regulatory approach seeks to realise further the value proposition of Islamic finance, as the industry advances towards a new level of maturity and sophistication.

11 As the primary source of legislation governing the licensing and operation of Islamic and international Islamic banking businesses conducted by financial institutions, the IFSA 2013, together with the guidelines and circulars issued by BNM,25 contains extensive provisions

on end-to-end Shariah compliance, governance and enforcement, which include the following basic premises:

(a) establishing BNM as the Shariah regulator over the financial sector;

(b) providing the legal basis for the rulings of BNM's Shariah Advisory Council (“BNM SAC”);

(c) prohibiting financial institutions that conduct Islamic and international Islamic banking businesses from carrying out non-Shariah-compliant activities; and

(d) empowering BNM to direct and penalise financial institutions for breaches of the IFSA 2013 and offences committed thereunder.26

12 Under the IFSA 2013, BNM was conferred regulatory and supervisory powers and was also empowered to issue guidelines and circulars on Shariah requirements to promote financial stability and ensure Shariah compliance. Following therefrom, the IFSA 2013 provides that the operations, structure, and the terms and conditions of Islamic financial products and services provided by financial institutions must be Shariah-compliant. Any entity that conducts Islamic banking business or international Islamic banking business must possess the...

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