Title
Author(s)
Islamic finance & maritime trade: economic, legal and regulatory
challenges
Zul Kepli, Mohd Yazid Bin.
Citation
Issued Date
URL
Rights
2012
http://hdl.handle.net/10722/188284
The author retains all proprietary rights, (such as patent rights)
and the right to use in future works.
Abstract of thesis entitled
“Shipping, Maritime Trade& Islamic Finance:
Economic, Legal and Regulatory Challenges”
Submitted by
Zul Kepli Mohd Yazid Bin
for the degree of Doctor of Philosophy
at The University of Hong Kong
in January 2013
Rapid development and commercialization within the emerging field of Islamic finance are
strong evidence of its sustainability. The Islamic finance industry has experienced remarkable
growth, more than US$1 trillion in just 40 years.This consistent growth and the industry’s proven
ability to safely navigate global recession and financial crisis while still coming up with
innovative products indicate its resilience and competitive edge. Its gradual adoption into the
financial portfolios of important financial centres including London, Singapore and Hong Kong
is further evidence of its promising future. While numerous studies on Islamic banking, finance
and insurance are now available, there has been very little systematic research on this industry’s
actual and possible implicationsin maritime trade and commerce. This research aims to fill those
gaps.
The feasibility of applying Islamic principles to maritime trade is the main theme of this
research, which argues that the reduction or removal of unnecessary uncertainties and harmful
risks as required under Islamis necessary to strengthen global maritime trade. Islamic principles,
as seen in various Islamic financial products applicable to modern maritime trade, will be
relevant in strengthening global trade. This is due to, among other things, Islam’s prohibition
from dealing with transactions tainted by excessive speculations in addition to the fairer
allocation of risks that it required. However, to truly benefit global trade it is proposed here that
Islamic financial products must consist of more than merely cosmetic changes to conventional
products;their essence must also be different.
Global trade can be very volatile, particularly in periods of recession and financial crisis.
Instead of wealth with real trade based on productivity, partnership and risk sharing, an
increasing number of people are simply conducting speculative activities based on zero-sum risktransfer and the speculative activities of others. Rather than reducing risk, interested parties are
making profits by increasing risk through a variety of speculative and risky transactions. This
unprecedented increase in speculative activities in maritime trade, from derivative products to
shipbuilding, is a dangerous scenario if left unmonitored. This research proposes that the legal
and regulatory framework governing maritime trade could be improved by incorporating some
Islamic principles. The legal and regulatory framework governing Islamic finance is also
analyzed here.
The development of Islamic finance in Southeast Asia is also covered, together with a
comparative study of the maritime trade sector in Malaysia, Singapore and Hong Kong as
background to show potential. This thesis proposes that a conducive legal and economic
environment is fundamental for maritime nations.
___________________________________________________________
An abstract of exactly 409 words
SHIPPING, MARITIME TRADE& ISLAMIC FINANCE:
ECONOMIC, LEGAL AND REGULATORY CHALLENGES
by
Zul Kepli Mohd Yazid Bin
LL.B. IIUM; MCL. IIUM; DSLP. IIUM
A thesis submitted in partial fulfillment of the requirements for
the Degree of Doctor of Philosophy
at The University of Hong Kong
January 2013
Epigraph
“O you who have believed, do not consume one another's wealth unjustly but only [in
lawful] business by mutual consent. And do not kill yourselves [or one another].
Indeed, Allah is to you ever Merciful”
(Qur’an 4:29)
i
Declaration
I declare that this thesis and the research work thereof represents my own work,
except where due acknowledgement is made, and it has not been previously included
in a thesis, dissertation or report submitted to this University or to any other
institution for a degree, diploma or other qualifications.
Signed
…………………………………………………………………
Zul Kepli Mohd Yazid Bin
ii
Acknowledgements
Praise is due to God, the Most Gracious and Most Merciful. Peace and Prayers be
upon all His Messengers. I express my deepest gratitude and sincere appreciation to
the University of Hong Kong for the invitation to come and undertake doctoral studies,
and for providing the atmosphere, research support and financial means (a
postgraduate studentship) to make it a worthwhile and memorable experience.
There is no doubt that I will be forever grateful to my adviser. The Faculty of Law,
especially my adviser, Dr. F.W.H. Chan have been very supportive, and his valuable
advice, supervision and encouragements are highly appreciated. His large pool of
knowledge, and his humality have been a great source of inspiration to me during
these years.
I must also thank those members of my oral examination committee who patiently
read the entire original work (initially around 200,000 words), made critical and
insightful comments, asked constructive questions and engaged me in positive legal
argument: Chairman Professor Say Goo, Dr. Zhao Yun, Mr.Richard Holt of the
University of Hong Kong; and Professor Asmadi Mohamed Naim of Universiti Utara
Malaysia. I am truly honoured to be in their good company.
This dissertation would not have been possible without the love and guidance
from my father, Dr. Zul Kepli Mohd Desa and my beloved mother, Zawiah Ismail. As
for individual, the list too long. Imust however thank the following people who have
assisted and critically commented on sections of this research. Their kind assistance
and insights are much appreciated. Any errors that remain are, of course, my own:
•
•
•
Dr Richard Wu, The University of Hong Kong
Dr. Mike Poole, Armstrong-Hilton Editing
Prof. Dr. Nor Faridah, Kuliyyah of Islamic Revealed Knowledge, International
Islamic University
•
Professor Dr. Norhashimah Mohd. Yasin, International Islamic University
Malaysia
•
Professor Dr. Abdul Ghafur Hamid @ Khin Maung Sein, International Islamic
University Malaysia
Special thank to the librarians, colleagues and friends for being there when it matters.
iii
Contents
CHAPTER 1: Introduction
CHAPTER 2: Maritime trade in Southeast Asia
CHAPTER 3: Maritime trade: Activities, transactions, risk management and legal
framework
CHAPTER 4: Islamic finance and prohibited elements in transactions (with special
focus to southeast Asia)
CHAPTER 5: Conformity of maritime trade to Islamic principles
CHAPTER 6: Risk management practices in maritime trade and Islamic finance
CHAPTER 7: Conclusion
iv
Contents
Epigraph ………………………………………………………….…………
Declaration …………………………………………………………………….……
Acknowledgements …………………………………………………………………
Contents ……………………………………………………………………………..
List of Tables ………………………………………………………………………..
List of Cases …………………………………………………………………………
Abbreviations ………………………………………………………………………..
Glossary ……………………………………………………………………………..
i
ii
iii
iv
ix
x
xvi
xix
CHAPTER 1: INTRODUCTION…………………………….……….….
1.0 Background …………………………………………………….…
1.1 Preliminary review of literature& Research gap ……………….
1.2 Research questionsand Problems statement ………………....….. 10
1.3 Limitation of research …………………………………...………..
1.4 Hypothesis………….…………………………………...….…….
1.5 Significant of research ……………………………………………
1.6 Research Methodology …………………………….…………..…
1
1
4
10
11
11
12
CHAPTER 2: MARITIME TRADE IN SOUTHEAST ASIA ………..…
2.0 Introduction ……………………………………………………..…
2.1 Maritime history and Islamic finance ……………………….……
2.1.1
Ancient times (until the 7th century) ……………….…..
2.1.2
Age of Navigation (7th century to 13th century) …….…
2.1.3
Age of Discovery (15th century to 17th century) …….…
2.1.4
Age of Sail (the 17th century to the mid of19th century) .
2.1.5
Modern era (mid 19th century onward) …………………
2.2 Maritime trade in Southeast Asia ……………………….……….…
2.2.1
Maritime trade in Singapore …………………………….
2.2.2
Maritime trade in Hong Kong …………………………...
2.2.3
Maritime trade in Malaysia ………………………….…..
2.3 Conclusion ………………………………………………………….
14
14
15
17
19
25
30
32
34
37
46
51
65
v
CHAPTER 3: MARITIME TRADE: ACTIVITIES, TRANSACTIONS,
MANAGEMENT AND LEGAL FRAMEWORK
3.0 Activities, transactions and risk management ……………….……..
3.1 Legal framework regulating maritime trade ……………………….
3.2 Conclusion ………………………………………………………….
RISK
67
77
79
CHAPTER 4: ISLAMIC FINANCE AND PROHIBITED ELEMENTS IN
TRANSACTIONS (WITH SPECIAL FOCUS TO SOUTHEAST ASIA)
4.0 Introduction to Islamic finance …………………………………….. 80
4.1 Development of Islamic finance ……………………………………84
4.2 Sources of Islamic principles and law ……………………………... 86
4.3 Secondary sources …………………………………………………. 88
4.4 Modern Islamic finance and its benefit …………………………… 91
4.5 Encouraged elements in Islamic finance ………………………….. 101
4.6 Prohibited elements in Islamic finance …………………………… 101
4.7 The doctrine of gharar……………………………………………. 102
4.7.1
Introduction to the doctrine of gharar……………….…104
4.7.2
Gharar in Qur’an………………………………..………. 106
4.7.3
Gharar in Hadith ……………………………………….. 109
4.7.4
Scholarly Views on gharar ……………….….………… 114
4.8 Classification of gharar……………………………….….……...…118
4.9 The benefits and advantages of Islamic finance ………………...… 121
4.10 Regulation and standardization …………………………………… 133
4.11 Islamic finance in Southeast Asia ………………………………… 136
4.11.1
Malaysia ………………………………………………... 139
4.11.2
Indonesia ……………………………………………..…145
4.11.3
Brunei …………………………………………………... 155
4.11.4
Singapore ……………………………………………….. 160
4.11.5
Hong Kong ……………………………………………... 169
4.11.6
Thailand ……………………….…………………........... 190
4.11.7
Philippines
…………………………………………... 195
4.12 Conclusion ………………………………………………………… 204
CHAPTER 5: COMFORMITY OF MARITIME TRADE TO ISLAMIC
PRINCIPLES
5.0 Islamic principles and maritime trade ……………………………
206
5.1 Applicability of Islamic financial products to maritime trade …. 210
5.2 Benefits and challenges of Islamic financial products ……...…
216
vi
5.3 The effects of global recession and financial crisis on
maritime trade ………………………………………………
5.4 Reasons behind financial crisis ……………………………..
5.5 Maritime trade and international monetary system …………
5.6 Conclusion ………………………………………………..…
217
218
222
233
CHAPTER 6: RISK MANAGEMENT PRACTICES IN MARITIME TRADE
AND ISLAMIC FINANCE
MANAGING RISK IN MARITIME TRADE
6.0 Introduction to risk management……………………………
236
6.1 Classification of maritime trade risk ……………………….
238
6.1.1
Price risk …………………………………………
239
6.1.2
Credit risk ………………………………………..
250
6.1.3
Pure risk ………………………………………….
254
6.1.4
Legal risk ………………………………………...
256
6.2 Limitation of insurance ……………………………………..
273
6.3 Limitation of derivatives ……………………………………
276
6.4 Risk management in Islam …………………………………
280
6.4.1
Authorities ……………………………………….
283
6.4.2
Benefits of Islamic risk management ………...…
286
6.4.3
Legal framework governing Islamic risk management
288
6.4.4
Objections and suggestions from Islamic scholars
291
6.4.5
Avoiding harm ……………………………………
293
6.5 Derivative in Islam …………………………………………
296
6.6 Insurance in Islam ……………………………………...……
300
6.7 The way forward …………………………………………...
304
6.8 Summary…………………………………………………..…
305
MANAGING LEGAL RISK IN ISLAMIC FINANCE
6.9 Managing risk in Islamic finance …………………………
308
6.10 Importance of proper legal and regulatory framework for
Islamic finance ……………………………………………..
318
6.11 Types of legal and regulatory framework on Islamic finance
331
6.11.1
Fully-Islamic …………………………….………
332
6.11.2
Dual system ………………………………………
336
6.11.3
Neutral ……………………………………………
340
6.12 Analysis of cases on Islamic finance ………………………
342
6.13 Possible improvements to the legal and regulatory framework
389
6.14 Conclusion …………………………………………………
399
vii
CHAPTER 7: CONCLUSION
……………………………………
403
References……………………………………………………………..
412
viii
List of Tables
Table 1
Table 2
Table 3
Table 4
Table 5
Table 6
Table 7
Table 8
Table 9
Table 10
Table 11
:
:
:
:
:
:
:
:
:
:
:
Growth of Modern Islamic finance
Shariah-compliant financial assets by country
Differences between Islamic finance and conventional finance
Total asset under management
Development of Islamic finance in Malaysia
Development of Islamic finance in Indonesia
Development of Islamic finance in Brunei
Development of Islamic Finance in Thailand
Corporate losses from derivatives trading
Cases on Islamic finance in Malaysia
Cases on Islamic finance in United Kingdom
ix
List of Cases
Affin Bank Bhd v Zulkifli bin Abdullah [2006] 3 MLJ 67
Al Rajhi Banking & Investment Corp (M) Bhd v Hapsah Food Industries Sdn Bhd &
Ors and another action [2012] 1 MLJ 115
Alfred C Toepfer Schiffahrtsgesellschaft mbH v Tossa Marine Co Ltd (The Derby)
[1985] 2 Lloyd’s Rep. 325
Ananda Non-Ferrous Metals v China resources Metal and Minerals Co Ltd [1993] 2
HKLR (affirmed [1994] 1 HKC 204, Court of Appeal
Apex Tech Investment Ltd v Chuang’s Development (China) Ltd [1996] 2 HKC 293
Arab-Malaysia Merchant Bank Bhd v Foreswood Industries Sdn Bhd & 4 others
[2007] MLJU 664 / [2007] 1 LNS 539
Arab-Malaysian Merchant Bank Bhd v Silver Concept Sdn Bhd [2010] 3 MLJ 702
Arab-Malaysian Merchant Bank Bhd v Silver Concept Sdn Bhd [2008] 6 MLJ 295
Arab-Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Ors (Koperasi Seri
Kota Bukit Cheraka Bhd, third party) [2008] 5 MLJ 631
Asfar & Co v Blundell [1896] 1 QB 123
Astel-Peiniger Joint Venture v Argas Engineering & Heavy Industries Co Ltd [1994]
3 HKC 328
Attorney-General of Ceylon v Scindia Steam Navigation Co Ltd [1962] AC 60 (PC)
Bank Islam Malaysia Berhad v Adnan Bin Omar [1994] 3 CLJ 735 / [1994] MLJU
221
Bank Islam Malaysia Bhd v Azhar bin Osman and other cases [2010] 9 MLJ 192
x
Bank Islam Malaysia Bhd v. Lim Kok Hoe & Anor and Other appeals [2009] 6 CLJ
22
Bank Islam Malaysia Berhad v Pasaraya Peladang Sdn Bhd [2004] 7 MLJ 355
Bank Islam Malaysia Bhd v Shamsudin Bin Hj Ahmad [1999] 1 LNS 275 / [1999]
MLJU 450
Bank Kerjasama Rakyat Malaysia Bhd v Emcee Corporation Sdn Bhd [2003] 2 MLJ
408
Bank Kerjasama Rakyat Malaysia Bhd v Nesaretnam Samyveloo [2002] 8 CLJ 95 /
[2002] 7 MLJ 103
Bank Kerjasama Rakyat Malaysia Bhd v PSC Naval Dockyard Sdn Bhd [2008] 1 CLJ
784 / [2007] MLJU 722
Bank Kerjasama Rakyat Malaysia Bhd v Sea Oil Mill (1979) Sdn Bhd & Anor [2010]
2 MLJ 740
Bank Muamalat Malaysia Bhd v Suhaimi Bin Md Hashin & Anor [2007] 1 MLJ 275 /
[2006] 7 CLJ 321
Brown Jenkinson & Co Ltd v Percy Dalton (London) Ltd [1957] 2 QB 621
Canstrand Industries Ltd. v. Ship Lara S [1993] 2 F.C. 553
Castellain v Preston (1883) 11 QBD
Coggs v Bernard [1703] 2 Ld Raym 909
Dato’ Hj Nik Mahmud Daud v Bank Islam Malaysia Bhd [1998] 3 CLJ 605
Dudgeon v Pembroke [1877] 2 App Cas 284
Effort Shipping Co Ltd v Linden Management SA (The Giannis NK) [1998] AC 605
Emmott v Micheal Wilson & Partners [2008] 1 Lyoyds’ Rep.616
xi
Fadzillah Ahmadi Bin Alii v Mayban Finance Berhad [2007] MLJU 663/ [2007] 1
LNS 536
Fiona Trust v Privalov [2007] UKHL 40
G H Renton & Co Ltd v Palmyra Trading Corp of Panama [1957] AC 149
Gay Constructions Pty Ltd v Caledonian Techmore (Building) Ltd Hanison
Construction Co Ltd, Third Party) [1995] 2 HKLR 35
Glencore International AG v Metro Trading International Inc [2001] 1 Lloyd’s Rep
284
Glynn v Margetson & Co [1893] AC 351
Gumm v Tyrie [1864] 4 B & S 680
The Glenfruin [1885] 10 PD 103
Havelock v Geddes [1809] 10 East 555
Hebei Import & Export Corp v Polytex Engineering Co Ltd [1999] 1 HKLRD 665
Henry Smith & Co v Bedouin Steam Navigation Co Ltd [1896] AC 70, 70
Hong Kong Fir Shipping v Kawasaki Kisen Kaisha [1962] 2 QB 26
Islamic Investment Company of the Gulf (Bahamas) Ltd v Symphony Gems and others
[2002] WL 346969
J I MacWilliam Company Inc (Respondents) v. Mediterranean Shipping Company SA
(Appellants) [2005] UKHL 11; [2005] 2 AC 423
J J Agro Industries (P) Ltd v Texuna International Ltd [1992] 2 HKLR 391
Joyce v Realm Marine Insurance Co [1872] LR 7 QB 580
Kailey Engineering Co Ltd v Farrance [1999] 2 HKC 765
xii
Kruger Inc. v. Baltic Shipping Co [1989] 57 D.L.R. (4th) 498
Levison v Patent Carpet Cleaning Co.Ltd [1977] 3 All E.R. 498
Light Style Sdn Bhd v KFH Ijarah House (Malaysia) Sdn Bhd [2009] CLJ 370 /
[2009] 1 LNS 193
Lyon v Mells [1805] 1 KB 697
Majlis Amanah Rakyat v Bass Bin Lai [2009] 2 CLJ 433
Malayan Banking Bhd v Marilyn Ho Siok Lin [2006] 7 MLJ 249
Malayan Banking Bhd v Ya’kup bin Oje & Anor [2007] 6 MLJ 389
Malayan Banking Berhad v Zainal Abidin Abdullah & Anor [2008] MLJU 180
McFadden v Blue Star Line [1905] 1 KB 697
Mohd Alias bin Ibrahim v RHB Bank Bhd & Anor [2011] 3 MLJ 26
Multi-Code Electronics Industries (M) Bhd and Another v. Toh Chun Toh Gordon
and Others [2009] 1 SLR 1000
Oriental Bank Berhad v Gandingan Ilmu Sdn Bhd & Ors [2003] MLJU 485
P.T. Asuransi Jasa Indonesia (Persero) v. Dexia Bank S.A. [2007] 1 S.L.R. 597
PT Dover Chemical Company v Lee Chang Tung Chemical Industries Corporation
[1990] 2 HKLR 257
Paklito Investment Ltd v Klockner East Asia Ltd [1993] 2 HKLR 3
Petroleum Dev. (Trucial Coast) Ltd. V Sheikh of Abu Dhabi, Int’l & Comp. [1952]
L.Q. 247
Robertson v French (1803) 4 East 130
xiii
Ruler of Qatar v International Marine Oil Co [1957] ILR 534,545
Saudi Arabia v Arab American Oil Co. (ARAMCO) (1956) 27 I.L.R. 117
Sea Oil Mill (1979) Sdn Bhd & Anor v Bank Kerjasama Rakyat Malaysia Bhd [2009]
3 MLJ 237
Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd and Others [2004] 4 All
ER 1072
SNIA v Suzuki (1924) 29 Com Cas 284
Soh Beng Tee v. Fairmount Development Pte.Ltd. [2007] 3 S.L.R. 86
Southern Bank Bhd v Ayer Keroh Park Sdn Bhd [2005] 6 CLJ 134 / [2005] 4 AMR
597
Steel v State Line; Dobell v Steamship Rossmore Co [1905] 2 QB 408
Tahan Steel Corp Sdn Bhd v Bank Islam Malaysia Bhd [2004] 6 MLJ 1
Tan Sri Abdul Khalid bin Ibrahim v Bank Islam Malaysia Bhd and another suit
[2009] 6 MLJ 416
The Caspian Sea [1980] 1 Lloyd’s Rep 91
The Gundulic [1981] 2 Lloyd’s Rep 511
The Irbenskiy Proliv [2005] 1 Lloyd’s Rep 383
The Kamsar Voyager [2002] 2 Lloyd’s Rep 57
The Kriti Rex [1996] 2 Lloyd’s Rep 373
The Lady Muriel [1995] 2 HKC 320
The Makedonia [1962] P 190
xiv
The Investment Dar Company KSCC and BLOM Developments Bank Sal [2009]
EWHC 3545 (Ch)
The Isla Fernandina [2000] 2 Lloyd’s Rep 15
The Vortigern [1899] P 140
Tinta Press Sdn Bhd v Bank Islam Malaysia Bhd [1987] 2 MLJ 192
Vinmar v Theresa [2001] 2 Lloyd’s Rep 1
Voss Peer v APL Co Pte Ltd [2002] 3 SLR 176
Zambia Steel and Building Supplies Ltd v James Clark & Eaton Ltd [1986] 2 Lloyd’s
Rep 225
xv
Abbreviations
AAOIFI
ADR
ASF
AIBIM
BIBF
BIMB
BIMCO
BNM
BOLERO
c.i.f.
CIM
CISG
CMI
COGSA
Congenbill
CTO
COLRAGS
dwt
ECR
EDB
EDI
ESS
f.a.s.
FCA
f.o.b.
f.i.o.
GATT
GDP
HDB
HKSAR
I-SIE
IAIE
IAMSAR
Accounting and Auditing Organization for Islamic Financial
Institutions
Alternative Dispute Resolution
Asian Shipowners Forum
Association of Islamic Banking Institutions Malaysia
Bahrain Institute of Banking and Finance
Bank Islam Malaysia Berhad
The Baltic and International Maritime Council
Bank Negara Malaysia (Central Bank of Malaysia)
Bill of Lading Electronic Registry Organization
cost, insurance, freight
International Convention on Carriage of Goods By Rail
The Vienna Convention on the International Sale of Goods 1980
Comité Maritime International
Carriage of Goods by Sea Act
charterparty bill of lading
combined transport operator
International Regulations for Preventing Collisions at Sea 1972
E-Commerce Electronic commerce
deadweight tonnage
Export Credit Refinancing
Economic Development Board
electronic data interchange
Electronic Shipping Solutions
free alongside ship
free contaioner load
free on board
free in and out
General Agreement on Tariffs and Trade
gross domestic product
Housing and Development Board
Hong Kong Special Administrative Region
Islamic Society for Institutional Economics
International Association of Islamic Economics
International Aeronautical and Maritime Search and Rescue
Convention
xvi
IBFIM
Islamic Banking and finance Institute Malaysia
IBF NET
Islamic Banking and Financial Network
ICAC
Independent Commission Against Corruption
ICC
International Chamber of Commerce
ICCS
Islamic Cross Currency Swap
ICD
Islamic Cooperation for the development of the Private Sector
ICS
International Chamber of Shipping
IMB
International Maritime Bureau
IMO
International Maritime Organisation
INCOTERMS International Commercial Terms
ISF
International Shipping Federation
ISO
International Organization for Standardization
IIBI
Institute of Islamic Banking and Insurance
IFSB
Islamic Financial Service Board
INCEIF
International Central for Education in Islamic Finance
INID
Islamic Negotiable Instruments of Deposits
IPRS
Islamic Profit rate Swap
IRTI
Islamic Research and Training Institute
JAFZA
Jebel Ali Free Zone Authority
LCL
less than container load
LIBOR
London Inter-bank Offered Rate
MARPOL
International Convention for the Prevention of Pollution from Ships
MAS
Monetary Authority of Singapore
MTO
multimodal transport operator
NIDC
Negotiable Islamic Debt Certificate
NGOs
Non-governmental organizations
NPOs
Non-profit organizations
NYPE
New York Produce Exchange
P and I Clubs Protection and Indemnity Clubs
PKFZ
Port Klang Free Zone
PRC
People Republic of China
OIC
Organization of Islamic Cooperation
OPEC
Organization of Petroleum Exporting Countries
SDR
special drawing right
STC
said to contain
SOLAS
Safety of Life at Sea Convention
STCW
International Convention on Standards of Training, Certification and
Watchkeeping for Seafarers
xvii
TEU
UCP
UN
UNCITRAL
UNCLOS
UNCTAD
twenty-foot equivalent unit
Uniform Customs and Practice of Documentary Credits
United Nations
United Nations Commission on International Trade Law
United Nations Convention on the Law of Sea
United Nations Conference on Trade and Development
xviii
Glossary
Ahliyah:
Legal capacity.
