Laying Down the Law

With legal expert Antony Hainsworth

New areas of law come about only rarely. The core principles of contract law, tort law and criminal law have long outlived their earliest practitioners. Some areas of law, including, for example, financial regulation, have expanded greatly from a small seed of minor legal issues to a great hulking oak of law; others, such as the law of restitution, come into being from isolated legal issues coalescing into a single, coherent body of law. The process by which new area of law are created is rarely, however, straightforward.

“Financial services regulators are finding that there are significant differences in the way that Islamic financial institutions operate, which they must take into account in regulating such institutions”
-Antony Hainsworth

The same is true of Islamic finance law. Shari’a law, in and of itself, is certainly not new. As Potter LJ observed in his significant speech in the decision of the Court of Appeal in Shamil Bank of Bahrain v Beximco Pharmaceuticals Ltd,[1] 'most of the classical Islamic law on financial transactions is not contained as 'rules' or 'law' in the Qur’an and Sunnah but is based on the often divergent views held by established schools of law formed in a period roughly between 700 and 850 CE.' What is new, however, is the growth of Islamic financial business into a significant part of the financial markets. This has lead to the courts systems of essentially secular countries having to grasp the significance of Shari’a principles. This process requires the courts to reach decisions on how what are, in essence, religious principles, are to interact with black letter law. As with many conventional areas of law, there is often no easy answer.

Significant steps were taken by the decision of the Court of Appeal in Shamil Bank. Although the court chose not to recognise the Shari’a as an independent body of law capable of governing the relationships between parties, significant concessions were made. It was recognised that Shari’a principles may be relevant to the intentions of parties when entering into a contract. It was recognised that the courts may have regard to expert evidence from Shari’a scholars in determining such intentions. From such simple beginnings larger things often grow.

The courts are not alone in having to meet the challenge that Islamic finance poses. Financial services regulators are finding that there are significant differences in the way that Islamic financial institutions operate which they must take into account in regulating such institutions. At the same time, regulators are finding conventional financial institutions which they regulate wishing to expand into the Islamic sector. Islamic financial institutions may pose different prudential and systemic risks from conventional institutions; this becomes all the more significant when Islamic financial institutions and conventional financial institutions are inextricably linked in a single, interconnected financial market. These are just some of the reasons why the UK Financial Services Authority chose to publish a significant policy paper in November last year entitled Islamic Finance in the UK: Regulation and Challenges. Financial services regulators in a number of other jurisdictions have already introduced regulatory rules on the operation of Islamic financial businesses. The FSA’s paper is an early indication that similar legislative measures should be expected in the UK in the near future.

With the United Kingdom positioning itself for the anticipated worldwide growth in Islamic finance, it is increasingly important to understand how secular English laws and regulations will be applied to Shari’a compliant products and services. Whilst there are a number of publications in the market which seek to explain Shari’a principles, there are few, if any, that seek to address the accompanying black letter law issues that come with them. It is this interaction between English laws and regulations and unfamiliar religious principles that will be of particular interest to practitioners. Even a passing knowledge of Shari’a principles will give some indication of the practical challenges that must be met. Should Shari’a compliant products and services be originated and marketed in a different way to conventional products and services? Do conventional financial institutions wishing to offer Shari’a compliant products and services need to engage the services of Islamic scholars? Are fatwas issued by Islamic scholars binding on an institution that commissioned them? Are default fees permissible under the Shari’a? If a default fee is impermissible under the Shari’a, is it enforceable before the English courts? These are just some of the questions that need sensible, practical answers.

It has been over a year now since I was first approached by LexisNexis to write a new chapter for the Encyclopaedia of Banking Law on Islamic Financial Institutions and Islamic Finance. This was no small undertaking. English jurisprudence on Islamic finance is in its infancy. A number of international bodies, including in particular the Accounting and Auditing Organisation for Islamic Financial Institutions ('AAOIFI') and the Islamic Financial Services Board (‘IFSB’), have taken steps to introduce standardised principles on the governance and operation of Islamic financial institutions, but are finding that there is a lack of consensus amongst Islamic scholars on the practical application of Shari’a principles. Institutions as significant as ISDA have commissioned projects to create Shari’a compliant versions of their standard documentation. Trying to capture and commentate on all these developments is, in many ways, like trying to paint a picture of a moving subject.

However, it is for precisely this reason that a publication such as the Encyclopaedia of Banking Law lends itself to the subject. As a loose-leaf work with monthly updates, it is very well positioned to take account of new developments in the area. In many ways, this is an editor’s dream. New decisions can be commented on promptly. New regulations can be taken into account. The publication can be responsive to new developments both at home and abroad. The chapter is likely to change and develop over the coming years as law and practice develops. I couldn’t be happier to be involved.

Antony Hainsworth is a LexisNexis section editor and leading lawyer on Islamic finance. He is also a financial services and financial regulation specialist at Clifford Chance LLP. He advises both local and international institutions on all aspects of regulated financial activity and financial business. He is the editor of the new Division on Islamic Financial Institutions and Islamic Finance in the LexisNexis Encyclopaedia of Banking Law.