Circular Re. Shariah Governance rules for finance companies

Saudi Central Bank

Ref: 42071901 Date: 15/10/1442 AH Attachments: 1 page

Circular

To Whom It May Concern,

Peace, mercy, and blessings of God be upon you,

Subject: Instructions on Shariah Governance in Finance Companies.

Based on the authorities vested in the Saudi Central Bank under its system issued by Royal Decree No. (M/36) dated 11/4/1442 AH, and the Finance Companies Supervision System issued by Royal Decree No. (M/5) dated 13/8/1433 AH, and with the Saudi Central Bank's desire to enhance Shariah governance procedures in finance companies to contribute to the development of Islamic finance in the Kingdom.

Accordingly, please find attached the Instructions on Shariah Governance in Finance Companies, which aim to set a minimum standard for Shariah governance practices in finance companies and enhance the environment of compliance with Shariah rulings and principles. These instructions also define the roles and responsibilities of the Board of Directors, Senior Management, and the Shariah Committee, as well as principles of independence and confidentiality of information.

For information and action effective from 1/1/2022 AD.

Accept my regards.

Fahd bin Ibrahim Al-Shathri Deputy Governor for Supervision

Distribution List:

• Finance companies operating in the Kingdom.

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Instructions on Shariah Governance in Finance Companies

Shawwal 1442 AH / May 2021 AD

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Table of Contents

Part	Page Number
Chapter One: Preliminary Provisions	3
Chapter Two: Responsibilities of the Board of Directors and Senior Management	5
Chapter Three: Shariah Supervision	6
Chapter Four: Controls on the Work of the Shariah Committee	6
Chapter Five: Independence and Confidentiality of Information	8
Chapter Six: Final Provisions	9

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Chapter One: Preliminary Provisions

Article One: Preamble

1. The Saudi Central Bank issued these Instructions pursuant to the authorities vested in it under the Finance Companies Supervision System issued by Royal Decree No. (M/5) dated 13/8/1433 AH, and its executive regulations issued by the Governor's decision No. (2/M Sh T) dated 14/4/1443 AH.

2. Compliance by a finance company with conducting financing activities in a manner consistent with Islamic Shariah rulings is one of the requirements of the Finance Companies Supervision System; Article (Third) of the Finance Companies Supervision System issued by Royal Decree No. (M/5) dated 31/8/1433 AH stipulates that "Companies licensed under this system shall conduct financing activities in a manner consistent with Islamic Shariah rulings, based on what Shariah committees chosen by those companies decide, without compromising the integrity of the financial system and fairness of transactions."

3. These instructions aim to enhance the work of Shariah committees in finance companies under the supervision of the Saudi Central Bank and ensure that financing activities are consistent with Shariah rulings and principles. To achieve this, it is expected that the Board of Directors and Senior Management of the finance company have a reasonable understanding of Shariah principles and their broad application in Islamic finance. It is also expected that the Shariah Committee has sufficient knowledge of financial matters in general and Islamic finance in particular, enabling it to understand the Shariah issues presented to it.

Article Two: Definitions

A. The meanings of the words and phrases used in these Instructions are those specified in the Finance Companies Supervision System and its executive regulations.

B. For the purpose of applying these Instructions, the following words and phrases - wherever they appear in these Instructions - have the meanings indicated opposite each of them, unless the context dictates otherwise:

• The Central Bank: The Saudi Central Bank.

• The Instructions: Instructions on Shariah Governance in Finance Companies.

• The Board: The Board of Directors of the finance company.

• The Committee: A specialized Shariah committee tasked with supervising compliance with Shariah rulings and principles and their applications in the financing activities conducted by the finance company.

• Committee Members: A group of specialists whose scientific background is not limited to knowledge of Shariah sciences, but includes their knowledge and expertise in contemporary financial transaction jurisprudence utilized in the form of Shariah decisions directed to the finance company.

• Independent Committee Member: A person who enjoys complete independence in their position and decisions and is able to perform their duties, express opinions, and vote on Shariah decisions objectively and impartially, and none of the independence impediments listed in these Instructions apply to them.

• Shariah Supervision: Monitoring and verifying the extent to which the finance company's activities comply with Islamic Shariah rulings and principles.

Other words or phrases used in these Instructions carry the meanings explained in the Finance Companies Supervision System, its executive regulations, and related instructions.

Article Three: Scope

First: These Instructions apply to a finance company licensed to conduct one or more of the following financing activities:

1. Real estate financing.
2. Productive asset financing.
3. Financing for small and medium-sized enterprises (SMEs).
4. Financial leasing.
5. Credit card financing.
6. Consumer financing.

