Shari'ah Governance: Fatwa Override and the Independence of the Shari'ah Board
A takaful operator's management committee approved a new savings product structured as wakala with an incentive fee. The product memo was reviewed by two of the five Shari'ah board members in an informal session; both raised no objection but noted they had not seen the actuarial model. The full Shari'ah board has not met. The CEO, under revenue pressure, instructs the finance team to launch in 30 days and to describe the product as 'Shari'ah-compliant' in marketing. Separately, the internal Shari'ah audit function reports to the CFO, and its last report flagged that the incentive fee may resemble riba if calculated as a percentage of the participant fund's gross returns. Management overruled the finding, citing the two members' informal view. The external auditor asks how the governance structure should have handled this.
1. Evaluate the governance failures against AAOIFI Governance Standard 1 (Shari'ah Supervisory Board) and GS 2 (Shari'ah Review).
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Key failures:
No valid fatwa/approval. GS 1 requires the SSB to issue a formal fatwa or resolution as a collective body. An informal view of two of five members is not a Shari'ah ruling and cannot support a 'Shari'ah-compliant' claim. The product must not launch until the full SSB has reviewed and approved, with the actuarial model made available.
Independence of the SSB. The SSB must be free from management pressure. The CEO's instruction to launch and to market as compliant overrides the SSB's authority and breaches the governance framework. The SSB's decision is binding on management.
Shari'ah review and internal Shari'ah audit. GS 2 requires an independent Shari'ah review function that reports to the SSB, not the CFO. Reporting to the CFO compromises independence and allows management to suppress findings. The riba concern about the incentive fee must be escalated to the SSB, which should determine whether the fee is a permissible wakala incentive or an impermissible return on money.
Disclosure. Marketing as 'Shari'ah-compliant' without a valid fatwa is a misrepresentation. The external auditor should report the control deficiency and consider the impact on the financial statements and disclosures.
2. What should the finance team do before launch, and how should the incentive fee question be resolved?
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Before launch:
- Escalate to the full SSB; convene a formal meeting with the actuarial model and product documentation.
- Obtain a written fatwa/resolution. No launch, and no 'Shari'ah-compliant' marketing, until then.
- Restructure the internal Shari'ah audit reporting line to the SSB (or an SSB committee), independent of the CFO.
- Document the escalation and the CEO's instruction as a governance breach.
Incentive fee:
- The SSB must assess whether the fee is a genuine wakala incentive (a share of profit as a reward for performance, permissible) or a fixed percentage of gross returns that functions as a guaranteed return on principal (which would resemble riba).
- If it is calculated on gross returns regardless of profit, it likely fails the profit-and-loss-sharing test and should be restructured to a share of realised profit or a disclosed fixed agency fee that is not linked to returns on the fund.
- The SSB's determination is binding; management cannot overrule it. Disclose the fee basis and the SSB's approval in the product documentation.