The governance layer, and why it is a gate rather than a formality
Sharia governance here is supervisory architecture, not opinion-gathering. Onshore, every Central Bank-licensed institution carrying on Islamic financial business maintains an internal Sharia supervision committee of qualified scholars, appointed by shareholders and independent of management. It approves products, structures and documentation, and its rulings bind the board.
Above it sits the Higher Sharia Authority, established under the Central Bank as the sector-wide authority for onshore Islamic finance. It sets minimum governance standards, issues resolutions applying across licensed institutions, and has adopted the Sharia standards of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) as the onshore reference. Where an institution's committee and the Authority diverge, the Authority prevails — which makes this a regulatory framework rather than a private contractual one.
Two functions sit beneath the committee. Internal Sharia control confirms on an ongoing basis that what is executed is what was approved. Internal Sharia audit tests afterwards whether the transaction behaved as certified: whether the commodity was purchased, whether title passed, whether rent was adjusted when the asset was out of service.
A fatwa is therefore conditional. If operational reality diverges from the structure as described, the audit function will find it, and the finding is a supervisory matter rather than a drafting point. Non-compliant income is customarily stripped out and given to charity, making an audit failure a profit-and-loss event.
Three regimes: the Central Bank perimeter, the DIFC and ADGM
There is no single UAE Islamic finance regime. There are three, and the governance obligations differ in each.
Onshore, the Central Bank licenses Islamic banks, Islamic windows of conventional banks, Islamic finance companies and takaful operators, and the Higher Sharia Authority framework applies to them. Documentation is enforced in the onshore courts, in Arabic.
In the DIFC, the Dubai Financial Services Authority regulates Islamic financial business through a dedicated module of its rulebook. A firm conducting Islamic business, wholly or through a window, requires an endorsement on its licence, its own Sharia supervisory board, and Sharia review and internal audit functions. The DFSA regulates the systems — board competence and independence, whether review actually happens, whether client disclosure is accurate — rather than adjudicating compliance itself. In ADGM, the Financial Services Regulatory Authority operates a materially similar model under its own rulebook, in a jurisdiction applying English common law directly.
Two points are consistently missed. The Higher Sharia Authority's mandate runs to Central Bank-licensed institutions; a DIFC or ADGM firm answers to the DFSA or FSRA and is not subject to the Authority. And a group operating across perimeters holds more than one board — boards that can reach different conclusions on the same structure.
| Regime | Regulator | Sharia governance requirement | Reference standards | Forum |
|---|---|---|---|---|
| Onshore UAE | Central Bank of the UAE, with the Higher Sharia Authority | Internal Sharia supervision committee appointed by shareholders, plus internal Sharia control and internal Sharia audit functions; the Higher Sharia Authority's rulings prevail over the institution's own committee | AAOIFI Sharia standards, as adopted for the onshore sector, together with the Higher Sharia Authority's own resolutions | Onshore courts, applying UAE law in Arabic |
| DIFC | Dubai Financial Services Authority | Islamic business endorsement on the licence; firm-appointed Sharia supervisory board; Sharia review and internal Sharia audit; systems-and-disclosure supervision, not adjudication of compliance itself | AAOIFI standards applied through the DFSA's Islamic finance module | DIFC Courts, applying DIFC law in English |
| ADGM | Financial Services Regulatory Authority | Equivalent endorsement and board requirement under the FSRA's own Islamic finance rulebook, with review and audit obligations | AAOIFI standards applied through the FSRA rulebook | ADGM Courts, applying English common law directly |
The core structures and what each is actually used for
The instruments are not interchangeable, and the compliance question in each is whether the risk the structure is meant to transfer is genuinely transferred.
Murabaha is a cost-plus sale on deferred terms: the financier buys the asset and resells it at a disclosed mark-up payable over time. It is the workhorse of trade and working-capital finance, and the financier must actually own the asset, however briefly, and bear ownership risk. The mark-up is fixed at the outset and cannot be increased for late payment, which is why murabaha behaves very differently from a loan once a customer starts to slip.
Ijara is a lease: the financier owns the asset and leases it on rent that may be reset against a benchmark, and in ijara muntahia bittamleek ownership transfers at the end. It dominates asset finance and long-tenor real estate because it accommodates floating pricing. The recurring issue is that ownership obligations — major maintenance, insurance in substance, casualty risk — sit with the lessor and cannot be moved to the lessee by wording alone.
Mudaraba pairs capital from one side with management from the other, profit shared on an agreed ratio and loss borne by the capital provider absent negligence or breach. It is genuinely risk-sharing, which is why guaranteeing the capital destroys it. Musharaka is a joint venture sharing profit and loss; diminishing musharaka, where the customer buys out the financier's units while paying rent on those still held, is the standard home finance structure here.
