UAE editor Paul Lee explains how the Dubai International Financial Centre’s systems-based model is one solution for creating a sharīʿa-compliant financial system.
The Dubai International Financial Centre (“DIFC”) is a parallel legal system to the legal systems of the Emirate of Dubai and the UAE as provided for by a series of federal and local laws.[1] The Constitution of the UAE generally confers exclusive authority to the federal government to regulate enumerated areas including, among other matters, “civil and commercial transactions and company law,”[2] while conferring residual authority to the individual emirates.[3] However, the UAE amended its Constitution in 2004 to allow for legislation governing the establishment of Financial Free Zones, which are “exempted from having to apply the rules and regulations of the Union.”[4]
The UAE then passed a federal law providing that Financial Free Zones may be established by a federal decree, stipulating that the location of these zones were to be fixed by a Cabinet resolution.[5] It further specified that such zones would be exempt from federal civil and commercial laws (but not other laws, including the anti-money laundering law).[6] That same year, the DIFC was established by a federal decree under this new law.[7] The Emirate in which it is located, Dubai, then laid out its structure and functions,[8] including the establishment of the Centre Authority,[9] a separate court system,[10] and the Dubai Financial Services Authority (“DFSA”).[11]
Currently, the Law Regulating Islamic Financial Business[12] and the Islamic Finance Rules[13] are principally responsible for regulating Islamic finance in the DIFC (and are promulgated at the DIFC level). These laws and rules exemplify a “systems-based” model of Islamic finance regulation.[14] The term “systems-based” describes a regime of monitoring and disclosure for financial services and investments via Sharīʿa Supervisory Boards (“SSB”s) at the level of the entity or transaction, rather than relying on a centralized sharīʿa authority (LINK2).[15]
The Islamic Finance Rules in the DIFC cover entities that operate in three overlapping areas: (1) holding oneself out as a business providing sharīʿa-compliant financial services, (2) the offer of sharīʿa-compliant securities, and (3) sharīʿa-compliant investment funds offered to the public and domiciled or managed in the DIFC. In each case, the Rules do not actively proscribe what kinds of activities are sharīʿa-compliant; instead, they provide for supervision by a Sharīʿa Supervisory Board that will monitor the activities of the business, securities, or fund,[16] and for a disclosure-based regime that allows buyers, customers, and others to confirm its sharīʿa-compliant status based on the opinion of the SSB. Generally speaking, the SSB is a committee of Islamic jurists that can issue a fatwā about whether or not a particular transaction or activity complies with sharīʿa.
In order for a provider of financial services, such as an Islamic bank or a takāful (Islamic insurance) operator, to hold itself out as being sharīʿa compliant, it must have obtained a license or license endorsement from the Dubai Financial Services Authority as either an Islamic Financial Institution (“IFI”) or an Islamic Window.[17] The difference between the two options is that an IFI is a business that is entirely sharīʿa-compliant, whereas the Islamic Window describes the sharīʿa-compliant portion, such as a division, of a business that is not itself sharīʿa-compliant. The Islamic Window provides greater flexibility for international financial institutions when setting up a sharīʿa-compliant arm in the DIFC, since conventional financial activities can be conducted in parallel as long as there is adequate separation of the two.[18] In either case, the business must appoint an SSB.[19]
IFIs and Islamic Windows are subject to numerous rules designed to ensure that they have certain processes in place for sharīʿa compliance. These businesses must implement and maintain policies regarding sharīʿa compliance and policies regarding the SSB,[20] follow certain rules to prevent conflicts of interest in the SSB,[21] perform internal reviews of sharīʿa compliance in line with international standards,[22] and disclose certain pieces of additional information related to sharīʿa compliance in their financial statements.[23] Furthermore, the Islamic Finance Rules provide that these businesses must disclose to their clients details regarding the SSB, and include such details in their marketing material.[24]
With respect to Islamic securities, the prospectus for the offer of such securities in or from the DIFC must contain details regarding the SSB appointed by the issuer and the Board’s opinion as to whether or not the securities are sharīʿa-compliant.[25] Any issuer of securities listed on an exchange in the DIFC or securities which have been offered to the public must continue to disclose material changes to the SSB as they occur,[26] providing for sustained reporting obligations beyond the time of issuance. Similarly, with respect to Islamic funds domiciled or managed in the DIFC offered to the general public in or from the DIFC, the fund or fund manager must have appointed an SSB and must disclose details regarding that SSB in their prospectus, which must have been approved by the SSB.[27] Such funds must also perform internal audits of sharīʿa compliance and its SSB must conduct an annual review, both in line with international standards.[28] The results of the annual review are then disclosed to investors of the fund via its annual report.[29]
In this manner, the DIFC provides a framework of monitoring and disclosure to ensure that Islamic financial activities are conducted without violating the principles of sharīʿa without the presence of a centralized authority. Such an approach has both advantages and disadvantages (see author’s post here) vis-à-vis other models of Islamic finance regulation. Investors, issuers, and regulators would be well advised to carefully consider what approach best suits their needs.
