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Istisna - Operational Requirements

Yahya Massoud
By Yahya Massoud
1 month ago
Istisna - Operational Requirements

Islamic banking, Shariah, Takaful, Bank

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  1. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 22 / 44 PART C OPERATIONAL REQUIREMENTS 31. G 31.1 Background An IFI may enter into an istisna` contract with a customer who intends to acquire an asset that needs to be constructed or manufactured based on an agreed specification. S 31.2 The IFI that enters into istisna` contract as a seller or a purchaser which result in the following obligation must comply with Shariah requirements (Part B) and operational requirements (Part C): (a) the IFI as a seller has the obligation to deliver the completed istisna` asset to the customer regardless if the IFI directly undertake the istisna` project or hiring a contractor or manufacturer (hereinafter must be referred to as a contractor) to complete the istisna` project; or (b) the IFI as a purchaser is expected to ensure the istisna` asset is completed as per the agreed specifications and delivered on the agreed date since the IFI would have the obligation to deliver the completed istisna` asset to the customer arising from the transaction to transfer the ownership of istisna` asset to the customer either via a forward sale or lease arrangement. Illustration on the product structures that use istisna` as the underlying Shariah contract is provided in Appendix 3. 32. S 32.1 Governance and oversight While the broad governance and oversight principles can be applied, specific requirements are needed to manage the distinct risks and the unique nature of the istisna` contract. The IFI must have sufficient understanding of its risk profile and availability of the resources with the appropriate knowledge and skill set. S 32.2 The board of directors (the Board) must establish a sound governance structure to facilitate an effective oversight function on the management and Issued on: 23 December 2015
  2. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 23 / 44 implementation of the istisna` contract. The adequacy of the governance structure must commensurate with the nature, scale, complexity and risk profile of the istisna` contract. S 32.3 The roles and responsibilities of the Board with respect to istisna` transaction must include the following: (a) set the IFI’s business strategy and risk appetite with regard to the application of the istisna` contract; (b) approve the IFI’s internal policies and oversee the internal procedures for effective risk management to ensure compliance with the relevant law and regulations; (c) establish appropriate systems to implement the application of istisna` contract consistent with Shariah requirements; (d) ensure that the IFI has adequate and qualified personnel with sufficient knowledge and competency on the concept, application and risks associated with the istisna` contract; and (e) ensure independent reviews are conducted regularly to assess compliance with the policy documents issued by the Bank and relevant internal policies established by the IFI. S 32.4 The Shariah Committee (SC) must perform the following to ensure that istisna` transaction is conducted in line with Shariah requirements– (a) endorse the application of Shariah requirements in the relevant policies and procedures governing the istisna` contract; (b) deliberate and endorse that the terms and conditions stipulated in the legal documentations and other documents such as information published for promotional materials, product manuals or other related publications are in compliance with Shariah; (c) assess the work carried out by Shariah review and Shariah audit functions, to identify issues and propose appropriate corrective measures; and (d) advise and provide clarification on relevant Shariah rulings, decisions or policy documents on Shariah matters issued by the Bank, if relevant, Issued on: 23 December 2015
  3. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 24 / 44 any other authorities. S 32.5 The roles and responsibilities of the senior management with regards to istisna` transaction must include the following: (a) develop and implement business strategies, internal control and risk management requirements in line with the IFI’s business objective; (b) establish internal policies, processes and procedures governing istisna` transaction; (c) implement relevant internal systems, infrastructure and adequate mechanisms to identify, measure, control and monitor risk inherent in the istisna` transaction; (d) ensure the IFI monitors and has proper and adequate reporting of the operation and performance of the istisna` transaction; (e) identify, assign and train key personnel with the appropriate skill and ensure that the roles and responsibilities