Second: These Instructions are advisory for other licensed financing activities under the Finance Companies Supervision System and its executive regulations, except for provisions stipulated in related systems and instructions as mandatory. The Saudi Central Bank has the right at any time to require these activities to apply some or all of the requirements of these Instructions.

Article Four: General Provisions

1. The finance company must establish policies and procedures regulating the work of the Committee and provide a copy to the Saudi Central Bank, including determining how meetings are held, the mechanism for decision-making and documentation, and the mechanism for preparing and submitting reports.

2. The finance company must ensure that the Committee's reports are submitted effectively and in a timely manner to the Board.

3. The Board must perform its duties and tasks effectively, ensure the independence of the Committee, verify the qualifications of its members, and ensure the effectiveness of Shariah supervision tasks.

4. The finance company must disclose the CVs of all Committee members on the company's website to enable stakeholders to judge their competence and ability to perform their duties effectively.

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Chapter Two: Responsibilities of the Board of Directors and Senior Management

Article Five: Responsibilities of the Board of Directors

1. The Board is primarily responsible for the financing activities conducted by the finance company and their consistency with Shariah rulings and principles according to the Committee's decisions. It is specifically responsible for the following:

   a. Supervising the finance company's compliance with and implementation of Shariah decisions issued by the Committee. b. Ensuring the existence of an effective policy and communication mechanism between the main units of the finance company to facilitate and enable these units to communicate with Senior Management on matters related to the consistency of financing activities with Shariah rulings and principles according to the Committee's decisions. c. Setting appropriate compensation and salaries for Committee members - based on the recommendation of the Remuneration and Nomination Committee - commensurate with the size of their duties and responsibilities. d. Evaluating the performance of Committee members based on indicators of competence, knowledge, contribution, and effectiveness.

2. The Committee reports directly to the Board.

3. The Board approves all policies and procedures regulating the work of the Committee and oversees their implementation.

Article Six: Responsibilities of Senior Management

1. Identifying Shariah issues and referring them to the Committee for its decision and providing it with the necessary information and disclosures in a timely manner.

2. Following up on and implementing Shariah decisions issued by the Committee.

3. Providing education and training programs for key internal stakeholders, including the Board, the Committee, and employees involved in Shariah and financial matters.

4. Ensuring that financing activities are consistent with Shariah rulings and principles as stated in the Committee's decisions and recommendations.

5. Reporting to the Board and the Committee about products suspected of being inconsistent with Shariah rulings and principles through official reports, and immediately stopping such products if their inconsistency with Shariah rulings and principles is proven.

6. Promoting a culture of compliance with Islamic Shariah rulings and adopting it within the finance company, and informing relevant employees about financing products consistent with Shariah rulings and principles.

7. Developing financing products in accordance with Islamic Shariah rulings and principles.

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Chapter Three: Shariah Supervision

Article Seven: Shariah Supervision Activities

First: Shariah Compliance:

1. The task of Shariah compliance is the regular evaluation of the financing activities conducted by the finance company to ensure their consistency with Shariah rulings and principles.

2. The person performing the Shariah compliance task must ensure the level of the finance company's compliance with Islamic Shariah rulings and principles, and corrective procedures to address non-compliance cases.

3. This task can be assigned to the Compliance Department or by utilizing the expertise of Shariah specialists within the finance company to perform Shariah compliance tasks.

4. The finance company may engage a specialized external party to perform Shariah compliance tasks after notifying the Saudi Central Bank.

Second: Shariah Audit:

1. The task of Shariah audit is the independent review process to provide objective assurance to improve the level of compliance of the finance company's financing activities with Islamic Shariah rulings and principles.

2. The person performing the Shariah audit task must conduct the audit process at least once a year.

3. This task can be assigned to the Internal Audit Department or by utilizing the expertise of Shariah specialists within the finance company to perform the Shariah audit process.

4. The finance company may engage a specialized external party to perform Shariah audit tasks after notifying the Saudi Central Bank.

5. The results and observations of the Shariah audit must be submitted to both the Audit Committee and the Shariah Committee at least once a year.

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Chapter Four: Controls on the Work of the Shariah Committee

Article Eight: Selection of Committee Members and Membership Conditions

The members of the Committee and its Chairman are selected and appointed by a Board decision - based on the recommendation of the Remuneration and Nomination Committee - after obtaining no objection from the Saudi Central Bank. The finance company may obtain the General Assembly's approval for the appointment of Committee members if its internal policy includes this. The Committee is constituted as follows:

1. The number of Committee members must be commensurate with the size and nature of the finance company's activities, with a minimum of two members and a maximum of five members.