Al-Rahn:
A pawn broking contractthatis Shariah-compliant.
Allah:
An Arabic word that literally means ‘God’. Allah is one of the many names of the
Muslim God, all of which refer to only one God. The word Allah is derived from the
word ilah, which means ‘the One deserving all worship’. Muslims (followers of the
monotheistic religion, Islam) believe that Allah is the same God that revealed the
Holy books to the prophet Moses, known in the Arabic language as Prophet Musa,
and to Jesus, known in Islam as Prophet Isa. Muslims believe that all of the prophets,
from the first prophet, Prophet Adam, to the last Prophet, Prophet Muhammad, are
messengers of the same God.
Amanah:
Trustworthiness, honesty, loyalty.
Amin:
An Arabic word that means ‘trustee’, ‘custodian’ or ‘the Trustworthy One’. This is
also one of the titles given to Prophet Muhammad by his community before his claim
of prophethood due to his honesty as a trader and as a person.
Aqd/Aqad:
Agreement/contract.
Aqidah:
Refers to faith and belief.
Arbitration:
A form of quasi-judicial dispute resolution in which a conflict or dispute is settled
outside court litigation using a neutral third party known as an arbitrator or arbitral
tribunal. The decision of the arbitrator or arbitral tribunal is binding upon the parties.
xix
Alternative Disputes Resolution (ADR):
All dispute resolution processeswith the exception of court litigation and arbitration.
Some literatures include arbitration as a type of ADR while many omit it due to its
various heavy similarities to litigation. The term ADR in this research includes
arbitration.
Ayat:
A verse of the Holy Qur’an, literally ‘a sign’.
Ayn:
Tangible goods or property with physical form.
Baitulmal:
The treasury of the Islamic state. In the past, everyone in the Muslim state was
required to pay zakat or taxes to the Baitulmal if they fulfilled the conditions. The
money is typically used to assist the poor and fund the activities of the state.
Bay:
Arab term for ‘sells’.
Bay al-Dayn:
Al-Dayn literally means ‘debt’, specificallythe sale of debt or debt trading. It can refer
to debt financing within which its existence is based on trade documents. For example,
John owes US$100 to Jimmy and the amount is to be repaid next year. Jimmy sells
the right to claim the debt to Adam at the price of US$80. Jimmy gets the cash now
and Adam collects a benefit of US$20 when he claims the US$100 from John. The
majority of scholars in the Middle East consider the trading of debt to be forbidden in
Islam unless certain rules are strictly followed. The restriction is due to their extension
of the principles and prohibitions governing money, particularly the prohibition of
usury. In contrast, scholars in a country such as Malaysia take a more flexible view
and consider debt trading to be permissible, especially if the debt originated in an
asset finance transaction. Therefore, financial products using this technique are not
extended to the Middle East due to that area’s scholarly view.
Bay al-Dayn bi Dayn:
The sale or exchange of a debt for another debt.
xx
Baligh:
Maturity, specificallya person who has attained puberty.
Batil:
Nullity/void.
Bay al-Inah:
Sale and buy back agreement. A ‘sale’ contract that imitates the sale and repurchase
process between two contracting parties. For example, the seller sells the asset with
credit and then repurchases it with cash at a lower price compared to the original
selling price. Many scholars believe that this is a legal trick to circumvent the
prohibition of usury. Some scholars, including those from the Shafi’is (and Zahiris)
schools, maintain that although this transaction is highly discouraged, it is valid
because it looks like a sale and purchase transaction. Other schools, including the
Mālikī and Hanbali,hold that this transaction is invalid and is merely usury in disguise.
The Malaysian Shariah Advisory Council, at its fifth meeting on 29 January 1997,
passed a resolution on the permissibility of bai` `inah in the Islamic capital market in
Malaysia. Generally, scholars are not in consensus on this controversia; agreement.
Bai Muajjal:
A sale based on deferred payment. Scholars unanimously agree that it is valid.
Bay al-Muhaqalah:
The sale or exchange of seed-produce, eg still in the ear, for grains of wheat. Basically,
muhaqalahis the selling of a crop when it is still in the spikes, an exchange that is not
allowed under Shariah if it involves major gharar.
Bay al-Mukhadarah:
The sale of fruit, grains or vegetables that are not yet ready. This type of sale is
forbidden if the contract contains uncertainty that can lead to injustice. For example,
if a seller tries to sell a tree’s future fruit to a purchaserfor US$100 and the fruit
proves bad or defective, it will cause injustice. In contrast, the circumstances are
different if the contract is valid. For example, if the seller agrees to sell good quality
apples to the purchaser for US$100 in one month and the amount, delivery date and
quality are specified, then the contract is valid. This is not to be confused with
al-mukhabarah; an agreement to lease land on rent for cultivation. The parties agreed
in advance to share the outcome/produce in fixed rations.
Bay al-Mulamasah:
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A contract of sale that is concluded by mere touch without the right or option to annul
after inspecting or seeing the merchandise. This contract is prohibited in Islam
because it can cause injustice. This type of contract is common these days in the sale
of expensive handbags or accessories whereby the purchaser is obliged to purchase
the product if they touch it. A similar concept can be extended to expensive clothes
whereby the customer is given no option to check or inspect the quality or the
merchandise, but is required to purchase it as the result of having merely touched it.
This can cause animosity and is prohibited in Islam.
Bay al-Muwafah:
The sale of goods that are not yet in the seller’s possession. This is prohibited because
it can cause injustice.
Bay al-Salam:
A future sale contract whereby the price of the goods is paid in advance but the
delivery of the goods will be made in the future. This type of sale contract is allowed
under Islam provided that the element of excessive uncertainty is removed. The
characteristics of the goods must not be vague; they must be fully defined and the date
of delivery must be fixed. There must be no elements of gambling or injustice.
Bay al-Urbun:
A sale with advanced payment or down payment. Under this contract, the down
payment or deposit will be forfeited if the purchaser refuses to purchase.
Bay al-Muzayadah:
It is, essentially, an auction and is also known as bai` fuqara’, bai` man kasadat
bidha`atuhu, bai` mahawijand bai` mafalis.
Bai Bithaman Ajil (BBA):
A sale with deferred payment.
Bulk carrier:
A single-deck ship that carries dry cargo such as coal, sugar, ore or cereals.
Charterer:
A person or company that hires a ship from a shipowner. This can be for a period of
time (time charter) or for a single voyage (voyage charter).
xxii
Credit default swap:
An instrument that permits an investor to hedge against (or speculate on) the
possibility of credit default.
Darurah:
Literally means ‘emergency’ or ‘necessity’. The basic concept in Islam is that even
things that are generally prohibited are allowed in emergency situations. For example,
a transaction tainted by excessive gharar is generally prohibited, but is allowed when
it cannot be avoided and the subject matter is important. Eating pork is generally
prohibited for Muslims, but would be allowed in the extremely rare event that there is
no other food to eat and its consumption is necessary to avoid starvation.
Dinar:
The currency of several modern countries. Its history is rooted in the Byzantine’s gold
currency, denarius auri. Of late, the Islamic gold dinar has been revived as a bullion
gold coin, eg as is used in the state of Kelantan in Malaysia.
Fadl (riba’):
A form of usury in Islam. This refers to the act of taking something of a superior
quality in exchange for the same kind of thing of poorer quality without first
converting it to money.
Faqih:
An Islamic scholar or jurist; a person who can provide an authoritative legal opinion.
Fatwa:
A religious decree/legal verdict.
Fiqh:
Islamic/Muslim jurisprudence; it includes all aspects of life including religious, social,
economic and political. Fiqh is based primarily on the Qur’an and the Sunnah, and
secondarily on ijma’ and ijtihad.
Freight rate:
The amount of money paid to the shipping line or shipowner for the carriage of goods
between named ports.
Gharar:
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An Arabic word derived from a root word that literally means ‘risk’, ‘deceive’,
‘uncertainty’ or ‘deception’. A gharar contract also involves a contract in which one
or more parties are ignorant of some essential and important element of the
transaction, eg contract terms such as the exact amount or condition of the subject
matter, delivery, existence or where the contract is tainted by gross uncertainty. While
minor, small or unavoidable uncertainty is allowed, a major and fundamental
uncertainty in a contract can breach the prohibition of gharar in Islam and make the
contract void or voidable.
Hadith:
The narrative record of the sayings and actions (including inaction and implicit
approval or disapproval) of Prophet Muhammad.
Hague Rules:
An important set of international rules governing the carriage of goods. One of the
ideas behind the Hague Rules is to establish a minimum mandatory carrier liability.
Hague-Visby Rules:
An important set of international rules governing the carriage of goods. One of the
principles of the Hague-Visby Rules (and of the earlier English Common Law) is that
a carrier has better bargaining power and, accordingly, the law should require only
minimum obligations for the carrier. Matters regulated by the Hague-Visby Rules
include definition of contract of carriage; geographical scope of application;
exclusions from the scope of application; period of application and period of
responsibility of the carrier; obligations of the carrier; liability of the carrier and
allocation of the burden of proof; liability of the carrier for other persons; liability of
servants; agents and independent contractors; notice of loss, damage or delay;
obligations and liability of the shipper; contract documents; limitation of liability;
time for suit and freedom of contract.
Halal:
Something that is permissible or permitted under Islam. For example, halal food is
food that is acceptable for Muslims to eat. Consuming pork is not halal, but eating
vegetables is halal. Accepting bribery is also not halal, but profit from legal business
is halal.
xxiv
Hanbalis:
One of the four main schools of thought within Islam. Hanbalis are followers of Imam
Ahmad bin Hambal. The Hanbali school of thought is mainly prevalent in Saudi
Arabia and is considered by many to be very strict and conservative. Famous Hanbali
scholars include Al-Hasan ibn 'Ali al-Barbahari, Ibn Aqil, Abdul-Qadir Gilani,
Abu-al-Faraj Ibn Al-Jawzi, Hammad al-Harrani, Abd al-Ghani al-Maqdisi, Ibn
Qudamah, Taqi al-Din Ibn Taymiyah, Ibn al-Qayyim, Ibn Rajab, Muhammad ibn
Abd-al-Wahhab, Ibn Humaid, Ibn al-Uthaymeen and Ibn Baz.
Hamburg Rules:
An important set of international rules governing the carriage of goods. New matters
regulated by the Hamburg Rules include deck cargo, live animals, the obligations and
liability of the actual carrier/maritime performing parties, jurisdiction and arbitration.
Hanafis:
Followers of Imam Abu Hanifah. Imam Abu Hanifa’s full name was Nu’mān ibn
Thābit ibn Zutā ibn Marzubān. He was born in 699 and is the founder of one of the
four most well-known Sunni Muslims schools of thought. The Hanafi school is the
oldest and largest sect of the Muslim community. It is more liberal than the other
three schools. This is largely the result of its being adopted as the official madhab of
the Abbasid Caliphate and the last Muslim Empire, the Ottoman Empire.
Haram:
The opposite of halal. Haram is something that is prohibited under Islam. For
example, accepting bribery is haram.
Hawala
Endorsement; bill of exchange; promissory notes, cheque or draft. Hawala also refers
to a method of transferring money as an alternative remittance channel that operates
outside traditional banking systems. Hawalah is often misinterpreted as underground
banking, which is misleading because most operate legitimately and openly.
Hilah:
A legal trick or device. While the validity of hilah is sometimes upheld, eg because
the contract strongly imitatesa sale and purchase contract despite the knowledge that
the parties merely intend to create a loan or obtain financing, the reality is thathilah is
usually useless from a productive commercial perspective. Instead of attempting to
circumvent the prohibition of usury by hilah, it is better and more sustainable for the
xxv
parties to be involved in real trade and business using a just and fair risk allocation
system that includes partnership or other risk-sharing methods.
Ibahah:
Permissibility
Ijara:
An Arabic word that refers to the contract of leasing.
Ijma’
An Arabic term referring to the consensus or agreement of the Muslim community.
Ijtihad:
The effort of a qualified jurist to formulate a judgment or rule of law on matters in
which the revelation is not explicit.
Ikhtikar:
Literally ‘monopoly’. Unfair monopoliesare forbidden in Islam, although observance
and adherence by Muslims is not consistent.
Ikhtilaf:
A divergence of views among scholars.
Illah:
The reason or attribute behind a particular divine ruling in all cases where it exists.
The extension of a divine ruling to a new matter must use illah as the basis. For
example, drinking wine is prohibited in the Qur’an. The illah is because it is
intoxicating. Therefore, drinking beer is also prohibited because it shares the same
illah (intoxicating).
IMO:
The International Maritime Organization, the United Nations agency entrusted with
regulating maritime matters.
Islam:
A monotheistic religion based on the Qur’an, a text considered by its followers to be
the words of God and on the teachings and examples of Prophet Muhammad,
considered by his followers to be one of the Messengers of God. The essence of Islam
xxvi
is that there is only one God and Prophet Muhammad is His Messenger. There are six
articles of faith in Islam: (1) belief in the oneness of God, (2) belief in the angels of
God, (3) belief in the Holy Books, (4) belief in the Prophets of God, (5) belief in
Resurrection after Death and the Day of Judgment and (6) belief in destiny. There are
also five pillars of Islam: (1) the shahada (creed) or the voluntary admission that there
is no God except one (Allah), (2) performing daily prayers five times a day, (3)
fasting during the month of Ramadan, (4) paying almsgiving (zakāt)and (5)
undertaking the pilgrimage to Mecca (hajj) at least once in a lifetime for those able to
do so.
Islamic banking:
A banking system that meets the requirements of Islam, also called Islamic financial
services and Islamic finance.
Isnad:
The chain of transmission accompanying a tradition/hadith. A study on hadith
involves, among other things, a careful and critical examination of the chain of
transmission accompanying each hadith.
Istinbat:
To search out and draw on a hidden meaning or unknown ruling through the process
of ijtihad or legal reasoning, also known as istikhraj.
Istisna’:
An Arabic term that refers to a manufacturing contract in which the customer agrees
to purchase non-existent subject matter at a specified future date withthe subject
matter to be manufactured according to the agreement. The element of uncertainty
must be removed or minimized and the specification and delivery date should be
clear.
Jahl:
Lack of knowledge, ignorance or ambiguity in the terms of a contract.
Judaism:
A religion based on the teachings of Prophet Moses and the Holy Books, the Tanakh
and the Talmud. Judaism is one of the oldest monotheistic religions and the oldest to
survive the modern era. [NOTE: Muslims believe in the prophethood of Prophet
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Moses. Prophet Moses is mentioned numerous times in the Qur’an. For example, it is
stated in the Qur’an:
Also mention in the Book (the story of) Moses: for he was specially chosen, and he
was a messenger (and) a prophet. And we called him from the right side of Mount
(Sinai), and made him draw near to Us, for mystic (converse). And, out of Our Mercy,
We gave him his brother Aaron, (also) a prophet. (Qur’an 19: 51-53).
Khamr:
Wine made from the juice of grapes. Drinking intoxicating beverages is prohibited in
Islam. The Qur’an notes that there are benefits to drinking wine, but stresses that the
harms and dangers outweigh the benefits. Muslims are prohibited from drinking
khamr.
Mālikīyah:
Followers of Imam Malik that compose one of the four main Sunni schools of thought
in Islam.
Maiser:
The act of gambling, literally ‘getting something too easily’. Gambling is prohibited
in Islam, but taking real risks in trade is encouraged.
Makruh:
Something that is not encouraged, but is not directly prohibited under Islam. Doing
something that is makruh is not a sin, but choosing not to do it will be rewarded.
Mejelle:
Short for ‘Majallah el-Ahkam-i-Adilya’, it was the civil code of the Ottoman Empire,
elaborated between 1869 and 1876. It was the first attempt at the comprehensive
codification of Shariah-law to be used by an Islamic state. It was based on the
principles and teaching of the Hanafis school of thought.
Middle Ages:
A period in European history from around the fifthcentury to the fifteenth century. It
is usually considered to have begun during the fall of the Western Roman Empire in
476 and to have ended during the Age of Discovery in the early fifteenth century
when European ships traveled around the world in search of gold, silver and spices
via new trading routes.
xxviii
Mudharabah:
A contract whereby the capital provider provides the capital for the business while the
managing partner provides the expertise. Profits are shared according to partnership
agreement. In cases of loss, the capital provider usually suffers the monetary loss
while the managing partner suffers the loss of time and effort.
Murabaha;
The sale of specified goods with an agreed profit/mark up on the cost. For example,
assume a customer needs to purchase a building or asset valued at US$10 million. The
customer can enter into an arrangement with an Islamic financier so that the bank will
purchase the asset for the customer, provided that the customer agrees to purchase it
at a higher price from the bank. This type of transaction is the result ofIslam’s
prohibition of usury.
Musharakah/Musyarakah:
A contract of partnership with elements of profit and risk sharing.
Phoenicians:
The citizens of Phoenicia, an ancient civilization in Canaan that was a famous
maritime trade centre in the Mediterranean from 1550 BC to 300BC. The Phoenicians
were among the finest maritime traders of their time.
Qard Hassan:
Literally,‘good loan’. This is the only type of loan allowed in Islam. Under this
concept of a loan, the borrower is only obliged to repay the exact amount that they
borrow. However, it is highly encouraged that the borrower make their own decision
to repay more than the amount they borrowed, without it having been stipulated
earlier.
Qur’an:
Believed by Muslims to be the definitiveHoly Book, revealed to mankind by God
through Prophet Muhammad.
Renaissance:
An important cultural movement from the 14th to the 17th centuries that began in Italy
and later spread throughout the rest of Europe. During this period, the pursuit of
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knowledge in science, art, religion, literature and politics flourished and assisted in
the creation of a stronger Europe.
Rhodians:
The citizens of Rhodes, an island of Greece. The dominance of Rhodians and their
influence in ancient maritime trade was reflected in the Rhodian Sea Law, which was
accepted throughout the Mediterranean (and applied during the Byzantine era).
Riba’:
An Arabic word that refers to usury. The concept of usury in Islam differs from the
typical Western understanding of the term. Riba’ is not merelyan increase in the
repayment amount involvedin a loan transaction. The termriba’represents a
complicated concept that warrants a comprehensive elaboration, although the basic
features are easy to understand. Usually, riba’ happens when there is an exchange
involving one the six riba’ commodities and the exchange is not made in equal value
and at the same time. Silver and gold (and by analogy, currency) are the most
common forms of riba’. For example, a loan of US$100 that must be repaid at
US$200 at a later stage is riba’. The exchange of one bag of high quality dates for two
bags of low quality dates is also riba’. Instead of this type of exchange, it is better to
convert the values into money first to avoid uncertainty. For clarity, many scholars
believe that riba’ is not limited to the 6 commodities.
Risk:
The potential that a decision (including the choice of inaction) will lead to a loss (an
undesirable outcome). The term “risk” has numerous meanings.
Rolls of Oleron:
Believed by many to be the first formal statement of maritime law in northwestern
Europe. They were created in 1160.
Rotterdam Rules:
An important set of international rules governing the carriage of goods.New matters
regulated by the Rotterdam Rules include carriage beyond the sea leg, electronic
records, the obligations and liabilities of maritime performing parties, the delivery of
goods, the rights of the controlling party and the transfer of rights. Rotterdam Rules is
not yet in force.
Salam:
xxx
A future contract.
Shariah:
Islamic law. Shariah is derived from two primary sources of Islam, the Qur’an and
the Sunnah.
Shafi’i:
Imam Shafi’i. His full name was Abū Abdullāh Muhammad ibn Idrīs al-Shafiī and he
was born in 767. He was the founder of the Shafi’i school of thought, one of the four
most well-known Sunni schools of thought. He is also known as the founder of
Islamic jurisprudence due to his contribution to devising clear and systematic ways of
deducing rulingsand decisions in Islam. He authored more than a hundred books, but
the most famous are al-Risala, Kitab al-Umm and Musnad ash-Shafi’i.
Shia/Shi’i
The second largest denomination of Islam. An estimated 10 to 15 percent of Muslims
worldwide areShias, while those that remain are mostly Sunnis.
Sukuk:
An Islamic bond;Shariah-compliant financial certificates that share some similarity to
bonds.
Sunni:
The largest branch of Muslims. Sunni refers the Sunnah or tradition of Prophet
Muhammad. Therefore, the Sunni are the followers of the Sunnah of the Prophet.
Southeast Asia:
A region of Asia that is geographically located east of India, south of China, north of
Australia and west of New Guinea. Southeast Asiais composed of Brunei, Burma,
Cambodia, Christmas Island, East Timor, Hong Kong, Indonesia, Laos, Malaysia, the
Philippines, Singapore, Thailand, and Vietnam. The population is estimated to be
around 593 million.
Sulh:
The Arabic word for mediation, also used to refer to Islamic mediation.
Sultan:
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A title with several historical meaningsthat usually refers to the head of the state,
either the de facto ruler or one who is merely symbolic in nature.
Sunnah:
The tradition or way of Prophet Mohammed. It includes his sayings, deeds, actions,
approvals and disapprovals as preserved in the hadith literature. It is also the second
source of revelation after the Qur’an.
Tabarru’:
Literally,‘the act of charity’. This can mean a contract that provides someone with
good or service without compensation or a contract in which the parties agree to
mutually assist each other in a difficult time. Islamic insurance is mostly based on the
concept of tabarru’.
Tahkim:
The Arabic word for arbitration that is also used to refer to Islamic arbitration.
Ummah:
The Muslim community.
Urf:
Custom or common practice. In Islam, the customs of the Muslim people can be
observed and considered when making a ruling, as long as doing so does not
contradictthe tenets of Islam.
Usury:
A concept prohibited in Judaism, Christianity and Islam. The Holy Bible, Exodus
22:25 states: ‘If you lend money to one of my people among you who is needy, do not
be like a moneylender; charge him no interest.’ In Deuteronomy 23:19-20: ‘Do not
charge your brother interest, whether on money or food or anything else that may earn
interest.’ The concept of usury differs between Muslims and non-Muslims.
Non-Muslims usually define usury as the practice of charging excessive or illegal
interest rates on loans. However, the concept of usury in Islam is wider. Briefly, usury
in Islam can be defined as an exchange of any of the usurious commodities (wheat,
barley, silver, gold, dates and salt) that is not immediate and on an equal basis. This is
according to the word of Prophet Muhammad: ‘Gold is to be paid for by gold, silver
by silver, wheat by wheat, barley by barley, dates by dates, and salt by salt – like for
like, equal for equal, payment being made on the spot. If the species differ, sell as you
xxxii
wish provided that payment is made on the spot.’Scholars explain that gold and silver
refer to currency. Therefore, the ‘exchange’ of US$100 (cash) for US$200 (credit)
with the agreement that it will be returned in a year is considered usury in Islam. For
simplicity, giving a loan with the condition that the borrower must repay a higher sum
is always usury in Islam.
Wadiah:
Literally, ‘safe-keeping’. Wadiah usually refers to a contract whereby the money
deposited by the depositor is guaranteed fullrepayment.
Wajib:
Obligatory, compulsory or mandatory.
Wakala:
The contract of agency.
Wakala al mutlaqa:
The resale of goods with a discount. It can also refer to absolute power of attorney.
Wali:
Guardian.
Zahiri:
A school of thought in Islamic jurisprudence. Zahiri is one of the Sunni branches
thatadoptsa literal interpretation of the Qur’an and theSunnah. The school is named
after one of its jurists, Dawud ibn Khalaf al-Zahiri.
Zakat:
An obligatory contribution prescribed by Islam to all capable Muslims. If the criterion
is fulfilled, it is obligatory to pay zakat. If someone is poor, that person might become
the receiver of zakat instead.
xxxiii
CHAPTER 1
INTRODUCTION
1.0 Background
Recent years have witnessed a remarkable renewal of interest in Islamic finance. The
ideal of a trading and financing system that incorporates good ethics and morality has
made a spectacular return to the economic agenda of both developed and developing
countries. This can be seen in the dramatic rise in and acceptance of Islamic finance
on a global scale, from the United Kingdom to Hong Kong and Singapore.