are properly delegated to the relevant functions to undertake the different activities under the istisna` transaction; (f) undertake regular reviews and monitor compliance with the approved policies; and (g) ensure timely disclosure of relevant information to the Board and the SC. S 32.6 At minimum, the IFI must ensure that− (a) the istisna` asset is in compliance with Shariah and consistent with the IFI’s risk appetite and risk management capacities; (b) adequate capacities (such as funding sources, skills and expertise) are available to fulfil the proposed specifications of the istisna` asset; (c) delivery process of the completed istisna` asset is effective and efficient; and (d) defects of the istisna` asset are effectively managed. Issued on: 23 December 2015
  4. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 25 / 44 Assessment of the istisna` asset S 32.7 In relation to paragraphs 32.6(a) and (b), the IFI is required to assess the specifications of the istisna` asset that are proposed by the customer prior to entering into the istisna` contract. The assessment must− (a) verify the purpose of istisna` asset is in compliance with Shariah requirements; and (b) identify the relevant capacities that the IFI must have in order to fulfil the proposed specification of the istisna` asset and validate whether the IFI have the identified capacities. S 32.8 The IFI is required to develop the internal eligibility criteria of the istisna` asset to facilitate its assessment on the specifications of istisna` asset that is proposed by the customer. G 32.9 The IFI may consider parameter such as availability of secondary market for the proposed istisna` asset in developing the internal eligibility criteria of the istisna` asset. For highly customised istisna` asset that has limited secondary market, the IFI is expected to use stable type of funding source and to have adequate level of expertise to monitor the progression of the istisna` project. Delivery of istisna` asset S 32.10 In relation to paragraph 32.6(c), the IFI is required to develop the internal policy and procedure on delivery of the istisna` asset. At minimum, the internal policy and procedure must cover for the following: (a) verification that the istisna` asset fulfills the agreed specification prior to the delivery; (b) procedure for delivery of the istisna` asset; and (c) treatment for rejecting delivery of the istisna` asset and the non-delivery event. Issued on: 23 December 2015
  5. BNM /RH/PD 028-1 G 32.11 Islamic Banking and Takaful Department Istisna` Page 26 / 44 For the purpose of paragraph 32.10(b), the IFI may notify and obtain customer’s consent prior to delivery of the completed istisna` asset, especially in the event where the delivery is earlier than the agreed delivery date. Defect of istisna` asset S 32.12 In relation to paragraph 32.6(d), the IFI must establish the internal policy and procedure on defect management of the istisna` asset. At minimum, the policy and procedure must include mechanism to manage customer’s rights due to defect3. S 32.13 Prior to entering into the istisna` contract, the IFI as a purchaser, must ensure that the contractor establishes a mechanism to manage defects of the istisna` asset. G 32.14 The IFI may provide a provision of warranty as a mechanism for defect management in the istisna` contract. G 32.15 33. S 33.1 The IFI may appoint another party to manage defects of the istisna` asset. Documentations The IFI must ensure that the documentation on the istisna` transaction is enforceable and complies with Shariah. S 33.2 At minimum, the IFI must ensure the following transactions are documented in writing and executed by the contracting parties: (a) sale and/or purchase transaction (istisna` contract) and financial arrangement4; (b) accepting or rejecting the delivery of the istisna` asset; and (c) where applicable, appointment of an agent, acceptance of guarantee (kafalah), security deposit (hamish jiddiyyah), earnest money (`urbun) or 3 For the avoidance of doubt, the defect refers to any defect that is occurred before the delivery of the istisna` asset but discovered after the acceptance of the delivery of istisna` asset. 4 Financial arrangement refers to method and other terms of the settlement of the selling price. Issued on: 23 December 2015
