Article Review: Corporate Crime

ARTICLE REVIEW

by NG BOON SIONG

            Raymond J. Michalowski and Ronald C. Kramer, The Space between Laws: The Problem of Corporate Crime in a Transnational Context. California: University of California Press, 1987.

Introduction

This paper seeks to review the abovementioned article written by Michalowski and Kramer in 1987, with the focal point revolving around the conceptualisation of the transgressions committed by transnational corporations as corporate crime. The authors have settled to use the term ‘Transnational Corporations’ (TNCs) to describe the corporations that expand their business operations beyond their resident countries to other countries that have less stringent laws and with societies having lower economic bargaining power compared to their resident countries. The authors delved extensively on the concept of corporate crime in relation to TNCs – primarily on its definition, perception, operation & influences from the societal and legal standpoint.

The authors’ perspective on corporate crime by TNCs also sought to push the limit of the traditional framework of criminal law to the extent that the definition of crime could be further expanded beyond the common parameters of violations of criminal codes of a State, that is to criminalise the violations of civil or regulatory provisions, in order to effectively categorise the transgressions committed by corporations as crime proper. The authors were keen to shed some light on the relevance of exploring the definitional framework regarding the space between the laws of both the home and host nations which has caused both positive and negative impacts. They have segmented the article into five (5) headings with several subheadings. It is viewed that the discussions in this paper is aptly arranged in accordance to the breakdown sequence of the headings and subheadings as set by the authors in their article in order to better illustrate and appreciate the framework of the authors’ objective on the topic.

 TNCs and Relocation of Corporate Hazards

After the end of the Second World War, especially since the economic upsurge from 1960 onwards, the activities of corporations around the globe have evolved from having business operations locally to broadening their wings to other countries as well, hence making them international in status, suitably addressed as ‘transnational’ in this context. This economic boom has sparked more transgressions committed by the TNCs not only in their home nation, but also in the host nations, primarily the developing countries. This development has thus prompted the authors to undertake the observation on the issue at hand.

Generally, the authors discussed at length the trend undergone that witnessed the relocation of TNCs’ industrial operations from their home nations which are usually a developed country, such as the United States and United Kingdom, to less developed nations such as the Third World countries. Guided by the studies undertaken by various researchers as well as the United Nation in mid-1970s through the 1980s, the authors observed that in the United States alone, majority of its multimillion dollars companies – specifically those with over $100 million in sales chose to set up their operation in the developing countries. One of the obvious reasons for such relocation was due to the lower capital and operating costs as well as less stringent compliance provisions and laws compared to those in their home nations. This has caused a prominent shift of not only the manufacturing activities from the developed countries to the developing ones, but also the baggage of the industrial hazards usually resulted from the injurious corporate activities engaged by the TNCs.

The authors also stressed that the TNCs have adopted a much more relaxed attitude in observing the legal standards and provisions of the host nations, unlike when they are operating in their home nations since the laws in the host nations, especially the developing countries have less-developed regulatory provisions. The relocation of both the manufacturing activities as well as the industrial violations and production hazards brought by the TNCs has induced great sufferings to the developing nations mainly because these nations have limited or adolescent awareness and legal control on relevant issues such as the environment, employment/labour rights as well as consumer protection. The authors have further narrowed down the industrial hazards exported to the less developed countries to three (3) undeniably noteworthy issues whilst being the host nations to the TNCs, they are the i) Working Condition, (ii) Environmental Pollution and (iii) Consumer Safety, all three being inter-related to one another.

(i)      Working Condition

It has been discussed by the authors that one of the striking problems of the industrial hazards exported to the developing countries that begs our attention is the condition of the workplace provided by the TNCs in the host nation. Although the workers may be working for the same company, the working atmosphere of the manufacturing facilities both in the home nation and the host nation are contrasting. The TNCs are more sensitive and obedient in ensuring the regulatory provisions on working condition of their employees in the resident country are complied with. However, they take a rather laissez-faire attitude in providing a reasonable working condition for their employees in the host nation simply because the labour-related provisions in the host nations, being a third world country, are not always as demanding or strict as the ones in the home nation.

However, this issue may not be as cut and dry ‘criminal’ as the authors implied it to be. It is felt that the TNCs should not be bombarded with criticisms merely because the working conditions in their manufacturing facilities may not match up to those in the home nation. This situation must be analysed objectively with other factors as well, such as the fact that the conditions of the workplace of both TNCs as well as the local companies may not be that much different after all. Furthermore, the workers of the TNCs are reasonably compensated with a much higher wages, at least twice as much, such as in Vietnam, compared to their fellow friends working in the local based companies in equally criticised working conditions[1].

(ii)      Environment Pollution

Many high-pollution industries prefer to have their manufacturing facilities in countries that have lower environmental standard and lower pollution control cost. This has caused the emergence of a new phenomenon that is the pollution export. The TNCs seem rather reckless in complying with the environmental standards in the host countries, unlike when they are in their resident countries which have stricter regulations. The authors highlighted that this attitude has resulted that the hazardous wastes produced in the developed countries were being exported to less developed countries. Pepsi, Nestle and Panasonic were among other giant TNCs, who have been found guilty of violating the water pollution control in China[2]. In Malaysia, one of many examples of hazard exports caused by TNCs was the case of Woon Tan Kan & 7 Ors v. Asian Rare Earth (1992) where the residents in Bukit Merah, Ipoh who were threatened by the dangers of radioactive wastes produced and stored by a Japanese-owned factory located nearby. Only after persistent efforts by the residents, a court injunction was granted to stop the hazardous operation.[3] The environmental pollution at hand is further aggravated by the inaptitude of the environmental authorities in the host nations in supervising the TNCs. Consequently, it has only caused more damages to the already alarming scenario.

However, the authors may have missed out in clarifying why should the TNCs be doing more than what they are expected to comply with when the host nations themselves do not even have strict regulations on environmental protection to embark on. Even when the TNCs are complying with the lax regulations of the host nations, some argued that it would still seem to be insufficient as the TNCs, having more financial stability and stronger economic leverage, ought to be expected to go an extra mile in ensuring that their profit-driven operation do not harm the society and the environment and at the same time to be the exemplary model for all the smaller enterprises to look up to in achieving sustainable development[4].

(iii)     Consumer Safety

The authors have associated TNCs with unsafe products exported to the consumers such as the sale of non-prescription drugs, which would have been illegal in the US due to its dangerous content but sold to a significant market elsewhere. Other examples were dangerous chemically-treated products, shoddily made mechanical objects, inadequate information on the use of products that may lead to injuries or even fatalities were some of many examples that can be related to insensitive profit-crazed TNCs who put the safety of the consumer as last in their priority list.

Concerns over consumer safety is one issue, but what is more alarming is the prosecution against these TNCs as the culprits of these injurious corporate actions has created another dilemma. More often than not, these violations do not fall under the category of crime in the host nations, again, due to the lax regulations on product safety. This was aggravated by the consistent efforts by the TNCs to find markets elsewhere, for the sale of products prohibited in their home nations. As such, it is understandable that some researchers are keen advocates for a higher level of supervision and control mechanism, to which these TNCs should succumbed to, that acts both as an umbrella to cover the no man’s land i.e. the space between laws, with guidelines and compliances as well as the referee to penalise any foul play amongst the corporate players. The authors have made a good attempt tapping on this issue under the subheading: U.N Code as International Politics, in the later part of the article.

TNCs and Regulatory Climates

Direct and Indirect Influence

The authors suggested that the TNCs have to a certain extent, direct and indirect influences on the host countries relating to regulatory denominator. Various strategies and incentives have been lined up by the developing nations who are competing with each other to attract foreign investments into their country such as the offering of lax regulations on environmental standards, limited labour rights, lower costs on labour and pollution control, imposition of lower tax and many more. The authors even suggested that there may be a double standard approach taken by the host nations at the expense of the workers, environment and consumers.

The notion raised by the authors is also supported by an article by UNESCO stating that the Asia-Pacific countries have been noted to have lower environment standard to attract foreign investment such as Indonesia and Philippines who have compromised their environment for the sake of attracting foreign investment in the mining industry[5]. It is quite understandable for the authors to note that the people’s rights as workers were put on the sideline by the host government to accommodate the TNCs as companies have been known to dissuade from investment in countries whose government could not control its people. It is also agreeable for the authors to suggest that too much repression by the host government would trigger unrest among its people, which would then result to wise TNCs pulling out from the investment.

The authors emphasised on the gap between the wages earned by the workers in the home nation and those in the host nation, the former earning much higher than the latter for the same job. This issue raises the question whether TNCs are inclined to degrade labour conditions. This point, as discussed earlier, may not always be such an unfair treatment as the workers of multinational companies operating in the host nations are usually earning at least twice as much as the workers in the local enterprises. The authors also mentioned that the TNCs have also been known to pressure the host nations to mould its regulations in favour of the TNCs to operate their manufacturing facilities with less hassles than in their home nations.  Using the economic bargaining power and strong leverage as TNCs, they have been known to use threats against the host nations with disinvestment. A United Kingdom-based firm known as P&O operating in India was reported to have pressured the Indian government to declassify the protected land of Dahanu so that their land can be used for the construction of an international port, thus adversely affecting the livelihood of the Dahanu residents who were mostly fishermen[6].

