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Recent Developments in UAE Islamic Banking

Guiding Principle
Islamic Banking and Finance is a topic of constant attention and many banks in the UAE do define themselves as Islamic. As certain structural changes in the Islamic banking sector in the UAE might be about to happen, the Islamic banking system in the UAE shall be presented and possible changes shall be assessed.

A. Introduction
In the style of a 21st Century Pop Star HH Sheikh Mohammad released the following tweet on Twitter on May 8, 2016 2:20 AM:
“We sanctioned the initiation of a Higher sharīʿa Council for financial and banking transactions in the state, to set standards and to overlook the sharīʿa boards of Islamic banks and financial institutions.”
The statement triggered a widespread response of followers on Twitter and in the local Arabic press during the following days. Ranging from a short and simple “OK” to calling the announced decision one of “strategic” dimensions.
This article would like to take this recent happening as triggering event to assess the Islamic banking system in the UAE and discuss possible consequences of the decision announced by his HH Sheikh Mohammad.
Therefore firstly, a short overview of the banking system in the UAE and its main legal pillars shall be given, followed by a brief introduction into Islamic finance and its main legal and sharīʿa features. Based on all this and finally the announced decision of HH Sheikh Mohammad shall be discussed in a number of possible scenarios.
B. The Basic Structures of the Banking System in the UAE
Banks do form a significant sector of the UAE’s economy as impressively underpinned by the 2016 Forbes Ranking of the World’s Biggest Public Companies. Half of the listed 14 UAE companies in the ranking are banks and with regard to assets the top five of the ranking are comprised of banks.
Concerning the legal regimes of banks and financial institutions, the first differentiation has to be made along geographical boundaries: Many of the banks in the UAE operate out of financial free zones, most notably the DIFC in Dubai but also ADGM in Abu Dhabi. Here special legislation applies that differs to a reasonable extent from the mainland legislation this article will focus on.
Mainland banking activities shall be taken into account from three different angles:
• Firstly the corporate aspect which focusses on the entity of the bank itself as a legal person and the legal regime that governs it;
• Secondly the regulatory aspect which revolves around the banking supervision and the government entities regulating banking operations in the UAE; and
• Thirdly the legal regime that governs the relations between the banks and its customers in everyday business.
   I. The Corporate Law Aspect
Most legal persons in the UAE are incorporated under the Federal Law 02 of 2015 on Commercial Companies (Commercial Companies Act) which has just recently been newly legislated in 2015. From the multitude of company types set out in this law only one suits for the incorporation of a commercial bank. Art. 79 (1) of the Federal Law 10 of 1980 on The Central Bank, the Monetary System and the Order of the Monetary Profession (UAE Banking Law) requires all commercial banks to be set up as public stock companies under the UAE Commercial Companies Act. This obligation explains, amongst other factors, why so many banks can be found in the aforementioned Forbes list of Public Companies.
It also means that largely commercial banks are subject to provisions of the Commercial Companies Act just as any other publicly listed stock company. This includes in particular the 51 percent ownership rule of UAE nationals as set out by Art. 10 (1) Commercial Companies Act as well as the monistic administrative structures characterized by a board of directors responsible to the general assembly of shareholders. An institution such as a supervisory council to control the board as e.g. the Aufsichtsrat in German public stock companies not exist. Again the nationality rules of the Commercial Companies Act come into play providing for the majority of board members and the president to be of Emirati nationality (Art. 151 Commercial Companies Act). A number of executive officers who have delegated competencies from the board regularly assumes the everyday management of the company. In comparison to a German Vorstand they are not an independent corporate body with statutory rights and duties. In many cases, these officers are not of Emirati nationality but do act as the major decision and management center of the corporation as prominently illustrated by the case of Shayne Nelson, CEO of Emirates NBD . In this context it might be interesting to note, that the new UAE Commercial Companies Act foresees sharīʿa boards for Islamically managed companies (e.g. Art. 132 (6), 177 (4) Commercial Companies Act) without defining their position and competences in the corporation.
