## 1. Status of Legal Frameworks for Consumer Protection

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### I. Scope, objectives, and sample
- Focus: Islamic banking products and Sukuk, which together account for 95 percent of the Islamic finance industry.
- Geographic sample: Bahrain, Egypt, Iran, Jordan, Kuwait, Lebanon, Malaysia, Oman, Qatar, Saudi Arabia, Sudan, the United Arab Emirates, the United Kingdom and Yemen.
- Primary aims:
  - Highlight sources of information asymmetries that can result in consumers making uninformed decisions.
  - Identify potential avenues for consumer exploitation in the design of Islamic financial products.
  - Evaluate adequacy of current legal and regulatory frameworks for consumer protection.
  - Discuss policy options to strengthen consumer protection in Islamic finance.
- Contextual notes:
  - Consumers of Islamic banking products were estimated at 30 million by end December 2013 (Ernst and Young (2013)).
  - Ernst & Young [2013] also estimates that Islamic banks serve 38 million customers globally.

### II. High-level findings and market significance
- Shar’iah principles (prohibitions of Gharar, Maysir and Riba) provide a strong foundation for consumer protection, but cannot alone guarantee adequate protection because practice sometimes deviates from principles.
- Conventional consumer protection frameworks are relevant but require adaptation to Islamic-finance-specific risks.
- Specific reform needs identified:
  - Consumer vulnerabilities from Profit Sharing Investment Accounts (PSIA).
  - Risks in Ijārah Muntahia Bittamlīk (lease-to-purchase) arrangements.
  - Partial coverage and Shar’iah conflicts in conventional deposit insurance schemes.
  - Legal risks for Sukuk investors, notably in cross-border default cases.
- Industry scale and structure:
  - Measured by Shar’iah-compliant assets, Islamic finance has grown by an annual average of 20 percent since 2007, reaching US$ 1.8 trillion by end-December 2013 [IFSB 2014].
  - Islamic banking sector accounts for about 80 percent of Islamic finance assets [IFSB 2014]; these assets are mostly financed by PSIAs [Lukonga 2015].
  - Sukuk market is equivalent to about 15 percent of the Islamic finance industry.
  - There are around 900 investment funds that account for 4 percent of the industry.
  - Sovereign issuers accounted for 45 percent as of [June 2014] in the Sukuk market.
- Market concentration and consumer choice:
  - Most countries (excluding Iran and Sudan, and excluding Islamic windows) have between four and seven Islamic banks; conventional banks mostly range between 15 and 50.
  - In Kuwait, Saudi Arabia, and Yemen the largest Islamic bank represents more than 50 percent of Islamic banking assets.
  - In nascent markets often only one or two banks offer Islamic financial products.

### III. Consumer protection, financial literacy, and financial stability
- Nexus between consumer protection and stability:
  - Inadequate disclosures or low financial literacy can lead to excessive debt, panic, herd behaviour, and crises.
  - Deceptive advertising raises legal costs and can undermine confidence in the financial system.
- Role of financial education:
  - Helps individuals understand risks and recourse options, increasing uptake of appropriate products and enhancing market monitoring by consumers.
- Pillars of effective consumer protection frameworks:
  - Laws and regulations governing provider–user relationships.
  - Financial education.
  - Enforcement mechanisms, including cost-effective dispute resolution.
  - For Islamic finance specifically: Shar’iah oversight and audit for Islamic financial institutions.
- Deposit insurance:
  - Deposit insurance schemes can protect consumers from loss, contribute to financial stability, and help maintain competitiveness of Islamic deposits vis-à-vis conventional deposits.

### IV. Product-specific vulnerabilities and information asymmetries
- Products raising unique vulnerabilities:
  - Profit-Sharing Investment Accounts (PSIAs) (Muḍārabah or Wakālah).
  - Ijārah Muntahia Bittamlīk (Lease to Purchase).
  - Sukuk.
- PSIAs — structural and disclosure concerns:
  - PSIAs constitute a significant share of Islamic banks’ funding sources.
  - Contractual forms:
    - Muḍārabah: IAH acts as investor; Islamic bank acts as entrepreneur (manager).
    - Wakālah: Islamic bank acts as wakeel (agent) and receives a management fee.
  - Restricted vs. Unrestricted PSIAs:
    - Restricted PSIAs: IAHs impose restrictions; funds managed as “off balance sheet” Funds Under Management (FUM).
    - Unrestricted PSIAs: IAHs authorize bank discretion; funds commingled with current accounts and shareholder funds and reported as “on balance sheet”.
  - Related concerns:
    - Commingling and lack of separate legal ownership exacerbate information asymmetries and principal–agent conflicts.
    - Corporate ownership structures including non-financial corporations create conflicts of interest.
- Returns and risk mechanics for PSIAs:
  - Returns depend on bank profits; banks determine profits on which payout is based.
  - Proportionate profit sharing is determined ex-ante by mutual consent.
  - Losses are borne by account holders unless caused by mismanagement or negligence by the bank.
  - Funding commingled and payouts smoothed through a “profit equalization reserve” (PER) or Investment Risk Reserve (IRR).
  - Industry/IFRS policies on reserves affect risk-return mix.
  - Unlike conventional deposits, investment accounts are not liabilities; bank is not obligated to return original amount in event of loss.
  - Empirical notes: for some banks the Mudarib’s share of profit ranges between 40 percent and 50 percent; operating expenses are charged to shareholders’ funds and not included in the calculation.
- Consumer risks from PSIA features:
  - Payouts largely determined by bank management; large asymmetries in accounting information enable banks to inflate expenses and reduce distributable profits.
  - PER and IRR raise intergenerational distribution conflicts.
  - PSIAs not treated as deposits — in resolution, claims would be subordinated to creditors.
  - Bank benefits from upside but is protected from losses, creating incentives to take excessive risks.
- Conglomerate structures and conflicts of interest:
  - SPVs, joint ventures and associate companies may receive liquidity, services and referrals from parent banks and create incentives to invest client funds in group companies.
  - Non-financial corporate subsidiaries pose challenges for board composition, oversight, and alignment of risk appetite between shareholders and IAHs.
- Shar’iah compliance risk and fund commingling:
  - Jurisdictional diversity: Jordan, Malaysia, United Arab Emirates require separation of funds raised by way of Islamic deposits; many other countries do not.
  - Some Wakālah contracts contain provisions guaranteeing a specified rate of return, arguably contravening Shar’iah principles; recent court decisions highlight this risk.
  - Non compliance possible if governance structures do not ensure products are Shar’iah compliant.
- Ijārah Muntahia Bittamlīk consumer risks:
  - Legal title passes to lessee only at end of term; in event of default a customer could lose all past payments.
  - Retained property ownership limits consumer ability to use capital gains to refinance or prepay.
- Sukuk — structure and investor risks:
  - Sukuk are certificates representing undivided shares in ownership of tangible assets, usufructs and services or ownership of assets of projects or special investment activity [AAOFI 2010].
  - Common structures: Ijārah, Wakālah, Mushārakah, Murabaha, Istina, Muḍārabahh and Salam or hybrids.
  - Asset-backed Sukuk: investors have recourse to underlying assets, provided genuine ownership is legally established.
  - Asset-based Sukuk: investors have no recourse to assets; structuring embeds a purchase undertaking creating debtor/creditor relationship; in originator default Sukuk are treated as unsecured debt subordinated to originator’s other obligations.
  - Observed pattern: most outstanding Sukuk are “asset-based”; complexity, regulatory arbitrage and tax motivations make investor risk assessment difficult.
  - Legal and cross-border resolution risks: investor rights depend on local laws; divergent outcomes in defaults due to different legal traditions and views on Shar’iah as source of law.
  - Examples of defaults/restructurings cited: Nakheel, Dana Gas (United Arab Emirates), Golden Belt (Saudi Arabia), The Investment Dar (Kuwait).
  - Practical impediments: legal transfer of ownership often not permissible or is complex and costly for international investors; minority holders can hijack restructurings.