2. The Chairman of the Committee must be an independent member. Independence for the Chairman is not achieved in the following cases:

   a. If he is an owner of five percent or more of the shares of the finance company or more in one of the company's subsidiaries. b. If he represents a legal entity that owns five percent or more of the shares of the finance company or one of the finance company's subsidiaries. c. If he has a direct or indirect interest in the activities and contracts conducted on behalf of the finance company. d. If he receives financial amounts from the finance company in addition to his salary or membership remuneration in the Committee.

3. Committee members should be qualified to perform the tasks entrusted to them, have a clear understanding of their duties and responsibilities, and have the ability to exercise sound judgment objectively. Collectively, members must possess diverse professional, practical, and administrative skills and appropriate Shariah and financial expertise, particularly integrity and commitment, and possess a high degree of good reputation, competence, and responsibility. The effectiveness of the Committee depends on the members' experience and their ability to judge from a comprehensive perspective. Member qualifications should include the following attributes:

   • Competence: Reflected by the level of education, training, and skills, and the availability of at least three years of experience in related fields.
   • Shariah and Financial Knowledge: Possession of appropriate Shariah knowledge in addition to the ability to read, understand, and interpret financial data and reports.

4. A member of the Shariah Committee for finance companies is not allowed to participate in more than five Shariah committees for finance companies.

5. The finance company must include a specific confidentiality clause in the contract or terms of appointment of a Committee member; in order to maintain the confidentiality and privacy of the finance company's information.

6. The finance company must notify the Saudi Central Bank in writing within (5) working days when the membership/resignation of any Committee member ends for any reason. The membership of Committee members cannot be terminated before the end of their term except for an acceptable reason, and the resigning member must submit their resignation with reasons to the Board.

Article Nine: Responsibilities of the Committee

The Committee bears responsibility for all its decisions regarding Shariah issues. The Board must rely on the Committee regarding the issuance of Shariah decisions concerning the finance company's activities. The Committee must perform the following tasks:

1. Meet regularly and whenever necessary, at least once every six months.

2. Issue decisions on referred Shariah issues in a timely manner and ensure that the finance company's operations are not affected by the difficulty of obtaining Committee decisions.

3. Ensure that policies and procedures prepared by the finance company are consistent with Islamic Shariah rulings and principles.

4. Ensure that financing products are consistent with Islamic Shariah rulings and principles; the Committee must approve the rulings and conditions contained in the product manual, forms, contracts, agreements, and other legal documents used in implementing operations.

5. To ensure the quality and consistency of Shariah decisions, the Committee must adopt a systematic procedure for making, documenting, approving, and maintaining Shariah decisions to ensure the reliability of the decision-making process and protect the Committee from any potential unjustified influences.

6. Inform the Board and recommend appropriate measures to address the situation if the Committee determines that the finance company has conducted financing activities inconsistent with Islamic Shariah rulings and principles.

7. Prepare an annual report on the consistency of the finance company's financing activities with Islamic Shariah rulings and principles and submit it to the Board.

8. Inform the Saudi Central Bank of cases where non-compliant activities with Shariah rulings are not addressed effectively or adequately, or where the finance company has not taken any corrective measures regarding them.

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Chapter Five: Independence and Confidentiality of Information

Article Ten: Independence

The independence of the Committee must be observed at all times in performing its duties to issue objective and reliable Shariah decisions, as follows:

1. The Board's recognition of the Committee's independence and ensuring that it is not subject to any influence that may hinder it from issuing objective Shariah decisions when discussing issues presented to it.

2. Shariah decisions issued by the Committee may not be modified or ignored without its approval.

3. The Committee must obtain accurate and complete information from Senior Management. The Committee has the right to request additional information from Senior Management if the provided information is insufficient.

4. In the event that the Committee is not provided with the required information, the Board must be notified, and the Board must take appropriate action to correct the situation.

Article Eleven: Confidentiality of Information

1. Committee members are committed to maintaining the confidentiality of internal information obtained during their work and not misusing it. Nor may any member use confidential or sensitive information obtained during their work in any way that may harm the finance company.

2. Without prejudice to the above, the Committee's disclosure of information to the Saudi Central Bank for the purpose of informing it about the commission of violations of Shariah rulings and principles by the finance company does not constitute a breach of the principle of confidentiality of information.

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Chapter Six: Final Provisions

Article Twelve:

The finance company must review and amend its adopted policies and procedures to ensure they do not conflict with these Instructions.

Article Thirteen:

These Instructions shall be effective from 1/1/2022 AD.

Article Fourteen:

The Saudi Central Bank may exempt a finance company from applying any of the provisions contained in these Instructions in a manner that does not conflict with the System.

Article Fifteen:

The Saudi Central Bank is responsible for verifying the implementation of the provisions contained in these Instructions. In case of non-compliance, the finance company will be penalized in accordance with related systems and regulations.