This general corporate legislation takes a modified shape in the case of UAE banks, as a considerable amount of legal prescriptions alter or abrogate the provisions of the Commercial Companies Act. A very prominent one is Art. 6 Commercial Companies Act. Here banks and financial companies are exempt from the governmental supervision of the Ministry of Economy, which shows that banks even in corporate issues fall under a special supervisory regime. In the UAE, this is predominantly exercised by the Central Bank of the UAE. Furthermore, additional demands are established concerning the criminal record of bank managers and personal incompatibilities (Art. 93 UAE Banking Law). A further field of special legislation concerning commercial banks are stricter provisions on capital and reserves, which have to be provided (Art. 79-82 UAE Banking Law). In addition, any changes made to their memoranda or articles of association are subject to approval of the Central Bank. Moreover, the winding up of commercial banks is subject to special provisions as defined in Art. 108 – 111 UAE Banking Law.
   II. The Regulatory Aspect
As already indicated the main – though not sole – regulatory body for commercial banks is the Central Bank, which exercises its respective powers predominantly through the Banking Supervision and Examination Department (BSED), one of its seven departments. The first and most important condition to operate a commercial bank is a banking license issued by the competent authority within the Central Bank (Art. 83 (1) UAE Banking Law). A similar license is needed, when a branch of a foreign bank strives to take up commercial bank activities in mainland UAE. Furthermore licenses must be obtained for mergers or closing of commercial banks. Following their licensing, commercial banks are enlisted in a special register. In a number of cases, the Central Bank may erase the commercial bank from the register, which resembles the withdrawal of a license. Furthermore, a number of activities most notably industrial and commercial activities as well as the purchase of shares are limited to a large extent by the UAE Banking Law. Violations of these legal stipulations give regulatory authorities an additional power to discipline commercial banks accordingly (Art. 112 UAE Banking Law). Furthermore the Central Bank is widely entitled to regulate generally and specifically on commercial banks (e.g. Art. 95, 96 UAE Banking Law) and to control the banks accordingly through the BSED (Art. 99, 100 UAE Banking Law).
Alongside this general regulatory system, the UAE Banking Law provides for a number of special provisions in the field of accounting and statistics (Art. 101 – 107 UAE Banking Law).
It should be mentioned that as far as the UAE Banking Law itself goes, the aforementioned regime concerning corporate and regulatory aspects is only applicable to commercial banks. By virtue of Art. 3 Central Bank Board of Directors Resolution No. 21/2/88 the vast majority of rules applicable to commercial banks are applicable to investment banks as well.
Another main area of regulative activities in the UAE banking system stretches onto the field of combating money laundering. Though this area of regulatory activity is highly dynamic in its development at present, it shall be not taken into account in this article, as it has little to no connection to explaining the system of Islamic banking and finance in the UAE.
   III. The Legal Regime in Relation to the Customer
Banking transactions between bank and customer are in general private law contracts. Thus in some countries like Germany they can be found directly in the Civil Code. The UAE however have taken a different approach and legislated banking transactions as third book of their Commercial Code. The UAE Commercial code regulates such transactions as deposits and transfers (Art. 371-389 UAE Commercial Code), current accounts (Art. 390-408 UAE Commercial Code), loans (Art. 409-439 UAE Commercial Code) including credits, bank guaranties, credit facilities and letters of credit as well as transactions on commercial (Art 440-449 UAE Commercial Code) and financial instruments (Art. 450-477 UAE Commercial Code). For some of these transactions the law expressively states them to be of commercial nature even when they should appear in a b2c relation.

C. The Islamic Finance in Theory and In The UAE Legal Framework
After looking at the core legal stipulations concerning the UAE’s banking system, it should be examined what makes Islamic finance Islamic finance in the UAE. So firstly, an insight shall be given into the main concepts of Islamic law concerning financial transactions, before we consider how the UAE law transfers these concepts into its legal system.