The authors have quoted an example which took place in Malaysia whereby the United States-based electronic firms have threatened the Malaysian government that they would withdraw their investment in Malaysia should the government proceeded with their plan to allow unionization of the workers in electronic field, as this would create much complications for the TNCs to deal with the demands for better labour rights such as wages, working hours, policies on recruitment and retrenchment. Since the developing nations were dependent on foreign investments to enhance their economy, the TNCs have also exploited the situation to their advantage to influence the political movement of the host nations while favouring the friendliest ones and most accommodating to their investment aside from thwarting those which are hostile and jeopardising their interest.

The U.N. Code as International Politics

The authors moved on to raise the concern that international politics have become a vital mechanism to govern the market operation of transnational businesses amongst all the corporate stakeholders. The authors observed that the “Draft Codes of Conduct on Transnational Corporations and the Guidelines for Consumer Protection” under the auspice of the United Nation (“U.N. Code”) has transformed the cross-border businesses into international politics. Unfortunately for the authors, they may have overlooked the fact that the U.N. Code has remained in its draft form and thus, it is hard to foresee that the code itself would have any political teeth or claws to regulate the conduct of the TNCs. To regulate the conduct of TNCs, it is viewed that the U.N. Code has failed to encourage TNCs in developing countries to pursue their own policies that are shaped based on the local conditions and culture in order to produce greater economic success in accordance with the international standards.

With regards to the formulation of the U.N. Code, the authors described the roles of various entities and organisations in the process of designing the code. Basically, the authors discussed the issues in the definitional process of corporate crime from the standpoints of the developing countries, developed countries and the TNCs themselves. For instance, the trade unions in developing countries favoured more public control in the world economy whilst the developed countries are more concerned with the conservative approach of providing more flexible room for the governance of corporate conduct in the realm of international businesses. On the other hand, the TNCs, especially the International Chamber of Commerce has questioned the essential principles that go into the roots of the U.N. Code since they emphasised more on the market force over the international politics in shaping such international code of conduct.

It is doubtful as to whether the political definition of corporate crime contained in the U.N. Code serves any significant impact upon the legislations governing the corporate conduct in developing nations as envisaged by the authors. Pilon (1987) opined that the U.N. Code was “designed to force Western companies to operate according to the New International Economic Order for mandatory resource transfers from the West to the developing world”[7]. Furthermore, it seems that no unanimous understanding on the U.N. Code was reached during the consultations convened at the United Nations General Assembly in 1992 due to the reasons that the changing “international economic environment and the importance attached to encouraging foreign investment requires that a fresh approach should be examined”.[8]

 The Search for Alternative Frameworks

That said, the authors recognised the fact that there were attempts by criminological researchers to reach alternative definitions of crime with the aim to create a proper regime for the research on the corporate misconducts of TNCs. This effort has eventually culminated in the notions of “human rights” as an alternative definition of crime. The author further observed that it has been a norm for the criminological researchers to distinguish the behavioural standards from the intervention of law. Baucus and Dworkin (2008) argued that “corporate crime” should not be confused with the words “illegal corporate behaviour” which denotes a different phenomenon in the context of corporate misconduct.[9] This contention strikes a perfect consonance with the arguments of Shapiro cited by the authors that it is inappropriate to conduct the studies on corporate crime based on considerations other than the element of illegality as far as the definition of corporate crime is concerned. Although the authors somehow agreed with the contention that law may cover moral choice in defining corporate transgression, they questioned the need to opt for one specific framework rather than the other framework in defining the appropriate boundaries of study on corporate crime.

Be that as it may, the argument that law should be utilised as a means to control corporate behaviours since it relates to the “moral agenda” of transnational corporations has thus invited vast criticisms against its practicality and application due to the gaps between the international law and the national law in governing corporate crime. As Stone (1975) augured well that:

Those who trust to the law to bind corporations have failed to take into account a whole host of reasons why the threat of legal sanction is apt to lack the desired effects when corporate behaviour is its target – for example, limited liability, the lack of congruence between the incentives of top executives and the incentives of “the corporation,” the organisation’s proclivity to buffer itself against external, especially legal threats, and so on.[10]

Conclusion

In a nutshell, it is noted that the issue of substantial gap between the laws of the home and host States pertaining to the examination of corporate crime has been persistently thorny in the field of criminological research. In this regards, the authors have also observed that there are different approaches adopted by researchers in the studies of the definitional crime of TNCs. However, to date, there is still no one conclusive definition and satisfactory evidence that may lead to the setting up of an appropriate framework for the purpose of criminological analysis. Nevertheless, it is opined that there is some relevance to the issue at hand which cannot be ignored, that the violation of corporate responsibility should no longer be seen as mere violation of moral responsibility since there are damages and harm done not to oneself but to other entities such as the society and the environment. As such, it is vital for research efforts to march on cogently in high spirit beyond the boundaries of conventional criminal law in order to experiment and explore the aforesaid subject with an open mindset since at the rate the world is evolving, both economically and environmentally, we cannot afford to go on being unintelligent and oblivious, as the damages done, will soon take its toll on all of us.

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[1] Flanagan, R. J. (2006). Globalization and labour conditions: Working conditions and workers rights in global economy. United Kingdom: Oxford University press.

[2] French, P. (2006). Pollution in China – Big foreign knuckles rapped. Retrieved from http://www.ethicalcorp.com/content.asp?ContentID=4748

[3] Woon Tan Kan & 7 Ors v. Asian Rare Earth, 4 CLJ 2299 (1992).

[4] Jianqiang, L. (2006). Multinational corporations violating China’s environmental laws and regulations. Retrieved from http://www.worldwatch.org

[5]  Jones, T. & McNally, R. (1998). Pollution for Export? Retrieved from http://www.unesco.org/courier/1998_12/uk/planete/txt1.htm

[6] Jones, T. & McNally, R. (1998). Pollution for Export? Retrieved from http://www.unesco.org/courier/1998_12/uk/planete/txt1.htm

[7] Pilon, J. G. (1987). The centre on transnational corporations: How the U.K. injures poor nations. Retrieved from http://www.heritage.org/research/internationalorganizations/bg608.cfm

[8] United Nations. General Assembly, 46^th Session. (15 September 1992). Report by the President of the forty-sixth session of the General Assembly [United Nations document, A/47/446]. Available: http://unctc.unctad.org/aspx/index.aspx [Accessed on 9 September 2009].

[9] Baucus, M.S & Dworkin, T.M. (2008). What is corporate crime? It is not illegal corporate behaviour. Law & Policy, 13 (3), 231–244.

[10] Stone, C.D. (1975). Where the law ends. New York: Harper and Row.

Sale of Debts under Islamic Law of Contract

Nurshuhaida binti Zainal Azahar

2011

Sale of debt or Bai Dayn is defined under Article 158 of the Majelle as, “the thing due (which can be either in the form of money or commodity) owed by a certain debtor”. It is a sale of payable right or receivable debt either to the debtor himself, or to any third party and it could be paid immediately or for deferred payment. [1] There is no clear provision on the prohibition of sale of debt in Quran and Sunnah and on that basis; there were divergent rulings among traditional Muslim Scholars on the permissibility of the sale of debt. As far as the issue of the sale of debt to the debtor himself, the Majority of jurists (Hanafis, Hanbalis and Shafies) unanimously agreed that the sale of debt to the debtor himself is valid (through the contract of hiwalah) provided that it is sold at par value.[2]

However, the Jurists differ in their views in regards to sale of debt by the creditor to a third party. The Hanafis, Hanbalis and Zahiris were of the view that such sale is invalid because the creditor is not in the position to ensure delivery of the subject matter (debt) to the third party. It is therefore, in the presence of this uncertainty (gharar), such sale is void. The Shafies on the other hand, allowed sale of a confirmed debt to a third party because these debts are deliverable without impediments. Similarly, the Malikis allowed sale of debt subject to fulfillment of additional conditions. Firstly, sale of debt must adhere strictly to the prohibition of riba and gharar. Secondly, it must not involve food item or money or any ribawi item.[3] Obviously, trading money for money is not allowed. Thirdly, the debt must be sold prior to receipt or else selling of a discharged debt would be unfair to the new creditor. Fourthly, the price of sale must be paid immediately to avoid the selling of debt for a debt (kali bi al kali) which is prohibited in Islam. Fifthly, the price must be different genus from the debt to avoid riba al-fadl.[4] In addition, the debtor must be present during the conclusion of sale between the creditor (seller) and new creditor (purchaser) so that his financial standing is known to the purchaser. Furthermore, the debtor must acknowledge his debt to avoid selling an uncertain thing, thus invalidating the sale. In addition, the debtor must be able to take the responsibility of the debt.[5] Most importantly, there is no enmity exists between the debtor and purchaser.  These conditions are meant to safeguard the likelihood of nonpayment of debt or non delivery of debt to the new creditor and debtor are not subjected to injustice. In this regards, Malikis’ view is practical and would serve as credit risk’s mitigation in modern Islamic Finance.