Wakala is an agency: the principal appoints an agent to invest funds against an expected profit rate, the agent taking a fee and usually any excess above it. It dominates interbank liquidity and the investment leg of many sukuk, and depends on the agent actually deploying funds into a compliant portfolio. Istisna'a is a commissioned construction or manufacture contract with staged payment before delivery, usually paired with a forward ijara. Salam is full prepayment for a commodity delivered later — narrow, but the classical prefinancing tool.
Tawarruq needs separate treatment. The customer buys a commodity on deferred terms and sells it on for immediate cash, ending with money and a deferred debt — economically, a loan. Nothing else delivers unrestricted cash as cleanly, and nothing in the field is more contested. Criticism, including from the international scholarly academies, targets organised tawarruq where the commodity trades are pre-arranged, simultaneous and never leave the platform. The onshore standards permit tawarruq subject to conditions on the commodity leg — real, sequential, capable of delivery. Institutions treating those trades as a booking convention are the ones that fail internal Sharia audit.
Sukuk: the asset question and what makes a certificate tradable
A sukuk certificate represents an undivided beneficial interest in an asset, a pool or a venture — not a debt claim on an issuer. That distinction determines whether the paper trades at a negotiated price and how much real recourse holders have. An ijara sukuk needs identifiable leasable assets and a defensible transfer; a wakala sukuk needs a portfolio whose composition is itself the compliance issue.
Tradability turns on tangibility. Under AAOIFI's Sharia standards, a certificate representing a pure debt receivable may only transfer at face value, because trading debt at a discount is trading in money; a certificate representing tangible assets, usufruct or an equity-type interest can trade at whatever price the market sets. The convention derived from those standards is that the pool must be predominantly tangible for the paper to trade freely, tested at issuance and, on stricter formulations, maintained throughout. A pool that amortises below the threshold can lose free tradability part-way through its life, and investors whose mandates require tradable paper will care long before the scholars do.
Purchase undertakings by the obligor to buy the assets at dissolution are what make most sukuk behave like a bond from a credit perspective. AAOIFI's 2008 pronouncement pushed back hard on this in equity-based structures: an undertaking to repurchase at face value in a mudaraba or musharaka sukuk hands capital risk back to the manager and defeats the risk-sharing the structure depends on. The market moved toward ijara and wakala structures, and toward pricing undertakings at market or net asset value where par is objectionable — the difference between bond-like paper and an equity risk the investor never intended.
Most Gulf sukuk are asset-based, not asset-backed. Assets are transferred to the issuer for structural purposes, but holders' realistic recourse is the obligor's covenant and purchase undertaking. That is understood institutionally; it becomes contentious when an obligor fails and holders discover the transfer might not be recognised against a liquidator where the assets sit.
Takaful and re-takaful
Takaful reorganises insurance as mutual risk-sharing. Participants contribute to a fund from which claims are paid; the operator manages it for a fee, usually on a wakala basis, and the surplus belongs to participants rather than to the operator. That separation — participants' fund on one side, shareholders' fund on the other — is the defining feature and the source of most regulatory attention.
Two consequences follow. The operator's remuneration must be a fee for services rather than an underwriting profit, and blurring the two is the most common finding. And deficits in the participants' fund are typically met by an interest-free loan from the shareholders' fund, recoverable from future surplus — whether that loan is realistically recoverable is a genuine solvency question.
Re-takaful is the constraint that shapes the sector commercially. Compliant reinsurance capacity is thinner than the conventional market, particularly for large industrial, energy and aviation risk. Operators therefore cede to conventional reinsurers under necessity-based reasoning approved by their boards, as a documented and time-limited exception. Where a programme depends on it, that should be papered and reviewed on renewal.
Islamic project and real estate finance
Islamic structures work best in project finance, because there is a real asset being built and a real asset generating revenue. The standard architecture pairs an istisna'a during construction, under which financiers commission the works and disburse against milestones, with a forward ijara beginning on completion, under which the project company leases the asset and pays rent that services the finance.
Running an Islamic tranche alongside a conventional one is routine on large regional projects and is where the drafting difficulty concentrates. The Islamic financiers hold title, or an interest in title, to assets the conventional lenders have security over, so the intercreditor arrangement must equalise economics and enforcement across two groups whose positions are not symmetrical — without giving the Islamic participants an entitlement that reads as interest or leaving them subordinated in a way their board will not accept. Cost overruns and delay compensation need compliant mechanics, because default interest is unavailable.