   I. Main Sharīʿa Concepts Applicable to Financial Transactions
Whereas the literary meaning of sharīʿa is “the physical access to drinkable water” , as a legal term it is quite commonly defined as “the rules and regulations governing the lives of Muslims” . So sharīʿa is the term used for the sum of all transcendently given rules regulating the life of Muslims in relation to God and between humans. This term though neither explains what rules there are nor how they are derived and from what sources. The knowledge of these rules is described as fiqh in Arabic, whereas sources and methods of deriving are tackled by the discipline of uṣūl al-fiqh, which evolved mainly out of the fiqh. Given this complexity, it is not surprising, that a number of different approaches and opinions with regard to the sharīʿa developed. The main views today in sunni Islam accumulate in four legal schools, the so called madhāhib (sg. madhhab), yet this does not mean that there can still be a number of different views when it comes down to a single rule between fiqh scholars.
On the other hand, it can be noticed, that the sharīʿa as described here is a system, which is predominantly connected to the single Muslim and can be utilized by him in order to determine his individual ethical standpoints and values. So legislature of states can include sharīʿa rules in varying degree and context. In most states of the Arab world today, the sharīʿa is applied in the framework the law has ordered for its application. An exception to this is mainly Saudi-Arabia, where the sharīʿa still directly applies and legislative acts of the government are subject to it. Also many states use sharīʿa generated rules and concepts as source of inspiration for their laws and let the sharīʿa be one of the major guidelines for interpretation of codified law (cf. Art. 1 Federal Law Nr. 5 of 1985 (UAE Civil Code) or Art. 7 UAE Constitution).
So, in order to find out more about the core concepts of the sharīʿa applicable in the field of banking and finance, reference should be made to the according works of fiqh. The theoretical basis for most sharīʿa transactions can be found in the elaborations on sales (bayʿ) contracts. From this basis most of the sharīʿa rules on Islamic banking and finance are derived.
Elements of a sales contract in sharīʿa are the parties (buyer and seller), the object (good and price) as well as the way of conclusion (offer and acceptance). Restrictions applicable in Islamic banking focus around the second element. This means price and good must fulfill certain conditions to be in line with sharīʿa. The main terms that appear in this context are ribā and gharar.
     1. The Concept of Ribā
The meaning of the Arabic word ribā can range from “gain” or “increase” to “exaggeration” or “usury”. As a sharīʿa term definitions for ribā can vary. The hanafī legal school defines it “void advantage in exchange treaties according to sharīʿa standards in favour of one party” whereas the mālikī legal school does not have a definition at all, but rather defines its subtypes only. According to fiqh sources it is mainly applied to two kinds of objects and two kinds of transactions.
The objects can be precious metals (gold and silver) (naqdān) and food (ṭaʿām). In Islamic banking and finance special attention is given to the first one. Even though modern currencies largely are not backed up by reserves of these metals, modern currencies are treated by sharīʿa scholars as if they were coined gold or silver. Therefore, money as core good of banking is subject to the concept of ribā object wise. Though not at the heart of modern banking, investments in foodstuffs could be subject to the concept of ribā as well.
The two ways that ribā can take in transactions are nasī’a and tafāḍul. The Arabic word nasī’a means “delay” or “postpone”. It refers to the idea that in the contractual exchange of good and price one of the two can be delayed. For the aforementioned objects this is not permitted in sharīʿa contexts: So gold, silver (and money) cannot be exchanged for one another other than on the spot. Whereas the nasī’a stresses the time element in the transactions, the tafāḍul focusses on an unevenness in value of the exchanged good and price, as tafāḍul is usually translated as “quantitative disparity”. This kind of ribā basically applies when the same type of metal (e.g. gold) or food is traded for its own kind with a difference in price for equal quantities.
All of the aforementioned explains why e.g. interest on borrowed money does impose a significant amount of problems in a sharīʿa conform finance system.
