Shariah Governance Rules for Finance Companies

Circular

To: Respected Parties,

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

Subject: Shariah Governance Rules for Finance Companies.

Based on the powers vested in the Saudi Central Bank (SAMA) under its system issued by Royal Decree No. (36/M) dated 1427/04/11 AH, and the Finance Companies Control System issued by Royal Decree No. (51/M) dated 1433/08/13 AH, and in 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 Shariah Governance Rules for Finance Companies, which aim to establish a minimum standard for Shariah governance practices in finance companies and enhance the compliance environment with Shariah rulings and principles. These Rules also specify the roles and responsibilities of the Board of Directors, Senior Management, the Shariah Committee, and the principles of independence and information confidentiality.

For your information and action effective from 01/01/2023 CE, Yours sincerely,

Fahd bin Ibrahim Al-Shathri Deputy Governor for Supervision

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Distribution Scope:

• Finance companies operating in the Kingdom.

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P.O. Box 2992 Riyadh 11169, Kingdom of Saudi Arabia Tel: +966 11 463 3000

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Shariah Governance Rules for Finance Companies

Shawwal 1442 AH / May 2021 CE

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Table of Contents

Page No.	Section
3	Chapter One: Preliminary Provisions
5	Chapter Two: Responsibilities of the Board of Directors and Senior Management
6	Chapter Three: Shariah Supervision
6	Chapter Four: Controls on the Operation of the Shariah Committee
8	Chapter Five: Independence and Information Confidentiality
9	Chapter Six: Final Provisions

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Chapter One: Preliminary Provisions

Article One: Preamble

1. The Saudi Central Bank (SAMA) has issued these Rules pursuant to the powers granted to it under the Finance Companies Control System issued by Royal Decree No. (51/M) dated 1433/08/13 AH, and its implementing regulations issued by the Governor's decision No. (2/M Sh T) dated 1434/04/14 AH.
2. A finance company's commitment to conducting financing activities in a manner consistent with Islamic Shariah rulings is one of the requirements of the Finance Companies Control System issued by Royal Decree No. (51/M) dated 1433/08/13 AH, and Article (Three) of the said system stipulates that "Companies licensed under this system shall conduct financing activities in a manner consistent with Islamic Shariah rulings, based on what Shariah committees appointed by those companies decide, without compromising the stability of the financial system and fairness of transactions."
3. These Rules aim to enhance the work of Shariah committees in finance companies supervised by SAMA and ensure that financing activities align with Shariah rulings and principles. To achieve this, the Board of Directors and Senior Management of a finance company are expected to have a reasonable understanding of Shariah principles and their broad application in Islamic finance. It is also expected that the Shariah Committee possesses 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 terms and expressions used in these Rules carry the meanings specified in the Finance Companies Control System and its implementing regulations. B. For the purpose of applying these Rules, the following terms and expressions - whenever used herein - carry the specified meanings:

• The Central Bank: The Saudi Central Bank (SAMA).
• The Rules: Shariah Governance Rules for Finance Companies.
• The Board: The Board of Directors of the finance company.
• The Committee: A specialized Shariah committee tasked with overseeing compliance with and the application of Shariah rulings and principles in the financing activities conducted by the finance company.
• Committee Members: A group of specialists whose academic background is not limited to Islamic Shariah sciences, but includes their knowledge and expertise in contemporary financial transaction jurisprudence, which is utilized in the form of Shariah decisions directed to the finance company.

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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 ensuring that the financing activities conducted by the finance company align with Islamic Shariah rulings and principles, in accordance with the Committee's decisions. It is specifically responsible for the following: A. Overseeing 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 finance company's main units, facilitating their interaction with Senior Management regarding matters related to the alignment of financing activities with Shariah rulings and principles, in accordance with the Committee's decisions. C. Setting appropriate remuneration and compensation for Committee members - based on the recommendation of the Remuneration and Nomination Committee - commensurate with 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 governing the Committee's work and oversees their implementation.