  6. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 27 / 44 collateral (rahn). S 33.3 The IFI must ensure the rights, duties, liabilities and obligations of the contracting parties are clearly stipulated in the respective documentations. S 33.4 The IFI must ensure that the application for the construction, building or manufacturing of the istisna` asset is supported by a written document. At minimum, such written document must outline the following: S 33.5 (a) specifications including feature and quantity of the istisna` asset; (b) purpose of the istisna` asset; (c) delivery date5; and (d) where applicable, proposed contractor of the istisna` asset. Prior to entering into the istisna` contract, the IFI (seller) must ensure that its ownership of the istisna` asset is evidenced in the enforceable document. S 33.6 In the event where the customer has purchased the istisna` asset from a contractor, the IFI (seller) must ensure that the mechanism to transfer ownership of the istisna` asset from the customer to the IFI complies with Shariah requirements. G 33.7 In relation to paragraph 33.6, list of possible legal instruments as example of the mechanism to transfer the customer’s ownership of the istisna` asset to the IFI is provided in Appendix 4. S 33.8 At minimum, the IFI must ensure the documentation on sale and/ or purchase transaction (istisna` contract) includes the following: 5 (a) specifications of the istisna` asset or subject matter of sale; (b) total selling price; (c) settlement terms of the selling price; (d) delivery date; (e) delivery arrangement; (f) where applicable, provision of rebate (ibra’) due to early settlement of This includes the time or period as agreed by the contracting parties. Issued on: 23 December 2015
  7. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 28 / 44 the selling price; (g) where applicable, the proposed contractor of the istisna` asset; (h) events of default; (i) clause on compensation or treatment due to events of default; (j) options available due to non-delivery and defects of the istisna` asset; and (k) S 33.9 treatment of force majeure events. The IFI must ensure the terms and conditions in all legal documentations do not− (a) waive the seller’s obligation to deliver the completed istisna` asset on the agreed delivery date; and (b) waive the seller’s liability for any material defect of istisna` asset after acceptance of delivery by the customer. S 33.10 The IFI must ensure any variation to the agreed terms and conditions of the istisna` contract such as specifications or selling price after entering into the istisna` contract are mutually agreed by the contracting parties and documented. G 33.11 In the event where a person is appointed to undertake the istisna` project or to monitor progression of the istisna` project, the IFI may include the following terms and conditions in the relevant documentations: (a) progress schedule including the proposed timeline for the cash disbursement from the IFI; (b) roles and responsibilities of the person who monitor progression of the istisna` project; (c) description of trigger events that enable the IFI’s intervention in the istisna` project; and (d) rights of the IFI to intervene in the istisna` project upon occurrence of any trigger events. S 33.12 The IFI must ensure the following are included in relevant documentation on delivery of the istisna` asset: Issued on: 23 December 2015
  8. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 29 / 44 (a) delivery date of the istisna` asset; (b) person accepting or rejecting the delivery of the istisna` asset; and (c) where applicable, confirmation that the istisna` asset fulfils the agreed specifications by the person whom accepting the delivery of the istisna` asset. S 33.13 In the event where the application of istisna` contract is combined with agency (wakalah) and/or guarantee (kafalah) contracts, the IFI must ensure that− (a) istisna` contract is executed separately from agency (wakalah) and/ or guarantee (kafalah) contracts; and (b) terms and conditions of the agency and/or guarantee contracts must not be made conditional upon any terms and conditions of the istisna` contract. 34. G 34.1 Risk Management The application of istisna` contract may expose the IFI to various types of risk, such as credit, market, liquidity and operational risk. These risks, which appear at various stages of transactions, may change in nature that necessitate a comprehensive and sound risk management infrastructure, reporting and contract framework. S 34.2 The IFI must establish comprehensive risk management policies and procedures, systems and internal control to address risks in line with its risk appetite, throughout the life cycle of the istisna` contract which must include the following: (a) the identification and monitoring of risks including, if applicable, risk arising from the performance of a contractor and the delivery process; (b) the establishment of prudential limits including concentration limits on the istisna` asset and/ or a contractor to be involved in istisna` transaction; (c) the risk mitigation techniques including establishing− (i) appropriate eligibility criteria and review process in identifying a list of contractor to be involved in the istisna` transaction; and Issued on: 23 December 2015