### V. Regulatory and institutional implications — priority reform areas
- Strengthen disclosure standards and Shar’iah governance to reduce information asymmetries and align marketed products with Shar’iah expectations.
- Adapt conventional consumer protection laws to Islamic-finance-specific features, including:
  - Clear legal status and separation (where appropriate) of funds held in PSIAs to protect IAH interests.
  - Rules on commingling, reporting (on-balance vs. off-balance), and treatment of PSIAs in insolvency/resolution.
  - Clarification of investor rights and remedies for Sukuk investors, including cross-border enforcement and legal clarity in default cases.
  - Reassessment of deposit insurance schemes' coverage and design to ensure consistency with Shar’iah principles and to avoid perverse incentives.
- Strengthen financial literacy and consumer education tailored to Islamic financial products, explaining unique structures and risk-sharing features.
- Improve enforcement mechanisms and cost-effective dispute resolution channels to ensure consumers can seek redress.
- Encourage adoption and consistent implementation of industry standards (IFSB, AAOIFI, IIFM) while recognizing uneven adoption.

### VI. Institutional, legal and enforcement gaps observed
- Fragmentation and gaps:
  - Legal and regulatory frameworks are fragmented; provisions are diffused across multiple pieces of legislation.
  - Very few countries (Oman, Malaysia, Bahrain) provide explicit guidance for Islamic financial products in consumer protection regulations.
- Disclosure guidance:
  - No international guidelines on specific disclosures; country practices vary significantly.
  - Some countries (Malaysia, Pakistan, Bangladesh) issued guidelines on calculation of profits; many others are silent.
- Treatment of PSIAs:
  - Regulatory treatment remains unclear and inadequate to protect IAHs.
  - Only a few countries (such as Saudi Arabia) require Islamic banks’ investment activities to be licensed by the Capital Market Authority (CMA).
  - Some countries (Yemen) lack capital markets and securities regulation.
- Legal infrastructure, insolvency and securitization:
  - Weak insolvency frameworks in many Sukuk-issuing countries; enforcing contracts still takes several years in most of these countries.
  - Most countries rank below 7 on the insolvency index (Index 0-16).
  - Absence of trust laws, taxation clarity, bankruptcy remoteness and enforceability of investor rights explains prevalence of “asset-based” Sukuk.
- Enforcement mechanisms and disclosure:
  - Regulations often not systematically implemented and enforced.
  - Consumer complaint statistics generally not available.
  - Dispute resolution: ADR and ombudsman offices exist but effectiveness undermined by limited awareness, procedural complexity and scarcity of Shar’iah expertise.
- Deposit insurance and financial literacy:
  - Islamic deposit insurance schemes (IDIS) exist in selected countries: Bahrain, Jordan, Kuwait, Malaysia, Turkey, Singapore, Sudan, the United Kingdom.
  - Bahrain: ex post IDIS introduced in 1993 (only implemented ex post system).
  - Sudan: ex ante IDIS developed in 1996.
  - Malaysia: dual deposit insurance system with parallel but separate schemes for Islamic and conventional banks.
  - Other countries (Indonesia, Jordan, Kuwait, Singapore, the United Kingdom) protect Islamic deposits under the country’s deposit insurance system.
  - Financial literacy programs for Islamic finance are in developmental stages; Shar’iah scholars remain scarce.
- Conflict with Shar’iah principles:
  - Conventional deposit schemes that offer partial coverage of current deposits contravene Shar’iah principles.
  - Wadiah (noninterest-bearing current accounts) are contractually committed to return the full amount placed on deposit.
  - Investment of deposit insurance assets in non-Shar’iah-compliant products poses Shar’iah non-compliance risk.
  - Lack of clarity on insurability of PSIAs.

### VII. Regulatory recommendations and operational measures
- Six priority reform areas (explicit list):
  - (i) strengthening the overall regulatory and supervisory framework for Islamic banks;
  - (ii) strengthening consumer protection frameworks for financial products in general and incorporating provisions to cater for the specifics of Islamic finance;
  - (iii) promoting financial literacy among consumers;
  - (iv) strengthening the governance structure so as to protect IAHs and ensure Shar’iah compliance;
  - (v) improving investor protection for Sukuk investors;
  - (vi) developing Shar’iah compliant deposit insurance schemes.
- Regulatory and supervisory needs:
  - Islamic banks require a hybrid of banking and capital markets regulations to cover cross-sector operations and to enforce Conduct of Business rules, including:
    - Segregation of funds for restricted investment account holders.
    - Best execution principle.
    - Enforcement against breach of client mandate.
  - Tailored regulations to minimize group risks from conglomerate structures and gaps in consolidated supervision.
  - Address limited secondary markets for Islamic financings that hamper withdrawal risk management in open-ended mutual funds.
  - Strengthen and harmonize Shar’iah governance structures.
- Disclosure and governance improvements (items banks should disclose):
  - Policies, strategies, and profit allocation basis of investment accounts.
  - Differences between restricted and unrestricted IAH.
  - Role of reserves and policies used to manage rates of returns and risks associated with PSIA.
  - Accurate, relevant, and timely financial statements on investments, including performance and valuation.
  - Governance structure for ensuring Shar’iah compliance.
  - Circumstances where losses are to be borne by IAHs.
  - Investors’ contractual rights with regard to early withdrawal or redemption.
  - For Ijārah Muntahia Bittamlīk, clarify consumer rights in default ex ante.
- Management of restricted IAH funds:
  - Should be governed by IOSCO principles for Collective Investment Schemes (CIS) and be subject to capital markets regulations on client mandates, commingling, segregation, disclosures, and fund manager certification.
  - In countries without capital markets, regulators should be empowered to develop prudential frameworks incorporating conduct of business rules and to oversee compliance.
- Monitoring, data and supervision:
  - Regulators should build capacity to enforce and monitor consumer protection mandates.
  - Compile data on consumer complaints and use impact assessments to inform policy.
- Dispute resolution:
  - Develop cost-effective ADR mechanisms, including arbitration procedures involving an ombudsman with knowledge of Shar’iah and commercial transactions, while retaining right to court.
- Human resource development and financial literacy:
  - Address shortage of Shar’iah scholars and expand training for practitioners, lawyers, accountants, regulators, judges, and other stakeholders.
  - Expand financial literacy programs tailored to Islamic finance.
- Sukuk investor protection:
  - Strengthen domestic bankruptcy regimes.
  - Harmonize international legal and regulatory environments.
  - Standardize contracts and documentation.
  - Strengthen securitization laws; enact or adapt laws to ensure true asset sale and separation of title from beneficial ownership where needed.
- Deposit insurance and PSIA treatment:
  - Seek to ensure Deposit Insurance Schemes are Shar’iah compliant and clarify PSIA treatment.
  - Jurisdictions currently vary: some protect both unrestricted and restricted PSIAs, some protect only unrestricted PSIA, some provide no protection to PSIAs.
  - Wadiah accounts should be guaranteed and require full coverage.