     2. The Concept of Gharar
Though not as prominent as the concept of ribā, the concept of gharar also influences Islamic banking and finance to some extent. A literary translation of the word would be “hazard” or “jeopardy”. This concept is connected to the idea that the good and price of a sharīʿa sales contract have to be defined and known (maʿrūf) as well as capable to be delivered (maqdūr ʿalā taslīmi-hī). So if these two requirements are not met, a valid sales contract cannot be enacted. Most prominent examples for the latter one in fiqh literature are the sale of fish in the sea or birds in the air. In general, the sharīʿa sales concept is based on the idea that goods can be inspected before the conclusion of the contract. Thus sales of goods that are not present at the place of contract are possible but under conditions only. The same applies if the buyer does not know the price.
     3. Further Concepts Relevant to Sharīʿa Investments
Other conditions for the sale of good in fiqh terms would be that they are ritually clean (tāhir) and of practical use (muntafiʿ bi-hī). So investments e.g. in pork or completely superfluous things would hardly conform with sharīʿa stipulations.
     4. Legal Creativity in Sharīʿa
As already implied in the aforementioned, specific sharīʿa concepts can be a point of discussion amongst scholars up to the level of dispute. This is especially the case, when it comes to single details of regulations. The preceding presentation was mostly oriented along the viewpoints of the mālikī legal school, as it is presumably the prevailing one amongst citizens of the UAE.
However, the academic dispute will come into play on another level as well. By time, Islamic jurists developed ways to stick formally to the conditions of sharīʿa concepts but tried to reach results that were forbidden by some or all of the transactions. These ways are called ḥiyal (sg. ḥīla) in Arabic. Again, different legal schools and scholars developed different views if and to what degree these ways are still compatible with sharīʿa rules and values. Generally speaking, the followers of the ḥanafī school of law (mostly found in Syria and non-Arabic Muslim countries) are most permissive whereas ḥanbalī followers (the prevailing school in Saudi-Arabia but also strong in other GCC countries including the UAE) would be most restrictive and followers of the mālikī and shāfiʿī schools would be found in the middle between these two.
All of these factors have an impact when assessing to what degree financial products can be seen as sharīʿa conform or not. It also results in Islamic banks taking other ways if investing their clients’ money e.g. in shared projects set up as companies where the client increases his shares by time to become the whole owner. To sum it all up, it should be pointed out, that there is a multitude of views to what can be seen as sharīʿa compliant and what exceeds its limits. In the end, it is left to the conscience of every single Muslim what views he follows and accepts.
   II. The Islamic Factor in the UAE Banking System
After explaining both the banking system in the UAE and the main concepts that curb an Islamic finance system, it is time to take a look at how both are connected i.e. how the Islamic banking and finance system in the UAE works.
This is regulated by Federal law 6 of 1985 on Islamic Banks, Financial Institutions and Investment Companies (UAE Islamic Banking Law).
According to this law, an Islamic bank is one that declares itself as an Islamic bank by virtue of its memorandum and articles of association (Art. 1 UAE Islamic Banking Law). This means, the UAE Islamic Banking Law does not request any special application or approval for Islamic banks other than normal banks.
Islamic Banks are generally set up in the same legal forms and under the same procedures as normal banks (Art. 2 UAE Islamic Banking Law). With regard to the operation of an Islamic bank, Art. 3 UAE Islamic Banking Law allows Islamic banks to undertake all financial transactions permitted to ordinary banks. Furthermore, certain transactions forbidden to ordinary banks are legalized for Islamic banks on the condition that the sharīʿa is obeyed (Art. 3, 4 UAE Islamic Banking Law). This happens in order to enable Islamic banks to be able to invest in a larger number of projects together with their clients.
On the other hand, certain additional provisions with regard to their corporate structure bind Islamic banks. Art. 6 UAE Islamic Banking Law provides for a sharīʿa control body in every bank. The law sets the number of members to a minimum of three and assigns them the task to check on conformity of transactions and interactions enacted by the bank with the Islamic sharīʿa and its rules. Details on the formation of this body, its precise tasks and procedures are left to be established by the articles of association of every Islamic bank itself.
Finally, Art. 5 UAE Islamic Banking Law foresees the establishment of a Higher sharīʿa Council. This council does not seem to have been established yet.