[1] See generally, Alejandro Carballo, The Law of the Dubai International Financial Centre: Common Law Oasis or Mirage within the UAE?, 21 Arab L. Quarterly 91 (2007).
[2] U.A.E. Const., art. 121 (as amended 2004).
[3] U.A.E. Const., art. 122.
[4] U.A.E. Const., art. 121; see also Const. Amend. No. 1 of 2004.
[5] Fed. L. No. 8 of 2004, art. 2 (as modified by Cabinet Resol. No. 28 of 2007).
[6] Fed. L. No. 8 of 2004, art. 3.
[7] Fed. Decree No. 9 of 2004.
[8] Dubai L. No. 9 of 2004 (as amended 2011).
[9] Dubai L. No. 9 of 2004, art. 6.
[10] Dubai L. No. 9 of 2004, art. 8.
[11] Dubai L. No. 9 of 2004, art. 7.
[12] DIFC Law No. 13 of 2004 (as amended 2014).
[13] DFSA Rulebook: Islamic Finance Rules (as amended 2014), promulgated pursuant to general authority in DIFC Law No. 1 of 2004, art. 23 (as amended 2014) (providing the DFSA with power to make rules); DIFC Law No. 13 of 2004, art. 11 (providing the DFSA with power to make rules on licensing of Islamic Financial Businesses); DIFC Law No. 1 of 2012, art. 8 (as amended 2012) (providing the DFSA with power to make rules concerning securities); DIFC Law No. 2 of 2010, art. 8 (as amended 2012) (providing the DFSA with power to make rules concerning investment funds).
[14] See, e.g., DFSA Annual Report 2013 at 47 (describing itself as a “Shari’a systems-based regulator”).
[15] This set of commentaries explores three different models of Islamic finance regulation: (1) systems-based model, (2) centralized model, and (3) a model of competitive equality. These are derived in part from an International Organization of Securities Commissions (“IOSCO”) report on Islamic securities. IOSCO, Analysis of the Application of IOSCO’s Objectives and Principles of Securities Regulation for Islamic Securities Products at 17 (Sep. 2008) available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD280.pdf.
[16] Generally, the SSB is composed of three members who must be competent in their functions. Islamic Finance Rules, art. 3.5.1(a)-(b).
[17] DIFC Law No. 13 of 2004, art. 9. Note that this provision applies to Authorized Firms and Authorized Market Institutions (together, Authorized Persons)¾the DIFC Regulatory Law provides that only Authorized Persons licensed for the particular activity may carry on a financial service in or from the DIFC. DIFC Law No. 1 of 2004, art. 41(1), (9), art. 42(3)(a)-(c). For a list of activities considered to be financial services, see DFSA Rulebook: General Module, art. 2.2.2 (as amended 2014),
[18] Islamic Finance Rules, art. 2.3 Guidance 5, 3.4.1(g), 3.8.3, 4.2.2.
[19] DIFC Law No. 13 of 2004, art. 13.
[20] Islamic Finance Rules, art. 3.4.1 (requiring policies regarding: (1) manner in which sharīʿa compliance will be undertaken, (2) how the SSB will oversee/advise the business, (3) how SSB fatwas will be issued/recorded/implemented, (4) how internal sharīʿa review will be conducted, (5) how disputes between the SSB and the business will be handled, (6) approval process for internal controls regarding sharīʿa compliance, (7) how, for an Islamic Window, conventional businesses will be kept separate from the sharīʿa-compliant business (see also Islamic Finance Rules, art. 3.8.3)), art. 3.5.2 (requiring policies for: (1) appointments/dismissals/changes of the SSB, (2) determining suitability of SSB members, and (3) determining the remuneration of the SSB).
[21] Including setting up policies for identifying and managing conflicts of interest and providing that no member of the SSB may be a director or 10% shareholder of the business. Islamic Finance Rules, art. 3.4.1(f), art. 3.5.1(d).
[22] Islamic Finance Rules, art. 3.7.
[23] Islamic Finance Rules, ch. 4.
[24] Islamic Finance Rules, art. 3.8.1, 3.8.2.
[25] Islamic Finance Rules, art. 7.2.3. A prospectus is a document containing certain mandated information about a security being offered, which is then used to solicit potential investors. Generally, an offer cannot take place without a prospectus. See, e.g., DIFC Law No. 1 of 2012, art. 14 (as amended 2014). A key protection for investors is the prohibition against misleading statements and omissions which attaches to the prospectus. DIFC Law No. 1 of 2012, art. 20, DIFC Law No. 2 of 2010, art. 56.
[26] Islamic Finance Rules, art. 7.3.1, 7.3.2.
[27] Islamic Finance Rules, art. 6.1.3, 6.2.1, 6.5.1. There is an exception to the SSB requirements if the fund relies on a widely accepted sharīʿa screening process. Islamic Finance Rules, art. 6.2.1(3).
[28] Islamic Finance Rules, art. 6.3.1, 6.3.2, 6.4.1.
[29] Islamic Finance Rules, art. 6.3.2.