### VIII. Selected contractual and numeric features (Muḍārabah example)
- Profit split described in one Muḍārabah example:
  - 90 per cent. to the Issuer (as Rab-al-Maal).
  - 10 per cent. to the Mudareb.
- First Call Date specified: 16 October 2018.
- Muḍārabah described as a perpetual arrangement with no fixed end date.
- Conditions that may trigger liquidation or redemption include:
  - a Tax Event (tax on amounts due under the Muḍārabah Agreement or the Certificates due to a change in law).
  - a Capital Event (notification by the UAE Central Bank that the notional amount of the Certificates would cease to qualify for inclusion in full in consolidated Tier 1 capital of ADIB).

_Italic: Source: IMF staff summary of “Status of Legal Frameworks for Consumer Protection” (working paper _wp15107)._

### 1. Status of Legal Frameworks for Consumer Protection ........................................................21

### 1. Status of Legal Frameworks for Consumer Protection

### I. Introduction — scope and objectives
- Focus: Islamic banking products and Sukuk, which together account for 95 percent of the Islamic finance industry.
- Geographic sample for analysis: Bahrain, Egypt, Iran, Jordan, Kuwait, Lebanon, Malaysia, Oman, Qatar, Saudi Arabia, Sudan, the United Arab Emirates, the United Kingdom and Yemen.
- Primary aims:
  - Highlight sources of information asymmetries that can result in consumers making uninformed decisions.
  - Identify potential avenues for consumer exploitation in the design of Islamic financial products.
  - Evaluate adequacy of current legal and regulatory frameworks for consumer protection.
  - Discuss policy options to strengthen consumer protection in Islamic finance.
- Contextual notes:
  - Consumers of Islamic banking products were estimated at 30 million by end December 2013 (Ernst and Young (2013)).
  - Ernst & Young [2013] also estimates that Islamic banks serve 38 million customers globally (both figures appear in the source).

### II. Main conclusions and high-level findings
- Shar’iah principles (prohibitions of Gharar, Maysir and Riba) provide a strong foundation for consumer protection, but:
  - These principles alone cannot guarantee adequate protection because not all providers are motivated by ethical precepts and practice sometimes deviates from principles.
- Conventional consumer protection frameworks are relevant but require adaptation to address risks specific to Islamic financial products.
- Specific areas needing reform:
  - Consumer vulnerabilities arising from current practices with respect to Profit Sharing Investment Accounts (PSIA).
  - Ijārah Muntahia Bittamlīk (lease-to-purchase) arrangements.
  - Conventional deposit insurance schemes and their partial coverage vis-à-vis Shari’ah principles governing current account deposits.
  - Legal risks for investors in Sukuk, particularly in cross-border default cases.

### III. Consumer protection, financial literacy, and financial stability
- Nexus between consumer protection and financial stability:
  - Inadequate disclosures or low financial literacy can lead to excessive debt, panic, herd behaviour, and crises.
  - Deceptive advertising raises legal costs and can undermine confidence in the financial system.
- Role of financial education:
  - Helps individuals understand risks and recourse options, increasing uptake of appropriate financial products and enhancing market monitoring by consumers.
- Prudential regulation and institutional arrangements:
  - Effective prudential regulation is an integral part of consumer protection.
  - Deposit insurance schemes can protect consumers from loss, contribute to financial stability, and help maintain competitiveness of Islamic deposits vis-à-vis conventional deposits.
- Pillars of effective consumer protection frameworks:
  - Laws and regulations governing provider–user relationships.
  - Financial education.
  - Enforcement mechanisms, including cost-effective dispute resolution.
  - For Islamic finance specifically: Shari’ah oversight and audit for Islamic financial institutions.

### IV. The case for consumer protection in Islamic finance — market structure and implications
- Industry growth and market importance:
  - Measured by Shar’iah-compliant assets, Islamic finance has grown by an annual average of 20 percent since 2007, reaching US$ 1.8 trillion by end-December 2013 [IFSB 2014].
  - Islamic banking sector is systemically important in Bangladesh, Brunei, most GCC countries, Malaysia, and Yemen; Iran and Sudan have exclusively Islamic banking systems.
  - Islamic finance has potential in markets with large Muslim populations and low penetration (examples cited: Egypt, Jordan, Kenya, Libya, Morocco, Nigeria, Tunisia; and the countries of the Caucasus and Central Asia (CCA)).
- Customer base:
  - Ernst & Young [2013] estimates Islamic banks serve 38 million customers globally (also the earlier estimate of 30 million by end-December 2013 is cited).
- Asset composition of the industry:
  - Banking sector accounts for about 80 percent of Islamic finance assets [IFSB 2014]; these assets are mostly financed by PSIAs [Lukonga 2015].
  - Sukuk market is equivalent to about 15 percent of the Islamic finance industry and is growing rapidly in volume, issuers and breadth of investors.
  - There are around 900 investment funds that account for 4 percent of the industry.
  - The balance comprises investment companies, Takaful (insurance), leasing, and micro finance [IFSB 2014].
- Sukuk market structure and issuer composition:
  - Sovereign issuers accounted for 45 percent as of [June 2014]; the balance comprised supranational institutions and corporations, including banks, non-financial corporations, and quasi-sovereign or government-related entities.
  - In the GCC, corporations have been the main issuers where governments have large fiscal surpluses.
- Market concentration and consumer choice:
  - Despite rapid growth, competition in Islamic finance is more limited than in conventional banking.
  - Most countries (excluding Iran and Sudan, and excluding Islamic windows) have between four and seven Islamic banks; conventional banks mostly range between 15 and 50.
  - Market concentration is very high: in Kuwait, Saudi Arabia, and Yemen, the largest Islamic bank represents more than 50 percent of Islamic banking assets.
  - In nascent markets, concentration is more pronounced—often only one or two banks offer Islamic financial products—reducing choice for consumers.