It would be wrong to view the rise of Islamic finance as a phenomenon that is
limited to Muslims, because many of the experts, investors and customers of Islamic
finance are non-Muslims. Islamic finance is globally embraced partly due to its sound
financial principles, including the rejection of excessive speculative activities that are
harmful in nature, in addition to the rejection of unfair risk allocation in which the
risks are mostly shifted to the borrowers. This research argues that the application of
Islamic principles can strengthen global maritime trade.
Currently, global maritime trade is getting more volatile. According to
Kenneth Koo Chee-kong, the former Chairman of the Hong Kong Shipowners
Association:
Incredible as it may seem, these over-the-top changes in our shipping industry have
instead seemingly spawned a shipping market that has become a speculators’ heaven,
where literally every hedge fund, venture capital equity, tax shelter, shipping IPO and
the like came in and ordered new ships. 1
He elaborated that orders were coming at a ‘frenzied pace equal to any real property
bubble in any major city around the world’. This research proposes that excessive
speculative activities can and will harm global maritime trade. This research addresses
how to strengthen maritime trade, if possible, using Islamic principles. The rejection
of excessive gharar or unnecessary uncertainties is one of the fundamental features of
Islamic finance. Many Islamic financial institutions performed significantly better
during the global recession because they were not allowed to be involved in certain
speculative activities, including the former subprime mortgage. The extension of these
principles from the financial industry to the real trade industry would have a huge and
positive impact.
1
Keith Wallis, ‘Speculation Blamed for Woes’ South China Morning Post (11 November 2011)
<http://www.scmp.com/article/984531/speculation-blamed-woes> accessed 20 October 2011
1
Various Islamic financial products for maritime trade are currently available. 2
However, a mere cosmetic change of conventional financial products to make them
Shariah-compliant is not adequate. This research proposes that the nature or core of
the transaction should be improved by embracing the principle of risk sharing and by
encouraging actual economic growth and productivity. A new legal and regulatory
framework is therefore needed.
Islamic finance is gradually becoming a global phenomenon. The fact that
more than 25 percent of the Islamic financial industry’s customers in a multiracial
country like Malaysia are non-Muslims indicates that a grasp of Islamic finance is no
longer limited to Muslim communities. Islamic financial products will be much more
useful and attractive if the industry focus is changed from mere financing and
Shariah-compliance(minimum observation of religious requirements) to actual
reforms that promote justice, fairness and competitive risk-sharing mechanisms. Such
changes would be gradual, but institutional reforms would be initiated to ensure
long-term success.
The title for this research might as well be ‘Strengthening Maritime Trade
with Islamic Principles’. There are numerous studies that explore maritime trade from
various angles, including risk management and financing, but there is still a large gap
in work that addresses the application of Islamic principles to maritime trade. This
research looks at various issues, including risk management, from an Islamic
perspective. The aim is not to show that one system is better or superior to another,
but to show that both can mutually assist and strengthen each other.
This research highlights the problems and challenges faced in the maritime
trade industry and investigates ways to avoid, reduce or eliminate them. A systematic
reduction or removal of uncertainty or gharar would contribute substantially to the
improvement of maritime trade. In contrast, unmonitored financial engineering that
uses complicated conventional financial products might hedge some of the risks in the
short-term and make huge profit for some parties, but the overall effect would be a
more volatile maritime trade sector. An efficient risk management system should
generate a situation in which all parties attempt to reduce risks and increase
productivity and efficiency. Under the current system, in which parties can just
2
This includes Islamic financial products offered by Malaysia, such as Shipping Guarantee-i and
Endorsement of Transport Documents, Accepted Bills-i, Wakalah Bills for Collection-i, Letter of
Credit-i, Trust Receipt-i, Bills of Exchange Purchased-i, Export Credit Refinancing-i (ECR-i), Onshore
Foreign Currency Financing-i, Collateral Management Arrangement-i, Islamic Negotiable Instruments
of Deposits (INID), Negotiable Islamic Debt Certificate (NIDC), Islamic Profit Rate Swap (IPRS) and
Islamic Cross Currency Swap (ICCS).
2
speculate and make huge profits from the losses of others, the motivation to reduce
risk is severely compromised.
Special focus will occasionally be given to Singapore, Hong Kong and
Malaysia. Hong Kong and Singapore are both international maritime trade centres and
Malaysia is an international Islamic financial hub. The development of maritime trade
and Islamic finance in Malaysia, Singapore and Hong Kong are also explored
specifically to study the feasibility of the application of Islamic principles to maritime
trade.
The study of gharar in Muslim literature is a common theme in the more than
1400-year-old Islamic financial system. Someof the traditional studies available
todaysimply focus on the permissibility or non-permissibility of various contractual
transactions strictly from the religious perspective without adequate focus on the
maximization of public interest and profit or ways to improve trade and commerce.
While some outstanding literatures covered the gaps found in others, these literatures
are usually in Arabic or other non-English languages, and modern scholars might face
difficulty in applying these literatures 3 . This research argues against the blind
adoption of the unmodified views of traditional scholars on commercial matters.
Instead, a new approach is needed to cater to modern needs while remaining true to
the basic principles prescribed in the major sources of Islamic law.
Risk management is very important in maritime trade. Uncertainty often exists
in complicated maritime disputes, especially those related to issues such as bills of
lading, carriage by sea of goods, transfer of rights and liabilities between parties and
limitations of liability. Elements of uncertainty can be easily seen in the contracts as
the complex rights and liabilities between the various parties are being transferred
from one party to another, from one carrier to another or between the consignee and
third party. However, legal uncertainties are not the main problem faced by global
traders. Price risk, credit risk and pure risk seem to merit more of their consideration,
and all of these issues are covered in this research.
This is a study on the Islamic financial system and global maritime trade. This
study proposed that excessive speculative activities cause enough harm to the
maritime trade market in the long-run that it outweighs any short-term benefits. Ways
to improve risk management are proposed from an Islamic perspective and
suggestions for improving maritime trade and commerce, among other elements, are
also presented.
3
While Shariah scholars trained in Arabic language will definitely have better mastery and
understanding of traditional Arabic literature, such scholars usually lack comprehensive understanding
of modern financial world (although this situation is gradually changing).
3
The growth of Islamic finance can be a positive global phenomenon.
Prosperity based on respect, fairness, mutual trade and understanding between people
from different religions and backgrounds is a better approach than the conflicts and
clashes of civilizations characterized by injustice, oppression, terrorism and war.
Rejections of Islamic finance or Islamic principles due to religious discrimination are
unfortunate and counter-productive.
1.1
Preliminary Review of Literature &Research Gap
A huge research gap exists on the actual and theoretical application of Islamic
principles to maritime trade and commerce sector. Contrary to 20 to 30 years ago,
there are now abundant literature on Islamic finance, ranging from its benefits to
challenges and obstacles. A simple search using ‘Islamic banking’ as the keyword at
the book section of well-known online retailer, Amazon.com will instantly give a hit
of more than 1,800 books.This research presents an amalgamated study of maritime
trade, Islamic finance, maritime electronic commerce, and risk management. However,
the theme of Islamic finance can be seen in almost all of the chapters. The reviewed
literature includes legislations, statutes, textbooks, books, journals, newspaper articles,
periodicals, reports, speeches, keynote addresses, conference papers and websites.
This research aims to fill the research gap on the application of Islamic
principles to modern maritime trade. It is proposed that such application is mutually
beneficial, both to those in the Islamic financial industry and maritime trade industry.
The detail and keen examination by shipping law experts and Islamic finance experts
in their works is the main foundation of this research.
Regarding maritime trade, this research is built upon the work of Wilson, 4
Girvin, 5 Baughen, 6 Chan et al, 7 Stopford, 8 Dockray, 9 and Sing. 10 The work of
Chan et al 11, Shipping and Logistics Law: Principles and Practice in Hong Kongis
referenced out of appreciation for the background and position of Hong Kong’s
4
John F. Wilson, Carriage of Goods by Sea (7th edn, Pearson Longman 2010).
5
Stephen Girvin, Carriage of Goods by Sea (Oxford University Press 2007).
6
Simon Baughen, Shipping Law (4th edition, Routledge-Cavindish 2009).
7
Felix W.H. Chan, Jimmy JM Ng and Bobby KY Wong, Shipping and Logistics Law: Principles and
Practice in Hong Kong (Hong Kong University Press 2002).
8
Martin Stopford, Maritime Economics, 3rd edition (Routledge 2009).
9
Martin Dockray, Carriage of Goods by Sea (3rd edition, Cavendish Publishing 2004).
10
Toh Kian Sing, Admiralty Law and Practice (2nd edition, LexisNexis 2007).
11
Felix WH Chan, Jimmy JM Ng and Bobby KY Wong, Shipping and Logistics Law: Principles and
Practice in Hong Kong (Hong Kong University Press 2002).
4
maritime trade, whereas Sing’s work is useful when studying Singapore and Malaysia.
Chan et al’s work on shipping and logistics law is very relevant to this research. It
provides an authoritative and clear explanation of shipping and logistics law with
special emphasis on Hong Kong, which is one of the three maritime centers (along
with Malaysia and Singapore) chosen for this study. Hong Kong is well known as a
credible international shipping hub and international arbitration centre. The work of
Chan et al clearly provides a general framework for the basic concept of shipping and
logistics law in Hong Kong, and it is well structured and contains a great deal of
useful information. 12 While this book is very useful for law students and law
practitioners (especially those in maritime trade industry), some limitations exist due
to the introductory nature of the book. More indepth study on shipping law and cases
can be be seen in Stephen Girvin’s Carriage of Goods by Sea. Since this book is
published in 2002, many important recent cases is understandly not covered. 13This
book however filled a research gap on Hong Kong’s shipping law and the incoming
edition will be very much welcomed.
John F. Wilson’s Carriage of Goods 14 is more than an examination of various
legal documentations, concepts and principles that together regulate maritime trade.
This book is a very reputable source for shipping law that is regarded by many to be
12
This work is very useful because it covers almost all of the basic issues relating to shipping and
logistics law. The early chapter on jurisdiction and alternative dispute resolution is simple and
straightforward. The subsequent chapters on carriage of goods by sea and other modes of carriage of
goods consist of detailed explanations of the relevant legal principles. This work is quite
comprehensive and covers the topics of freight forwarding and transport insurance as well. A book on
Hong Kong shipping and logistics laws is not complete without reference to the Republic of China’s
laws. Accordingly, the final chapter of this book is on PRC maritime law. This book contains sufficient
extracts of the relevant legislation and illustrations from case law. Furthermore, it also includes sample
documents for reference, including shipping and marine insurance documents. This book is unique
compared to other law books because it is a very practical combination of law and logistic study. This
is, perhaps, partly explained by the different backgrounds of the authors. This book briefly mentions
alternative dispute resolution, which is also relevant.
13
Examples include the case of ACP Capital Ltd v IFR Capital plc [2008] 2 Lloyd’s Rep 653, Action
Navigation Inc v Bottigliei di Navigazione. The Kitsa [2005] 1 Lloyd’s Rep 432, Allianz Spa West
Tankers Inc. Case C185/07 [2009] 1 Lloyd’s Rep 413, Alphapoint Shipping Ltd v Rotem Amfert
Negev Ltd. The Agios Dimitrios [2005] 1 Lloyd’s Rep 23, Bank of China v NHM LLC [2002] 1
Lloyd’s Rep 506, Bunge v ADM DO Brasil Ltda [2009] 2 Lloyd’s Rep 175, CMA CGM SA v Classica
Shipping Ltd [2004] 1 Lloyd’s Rep 460, ERG Raffinerie Mediterranee v Chevron USA [2007] 2
Lloyd’s Rep 542.
14
John F. Wilson, Carriage of Goods by Sea (Pearson/Longman 2008).
5
one of the best books on shipping. It covers most of the important aspects of modern
conventional maritime trade. 15 Wilson provide a good description onimportant
documents and concepts. The work occasionally seems descriptive rather than
prescriptive as the author describe and summarize current legal position. The only
piece of work that seems to deserve equal standing is Stephen Girvin’s Carriage of
Goods by Sea. 16
The second edition of Stephen Girvin’s Carriage of Goods by Sea continues
the tradition of quality research established in the earlier edition of his work.
Obviously intended as an important textbook for maritime trade lawyers and students,
the descriptions and explanations on shipping law and maritime trade tend to be
concise but never oversimplistic. Girvin’s work demonstrates the depth of
Western-based shipping law and highlighted the ‘evolution’ of its legal principles as
shaped by judges and legislators. A more critical comparison and analysis of Girvin’s
work reveals that many of the principles that regulate maritime trade sector is actually
compatible with Islamic principles. 17
Regarding Islamic finance, this research directly references the primary
sources of Islamic law, namely the Qur’an 18 and Hadith. 19 The secondary sources of
Islamic finance are also referenced. Works by traditional and modern scholars are
15
This excellent work was constructed with a high degree of care and demonstrates the full
understanding of the author in relation to charter parties, bills of lading, problems and documentation
involving multimodal and combined transport and other matters related to the carriage of goods by sea.
Moses fills the long-felt gap with a work that is revised and equipped with the latest statutory
developments, judicial decisions and critical analyses of the shipping practice. It also discusses the
series of leading cases on title to sue, negligence and fundamental breach. A study of the various
e-commerce
issues
involved
in
transport
documentation
is
also
included.
Despite
its
comprehensiveness, it still maintains a sense of simplicity with text that is easy to understand and
straight to the point. This excellent piece of work has been very useful in my research because it shed
some light on some of the issues I have attempted to address in various chapters. The chapter devoted
to dispute settlement is also helpful, but quite short as the focus of this work is shipping rather than
alternative dispute resolution.
16
17
Stephen Girvin, Carriage of Goods by Sea (Oxford University Press 2007).
This is partly because under Islamic law, everything is permissible unless those expressly prohibited
under the primary sources of Islamic law. Secular or Western-based shipping law that aims for justice,
fairness and business efficiency is largely compatible with Islamic law, subject to minor differences in
certain area.
18
The Qur’an is the Holy Book of the Muslim people. It is also the main source of Islamic law and the
main reference for Muslims in various matters.
19
The Hadith are an account of the sayings, actions or tacit approval of Prophet Muhammad.
6
discussed as well. Among the modern work on Islamic law and finance referenced for
this research are those of Nawawi, 20 Nik Yusoff, 21 Hassan, 22 Buang, 23 Askari et
al 24 and Bakar and Ali. 25
Essential Readings in Islamic Finance, edited by Mohd Daud Bakar and
Engku Rabiah Adawiah Engku Ali contributed significantly to this research from the
Islamic finance perspective. This book is actually a compilation of separately written
papers that have been presented in international seminars by the writers. In total, there
are five themes and twenty-two papers. While the topics covered are diverse, the
authors made their points, recommendations and suggestions clear and enlightening.
This book is relevant to this research as some of the authors also analyze the specific
practicalities of contemporary Islamic financial products.
Some of the works are more specific in nature. For example, Simon Archer
and Rifaat Ahmed Abdel Karim’s Islamic Finance: The Regulatory Challenges and
Abdul Karim Aldohni’s The Legal and Regulatory Aspects of Islamic Banking deals
with the regulatory aspect of Islamic finance. The benefits of Islamic finance is
largely covered in the outstanding work of Aamir A. Rehman, Gulf Capital & Islamic
finance: The Rise of New Global Players.This research also includes materials on
Islamic finance presented by the author in international conferences, symposiums and
seminars. 26
20
21
Razali Haji Nawawi, Islamic Law on Commercial Transaction (CERT Publications Sdn Bhd 2009).
Nik Mohamed Affandi Bin Nik Yusoff, Islam and Business (Pelanduk Publications (M) Sdn Bhd
2002).
22
Abdullah Alwi Haji Hassan, Sales and Contracts in Early Islamic Commercial Law (The Other
Press Sdn Bhd 2007).
23
Ahmad Hidayat Buang, Studies in the Islamic Law of Contracts: The Prohibition of Gharar
(International Law Book Services 2000).
24
Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor, The Stability of Islamic
Finance: Creating a Resilient Financial Environment for a Secure Future (John Wiley & Sons (Asia)
Pte. Ltd 2010).
25
Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Readings in Islamic
Finance (CERTS Publications Sdn. Bhd 2008).
26
This includes Mohd Yazid Bin Zul Kepli, ‘Removing Uncertainty (Gharar) from Maritime Trade
and Maritime Arbitration’ (ASLI Conference, “Law in a Pluralist Asia: Challenges and Prospects”, 7th
Asian Law Institute Conference, Kuala Lumpur, Malaysia, 25-26 May 2010); Mohd Yazid Bin Zul
Kepli, ‘Islamic Finance in Hong Kong: Benefits and Challenges’ (Foundation of Islamic Finance Series
Second Conference, Nikko Hotel, Kuala Lumpur, Malaysia, 8-10 March 2011); Mohd Yazid Bin Zul
Kepli, ‘Islamic Finance in Hong Kong: Benefits, Challenges and the way forward’ (Global Islamic
Marketing Conference (GIMC), Dubai, United Arab Emirates, 20-23 March 2011); Mohd Yazid Bin
7
The main journals referenced in relation to Islamic finance include the Journal
of King Abdul Aziz University, the Islamic Research and Training Institute Journal,
the Journal of Islamic Economics, Banking and Finance (JIEBF) and the International
Journal of Islamic and Middle Eastern Finance and Management.
There is serious lack of good modern literature, especially in the English
language, on Islamic finance, particularly regarding the doctrine of gharar or
uncertainty. This is despite the fact that the prohibition of excessive uncertainty (also
known as ‘extreme gharar’in Arabic terminology) is a common literary topic under
Islamic law. Even the historical background on the application of Islamic principles to
the trade and commerce of local Muslims is scarce and unsatisfactory. Among the
good modern literature on Islamic finance are the works of Askari et al 27 and Bakar
and Ali. 28 The views of traditional Muslim scholars on finance-related matters are
summed up in the work of Al-Zuhaily. 29However, the defining work on gharar can be
seen in the work of Ahmad Hidayat Buang entitled Islamic Law of Contracts: The
Prohibition of Gharar. 30
The removal of uncertainty is one of the basic transaction conditions for
Muslims due to the prohibition laid down in the primary sources of Islamic law. Thus,
methods for identifying and removing uncertainty from transactions are discussed
regularly in traditional Muslim literature, but rarely discussed in detail in modern
literature, especially in relation to shipping. Currently, modern contributions largely
come from regulators and established Islamic financial institutions through the
collective efforts of scholars and the series of guidelines released by such institutions.
Zul Kepli, ‘Integration or Peaceful Separation?’ (Recognition and the Politics of Identity and Inclusion
in the 21st Century: Managing Diversity in Plural Societies, The University of Hong Kong, Hong Kong,
28-29 April 2011) and Mohd Yazid Bin Zul Kepli, ‘Islamic Finance in Hong Kong’ (8th ASLI
Conference: Law in a Sustainable Asia’, Kyushu University, Japan, 26-27 May 2011).
27
Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor, The Stability of Islamic
Finance: Creating a Resilient Financial Environment for a Secure Future (John Wiley & Sons (Asia)
Pte. Ltd 2010).
28
Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Readings in Islamic
Finance (CERTS Publications Sdn. Bhd 2008).
29
Wahbah al-Zuhayli, Al-Fiqh Al-Islami wa Adillatuh (Volume 5) (4th edn, Dar Al-Fikr 1997) as
translated in Mahmoud A. El-Gamal (translator) Financial Transactions in Islamic Jurisprudence
(Vol.1)(Dar al-Fikr 2007).
30
Ahmad Hidayat Buang, Islamic Law of Contracts: The Prohibition of Gharar (International Law
Book Services, 2000)
8
Since this research includes a background study, books on the history of
Southeast Asia, particularly Malaysia, Singapore and Hong Kong, are also referenced.
Introduction to Malaysian Legal History 31and Malaysian Legal History: Cases and
Materials 32 provide details and an interesting analysis of the legal histories of
Malaysia and Singapore.
Reference is also made to online materials such as the digital reference for the
Oxford Encyclopedia of Maritime History. 33 This wide-ranging encyclopedia covers
the entire history of seafaring, which can be traced back to ancient Egypt, Greece and
Rome. Around 900 articles are written by experts, academicians and historians
examining various aspects of maritime history in detail. Maritime history is a
multi-dimensional field that cuts across the boundaries of academic disciplines, but
for this study the focus will be more on the legal and commercial aspects. The idea
behind an historical analysis is to understand how the modern maritime trade system
came into practice (not to provide a detailed historical account).
The materials on historical background are occasionally contrasted with
materials on Islamic finance. Angelo M. Venardos’s Islamic Banking & Finance in
Southeast Asia: Its Development and Future is a great example of literature that
analyzes the practical application of Islamic finance to specific region. 34Unfortunately,
this work only covers a few countries like Malaysia, Brunei, Indonesia and Singapore.
Obvious research gap still exists and more research is needed to cover the gaps.
It can be concluded that the huge contributions made by the experts and
scholars are directly responsible for the emergence of this research. Without their
in-depth works and analysis, cross-discipline study such as this will not be possible.
This research aims to contribute to the existing literature by analyzing the
feasibility and practicality of applying Islamic principles to modern maritime trade.
While the huge research gap on the application of Islamic principles to actual
maritime trade cannot be comprehensively covered in one single research, it is one of
the aims of this research to start the intellectual discussion on this interesting aspect.
31
Ismail Mohd. Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Abd Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd, Malaysia 2004).
32
33
Salleh Buang, Malaysian Legal History: Cases and Materials (Dawama Sdn Bhd, Malaysia 2008).
‘The Oxford Encyclopedia of Maritime History’ <http://www.oxford-maritimehistory.com>
accessed 10 January 2012
34
Angelo M Venardos, Islamic Banking & Finance in South-East Asia (2nd edn, World Scientific
2007)
9
1.2 Research Questions and Problems Statement
This comparative research will attempt to answer the main question: ‘Can Islamic
principles be applied to strengthen modern maritime trade?’. The application of
Islamic financial principles to the banking and insurance industry seems to be
sustainable and competitive as the market of Islamic finance reach beyond USD 1
trillion. Although there is still a big room for improvement, there is no serious doubt
whether Islamic financial principles can be applied to the banking or financing
industry. The consistent growth for the last 30 years indicates that the application of
Islamic principles to banking and financing industry is feasible. This research aims to
take the discussion further. It is proposed that the application of Islamic principles can
also be extended to the maritime trade industry and to actual trade and commerce. The
application can be beyond financing. This research aims to answer some minor
questions as well. Each chapter will address its own set of minor questions although
the main question is the same. The main theme for this research is the application of
Islamic principles to maritime trade or, in particular, the removal of unnecessary risks
and uncertainty from maritime trade.
1.3 Limitation of Research
This research does not reference non-commercial maritime disputes. State matters
including sovereignty, state boundaries and exclusive economic zones are not
included in this study. This research does not merely study the application of Islamic
principles to trade from a religious point of view. The focus is on the possible
contributions to modern maritime law, particularly in relation to the removal and
reduction of uncertainty. Attention is also paid to the legal and regulatory aspects.
Therefore, this research departs from the traditional work of Muslim scholars that
often rely heavily on a strict approach and are non-permissive in nature. It aims to
adhere to the maqasid shari’ah or the purpose of such law, eg protecting the interests
of the community without sacrificing the fundamental concepts.
The development of traditional Islamic finance can be traced back through a
long history that began in the seventh century. Various schools of thought emerged,
including the Hanafis, Mālikī, Shafi’is and Hanbalis. These schools of thought have
produced abundant literature on Islamic finance, from the formation of contracts to
the effects of subsequent breaches. Most of these sources are in Arabic, although
some have been translated into English. However, this research is not focused on the
views developed by traditional scholars. This is not because their views are obsolete
or irrelevant. The main reason is that such research has already been done.
10
Furthermore, their views are shaped by the challenges and problems faced during
their own times. A more innovative approach is needed to settle the challenges and
problems produced in this age, although some of the traditional views do, admittedly,
provide useful guiding principles. This research focuses more on the writings of
modern Islamic finance scholars because their views are often collectively developed
after considering the unique challenges of this modern age.
This research is not limited to Islamic finance, principles and concepts. It
relies heavily on the works of conventional experts and scholars of maritime trade,
maritime electronic commerce, maritime economics, and risk management.
1.4 Hypothesis
This research proposes that the application of Islamic principles, particularly the
rejection of excessive uncertainties and extreme speculative activities, to the maritime
trade sector is feasible, practical and beneficial. However, simple cosmetic changes
are not sufficient. This research argues that systematic removal, or at least reduction,
of unnecessary uncertainties and risks are necessary to strengthen global maritime
trade.
