Decades of parsing turgid legal documents have not dampened the enthusiasm of octogenerian Islamic scholar Sheikh Hussein Hamed Hassan. He gets agitated as he searches for a paper among piles of documents strewn across his posh Dubai office. Wearing a dark grey suit with no tie, the Egyptian-born academic talks to a visitor for almost two hours about Islamic banking, which he has been instrumental in developing over half a century of writing and lecturing.
"Listen to me. You have to understand the basics of sharia, what's allowed and not allowed in Islam. If you get it, then you'll write it. And the whole world will understand," he says.
Sheikh Hussein is one of the world's most sought-after scholars in applying sharia or Islamic law to finance, chairing no fewer than 22 of the boards which rule on whether products and practices in the industry obey religious principles.
One position in particular stands out. As chairman of the sharia advisory board of London- and Dubai-based consultants Dar Al Istithmar, he is having to answer some searching questions on behalf of one of its most high-profile clients, U.S. investment bank Goldman Sachs.
Last October Goldman announced it would issue as much as $2 billion in sukuk or Islamic bonds, making it one of the first top Western banks to raise money in that way. But the plan has run into controversy among potential investors over whether it follows Islamic principles, as Dar Al Istithmar insists it does. There is also controversy over the fact that Goldman publicly named at least three Islamic scholars as potential advisers on the sukuk even though they had not even seen the prospectus.
"A copy of the Goldman Sachs sukuk prospectus was sent to these scholars for consultation but they never responded back," Sheikh Hussein told Reuters. "They could be busy or did not approve the structure, but we didn't hear from them. Their approval is not necessary anyway."
The controversy over the Goldman sukuk illustrates some of the weaknesses of the Islamic finance industry. These are leading to growing pressure for reform of the scholar system, though the power of entrenched interests, and the difficulty of coordinating policy in an industry where authority is spread across the Middle East and southeast Asia, may slow any change.
Scholars such as Sheikh Hussein command great influence but their opinions, lacking definitive legal sanction, are often challenged, creating an uncertain regulatory environment. And some scholars sit on scores of boards, leaving them open to charges of conflict of interest and making it hard for them to keep up with all areas of their work.
"The big problem is that there just aren't enough of them," said one Dubai-based banker in the industry, who declined to be named because of the sensitivity of the issue. "It's a bit like being a rock star. They are disproportionately recognised, with people saying: 'I want that name in Malaysia, I want that name in Bahrain.'"
Islamic finance, based on principles such as bans on interest and pure monetary speculation, has grown rapidly over the last several years because it draws on pools of investment money in the oil-rich Gulf and Asia that have been relatively untouched by the global financial crisis.
The industry's global assets are expected to rise 33 percent from 2010 levels to $1.1 trillion by the end of 2012, according to consultants Ernst & Young. Islamic finance will remain far smaller than conventional finance, with its tens of trillions of dollars, but the gap may continue narrowing; Ernst & Young expects Islamic banking in the Middle East and North Africa to expand over the next five years at a compound annual rate of 20 percent, versus less than 9 percent for conventional banks.
Sharia scholars, with expertise in both religious and conventional law, are key to this growth. Investors will not buy instruments without believing they are religiously acceptable, so most wholly Islamic financial firms have their own board of sharia scholars which certifies products and monitors the firm's business. "Independent" sharia boards also exist, offering their services to financial firms for a price.
There are over 400 sharia scholars worldwide but only around 15 to 20 prominent and experienced ones, which creates demand for scholars to sit on multiple boards. The top 20 scholars hold 14 to 85 positions each, occupying a total of around 620 board positions or 55 percent of the industry, data compiled by investment research firm Funds@Work show.
The shortage of scholars is a capacity constraint for the industry, said Sheikh Muddassir Siddiqui, a sharia scholar and Harvard-trained attorney at law firm SNR Denton. He is a member of the sharia standards committee of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), a Bahrain-based body setting standards for the industry.
"If you engage a lawyer or a doctor you would naturally want someone with a big name and reputable," said Siddiqui.
"But unlike a rock star who can entertain thousands of people at once, a sharia scholar's role should be viewed more like a doctor's -- it is natural to ask how many surgeries a doctor can perform in one day. It is a question of capacity."
The capacity problem is worsened by the fact there is no single, universally accepted interpretation of religious principles. So firms seek out the scholars who they think will carry the most weight with investors; in effect, a scholar's reputation becomes a currency used in completing a deal.
"The reason the Islamic finance industry is still emerging is that governance standards are not as well established as in other industries," said Murat Ünal, CEO of Funds@Work.
"It's like a social network. People and their relationships play a very important role. If you have a prominent scholar on board, this increases trust and makes up for the lack of governance standards. Institutions sell their products via the reputation of the scholars, so you better make sure you have accepted scholars on board."
And this leads to sky-high fees paid to the top scholars. A senior banker at an Islamic lender said some scholars could be paid $1,000 to $1,500 per hour of consultation -- in addition to an annual bonus of between $10,000 and $20,000 per board seat.
Sheikh Hussein and other scholars strongly reject the idea that there is anything improper in the fee system.
"What's wrong with getting paid for issuing a fatwa or reviewing the sharia compliancy of a financial instrument?" Sheikh Hussein said. "We're just like auditors, lawyers. Each one of us has years and years of experience in sharia law. We do our job and get paid for it. Nobody is allowed to question our honor, integrity and truthfulness."
Nevertheless, the system is open to accusations of conflict of interest because scholars head or sit on the boards of the industry's standard-setting bodies, such as AAOIFI, at the same time as they are being paid handsomely by the firms which are being regulated.