### V. Product-specific vulnerabilities and information asymmetries
- Products identified as raising unique consumer/investor vulnerabilities (in absence of well-defined regulations):
  - Profit-Sharing Investment Accounts (PSIAs) based on Muḍārabah or Wakālah.
  - Ijārah Muntahia Bittamlīk (Lease to Purchase).
  - Sukuk.
- Profit-Sharing Investment Accounts (PSIAs) — structural and disclosure concerns:
  - PSIAs constitute a significant share of Islamic banks’ funding sources in most countries.
  - Contractual forms:
    - Muḍārabah: IAH (Investment Account Holder) acts as investor; Islamic bank acts as entrepreneur (manager).
    - Wakālah: Islamic bank acts as wakeel (agent) and receives a management fee.
  - Restricted vs. Unrestricted PSIAs:
    - Restricted PSIAs: IAHs impose restrictions on where/how/for what purpose funds are invested; similar to non-discretionary wealth management accounts, but funds are not vested in a separate legal entity and are managed by the Islamic bank as “off balance sheet” Funds Under Management (FUM).
    - Unrestricted PSIAs: IAHs authorize the bank to invest funds as the bank deems appropriate; similar to discretionary wealth management but offered to retail (not only HNW) clients; account holders’ funds are commingled with current accounts and shareholder funds and are reported as “on balance sheet” items.
  - Related concerns highlighted:
    - Commingling of funds and lack of separate legal ownership can exacerbate information asymmetries and principal–agent conflicts.
    - Corporate ownership structures that include non-financial corporations can create conflicts of interest between the bank’s business interests and fiduciary responsibility to IAHs.
- Sukuk-specific risks:
  - Increasing complexity of Sukuk structures and widening issuer base expose investors to differing counterparty and legal risks.
  - Legal risks are particularly significant in cross-border default cases.
  - The paper notes broader issuer base includes advanced, emerging market and developing countries, sovereigns and corporates, increasing exposure to differing credit and legal environments.

### VI. Regulatory and institutional implications — priority areas for policy reform
- Strengthen disclosure standards and Shar’iah governance to reduce information asymmetries and ensure marketed products meet Shari’ah-compliant expectations.
- Adapt conventional consumer protection laws to address Islamic-finance-specific features, including:
  - Clear legal status and separation (where appropriate) of funds held in PSIAs to protect IAH interests.
  - Rules on commingling, reporting (on-balance vs. off-balance), and treatment of PSIAs in insolvency or resolution scenarios.
  - Clarification of investor rights and remedies for Sukuk investors, including cross-border enforcement and legal clarity in default cases.
  - Reassessment of deposit insurance schemes' coverage and design to ensure consistency with Shari’ah principles and to avoid perverse incentives.
- Strengthen financial literacy and consumer education tailored to Islamic financial products, including explanation of unique product structures and risk-sharing features.
- Improve enforcement mechanisms and cost-effective dispute resolution channels to ensure consumers can seek redress.
- Encourage adoption and consistent implementation of industry standards (e.g., IFSB, AAOIFI, IIFM) while recognizing uneven adoption and evolving standard-setting.

*Source: IMF staff summary of “Status of Legal Frameworks for Consumer Protection” (chapter text). Note: All figures and country listings are reproduced exactly as presented in the source content.*

### 26.      The returns to PSIAs are influenced by a variety of factors. The capital value and

### 26.      The returns to PSIAs are influenced by a variety of factors. The capital value and

### Returns to PSIAs: determinants and mechanics
- Capital value and returns to PSIAs depend on the banks’ profits, and banks determine the profits on which the payout is based.
- The proportionate share of profits, between the bank and the holders of PSIAs, is determined ex-ante by mutual consent.
- Losses, if any, are borne by the account holders, unless the loss has been caused by mismanagement or negligence on the part of the bank as a manager of the funds, or by a violation of the terms of the contract.
- Returns depend on the profitability of the individual enterprises that are financed, but:
  - funding is comingled and payouts smoothed through a “profit equalization reserve” (PER) or Investment Risk Reserve (IRR).
  - Industry or International Financial Reporting Standards (IFRS) specific policies on maintaining appropriate reserves to manage PSIA returns also affect the risk-return mix for PSIAs.
- Unlike deposits in conventional banks, investment accounts are not liabilities of banks and the bank is not obligated, in the event of loss, to return the original amount.
- Empirical note from review of annual reports and audited accounts of Islamic banks:
  - according to the terms of acceptance of the unrestricted investment accounts, 100 percent of the funds is invested taking into consideration the relevant weightage, if any.
  - For some banks, the Mudarib’s share of profit ranges between 40 percent and 50 percent.
  - operating expenses are charged to shareholders’ funds and not included in the calculation.

### Consumer risks arising from PSIA features
- Key disadvantages and incentive problems for account holders (IAHs):
  - payouts are largely determined by bank management and there are large asymmetries in accounting information, enabling banks to inflate expenses and reduce distributable profits.
  - PER and IRR raise an intergenerational distribution conflict because profits added to the banks PER do not accrue to existing investors.
  - Because PSIAs are not treated as deposits, in resolution, the claims would be subordinated to creditors.
  - The bank benefits from upside but is protected from losses, creating incentives for a bank to take on excessive risks.

### Conglomerate structures and conflicts of interest
- Conglomerate structures of Islamic banks may create conflicts between group business interests and fiduciary responsibilities to IAHs.
- Shar’iah principles require linking transactions to real productive economic activities; banks have been permitted to establish subsidiaries of non financial corporations to facilitate investment activities.
- SPVs, joint ventures and associate companies:
  - benefit from parent banks via liquidity provisions, shared services, and business referrals.
  - create incentives to invest client funds in group companies, which may not ensure best returns for IAHs who bear loss risk.
- Non financial corporations in the group pose challenges for board composition and oversight, affecting:
  - internalizing a strong risk culture;
  - synergy between risk governance and Shar’iah governance;
  - alignment of risk appetite between shareholders and IAHs.