The current risk management system, e.g. the increasing use of conventional
derivatives, could produce a disastrous effect similar to the one suffered by the
financial sector during the recent global recession. The harm caused speculative
elements can outweigh the various benefits that they promise. The Islamic principles
seen in various Islamic financial products that are applicable to modern maritime
trade will be relevant in strengthening global trade. This is the result of, among other
things, Islamic finance’s prohibition from dealing with transactions tainted by
excessive speculations (gharar) along with the fairer allocation of risks that it requires.
However, to truly benefit global trade, it is proposed here that Islamic financial
products must not merely present a cosmetic change in conventional products; their
essence must also be different.
1.5 Significance of Research
This research focuses on the removal of uncertainty from maritime trade and
contributes to the existing research from both a theoretical and a practical perspective.
This focus on the removal of uncertainty is also a continuation and extension of
Islamic trade law. It is proposed that some of the basic guidelines applied under
Islamic law can be applied to improve present-day maritime trade. While the Islamic
11
banking system is a notable alternative to conventional systems 35 (illustrated by its
survival of the 2008 global recession), Islamic maritime trade is rarely discussed. In
other words, the application of Islamic principles to trade and commerce, beyond
financing and insurance, is relatively rare. This research proposes that the various
basic principles responsible for the success and achievements of the Islamic banking
system could also be extended to trade and commerce.
1.6 Research Methodology
This research will attempt to answer the main question: ‘Can Islamic principles be
applied to strengthen modern maritime trade?’. The research methodology is tailored
to answer the main research question. There are various types of research including
descriptive, analytical, conceptual and empirical research. Research can also be either
applied research (aims at finding a solution for an immediate problem) or fundamental
research (usually for formulation of theory and more general in nature). Another
classification is quantitative (based on something measurable) and qualitative research
(based or concerned with qualitative phenomenon e.g. reasons for human behavior).
This research is library based although the initial plan was to use qualitative method.
According to an expert in research methodology, Kumar:
Quantitative research is based on the measurement of quantity or amount. It is
applicable to phenomena that can be expressed in terms of quantity. Qualitative research,
on the other hand, is concerned with qualitative phenomenon, i.e., phenomenon relating
to or involving quality or kind… This type of research aims at discovering the
underlying motives and desires, using in depth interviews for the purpose. 36
Due to the size of this research, qualitative method would be too time-consuming and
the impact will be minimum. The main findings of this research are built upon the
literature and works contributed by experts and scholars in Islamic finance and
shipping law. Major works and important literature on these two fields are critically
referred and studied. This includes finding common point or contradictions among the
scholars, supporting or disagreeing with one or another; locating weaknesses and
obstacles, extending their theories, or testing their findings to other contexts or
objects.
35
Abdus Samad, Norman D. Gardner and Bradley J. Cook, ‘Islamic Banking and Finance in Theory
and Practice: The Experience of Malaysia and Bahrain’ (2005) American Journal of Islamic Social
Science, Number 2 Vol. 22.
36
C. Rajendra Kumar, Research Methodology (APH Publishing Corporation 2008)
12
Below are the relevant stages:
Stage one:
Planning and framing issues
Stage two:
Gathering materials (major literature, textbooks, books,
articles in journals, statutes, newsletter etc)
Stage three: Analyzing the information and testing the hypothesis
Stage four:
Writing
This research is not quantitative or empirical due to the nature of the research.
13
CHAPTER 2
MARITIME TRADE IN SOUTHEAST ASIA
2.0 Introduction
Islam is widely practiced in Southeast Asia, with around 240 million followers. In
addition, many Southeast Asian countries are maritime nationsincluding Malaysia,
which is alsohome to the most sophisticated Islamic finance industry in the world.
Therefore, the selection of Southeast Asia as the backdrop for this studyis easily
understood. Southeast Asia is home to more than 610 million people from a variety of
different religions, races, languages and cultural backgrounds. For generations,
Southeast Asia had multiple maritime trade routes that connected the countries in the
West and the East, and some of Southeast Asia’s maritime nations have prospered by
positioning themselves as maritime trade centers.
This research rests on the hypothesis that the application of Islamic principles to
maritime trade industry is feasible, beneficial and necessary. Before testing the
hypothesis in subsequent chapters, this chapter analyzes the application of Islamic
principles to global maritime trade industry throughout history. This is to see whether
such application has occurred before or not. If such application has successfully been
made at a global or large scale in the past, the prospect of similar application
nowadays will be more promising. The findings in this chapter will not conclusively
answer the main research question since successful former application is no guarantee
for future performance. However, the analysis will be very useful in reaching better
appreciation of the issue.
This chapter also reviews the background of maritime trade in Southeast Asia
with special emphasis on Singapore, Hong Kong and Malaysia. First, the general
history of Islamic and global maritime trade is summarized, and then the focus is
extended to the three-abovementioned jurisdictions. Singapore and Hong Kong are
both established, important international maritime trade centers; respected for their
efficiency, free markets and transparency. Both are some of the busiest ports in the
world. In contrast, while Malaysia is one of most developed Islamic financial hubs in
the world, its maritime trade sector lags far behind those of Singapore and Hong Kong.
The golden days of the fifteenth century when Malacca (one of Malaysia’s current
states) was the centre of maritime trade in Southeast Asia are now long gone. This
chapter not only analyzes the historical development of maritime trade in Singapore,
Hong Kong and Malaysia, it explores the current position of maritime trade in these
three jurisdictions while comparing the different views and propositions regarding the
reasons for their successes and failures.
14
During the recent global recession, Islamic financial institutions and
conventional banks with Islamic windows performed far better than purely
conventional financial institutions. This was partly due to the features of Islamic
finance that shun excessive speculative activities. Islamic finance prohibits usurious
transactions and insists on real trade and commerce. It directly encourages real growth
in the economy rather than mere interest-based financing. Usury, prohibited in Islam,
is defined bythe Concise Oxford Dictionaryas ‘the act or practice of lending money at
interest or at an exorbitant rate’. 37Because usury is prohibited, those adopting Islamic
finance must ensure a better allocation of risk through partnership and risk sharing.
Furthermore, Islamic finance prohibits gambling and transactions tainted by similar
elements, such as excessive speculation.
Becauseso many of the conventional derivatives are prohibited, the Islamic
financial institutions are not typically damaged as badly during financial crises and
recessions because the bad debts that result from these financial products do not
extend to them. However, this does not mean that Islamic finance is a medieval
system in which everything is prohibited. One of the interesting characteristics of
Islamic finance is that it actually offers safer alternatives, including Islamic
derivatives and bonds. Islamic risk management is also expected to grow in popularity
in the near future. In other words, the adoption of Islamic principles that insist on
fairness and ethical trading and reject the separation of morality and trade is gradually
gaining firmer ground. Jurisdictions such as London, Singapore and Hong Kong are
also including Islamic finance in their portfolios.
Before proceeding, a brief historical reference is necessary. The key concern
here is to highlight that the theory proposed in this research is not a new one, but a
mere logical extension of centuries-old principles.
2.1
Maritime History and Islamic Finance
Maritime history can be classified into five different eras:
1.
2.
3.
4.
5.
37
Ancient times
Age of Navigation
Age of Discovery
Age of Sail
Modern era
The Concise Oxford Dictionary of Current English (Oxford University Press 1998) 1546 [The
concept of usury in Islam is, however, larger in scope than the common understanding of usury in
Western literature].
15
The application of Islamic principles to maritime trade and commerce has existed
since the beginning of Islam in the seventh century and has since influenced the
development of maritime law. Although the development of the Islamic legal system
was temporarily halted during the colonization of Muslim countries and further halted
after the fall of the last Muslim empire during World War I, it is proposed that the
Islamic legal system continued to influence global trade and commerce. With around
one-fifth of the world population being Muslim, this is hardly surprising. The revival
of Islamic finance in the twentieth century is expected to accelerate the application of
Islamic principles to encourage real trade and commerce (instead of speculations) and
provide better risk management, eg through partnership and risk-sharing mechanisms
(instead of risk transfer).
Attempting to understand the historical background of Islamic maritime
commerce can be challenging. Siddiqi aptly expressed this difficulty, partly due to a
lack of good resources:
The source of most of the economics projected as Islamic has been fiqh, which is largely
based on the historical experiences of the first four centuries, mostly in what we now
call the Middle East. Historical experiences over the next thousand years, especially
those in Andalus, the Maghreb, India, South-East Asia, Turkey and Iran have neither
been studied properly nor allowed full impact on fiqh. Among the very few attempts to
sift through Islamic history for knowing more about such institutions and practices as
waqf, zakat, mudaraba, suftajah, and such concepts as israf, infaq, etc.(1), the sources
covered are all in Arabic and from one particular region. This has deprived us of the
variety of interpretation and diversity of experience in living according to Qur’an and
the Sunnah. Economic history of Muslim peoples is a very thinly researched area, and so
is the economic thought of Muslims. This can hardly do, as living according to norms
and concepts handed down centuries ago is a challenging task, especially in economic
affairs. 38
It should be noted that the following historical summary is not, by any account, a
comprehensive summary of global maritime history. Its goal is merely to highlight
some of the key events and to show how Islamic maritime trade fits into the global
scenario.
38
Mohammad Nejatullah Siddiqi, ‘Obstacles of Research in Islamic Economics’ (2008) Journal of
King AbdulAziz University Islamic Economics, Vol. 21, No.2, 83-95.
16
2.1.1 Ancient times (until the seventh century)
Many scholars consider the ancient times to have begun withthe event of recorded
human history, lasting until the coming of Islam in the seventh century or the fall of
the Roman Empire. 39To understand the history of maritime trade, reference should be
made to the history of maritime transportation. One of prehistoric man’s most
outstanding achievements, the creation of a proper boat made out of planks, can be
credited to the Egyptians of the fourth millennium BC. 40 In southern Egypt,
archeologists have found a multitude of images of boats in pottery decorations before
3100 BC. 41 It seems most likely that the first true sea voyages were made by the
Egyptians, the Mesopotamians or the Indians who sailed between the Persian Gulf
and India. 42
The most famous story of maritime transportation is that of Noah’s Ark. The
story is mentioned in Biblical narratives, Judaism, Islam and other traditions. These
stories can be found in the Book of Genesis (chapters 6-9) and the Qur’an (the
chapters of Hud and Al-Mu’minoon). The famous story describes the creation of a
large ark by Prophet Noah to save the believers and the world’s animals from a global
flood known in history as the Great Flood.
Maritime history is an important branch of the history of mankind. Strong
ancient maritime nations usually possessed strong navies and experts in maritime
affairs. For example, the ancient Egyptians were known to have knowledge about sail
construction and the science of aerodynamics. Although the details of ancient
maritime laws are largely lost, there seems to be a consensus that custom played an
important role.
Ancient China was also known to be involved in maritime trade. An ancient
Chinese naval map clarifying the maritime Silk Road has survived from the second
century BC.. Another historical source is theYuejueshu or ‘The Lost Records of the
State of Yue’, written in 52AD by Yuan Kang, a Han Dynasty scholar. This book is
one of the oldest known Chinese books on maritime matters.
39
While there is no conclusive point of historical origin for maritime law, the oldest currently known
example is allegedly found in a small portion of the Babylonian Code of Hammurabi (c. 2050–1750
BC).
40
Lionel Casson, The Ancient Mariners: Seafarers and Sea Fighters of the Mediterranean in Ancient
Times (2nd ed, Princeton University Press, New Jersey 1991) 1.
41
Lionel Casson, The Ancient Mariners: Seafarers and Sea Fighters of the Mediterranean in Ancient
Times (2nd ed, Princeton University Press, New Jersey 1991) 1.
42
Lionel Casson, The Ancient Mariners: Seafarers and Sea Fighters of the Mediterranean in Ancient
Times (2nd ed) (Princeton University Press, New Jersey 1991) 4.
17
However, to truly understand the origin of ancient maritime law, it is necessary
to turn to the Mediterranean Sea, where maritime trade has had a continuous history
of nearly five thousand years. Research on the history of maritime law almost
unanimously leads to early the Phoenicians (900 BC). 43It is difficult to determine
much about the Phoenicians, but they were known to be sharp traders. 44 For example,
when King Solomon was about to proceed with the building of his famous temple
around 970 BC and he needed timber, he turned to the Phoenicians and negotiated a
contract. 45
Historically, Rhodian maritime law is important. Rhodes, an island state,
depended on the sea and maritime trade and had built up a small but highly respected
navy. 46 To ensure that the fleet was in a constant and perfect state of repair, Rhodes
maintained extensive, complex navy yards that were the only ones in the ancient
world that we know had a comprehensive security system in which certain portions
were closed except to authorized personnel, and breacheswere punishable by death. 47
History shows that Rhodes built up a fine navy and worked hard to sweep its seas
clean of pirates. 48
Rhodes became a centre of commerce and achieved great prosperity during
the height of its power around 300 BC, and it has been suggested that its maritime
code was promulgated around this time. 49 Many believe that the first authoritative
code of maritime law belonged to Rhodes. 50The Rhodian laws are said to be the
43
C. G. Roelofsen, Frank L. Wiswall Jr., David H. Anderson, J. Ashley Roach and Craig J. S. Forrest,
‘Law’ (The Oxford Encyclopedia of Maritime History)
<http://www.oxford-maritimehistory.com/entry?entry=t232.e0457-s006> accessed 6 January 2012.
44
Lionel Casson, The Ancient Mariners: Seafarers and Sea Fighters of the Mediterranean in Ancient
Times (2nd ed) (Princeton University Press 1991) 62.
45
Lionel Casson, The Ancient Mariners: Seafarers and Sea Fighters of the Mediterranean in Ancient
Times (2nd ed) (Princeton University Press 1991) 63.
46
Lionel Casson, The Ancient Mariners: Seafarers and Sea Fighters of the Mediterranean in Ancient
Times (2nd ed) (Princeton University Press 1991) 135.
47
Lionel Casson, The Ancient Mariners: Seafarers and Sea Fighters of the Mediterranean in Ancient
Times (2nd edn, Princeton University Press 1991) 140.
48
Lionel Casson, The Ancient Mariners: Seafarers and Sea Fighters of the Mediterranean in Ancient
Times (2nd edn, Princeton University Press 1991) 142.
49
Grant Gilmore and Charles L. Black Jr, The Law of Admiralty (2nd edn, The Foundation Press Inc
1975) 3.
50
Henry Flanders, A Treatise on Maritime Law (The Lawbook Exchange Ltd, New Jersey 2001) 4.
18
source of jurisprudence for the Romans and that they were observed in maritime
disputes as long as theywere not contrary to the express laws of Rome. 51
Rhodian Sea Laws were both comprehensive and advanced for their time:
Part I of the Rhodian Sea Laws, a prologue, provides support for a uniform
Sea-Law on the basis of declarations of various emperors. Part II concerns
such matters as the apportionment of voyage profits among ship crew
members, on-board vessel regulations, limitation of the captain's liability for
loss of passengers' valuables, general average procedure, and maritime loans.
Part III is an extensive section which deals with such diverse topics as the
responsibility for thefts of cargo, liability for seamen's personal injuries,
responsibility for injury to ship or cargo, the consequences of abandonment of
a vessel by a captain and crew, and the chartering of vessels by merchants. In
the remaining chapters of the Sea Laws, provisions for liability for collision
and salvage are set forth. 52
2.1.2
Age of Navigation (the seventh century to the fourteenth century)
The Age of Navigation was an interesting and colorful time. Various scholars
believethat the arrival of Islam in the seventh century marked the end of the ancient
times. The rise of Islam influenced the world in various ways. One aspect was that the
Arab nations and its people were united for the very first time. This enabled the
creation of a strong state with a clear legal system based primarily on the Qur’an and
the Sunnah that emphasized justice and fairness for all. However, the story of the rise
of Islam is not limited to the Arab people. There were numerous Muslim empires that
were non-Arab in nature. The most prominent and well-known was the Ottoman
Empire (1299-1923):
The third phase of victories started with the establishment of the Ottoman Empire at
the end of the seventh century AH and within a short time the Ottoman Turks crossed
the Dardanelles and conquered the Balkan Peninsula to the banks of the Danube
River. Thus Bulgaria, Macedonia, Albania, Kosovo, Serbia and Romania came under
the banner of Islam. After a century, in 857AH/1453 CE, Sultan Muhammad Fateh
conquered Constantinople and thus the Roman Empire, stretching over fifteen
centuries, came to an end. This young Sultan also occupied Crimea, Trabzon, Greece,
51
Henry Flanders, A Treatise on Maritime Law (The Lawbook Exchange Ltd, New Jersey 2001) 4.
52
Gordon W. Paulsen, ‘Historical Overview of the Development of Uniformity in International
Maritime Law’ (1982-1983) Tulane Law Review, 1065.
19
Bosnia and Herzegovina and many Greek islands. And during the next century
Moldavia, Croatia, Slovenia, Cyprus, Rhodes, Hungary, Syria, Palestine, Jordan,
Egypt, Hijaz, Yemen, Iraq, Tripoli, Bahrain, Tunis, Algeria, Morocco, Mauritania,
Mali, Sudan, Somalia, Bornu (Nigeria), Bagermi (Chad) and Mombassa (East Africa)
all become Ottoman dominions. 53
The Ottoman Empire applied Islamic law for more than 600 years:
Up to the middle of the nineteenth century Islamic law was still theoretically
considered as the basic law in the Ottoman Empire. In practice, however, especially
when the relation with European countries began to increase due to trade and
diplomatic relations, certain regulations and tribunals supplemental to the Shari’a
Court were established mainly to handle matters related to commerce. Already in the
early nineteenth century the European traders were given a special license, known as
Berath (or letters patent), which exempted them from the proceedings of the Shari’a
Court. 54
Detailed studieshave shown that it is not accurate to assume that the relationships
between Islamic civilizations or Muslim empires and thoseof different religions can
only be characterized by crusades, conquests or military expeditions. Trade and
commerce based on mutual understanding and fairness are also some of
theserelationships’ defining characteristics.
During the Age of Navigation, the Muslim empire maintained and expanded a
massive trade network across various parts of Africa, Asia and Europe and was
considered a dominant world power from the seventh to the thirteenth centuries.
During the Age of Navigation Islamic principles were largely applied to maritime
trade and commerce in international transactions involving Muslim parties. The
defining criteria of these principles were adherence to the guidelines provided in the
Qur’an.
The Age of Navigation was also the golden age of Islam (750-1258). During this
era, efforts were made to incorporate the knowledge of other cultures and civilizations
as part of a strong tradition of seeking knowledge. Arabic literature was translated
into Hebrew, Ladino and Latin as part of its contribution to the development of
53
Samih Stretch/Mohsin Farani (trans), Atlas of the Islamic Conquests (Maktaba Dar-us-Salam, 2010)
28-29.
54
Ahmad Hidayat Buang, Studies in the Islamic Law of Contracts: The Prohibition of Gharar
(International Law Book Services 2000) 12.
20
European literature. In the field of medicine, writings from ancient Greek were
translated into Arabic and harmonized to provide new and useful knowledge. The
work of the Muslim scholar, Ibn Sina (popularly known in Europe as ‘Avicenna’),
was also translated into Latin and distributed throughout Europe at this time.
During this era, the Muslims’ navigational sciences were highly developed.
During this time, Europeemerged from its long sleep to overcome a variety of
obstacles and challenges. For example, between 1348 and 1350 one of the most
devastating pandemics in human history, the Black Death,devastated Europe and was
estimated to have killed 30 to 60 percent of the population. Between 75 and 100
million Europeans died due to the plague, and this had a significant impact on the
course of European history.
The close of the Age of Navigation witnessed the emergence of Western
colonialism, at which point the use of Islamic principles in trade and commerce began
to decline as Western laws gradually replaced Islamic law all over the world. Western
civilization was largely strengthened by its exposure to Islamic civilization during the
Age of Navigation. Exposure to Islamic civilization enabled the reintroduction of long
lost literature, particularly works from the ancient Greeks and Romans. The
knowledge amassed by the Muslims during the Age of Navigation was also
transferred to Europe as paper and books became more widely available. Western
civilization was also revived and strengthened through their exposure to and conflicts
with the Muslim empire. The fall of Constantinople and capture of the capital of the
Byzantine Empire due to the siege laid by the Ottoman Empire in 1453 marked the
end of the Roman Empire, which had lasted for 1,500 years. Many of the Greek and
non-Greek scholars fled or migrated to Italy and Europe totake part in the
Renaissance, an important turning point in history that resulted in a stronger Europe.
The development of maritime trade and transportation continues in Europe. In
Western Europe, the 1160 maritime code known as the Rolls or Judgments of Oleron
(hereafter the ‘laws of Oleron’) significantly contributed to this development. 55 This
last customary code later dominated English practice and, in the fifteenth century
(after the Age of Navigation),it was written down as the Black Book of the Admiralty
and became the basis of English maritime law. 56
The laws of Oleron contain the principles of all of the maritime laws of
European Western nations and are acknowledged for their great guidance, although
some of thesevere punishments and pecuniary mulcts (fines) for crimes and offences
fell out of use. 57
55
Robert Grime, Shipping Law (Sweet & Maxwell Limited 1991) 1.
56
Robert Grime, Shipping Law (Sweet & Maxwell Limited 1991) 1.
57
Henry Flanders, A Treatise on Maritime Law (The Lawbook Exchange Ltd 2001) 17.
21
Chancellor Kent, however, upon a review of various authorities arrived at the
conclusion that the earliest code of modern sea laws was compiled for the trading
republic of Amalfi at about the time of the First Crusade, towards the end of the
eleventh century. 58
From the eighth century until the fifteenth century, the Republic of Venice
(and other maritime republics) held a monopoly of European maritime trade with the
Middle East. A closer look reveals that comprehensive lawsfor maritime trade were
already available in the eighth century, albeit not in the English language.
While some Islamic principles have influenced the development of Western
law, their influence on maritime trade seems to be minimal. There are many
differences. For example, due to the prohibition against dealing in transactions tainted
by gambling or excessive uncertainty, Muslim sailors need to be paid a fixed wage
because employment contracts must clearly specify the wage amount and the exact
duration. The nature of maritime trade also differs because traders must share profits
and lossesin agreed proportions. During the golden age of Islamic dynasties Islamic
law, including Islamic trade law, was widely practiced. This immense empire
stretchedfrom the Chinese border in the east to the Pyrenees in the west and from the
Slavic lands in the north to sub-Saharan Africa in the south. 59 This new and immense
empire created novel trading systemswith various aspects, including maritime law,
that were based on what the Muslim believe to be a set of divine principles and
prohibitions. The scope of this new economic and geopolitical space was large and it
included the Indian Ocean, the Mediterranean, the Red Sea, the Atlantic Ocean, the
Caspian Sea and the Aral Sea. 60
From the beginning of the eighth century, the Muslim empire had within its sway
thousands of kilometers of coasts that allowed for the creation and development of
numerous activities connected to the sea, including the exploitation of marine
resources, the design of new boats, the creation of shipyards to build and repair war
fleets, the construction or enlargement of ports, the invention and perfection of
navigation instruments and the opening of new trade routes and revitalization of
58
59
Henry Flanders, A Treatise on Maritime Law (The Lawbook Exchange Ltd 2001) 10.
Ahmed Djebbar and Johanna M. Baboukis, ‘Arab Seafaring’ (The Oxford Encyclopedia of Maritime
History, 13 October 2009)
<http://www.oxford-maritimehistory.com/entry?entry=t232.e0035> accessed 6 January 2012.
60
Ahmed Djebbar and Johanna M. Baboukis, ‘Arab Seafaring’ (The Oxford Encyclopedia of Maritime
History, 13 October 2009)
<http://www.oxford-maritimehistory.com/entry?entry=t232.e0035> accessed 6 January 2012.
22
existing ones. 61 From the mid-eighth century there is also evidence of the presence of
Arab and Persian merchants in various areas, including Chinese ports such as
Guangzhou (Canton) in particular. 62
One of the defining differences between Islamic maritime trade laws and their
counterparts, including Western maritime trade laws, is the fact that Islamic trade law
is always based on the Qur’an and the Sunnah. It was based on these sources 1,400
years ago, it is based on themnow and it will be based on them a thousand years from
now. The principles remain feasible and practical because they promote fairness and
justice and are usually general in nature.