  9. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 30 / 44 (ii) list of key trigger events that require the IFI’s intervention in the istisna` project and procedure to manage the identified trigger events. (d) S 34.3 the monitoring and reporting mechanism. The IFI must ensure that the relevant resources to undertake the risk management processes, which include identification, measurement, mitigation, monitoring and review of the risks associated with istisna` transaction are available. Risk associated with performance of contractor S 34.4 Prior to appointing a third party contractor to undertake the istisna` project, the IFI as a seller, must assess the contractor’s capacity to construct or manufacture the istisna` asset as per the agreed specifications in the istisna` contract. S 34.5 The IFI as a purchaser must assess capacity of the contractor that is identified or proposed by customer. S 34.6 The IFI must establish the internal eligibility criteria on the contractor. At minimum, the criteria are able to ensure the contractor has the capacity to undertake the istisna` project and fulfil the agreed specifications of the istisna` asset. S 34.7 At minimum, the IFI must consider the following aspects in developing the internal eligibility criteria of the contractor: (a) financial position of the contractor; and (b) the contractor’s performance in its previous projects. G 34.8 The IFI may identify and maintain a list of alternative contractor to facilitate the construction of the istisna` asset in the event that the appointed contractor fails to complete the istisna` project. Issued on: 23 December 2015
  10. BNM /RH/PD 028-1 G 34.9 Islamic Banking and Takaful Department Istisna` Page 31 / 44 The IFI as a seller may request a third party or customer to guarantee performance of the contractor to deliver the istisna` asset as per the agreed specifications and at the agreed date, time or period. Risk associated with the istisna` project S 34.10 The IFI is required to monitor the progress of the istisna` project. S 34.11 The IFI must establish the internal policy and procedure on monitoring of the istisna` project. At minimum, the internal policy and procedure must include the following: (a) scope of monitoring including aspects to be monitored; (b) method of monitoring, such as periodical on-site inspection or submission of progress report; (c) timeline or frequency of the project monitoring; and (d) identification of a party to be involved in the project monitoring and the accountabilities. G 34.12 The IFI as a purchaser may monitor the progress of the istisna` project to ensure that the disbursement for payment of the istisna` selling price commensurates with the stage of completion of the istisna` project. G 34.13 In relation to paragraph 34.10, the IFI may appoint another party as its agent to monitor the progress of the istisna` project. S 34.14 Pursuant to paragraph 34.2(c)(ii), upon occurrence of any identified trigger events, the IFI must take necessary actions in line with the internal procedure to manage the trigger event. G 34.15 Illustration on the trigger events and risk mitigation strategies to be undertaken by the IFI upon the occurrence of the trigger events is provided in Appendix 5. S 34.16 The IFI must assess and review the suitability and effectiveness of the Issued on: 23 December 2015
  11. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 32 / 44 monitoring method for different nature of istisna` asset and project. Risk associated with the delivery of istisna` asset G 34.17 The IFI may employ risk transfer mechanism such as takaful coverage to minimise the risk associated with the delivery of the istisna` asset. For instance, the takaful coverage may minimise potential losses arising from any damage to the istisna` asset during the delivery process to the customer. S 34.18 For the purpose of paragraph 34.17, the scope of takaful coverage and payer of the contribution amount must be determined and agreed by the contracting parties. 35. S 35.1 Business and market conduct The IFI must give due regard to the interests of the customers in its policies and procedures to ensure that the istisna` contract is conducted in a fair, transparent, responsible and professional manner. Fair dealings S 35.2 The IFIs’ internal policies and procedures on business and market conduct for the istisna` must reflect fair dealing practices, including− (a) the information provided must be accurate, clear and not misleading; (b) the fees and charges, if any; and (c) reasonable care is taken to ensure suitability of advice and recommendations made by the IFI, if any. Disclosure of information S 35.3 The IFI must explain clearly to the customer on the concept of istisna` contract to facilitate the customer’s understanding on the istisna` transaction. S 35.4 The IFI must ensure the accuracy of the description, nature and feature of the istisna` and other Shariah contracts or concepts applicable to the particular Issued on: 23 December 2015