Article Six: Responsibilities of Senior Management

1. Identifying Shariah issues, referring them to the Committee for decision, and supporting them with necessary information and disclosures in a timely manner.
2. Monitoring and implementing Shariah decisions issued by the Committee.
3. Providing continuous education and training programs for internal stakeholders, including the Board, the Committee, and employees involved in Shariah and financial matters.
4. Ensuring that financing activities align with Islamic Shariah rulings and principles as reflected in the Committee's decisions and recommendations.
5. Reporting to the Board and the Committee about products that do not align with Islamic Shariah rulings and principles through official reports.
6. Promoting a culture of compliance with Islamic Shariah rulings and principles within the finance company, and familiarizing relevant employees with financing products that comply with Shariah rulings.

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Chapter Three: Shariah Supervision

Article Seven: Shariah Supervision Activities

First: Shariah Compliance:

1. The role of Shariah compliance involves the regular assessment of the finance company's financing activities to ensure their alignment with Islamic Shariah rulings and principles.
2. The person performing the Shariah compliance function must ensure the level of the finance company's compliance with Islamic Shariah rulings and principles, as well as corrective procedures to address non-compliance cases.
3. This function may be performed by the Compliance Department or by utilizing the expertise of internal Shariah specialists within the finance company.
4. The finance company may engage a specialized external entity to perform Shariah compliance functions, subject to SAMA's approval.

Second: Shariah Audit:

1. The role of Shariah audit involves an independent review process to provide objective assurance that enhances the level of alignment between the finance company's financing activities and Islamic Shariah rulings and principles.
2. The person performing the Shariah audit function must conduct an audit at least once a year.
3. This function may be performed by the Internal Audit Department or by utilizing the expertise of internal Shariah specialists within the finance company.
4. The finance company may engage a specialized external entity to perform Shariah audit functions, subject to SAMA's approval.
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 Operation of the Shariah Committee

Article Eight: Selection and Qualifications of Committee Members

Committee members are selected and appointed by the Board - based on the recommendation of the Remuneration and Nomination Committee - following approval from the General Assembly for appointing committee members, if the internal policy so provides. The Committee is constituted as follows:

Article Nine: Responsibilities of the Committee

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

1. Meeting regularly and as needed, with no less than one meeting every six months.
2. Issuing decisions on Shariah issues referred to it in a timely manner and ensuring that the finance company's operations are not adversely affected.
3. Resolving difficulties in obtaining the Committee’s decisions.
4. Ensuring that policies and procedures prepared by the finance company align with Islamic Shariah rulings and principles.
5. Ensuring that financing products align with Islamic Shariah rulings, and the Committee must adopt procedures for making Shariah decisions.
6. Documenting and approving them to ensure a reliable decision-making process and protect the Committee from any unjustified potential influences.
7. Informing the Board and the Committee of appropriate measures to address the situation, if it is established that the finance company has conducted financing activities inconsistent with Islamic Shariah rulings and principles.
8. Notifying SAMA of cases where non-compliant activities are not effectively or adequately addressed, or where the finance company fails to take any corrective measures regarding them.

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Chapter Five: Independence and Information Confidentiality

Article Ten: Independence

The Committee's independence must be constantly maintained in exercising its functions to issue objective and reliable Shariah decisions, as follows:

Article Eleven: Information Confidentiality

1. Committee members are committed to maintaining the confidentiality of internal information obtained during their duties and avoiding misuse. Furthermore, confidential or sensitive information obtained by any Committee member during their tenure must not be used in any manner that could harm the finance company.
2. Without prejudice to the above, the Committee's disclosure of information to SAMA for the purpose of notifying it about the finance company's violations of Shariah rulings and principles does not constitute a breach of the information confidentiality principle.

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Chapter Six: Final Provisions

Article Twelve:

The finance company shall review its adopted policies and operational procedures and amend them so as not to conflict with these Rules.

Article Thirteen:

These Rules shall be effective from 01/01/2023 CE.

Article Fourteen:

SAMA may exempt finance companies from applying any of the provisions contained in these Rules, provided such exemption does not conflict with the governing system.

Article Fifteen:

SAMA is responsible for verifying the application of the provisions contained in these Rules, and in case of non-compliance, the finance company shall be subject to penalties in accordance with relevant systems and regulations.