In sum, it can be gathered from those rulings, that as a general principle, the sale of debt at its equivalent value and on spot payment is permissible.[6]  According to the Majority of Jurists, the permissibility of sale of debt for spot price is supported by the Hadith narrated by Abd Allah Ibn Umar, who said, “I came to Prophet (s.a.w.s) and said, I sell a camel in al Baqi, with the price denominated in gold coins and collected in silver coins and sell them in denominated silver coins and collecting in gold coins” He (pbuh) said, “there is no harm if you take it at its spot price, as long as you do not depart without fully concluding the transaction”.  On the authority of this Hadith, sale of debt was opined to be approved by the Prophet (s.a.w.) (Wahbah Zuhayli, 2003). [7]  This opinion is later endorsed by the Islamic Fiqh of Jeddah in 2002 which held that sale of debt for immediate payment is allowed.[8] In other words, the debt must be sold at an equivalent value; not more and not less or else any additional sum accruing from the sale of debt is riba.

Despite the standing of traditional Majority Muslim jurists that any surplus out of sale of debt is amounting to riba, it can be seen that Islamic banks and financial institutions continue to practice so by selling debt products such as the Islamic Accepted Bills and Islamic Bonds on discount. This paper shall unveil the operation of such products later and it can be observed that these Islamic Finance products are mere replications of conventional financing products. These products have incorporated the contract of sale of debt (bay’ al-dayn) to justify the “additional income” made such sale which shall be called as “profit” out of the trading of debts.  Indeed, while the Middle East Countries have prohibited the sale of debt, in Malaysia such practice is permitted on the basis the debt sold by Islamic banks is essentially the “profit” generated from sale of commodity based mode of Islamic Finance such as Murabahah. In other words, a debt is a tradable commodity/asset because its existence is attached or tied to the real assets sold under the Murabaha sale.

Another view to justify the permissibility of the sale of debt at a discount rate propounded by the minority of Muslim jurists is that such debt is in the form of the “rights” sold to the purchase. It is the sale of “haqq” and not the debt itself.  Thus, any gain out of this sale is considered a profit. However, the justification is considered unsound by majority of Muslim jurists.[9] Another contemporary view supporting the sale of debt at a discounted value is based on the principle of Ibra’. Ibra’ allows the discharge of a whole or part of one’s claim on a debtor. Hence, it is entirely the banks’ right to sell the debt at a discounted value. Nevertheless, scholars do not agree with this argument holding that Ibra’ and sale of debt have a completely different objective and implementation.[10]

In spite of such “justifications”, they are refuted by Mufti Taqi Uthmani who is of the view that sale of debt at discount value (even though backed by murabaha’s commodity) is prohibited because upon sale of the asset in a Murabahah transaction, the ownership has already been passed from the bank to the purchaser and it is no longer the commodity of the seller/bank. The bank is only entitled to the money (monthly installments) being the consideration of the commodity sold. Then, it is apparent that the bank is selling money rather than assets. [11]  Hence, the banks cannot justify the issuance of such paper money at discount. Thus, it is clear that any gain made on the sale of money for money is deemed as riba al fadhl.

 

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[1] Article 158, Majjellah Al Ahkam Addliyyah

[2] Wahbah Zuhayli, Financial Transaction in Islamic Jurisprudence, Dar al Fikir: Damascus. 2003 V.1, P. 84.

[3] Hj. Zaharuddin, “Ruling on Debt Trading in Shariah” NST Business Times, 21^st June 2006.

[4] Wahbah Zuhayli, Financial Transaction in Islamic Jurisprudence, Dar al Fikir: Damascus. 2003 V.1, P. 84.

[5] Ibid p.84

[6] Saiful Azhar Rosly & Mahmood M. Sanussi, “ The Application of Bay’ al- Inah and Bay’ al- Dayn in Malaysian Islamic Bonds: An Islamic Analysis”. International Journal of Islamic Financial Services Vol. 1 No. 2.

[7] Wahbah Zuhayli, Financial Transaction in Islamic Jurisprudence, Dar al Fikir: Damascus. 2003, First Edition. V.1;P. 81.

[8] 16^th Convention on Islamic Fiqh Academy of Jeddah, Mecca, 5^th-10^th January 2002.

[9] Hj. Zaharuddin, “Ruling on Debt Trading in Shariah” NST Business Times, 21^st June 2006

[10] Hj. Zaharuddin, “Ruling on Debt Trading in Shariah” NST Business Times, 21^st June 2006.

[11] Taqi Uthmani (2002), An Introduction to Islamic Finance, Kluwer Law International:Hague.

2010 LegalPedia Blog in review

The stats helper monkeys at WordPress.com mulled over how this blog did in 2010, and here’s a high level summary of its overall blog health:

The Blog-Health-o-Meter™ reads Fresher than ever.

Crunchy numbers

A helper monkey made this abstract painting, inspired by your stats.

The average container ship can carry about 4,500 containers. This blog was viewed about 21,000 times in 2010. If each view were a shipping container, your blog would have filled about 5 fully loaded ships.

In 2010, there was 1 new post, growing the total archive of this blog to 17 posts.

The busiest day of the year was April 29th with 144 views. The most popular post that day was Islamic Finance in the Blue Ocean.

Where did they come from?

The top referring sites in 2010 were facebook.com, search.aol.com, google.com.my, abajournal.com, and search.conduit.com.

Some visitors came searching, mostly for ocean, blue ocean, trial by jury, jury trial, and ocean pictures.

Attractions in 2010

These are the posts and pages that got the most views in 2010.

1

Islamic Finance in the Blue Ocean April 2009
5 comments

2

THE COMPARISON OF TRIAL WITH JURY AND TRIAL WITHOUT JURY IN MALAYSIAN LEGAL SYSTEM (PART IV) February 2009
1 comment

3

THE COMPARISON OF TRIAL WITH JURY AND TRIAL WITHOUT JURY IN MALAYSIAN LEGAL SYSTEM (PART II) February 2009

4

THE COMPARISON OF TRIAL WITH JURY AND TRIAL WITHOUT JURY IN MALAYSIAN LEGAL SYSTEM (FINAL PART) February 2009
3 comments

5

THE COMPARISON OF TRIAL WITH JURY AND TRIAL WITHOUT JURY IN MALAYSIAN LEGAL SYSTEM (PART III) February 2009

Comments: “Still a long way to go in substance over form?” (Part I)

Recently, the Business Times Online has published an article “Still a long way to go in substance over form?” which reported the excerpts from the discussion amongst the prominent market players and regulators at the Securities Commission-Business Times Roundtable on Corporate Governance.  The discussion quickly captured my serious attention as it has drawn me closer to the thorny issues on corporate governance in Malaysia.  I could not agree more but to add that most of the directors of public-listed companies (PLCs) in Malaysia have tried their level best to adhere to the “comply or explain” rule on corporate governance. However, such conformance to the corporate governance statement which is required under the Bursa’s Listing Requirements is of no useful purpose if the form is emphasized over the implementation of the substance.

Although efforts of the regulatory authorities in providing a “Corporate Governance Guide”  and Malaysian Code on Corporate Governance to the directors are commendable, it is believed that most directors still have some long distance to travel before even reaching the desired full implementation of the corporate governance best practices. I do not wish to undermine the mental capabilities or professional skills that a director has, rather I would like to point out the importance for the proper establishment of corporate governance mechanisms in order to effectively carry out the best practices adopted. It remains a daunting task as the directors may have no or little time to meticulously craft out a comprehensive corporate governance mechanism or system due to their onerous responsibilities in managing and overseeing the operations and business activities of a corporation.

Most often than not, the duty to comprehend and comply is left with the company secretaries, compliance officers or legal executives who may have no power or authority to implement the corporate governance practices even if they wish to do so. Hence, the Corporate Governance Guide or the Malaysian Code on Corporate Governance would at most serve as letters carved on the stone unless the directors have the initiatives to transform the letters into real corporate actions for the best interest of the company.

To illustrate such box-ticking approach, the Malaysian Alliance of Corporate Directors’ deputy president Paul W. Chan. rightly raised the concern that:

“I sit on some of the boards as well, and when it comes to application, the board is usually advised by the company secretary on corporate governance issues. The company secretary will photocopy the guide and say this is what you should be doing. This are of course some guidelines, but I think the board may not be so sophisticated to device a mechanism of how to apply the guidelines.”

