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Malaysia, the world’s largest market for sukuk, plans to improve its legal system to become an alternative location to the U.K. for resolving international Islamic finance disputes.

The goal is to position Malaysian “laws as the law of choice for Islamic finance transactions globally,” the central bank said in a statement Aug. 30. Disputes about compliance with Shariah principles are a risk to the industry’s expansion, it said. Persian Gulf companies have traditionally based cross- border contracts on U.K. law to take advantage of the country’s developed legal system and neutrality, according to Unicorn Investment Bank BSC in Bahrain.

“Whilst there is nothing wrong with the Middle Eastern legal systems, many of them are archaic in their procedures,” said Nida Raza, senior vice president of capital markets at Unicorn, an Islamic investment bank in Manama. Malaysia can be “an alternative jurisdiction” as it has sukuk expertise and a system based on British common law, she said.

The Islamic finance industry, with assets of more than $1 trillion expanding 15 percent annually, needs to develop services that can win global investor confidence while taking into account different interpretations of the Koran. U.K. courts lack the expertise to decide on religious matters, according to Hussain Hamed Hassan, chairman of the National Shariah Coordination Committee of the Islamic Financial Institutions in the United Arab Emirates, and Mohamed Azahari Kamil, the head of Qatar Islamic Bank’s Malaysian unit.

Investment Dar Co., the Kuwait-based owner of half of luxury carmaker Aston Martin Lagonda Ltd., had an appeal thrown out of a U.K. court this year in a case where the company argued that financing from a bank breached Islam’s ban on interest payments.

‘Lack of Knowledge’

“Courts prefer not to decide on issues of Shariah compliance given their relative lack of knowledge in this area,” the Malaysian central bank said. “The underlying laws don’t provide sufficient platform to satisfactorily resolve dispute.”

The government set up a special committee in July to improve legislation, Muhammad Ibrahim, deputy governor at Bank Negara Malaysia, said in a speech that month in Kuala Lumpur.

The new Law Harmonisation Committee is headed by the former Chief Justice of Malaysia Abdul Hamid Mohamad, who is also a member of the National Shariah Advisory Council.

Potential changes could range from amendments to bankruptcy legislation to ensuring interest-free damage awards, Madzlan Mohamad Hussain, a partner in Kuala Lumpur at Zaid Ibrahim & Co., Malaysia’s biggest law firm, said in a Sept. 6 interview.

Middle East Acceptance

The challenge will be to gain acceptance in the Middle East because of different religious interpretations in various jurisdictions, Priya Uberoi, director of Islamic derivatives and structured products in London at Clifford Chance, the third- largest U.K. law firm by revenue, said in a Sept. 6 interview.

“Malaysia has a very good model,” Uberoi said. “It’s very robust and very sophisticated, but you can’t take one law and impose it in another country because a product that’s run in Malaysia doesn’t mean that it will be automatically acceptable in Saudi.”

Global issuance of Islamic debt dropped 12 percent to $10.3 billion so far this year, according to data compiled by Bloomberg. Malaysia accounted for more than half of the sales in the first half, the central bank’s Muhammad said.

Islamic bonds returned 10 percent so far this year, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index, while debt in developing markets gained 13 percent, JPMorgan Chase & Co.’s EMBI Global Diversified Index shows. The spread between the average yield for sukuk and the London interbank offered rate narrowed 87 basis points so far this year to 380, according to the HSBC/NASDAQ Index.

Final Say

The extra yield investors demand to hold the Dubai Department of Finance’s dollar sukuk rather than Malaysia’s 3.928 percent Islamic note due June 2015 narrowed 23 basis points this month to 390 basis points, according to Royal Bank of Scotland Group Plc data.

Malaysia practices a dual legal system with a civil court system and a separate Islamic one to govern marriage, inheritance and other family matters for Muslims.

Disputes arising from Islamic finance contracts are tried by the civil court. A central bank act issued in 2009 makes the Shariah advisory council at the central bank and the Securities Commission the highest authority in such rulings.

A group of scholars in Kuala Lumpur is helping to set up a committee to prepare the first global certification for Shariah experts, Aznan Hasan, the president of the oversight committee, said last month.

“Malaysia has an infrastructure to put finality to Shariah-based disputes” such as Investment Dar’s, Madzlan of Zaid Ibrahim said.

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