Substantial differences exist between Islamic principles and the other laws of
that time, although there are many similarities. It should be understood that Islamic
law accepts other laws, urf or customs as secondary sources unless theyare directly
contrary to the teachings of Islam. In Islam, the general theory is that everything is
permissible unless it is expressly prohibited by theQur’anor theSunnah, and not the
other way around.
Among the notable differences are the prohibitions under Islamic trade law
against hoarding, uncertainty, monopolies and riba’ or ‘usury’. The prohibition of
usury isin contrast to some ancient laws. For example, it is noted that during the
Babylonian period (1900BC- 732BC), King Hammurabi issued the code of
Hammurabi,which recognized the interest rate established during the Sumerian period
(3000BC - 1900BC) and adopted it as the legal rate (for almost 1,200 years). 63
Trade tainted by serious uncertainty or gharar is also strictly prohibited under
Islamic trade law. Bribery, unfair monopolies and oppression are also prohibited. The
influence of Islamic law can be witnessedin its application throughout the Umayyad
dynasty, the Abbasid dynasty and the Ottoman Empire. Its effect can also be seen in
Asia, especially beginning in the fourteenth century when it was used as the law of the
land during the Sultanate of Malacca (and later during the twentieth and
twenty-firstcenturies with the emergence of Malaysia as an Islamic finance hub). This
application of Islamic principles to trade and commerce gradually declined as
61
Ahmed Djebbar and Johanna M. Baboukis, ‘Arab Seafaring’ (The Oxford Encyclopedia of Maritime
History, 13 October 2009)
<http://www.oxford-maritimehistory.com/entry?entry=t232.e0035> accessed 6 January 2012.
62
Ahmed Djebbar and Johanna M. Baboukis, ‘Arab Seafaring’ (The Oxford Encyclopedia of Maritime
History, 13 October 2009)
<http://www.oxford-maritimehistory.com/entry?entry=t232.e0035> accessed 6 January 2012.
63
Sudin Haron and Wan Nursofiza Wan Azmi, Islamic Finance and Banking System: Philosophies,
Principles & Practices (McGraw-Hill (Malaysia) Sdn. Bhd, 2009) 164.
23
colonialism began. The 1511 fall of Malacca, an important Islamic trading centre,to
the Portugueseaccelerated the colonization of Asia.
There are a few defining characteristics that distinguish Islamic maritime trade
laws. First, although people from a variety of different races, nations and backgrounds
are Muslim, Islamic law, including Islamic maritime trade law, is always based on
theQur’an and theSunnah. This encourages consistency and certainty. Non-Muslims,
eg European traders, are given exemptions from Shariah law. Some non-Muslims are
willing to observe Islamic law, including Islamic maritime trade law. Some of the
reasons for this compliance include fairness, justice,property, honor, reputation and
the comprehensive protection of people’s lives. The application or adoption of a
foreign law is not entirely uncommon, and can typically be accepted by the
community as long as justice is observed. For example,commonwealth countries,
including those in Asia,adhere have to common law not because they were colonized
by the British, but because justice and fairness are evident in that form of law.In the
end, people will look at the essence of a law and see whether the element of justice is
there.
Islamic principles and Islamic law were widely accepted during the Age of
Navigation. Under Islam, local custom, also known as urf,was considered and
accepted as part of the law as long as it did not expressly contradict Islamic teachings.
However, a more comprehensive study shows that in many cases, local elements that
are contrary to Islamic teachings are also incorporated into local law. For example,
while the laws of the Sultanate of Malacca were largely based on Islam, contrary
elements were also included, such as the punishment of sula, which is based on Hindu
practices and directly contradicts Islam.
The decline of the Muslim empires at the end of the Age of Navigation can be
directly attributed to, among other things, the failure to maintain global trade and
commerce. By the end of the Age of Navigation, various Western nations had
attempted to break up the previous maritime trade route formerly dominated by
Muslim traders. For example, the fall of Malacca, the strongest Muslim nation in Asia
in the fifteenth century, to the Portuguese eventually led to the colonization of Asia by
the West. 64 The colonization of Asia, rich with luxurious minerals including gold,
silver, spices and other luxurious commodities, 65 brought a huge fortune to the
Western countries. Colonialism was successful because many of the local leaders in
Asia at that time were inefficient, corrupted and poorly coordinated with some
64
In 1511, Alfonso de Albuquerque conquered Malacca (then the main centre of Asian trade) on
behalf of Portugal.
65
Colonialism led the Western countries to the secret location of the ‘spice-islands’ or Maluku. Banda,
in Maluku, was the only known source in the world of nutmeg and cloves at that time.
24
actingas proxy to the Western colonial powers. This is compared to the superior
leadership, strong will, better weaponry and ships of the Western colonial powers.
The significance of the historical effect of the fall of Malacca should not be
underestimated. Tome Pires, an apothecary who spent from 1512 to 1515 in Malacca,
boldly stated in his famous book, the Suma Oriental, that‘Whoever is lord of Melaka
has his hand on the throat of Venice’. 66The colonization and creation of Western
empires hadboth positive and negative effects. According to Freeman:
While some pragmatic Christian city states, such as Venice and Genoa, had made a
kind of commercial treaty with the Muslim Arabs that gave them a European
monopoly on eastern luxuries imported through Egypt and other Arab lands, the
Portuguese and the Spanish, with their implacable hatred for Islam, sought ways to
bypass this monopolistic structure and establish their own trading systems with China
and India... The Portuguese program of commercial expansion in both the Old and the
New World was, thus, both aggressive and well-coordinated at the national level. 67
This research argues that the removal of unnecessary uncertainties and risks would
strengthen global maritime trade. The application of Islamic principles by Muslim
traders during the Age of Navigation, including the rejection of excessive speculative
activities and unjust uncertainties, justified the view that global maritime trade is not
against such applications. It demonstrates that as long as such applications bring
useful benefits to the global traders’ community, they will be welcomed. The doctrine
on gharar manifested itself at various levels in this age, from the requirement of
mutually agreed and fixed wages for sailors to the insistenceon clear aqad or contracts
between parties with a fair allocation of risks and profits.
2.1.3
Age of Discovery (the fifteenth century to the seventeenth century)
The Age of Discovery (also known as the Age of Exploration) was an historical
period in which brave Europeans explored the world, largely uncharted at that time, in
search of gold, silver, spices and with the aim of spreading their religions and beliefs.
This European exploration led to the rise of the colonial empires. Beginning in 1418
the Portuguese, under the sponsorship of Prince Henry, managed to systematically
66
The Suma Oriental of Tome Pires, 15, 19, 56, 144-145, 287 [This book is the first European
description of Malaysia. It compiles detailed information about the situation there in the sixteenth
century, including the historical background, geography, economy, commercial culture and monetary
system].
67
Donald B. Freeman, The Straits of Malacca: gateway of Gauntlet (McGill-Queen's University Press
2003) 91.
25
explore the Atlantic coast of Africa. In 1498, Vasco da Gama reached India by sailing
around Africa, enabling direct trade with Asia.
During the Age of Discovery, attempts were made to overthrow the Ottoman
Empire, but they failed. In 1444, Europe formed an alliance to conquer the Ottoman
Empire, but that effort failed as well. By 1453 Sultan Muhammad II besieged
Constantinople (Istanbul) and Constantinople was conquered. This was followed by
numerous conquests including the Serb lands and Athens (Greece) in 1461, Wallachia
(Romania) in 1463, Albania, Amastris (Amastra), Sinop and Trabzon (Turkey) in
1464, Hungary in 1464, Bosnia and Herzegovina in 1465, Slovenia in 1484, Croatia
in 1484, Syria in 1516, Al-Hijaz in 1517, Belgrade in 1521, Buda (Hungary) in 1541,
Cyprus in 1570 and Moscow in 1571. 68 Despite this series of victories, the Muslim
empire became a victim of its own success:
The extraordinary enterprise represented by the Muslim scholarship, science, religion
and commerce probably reached its highest level of achievement at the end of the
fifteenth century; the reversal since that time has been quite remarkable. From around
the middle of the sixteenth century, Islamic learning began to be superseded by
dramatic growth of knowledge in the West. In this last respect, the Muslim world was
actually a victim of its own success. The fall of Constantinople to the Turks in 1453
prompted a mass exodus of Byzantine scholars to Rome and other European centres
of learning. They brought with them the learning of ancient Greece, which had been
preserved in the libraries and universities of Byzantium, and thereby set in motion a
process of intellectual reawakening which eventually brought about the eclipse of
Islam as a world power. 69
In Asia, the Age of Discovery began with a sense of promise with the voyage of
Muslim commander Cheng Ho of China, but was abruptly halted when China
changed its policy to discourage and, in some cases,even prohibit maritime trade.
Between 1405 and 1421 China’s third Ming Emperor, Yongle, sponsored a maritime
expedition under the Chinese Muslim commander, Cheng Ho thattook 300 strong
shipsto Arabia, East Africa, India, the Malay Archipelago and Thailand. 70 However,
upon the demise of Emperor Yongle, the Ming dynasty mistakenly retreated into a
68
Samih Stretch/Mohsin Farani (trans), Atlas of the Islamic Conquests (Maktaba Dar-us-Salam, 2010)
422-423.
69
Angelo M. Venardos, Islamic Banking and Finance in South-East Asia: Its Development and Future
(3rd edn, World Scientific Publishing Company 2011) 17.
70
See Louise Levathes, When China Ruled the Sea: The Treasure Fleet of the Dragon Throne,
1405-1433 ( Oxford University Press 1997)
26
policy of isolationism that prevented global maritime trade and proper contact with
the outside world. This significantly limited the potential growth of China during that
time and they failed to prevent the colonization of various Asian countriesat the hands
of the Westdespite strong, long-lived, traditional ties:
The only Asian power that might have challenged Portuguese incursions, China, had by
this time turned inward, relinquishing any political interest in Southeast Asia under the
xenophobic policies of the Manchu overlords. 71
The rapid expansion of Western colonial powers during this time was also largely due
to their technological advancements in shipping and weaponry:
At sea the Portuguese were, at least in the short run, able to exert the necessary
military power to choke Muslim maritime trade. Portuguese guns turned out to be
more effective (though not more numerous) than Asian guns. European advances in
the technology of gunmaking had overcome many of the problems that beset late
medieval cannon. In particular, with the development of cast bronze guns, the weight
of cannon had been much reduced and, although still prone to this problem, they were
much less likely to blow up in the faces of the gunners than the welded pieces that
preceded them. Again, Portuguese vessels, built for the inhospitable Atlantic, were
more solid than those of their Muslim adversaries. Cipolla puts it in this way: ‘The
gunned ship developed by Atlantic Europe in the course of the fourteenth and
fifteenth centuries was the contrivance that made possible the European saga. It was
essentially a compact device that allowed a relatively small crew to master
unparalleled masses of inanimate energy for movement and destruction’. 72
The development of the legal framework governing maritime trade entered a new
phase during this time. In the sixteenth century, a national maritime law was
prospering independently using the codification of several national maritime codes. 73
The origin of the admiralty law in a country like England is not clear, but it has been
suggested that it can be traced to the reign of Edgar because the seals of the Judicial
71
Donald B. Freeman, The Straits of Malacca: gateway of Gauntlet (McGill-Queen's University Press
2003) 91.
72
John Law, ‘On Social Explanation of Technical Change: The Case of the Portuguese Maritime
Expansion’ (1987) Technology and Culture, Vol. 28, No.2 (April), 247.
73
Fan Wei, ‘The Measurement of Damages in Carriage of Goods by Sea- A Comparative Study of
English and Chinese Law with a view to Possible Revisions of the Chinese Maritime Code and other
Legislation’ (PhD thesis, University of Exeter 2008).
27
Committee of the Privy Council, with which all admiralty appeals are sealed, bear
Edgar’s name and title.
English maritime law more closely resembles the European civil law system than
English common law because it originated in the Mediterranean and Europe. 74 In the
latter part of the fourteenth century, admiralty courts were set up and they followed
civil law and procedures. 75 The lawyers and judges of the admiralty were trained in
the Roman legal tradition and made use, accordingly, of civil law in their arguments.
This changed only after the common law court restricted the jurisdiction of the
admiralty court around 1669-70, 76 at which point the influence of civil law on
English maritime law started to decline. 77
The Age of Discovery firmly influenced the flow of history. This period ushered
in claims of superiority by Western colonial powers. With the wealth from the
colonized countries, particularly gold and silver, transferred from mineral-rich Asia to
the West, the Western colonial nations grew stronger and richer while the people of
the colonized countries grew poor and subservient to their colonial masters. This
circle of oppression took centuries to break and it happened, gradually, only after
World War II, partly due to changesin policy and largely due to local resistance.
During the Age of Discovery, Muslims continued to apply Islamic principles
totheir trade and commerce transactions. However, such an application on a national
or state level among the colonized Muslim countries dropped to a minimum as
Western colonial powers became the dominant force in maritime trade, and their
strong hostility towards Islam was often reflected in their discrimination towards
Muslim traders:
The gratuitous and indiscriminate violence of Portuguese assaults in their first phase
frequently was successful, despite the overwhelming numerical superiority of the
74
Fan Wei, ‘The Measurement of Damages in Carriage of Goods by Sea- A Comparative Study of
English and Chinese Law with a view to Possible Revisions of the Chinese Maritime Code and other
Legislation’ (PhD thesis, University of Exeter 2008).
75
Fan Wei, ‘The Measurement of Damages in Carriage of Goods by Sea- A Comparative Study of
English and Chinese Law with a view to Possible Revisions of the Chinese Maritime Code and other
Legislation’ (PhD thesis, University of Exeter 2008).
76
Fan Wei, ‘The Measurement of Damages in Carriage of Goods by Sea- A Comparative Study of
English and Chinese Law with a view to Possible Revisions of the Chinese Maritime Code and other
Legislation’ (PhD thesis, University of Exeter 2008).
77
Fan Wei, ‘The Measurement of Damages in Carriage of Goods by Sea- A Comparative Study of
English and Chinese Law with a view to Possible Revisions of the Chinese Maritime Code and other
Legislation’ (PhD thesis, University of Exeter 2008).
28
Muslims, because Muslim ships in the Indian Ocean, unlike those in the
Mediterranean, rarely carried arms and used ships that were ill suited to the mounting
and firing of cannon. The Ottoman empire and the Mamluk state in Egypt faced many
challenges internally and on their other frontiers and had to mount their Indian Ocean
expeditions from desert coasts; they were only occasionally able to send a major fleet
to defend their fellow Muslims in India against Portuguese attacks and did not
establish a permanent base or presence on the Indian coast. The Portuguese Estado da
India was a ramshackle and conflict-ridden structure, but the Muslims in the Indian
Ocean had no overarching political structure of their own. 78
The Age of Discovery was characterized by Western expansion. Colonialism is
defined in the Concise Oxford Dictionaryas ‘a policy of acquiring or maintaining
colonies’. 79 This policy is regarded as ‘the economic exploitation of weak or
backward peoples by a larger power’. 80
A varietyof detailed literature on European expansion is available. 81 Jonathan
Israel’s Dutch Primacy in World Trade comprehensively explained the rise of the
Dutch colonial power in Asia andthe influence of its strong naval power and
elaborated on how Asian trade assisted Dutch control of European trade. 82
Bayly’s Imperial Meridian is also fundamental to understanding British colonial
power and the results of its interactions with others, including the Muslim empires. 83
This book brought into focus developments throughout the world in the period of the
French Revolution, the Napoleonic Wars and their aftermath. Bayly proposed that the
control of a colonial power like that of the British is not merely due to British policies,
but instead was more influenced by the degree of centralization or central rule
possessed by each of the Muslim empires.
78
John E. Wills (reviewer), ‘Maritime Asia, 1500-1800: The Interactive Emergence of European
Domination’ (1993) The American Historical Review, Vol. 98, No.1 (February), 93.
79
The Concise Oxford Dictionary of Current English (Oxford University Press 1998) 260.
80
The Concise Oxford Dictionary of Current English (Oxford University Press 1998) 260.
81
These include C. R. Boxer, The Dutch Seaborne Empire 1600-1800 (Penguin Books 1990); C.R.
Boxer, The Portuguese Seaborne Empire,1415-1825 (New York 1969); J. H. Parry, The Age of
Reconnaissance (London 1963); J.H Parry, The Spanish Seaborne Empire (New York 1966); J.H.
Parry, The Discovery of the Sea (Berkeley 1981) and Malyn Newitt, Portugal in European and World
History (Reaktion Books Ltd 2009).
82
83
Jonathan I. Israel, Dutch Primacy in World Trade, 1585-1740 (Clarendon Press 1989).
C.A. Bayly, Imperial Meridian; The British Empire and the World 1780-1830 (Studies in Modern
History) (Longman 1989).
29
Tracy’s work suggested that there are many reasons for the dominance of
European colonial power in maritime trade:
In responding to this question, one can argue that Europeans had better means of
transportation, or better business methods, including more sophisticated forms of credit.
Alternatively, one can contend that Asian business methods were in no way inferior,
armaments for commercial aims. Finally, one may conclude, as Professor Steensgaard
does in an important essay, that Europeans succeeded because they created forms of
organization in which ‘the use of violence was subordinated to the rational pursuit of
profit’. 84
Chaudhuri’s work on the relationship between the East India Company and Asia
is also detailed and useful. 85 The bookexplained elements such as the nature and
structure of international trade between Europe and Asia, the structure of early trade
and the pattern of commercial settlements in Asia, the movements in total exports and
imports, the monetary system and the structure of country trade in Asia.‼!
Pearson’s work clarifies the nature and extent of the first European imperial
power in Asia, the Portuguese. 86 According to Pearson, the aim of his work is ‘to
assess the influence or impact of the Portuguese on India’. He provides a detailed
account ofthe Portuguese and their activities in the Indian Ocean beginning in the
sixteenth century. Pearson suggests that the actual impact of Western colonial power
on colonized countries like India was actually more limited than previously assumed.
2.1.4
Age of Sail (the seventeenth century to the mid-nineteenth century)
During this age, global trade and commerce continued to flourish. However, the
unfairness and injustices in global trade and commerce were evident. A monopoly of
the world’s wealth was focused on a few select, rich nations and even among these
rich nations the wealth circled a smaller group of rich traders, royals and elites.
Significant portions of the world community were illiterate at this time.
The domination of the Western colonial powers continued, largely due to its
strong navy. According to Benjamin and Thornberg:
84
James D. Tracy, The Political Economy of Merchant Empires: State Power and World Trade,
1350-1750 (Studies in Comparative Early Modern History) (Cambridge University Press 1997) 2.
85
K.N. Chaudhuri, The Trading World of Asia and the English East India Company: 1660-1760
(Cambridge University Press 2006).
86
M. N. Pearson, The Portuguese in India (The New Cambridge History of India) (Cambridge
University Press 2006).
30
The British Navy in the age of sail was the most successful bureaucracy of its time. Its
organization and incentive structures differed importantly from contemporaneous
private sailing ventures, but closely resembled those of today’s large corporations. To
induce efficient effort, the navy used a hierarchical tournament, in which sailors
competed for higher pay that came with promotions based on relative performance.
Promotion probabilities, the option value of future promotions, and the higher effort
required of men in higher ranks and on larger vessels, combined to yield a highly
skewed pay structure. 87
From 1690 to 1725, piracy became a very serious threat, to the extent that this period
is also known as the golden age of piracy. However, the nineteenth century is also
known as the golden Age of Sail in Europe when the use of commercial sailing
vessels reached its peak. The main challenges in this era includeda lack of quality
ships that could survive long voyages and rampant piracy.
The application of Islamic principles in financing and global trade and commerce
gradually declined during this period, together with the decline of the Muslim
empires:
At times, Muslim states have played dynamic roles in commerce. Historians speak as
readily of Fatimid or Ottoman trade as they do of Muslim trade. The 18th century
found the larger Muslim states in reduced political circumstances, and this extended
to commerce as well. For instance, the Mughals of Delhi lost control over the port of
Surat by the 1730s; after the death of Nadir Shah (1747), the ports of Iran changed
hands frequently and were seldom subject to any central authority. Instability or
inadequate state institutions could lead to a decline in trade, more specifically, to
arbitrary trade practices, fear of theft and injury, and a decline in the consumer
population. However, while large states were in decline, Muslims found state
structure in small, localized polities: Kuwait, Qatar, and Bahrain under various cUtbi
Arabs; Omani and East African ports under the Al bu Sacid; and largely Hindu
Mysore under the Muslim Tipu Sultan. 88
87
Daniel K. Benjamin and Christopher Thornberg, ‘Organization and incentives in the age of sail’
(2007) Explorations in Economic History 44, 317-341.
88
Patricia Risso, ‘Muslim Identity in Maritime Trade: General Observations and Some Evidence from
the 18th century Persian Gulf/Indian Ocean Region’ (1989( International Journal of Middle East
Studies, Vol. 21, No.3, August, 382.
31
2.1.5
Modern Era (the mid-nineteenth century onward)
The failure of the Muslim scholars to develop proper Islamic financial products
contributed indirectly to the collapse of the last Muslim empire:
The modern Western banking and insurance industries started their development over
300 years ago, in the mid-17th century, when development in mathematics and
statistics provided powerful tools for financial mathematics and actuarial science
which were paralleled by the emergence of a number of major banks and of the
Lloyd’s insurance market in England. These tools were further developed over the
following centuries, also influencing the development of economics, especially in the
late 19th and early 20th centuries, which saw the beginning of modern financial
economics with work such as that of Jevons, Bohm-Bawerk, and Fisher. Such tools,
however, were and largely interest-based as well as having other characteristics that
are not Shari’ah-compliant. There was no parallel development of Shari’ah compliant
tools in the Muslim world, then dominated (and in the Middle East and North Africa,
controlled) by the Ottoman Empire, which did not accord priority to institutional
development. The Ottomans, in their complacent belief that the Muslim world
maintained the intellectual and cultural superiority over Western Christendom that it
had possessed in the centuries preceding the Renaissance in Western Europe, did not
encourage their subjects to participate in the major developments taking place in the
latter. This complacency extended to financial services; in the Ottoman Empire,
commerce relied on forms of financing that did not involve banks as financial
intermediaries… 89
Two of the biggest world wars occurred in the Modern Era. The development of the
world economy and the rise of new superpowers were influenced by these two wars.
World War I was a major war occurred in Europe from 1914 until 1918. More than 70
million military personnel were involved and around 9 million combatants were killed.
The total number of casualties in World War I exceeded 35 million, with more than
15 million deaths and 20 million wounded. While the previous European alliance in
1444 failed to overthrow the Ottoman Empire, this time around they succeeded. By
the end of the war, the German Empire, the Russian Empire, the Austro-Hungarian
Empire and the last Muslim empire, the Ottoman Empire,had all been defeated.
World War II stretched from 1939 to 1945 and involved all of the world’s great
powers at that time. More than 100 million military personnel were mobilized in the
series of conflicts between the Allies and the Axis. It was the deadliest conflict in
89
Simon Archer and Rifaat Ahmed Abdel Karim (eds), Islamic Finance: The Regulatory Challenge
(Wiley 2007)
32
human record with between 50 and 70 million deaths. The war finished with the
success of the Allies over Germany and Japan in 1945.
The end of World War II (and the Cold War) led to the emergence of the United
States as the only world superpower. Peace paved the way for global economic
recovery. Colonialism also gradually ended and attempts at peaceful conflict
resolutions were strengthened by the establishment of the League of Nations and, later,
the United Nations.
The application of Islamic principles to trade and commerce waspeacefully
revived during this period. While the previous era was marked by imperialism, wars
and oppression, the existence of the United Nations and the desire to avoid war
createdthe better potential for peaceful interactions between people from different
nationalities, religions and backgrounds.
For example, modern Islamic finance, a financial system that emerged around
the 1970s through institutional involvement is now included in the financial portfolios
of various non-Muslim jurisdictions, including the United Kingdom, Singapore and
Hong Kong.
It has been proposed that global maritime trade could be strengthened by the
voluntary application of Islamic principles that stress justice, fairness and equity. The
future direction of world history is hard to identify, although it is clear that there are
two possible paths. The first path is the path of conflict and violenceand the second
path is the path of mutual respect, prosperity and peace.
It is possible for the world community to strive for a better future in which
people tolerate each other’s differences and cooperate in matters involving mutual
interests. To achieve this, balanced and fair media coverage is necessary, as is the
rejection of anti-Semitic, anti-Islam and racist politics. Unnecessary provocations
from both sides should be avoided and politicians must refrain from using religious
and racial sentiments for short-term political benefit. Islamic finance is another way to
improve mutual understanding and set aside prejudice and bias. Hopefully, the world
community will opt for the second path.