### Shar’iah compliance risk and fund commingling
- IAHs with strict Shar’iah preferences face Shar’iah non compliance risk arising from banks breaching client mandates.
- Jurisdictional diversity:
  - some countries (Jordan, Malaysia, United Arab Emirates) require banks to separate funds raised by way of Islamic deposits from other funds.
  - many other countries have no such requirements; potential for commingling funds is high, particularly for Islamic windows.
- Wakālah contract issues:
  - some Wakālah contracts contain provisions that guarantee a specified rate of return or certain profits despite the results of the transaction(s).
  - Such provisions arguably contravene Shar’iah principles because guaranteed returns or profits do not enable risk sharing between the wakeel and the muwakkil.
  - Recent court decisions regarding disputes involving such Wakālah contracts underscore this risk.
- Non compliance with Shar’iah is also possible if there is no governance structure to ensure that products issued by Islamic banks are Shar’iah compliant.

### Need for stronger disclosures and governance
- To protect consumers, regulations on disclosures and governance need strengthening.
- Ex-ante information requirements for Islamic banks to enable informed client choices:
  - publish investment strategies, objectives, and risk-reward thresholds in addition to ex-post audited financial statements.
- Need for board representation to ensure investment decisions are in IAHs’ best interest.
- Standards and enforcement:
  - The IFSB and AAOFI have issued standards and guidelines to improve disclosures, transparency and governance, but adoption and enforcement is highly uneven across countries.
  - While PSIAs share many features of Collective Investment Schemes (CIS) regarding fiduciary responsibilities, in practice Islamic banks in many countries undertake this fiduciary role without being subject to Conduct of Business (COB) rules ensuring adequate disclosures to holders of PSIAs on investment objectives, strategies, risks, computation of profits and valuation of assets.
  - Regulatory and supervisory gaps noted: some countries (e.g., Yemen) lack capital markets and securities law; coordination between regulators in countries where investment activities are licensed by capital markets authorities (Bangladesh, Malaysia, Pakistan) is weak.
  - Selected countries have issued guidelines on the calculation of profits.

### Ijārah Muntahia Bittamlīk (Lease to Purchase)
- Definition and mechanics:
  - Ijārah is a contract of sale of the right to use an asset for a period of time.
  - Under Ijārah Muntahia Bittamlīk, the legal title of the assets only passes to the lessee at the end of the Ijārah term, through gift, consideration or gradual sale, provided all Ijārah installments are settled.
- Consumer disadvantages in the absence of tailored oversight:
  - In event of default on lease payments, a customer who fails to meet payments mid-way through the term of an Ijārah agreement could lose all past payments.
  - Because lenders retain property ownership (Ijārah and Murābahah loans) or release it only progressively (Mushārakah templates), the consumer cannot take advantage of capital gains to prepay or refinance the mortgage if financial position deteriorates.

### Sukuk: definitions, structures, and investor risks
- Definition:
  - Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufructs and services or in the ownership of the assets of particular projects or special investment activity [AAOFI 2010].
- Structuring and variety:
  - Sukuk rely on concepts such as equity participation and asset securitization; production process akin to project finance.
  - Underlying structure varies by issuer, investors, country-specific and lead managers.
  - Commonly used structures: Ijārah, Wakālah, Mushārakah, Murabaha, Istina, Muḍārabahh and Salam or hybrids.
- Asset-backed versus asset-based Sukuk:
  - Asset-backed Sukuk:
    - certificate holders, in principle, have recourse to underlying assets in event of default, provided legal arrangements for genuine ownership are in place.
    - investor risk: at most market risk (decline in prices of underlying assets) and/or default of lessee on rental payments.
  - Asset-based Sukuk:
    - investors or Sukuk holders have no recourse to the assets.
    - structuring embeds a purchase undertaking by the issuer, creating a debtor/creditor relationship in event of default.
    - investor takes risk of the “Obligor”—the party providing an undertaking.
    - In event of default of the originator, Sukuk are treated as unsecured debt subordinated to the originator’s other obligations.
- Observed market patterns and consequences:
  - So far, most outstanding Sukuk are “asset-based”.
  - Sukuk structures have tended to be complex, sometimes motivated by regulatory arbitrage or tax efficiency; complexity makes it difficult for investors to discern risks.
  - Sukuk restructurings and defaults exposed inconsistencies between theoretical Sukuk principles and actual structures, and gaps in investor understanding of risks.
  - Prominent Sukuk defaults/restructurings cited: Nakheel and Dana Gas Sukuk (United Arab Emirates), Golden Belt Sukuk (Saudi Arabia), The Investment Dar Sukuk (Kuwait).
  - Many of these Sukuk were asset-based rather than asset-backed; resolution outcomes were often unexpected for investors who believed they had recourse to assets.
  - In some cases (Nakheel and Dana Gas) investors ignored credit risk based on expectations of government intervention.
- Legal and cross-border resolution risks:
  - Investors’ rights depend on local laws and strength of legal rights in jurisdiction where collateral is contested.
  - Sukuk issued in environments with varying legal traditions and divergent views on Shar’iah as a source of law led to:
    - lack of legal certainty in cross-border insolvencies;
    - lack of transparency;
    - unequal treatment;
    - risk of contract unenforceability with respect to Shar’iah compliance issues.
  - Outcomes in default cases varied with local laws and post-default decisions.
  - Examples of divergent outcomes:
    - Golden Belt 1 Sukuk default (November 2009): royal commission restructured debts addressing amounts owed to local investors; foreign investors have not been able to gain access to assets held by the Sukuk sponsor.
    - East Cameron Sukuk (U.S.): U.S. court ruled it was an asset-backed Sukuk and that investors had the right to a certain quantity of gas produced over the life of the Sukuk.
    - Few Sukuk restructurings have been finalized; many have been ongoing for years; without swift resolution precedent and clear legal frameworks, Sukuk holders face case-by-case negotiations subject to local judicial systems.
- Practical legal impediments:
  - IIFM review (2013) found that in practice, even in asset-backed Sukuk, legal transfer of ownership where international investors are involved is often not permissible under local laws or is a complicated and expensive process.
  - Restructuring defaulted Sukuk faced obstacles including minority holders hijacking restructurings and demanding full repayment.