Tags: corporate, Corporate Governance

Sub-Prime Crisis: Islamic Commercial Law Perspective (Part 2)

by Ng Boon Ka

2009

COLLATERALISED DEBT OBLIGATIONS (CDO): DEBT TRADING IN ISLAM

CDO is a financial instrument in which a number of already existing debt securities are pooled together and the various levels of risk and return are allocated to a number of new securities according to a set of cash flow rules. A CDO investor takes a position in an entity that has defined risk and reward, not directly in the underlying assets. Therefore, the investment is dependent on the quality of the metrics and assumptions used for defining the risk and reward of the tranches. The issuer of the CDO, typically an investment bank, earns a commission at time of issue and earns management fees during the life of the CDO. An investment in a CDO is therefore an investment in the cash flows of the assets, and the promises and mathematical models of this intermediary, rather than a direct investment in the underlying collateral.

Creating CDOs from other CDOs creates enormous problems for accounting, allowing large financial institutions to move debt off their books by pooling their debt with other financial institutions and then bringing these debts back on to their books calling it a Synthetic CDO asset. This not only has allowed financial institutions to hide their losses, but has allowed them to inflate their earnings.¹⁷ This has the unfortunate effect of doubling potential losses book-wise.

A credit document emerging from any transaction of credit sale represents a debt which cannot be sold as per Shariah rules due to the involvement of gharar and/or riba. The OIC Fiqh Academy and Shariah scholars in general consider the sale/purchase of such securities or documents representing debt at a price other than their nominal value incompatible with the tenets of the Shariah. Even on face value, the sale of debt is allowed only when the purchaser has recourse to the original debtor, as in the case of hawalah.¹⁸

‘Al Kali bil Kali’, a fiqh maxim forbidding the sale of debt, means the exchange of two things both delayed or exchange of one delayed counter value for another delayed counter value. The practice of Bai al Kali bil Kali was prevalent among the pre-Islamic Arabs and was also termed Bai al-Dayn bid-Dayn. What is prohibited by this contract is the purchase by a man of a commodity on credit for a fixed period, and when the period of payment comes and he finds he is not able to pay the debt, he says: ‘‘Sell it to me on credit for a further period, for something additional’’. The Prophet prohibited such a sale.¹⁹

However, a debt can be assigned or transferred on the basis of hawalah, which implies transfer of debt obligation from the originator to a third party.²⁰ The difference between the ‘sale of debt’, which is prohibited, and the ‘assignment of debt’, which is permissible, is that in the latter, there is recourse to the assignor or the original debtor if the assignee does not pay the debt for any reason.²¹

When a share or certificate is supported by an asset, as evidenced via the securitization process, it is transformed into an object of value and therefore qualifies to become an object of trade, whereby it can be

purchased and sold in both the primary and secondary markets subject to the condition that a return on it is based on cash flow from the asset backing the instrument. Investors do have the right to sell such instruments.²²

In the securitization of subprime loans, certain entities such as the Credit Enhancement Provider and Trustee exist to act as an extra layer of protection for the transaction. This may include credit enhancement (designed to decrease the credit risk of the structure) provided by an independent third party in the form of letters of credit or guarantees. A trustee is a third party appointed to represent the investors’ interests in a securitization. The trustee ensures that the securitization operates as set forth in the securitization documents, which may include determinations about the servicer’s compliance with established servicing criteria.

From the Islamic perspective, a guarantee is a gratuitous contract for which the guarantor expects reward only from Allah for easing the financial distress of his fellow human being. Thus, the guarantor is not allowed to charge fees for such guarantee. However, if the debtor on his own willingness gives some token to the guarantor as a way of appreciation, the guarantor is allowed to take such token.

From an Islamic economist’s viewpoint, Umer Chapra emphasized the significance of the condition that prevents a creditor from transferring the risk to someone else by selling the debt as “this will help eliminate a great deal of speculative and derivative transactions where there is no intention of giving or taking delivery. It will also help prevent an unnecessary explosion in the volume and value of transactions and the debt from rising far above the size of the real economy.” Furthermore, it will also release a greater volume of financial resources for the real economic sectors and, thereby, help expand employment and self-employment opportunities and the production of need-fulfilling goods and services.²³

MARKET DISCIPLINE AND REGULATORY INTERVENTION IN ISLAM:

Against the principles of free market capitalist economic theory, the recent weeks witnessed the most remarkable period of government intervention in the financial markets of the world since the Great Depression. There was unprecedented coordinated action by the central banks of Europe and North America to cut interest rates. There were also moves to guarantee bank deposits or raise the guarantee limits. Asia-Pacific central banks also carried out substantial monetary easing in a bid to help lift the gloom in financial markets.²⁴ The credit crisis which was triggered by subprime over lending activity has proven that there is a need for proper regulation and supervision in financial system, both as a matter of prevention and cure.²⁵

It is, therefore, established that the responsibility of the government is to maintain a balance of economic activities and services. If the balance is distorted by economic agents with vested interests, the State has to restore the balance. Quran’s disapproval of the concentration of wealth

(59:7) and emphasis on justice (14:90) is beyond any doubt. On account of this, one of the important duties of an Islamic government will be to recover wealth usurped through illegal means and return it to its genuine owners or to deposit it with the State exchequer.²⁶ Hence, it does not take an expert to wonder whither the money (in the form of subprime losses) was directed and ended in the hands of unscrupulous parties. Logically, investigation is not nigh impossibility, what matters are the political and legal will to take actions.

It is also because of the non-coercive nature of Shariah that the market is relied upon as a natural phenomenon of ethical human transformation. The holy Prophet (pbuh) categorically discouraged intervention for price fixation as long as price fluctuations occurred due to market forces alone.²⁷ But when undue monopolistic and unjust pricing, production and distributional practices were existent, Al-Hisbah (the institution of the ombudsman run by people of high integrity) was empowered as a social regulatory body to check these imbalances for purposes of reestablishing a better semblance of market-driven

exchanges in the light of the just order that Shariah aims at in society at large.²⁸

The bailing out of many of the ‘once thought to be too big to fail’ financial institutions has triggered the question of whether the government could buyout (in the form of loan or equity) the institutions at a price determined by the government alone, even if market forces have failed to be effective.²⁹

In whatever the forms of intermediation, it is essential to focus on the types and nature of risks, and how these risks are distributed among the players. Before this crisis, the main focus was on risks posed by hedge funds. As it turns out, a large part of the risks were sitting in the core banking system, in the form of off-balance sheet items held in structured investment vehicles. Mortgage lenders which originated subprime mortgages were outside the regulatory ambit.³⁰

Another lesson from the Islamic system is striking a balance between flexibility and oversight. All Islamic contracts and financial products must be approved by a committee of scholars and bankers.³¹ In short, there exist a built-in Shariah compliance mechanism with the orientation of contemporary Islamic commercial interest as safeguard of market discipline and regulatory oversight.

¹⁷ http://www.creditmag.com/public/showPage.html?page=133213

¹⁸ Muhammad Ayub, Understanding Islamic Finance, John Wiley & Sons, Ltd 2007, p. 147.

¹⁹ Supra n. 18, p. 147.

²⁰ Tirmidhi, 1988, No. 1331, pp. 30, 3; Muslim, 1981, 10, pp. 227, 228.

²¹ Supra n. 18, p. 147.

²² Supra n. 18, p. 147. In a write-up on ‘‘Tasneed -Securitisation the Islamic Way’’, Rasameel Structured Finance, a Kuwait-based Islamic structured finance firm explained how securitisation can help solving the current disaster of financial crisis which is affecting the world’s capital markets. In tasneed, all investors must be subjected to the risk of the assets that generate the return as certain parties are not permitted to earn returns with no risk. The transaction is used to fund productive activities, to finance the purchase and sale of real assets, and generally to produce socially useful financing opportunities. Above all, a tasneed transaction will not contain excessive levels of leverage nor will it contain a promise-to-pay asset or other type of synthetic asset like a Credit Default Swap. Hence, tasneed prohibit those features of conventional securitisation that have resulted in so many problems.

²³ Supra n. 2.

²⁴ Supra n. 7.

²⁵ The role played by regulators is critical to the progress of Islamic finance. Many panellists in the recent DIFC Forum felt that Islamic finance institutions need to be regulated differently from conventional banks and regulators are sometimes extremely stringent on the Islamic finance sector. (DIFC Forum: Islamic Finance Can be a Role Model for the Global Economy 2008-11-26).

²⁶ Supra n. 18, p. 40.

²⁷ With regard to principles concerning operations in the market, the Jeddah-based Council of the Islamic Fiqh Academy of the OIC in its fifth session (10-15^th December, 1988) held, inter alia, that, ‘‘Government should not be involved in fixing prices except only when obvious pitfalls are noticed within the market and prices due to artificial factors. In this case, the government should interveneby applying adequate means to get rid of these factors, the causes of defects, excessive price increases and fraud.’’(Supra n. 18, p. 69).