This research proposes that the gradual integration of Islamic principles into
global trade and commerce wouldbe a departure from the traditional practice of
discrimination and intolerance based on beliefs or religion. Modern maritime trade
law is not just a mixture of various ancient laws, it represents a new system shaped by
international conventions, national legislations and commercial needs. Its purpose is
to comprehensively govern, facilitate and assist maritime trade and settle modern
maritime disputes that sometimes consist of new challenges, including e-commerce,
electronic bills of lading, conflicts of law and much more.
33
Most of the documents involved in international trade are quite uniform and are
only drafted after careful analysis. Accordingly, the elements of uncertainty should be
reduced. However, despite even careful drafting of modern contract documents and
the benefits of the modern global trade system, many uncertainties remain.
Unmonitored and misused financial engineering is one of the main challenges facing
maritime trade in the Modern era. Currently, maritime trade is growing more fragile
and risky due to excessive speculative activities:
If our industry continues to deteriorate into nothing more than a speculative
hothouse, shipowners and ship managers like ourselves will continue to be penalised for
the actions or inactions of the quasi-owners, whom in turn, get away scott-free and
continue their destructive ways... 90
2.2 Maritime Trade in Southeast Asia
To travel in Europe is to assume a foreseen inheritance; in Islam, to inspect that of a
close and familiar cousin. But to travel in farther Asia is to discover a novelty
previously unsuspected and unimaginable.
-Lord Byron, English Poet
There are around 240 million Muslims in Southeast Asia, close to 40 percent of the
area’s entire population. The majority of the populations of Indonesia, Malaysia and
Brunei are also Muslim. From thisperspective, the rise of Islamic finance in Southeast
Asia is not surprising. However, the acceptance of Islamic finance among Southeast
Asia’s non-Muslim community, particularly Malaysia, is an indication that the
application of Islamic principles to trade and commerce is both useful and marketable.
This research proposes that the voluntary application of Islamic principles to maritime
trade will create more chances for diversification and further strengthen global trade,
and Southeast Asia would be a good starting point.
Southeast Asia is a sub region of Asia that consists of the countries south of
China, east of India, west of New Guinea and north of Australia.Many of the
countries in Southeast Asia were maritime nations with adequate legal and regulatory
frameworksfor governing maritime trade, even before Western colonialism in the
sixteenth century:
90
Keith Wallis, ‘Speculation Blamed for Woes’ South China Morning Post (11 November 2011)
<http://www.scmp.com/article/984531/speculation-blamed-woes> accessed 20 October 2011
34
From the legal point of view, it is important to note the existence of a written
maritime code in Malacca, compiled during the reign of Sultan Mahmoud Shah at the
end of the fifteenth century, codifying commercial and maritime usages. The Malacca
Code contains interesting rules about the rights of the captain of the ship, who was
considered “the sovereign at sea”, and those of sailors, as well as about the
maintenance of law and order on the high seas, and the organization of trade on a ship.
While it was the task of the ship’s captain to settle disputes on the ship and to punish
offenders, the pilot officer (Ma’lim) was charged with the direction of the vessel and
with all the technical details of its navigation. Other rules related to fishing, ships in
distress, and shipwreck. The legal status of the ship changed as soon as it entered
harbor. There the captain’s exclusive jurisdiction was replaced by the jurisdiction
exercised by the Shahbandar or harbor master. 91
The current population of Southeast Asia is estimated to be around 593,000,000.
Southeast Asia’s GDP in 2009-10 wasUS$1.486 trillion. In comparison, the
population of China in 2010 was estimated to be around 1,339,724,852, but its GDP
in 2011 was around US$11.316 trillion. Therefore, while the population of Southeast
Asia is almost half that of China, the collective GDP of the Southeast Asian
countrieswas less than 20 percent of China’s.
Despite the collectively low GDP of Southeast Asian countries, individual
Southeast Asian maritime jurisdictions like Singapore and Hong Kong have some of
the highest GDPs in the world. For example, Singapore’s GDP in 2010 was around
US$291.9 billion (the 41sthighest in the world) while their GDP per capita was
US$62,100 (the 5th highest in the world). Hong Kong’s GDP in 2010 was around
US$326 billion while their GDP per capita was around US$45,736 (the 9th highest in
the world).
Many Southeast Asiancountries are maritime nations. Hong Kong and Singapore
are excellent examples of maritime trade centers that managed to maximize their true
potential through efficient leadership, effective planning, conducive trade
environments, almost flawless implementation and mutual cooperation. In contrast,
there are some maritime nations whose geographical locationsare ideal for maritime
trade and commerce, like Malaysia and Indonesia,yetthey still lag behind with their
true potential left largely untapped, partly due to ineffective management and rampant
corruption.
This research analyzes the reasons for the rise of some maritime trade centers,
like Hong Kong and Singapore. Comparisons will then be made between these
91
R. P. Anand, ‘Maritime Practice in South-East Asia until 1600 A.D and the Modern Law of the Sea’
(1981) The International and Comparative Law Quarterly, Vol. 30, No. 2 (April) 446.
35
successful maritime trade centers and Malaysia to understand why the latter failed to
achieve similar success despite its strategic location and various opportunities.
This comparison and brief detour from the theme of Islamic finance is arguably
necessary to show that a country’s legal and regulatory framework and its economic
environment must first be generally sound before the detailed application of Islamic
finance principles such as the rejection of excessive speculative activities can be
achieved.
36
2.2.1
Maritime trade in Singapore
An analysis of Singapore’s success reveals that it is largely due to sheer determination,
strategic planning and meticulous executions. It is not simply due to location. Other
maritime nations in Southeast Asia are also strategically located, including Malaysia,
Indonesia and Vietnam. However, none of them have achieved a similar level of
success. Still, strategic location plays important role as well. Singapore is located at
the centre of a web of trade routes and is connected to more than 600 ports in over
120 countries.
There are a varietyof other reasons for Singapore’s success. First, Singapore’s
legal environment is conducive to shipping and international trade and commerce.
The level of corruption in Singapore is one of the lowest in the world. 92 This is partly
due to the strict and independent enforcement of the laws that govern criminals.
Various effective actions are currently in place to reduce corruption in Singapore,
including educating the public, heavy punishment, independent enforcement bodies
and ensuring that government officials are being paid proper, sometimes high salaries.
Singapore’s low level of corruption is directly important to its prosperity as an
international maritime trade centre. If corruption were high, investors and
international traders and shippers would shy away from Singapore and the cost of
conducting business and trade there wouldincrease (due to bribery, etc.). Furthermore,
corruption and unnecessary bureaucracy would make the trading process slower and
much less attractive.
Singapore’s positive legal environment can be viewed from multiple
perspectives. It has a judiciary system that is supportive of international trade. This is
in line with its position as an important international trade centre. Second, there are
numerous experts in Singaporein every aspect of maritime trade, from advocates and
solicitors to maritime arbitrators.
Singapore’s huge pool of talent is the result of its positive attitude towards
professionals and experts from other nationalities. In other words, Singapore offers
various incentives to attract the best brains from all over the world. Out of a
population of 5 million, 1.2 million of the people in Singapore are not residents and a
large number of the non-residents are actually experts from various fields.
Third, Singapore’s stability has contributed significantly to its success. Riots and
other political instabilities are almost unheard of in Singapore. The government
largely enjoys strong support from the population. In return, this political stability
enables the government to plan its economic direction without much hassle. The
92
For example, see Jon S.T. Quah, ‘Combating Corruption in Singapore: What can be learned?’
(2001) Journal of Contigencies and Crisis Management, Volume 9, Number 1 (March)
37
strong support is partly due to the efficient administration of the government, coupled
with a low level of corruption among government officials.
Fourth, the strong support of the government and a clear and effective plan for
the future direction of the economy hasproven effective. Singapore’s strategic
location along major sea-lanes and the existence of a large pool of experts have given
Singapore an economic importancethat is disproportionate to its small size. However,
the clear and effective plan for the future direction of the economy is the defining
difference responsible for Singapore’s success. Politicians, with the help of
experts,meticulously provided the country with an economic plan and the
implementation was flawless.
On the national level, the government promotes high levels of savings and
investment via the Central Provident Fund and a large portion of the governmental
budget is spenton education and technology. Singapore’slarge governmental reserve is
evidence of this strategic planning. As a maritime nation that depends heavily on
international imports and exports, the global financial crisis could have had a
disastrous effect on Singapore. However, due to its strategic planning and the
resulting reserve, they have been able to survive financial crisis. Strategic economic
planning also minimizes costs while increasing productivity and outcomes.
Singapore’s ability to establish a clear and effective plan for the future direction
of its economy is thanks, in part, to the large number of highly qualified and educated
people serving as government officials. A deeper analysis reveals that many of
Singapore’s Cabinet members possess postgraduate degrees from established and
respected international universities from all over the world,unlike the Cabinet
members of some of Singapore’s neighbouring countries who are not as
well-educated.
A government’s establishment of suitable authorities is also relevant. According
to Khalid et al:
The ‘champion agency’ at the forefront of developing Singapore’s maritime prowess
is the Maritime and Port Authority of Singapore (MPA). MPA is one of the four
statutory boards established by the Singaporean government to oversee all port and
maritime affairs of Singapore. It also plays a leading role in promoting Singapore as a
premier global hub port and International Maritime Centre (IMC) and to protect its
strategic maritime interests. It also acts as the regulatory body for Singapore Port and
oversees the country’s maritime affairs. To ensure that the Singapore Port stays
38
relevant and important internationally, the MPA recently formulated an integrated
master plan called Port Improvement Plan of Singapore (PIPS). 93
Singapore also possesses advanced and efficient infrastructures that are capable of
meeting the complicated demands of global maritime trade.
History of Singapore
Singapore has a colorful history. It is the smallest country in Southeast Asia, an
island-city located south of Johor (Malaysia) and north of Riau (Indonesia). Despite
its small size, Singapore is one of the most advanced and developed countries in the
world. Before 1819, only a few hundred local Malays, living simple lives in fishing
villages, populated Singapore. 94 This changed in 1819 with the arrival of Sir Thomas
Stamford Raffles (1781-1826) who, acting on behalf of the British East India
Company, took over Singapore. 95 The first major event was Britain’s takeover of
Singapore from the Dutch. Singapore was a very important part of the English East
India Company’s (EIC) ambitious plan to control the Straits of Malacca. Control over
Penang allowed the EIC to control the northern entrance of the Straits while control
over Singapore gave it control over the southern exit. 96
Singapore was the first modern free port in Southeast Asia and it rapidly
overtook Penang and Malacca to become the most important centre of regional and
international maritime trade in the Malay Archipelago. 97 Singapore was originally
under the influence of the Malay Sultan but the British pretended to set up a factory,
which helpedthem obtain the necessary approval from the Sultan to operate and, later,
provided the foothold needed take full control of the island. This was done to break
the Dutch domination of the maritime route along the Straits of Malacca. For nearly
93
Nazery Khalid, Armi Suzana Zamil and Farida Farid, ‘The Asian Experience in developing the
maritime sector: Some case studies and lessons for Malaysia’ (Maritime Institute of Malaysia)
<http://www.mima.gov.my/index.php?option=com_content&view=article&id=166&catid=43&Itemid
=89> accessed 16 November 2011.
94
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 113.
95
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 113; Stephen Dobbs,
‘Singapore’ (The Oxford Encyclopedia of Maritime History)
<http://www.oxford-maritimehistory.com/entry?entry=t232.e0782> accessed 6 January 2012.
96
Peter Church (ed), A Short History of South-East Asia (5th edn, Wiley 2009) 143.
97
Stephen Dobbs, ‘Singapore’ (The Oxford Encyclopedia of Maritime History)
<http://www.oxford-maritimehistory.com/entry?entry=t232.e0782> accessed 6 January 2012.
39
200 years the Netherlands United East India Company (VOC) has been the EIC’s
archrival in Southeast Asia. 98
The British commercial community strongly favored the acquisition of
Singapore, seeing it as a boost to trade in Southeast Asia. 99Singapore attracted traders
from China, India and other regions due to its nature as a free port. The free trade
policy was in direct contrast to the cruel monopoly used by the Dutch and resulted in
fantastic growth from £2,610,000 in 1825 to £10,062,187 in 1857. 100
The second major event was the fall of Singapore to the Japanese imperial forces.
Singapore fell during the Japanese invasion of 1942 and the Chinese, Indian and
Malay communities suffered greatly for almost four years at the hands of the
Japanese. 101 After Britain re-occupied Singapore in 1945, the policy was changed.
The British envisionedan independent Malaya, but initially decided to maintain
control of Singapore to maintain British commercial interests in Southeast Asia, to
use Singapore’s strategic location to establisha British naval base andfor fear that
Singapore might becomethe fifth ‘communist column’ in Southern Asia. 102 The third
major event was independence from both Western colonialism and Malaysian control.
In 1963, Singapore joined Malaysia and the union marked the end of Western
colonialism in Singapore. After two years in this tense partnership, due to racial and
ideological differences, among other things, Singapore broke its tie to Malaysia 103
and started over with the facilities it had gained. For example, according to Good:
In August 1965, when Singapore gained independent sovereignty after a brief union
with Malaysia, possibilities seemed limitless for the city-state’s new government,
economic prosperity seemed extremely far away. … the myth that Singapore,
beginning at independence, arose out of the abject poverty of a backwards fishing
village to an advanced economy in twenty or thirty years, is clearly misleading. In
1965, the city was already one of Asia’s most developed centers, described as the
‘New York of Malaysia,’ where ‘trade, commerce, and business flourish.’ These
characteristics, as well as the port assets and related facilities that the British handed
over to the government at final withdrawal in 1971, were the legacy of its trading
history, and what Lee Kwan Yew, Singapore’s long-time prime minister who would
98
Peter Church (ed), A Short History of South-East Asia (5th edn, Wiley 2009) 143.
99
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 114.
100
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 215.
101
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd, Singapore 1995) 119.
102
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd, Singapore 1995) 119.
103
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd, Singapore 1995) 120.
40
lead the country through economic growth, acknowledged was a ‘modern city’ at the
time of independence. 104
Singapore’s growth is still remarkable. There are a number of reasons forthis success,
including: (1) a strong, stable and corruption-free government that carefully planned
developments, (2) economic policies that created an ample national reserve, (3) fair
social policies that ensured benefits to all Singaporeans and (4) an
excellent,comprehensive education system. 105 Singapore also adopted various
measures to prevent corruption and inefficiency,with everyone from politicians to
laborers subject to the law. By the late nineteenth century, Singapore had become an
important and established financial and commercial centre and a major transshipment
port. 106An important lesson to be taken from all this is that history might influence or
shape a country, but the sheer determination of that country’s leadership and its
people is the main factor responsible for its success.
Singapore’s Conducive Legal System
Fiat justitia ruat caelum. ‘Let justice be done though the heavens fall’. 107– Latin
maxim
The British ruled Singapore from 1819 to 1942. Understandably, aspects of
Singapore’s present-day legal system, which is highly conducive to trade and
commerce, are based on the English Common Law system. The main source of law,
however, is the legislation that governs almost all matters, including contractual
relationships between parties, administration, property law and maritime law.
Similar to Malaysia, some of the Singaporean statues are based on other
jurisdictions, including India and Australia, rather than on English Common Law. For
example, Malaysia and Singapore’s penal codes and evidence law have Indian
origins.
104
John Patrick Good, ‘Present and Future Singapore: Internal Challenges & Strategic
Regionalism’(2010) The Senior Essay in International Studies
<http://pro.jpgnexus.com/assets/portfolio/writings/John_Good_IS_Senior_Essay.pdf>
accessed
16
November 2011.
105
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd, Singapore 1995) 121; Peter
Church (ed), A Short History of South-East Asia (5th edn, Wiley 2009) 152.
106
107
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 115-116.
Fiat justitia ruat caelum is a Latin legal phrase meaning ‘Let justice be done though the heavens fall’.
This maxim highlights that justice must be realized, regardless of consequences.
41
In 1823 Raffles enacted ‘regulations’ for Singaporean administration. Similar to
British practice in other Malaya states, Raffles appointed John Crawfurd as the
Resident of Singapore. As Resident,Crawfurd was in charge of the overall
administration of the state. The legitimacy of the judicial system at this time was in
serious doubt. 108 The British ruled Singapore until 1942 when it fell to the Japanese.
The Japanese ruled until 1945 and while the British later took over again, Singapore
was granted the right to govern itself in 1958. Singapore later joined the Federation of
Malaysia on 16 September 1963. The merger was unsuccessful and Singapore
received its independence in 1965. As a result, the Malaysian and Singaporean legal
systems share many similarities.
After its separation from Malaysia, Singapore faced a series of challenges,
includingageneral lack of natural resources and expertise. To strengthen its economy,
Singapore adopted an economic policy based on its strategic location in the centre of
maritime trade routes. 109The 1970s sawthe gradual realization of a drive to create a
legal system that best served Singapore’s interests without adhering blindly to English
law. Singapore’s legal system is unique in a number of ways. It is tailored to adopt the
best practices from other countries. Therefore, instead of blindly following the laws of
another jurisdiction, concrete efforts were made by experts and scholars to improve
the legal system by ensuring that it considered the unique needs of Singapore.
However, Singaporean law is largely similar to English law in relation to the carriage
of goods by sea. 110
108
Doubts regarding legal authority remain, to the extent that cases involving British subjects cannot
be tried and must be referred to Calcutta. On 24 June 1824 Malacca and Singapore were formally
transferred to the East India Company's (British) administration.
109
To make Singapore attractive to international traders and investors, it is necessary to have a
well-developed legal system that can cater to the needs of the parties involved. Singaporean law, which
has its roots in English law, has now evolved into a distinctive jurisprudence.
110
The Carriage of Goods by Sea Act and the Bills of Lading Act are the basis of the law of carriage
by sea. The Merchant Shipping Act is an important legislation that covers the registration of mortgages,
the limitation of liability, the rights of the crew, the registration of ships and the scope of power
exercised by the port authorities. In Singapore, before the Merchant Shipping (Amendment) Act of
2004, the limitation of liability (based on a vessel’s tonnage) was the 1957 International Convention
relating to the Limitation of the Liability of Owners of Sea-going Ships. With the adoption of the
Convention on Limitation of Maritime Liability for Maritime Claims in 1976 (via the amendment),
Singapore now possesses a more comprehensive legislation to safeguard the interests of shipowners.
42
Singapore’s Success
Try to become not a man of success, but try rather to become a man of value. 111
-Albert Einstein
The defining reasons for Singapore’s success in maritime trade can be summarized as
follows:
• Willingness to take chances
Singapore’s founding father, Lee Kuan Yew, is often asked to reveal the secret to
Singapore’s success. His simple answer has been, ‘there was no secret; we had no
choice but to take a chance and sail into rough waters.’ Singapore is both a free
market and a tightly regulated planned economy. Singapore’s success can be
attributed to a consistent willingness to take chances and try something new, even in
unchartered territory.
• Transparency and low corruption
Corruption is defined in theConcise Oxford Dictionary as ‘moral deterioration, use of
corrupt practices, esp. bribery or fraud.’ 112In 2010, Singapore was ranked first of the
top five least corrupt countries in the Corruption Perception Index from a total of 178
countries. Since 2001, Singapore has always ranked one of the top five countries with
the least corruption, and this eradication or minimization of corruption has been
fundamental in its success. Rampant corruption leads to the waste of national wealth
and resources and breedsexcessive bureaucracy and incompetency. The existence of
independent anti-corruption agenciessuch as the Corrupt Practices Investigation
Bureau, combined with a culture that shuns corrupt practicespromotes low corruption.
• Capable ports and terminals
As an integrated logistics hub, Singapore ensures that their portsremain capable of
catering to the needs of global traders. These portsare the world’s busiest in terms of
shipping tonnage handled, with 1.15 billion gross tons (GT) handled in 2005 alone.
The ports in Singapore include Brani, Cosco-PSA, Jurong, Keppel, Pasir Panjang
(PPT) Phase 1, Pasir Panjang (PPT) Phase 2A, Pasir Panjang (PPT) Phase 2B, Pasir
Panjang (PPT) Phase 2C, Pasir Panjang (PPT) Phase 2D, Pasir Panjang (PPT) Phase 3,
Pasir Panjang (PPT) Phase 4, Pasir Panjang Wharves, Sembawang and Tanjong
Pagar.
111
As quoted by William Miller in ‘Life Magazine’ (2 May 1955).
112
The Concise Oxford Dictionary of Current English (Oxford University Press 1998) 301.
43
• Infrastructure
Over the years, Singapore has provided an advanced and reliable infrastructure that
meets the needs and demands of the economy. Around forty years ago, Singapore
struggled with a poor infrastructure and living conditions. Singapore’s high-quality,
present-day infrastructure is the direct result of proactive and farsighted planning. For
example, the Housing and Development Board (HDB) and Economic Development
Board (EDB) were created to address the lack of housing (and unemployment). In
Singapore, the idea behind public housing policy is to provide affordable housing in
high-density areas. The transportation infrastructure is also firmly in place and
includes the comprehensive Mass Rapid Transit (MRT) rail network that is so
fundamental toa country with Singapore’s concentrated population.
• Modern legislation
The legislation in Singapore is often updated to incorporate the latest and best
practices available. Instead of blindly following another legal system, Singapore
ensures that its legal system is tailored to meet the country’s specific needs. As one of
the commonwealth countries, Singapore’s legal system is recognized by almost all
countries.
• Strategic location
Singapore is strategically located at the entrance to the Straits of Malacca.
• Stability
The political situation in Singapore is always stable. This peaceful political
environment enables the citizens to focus on economic development and other
important matters.
• Strong military and navy
The existence of a strong military and navy ensures peace and maintains the interest
of global traders. The Singapore Armed Forcesare composed of three branches: the
Singapore Army, the Republic of Singapore Air Force (RSAF) and the Republic of
Singapore Navy (RSN). With the active strength of more than 70,000 personnel, the
Singapore Armed Forces are capable of mobilizing more than 350,000 reservists if
necessary. Deterrence and diplomacy have been the fundamental doctrine of
Singapore's military defense policy.
44
• Strong leadership
Strong leadership is necessary to ensure a nation’s success. It has been a tradition in
Singapore for the Cabinet members and leaders to possess high academic
qualifications and show effective leadership to gain their positions. This selection of
capable leaders based on merit is directly responsible for a large portion of
Singapore’s success.
• Long-term plans and policies
The success of maritime trade in Singapore is largely due to the effective
implementation of a meticulous, long-term economic plan. In other words, the
government has got its policies right. The People’s Action Party, the government of
Singapore since 1959, has a good record of formulating sound financial principles
based on clean government, competitiveness and policy diffusion (learning from
others). The initial education policy was also geared towards the creation of a working
class that possesses the requisite skills of an emerging economy. However, due to
labour shortage problems, Singapore adopted a pro-immigration policy in 1980.
Furthermore, realizing that the regional market for exports was difficult (partly due to
trade barriers), Singapore cleverlyfocused of Foreign Direct Investment (FDI).
• Diversification
Singapore’s economy is diversified, and although it is largely based on import-export
and manufacturing, Singapore’s government has also diversified by investing in the
immediate region and beyond. Such policies enable Singapore to penetrate protected
regional and overseas markets. At the end of 2005 alone, Singapore’s direct equity
investment abroad was no less than S$154 billion (compared to a mere S$13.6 billion
in 1990).
45
2.2.2
Maritime trade in Hong Kong
Hong Kong is similar to Singapore in various ways. Both city-states are strong
maritime trade centers, important shipping hubs. Hong Kong, Singapore and Malaysia
were all British colonies. Hong Kong is one of the world’s leading financial capitals
and a major trade and commerce hub. It is also recognized as one of Asia’s greatest
trading and shipping centers. 113 In 2010, the United Nations Conference on Trade
and Development (UNCTAD) ranked trade as the eighth largest maritime centre in
terms of the vessel tonnage it controls.
Hong Kong has a long history as a maritime trade centre 114 that shares some
similaritieswith Malacca and Singapore. For example, the area surrounding Hong
Kong’s ports was threatened by piracy, as in the Straits of Malacca. One notable
difference between the history of Hong Kong andthose of Singapore and Malaysia is
the fact that Hong Kong is basically part of China. 115
Under Hong Kong’s legal system, the courts can refer to decisions rendered by
other common law jurisdictions. Furthermore, common law judges can participate in
Hong Kong’s court proceedings. The facilitative attitude of Hong Kong’s legal system
towards maritime arbitration is one of the key factors in the success of its maritime
trade because it provides a comprehensive environment for efficient international
trade.
