Ethics and governance in the European Financial centers

In a recent letter to Hans-Rudolf Merz, Angel Gurria clarifies the role of the OECD and how Switzerland was actually informed of what was going on.

I have personally no doubt that Switzerland, which is a jurisdiction that has a long banking tradition, will be able to be a faithful player.

Luxembourg Government recently announced a series of supportive measures for Islamic finance in Luxembourg

Mr Grulms identified Islamic finance as a concept that is not limited to the Arab world but which has values in common with the socially responsible investment principles that are gaining popularity in western countries.  In the "dense fog" that surrounds the immediate future of the financial sector, ethical and moral standards for investing "will inspire our actions of today and tomorrow". 

I am afraid Luxembourg professionals are not aware of the stake and the requirements of islamic finance beyond a motto like "In the 'dense fog' that surrounds the immediate future of the financial sector, ethical and moral standards for investing 'will inspire our actions of today and tomorrow'."

A FSA report dated November 2007 on Islamic Finance lists five main pillars on which Islamic finance is based and this is a significant challenge to Luxembourg financial institutions which should not be underestimated:

1. The Islamic economic model emphasises fairness. This is reflected in the requirement that everyone involved in a transaction makes informed decisions and is not misled or cheated. On a macro-economic level, the Islamic model aims at social justice and the economic prosperity of the whole community; for example, specific Sharia rulings seek to reduce concentration of wealth in a few hands, which may be detrimental to society.
2. Islam encourages and promotes the right of individuals to pursue personal economic wellbeing, but makes a clear distinction between what commercial activities are allowed and what are forbidden. For example, transactions involving alcohol, pork related products, armaments, gambling and other socially detrimental activities.
3. One key Sharia ruling on economic activities of Muslims is the strict and explicit prohibition of Riba, most usually described as usury or interest. Sharia scholars consider exchanging interest payments within the conventional banking system as a type of Riba. Modern Islamic banking has developed mechanisms to allow interest income to be replaced with cash flows from productive sources, such as returns from wealth generating investment activities and operations. These include profits from trading in (real) assets and cash flows from the transfer of usufruct (the right to use an asset), for example, rental income.
4. The Islamic economic model is based on a risk and profit-sharing (and loss-bearing) philosophy. So, in this respect, Islamic transactions are similar to, if not the same as, equity-based transactions in rewarding performance. However, Sharia requirements go further to ensure that in distributing profits more emphasis is placed on reward for effort rather than reward for merely owning capital.
5. The Islamic Law of Contracts plays a pivotal role within the Islamic financial system. Islamic commercial jurisprudence consists of principles and rules that must be observed for transactions to be acceptable in Islam; and the Islamic Law of Contracts is at the heart of this. One important principle is contractual certainty. Under this body of law, uncertainties or ambiguities that can lead to disputes may render a contract void under Sharia.

Neither most Luxembourg  products and institutions nor the business culture meet these ethical criteria: business ethics does not exist in the jurisdiction.

The implementation of Islamic finance requires a cultural change in Luxembourg all the more than there are risks that were identified by the FSA and may be adapted to Luxembourg: 

• Sharia Arbitrage: There is a diversity of opinion as to whether particular practices or products are Sharia compliant. This means that some products and services may be approved as being Shariacompliant by some Sharia scholars but not by others. On a global level, the approval of Islamic firms' products and services may also depend on the jurisdiction they are to be offered in. This can add another layer of complication for regulators. The CSSF like the FSA is in no position to assess the suitability of the scholars consulted by Islamic firms. It should, however, see the basis on which an Islamic firm claims to be Sharia -compliant is communicated appropriately to the consumer. More generally, it shpould support moves to develop common Sharia standards by organisations such as the Islamic Financial Services Board (IFSB) and the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). Greater standardisation could reduce the potential for Sharia 'arbitrage' as well as making it easier for bankers and investors to understand the market.
• Sharia compliance throughout the product life cycle: For Islamic finance providers, gaining approval from the SSB on Sharia compliance of a product before its launch is vital. Equally important for firms is recognising that Sharia compliance is a continuous process that means their products and services are adequately monitored. Unlike conventional finance, this has implications for an Islamic firm's prudential requirements as well as conduct of business: some products, if they breach Sharia compliance rules, can adversely affect a firm's solvency by converting an asset into a liability on the balance sheet. Effective monitoring of Sharia compliance by an Islamic firm may involve reinforcing more remote SSB oversight through the Internal Sharia Audit process and by developing more knowledge and expertise within the firm.
• Issues for Sharia Scholars: The shortage of appropriately-qualified Sharia scholars in the Islamic financial industry means it is common for individual scholars to hold positions on the SSBs of a number of Islamic firms. This raises concerns over the ability of SSBs to provide enough rigorous challenge and oversight of firms' products and services. Another issue is where the SSB of a firm is responsible for the yearly Sharia audit as well as approving products for Sharia compliance. As with conventional firms, the CSSF like the FSA should see these conflicts recognised and carefully managed.
• Human resources: It is widely acknowledged that there is a global shortage of experienced professionals in the Islamic finance sector. There is clearly scope for more education and training in Luxembourg (Luxembourg School of Finance). These include university degrees and professional training courses.
• As explained earlier, the shortage of resources also extends to Sharia scholars who have relevant banking experience. To address this, some firms have placed less-experienced scholars alongside experienced ones on their SSB, thus helping to develop more knowledgeable scholars.
• Contract and documentation risk: In contracts for Islamic transactions, the enforceability of terms and conditions depends on the governing law. In the€ case of a dispute, it is unlikely that a Luxembourg court will give a verdict based on Sharia law. There are two main reasons. First, there is no provision for the choice or application of a non-national system of law, such as Sharia. Second, because the application of Sharia principles was a matter of debate, even in Muslim countries. To mitigate this risk, contracts have to be written very carefully to minimise potential disputes and state the governing law.
• Risk of contagion: In Luxembourg, the risk of contagion to the wider economy and financial markets through a failure of an Islamic financial institution is limited as the market is currently relatively small. In countries where Islamic institutions have a larger share of the market the impact would be wider.

Bloomberg has reported that Jean Guill, 58, who became director-general of the Commission de Surveillance du Secteur Financier May 1, isn’t “particularly worried” about Madoff damaging the country’s financial market.

He is coming so he cannot say anything else to avoid investor’s fears.

His predecessor gave a much more balanced interview a couple of weeks ago.

According to Deminor, the CSSF is very good at using its powers to help investors to get recoveries, but the big open question is whether they did enough before the fraud.

I totally agree to state that the CSSF is doing a good job compared to its counterpart in Ireland, as the Irish regulator:

- did not communicated a lot on Madoff

- does not seem to have decided measures in order to safeguard at best the investors' rights.

Nevertheless the legal and regulatory framework in Luxembourg remains in question.