This post is inspired by a question posed by, and a most pleasant dinner conversation with, the wise Martin Lau of the School of Oriental and African Studies during the Venice Conference mentioned in the last post. The views, however, and any mistakes made herein, are my own.

Several years ago I was discussing my research interests with a person who was fairly senior at Qatar University, whose name shall not be disclosed.  The main focus of my work at the time was Islamic finance, and she cut me off after I began, with something along the lines of "I don't believe in this nonsense.  You go to the mall these days, it's Islamic finance, Islamic tourism, Islamic movies, people think you just put the words "Islamic" in front and somehow that makes it better to buy."

I was a bit taken aback at the time.  I think those who read the blog probably know my (severe) criticisms of Islamic finance reasonably well, but I didn't think at the time it could be compared to "Islamic tourism" which is more a form of advertising in a niche market than anything else.  Sure, if you go on a trip billed as a form of "Islamic tourism", my guess is it doesn't involve nude beaches or bar crawls, but it's not a legal practice is the point.  The "Islamic" doesn't so much indicate compliance with an elaborate set of rules, but rather an ethos, and the use of the word to attract customers interested in that.  It's all about the advertising.

I've always thought Islamic finance as different.  Yes I've considered the rules ridiculous, and still do, but there's a deeper problem.  In this post I want to take a different, Realist approach to Islamic finance, away from what might be called Realist rule skepticism (ie focused on the rules, their origins and effects) and towards something a bit more sociological (what’s going on in the world).  So let’s leave aside whatever disputes I have with the set of rules that comprise Islamic finance and look at the means by which the practice is supposed to conduct itself.  I think we might well find the emperor might not be quite stark naked, but he’s probably not sporting much more than a Speedo.

First of all, no sane person drafting an Islamic finance contract selects “shari’a” as the choice of law.  Aside from anything else, that does not mean anything, there are too many varieties.  You can’t reference the principles of AAOIFI (major standard setter for Islamic finance) because nobody sticks to those tightly, they couldn’t do a deal if they did. I guess you could select Malaysian law or Malaysian law and regulations applicable to Islamic banks or whatever, but nobody does that either.  They want clear, and they want certain, so usually it’s English or NY law.  If you try to get too cute with the choice of law provision (“English law informed by the principles of the glorious shari’a” or some such nonsense), the court will probably and has in England ignored the shari’a reference, and they should when the drafting is that awful.  So yeah it’s great to say we respect choice of law and so that’s how we ensure Islamic rules are preserved, but here there is no real law to choose, except Western law that won’t ensure Islamicity.

So where does shari’a compliance come from?  Ah, say the experts, it’s written into the contract itself, and it will be enforced by the courts, which enforce the contract as written.  Even if the court isn’t knowingly enforcing shari’a, but English law, it is enforcing shari’a unwittingly because the contract contains shari’a principles in its structure.

And who ensures the contract as written has shari’a principles in it? The shari’a board which must approve the transaction as a condition to its going through.  So it all comes back to the shari’a board.  They are the first and last guarantors of shari’a compliance, what they say effectively ends any question on this score, as the courts will not look to Islam but secular law to do their enforcement.  The awesome responsibility rests on their shoulders alone, no appeals, no reviews.

Here’s what we know about these boards.  They are paid by the institutions seeking to do the deal.  We might as well stop there, though some say that’s not enough proof of bias, as companies also pay their auditors.  These people say if it works for auditing, it must work for shari’a boards.  That’s what they say.  I say it doesn’t work for auditing, look at Enron.

Secondly, unlike auditing, where there is reliance on GAAP, Islamic finance has no generally applicable principles, and the practitioners in the field resist generally any call for standardization because it will “reduce flexibility” in structuring the deal.  Much like rules in football such as no kicking the other guy in the groin “reduces flexibility” in structuring a defense, I surmise.  
 

Third, they operate on the basis of confidentiality.  So you don’t actually know what the hell they’re ruling on or why, unless you are part of the contract. 

Finally, they can be fired at any time.  Imagine Arthur Anderson paid to give secret auditing advice while not having to heed any recognized accounting rules with the ability to fire them and hire another firm without consequence.  How do you think that would turn out?

Ah, say some supporters, but Islam requires the board members to be independent.  I don’t know what that means given the incentives above, but to the extent it is a vision that somehow if a person is pious, and believing, and honest, his views aren’t going to be swayed by buckets and buckets of cash, it is extremely naïve.  If you want independence, you have to create it with incentives and protections, not just say it and kiss a Qur’an and hope it all works out. 

I am also told that these people are well educated, speak several languages and are successful.  Again, to the extent that is supposed to suggest independence in the absence of professional and financial incentives and protections to ensure independence, it is ridiculous.