113
See Anthony Lau, John Adams, Jeff Yeung and Min Zhang, The Challenges and Opportunities
Facing the Hong Kong Logistics Industry (Literate Publication Ltd. 2012)
114
Hong Kong began as a simple coastal island consisting of a small trading centre, a salt production
site and a fishing village before the engagement between British and Imperial China. Despite the long
history of human settlement in Hong Kong, written record of the name ‘Hong Kong’ did not appear
until the Treaty of Nanking in 1842. The earliest record of a visit to Malacca by Europeans is around
1400, as reflected in the writing of Tome Pires, and the earliest written record of a European visitor to
Hong Kong is around 1513. That visit was made by Jorge Alvares, a Portugese explorer.
115
One of the most important events in Hong Kong’s history is the first Opium War between the Qing
Dynasty and Britain, sparked by the Qing Dynasty’s refusal to import opium at Britain’s request. The
British managed to occupy Hong Kong Island in 1841 and formalized the occupation under the Treaty
of Nanking in 1842. In 1860, China lost the Second Opium War and it resulted in the Convention of
Peking. In 1898 Britain managed to obtain a 99-year lease of Lantau Island and the northern lands (the
New Territories). The British mainly used Hong Kong as a free port. In 1941, the Japanese invaded
Hong Kong and remained until Japanese surrender in 1945. After the Japanese surrender, the British
resumed their control of Hong Kong. Hong Kong's sovereignty was returned to China in 1997. Under
British control, Hong Kong prospered as an international trading centre and this prosperity has
continued since Hong Kong’s return to China.
46
Hong Kong has always been one of the ten busiest ports in the world since the
late nineteenth century, and in 2007 is among the top five. 116 It serves over 400 ports
in 135 countries. 117 Between 1997 and 2007, the Hong Kong port has grown steadily
in all criteria, whether in respect to commercial shipping, eg TEUs handled, volume
and tonnage of cargo, annual ship movements, or in connection with total annual
tonnage of shipping handled, vessels in the government fleet and pleasure vessels. 118
The only exception is the fishing fleet, which is shrinking. 119
In 2007, Hong Kong was the fifth largest fleet in tonnage, but only the twelfth
in terms of ship numbers,because Hong Kong’s 1,246 ships are very large. To be a
successful maritime arbitration centre, it is vital that the interested jurisdiction have a
strong and comprehensive maritime trade industry. In Hong Kong, not only does the
legal system facilitate maritime arbitration, the maritime trade industry is also very
strong, as reflected by the existence of various important associations.
The Hong Kong port is also the People’s Liberation Army (PLA) Navy’s
Ngong Shuen Chau base and the home base of Hong Kong’s government fleet, a
waterborne workhorse of law enforcement, security and environmental protection
with over 600 vessels including the Police Marine Division’s 166 small ships. 120
One of the strengths of Hong Kong’s maritime trade industry is the strong
support it receives from Mainland China. Although Hong Kong is given proper
autonomy to handle its own affairs, the support it receives from China ensures
itsfurther success. For example, the National 12th Five-Year Plan, promulgated in
March 2011, is of great significance to Hong Kong and its shipping industry. This
Plan contains a Dedicated Chapter (Chapter 57) on Hong Kong and Macau,
unofficially translated as ‘Maintaining the long-term prosperity and stability of Hong
Kong and Macau’. 121
116
Stephen Davies, Hong Kong Maritime Focus (Maritime Museum Ltd, Hong Kong 2007) 4.
117
Stephen Davies, Hong Kong Maritime Focus (Maritime Museum Ltd, Hong Kong 2007) 4.
118
Stephen Davies, Hong Kong Maritime Focus (Maritime Museum Ltd, Hong Kong 2007) 4.
119
Stephen Davies, Hong Kong Maritime Focus (Maritime Museum Ltd, Hong Kong 2007) 4.
120
Stephen Davies, Hong Kong Maritime Focus (Maritime Museum Ltd, Hong Kong 2007) 18
121
Hong Kong Shipowners Association, Yearbook 2010/2011
<http://www.hksoa.org/association/yearbook2011/HKSOAYearbook-2010-11.pdf> accessed 6
January 2012.
47
Hong Kong’s Success
The following are some of the reasons for the success of maritime trade in Hong
Kong:
• Transparency and low corruption
In 2010, ranked thirteenthamong the least corrupt countries in the Corruption
Perception Index from a total of 178 countries. The eradication or minimization of
corruption in Hong Kong has been fundamental to its success. Rampant corruption
leads to a waste of national wealth and resources and breedsexcessive bureaucracy
and incompetency. The existence of an independent anti-corruption agency such as
the Independent Commission against Corruption (ICAC) in a culture that shuns
corrupt practicescreates an environment in which a low level of corruption can be
achieved. In the early years of the ICAC, the main target was the police force, one of
the most corrupted elements of Hong Kong society at that time. Despite the
opposition and hostility expressed by the police force during that time, the ICAC
persevered with a ‘look forward’ policy. These days, the Hong Kong police force is
highly respected and known as ‘Asia’s finest’.
• Capable ports and terminals
As an integrated logistics hub, Hong Kong ensures that their port is capableof catering
to the needs of global traders. The responsibility for administering to the port in Hong
Kong belongs to the Director of Marine. The Hong Kong Port Development Council
advises the government on matters related to port planning and development.
Currently, there are nine container terminalson Stonecutters Island, Tsing Yi and
Kwai Chung.
• Infrastructure
Over the years, Hong Kong has developed a high-quality infrastructure that meets the
needs and demands of the economy. Around 40 years ago, Hong Kong struggled with
poor infrastructure and living conditions. These days, a reliable transportation-related
infrastructure is firmly in place. The comprehensive MTR rail network is fundamental
for high-density countries like Hong Kong. Modern Hong Kong has a highly
advanced and sophisticated transport network consisting of both private and public
transport with more than 90 percent of daily journeys made via public transport.
• Modern legislation
The legislation in Hong Kong is updated often to incorporate the latest and best
practices available. Instead of blindly following another legal system, Hong Kong
48
ensures that its legal system is tailored to meet its own unique needs. 122 Hong Kong’s
legal system is recognized by almost all countries.
• Strategic location
Hong Kong is located in the heart of Asia Pacific, which makes it an attractive option
for ships because it functions as a gateway from China and other Asian countries to
Western countries and other regions. Hong Kong is also a global marketplace that
links major world markets to the booming economies of Asia and Mainland China.
• Stability
The political situation in Hong Kong is always stable and freedom of expression can
be observed, which enables the citizens to focus on economic development and other
important matters.
• Strong military and navy
As a Special Administrative Region of the PRC, Hong Kong has never had a military
force of its own. This is in direct contrast to Singapore and Malaysia. These days, the
defense of Hong Kong is entrusted to the PLA Hong Kong Garrison. The support of
the PRC’s strong military and navy is fundamental to ensure peace and maintain the
interests of global traders.
• Strong leadership
Strong leadership is necessary to ensure a nation’s success. It has been a tradition in
Hong Kong for the Cabinet members and leaders to possess high academic
qualifications and show effective leadership to earn their positions. The Chief
Executive is the head of Hong Kong and is elected by an 800-member Election
Committee consisting of voters from a variety of sources, including functional
constituencies, municipal and central government bodies and religious organizations.
• Long-term plans and policies
The success of maritime trade in Hong Kong is largely due to the effective
implementation of meticulous, long-term economic plans. In other words, the
government has got its policies right.
122
See Ian Dobinson and Derek Roebuck, Introduction to Law in the Hong Kong SAR (2nd edn, Sweet
& Maxwell Asia 2001)
49
• Diversification
The economy of Hong Kong is diversified, and although it is largely based on
import-export and manufacturing, the government also diversifies by investing in the
region and beyond. Such policy enables Hong Kong to penetrate protected markets in
the surrounding area and overseas.
50
2.2.3
Maritime Trade in Malaysia
Malaysia, a country in Southeast Asia, is one of the three countries that have
significant influence and control over the Straits of Malacca. The Straits are vital to
the sub-regional community of Malaysia, Indonesia and Singapore and to the
international shipping community that regard it as an important trade and
communication link. 123 The strategic importance of the Straits is obvious becauseit
provides the shortest and most practical sea route between the Indian Ocean (through
the Andaman Sea) and the Pacific Ocean (through the South China Sea). 124
A look at Malaysia’s long historymakes it easy to understand the reasons behind
the strength of its current position as an established Islamic financial centre despite
the surprisingly slow-pace of its shipping industry. The Malays have a long history
and Islamic culture beginning in the fifteenth century, in which they take great
pride. 125 In the colonial era, their cultural world, which extends across the Malay
Peninsula and Indonesian Archipelago, was divided by various Western powers and
the Malays were reduced to insignificant social roles, virtually barred from a
foreign-financed modernizing economy that used immigrant labour. 126 The Malays
are Muslims by choice and tradition, a characteristic that remainedlong after the
formation of Malaysia. 127 The role of Islamic law, greatly reduced during the colonial
era,has slowly been re-asserted, mostly in finance and trade (for all) and criminal,
inheritance and family matters involving only Muslims. Islamic finance has recently
been revived in Malaysia, although the development of Islamic maritime trade seems
slow.
This research argues that the removal of unnecessary uncertainties and risks is
indispensable to strengthen global maritime trade. Islamic principlessuch as the
prohibition of involvement in transactions tainted by excessive speculations (gharar),
among others, will be relevant to the improvement of global maritime trade. Therefore,
this research suggests that the application of Islamic principles to a maritime nation
such as Malaysia would further strengthen its maritime trade sector. However, a
deeper probe indicates that this might not be the case if the surrounding economic and
legal environment is not conducive in nature. In fact, the partial application of Islamic
123
Mary George, Legal Regime of the Straits of Malacca and Singapore (LexisNexis Malaysia Sdn
Bhd 2008) 4.
124
Mary George, Legal Regime of the Straits of Malacca and Singapore (LexisNexis Malaysia Sdn
Bhd 2008) 16.
125
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 67.
126
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995 67.
127
A Malay is defined in Article 160 of the Federal Constitution of Malaysia as someone who is a
Muslim, speaks the Malay language and practices Malay culture.
51
principles can be difficult when the legal and economic environment is tainted by
dangerous elements such as corruption and fraud. The details of this matter are
discussed in subsequent chapters.
History of Malaysia
Malaysia’s origin can be traced to the Sultanate of Malacca that began in 1400. Most
of Malaysia’s states were once under the rule or influence of the Sultanate of Malacca.
Before Malacca was founded by Parameswara in 1400 the area was largely unknown
and of no notable significance. 128 This is indicated by Malacca’s absence in the
historical recordsof the time, including Marco Polo in 1292 (the famous Venetian
traveler), Odorico of Pordenone/Odorico Mattiussi in 1323, Ibn Battutta in 1345 (the
Arab traveler) or the 1365 Javanese chronicle,Nagaritagama. 129
Under the rule of Parameswara and his descendants, Malacca became the chief
local trading and Islamic centre. 130 Approximately six major reasons are given by
scholars for the success of Malacca, including Malacca’s strategic location alongside
the Straitsthat would later carry its name. The heavily-used Straits attracted traders
from Western and Eastern countries, provided favourable winds and safe harbors on
the passageway between the Indian Ocean, Andaman and South China Seas. 131
Maritime trade through the Straits of Malacca has been influenced or controlled
by the Arabs, Dutch, Portuguese and British for close to 500 years. Piracy has always
been rampant in the Straits of Malacca and remains a major problem for shipping
even in the present day. The Straitsof Malacca are the second busiest international
shipping lane in the world, second only to the Dover Straits in Britain. 132
Tom Pires, the Portuguese historian, wrote in his book The Suma Oriental that
Parameswara or Paramijura arrived in Malacca around 1400, and this is in line with
the book written by Alfonso de Albuquerque’s son. 133
128
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd 2004).
129
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd 2004).
130
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd 2004).
131
Krista Maglen and Gerard J. Mangone, ‘Straits’ (The Oxford Encyclopedia of Maritime History) <
http://www.oxford-maritimehistory.com/entry?entry=t232.e0807-s001> accessed 6 January 2012.
132
Krista Maglen and Gerard J. Mangone, ‘Straits’ (The Oxford Encyclopedia of Maritime History) <
http://www.oxford-maritimehistory.com/entry?entry=t232.e0807-s001> accessed 6 January 2012.
133
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd 2004).
52
Malacca was the key to the spice trade, but its importance was primarily based
on its geographical position along the main East-West searoutes and where
theNorth-East and South-West monsoon wind systems met. 134 As an international
trading centre, Malacca enjoyed diplomatic and trade relationships with various
countries, including China. In 1409, the Emperor of China sent Admiral Zheng
He/Cheng Ho, also known as Ma Sanbao and Mahmud Shamsuddin, a Muslim with a
fleet of 300 ships, to Malacca. 135 He took with him a royal decree raising Malacca to
the status of Kingdom and was ordered to collect tribute and information for China. 136
The close relationship between Malacca and China is reflected by the various
diplomatic visits between Malacca and China. This relationship was important to
Malacca because it helped contain the threat from the northern Siamese (now known
as Thailand). Under China’s protection, Malacca was safe from Siamese threats and
could concentrate on developing into a great maritime trading centre and empire.
The wealth Malacca acquired in trade with various countries, especially China
and India, enabled it to embark on a policy of territorial expansion to other parts of
peninsular Malaysia and Sumatra. 137 Malacca benefited significantly from this
conquest because the conquered states were rich in spices and minerals. 138 Malacca
also expanded through diplomatic means, including marriage and tributes. The wealth
was partly used to further strengthen Malacca by ensuring that a capable military
force was in place:
Once firmly established and prosperous on the basis of this long-distance trade,
Melaka was able to meet and defeat a number of further challenges to its control of
the straits, including several more from its old enemy Siam. Its ability to withstand
these assaults was due to its strong fortifications and its well-organized military and
navy, under the command of a series of powerful Laksamannas whose duties also
included combatting piracy in the straits. 139
134
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 18-19.
135
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd 2004).
136
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd 2004).
137
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd 2004).
138
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd 2004).
139
Donald B. Freeman, The Straits of Malacca : Gateway of Gauntlet (McGill-Queen's University
Press 2003) 88.
53
Malacca’s trading success can be contributed to three essentials: its strategic position,
efficient and secure conditions for traders and its tributary relationship with potential
rival ports. 140 Malacca also established a political stability by becoming the tributary
of stronger powers, most importantly China, but also Majapahit and Thai. 141 The
rulers of Malacca adopted Islam in its early stages and this made Malacca a favored
destination for Arab and Indian Muslim traders. 142 According to Freeman:
A fifth factor was the conversion of Parameswara (in some accounts) or his heirs to
Islam, which strengthened the trade connections of Melaka with Islamic Gujerat and
Bengal in India and Pasai and other Islamic centres in the Indonesian archipelago. In
the account offered by Horace Stone (1965, 20) and by the Melaka Maritime
Museum's Historical Exhibit, in 1414 Parameswara married the daughter of the
Islamic king of Pasai, where there was already an established trade centre, and his
conversion to Islam at this time cemented a lucrative commercial relationship with
Pasai. 143
The law as it is applied in Malacca is highly influenced by Islamic principles,
although a careful analysis reveals that some of the laws are directly contrary to
Islamic teachings, such as the punishment of sula, which originated in Hindu law and
is prohibited in Islam.
Ismail et al (2004) detailed seven reasons behind the glory of Malacca,
includingits strategic location, the leadership of excellent rulers, protection from
China, an ideal entry port (meeting place between east and west), assured trader safety,
efficient administration and proper port facilities. 144Early in the fifteenth century,
Malacca’s rulers adopted Islam and this, too, contributed to the city’s success, making
it a preferred destination for Arab and Indian Muslim traders. 145
Malacca’s golden age ended abruptly in August 1511 when, after a month’s
siege, it fell to the superior weapons of the Portuguese. 146 The Portuguese wanted to
140
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 68.
141
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 68.
142
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 68.
143
Donald B. Freeman, The Straits of Malacca : Gateway of Gauntlet (McGill-Queen's University
Press 2003) 86.
144
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History, (Ilmiah Publishers Sdn Bhd 2004) 34-37.
145
Peter Church (ed), A Short History of South-East Asia (5th edn, Wiley 2009) 84.
146
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 69.
54
take over Malacca’s control, especially over the spice trade, and the Portuguese, who
were strongly anti-Islam, intended to put a stop to the Muslim influence in Asia. 147
In 1509, Diego Lopez de Sequeira was sent to provide the necessary excuse to
attack Malacca after the Portuguese captured Goa, India and established it as the new
headquarters. 148 The Arab and Muslim Gujerat traders had already warned the
Sultanate of Malacca that the Western colonial powers, particularly the Portuguese,
intended to invade Malacca. They knewthis because their own territory hadbeen
invaded by the Portuguese. However, despite the warning, the Sultanate of Malacca
still failed to prepare itself properly.
In 1511, Albuquerque led an armada of eighteen Portuguese ships carrying 1,100
men (800 Portuguese and 300 Malabaries) and set sail for Malacca, which was
successfully captured in the second attack in August 1511. 149 This ended the
strongest Muslim Sultanate in Southeast Asia after a short existence of just over one
century and heralded the beginning of centuries of Western colonialism. After the fall
of Malacca, Albuquerque ordered the construction of a strong fort built on the high
ground of the left bank at the river’s mouth where the mosque and the royal town had
once stood, using materials from the demolition of the mosque and quarries in the
offshore islands. 150
Scholars note that Malacca was already weakening even before the attack of the
Portuguese. Ismail et al (2004) identifiednine reasons for the downfall of Malacca,
five internal and four external. The internal factors were inefficient leadership, eg
Bendahara;the weak administration of Sultan Mahmud Shah; widespread corruption;
Malacca’s trading decline (due to heavy taxes) and disunity, especially due to feuds
between Malays and Tamil-Malays. 151 The external factors included the support
given by foreign traders to the Portuguese, the separation and disunity between the
states under Malacca, the strength of the Portuguese army and the efficiency of the
Portuguese troops. 152
The fall of Malacca was a major event that can be likened to the destruction of
Pearl Harbor and the fall of Singapore to the Japanese in 1941-42 because it indicated
the beginning of European rule in Asia with the Spaniards, the Dutch, the French and
147
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 69.
148
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 19.
149
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 19.
150
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 55.
151
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd, 2004) 37-39.
152
Ismail Mohd @ Abu Hassan, Hakimah Haji Yaakob and Khairatul Akmar Ab Latif, Introduction to
Malaysian Legal History (Ilmiah Publishers Sdn Bhd, 2004) 40-41.
55
the English following the footsteps of the Portuguese. 153 Had Malacca managed to
unite all of its states under its control and prevent the aggression of the Portuguese
with detailed and careful planning, the course of history might have changed
drastically.
China’s refusal to extend its previous protection to other countries, including
Malacca due to its ban on maritime trade,was detrimental. Such refusals to help each
other ledto the loss of sovereignty in various Southwest Asian countries.
The series of wars between Sultan Mahmud, his followers and the Portuguese ended
withSultan Mahmud’s defeat in Muar (1512). 154 The attack on Portuguese shipping
then continued from Riau and the Portuguese retaliated by razing the capital to ground.
Sultan Mahmud was forced to move into exile in Kampar, where he died in 1529.
This brought the Portuguese a period of calm until 1533. 155
Although the Portuguese held Malacca for almost 130 years and controlled a
good portion of its maritime trade, the country was not under Portuguese rule as a
whole because the peninsular territories were influenced, to a certain extent, by the
Sultans of Johor. 156Some scholars argue that after the fall of Malacca, its ruling elite
and their followers eventually established the Sultanate of Johor while other states
formerly under the control of Malacca continued to flourish separately, independent
from Johor’s influence. 157
For the next 500 years, the various states in Malaysia were ruled separately,
mostly by their Sultans, with considerable interference and influence from the Dutch,
the British and, for a short period, the Japanese. 158 The Malay elite competed
strongly amongst themselves for authority and power and the sultans were often weak
and ineffectual rulers. 159This period also saw the rise of Acheh as a new maritime
power in Southeast Asia.
In 1641 the Dutch managed to capture a weak Malacca and ruled it with force
until the arrival of the British, the last colonial power,by way ofthe East India
Company. The commerce policy adopted by the Dutch had beenpoor and the local
people were no longer able to participate properly in trade. Before the Dutch, the local
people, especially the Malay,had been well-known traders:
153
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 19.
154
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 55-56.
155
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 55-56.
156
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 55.
157
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 69; Joginder Singh
Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 59.
158
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 69-78.
159
Peter Church (ed), Focus on Southeast Asia (KHL Printing Co Pte Ltd 1995) 70.
56
They are addicted to commerce, which has already given them taste for luxuries, and
this propensity they indulge to the utmost of their means. 160
According to some, the reasons for the origin of rampant piracy in the Straits of
Malacca can also be attributed to colonialism:
A maritime and commercial people, suddenly deprived of all honest employment, or
the means of respectable subsistence, either sunk into apathy and indolence, or
expended their natural energies in piratical attempts to recover, by force and plunder,
what they had been deprived of by policy and fraud. 161
After the invasions of the Portuguese and the Dutch, the various Malaya states were
controlled by the British. In 1824, an Anglo-Dutch treaty delivered Malacca into
British hands as part of the two European powers’systematic delineation of their
respective control in maritime Southeast Asia. 162 Maritime trade prospered under
British rule, together with mining and plantation operations, but the profits went
mostly to the British while the locals were left poor and uneducated, with the
exception of a small group of the local elite.
The Malaya states were rich in minerals and natural resourcesandMalacca was a
strategic location for maritime trade. However, the British purposely prevented the
locals from getting involved in trade and commerce, bringingpeople from India and
China to do the work instead. This decision wasbased on a fear that the locals would
challenge British ruleif given the opportunity to learn a trade or become economically
independent. The policy of the British was to divide and rule.
The British turned Penang, Malacca and Singapore into the Straits Settlements
while relations with other states in the Malay Peninsula were kept on a commercial
basis. 163 The Straits Settlements were regarded not as another colonial jewel in the
British Crown, but merely as trading centres along the route to India and China. 164
160
Thomas Standford Raffles, F.R.S, ‘Introduction’ in John Leyden, John Leyden’s Malay Annals with
Introductory Essay by Virginia Hooker and M.B. Hooker (Academe Art & Printing Services Sdn. Bhd
2009).
161
John Leyden, John Leyden’s Malay Annals with Introductory Essay by Virginia Hooker and M.B.
Hooker(Academe Art & Printing Services Sdn. Bhd 2009).
162
Peter Church (ed), A Short History of South-East Asia (5th edn, Wiley 2009) 88.
163
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 226.
164
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 226.
57
During the nineteenth century, Malacca was one of the Straits Settlements (along
withSingapore and Penang) and grew as an outpost of British trade and influence. 165
Under the British, the Malacca harbors had become silted and useless to the big ships
of this period. The yearly trade was only £318,426 in 1826 and by 1844, trade figures
has stumbled to a mere £159,529.
Piracy had been a major problem in the past,Malaccan waters were no exception.
Piracy was practiced by the Orang Laut of the Southern Johore, the Orang Sikarna of
the Riau-Lingga Archipelago, the Lanuns of Mindanao, the Bugis of the Celebes, the
Balanini of the Sulu Sea, the Siamese, the Chinese and even the local sultans and
chiefs. 166Widespread piracy remained unchecked until 1837 for the following reasons:
(1) the arrival of the heavily armed steamship “Diana’ that could move against the
wind (a new naval capability for the period) and itsability to effectively fight piracy
and (2) the extension of admiralty jurisdiction to the local courts of the Straits
Settlements that enabled them to try piracy on the high seas. 167
After World War II, Malacca, together with other peninsular Malaya states,
formed a united government called the Federation of Malaya and managed to obtain
peaceful independence from the British on 31 August 1957. Malaysia was formally
established in 1961.
Islam and Malaysia
The reason for Malaysia’s success as an international Islamic financial hub can be
traced back to its history. Islam is not strictly aspriritual religion of the afterlife
because it also consists of detailed rules and regulations assisting and regulating every
aspect of life, including trade and commerce. Islamic law, also known as Shariah,
consists of the basic principles provided in the two major sources, the Qur’an (the
Holy book for Muslims) and the Hadith (the records of the sayings, actions or tacit
approval of the Prophet). The rules of the Shariah are as complex as any set of laws
and they also vary from state to state. 168
Islamic law has influenced trade and commerce in Malaysia for a very long time.