In real estate, diminishing musharaka dominates residential finance, with ijara muntahia bittamleek used where a lease is cleaner than co-ownership. The practical issue is registration: the financier's interest must appear on the title in a form the land authority will accept, and the sequencing of transfer, registration and staged buy-out has to work against that registry's practice rather than the structure diagram.
What actually happens when a Sharia-compliant facility defaults
This is the part clients understand least well at signing.
There is no default interest. A murabaha mark-up is fixed at inception and cannot be increased because payment is late. The standard mechanism is a late-payment charge the financier collects and pays away to charity: a discipline mechanism, not compensation.
The claim is not a debt claim in the ordinary sense. On acceleration under a murabaha the financier claims the outstanding deferred sale price. Under an ijara it terminates the lease, claims accrued rent and its rights under the purchase undertaking, and holds title — materially stronger than a mortgagee's position. Under a mudaraba or wakala, absent negligence or breach of mandate, the loss may genuinely sit with the capital provider — which is why every wakala here contains carefully drafted events of negligence, wilful default and breach of mandate.
Restructuring is constrained. A murabaha debt cannot simply be repriced upward, so a workout usually requires unwinding and re-entering a fresh compliant transaction — with fresh board approval, asset identification and often registration. Where Islamic and conventional creditors sit in the same syndicate, those steps go into the timetable at the start.
Enforcement is enforcement. Once in court, an onshore judge applies UAE law to a documented claim, with the same registration, standing and translation issues as any other. The Islamic character of the facility neither accelerates the process nor relieves the claimant of proving its case.
Governing law, and whether a court will review Sharia compliance
Two questions are constantly conflated: what law governs the contract, and who decides whether it is compliant.
Sharia is not a governing law of the documents. Wholesale Islamic transactions here are overwhelmingly governed by English, DIFC or ADGM law. In Shamil Bank of Bahrain v Beximco Pharmaceuticals, the English Court of Appeal held that subjecting an agreement to English law subject to the principles of the Glorious Sharia
did not make Sharia a governing law: a contract has one governing law, and it must be the law of a country. Sharia principles could at most operate as incorporated terms, and only if identified with sufficient certainty.
Courts and tribunals do not sit as Sharia boards. A DIFC or ADGM court asked to enforce an ijara construes the documents under the applicable law rather than inquiring into religious validity, and in most structures the parties have expressly agreed that compliance is a matter for the Sharia board and that neither may raise non-compliance as a defence. Those non-contestation provisions exist for a concrete reason: in The Investment Dar v Blom Bank, a party argued that its own wakala was outside its objects because it was not in fact compliant.
Onshore differs in degree. UAE law is itself informed by Sharia principles, and onshore courts have shown a readiness to disallow claims amounting to compound interest or charges they regard as unjustified. The guidance is unchanged: build compliance into the structure and its governance rather than relying on a court to supply it.
Where this goes wrong
The failure modes repeat across institutions and deal sizes.
The conventional template, renamed. A term sheet drafted as a loan, interest relabelled as profit, with no underlying sale, lease or agency doing any work. The board rejects it, and structuring restarts from a position where the commercial terms are agreed and the borrower has to be told the economics have moved.
The Sharia board engaged last. Approval treated as a condition precedent to be collected in the final fortnight. Boards meet on their own schedule and are not moved by a closing timetable.
The asset that does not exist. Ijara and sukuk structures assuming unencumbered, transferable assets, where diligence later shows they are already secured or cannot move without a consent nobody sought.
Operational drift. The structure is certified, then both legs of the commodity trade are booked simultaneously, or the agent never invests, or rent accrues while the asset is out of service. Internal Sharia audit finds it, income is purified, and a transaction compliant on paper produces a supervisory finding and a hit to earnings.
A workout planned as a conventional workout. A restructuring timetable ignoring the need to unwind and re-execute compliant transactions, obtain fresh approval and re-register interests. The Islamic creditors then hold up a deal everyone else has agreed.
Frequently asked questions
Can a Sharia board actually stop a transaction that is commercially agreed?
Yes, and it is the reason the board should be engaged at structuring rather than at closing. For an onshore Central Bank-licensed institution, the internal Sharia supervision committee's rulings bind the institution, and the Higher Sharia Authority's position prevails over the committee's. In the DIFC and ADGM, the firm's own board performs the same function under the DFSA and FSRA rulebooks. A board can require that an asset be identified, that a genuine sale occur, that a purchase undertaking be repriced away from face value, or that a fee stop tracking a benchmark. Each of those changes moves cash or risk. The commercial cost of a late objection is not the objection itself but the fact that every remaining alternative is worse.