²⁸ Supra n. 18, p. 31. Medieval jurists discussed the role of the state in organizing the business sector in the country. For example, Ibn Taimiya (1262-1368), in outlining the surveillance role ofthe state over the business sector, indicated that the state had the duty to organize trade and professional occupations in such a way as to purge trade from unlicensed intruders and to guarantee the correctness of commercial deals (Ibn Taimiya, 1982). This would not have been feasible unless the state had a kind of registration system. (Ahmed Abdel-Fattah El-Ashker, The Islamic Business Enterprise, London: Croom Helm, 1987, p. 78).

²⁹ Once, the Pious Caliph, Umar (Allah be pleased with him) asked a person who was selling a commodity at a much lower price than the market price to increase the price / rate or to leave the market.

³⁰ Supra n. 18, p. 20.

³¹ Loretta Napoleoni, Economist Suggests Islamic Finance as Solution to Economic Crisis, lecture sponsored by UNM’s International Studies Institute, 18 Nov 2008. Napoleoni’s talk on “The GlobalFinancial Crisis” was the keynote of ISI’s lecture series, “Global Instability: Causes, Consequences and Cures.”

Sub-Prime Crisis: Islamic Commercial Law Perspective (Part 1)

By Ng Boon Ka

2009

ABSTRACT:

Since the subprime crisis provides an opportunity for Islamic finance to emerge as an alternative in the global financial system, analysis should be taken from the Islamic commercial law perspective to better understand the crisis (origin and measures). The paper emphasises on some root causes of the crisis with study of post crisis measures taken by financial authorities. It begins with whether Islamic finance is immune from the sub-prime and financial crisis, followed by discussion on mutuality of risk taking and risk sharing as well as collateralised debt obligations and its relation with debt trading in Islam. From the Islamic perspective, it is vital to stress the importance of market discipline and regulatory intervention which somehow gave rise to the guarantee protection of deposit. Lastly, the repackaged subprime loans calls for a renaissance of Islamic commercial ethics. Moving forward, financial innovation should not be pursued at the expense of regulation and stability.

INTRODUCTION:

To understand the subprime crisis, one should note Umar Chapra’s illustration where the Islamic economist associated excessive and imprudent lending by banks as the main cause of the current global crisis. There are three factors that make this possible: inadequate market discipline in the financial system resulting from the absence of profit and loss sharing (PLS); the mind-boggling expansion in the size of derivatives, particularly CDSs¹; and too big to fail concept of banks who believe that the central bank would come for their rescue.²

Securitization or the originate-to-distribute model of financing has played a crucial role in this. Mortgage originators collateralized the debt by mixing prime and subprime debt. By selling the collateralized debt obligations (CDOs), they passed the entire risk of default to the ultimate purchaser. They had, therefore, less incentive to undertake careful underwriting. Consequently a number of banks have either failed or have had to be bailed out or nationalized by governments in the US, the UK, Europe and a number of other countries. This has created uncertainty in the market and led to a credit crunch, which has made it hard for even healthy banks to find financing. When there is excessive and imprudent lending and lenders are not confident of repayment, there is an excessive urge for resorting to derivatives like CDSs to seek protection against default. The buyer of the swap (creditor) pays a premium to the seller (a hedge fund) for the compensation he will receive in case the debtor defaults.³

Notwithstanding the gargantuan volume of write-ups that have flooded the media recently, there has not been a comprehensive analysis from the Islamic commercial law perspective. This paper is a potpourri of empirical data, news reports, articles, speeches and opinions with substantive analysis from the perspective of Islamic commercial law. It emphasises on some key root causes of the subprime crisis with analysis of post crisis measures taken by the financial authorities.

SUB-PRIME AND FINANCIAL CRISIS: IS ISLAMIC FINANCE IMMUNE?

On 3 December 2008, Gulf News entitled ‘Islamic Finance no longer immune to Crisis: Experts’ (reported by Reuters) highlighted that Islamic banking can no longer claim immunity from the global financial crisis now that it is hitting the industry’s main source of funding and property values in the Gulf Arab region. In a report issued last week debt rating agency Moody’s said Islamic financial institutions in the Gulf showed strong resilience during the global financial turmoil, but that they are not risk-immune due to a shortage of liquid instruments and the lack of an Islamic interbank market.⁴

For example, the United Arab Emirates last week bailed out Islamic mortgage lenders Amlak and Tamweel. There are also structural impediments. Jamal Abbas Zaidi, chief executive officer of the Islamic International Rating Agency raised the issue of legal protection from the authorities (in an ijara deal) in case of a default and the lengthy procedures to enforce the right (as with a conventional mortgage) which has yet to be tested in the courts.

MUTUALITY OF RISK TAKING AND RISK SHARING:

In her keynote address at the Islamic Financial Services Board and Institute of International Finance Conference: “Enhancing the Resilience and Stability of the Islamic Financial System,” on 20 November 2008, the Governor of Bank Negara Malaysia described the problem of excessive risk taking aggravated by the complexity in financial innovation and weak risk management, as the crisis propeller in the following succinct words:

‘‘In the current crisis, financial innovation occurred at a pace that outstripped the ability to manage the associated risks with such innovations. There was excessive risk taking and a lack of transparency and disclosure in the financial transactions. The complex structured instruments and securitisation process resulted in multi-layered structuring of financial products which were not supported by enhancements to governance processes and the risk management infrastructures and practices. This resulted in an underestimation of the risks involved and the capital buffers that were necessary.’’⁵

While some may accord the blame to the U.S. government policies and competitive pressures for several years prior to the crisis which encouraged higher risk lending practices,⁶ all the institutions that have failed found that they had bought into the euphoria of this new way of making money by moving risk to others; in the end they were all holding toxic papers which quickly led to huge losses.⁷

In this regard, the primary concern of the Shariah, for the purposes of making a gain, is to ensure the exchange of an actual commodity and not merely a financial exchange.⁸ Umer Chapra explained that, “In the Islamic system, credit is primarily for the purchase of real goods and services which the seller owns and possesses and the buyer wishes to take delivery. It also requires the creditor to bear the risk of default by prohibiting the sale of debt, thereby ensuring that he evaluates the risk more carefully.”⁹

The old adage in investing is “no risk, no return”. While this might sound as if it advocates rampant risk taking, risk within an Islamic context should be ideally translated into “managed risk equals managed returns”.¹⁰ In this context, Monzer Kahf mentioned,

“We also question the wisdom of some traditional Islamic finance writings that have been calling on Islamic banks to use the Mudarabah contract on their asset side as if it is better, according to Shariah, to take more risk. Some times this theoretical preference is mixed up with the premise of “al Ghunmu bi al Ghrum” as if taking risk is what justifies deserving a return and therefore the more risk an Islamic bank takes the better Islamic it is! In fact, the Shariah does not assign any moral value to risk taking, it does not have any reference to preferring more risk over less risk and it does not make risk the cause for earning a return.” ¹¹

Having painted a general picture, it is vital to discuss leverage gain in the context of both conventional and Islamic finance. Conventional finance is a zero sum game. One investor gains at the expense of another. And even that unhappy state gets worse when greedy, unscrupulous third parties get involved. Far too often, this competitive antagonism in conventional finance produces a lack of alignment of interest among investors even within the same company. In a highly-leveraged company, risky, high-payoff speculative transactions are attractive to equity investors who have little to lose, but these transactions can devastate the senior debt holders if they go bad. Within a single Collateralised Debt Obligations transaction, one of the security types that brought on the current financial crisis, investments that benefit the equity class can be damaging to the senior classes and vice versa.¹²

After 1950s, profit rates in general ran much higher than the rates of interest in most economies and business firms increasingly went for short-term bank finance to meet even their long term financial requirements. Excessive use of leverage fuelled profits and business expectations. That created bubble economies which came to grief sooner than later with the collapse of businesses and the setting in of recessions.¹³

It is naïve and inaccurate to state that there is no leverage gain in Islamic finance. By looking at the firm/business entity’s angle, Professor Zubair Hasan argued that profit sharing has the element of leverage gain. There exist a fundamental difference between an interest based and an interest free system as the risk premium is transferred to the financial institutions in the latter case. Furthermore, the leverage gain in an interest free system is smaller, which can reduce the magnifying effect of profit. With this, the economy would be relatively more stable as firms will carry greater risk (of their own capital and the bank’s capital) to gain on their own capital while the banks would be more cautious when investing due to the assumption of risk.¹⁴

In the article ‘‘An Effective Regulatory Framework for Islamic Finance’’, juxtaposition and contrast were made between the conventional and Islamic financial risks which merits the inclusion in this paper. Many of the risks inherent in Islamic finance are similar to those of conventional finance, including credit risks, market risks, market conduct risks, operational and reputational risks. However, the exposure to those risks could differ between conventional and Islamic finance. For instance, Islamic banks are generally exposed to substantially more liquidity risk than their conventional counterparts, as the range of liquid instruments and hedging instruments are more limited.¹⁵

Islamic banks tend also to be more exposed to the property and infrastructure sectors, in part because these are the prevalent asset classes in the Gulf and also in part because Islamic finance has to be based on physical assets. Given the “large and lumpy” nature of such transactions and the tendency for asset bubbles to build up quickly, it is a risk that merits special attention. In addition, there are also risks unique to Islamic finance such as Shariah compliance risk. If products are later found to be non-Shariah compliant, the institutions not only face reputational damage but also costly unwinding of such structures, with possible losses to investors.¹⁶

Endnote

1 Credit Default Swaps which are derivative contracts whose value depends on the price movements of a real, underlying fixed income cash security. One real security can be the basis of several tens to several hundred times the amount of credit default swaps. (Recently, the credit default swap market was estimated to be $33 trillion. Even this number has been criticised as being 25 per cent too low. No one knows the actual outstanding amount.)