### Boxed case findings: selected Sukuk defaults and legal risks
- East Cameron Partners (ECP): Sukuk Al Mushārakah
  - Contract: Mushārakah; investors co-owned an Overriding Royalty Interest via SPV in Cayman Islands; Sukuk rated CCC+ by S&P.
  - Default: 2008 Chapter 11 filing; default due to shortfall in oil and gas production after hurricane damage.
  - Resolution: U.S. bankruptcy court rejected request to treat transaction as secured loans; precedent protected Sukuk holders’ rights; case resolved through negotiation and underlying Sukuk assets were transferred to the issuer for benefit of Sukuk investors.
- Investment Dar Company (TID): Mushārakah Sukuk
  - Contract: Mushārakah Sukuk with SPV in Cayman Islands; originator provided undertaking to repurchase SPV share at end or upon insolvency.
  - Default: May 2009 failure to make periodic payments on a $100 million Sukuk; holding company had debt of about $3.5 billion including two Sukuk for US$250 million.
  - Resolution: restructuring process with Central Bank of Kuwait supervision; Kuwait court protection under the Financial Stability Law (FSL); restructuring plan involved repayment in tranches, conversion of part of debt into equity, and shareholder liquidity injection; case is yet to be resolved.
- Golden Belt 1 (Saad) Ijārah Sukuk
  - Contract: SPV registered in Kingdom of Bahrain; leasehold rights on land parcels; contract included dissolution event.
  - Default: June 2, 2009 Saad Group defaulted on periodic payments amid liquidity crisis; Saudi Arabian Monetary Authority (SAMA) froze Saad Group assets; litigation dragged on for three years and remains in Saudi courts.
  - Resolution: litigation and contested claims; issues over access to assets and genuineness of promissory note.
- Nakheel Sukuk (Ijārah manfaa)
  - Contract: asset-based Ijārah-manfaa where Sukuk holders bought leasehold interest via SPV without acquiring title to assets; holders had rights to income stream but not assets.
  - Default: November 25, 2009 Dubai macroeconomic shock led government to seek standstill for US$59 billion in Dubai World debt including US$3.5 billion in Sukuk.
  - Outcome: majority of Sukuk certificate-holders were not aware of lack of recourse to trust assets via purchase undertaking; outright default prevented through Abu Dhabi bailout and all Sukuk holders were paid out.
- Cross-cutting observations from cases:
  - Disparities in legal frameworks produce different resolution outcomes for similar Sukuk structures.
  - Perceptions of government guarantees can lead to underestimation of risk even by financially literate investors.
  - Restructurings are protracted and often unresolved, leaving investors reliant on case-by-case judicial resolutions.

*Italic: Source: _wp15107 - 26.      The returns to PSIAs are influenced by a variety of factors. The capital value and*

### 41.      Deposit schemes for conventional banks that offer partial coverage of current deposits

### _wp15107 - 41.      Deposit schemes for conventional banks that offer partial coverage of current deposits

### Conflict with Shar’iah principles
- Deposit schemes for conventional banks that offer partial coverage of current deposits contravene Shar’iah principles.
- Under Islamic banking:
  - Noninterest-bearing current accounts, such as Wadi’ah, that are for safekeeping are investments that is to be redeemed at par.
  - An Islamic bank is contractually committed to return the full amount placed on deposit by the client.
- In countries where Islamic banks are covered by conventional deposit schemes:
  - The investment of the deposit insurance schemes assets in non Shar’iah compliant products poses the risk of Shar’iah non compliance.
  - There is a lack of clarity as to the insurability of profit-sharing investment accounts.

### Current practices in consumer protection (IV. CURRENT PRACTICES IN CONSUMER PROTECTION)
- Global initiatives and milestones:
  - November 2010: World Bank launched a global program on consumer protection and financial literacy.
  - 2012: World Bank developed good practices for financial consumer protection.
  - 2011: G20 endorsed the high level principles on consumer protection for financial services.
- International standard setting for Islamic finance:
  - IFSB has issued standards relevant to consumer protection, including IFSB-4, IFSB-6, and IFSB-9.
  - Joint publication by IFSB/IOSCO and Malaysia Securities Commission on Disclosure requirement for Islamic Capital Market (ICM) products released in 2013.
  - IFSB planned a 2015 Working Paper on guiding principles on disclosures related to Sukuk, ICIS and Shar’iah compliant equities.
  - AAOIFI disclosure standards: FAS 11 (1996), FAS 14 (2000), and transfer of detailed guidance on profit share calculation from FAS 6 to FAS 27.
  - IIFM initiated efforts to address Sukuk standardization.
- Country reforms and institutional models:
  - Examples of institutional changes: United Kingdom, Australia, South Africa introduced twin peak models (one regulator for safety and soundness; another for Conduct of Business).
  - Many countries introduced consumer protection regulations within prudential frameworks and established processes for complaints and redress.
- Implementation challenges:
  - 2014 World Bank Global Survey shows not all countries enacted consumer protection laws; among those that have, regulations often not consistently applied or enforced.
  - Less progress integrating consumer protection issues specific to Islamic finance.

### The Legal and Regulatory Framework
- Fragmentation and gaps:
  - Legal and regulatory frameworks are fragmented; legal provisions relevant to financial services consumer protection are often diffused across multiple pieces of legislation.
  - Very few countries (Oman, Malaysia, Bahrain) provide explicit guidance for Islamic financial products in consumer protection regulations.
- Disclosure guidance:
  - No international guidelines on specific disclosures; country practices vary significantly.
  - Some countries (Malaysia, Pakistan, Bangladesh) issued guidelines on calculation of profits by Islamic banks; many others are silent.
- Treatment of PSIAs:
  - Regulatory treatment of PSIAs in supervisory frameworks remains unclear and does not offer adequate protection for IAHs.
  - Only a few countries (such as Saudi Arabia) require Islamic banks’ investment activities to be licensed by the Capital Market Authority (CMA).
  - Some countries (Yemen) do not have capital markets and therefore no securities regulation, leaving Islamic bank investment activities in a regulatory vacuum.
  - Absence of clear Conduct of Business rules (disclosure requirements, segregation of funds, certification of investors, custody rules) raises risk of comingling investor assets and potential losses to IAHs in bankruptcy.

### Legal infrastructure, insolvency and securitization
- Weak insolvency frameworks for many Sukuk-issuing countries:
  - Enforcing contracts still takes several years in most of these countries (Figure 5: Enforcing Contracts (Time in Years) shows wide variation; insolvency index referenced on scale 0-16).
  - Most countries rank below 7 on the insolvency index (Index 0-16).
- Consequences for Sukuk securitization:
  - Bankruptcy remoteness and enforceability of investor rights are prerequisites for Sukuk securitization.
  - Absence of conducive legal and regulatory infrastructure (true asset sale, separation of title from beneficial ownership, trust laws, taxation, insolvency and bankruptcy laws) is a major challenge.
  - Explains prevalence of “asset-based” Sukuk over “asset-backed” Sukuk.