What does the Higher Sharia Authority do, and does it apply to DIFC or ADGM firms?
The Higher Sharia Authority sits under the Central Bank and is the sector-wide Sharia authority for onshore Islamic financial institutions. It sets minimum Sharia governance standards, issues resolutions binding across the licensed sector, and has adopted AAOIFI's Sharia standards as the onshore reference framework. Its mandate runs to Central Bank-licensed institutions. A firm licensed in the DIFC is supervised by the DFSA and a firm in ADGM by the FSRA; those regulators impose their own Sharia governance requirements through their own rulebooks. A group operating across perimeters therefore runs more than one Sharia governance structure, and approvals obtained in one do not carry into another.
Is tawarruq acceptable in the UAE?
Tawarruq is used extensively, and the onshore standards permit it subject to conditions on how the commodity leg is executed. The controversy is real and worth understanding rather than dismissing. Criticism, including from international scholarly academies, is directed at organised tawarruq where the commodity purchase and onward sale are pre-arranged, executed simultaneously, and never involve any real prospect of delivery — on that view the commodity is a device and the transaction is a loan. The conditions imposed in practice are aimed at that concern: the trades must be genuine and sequential, the commodity must be capable of delivery, and the financier must not act as the customer's agent to sell back to itself. Institutions that treat the commodity trades as a booking convention are the ones that fail internal Sharia audit.
What makes a sukuk freely tradable?
The composition of what the certificates represent. Under AAOIFI's Sharia standards, a certificate representing a pure debt receivable may only be transferred at face value, because trading a debt at a discount is trading in money. Certificates representing tangible assets, usufruct or an equity-type interest may be traded at a negotiated price. The market convention derived from those standards is that the underlying pool must be predominantly tangible for the paper to trade freely, tested at issuance and, on stricter formulations, maintained through the life of the instrument. A pool whose receivable component grows as tangible assets amortise can lose free tradability part-way through its life, which is why the maintenance mechanism matters as much as the issuance-date ratio.
Are sukuk holders secured on the underlying assets?
Usually not in the way the structure diagram suggests. The large majority of Gulf sukuk are asset-based rather than asset-backed. Assets are transferred to the issuing vehicle for structural purposes, but holders' realistic recourse in a default is the obligor's payment covenant and its purchase undertaking, not enforcement and sale of the assets. That is disclosed and understood in the institutional market. It becomes a live issue when an obligor fails and holders test whether the transfer would be recognised against a liquidator in the jurisdiction where the assets actually sit — which is a question of that jurisdiction's insolvency and property law, not of Sharia.
Will a court decide whether a transaction is Sharia-compliant?
Generally no. English, DIFC and ADGM courts construe the documents under the chosen governing law and do not sit as Sharia boards. The English Court of Appeal in Shamil Bank of Bahrain v Beximco Pharmaceuticals held that a contract has one governing law and that Sharia, not being the law of a country, could not serve as one; a reference to Sharia principles could at most operate as incorporated terms, and only if sufficiently certain. Most modern documentation goes further by recording that compliance is a matter for the Sharia board and that neither party may raise non-compliance as a defence. Onshore is different in degree rather than in kind: UAE law is itself informed by Sharia principles, and onshore courts have disallowed claims amounting to compound interest or to charges they regard as unjustified. Compliance should be built into the structure and its governance, not left for a judge to supply.
What happens to the pricing if a customer defaults on a murabaha?
The mark-up is fixed when the sale is entered into and cannot be increased because payment is late. There is no default interest. The accepted mechanism is a late-payment charge that the financier collects and pays away to charity rather than booking as income — it exists to deter delay, not to compensate the financier. The practical consequence for lenders is that a portion of the recovery economics available in a conventional facility is simply not available here, and that should be priced into the credit at approval rather than discovered in workout. On acceleration the claim is for the outstanding deferred sale price, and it is proved and enforced like any other documented claim.
Can Islamic and conventional tranches sit in the same financing?
Yes, and on large UAE and regional project financings it is normal. The difficulty is not the documentation of either tranche but the intercreditor arrangement between them. The Islamic financiers typically hold title, or an interest in title, to assets over which the conventional lenders hold security, so the two groups' legal positions are not symmetrical even where their economics are intended to be equal. Enforcement rights, voting, sharing of recoveries, and the treatment of cost overruns and delay all need mechanics that equalise outcomes without giving the Islamic participants an entitlement that reads as interest or leaving them structurally subordinated in a way their Sharia board will not accept. This is worked through at term sheet, not in the intercreditor draft.