² Umer Chapra, Islamic finance panacea for global crisis, by P.K. Abdul Ghafour, Arab News, 23 October 2008.

³ Supra n. 2.

⁴ The ratings agency expects growth in Islamic banking assets to slow sharply in 2009, to around 10 to 15% from a range of 20 to 30% this year. Islamic banks now stand in the same firing line as their non-Islamic counterparts, facing a slump in equities valuations and a slump in Gulf real estate, to which they are heavily exposed.

⁵ The low interest rate environment also accentuated the build up of the excesses and rising assetvalues. In the United States, it had increased close to 240% in 2007. The excessive leveraging and increased risk taking reinforced the formation of asset bubbles (per BNM Governor Dr. Zeti).

⁶ NYT-Pressured to Take More Risk, Fannie Reached Tipping Point

⁷ Nathif J Adam, Islamic Finance Presents a Credible Alternative to the Conventional Financial System, Islamic Finance News, Vol. 5, Issue 42, 24 Oct 2008.

⁸ Supra n. 7.

⁹ Supra n. 2. In other words, Islamic finance requires that investors should share in risk and rewards and not guarantee some investors a return that will be at the expense of other investors.

¹⁰ A financial oasis in a credit desert, 3 Nov 2008, http://www.thebanker.com/news/fullstory.php/aid/6125/A_financial_oasis_in_a_credit_desert.html

¹¹ Monzer Kahf, Maqasid al-Shariah in Prohibition of Riba, p. 16. ¹² Supra n. 9.

¹³ Zubair Hasan (2008) Credit creation and control: an unresolved issue in Islamic banking, http://mpra.ub.uni-muenchen.de/8130.

¹⁴ Zubair Hasan, Lecture on Islamic Economics, INCEIF, 8 Nov 2008. ¹⁵ Heng Swee Keat, An Effective Regulatory Framework for Islamic Finance, Islamic Finance News, 28 November 2008, p. 20.

¹⁶ Supra n. 15.

Islamic Finance in the Blue Ocean

by Ng Boon Ka
2009

‘‘We don’t want to go back to the same normalcy that we’re coming from.
We will create a new normalcy which will stay and keep on moving and change the world.’’

Nobel Peace Prize winner Muhammad Yunus,
World Economic Forum 2009, Davos

Inspired by the ‘Blue Ocean Strategy (BOS)-How to Create Uncontested Market Space and Make the Competition Irrelevant’, a book of strategy and management by Prof. W. Chan Kim and Prof. Renee Mauborgne, it is high time to strategise the art of Islamic banking in a nascent ‘box’ altogether. Putting this into perspective, it is both strategically sound and tactically tenable in light of Albert Einstein’s words that, ‘‘we cannot solve our problems with the same thinking we used when we created them’’.

Leveraging on the distinctive and holistic fundamentals of Islamic finance such as the sharing of risk and reward, the prohibition of interest (riba) and gambling (maisir), minimisation of induced uncertainty (gharar), emphasis on real transactions, as well as ethical and charitable activities, a paradigm shift in the thought process of innovation and development is therefore warranted chiefly in vogue with the current age of financial turbulence.

To begin with, the thinking within the conventional box which seeks to benchmark against conventional risk and return profile in order to gain market share is plausibly applicable to underdeveloped and infant markets where Islamic finance is merely a small subset of the whole financial system. However, such thinking works in an accommodative rather than an innovative mode, taking into account the spirit of maslahah.

As Islamic financial markets are maturing with growing market shares, a more robust Shariah compliant approach would necessitate an upward shift towards thinking outside the conventional box. Once Islamic finance has gained dominant market shares at the higher innovation stage, the ideal level of thinking in a distinctive and ever-expansionary ‘Shariah box’ with a Shariah based approach, rather than a superficial realm of ‘outside the box’, shall achieve the higher ideals of Islamic economics and social order.

Having witnessed the unprecedented growth of Islamic banking along the global financial trajectory in recent decades, there is a current and sanguine need for a strategic metamorphosis from a niche ‘green field’ to an uncharted ‘blue ocean’, in lieu of a ‘red ocean’ with conventional banking.

ISLAMIC FINANCE IS RIDING THROUGH THE WAVE OF BLUE OCEAN

Moving beyond Sun Tzu’s Art of War adage, ‘‘If you know both yourself and your enemy, you can come out of hundreds of battles without danger’’, to a higher ground of defeating an enemy without even fighting, the BOS advocates a better strategy by exploring ‘blue oceans’ – untapped and untargeted markets which hold tremendous growth potential – rather than going head-to-head against rivals for a share of the existing market. The latter scenario is akin to a ‘red ocean’ where competition is based on outperforming the existing competitive benchmark. In other words, the best approach to earn a competitive edge is to gain the first mover advantage over competitors.

While competitors are the ones who set the agenda and rule of the game in red oceans, competition becomes insignificant in blue oceans. At the heart of BOS lies the creation of value innovation which seeks to integrate all the firm’s functional and operational activities. That said, the development of BOS revolves around preference for more risk minimization and less risk taking by reconstructing market boundaries; focusing on big picture, not numbers; reaching beyond existing demand; and getting the strategic sequence right. Being a departure from business-as-usual, the execution of BOS entails the overcoming of organizational hurdles and the embedding of execution into strategy.

The current global economic crisis poses a ‘creative destruction’ whereby ‘out of destruction a new spirit of creativity arises’ for Islamic finance to be the optimistic agent of change. However, given that a full operation of an ‘Islamic institutional scaffolding’ (a platform of Islamic behavioral rules) is currently lacking, there is ‘‘need for the design and development of a comprehensive and dynamic regulatory-prudential-supervisory framework, uniquely designed for an Islamic financial system,’’ as highlighted by Abbas Mirakhor.

For Islamic finance to be the role model for global economy, emphasis should be also given to the formulation of Islamic monetary and fiscal system, banking for the poor and the unbanked, prioritization of inherent corporate social responsibility to create wider appeal for Islamic financial products, acquisition and transformation of conventional banks into Islamic banks, increasing market share as early market entrants particularly in emerging and/or underdeveloped markets such as Central Asia and Xin Jiang of China, among others.

It is worthy to note that, in promoting knowledge-based innovation with practical adherence to the tenets of Shariah, Malaysia has created a market space from her position of strength in advancing innovative drive by the establishment of institutional infrastructures like INCEIF and ISRA.

Viewing Islamic finance with the original spectacle in a new vision rather than a purely conventional glass may be the propeller for the departure of a prescriptive Shariah compliant approach towards a principle-based Shariah system. To conclude in Bank Negara Malaysia Governor Tan Sri Dr. Zeti Akhtar Aziz’s words, ‘‘Islamic banking and finance is a ‘mirror of the sea’ for until and unless we have the courage to explore its depth, we would never be able to uncover the treasures that reside within.’’

The summary of this article was published in The Malaysian Reserve on 6th April 2009.

Click here to find “A Blue Ocean Revolution in Islamic Finance” by Gabor George Burt, who is an internationally recognized expert on Blue Ocean Strategy and Value Innovation; the highly acclaimed, new approach to high-growth strategy formation and implementation conceived by INSEAD professors W. Chan Kim and Renee Mauborgne.

Tags: islamic finance

ISLAMIC BANKING IN MALAYSIA

by Nurshuhaida Zainal Azahar

ISLAMIC BANKING IN MALAYSIA

Islamic banking (IB) in Malaysia had developed quite fast for the past of more than 20 years, starting with the establishment of Bank Islam in 1983. IB is governed by both Islamic Banking Act 1983(IBA) and Banking and Financial Institution Act 1989(BAFIA). Section 3 of IBA defines Islamic Bank as “any companies which carries on Islamic banking business and hold a valid license; and all the offices and branches in Malaysia of such a bank shall be deemed to be one bank”. Islamic Banking Business is further defined as “banking business whose aims and operations do not involve any element which is not approved by the Religion of Islam”. In addition to this statute, Section 124 of BAFIA allows any licensed institution to carry Islamic Banking Business and Islamic Financial Business.

In my opinion, the progressive development of IB in Malaysia has its advantages and disadvantages. One of the advantages is that IB allows for a wide banking transaction compared to conventional banking. This is supported by the legal definition of “Islamic Banking Business” provided under Section 3 of IBA, “banking business whose aims and operations do not involve any element which is not approved by the Religion of Islam”. Meanwhile, in conventional Banking System, the banking transaction is limited to the definition provided under Section 2 of BAFIA, inter alia receiving deposits, paying and collecting cheques and provision of finance.