In some ways the situation is similar to that of credit rating agencies in conventional financial markets. The agencies are paid by the companies they rate, which may have made them slow to downgrade debt before the global financial crisis, allowing imbalances to build up that triggered the crisis.
"Certainly there is a need for improvement in the way sharia supervisory boards play their role," said Sheikh Siddiqui.
"There needs to be some sort of enforcement body that stipulates who is qualified, how to protect against the conflict of interest, and other reasonable conditions for the conduct of a sharia board."
Sheikh Siddiqui also advocates separating some of the duties of sharia boards so that scholars, who may now effectively act simultaneously as lawyers, product developers and auditors for instruments, do not end up "judging their own work".
The impact of individual scholars on the Islamic finance industry can be huge. In late 2007 and early 2008, sukuk issuance slowed after Sheikh Muhammad Taqi Usmani, chairman of the board of scholars at AAOIFI, suggested that about 85 percent of sukuk might not comply with Islamic law.
Haissam Arabi, chief executive of Gulfmena Investments, a Dubai-based asset management firm, says he has personally experienced the pitfalls of the scholar system: products have been approved for investment by his firm's sharia board, only for their sale to be delayed by the boards of other firms.
"Here is a crack in the system which needs to be remedied," he said. "When you can't sell or distribute because your board is different from my board, you end up not being able to achieve scale and you're left with a very expensive product. That's what's hindered the development of sharia asset management."
Another area of frustration in the industry is the lack of transparency in the way that sharia boards reach their findings and communicate them, industry participants say.
"Sharia scholars' opinions are not published and in some cases not even circulated," said Oliver Agha, partner of Agha & Co, a sharia-compliant law firm in Dubai.
Mohammed Akram Laldin, executive director of Malaysia's International Sharia Research Academy for Islamic Finance, said few boards disclosed their methodology. This is dangerous, he said, since as the industry grows and products become complex, investors need to be sure scholars understand the markets.
"Scholars are no doubt well-versed in Islamic law," he said. "But sometimes they might not be as well-versed on the market side." In other cases, he added, scholars may not even be fully informed of the ultimate purpose of a product -- an important issue for them to consider when forming a judgement.
"They only see a half-cooked structure...Something is not being disclosed to the scholar, and some who have more disclosure might ask more questions."
There are signs that the industry is moving towards reform of the scholar system. The Goldman case is one impetus for reform, because it underlines the large amounts of new business that could be generated in the industry if Western financial institutions become heavily involved; they are likely to demand a more transparent and predictable environment.
The shortage of experienced scholars is unlikely to be remedied quickly, but proposals within the industry include setting minimum quotas for the number of young scholars on sharia boards, and introducing apprenticeships to give young scholars more experience. Some companies may begin adopting these measures even if the industry's standards-setting bodies do not decide to recommend them universally.
"We do need more trained sharia scholars, but it's beginning to happen because of demand pressures," said Jasseem Ahmed, secretary-general of the Malaysia-based Islamic Financial Services Board (IFSB), another industry body.
Scholars are likely to face stricter guidelines for their behaviour from bodies such as AAOIFI. The organisation's assistant secretary-general Khairul Nizam said it was discussing internally proposed new standards for scholars; they are expected to be issued by the end of this year as part of a strategic review of AAOIFI standards, he said. A draft is likely to be distributed to the industry at mid-year for consulation.
The new standards will try to give more guidance on scholars' responsibilities, their relationship with banks, the issue of confidentiality, and the terms of reference of sharia boards, which should be similar to those that govern bank boards in conventional finance, Nizam said.
Regulations imposed by Malaysia's central bank could provide one model for the AAOIFI reforms. Among other rules, scholars in Malaysia cannot sit on the board of more than one bank; sharia board members must attend at least three-quarters of the board's meetings each year, and two-thirds of a board's members must be present for the board to meet.
Pressure is also growing for action to reduce the differences of opinion and conflicting judgements between the sharia boards at individual companies.
The central bank governor of the United Arab Emirates, Sultan Nasser al-Suweidi, is among those who have suggested the creation of a global body that would provide legal guidance to boards around the world.
"The solution here may lie in the establishment of a supervisory or a control body that would issue fatwas or rulings on the general policy of Islamic banking," he told Reuters.
Once again, Malaysia could be a model; a Shariah Advisory Council (SAC) established by that country's central bank acts as "the apex authority for the determination of Islamic law", helping to resolve differences of interpretation between scholars or companies.
Globally, however, the Islamic finance industry is unlikely to achieve the strictness and consistency of regulation seen in Malaysia any time soon.
A source familiar with AAOIFI's review of standards, who declined to be named, told Reuters that the review would probably not look at restricting the number of board positions that scholars could hold, or at setting up a global version of Malaysia's SAC to iron out legal disputes.
"Such steps are years away," the source said.
The industry is so diverse that without the intervention of central banks and governments, it may be unable to agree on strict regulation of itself. And outside Malaysia, most central banks and governments have hesitated to take on the responsibility of setting standards for the industry.
Many in the industry are wary of inviting official intervention, arguing that it could curb their freedom to innovate and slow the market's growth.
"If you have a central sharia board the government will be more involved, and as we know bureaucracy kills growth," said Mohamed Elgari, a prominent scholar. "Centralised government entities should be concerned about risks but should refrain from sharia issues."
Others believe that an industry based on the interpretation of religious principles is never going to achieve the same consistency and predictability as conventional finance.
"On the whole there is some convergence that has taken place, but we can never aim at 100 percent. It is just the nature of Islam -- people have different approaches," said the IFSB's Ahmed.