GUIDING PRINCIPLES ON GOVERNANC - Essay Example

Guiding Principles on Governance for Islamic Collective Investment Schemes: As Islam established itself as an important religion with substantial following across the world, its religious leaders developed a financial system that is consistent with principles laid out in the Holy Koran and other sacred texts. The Islamic Financial Services Board (IFSB) is an important organization which is constantly refining and improving the guidelines for financial transactions among the believers. Headquartered in Jeddah, the IFSB issued a list of Guiding Principles on Governance for Islamic Collective Investment Schemes in the year 2009.

The following is a summary of the principles. The guiding principles are meant to cover all sorts of Islamic Collective Investment Schemes (ICIS) including Islamic unit trusts, Islamic investment funds or Islamic mutual funds, etc. One of the main reasons for developing these principles is to standardize financial and banking practices across the Islamic world. Hence ICIS is defined to include a wide array of financial schemes that meet three key criteria. First criterion is that investors should have pooled their capital contributions in a fund and are willing “to share in the profits or losses derived from those assets”.

The second criterion is that Shariah law is fully respected in the management of these funds. And finally, the ICIS is independently and financially accountable for its assets and liabilities. Part 1 of the Guiding Principles pertain to the structure and processes to be followed by the ICIS Governing Body (GB), which shall “establish a comprehensive governance policy framework which protects the independence and integrity of each organ of governance, and sets out mechanisms for proper control and management of conflicts of interest and duty.”. In essence, this part recommends best practices and ideal bureaucratic structures to be followed by affiliated institutions.

Part 2 of the document deals with transparency issues in the disclosure of financial reports. The need for presenting financial reports accurately and punctually in a format easily accessible to all investors is emphasized. In order to facilitate comprehension of financial data, a standardization of terms, language and performance reporting is required. Similarly, “comparable measures of, or ways of explaining, charges, risks, profit calculation, asset allocation and movement, investment strategies, as well as mechanics of smoothing the returns (if any); and easy access to such information.

” Further, the importance of informing investors about all management activity is reiterated so that they are well-aware of the risks and rewards attached to their capital contributions. The costs associated with information asymmetries are articulated in this section with suggestions for optimizing such costs. Contentious issues such as conflict of interest, insider bias, ownership structure, ethical conduct, etc are all touched upon. More importantly, the articulation of financial reports/releases in accordance with Shariah laws are emphasized.

The third part of the Guiding Principles is probably the most important, for it talks about incorporating Shariah rules and laws both in letter and in spirit. It outlines requisite “systems and mechanisms for monitoring ex-ante and ex-post Shari`ah compliance”. In order for satisfying this requirement, properly trained and qualified reviewers should conduct audits. These reviewers should be given the right to take necessary corrective action where deemed apt. Shariah governing systems have been in place for centuries and there is plenty of case histories and precedents for reviewers/auditors to peruse.

While this could make the task more complex and cumbersome, it is imperative that the ICIS Governing Body consults Shariah boards and follows procedures approved by the latter. It is advised that investment scheme managers participate in stock-markets in line with Shariah rules, for some of the newly developed financial products could go against Islamic tradition. Finally, part 4 outlines additional protection for ICIS investors. The primary focus of this section is the protection of stock holder interests.

An important guiding principle is to always make investment decisions based on the stated objectives of contributing investors. The need to have sufficient liquidity should be balanced by ensuring reasonable returns on investments. One of the challenges facing fund managers is managing traditional Islamic investments like Mudarabah and Wakalah. Compliance with both fiduciary laws as pertaining to national jurisdictions would have to be complied alongside Shariah mandates, which can at times be conflicting.

In such scenarios, Shariah mandates assume more importance for it is at the core of Islamic financial system. Principle 4.2 is also important for it states that “ICIS Insiders shall be transparent in the imposition of any fees, creation of any reserves and the smoothing of any dividend payments ”. In this context, the process of creating profit equalization reserves (PER) or Investment Risk Reserve (IRR) are significant. By creating these reserves, the ICIS manager would beable to streamline flow of returns on investments made, “especially while compeing against the returns offered by their conventional counterparts”.

In conclusion, the Guiding Principles document sets out comprehensive lists of best practices, structures and processes in order to alleviate governance issues pertaining to Islamic Collective Investment Schemes.