On this basis, we can find the concept/ products of Bai’ Bithamin Ajil (deffered sales), Ijarah (leasing), Qard al Hasan (money lending), Mudharabah (dormant partnership) and murabahah (active partnerships), and Istis’na (manufacturing) began to evolve for the past 20 years. However, the development of conventional banking remained static relying heavily on its main business of financing (loan) till now because of the restrictions in BAFIA, example Section 33 (restriction on carrying on of trade) and Section 66 (restriction on investment). Islamic Banking Business to some extent may also include Islamic Insurance (TAKAFUL) without a necessity to form another company to manage it if Bank Negara allows it.

Therefore, I am of the opinion that Islamic Banking had more prospect and profitable than Conventional Banking. This can be seen when many conventional banks had turned to Islamic Banking Business under section 124 of BAFIA. Some of the examples are RHB Islamic Bank and Maybank Islamic Bank. IBB is more profitable owing to the fact that there are wide varieties of banking products yet to be introduced. In addition, majority Muslim population in Malaysia contributes to a good prospect of IBB in future.

Nevertheless Islamic Banking still has its weaknesses. Firstly, there is a conflicting jurisdiction between Civil Courts and Syariah Courts. The issue of Islamic Banking’s jurisdiction had been resolved in the case of BIMB v. Adnan Bin Omar [1994] 3 CLJ 735, by N.H Chan J., where it was held that the case was rightly brought before the Civil Court because List I of Ninth Schedule includes banking being the subject matter where the Parliament can enact laws.

However, in my opinion, Islamic Banking’s cases should be brought before Syariah Court. This is due to the fact that not all Civil Court’s judges (with due respect) are well versed in Islamic transaction, what more in Islamic Jurisprudence in order to interprete the IB’s laws. My opinion might be obsolete based on Adnan’s case but I think that it is the time where High Court may set up an Islamic Division to deal specially with Islamic Banking cases. It would encourage specialization of judges and lawyers in IB as has been done with four other divisions (commercial, civil, criminal and appeal and special powers). This is the least we can do to serve the object of Islamic Banking. What is the point of setting up Islamic Banking if upon disputes; they may be interpreted by non Islamic Principles.

Secondly, Islamic Banking Products to certain extent, especially Bai’ Bithamin Ajil (BBA) is oppressive to the customers. For example in the case of Adnan Omar, the buyer (customer) had entered into BBA contract with BIMB, the purchasing price being RM 265,000 and the selling price was RM 583,000 for a deffered payment to be made in 180 months (15 years). The defendant had defaulted in payment after 2 year the contract was made. It was held in the case that the defendant was required to pay the amount of selling price of RM 583,000 and not entitled to Ibra’ (rebate) for early settlement.

In my opinion, this is unfair. The amount of selling price of RM 583,000 was agreed based on the consideration of the time factor of 15 years. When the defendant defaulted, the value of the house would not reach RM583, 000 just within 2 years, yet the defendant must pay such amount. This is unearned income by the bank. It defeats the object of Islamic transaction as it involves the element of oppression. In Affin Bank v. Zulkifli Bin Abdullah [2006] 1 CLJ 438 Abd Wahab Patail J., fortunately held that the customer was entitled to rebate even though he had defaulted in the payment. This is because the Bank is not entitled to gain such unearned income. The judge also had commented that Islamic Banking is oppressive compared to conventional banking.

In conclusion, Islamic Banking is a relief to the Muslims in this country who longed for Islamic financial aids. IB had come out with many products to serve this purpose. However, the fact that IB cases are decided by Civil Courts by Non Muslim judges or judges who are not well versed in Islamic transaction, raised doubts in the society. Is IB interpreted based on Islamic principles? Another interesting fact is, is BBA Islamic enough? Is the decision in Adnan Omar justifying the Islamic principle that a Muslim is not entitled to an unearned income? Should the Muslims still proceed to BBA knowing the fact that it is oppressive when they are unable to pay the sum within the specified period? Based on these reasons, I am of the opinion that IB must be reviewed frequently so as to ensure Islamic principles, forming the foundation of Islamic Banking is strictly adhered to.

Tags: bank, banking, islam, islamic, islamic bank

Does The Peacock Deserve Better Recognition Than The Satyam?

Satyam Scandal in India

A recent post by the Livemint mentioned that Satyam Computer Services will be stripped off the Golden Peacock Award. It was stated that the said Award was the very laurel it used for trumpeting its corporate governance norms when the controversy broke out.

The question that springs into our minds is the effectiveness of corporate governance. Why has Satyam been awarded such a prestigious award of good corporate governance when the dark side of the Satyam corporate practice remained hidden at the time of the bestow of such award?

This begs further serious doubts upon the sanctity of the Golden Peacock Award. After the fall of Satyam, one starts to wonder what are the best corporate governance yardstick employed by the World Council for Corporate Governance before deciding the recipient of such award.

Perhaps, it is merely a matter of trust confided upon Satyam to prove that it did deserve the Peacock Award. However, it was sad to say that Satyam has clearly gone beyond a matter of trust. As quoted from the Times of India:

“What do the two hot topics in business the global economic crisis and the Satyam swindle have in common? At the bottom of both are failures of business institutions leading to an erosion of trust in the economy. The collapse of Lehman Brothers in the US, and weaknesses in AIG, Fannie Mae, Citibank, GM, and many other large firms, have created panic extending beyond the US.

Similarly, the shenanigans of Satyam’s promoters have created widespread reverberations in India and abroad. It is not just the governance of these firms, but also the institutions set up to ensure the integrity of the corporate system auditors, credit rating agencies, etc, many of which are also business institutions which have failed in their duties to society. Recent polls show a dramatic erosion of faith in business. Three out of four Americans trust business less than they did one year ago.

At the World Economic Forum in Davos this year, economists from the IMF and global think tanks painted a dismal picture of the world economy. They described a global economic edifice shaken by an unexpected earthquake with its epicentre in the US subprime loan market. There is no safe haven in it they said and warned of further after-shocks, in Europe, the US, and Asia, for which India too must be prepared. The immediate solutions offered for central banks to release more money and for governments to spend more money seem inadequate. Whereas what the global economy needs is a new architecture to prevent such catastrophes and to restore trust in free-market capitalism.

Business leaders, who until 2008 had urged governments to stay out of business, are now urging governments to vigorously save businesses. They want governments to intervene in the markets but at the same time to keep markets free. This raises questions in the public’s mind about what they want markets to be free from. Freedom only from barriers to trade? Or also freedom from government regulations? Or even freedom from responsibility for their actions?

The freedom to succeed and to fail is the essence of the system of free enterprise. However, with these economic freedoms, entrepreneurs and managers cannot be given freedom from responsibility towards others. When top executives in Enron and WorldCom found ways to beat the systems then in place, Sarbanes-Oxley followed. Corporations doing business in the US complained that it was an overreaction to isolated deviant acts for which everyone was being inconvenienced. Satyam is turning out to be a case of criminal fraud, which overwhelmed systems of corporate governance. Businessmen fear that the reaction to the corporate failures in the US and Satyam in India will be more controls which could stifle business freedoms. Therefore, the architectural challenge is to shape institutions and systems of corporate governance that give business managers freedom to innovate with safeguards to ensure that they also fulfil society’s requirements.

If one used the metaphor of a house, trust in institutions is the solid roof that we all need above us. It gives us security to live without fear of bad things falling upon us. Structures are necessary to uphold this roof. When the roof begins to cave in, architects may propose more vertical pillars to support it. Thus, when problems of malfeasance appear in economies and societies, there is demand for more rules and more agencies that will regulate and control. The multiplication of such structures reduces the room to move around within the house, thus reducing the freedom of enterprises. Therefore, the architect must conceive of other ways to strengthen the structure that do no require this plethora of top-down controls. These could be well-placed horizontal beams, which strengthen the integrity of the structure while giving space within it.

These horizontal structures are the values by which people relate to each other and business conducts itself. Economists say that incentives must be aligned to induce people to behave properly. Economists tend to think of incentives in terms of improvement of measurable financial outcomes for individuals and investors. Therefore, they emphasise the creation of financial wealth, and measure ‘value’ in financial terms. And when societies are in trouble, economists will concentrate on improving the flow of money and investments. Whereas the present crisis of confidence in the free-market system requires that leaders also focus on moral and ethical values.

Like Arjun on the battlefield at Kurukshetra who asked Krishna a moral question, not advice on how to fight the battle, business leaders fighting the recession must also ask what they must change in their approach to business to regain society’s trust if they want more freedom in future. Therefore, corporate boards should introspect from time to time about the values that guide their decisions. Independent directors on boards are not expected to merely provide functional expertise, in finance, law, business management, etc or knowledge of the industry. These directors must also be a moral check, built into the system of corporate governance, to sense when promoters and managers are failing in their responsibilities to society and to correct them. How many independent directors are prepared to fulfil this role? And how often does the board candidly introspect into the values guiding its work?”