  12. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 33 / 44 purpose and product structure. S 35.5 At the pre-contractual stage, the IFI must provide adequate and relevant information to the customers in the marketing or promotional materials, product disclosure sheet and any other relevant materials with regard to istisna` transaction. The information must include− (a) an overview of the product’s structure including a description of the nature and salient features of istisna` contract; (b) the roles and responsibilities of the contracting parties; (i) customer’s rights and obligations as a purchaser. At minimum, the following must be disclosed: (A) obligation to accept the delivery of the istisna` asset that has been completed and fulfilled the agreed specification and pay the istisna` selling price; and (B) rights to exercise options arising from non-delivery of the istisna` asset and defects. (ii) customer’s rights and obligations as a seller. At minimum, the following must be disclosed: (A) obligation to deliver the istisna` asset that has been completed and fulfilled the agreed specification; and (B) obligation to provide options arising from non-delivery and defects of the istisna` asset. (iii) where relevant, customer’s obligation and liabilities as the IFI’s agent and/or guarantor; (c) a description of eligible asset to be financed under istisna` contract; (d) the key terms and conditions of the relevant documentation for the purpose of istisna` contract; (e) an explanation on the event of default and negligence; (f) the applicable fees and charges, including the fees and charges imposed due to the following: (i) safe keeping the istisna` asset due to delay on the acceptance of the istisna` asset by the customer; and (ii) appointment of a person to perform a specific function in the Issued on: 23 December 2015
  13. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 34 / 44 istisna` transaction. In relation to the product disclosure sheet, the IFI is also required to observe the minimum information to be disclosed in the product disclosure sheet as prescribed in the Guidelines on Product Transparency and Disclosure. G 35.6 During term of the istisna` contract, the IFI may disclose statement on workin-progress of the istisna` asset to the customer. Late delivery charges G 35.7 The IFI may agree with other contracting parties on the provision of late delivery charges (LDC). S 35.8 In the event where the contracting parties agree to impose LDC, the IFI is required to ensure a clause on LDC and computation of the LDC are incorporated in the relevant documentations. Rebate (Ibra’) S 35.9 Notwithstanding paragraph 3.2 of the Guidelines on Ibra’ (Rebate) for Salebased Financing (the Guidelines), the IFI must comply with the Guidelines except for the requirements on termination of financing arising from nondelivery or non-possession of the underlying asset6. Treatment for non-delivery and defect of istisna` asset S 35.10 The IFI, as a seller is required to provide options to customer in the event of non-delivery and defect of the istisna` asset. The options must be endorsed by the SC. S 35.11 The IFI, as a seller must ensure that the customer understands the options and implication of each option. S 35.12 6 For the purpose of paragraph 35.11, the IFI must provide the following As described in paragraphs 8.9 – 8.12 of Guidelines on Ibra’ (Rebate) for Sale-Based Financing. Issued on: 23 December 2015
  14. BNM /RH/PD 028-1 Islamic Banking and Takaful Department Istisna` Page 35 / 44 options to customers in the event of defective istisna` asset: (a) terminate the istisna` contract; or (b) accept the defective istisna` asset, with or without any variations to the terms of the istisna` contract. G 35.13 For the purpose of paragraph 35.11, the illustration on the options available in the event of non-delivery and the implication to the customers is provided in Appendix 6. 36. S 36.1 Submission requirement The Board and the SC must respectively approve and endorse the IFI’s implementation plan to ensure compliance with the policy document by 1 July 2016. S 36.2 The IFI that offers product or service that is structured based on istisna` contract, must submit the implementation plan to Jabatan Perbankan Islam dan Takaful (JPIT) no later than 31 January 2016. G 36.3 In relation to paragraph 36.2, the Bank expects the IFI to− (a) review and confirm existing policies, procedures and internal limits; (b) clarify roles and accountabilities; (c) where applicable, undertake enhancement to the existing system to address the risks associated with the istisna` contract; and (d) establish appropriate monitoring and reporting mechanisms to ensure compliance with the requirements. S 36.4 The IFI must immediately notify JPIT if the IFI identifies any cause that will affect full compliance by 1 July 2016. Issued on: 23 December 2015