D. Evaluation the Announced Decision of HH Sheikh Mohammed
So what kind of council does HH Sheikh Mohammed aim to establish? What could be its structure and competences and how could it affect the existing system of Islamic banking and finance in the UAE?
It seems reasonable to assume, that the council HH Sheikh Mohammad mentions in his tweet is the council set out by Art. 5 UAE Islamic Banking law. This is due to the tweet and Art. 5 UAE Banking law using exactly the same terminology in Arabic to name the council (“hay’a sharʿīya ʿulyā”). Furthermore, HH Sheikh Mohammed would be the legal competent authority to announce such a decision since his position as Prime Minister of the UAE. Art. 5 UAE Islamic Banking Law orders the Higher sharīʿa Council to be set up by a decision (qarār) of the Council of Ministers. In accordance with Art. 55 UAE Constitution the Council of Ministers is composed of a President, Vice President and the remaining Ministers, thus HH Sheikh Mohammed as Prime Minister (President of the Council of Ministers) is the leading figure to speak on behalf of the competent constitutional authority. Moreover it is assumed, that the council set out by Art. 5 UAE Islamic Banking Law does not exist yet. Thus, it seems highly probable that HH Sheikh Mohammed intended to announce the establishment of this council now.
Therefore, what structures does Art. 5 UAE Islamic Banking Law foresee for the Higher sharīʿa Council? It should be composed out of Islamic scholars, jurists and bankers. This lets it appear as more than just a council composed purely of religions scholars. On the other hand, there is no indication in the law, that all of the three professions have to be represented in the same share. Nor does the law state what qualification the members have to fulfil. Furthermore, the council will be established under the authority of the Ministry of Islamic Affairs and Endowments (Art. 5 Islamic Banking Law). This in theory adds another ministerial authority to the authorities taking responsibility for Islamic Banking and finance. On the other hand, this ministry does not appear in the portfolio of ministries of the UAE. As per today the General Authority of Islamic Affairs and Endowments administers Islamic affairs and endowments. An authority with a more independent position (e.g. an own legal personality) vis-à-vis the Council of Ministers then the former ministry.
With regard to competences Art. 5 UAE Islamic Banking Law outlines some of the competences expected to be vested in the Higher sharīʿa Council. These competences are twofold: Firstly, the council shall be the highest control body to safeguard the legitimacy of banking transactions from a sharīʿa point of view. It shall secondly be competent upon request of Islamic banks to decide questions that pose itself to the banks during their activity and conduct. All of this seems to go into a direction to establish a second regulatory system for Islamic banks from a sharīʿa perspective. This would indeed be a fundamental structural change in the Islamic banking system compared to how we know it in the UAE today.
All of the above being said, if the legal framework set out by the UAE Islamic Banking Law was not adjusted or altered, which with regard to the many changes the legal system of the UAE has experienced since 1985 could very well be an option.
Apart from formal aspects, the last question remaining is what would these reforms mean for the single customer investing his money in Islamic banks. Assuming the council would become a new regulatory authority in the UAE Islamic banking system it would structurally lead to a higher degree of centralization and unification in respect of Islamic financial products in the UAE. This seems to be what is intended by the decision of HH Sheikh Mohammed. It would thus have the positive impact for the customer to find a more transparent and reliable set of sharīʿa conforming financial products. On the other hand, the multitude of Islamic finance products possible to be offered on the UAE market could be reduced and hence exclude a number of products that would still be acceptable form an ethical point of view to some investors.
The solution between the extremes of laissez fair and choking the market would most probably lie in a carefully selected composition of the council members. In turn, they would be able to define reliable outer boundaries for sharīʿa conforming financial products and structures to let enough space for the single customer to decide according to his religious and ethical conscience to what extent he would be willing to go.
With one of the longest Islamic historic experiences and an open eye for the future, the UAE should be the place to successfully establish a council meeting all these demands.

October, 2016 Heinrich Köllisch
Meyer-Reumann & Partners, Dubai Office
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