Hence, I strongly urge that companies must strictly adhere to the international best practices in corporate governance and disclosure standards since these benefits the companies. Transparency and good corporate governance practices provide additional comfort to stakeholders and enhance the long-term value of the company for its shareholders. It fosters and maintains investor and stakeholder confidence.

The companies’ annual reports should talk about their risk management policies, which include the institutionalization of an enterprise-wide risk management system, as well as the creation of on oversight board committee on risk management. Their annual reports should also feature the attendance of directors in board meetings, corporate governance scorecard, and code of conduct and ethics, among other things. This can also be ensured via the independence of board directors besides meeting the expectations of shareholders.

Empirical data is pertinent in validating research – Merits and demerits in relation to the various methods of data collection

By Ng Boon Ka 2008

"RESEARCH" ZOOMED IN

INTRODUCTION:

According to the Oxford English Dictionary (2nd Edition, 1989), empiric is derived from the ancient Greek for experience, έμπειρία, which is ultimately derived from έυ in + πεἳρα trial, experiment. Therefore, empirical data is information that is derived from the trials and errors of experience. In this way, the empirical method is similar to the experimental method. However, an essential difference is that in an experiment the different ‘trials’ are strictly manipulated so that an inference can be made as to causation of the observed change that results. This contrasts with the empirical method of aggregating naturally occurring data.[1]

Notably, strict empiricists derive their rules of practice entirely from experience, to the exclusion of philosophical theory. Notwithstanding the disagreement of this author with such approach, the importance of an underlying philosophy will not be discussed in this paper due to the limit of space and time. For the purpose of this paper, this author proposes to discuss the matter at hand in an avant-garde style which seeks to unravel the merits and demerits of empirical data in validating research by reference to various data collection methods. A bold approach shall be taken by going beyond the confinement of traditional data collection methods, namely, questionnaires, interviews and observations, into structured and combined methods such as forecasting tools. This introduction shall be followed by different research areas (physics, metaphysics and divinity) which will determine the use of various kinds of collection tools. The kernel of the discussion shall revolve around core concepts like accuracy, predictability and practicality. Last but not least, the simplicity and clarity of thoughts is captured by a flow chart given in the appendix.

PHYSICS, METAPHYSICS AND DIVINITY:

While physics is the science concerned with the study of physical objects and substances, and of natural forces by employing empirical methods, metaphysics, on the other hand, is the part of philosophy that is concerned with trying to understand and describe the nature of truth, life, and reality. A higher level of ‘divine data’, which can be both visible and hidden from mankind, is beyond physics and metaphysics. Hence, it is obvious that only the first category may produce empirical data and not the latter two.

As pointed by Uma Sekaran, though moods, feelings, and attitudes can be guessed by observing facial expressions and other nonverbal behaviors, the cognitive thought processes of individuals cannot be captured.[2] Howbeit, Uma qualified this by introducing projective methods where certain ideas and thoughts that cannot be easily verbalised or that remain at the unconscious levels in the respondents’ minds can usually be brought to the surface though motivational research.[3]

In this regard, while some stretched psychological testing tools, both electronically and traditionally, to test intuition and inspiration, which may be subjective and abstract, it is nigh to impossibility to test divine revelation. In the Islamic context, the Quranic revelations were always accompanied by certain psycho-physiological changes that could easily be perceived by those present with the Prophet S.A.W. As for the revelations themselves, they occurred according to definite measures and in varying time intervals in a way clearly neglectful of the personal state of the person who was receiving them. Put differently, those revelations were taking place irrespective of the Prophet’s grief and sufferings or wishes and aspirations.[4] Hence, Muslims must accept the incident of such Quranic revelation without an iota of doubt and empiricism. Any empirical method which claims to test the revelation would not validate such benign research of the Quranic origin.

This author is of the view that the compilation of the Quranic ayat in the early ages of Islam as a collection of data encompassed both empirical and non-empirical methodologies. It was empirical because of the direct observation by the Prophet’s sahabat and non-empirical as they believed in the words of Allah as long as they were authentically recorded.

The research on the nature of truth, life, and reality can be creatively seen in the context of the booming growth of Islamic finance. The survey on the use of Islamic financial products and services by customers either in the form of interview or questionnaire is a good empirical method to gauge the confidence and satisfaction level of customers. Seen in the light of communicational clarity, personal interviews may enable the identification of nonverbal cues and the building of rapport, thus, affording more insights to the subject matter. The questions may be structured in a systematic manner (e.g. Longitudinal scale or Likert scale in different products) which facilitates the supply of answers by the respondents. These methods had been also improved by the use of computer-assisted interviewing (CAT) which enhances the relevance of empirical data in validating research.

Nonetheless, such empirical data may not be able to identify the actual reasons of the use of Islamic financial products and services in the first place as some may wish to invest in such products regardless of its validity in the Shariah as long as it provides satisfactory returns. In other words, although interviews and questionnaire may churn out empirical data in relation to the confidence and satisfaction level of the customers (which may be expressed); it may not be deep enough to furnish wholesome understanding of its genuineness (which may be hidden or distorted).

ACCURACY:

Empirical data obtained through observational studies are generally reliable, rich and free from respondent bias. This resonate the ‘first hand theory’ as opposed to hearsay evidence in which the former underlines the importance to appreciate matters first hand rather than relying on transmission of data without credibility and transparency. Historically, in the ninth century, it was amazing that al-Razi hung raw meat at different places to find the locality with the slowest rate of decay which was later recommended for the building of the new Audidi hospital in Baghdad. This experiment by contact with nature has motivated mankind to understand the complexity of God’s universe in an ingenious and diverse manner.[5]

Nevertheless, the aforesaid example on observation may be tainted with extraneous factors which may skew the examination, determination and final result. Likewise, while it is easier to note the effects of environmental influences on specific outcomes through observational studies[6], there are possibilities that empirical data derived thereof may be invalidated by vitiating factors like natural causes which are beyond our control. Biasness that crop into the data collection methods may result in recording errors, interpretational errors, memory lapses, and unreliability of the empirical data.

PREDICTABILITY:

The use of meteorological tools to examine natural phenomena like the weather not only gives good empirical data of current status quo, but also gives good forecast to a certain extent. Empirical data from forecast is still second to none in most areas of physical sciences. However, a good forecast remains only as a good estimator since certainty of knowledge is still beyond the realm of human’s intellect. In short, the extrapolation of current or past empirical data to predict the outcome in the future may not indicate the whole truth. Assuming a research is done on the date of kiamat (Last Day), is it possible that we use forecasting tools to predict such an incident? Ostensibly, it is an affront to common sense!

Correspondingly, although fortune telling by observation of the palm and face is a type of empirical data upheld by some people, this kind of data derived from such data collection method may not validate a research, for instance, on the success rate of a person in the future. On the same token, biased empirical data can be found in the criminal profiling of certain suspects based on their DNA, cultural background and even religious belief as evidenced by the negative profiling of Muslims as potential terrorist after the Sept. 11 attack. On the flip side, the data collected though clinical (lab) experiment on the food intake of children may be used to gauge their growth rate in the future.

PRACTICALITY:

The collection of empirical data largely hinges upon resources such as time, energy and cost of the researcher which might bias the recorded data due to observer fatigue. In the retrieval of preexisting records particularly historical ones, one may doubt the extent of which all records have survived to allow for fair representation of the sample. In spite of that, empirical data is still better than non-empirical data especially in the historically-oriented research. In short, the practicality of the empirical data is matter to be judged according to the area of research that we are interested.

THE NUTSHELL:

As there is no certainty in knowledge, no single method and data are sufficient to provide a complete comprehension of an area of research. Empirical data from various data collection methods is the most useful source for contemporary research compared to futuristic and historical research. In both the latter cases, there are elements of uncertainty and subjectivity. In essence, it is contended that a research which adopts a multi-method and multi-data approach (the triangulation of methods), may yield more constructive outcomes. Thus, the axiom ‘do not put all your eggs into one basket’ rings a bell!

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[1] http://en.wikipedia.org/wiki/Empirical_method

[2] Uma Sekaran (2003), Research Methods For Business – A Skill-Building Approach, John Wiley & Sons, Inc., 4^th Ed, pg. 254.

[3] Techniques such as word associations, sentence completion, thematic apperception tests (TAT), inkblot tests, and the like.

[4] Malik Bennabi (2004), The Qur’anic Phenomenon – An Essay of a Theory on the Qur’an, Islamic Book Trust, pg. xxi.

[5] This point was stated in the earlier assignment on Muslim Contribution to Scientific Research – A Renaissance.

[6] Uma Sekaran (2003), Research Methods For Business – A Skill-Building Approach, John Wiley & Sons, Inc., 4^th Ed, pg. 253.