### Enforcement Mechanisms and Disclosure
- Implementation weaknesses:
  - Regulations are often not systematically implemented and enforced.
  - A World Bank [2014] survey shows requirements in some countries for reporting complaint statistics, operating hot-lines, or monitoring advertising; these relate to financial services in general, not specifically Islamic products.
  - Statistics on consumer complaints were generally not available.
- Disclosure practices:
  - Improvements driven by market pressures, IFRS, Basel II and IFSB 2007 guidance.
  - Islamic financial institutions disclose management policies, risk exposures and risk management practices, but variation exists in disclosures specific to Islamic finance (investment objectives, strategies, payout formulas for IAHs, Shar’iah compliance).
  - Not all countries require publishing statements about Shar’iah compliance; Islamic and conventional banks often subject to same disclosure requirements.
  - IFSB/IOSCO/Malaysia [2013] review found significant variation in Sukuk prospectus contents and lack of international standards on specific disclosures.
- Dispute resolution:
  - Frameworks encompass litigation and Alternative Dispute Resolution (ADR) mechanisms due to complexity and need for Shar’iah expertise.
  - Examples of ADR initiatives: local arbitration centers in Malaysia, Qatar, United Arab Emirates.
  - Common ADR methods: negotiation, conciliation, mediation, arbitration.
  - Ombudsman offices exist in many countries for retail clients; effectiveness undermined by inadequate awareness and procedural complexity.
  - Survey by Jonathan Lawrence (2012) showed very few arbitration cases involving Islamic finance.
  - Information on whether Ombudsman offices have expertise in Shar’iah laws was not available.

### Deposit Insurance Schemes and Financial Literacy
- Deposit insurance in Islamic finance:
  - Deposit insurance is relatively new to Islamic finance.
  - Only selected countries have introduced Islamic deposit insurance schemes (IDIS): Bahrain, Jordan, Kuwait, Malaysia, Turkey, Singapore, Sudan, the United Kingdom.
  - Variations in approaches:
    - Bahrain: introduced an ex post IDIS in 1993 and remains the only country to have implemented such a system.
    - Sudan: developed a full-fledged ex ante IDIS in 1996.
    - Malaysia: dual deposit insurance system with parallel but separate insurance schemes for Islamic banks and for conventional banks.
    - Other countries (Indonesia, Jordan, Kuwait, Singapore, the United Kingdom) protect Islamic deposits under the country’s deposit insurance system.
- Financial literacy and capability:
  - Programs for financial literacy in Islamic finance are in developmental stages.
  - Growing trend of degree programs and professional qualifications in Islamic finance among higher education and training institutions.
  - Islamic Development Bank (IsDB) collaborated with central banks on programs for regulators and policy makers.
  - Financial supervisors in some economies (Malaysia, Saudi Arabia) active in financial education.
  - Bahrain established a Waqf Fund to support Islamic finance training, education and research:
    - Waqf Fund established in November 2006 under the auspices of the Central Bank of Bahrain (CBB) in partnership with Islamic Financial Institutions (IFIs) in Bahrain.
    - Member institutions made one-time contributions to the Waqf Fund's corpus which is invested in Islamic money market instruments and the return is used to finance the Fund's initiatives.
  - Many countries have yet to provide education programs for financial literacy in Islamic finance; Shar’iah scholars remain scarce.

### Conclusions and options for strengthening consumer protection (V. CONCLUSIONS AND OPTIONS FOR STRENGTHENING CONSUMER PROTECTION)
- Importance and current state:
  - Consumer protection is important for sustained stability and efficient development of financial systems, including Islamic finance.
  - Progress in developing consumer protection frameworks has been highly uneven; even less progress in tailoring frameworks to specifics of Islamic finance.
  - Regulations on consumer protection for Islamic finance are often new and further analysis is needed to inform policymaking.
  - Strengthening consumer protection should be a policy priority; frameworks should adapt to specifics of Islamic financial products.
- Six areas for reform identified (explicit list from the paper):
  - (i) strengthening the overall regulatory and supervisory framework for Islamic banks;
  - (ii) strengthening consumer protection frameworks for financial products in general and incorporating provisions to cater for the specifics of Islamic finance;
  - (iii) promoting financial literacy among consumers;
  - (iv) strengthening the governance structure so as to protect IAHs and ensure Shar’iah compliance;
  - (v) improving investor protection for Sukuk investors;
  - (vi) developing Shar’iah compliant deposit insurance schemes.

### Strengthening regulatory, supervisory and consumer protection frameworks
- Regulatory and supervisory needs:
  - Islamic banks undertake investment banking in addition to standard intermediation, have complex corporate structures with subsidiaries of non financial corporates, and require transactions to be Shar’iah compliant.
  - Regulatory and supervisory frameworks need additional provisions to address these risks specific to Islamic finance.
  - International standard setting bodies have developed standards, but adoption and consistent application across countries has been uneven.
  - Regulators may lack capacity or willingness to ensure Shar’iah compliance, undermining consistency within and across borders.
- Required reforms and targeted measures:
  - Islamic banks require a hybrid of banking and capital markets regulations to cover cross-sector operations and to enforce Conduct of Business rules, including:
    - Segregation of funds for restricted investment account holders.
    - Best execution principle.
    - Enforcement against breach of client mandate.
  - Tailored regulations to minimize group risks arising from complex conglomerate structures and gaps in consolidated supervision.
  - Address risk that financings of Islamic banks lack a secondary market, which hampers management of withdrawal risk in open-ended mutual funds.
  - Strengthen and harmonize Shar’iah governance structures.
- Consumer protection framework enhancements:
  - Areas for further reform include:
    - (i) streamlining the legal and regulatory framework for consumer protection in financial services;
    - (ii) providing regulatory clarity for IAHs;
    - (iii) enhancing disclosure requirements;
    - (iv) monitoring compliance;
    - (v) establishing cost-effective dispute resolution frameworks.
  - Need for effective coordination mechanism among regulators and key stakeholders to define strategic priorities and clarify roles and responsibilities.
- Treatment of IAHs in resolution:
  - Treatment of IAHs in resolution should be clarified in law.
  - Many regulators currently treat IAHs as deposits, but ranking in bankruptcy remains unclear and often not codified.
  - Under a conventional deposit insurance scheme all depositors are ranked equally, but an Islamic deposit insurance scheme could distinguish:
    - Between actual deposits (Wadiah) and Qard on the one hand and PSIA on the other hand;
    - Between restricted and unrestricted PSIA.
- Disclosure and governance improvements:
  - Implementing IFSB and AAOIFI standards and guidelines on disclosures and governance can enhance transparency.
  - Because unrestricted investment accounts allow commingling of bank and IAH funds, adequate transparency is essential for IAHs to assess management performance.
  - Islamic banks should disclose:
    - Policies, strategies, and profit allocation basis of investment accounts;
    - Differences between restricted and unrestricted IAH;
    - Role of reserves and policies used to manage rates of returns and risks associated with PSIA;
    - Accurate, relevant, and timely financial statements on investments, including performance and valuation;
    - Governance structure for ensuring Shar’iah compliance;
    - Circumstances where losses are to be borne by IAHs;
    - Investors’ contractual rights with regard to early withdrawal or redemption.
  - For Ijārah Muntahia Bittamlīk, consumer rights in default should be clarified ex ante.

*Source: _wp15107 - 41.      Deposit schemes for conventional banks that offer partial coverage of current deposits*

### 66.      Consistent with IFSB recommendations, the management of restricted IAHs funds

### _wp15107 - 66.      Consistent with IFSB recommendations, the management of restricted IAHs funds

### Management of restricted IAHs funds and regulatory framework
- Management of restricted IAHs funds should be governed by International Organization of Securities Commission (IOSCO) principles governing Collective Investment Schemes (CIS).
- Such investment business should be subject to capital markets regulations related to:
  - client mandates,
  - commingling of client assets,
  - segregation of client funds,
  - disclosures on investments,
  - requirements for training and certification of fund managers.
- For countries without capital markets and therefore no securities regulation, the regulator should be given legal powers to:
  - develop a prudential framework for Islamic banks that incorporates conduct of business rules,
  - oversee these rules.
- Supervision should ensure that customer agreements are followed.

### Financial consumer protection: monitoring, capacity, and data
- Monitoring compliance with financial consumer protection regulations is essential to effective implementation of the legislation and can inform public policy.
- Regulators should build capacity to enforce and monitor the consumer protection mandate.
- Country level impact assessments are important to determine effective approaches, including assessment of:
  - effects on users of Islamic financial services,
  - cost to financial institutions.
- Data on consumer complaints should be compiled and used to inform consumer protection policies.

### Dispute resolution and redress mechanisms
- Cost-effective dispute resolution mechanisms are needed, including ADR mechanisms, while retaining the customer’s right to go to court.
- Rationale:
  - Retail client disputes often involve amounts too small to justify litigation expense and time.
  - Litigation may not be geared to resolving Islamic finance disputes unless judges are schooled in Shar’iah principles.
- Recommended mechanisms:
  - arbitration procedures involving a financial ombudsman with knowledge of both Shar’iah and relevant commercial transactions.
- There is a need to increase consumer awareness of redress mechanisms.

### Promoting financial literacy and human resource development
- Islamic finance education and training opportunities have expanded but significant scope for improvement remains at all levels.
- Major challenge: human resource development for practitioners, Sharī`ah scholars, lawyers, accountants, regulators, judges, politicians and other stakeholders.
- Limited awareness about Islamic finance persists among the general public, including the educated and influential elite.
- Policy priorities:
  - addressing the shortage of Sharī`ah scholars,
  - expediting financial literacy programs.

### Strengthening corporate governance structures for IAHs
- Governance arrangements need strengthening to ensure protection of IAHs and Shar’iah compliance.
- In line with IFSB guidelines, establishment of a Governance Committee responsible for governance issues relating to IAHs can:
  - enhance transparency of returns and risks,
  - ensure investment decisions are in the best interest of IAHs.
- Consumers investing in Shar’iah compliant products need protection to ensure their requirements are complied with.
- Decision point: centralized Shar’iah board covering Islamic banks versus decentralized bank-level Shar’iah governance.
  - Supervisors need full understanding of pros and cons of each model.
  - Any Shar’iah governance system should have features of “competence, independence, confidentiality and consistency”.
  - Advantages of a centralized Shar’iah board:
    - harmonizing Shar’iah rulings across the Islamic sector,
    - reducing the cost of Shar’iah compliance for Islamic banks,
    - enhancing consumer confidence,
    - easing constraints from a shortage of Shar’iah scholars.

### Strengthening the protection of Sukuk investors
- Challenges:
  - Sukuk structures can be very complex, making it difficult for investors to discern risks.
  - Legal and regulatory frameworks are not harmonized across countries, exposing investors to legal risks in cross-border defaults.
- Protection of Sukuk investors requires action on four broad fronts:
  - strengthening domestic bankruptcy regimes,
  - harmonizing the international legal and regulatory environment,
  - standardizing contracts,
  - strengthening securitization laws.

- Observations and implications:
  - Sukuk defaults exposed investor vulnerability to cross-country differences in legal frameworks, and disparities between ex ante provisions and ex-post outcomes.
  - Investors’ rights were better protected in countries with stronger insolvency regimes.
  - Rising volume of cross-border Islamic financial transactions increases urgency to harmonize regulatory frameworks to reduce legal risk in Sukuk default.
  - Even asset-backed Sukuk may be challenged due to limited experience with the instrument and variation in legal opinion across jurisdictions.
  - International collaboration is needed to address cross-country differences in insolvency regimes.

- Contract standardization:
  - Standardization of contracts would enhance consumer protection by clarifying documentation, guidelines, best business practices, and transparency.
  - Strengthening and streamlining Shar’iah approval processes is needed.
  - IIFM efforts and current work in Islamic Capital & Money Market (ICMM) standardization are important steps.

- Securitization laws:
  - Inadequacies in securitization laws contribute to issuance of asset-based Sukuk (where investors do not have recourse to underlying assets).
  - Policy actions:
    - some countries will need to enact new laws;
    - others must ensure existing laws cater to specifics of Islamic capital market products.

### Deposit insurance schemes and treatment of PSIA
- Countries offering Islamic financial services should seek to ensure Deposit Insurance Schemes are Shari’ah compliant and should clarify the treatment of PSIA.
- Current landscape:
  - The IFSB has not adopted a standard or guideline on Shari’ah-compliant deposit insurance.
  - Jurisdictions are divided on definition and treatment of PSIA:
    - some provide protection to both unrestricted and restricted PSIA holders,
    - some provide protection only to unrestricted PSIA,
    - some do not provide any protection to PSIAs.
- Other account types:
  - Wadiah accounts (a type of current account) should be guaranteed and, unlike conventional accounts (where coverage is usually up to a specified amount only), these accounts would require full coverage.
- To minimize Shar’iah non-compliance risks:
  - strengthen governance structures,
  - ensure investments are consistent with Shar’iah rules.

### Selected numeric and dated contractual features (Muḍārabah example)
- Profit split in the Muḍārabah structure described:
  - 90 per cent. to the Issuer (as Rab-al-Maal),
  - 10 per cent. to the Mudareb.
- The First Call Date specified: 16 October 2018.
- The Muḍārabah is described as a perpetual arrangement with no fixed end date.
- Conditions that may trigger liquidation or redemption include:
  - a Tax Event (circumstances where the Mudareb or the Issuer would be required to pay tax on amounts due under the Muḍārabah Agreement or the Certificates due to a change in law),
  - a Capital Event (circumstances where ADIB is notified in writing by the UAE Central Bank that the notional amount of the Certificates which qualifies as regulatory capital would cease to qualify for inclusion in full in the consolidated Tier 1 capital of ADIB).

_Italic: Content derived from the specified IMF working paper section._

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15107.pdf_