Its history begins during the early years of Malacca (1409) and its influence remains
even through the present day. For example, even though Malaysia is currently a
multi-racial and multi-religious independent country with a comprehensive,
conventional banking system, its Islamic banking system was widely popular among
165
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 215.
166
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 231.
167
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 231.
168
Alan Redfern and Martin Hunter, International Commercial Arbitration (3rd edn, Sweet &
Maxwell 1999) 111.
58
the people, both Muslims and non-Muslims. This indicates the competitive
capabilities of Islamic banking, which manages to attract non-Muslims as well.
Islam was introduced to Malacca by Arab traders and most of the populations
became Muslims when their kings converted to Islam. Islamic law was applied
through legislation and became the major source of law during this time.
There were several written laws available in Malacca, all influenced by Islamic
law and Malay customs. 169 There was also a mixture of elements from Malay
customary law, but this did not erase its Islamic character. Nevertheless, in the wake
of this legislative process the local elements seem to have remained resilient
withsome laws that originated from customs surviving despite the fact that some
contradicted Islamic teachings. According to R.O. Winsteadt, the two digests that
constituted the ancient law of Malacca were largely influenced by:
(1) A mixture of relics from Hinduism
(2) Islamic law (mostly)
(3) Malay Indigenous Customary Law (adat Temenggung)
The Islamization process can be seen in the earlier versions of the Risalat Hukum
Kanun or Undang-undang Melaka, (hereafter Laws of Malacca),which indicated the
customary laws and the influence of Islamic law as set out in Abu Shuja’sAl-Taqrib,
Ibn Al-Qassim Al-Ghazzi’s Fath al-Qarb and others.
The Laws of Malacca was codified in a very comprehensive and precise manner.
It covered a wide area of Islamic law, includingqisas, hudud, diyah, tazir, muamalah
and family law. It consists of forty-four chapters, most of which are based on the
patriarchal law of adaptingtemenggung, and were claimed to have been followed by
all large lands and all great rulers and their viziers.
The influence of Islamic law in the Sultanate of Malacca was reflected in the
Hukum Kanun Malacca and Undang-Undang Laut Melaka. From the establishment of
the Sultanate of Malacca in 1400 until the independence of Malaysia in 1957, Islamic
law was applied at different levels. During the Sultanate of Malacca (1400-1511),
Islamic law was clearly the most important legal source for governing criminal
169
One well known example is the comprehensive Risalat Hoekoem Kanon or ‘The Malacca Digest’,
which consisted of forty-four parts divided between criminal law, family law, muamalat or ‘transaction’
law, evidence and procedure law, the rule of judge and administrative law. The compilations of these
laws was introduced by Sultan Muhammad Shah [1424-1456] and later completed by Sultan Muzaffar
Shah [1444-1456]. In addition, there was also the Malacca Maritime Law, written during the reign of
Sultan Mahmud Shah [1488-1511] and mostly based on the concepts of Shafi’i, one of the four major
schools of thought under Islamic law.
59
matters, trade, family matters and other disputes. The application of Islamic law to
maritime matters and trade disputes was also clear. However, this application of
Islamic law was gradually reduced during the subsequent 400 years of colonialism.
The states were invaded and occupied by the Portuguese, the Dutch, the Japanese and
the British for 400 years. Remarkably, by the time Malaysia received its peaceful
independence from the British the influence of Islam still existed. Perhaps the most
important reflection of this influence was the constitution of Malaysia, which stated
that Islam was the religion of the federation, and article 121(1A), which stated the
exclusive jurisdiction of Shariah court.
Malaysia is currently well known for its modern Islamic banking system, one of
the most advanced and developed in the world, especially in terms of the
contemporaryproducts and services offered. Adherence to Islamic law in trade and
banking matters shows that the basic principles laid down in Islamic trade
laws,particularly the prohibition of interest and the removal of uncertainty, are
relevant and attractive. A loan from a conventional bank can cause some uncertainty
because repayment might be based on various uncertain factors, including the based
lending rate (BLR). However, because interest and uncertainty are not allowed under
Islamic law, the amount that the customer must pay within the Islamic banking system
is stated from the very beginning,whichimbues the transaction with valuable certainty.
English law has also had a major influence on Malaysian law. It is important to
note that various principles of English law that emphasize justice and fairness are
actually consistent with Islamic principles. The application of English law in Malaysia
has a long history. Malaysia’s connection with the British began with individual
trading ventures from 1576 to 1684, as illustrated by Sir Francis Drake’s visit to
Malaya in 1578. 170 The principal intention of the British was to trade. 171 In 1600, the
English East India Company was properly formed and received a Royal Charter for
fifteen years from the English Crown with trading as its principal objective. Until
1684, the Britain’s relationship with Malaya was non-political and profit-oriented. 172
This policy changed when, from 1684 to 1762, political considerations became the
defining factors of the relationship. 173This shift was reflected in the occupation of
Penang by Francis Light on 15 July 1789. He arrived at Penang with a garrison of
marines, hoisted the British flag and renamed it ‘Prince of Wales Island’, despite the
fact that the island was already natively occupied. 174
170
Salleh Buang, Malaysian Legal History: Cases and Materials (Dawama Sdn Bhd 2008)
171
Joginder Singh Jessy, History of South-East Asia (1824-1965) (Penerbitan Darulaman 1985) 215.
172
Salleh Buang, Malaysian Legal History: Cases and Materials (Dawama Sdn Bhd 2008).
173
Salleh Buang, Malaysian Legal History: Cases and Materials (Dawama Sdn Bhd 2008)
174
Salleh Buang, Malaysian Legal History: Cases and Materials (Dawama Sdn Bhd 2008).
60
This attitude was in direct contrast to the friendly diplomatic trade visit of
Admiral Cheng Ho from China with his navy of 300 ships. However, the British
occupation was not an entirely new dynamic considering that Malaya had been
previously invaded and occupied by the Portuguese and the Dutch.
The validity of Francis’s occupationhas been questioned by various scholars,
including Salleh, all of whom have disputed whether it was consistent with the norms
of international law. This research posits that the answer is resoundingly
negativebecause modern international law prohibitsthe invasion and illegal occupation
of other countries. To conclude, various other laws have influenced the laws of
Malaysia, and their incorporation is partly responsible for shaping Malaysia as it is
today.
Maritime Trade in Malaysia: Challenges to Overcome
According to Malaysia’s Logistics Directory for 2011-12:
Frost & Sullivan, one of the leading global research and consultancy
companies, predicted that the Malaysian logistics industry is set for a growth
of 11.5% to reach RM121 billion this year; up from RM108.5 billion in 2010.
The growth is spurred by the country’s stable economic outlook and strong
external trade that is expected to increase by 10% year-on-year to RM1.28
trillion this year. 175
Currently, more than 40 percent of the world’s shipping tonnage is controlled by
Asian interests. Accordingly, Asia is expected to play an important role in the
shipping industry. Singapore, located at the crossroads of one of the busiest shipping
routes, is trying to meet the growing demand for maritime services and, in particular,
dispute resolution services through arbitration. Singapore is already a respected and
credible maritime arbitration centre or, at least, becoming one. Meanwhile, Hong
Kong is a recognized world centre of expertise in shipping, international trade,
finance and construction with numerous experienced professionals available to
support dispute settlements. In addition to qualified lawyers who are ready to provide
service on matters related to Hong Kong law, there are also many capable and
experienced lawyers from major international trading nations who can advise on the
laws of their respective jurisdictions. Despite all of this, this research proposes that
strong support from the government is always essential to a maritime arbitration
175
‘Editorial’ (Malaysia Logistic Directory 2011/2012)
<http://www.msialogistics.com/IndProf%5CMLD%5Cmldeditorial.pdf> accessed 6 January 2012.
61
centre’s success, and Hong Kong is just such an established maritime arbitration
centre.
Unfortunately, other countrieswith potential such as Malaysia, despite sharinga
strategic location with Singapore (both are located at the crossroads of one of the
busiest shipping routes in the world), show no sign of becoming credible maritime
arbitration centres in the near future. It is proposed that a government must
systematically and strongly support the establishment of a credible maritime
arbitration if the host country expects to benefit from the huge demand for maritime
services.
Although a maritime arbitration centre should generally be free and independent
from government interference, this research suggest that strong governmental support
is necessary not only in the early formation of such a centre, but alsoon a continuing
basis.
To fulfill the growing demand for maritime services, a government must provide
a ‘good environment’, which includes up-to-date laws, an excellent court system
capable of enforcing arbitration awards and, of course, an exceptional maritime
arbitration centre. This researchproposes that failure to provide this type of ‘good
environment’ will directly result in a substantial loss of opportunity because the
parties will, in most cases, refer the disputes to another country with an effective
maritime arbitration centre.The following are some the reasons behind Malaysia’s
current failure to achieve its true potential as a maritime nation, despite its strategic
location;
• Corruption
Corruption is a serious problem in Malaysia 176, and while itmay be less common
compared to other Southeast Asian countries (with the obvious exception of Hong
Kong and Singapore), it is still a threat due to the magnitude of the corruption. To
strengthen the maritime trade industry in Malaysia, corruption must be controlled.
Currently, corruption is one of the main reasons behind the problems plaguing the
maritime trade industry in Malaysia. It is a well-known fact that investors shy away
when there is too much bureaucracy plagued by extra and hidden costs, but the
problem is actually much bigger than that. Corruption and bribery also interfere with a
country’s profit projection or trajectory. To tackle corruption, the Malaysian
government put forward an Anti-Corruption Bill in late 2008 and replaced the old
Anti-Corruption Agency (ACA), which was criticized for being politicized and
176
See Noore Alam Siddiquee, ‘Combating Corruption and Managing Integrity in Malaysia: A Critical
Overview of Recent Strategies and Initiatives’ (2010) Public Organization Review, Volume 10, Issue 2,
153-171
62
lacking independence, with the new Malaysian Anti-Corruption Commission
(MACC). However, the new MACC is perceived by many to be unreliable due to a
series of scandals andclaims of negligence, particularly the death of some
witnesseswho were in custody, including Teoh Beng Hock in July 2009 and Ahmad
Sarbani Mohamaed in 2011.
• Lack of experts
Many maritime trade experts prefer to go to Singapore, Hong Kong or other countries
where there are better incentives and offers. The low salary offered in Malaysia,
coupled with seriously excessive bureaucracy, make it unattractive to many experts.
This is also partly due to a national policy that failed to attract the ‘best brains’ from
outside Malaysia and was unsuccessful in convincing the ‘best brains’ in Malaysia to
stay.
• Basic infrastructure
Some of Malaysia’s infrastructure is inadequate. The transportation system is
basically adequate and the network of roads in peninsular Malaysia is largely of a
high quality, but the same cannot be said of East Malaysia. Public transportation is
tolerable, but most vehicles not punctual, unlike their counterparts in Singapore and
Hong Kong. To strengthen maritime trade in Malaysia, an advanced infrastructure is
required.
• Port efficiency
Many researchers have concluded that port efficiency is animportant determinant of a
country’s competitiveness, and that it can be influenced by public policies. 177Malaysia
has many ports. However, to tap Malaysia’s true potential and attract global traders,
there must be more incentives and the quality of the ports must be maintained.
According to an expert on maritime trade, Nazery Khalid from MIMA:
For ports to play the vital role of facilitating trade efficiently and effectively amidst
these dynamics, they must continue to evaluate the environment in which they
operate, identify current trends, anticipate new ones and formulate viable strategies to
face the challenges brought about by those trends. Major developments affecting
ports such as containerization, the advent of a new generation of super ships and the
use of IT, for example, have a huge bearing on port operations and in determining
177
Richardo J Sanchez , Jan Hoffmann, Alejandro Micco, Georgina V Pizzolitto, Martin Sgut and
Gordon Wilmsmeier, ‘Port Efficiency and International Trade: Port Efficiency as a Determinant of
maritime Transport Costs’ (2003) Maritime Economics & Logistics, 5, 199-218.
63
their strategic direction. In addition, business trends like mergers and alliances
amongst shipping liners - as a result of overcapacity and diminishing profit margins
and the breakneck changes in the logistics industry - also affect port operations and
strategies. Increasing convergence of transport modes, links and nodes – in response
to increasing demand of shippers to deliver goods cheaper, faster, further, safer and in
greater volumes – dictates that ports must increasingly integrate with other transport
modes. 178
178
Nazery Khalid, ‘Global Trends Affecting Port Development and their implications for Malaysia
ports’ (Maritime Institute of Malaysia 2007).
64
2.3 Conclusion
This research proposes that the application of Islamic principles, particularly the
rejection of excessive uncertainties and extreme speculative activities, to the maritime
trade sector is realistic, useful and advantageous. However, simple cosmetic changes
are not sufficient. Instead, systematic removal, or at least reduction, of unnecessary
uncertainties and risks are necessary to strengthen global maritime trade.
The hypothesis is indirectly tested in this chapter. This chapter shows that
successful application of Islamic principles to maritime trade industry has occurred in
the past. For centuries, the Muslim empire maintained and expanded a massive trade
network across various parts of Africa, Asia and Europe and was considered a
dominant world power from the seventh to the thirteenth centuries. During this period,
the application was widespread although it begins to decline together with the decline
of Muslim empire from the fourteen century.
This chapter analyzes the maritime trade industry in Singapore, Hong Kong
and Malaysia as well. This is necessary as preparation to test the hypothesis at deeper
level in subsequent chapters. One of the interesting findings from this chapter is the
serious need to have a conducive environment before specific Islamic principles can
be attempted. The benefits of applying specific Islamic financial or trade principles to
maritime trade industry by a country will be minimum if the country’s maritime trade
industry is corrupted, inefficient or lack clear direction. A good environment is
necessary. Without good economic and legal environment, it will be difficult to see
the beauty of the application.
This chapter provides historical evidence that a precise and comprehensive legal
framework for governing maritime trade is fundamental to the success of any
maritime nation. This can be seen in the modern era as reflected by the
comprehensive and capable maritime trade legislations adopted by Hong Kong and
Singapore, but also in the past as indicated by the introduction of such legal
frameworks in famous ancient and traditional maritime trade centres from Malacca to
Venice and Amalfi.
Chapter 2 shows that the adoption of Islamic principles in maritime trade and
commerce is not something totally new. The emergence of modern Islamic finance in
the twentieth century should not lead to the interpretation that the application of
Islamic principles to global trade and commerce is an untested idea or the creation of
recent scholars.
The application of Islamic principles between traders from various nations in the
past indicates the feasibility of this concept, including the rejection of usury and
excessive speculative activities.
65
Some might question the practicalityof analyzing the feasibility of the
application of Islamic principles to modern global trade, especially when much
hostility exists between people from different religions and belief in the modern era as
partially portrayed by conflicts, suspicion and threats.
The answer is positive. Despite current clashes between some of Muslim
countries and the Western world, it is possible to break through the barriers created by
centuries of conflict, even if the process must be gradual. Islamic finance seems to
currently be opening a new chapter on the relationships between countries, and
secular countriessuch as the United Kingdom, Singapore and Hong Kong are
including Islamic finance in their financial portfolios.
This research argues that the removal of unnecessary uncertainties and risks is
necessary to strengthen the legal framework of global maritime trade in a varietyof
ways. History has shown that trade and commerce based on real productivity and
growth can be sustainable. Currently, global trade and commerce seems to be out of
balance or not in sync with the financial sector. For example, the notional value of the
modern derivative alone is around US$700 trillion, a figure that is not backed by real
trade and commerce.
However, to clarify, while this research proposes that the rejection of excessive
speculative activities and uncertainties, as promoted by Islamic finance, can
strengthen global legal and regulatory frameworks for maritime trade, it is noted that
many Muslim countries still suffer from some fundamental defects, particularly
rampant corruption and the ineffective management and administration of public
wealth, that will halt development. In other words, this research suggests that the
selective application of Islamic principles, such as the doctrine on the rejection of
excessive uncertainties, will not be sufficient when the basic legal and regulatory
frameworks in a country are inadequate or problematic. To truly benefit from various
Islamic principles, a country’s basic legal and regulatory framework must first be
improved and strengthened with legal loopholes and institutional defects capable of
leading to corruption and inefficiency carefully closed or corrected.
66
CHAPTER 3
MARITIME TRADE: ACTIVITIES, TRANSACTIONS, RISK
MANAGEMENT AND LEGAL FRAMEWORK
3.0 Activities, transactions and risk management
It is not an exaggeration to claim that modern life, as we understand it will cease to
exist without maritime trade. According to UNCTAD, 85% of the world's trade (by
volume) is carried by seaborne transport and for country like Malaysia, 95% of its
trade is carried by merchant ships, and most of its hydrocarbon energy riches are
found offshore. 179 The defining role of maritime trade can be seen in all aspect of
life due to the overwhelming size of the maritime industry. The consistent growth of
maritime trade industry is also obvious. According to Stopford:
In 2005, the shipping industry transported 7.0 billion tons of cargo between 160
countries. It is a truly global industry. Businesses based in Amsterdam, Oslo,
Copanhagen, London, Hamburg, Genoa, Piraeus, Dubai, Hong Kong, Singapore,
Shanghai, Tokyo, New York, Geneva and many other maritime centers compete on
equal terms. English is the common language, which nearly everyone speaks. Ships,
the industry’s main assets, are physically mobile, and international flags allow
shipping companies to choose their legal jurisdiction, and with it their tax and
financial environment. It is also ruthlessly competitive, and some parts of the industry
still comform to the ‘perfect competition’ model developed by classical economists in
the nineteenth century. Merchant shipping accounts for roughly a third of the total
maritime activity … which divides the maritime business into five groups: vessels
operations (i.e. those directly involved with ships); shipbuilding and marine
engineering; marine resources, which includes offshore oil, gas, renewable energy
and minerals; marine fisheries, including aquaculture and seafood processing; and
other marine activities, mainly tourism and services. When all these businesses are
taken into account the marine industry turnover in 2004 was over $1 trillion. 180
179
Maritime Institute of Malaysia, ‘FAQ’
<http://www.mima.gov.my/index.php/research-centres/mei/mei-faqs> accessed 28 November 2012
180
Martin Stopford, Maritime Economics (3rdedn,Routledge 2009) 48
67
As comparison, the size increase to more than 8 billion in just a few years 181:
In the 2008 trading year, an estimated 8,168 billion tonnes of cargo were transported
by sea. This was almost double that in 1990 and reflects a continuing growth in the
transport of cargoes to all four corners of the globe. The cargo transported is
extremely varied. There are raw materials, such as oil, gas, coal, and iron ore;
agricultural commodities, such as grain oil seeds and cake, sugar and refrigerated
foods; including materials such as rubber, cement, fertilizers, fibres, and chemicals;
and manufactured goods, which can include anything from motor cars to machinery
and consumer goods.
From the consistent growth of the maritime trade industry, it seems that the shipping
industry is an efficient industry in which the freight rate of a ship is economical and
reasonable. In other words, the shipping industry is doing fine. Although recent
financial crisis caused huge losses to many of the parties involved in maritime trade,
the losses are mostly due to lack of demand. The shipping industry merely suffers the
impact of the financial crisis. The situation would be completely different if the crisis
originated from the maritime trade industry. This research proposed that the
worrisome use of financial engineering, if not properly regulated and monitored, can
harm the maritime trade industry.
Of late, there is an exponential growth in the use of arguably risky financial
products like freight derivatives. In addition, speculative activities in various area of
maritime trade also deserve proper attention from the regulator. For example,
traditionally, shipbuilding is a very specific area in which only interested party with
long experience will enter. Before ordering the ship, a detail calculation of the cost,
and an in-depth analysis of supply-demand will be made first. The priority of the
parties is usually to be cost and time efficient. Therefore, it is in everyone best interest
if the freight rate is efficient and stable. However, due to financial engineering, third
party with no real interest is also barging into the maritime trade industry, usually in
the form of speculators. The rule of the game is now changed since the speculators
can make huge sum of profit at the detriments of others if the speculators manage to
speculate wisely. Sometimes, it might be in the best interest of the speculators if the
freight rate goes out of control, as the speculators will be able to make short-term
profit, depending on the position that the speculators take.
Under Islamic financial principles, it is prohibited to be involved in gambling
or in activities tainted by excessive speculations or uncertainty. During the recent
181
Stephen Girvin, Carriage of Goods by Sea (2nd edn, Oxford University Press 2011).
68
global recession, Islamic financial institutions were spared from the disastrous
financial problem caused by subprime-mortgage, partly due to the prohibition.
At the same time, it is noted that there are real benefits offered by financial
engineering and derivatives in certain situations. For example, hedging is an
important elements of modern risk management. Managing maritime trade risk is a
traditional challenge faced from ancient time. According to Jacque:
From immemorial times, traders have been faced with three problems: how to finance
the physical transportation of merchandise from point A to point B – perhaps several
hundreds or thousands of miles apart and weeks or months away – how to insure the
cargo (risk of being lost at sea or to pirates) and last, how to protect against price
fluctuations in the value of the cargo across space (from point A to point B) and over
time (between shipping and delivery time). In many ways, the history of derivative
contracts parallels the increasingly innovative remedies that traders devised in coping
with their predicament. 182
While professional advice and assistance from experts should be sought, all prudent
traders should understand the basic risks in maritime trade. There are numerous ways
to classify risks as reflected by the divergence of approaches seen in the annual
reports of all shipping companies. For example, APM-Maersk in its 2010 Annual
Report elaborated that there are currently 6 major risks faced it 183: (1) cyclical
exposure 184, (2) political exposure 185, (3) oil reserves 186, (4) environment 187, (5)
182
Laurent L Jacque, Global Derivative Debacles: From Theory to Malpractice (World Scientific
Publishing Co. Pte. Ltd 2010) 4
183
Hans Christian Aagard, Jesper Cramon, Trine Gram and Henrik Lund (editors), A.P. Moller- Maersk
A/S Annual Report 2010 (Denmark 2011)
<http://www.apmterminals.com/uploadedFiles/corporate/About_Us/Financials/Annual%20Report%20
2010%20APMT.pdf> accessed 6 January 2012
184
Cyclical exposure: Many of its businesses are recurring in nature due to their dependence on
developments in the world economy. There exist imbalances on supply-demand and instability in oil
prices, freight rates and also market value for assets. The cyclical exposure risk falls under the price
risk and is beyond the control of the parties under current system.
185
As with many global traders, the uncertainty in the geopolitical arena can interfere with the
performance of shipping company. For example, trade barriers, currency restrictions, war, taxes etc can
negatively impact its business.
186
Oil is a limited commodity. Oil reserves decline with every extraction. Failure to replace oil reserve
will be disastrous for shipping company. The price of oil etc usually falls under the price risk. However,
69
operational risks and (6) financial Risks 188. Risk management is fundamental for
shipping company and for all parties involved in maritime trade:
Before shipping companies attempt to make any decisions on risk considerations,
they must identify the underlying risk factors (e.g., market downturns, exchange rate
fluctuations, etc.) and understand their behavior. Next, they must estimate the
probability of these events occuring. In doing so, macro-economic information such
as historical price movements and price forecasts will be applied under different
scenarios to all contracts booked, and subtract from each contract's book value the
amount that is, on average, at risk. After identifying the underlying risk factors, they
must determine their significance and quantify their influence on portfolio value and
financial results. 189
For consistency, in this research, the risks in maritime trade will be summarized into
four major categories of risk; price, credit, pure and legal. Price risk is the risk directly
related to the profit or loss that the parties in maritime trade will gain or suffer. Price
risk refers to the uncertainty over the magnitude of cash flow due to the movement in
output or input prices. 190 Output price risk refers to the risk and uncertainty related to
the price that the party can demand for its goods and services while the input price
refers to the cost that the party has to pay eg for raw materials, operational cost or
services. Price risk also refers to the possibility of loss occurring from adverse
movement in the market price of an asset. 191
Some of the risks are beyond the control of the parties. 192 For example, an
unexpected war, trade embargo, tsunami or large-scale earthquake is beyond the
the availability of oil itself is another type of risk altogether. Assuming that oil will eventually be
depleted, it is necessary to find an alternative source of sustainable energy.
187
Accidents in the maritime trade can be very costly. The costs can be very huge to remedy
environmental disasters caused by accidents in the sea. This type of risk usually involves pure risk and
legal risk.
188
Financial risks include exchange rate risks, interest rate risks, oil price risks, credit risks and also
liquidity risks.
189
190
Peter Lorange, Shipping Strategy: Innovating for Success (Cambridge University Press 2009) 219
Scott
E.
Harrington
and
Gregory
R.
Niehaus,
Risk
Management
and
Insurance
(Mc-Graw-Hill/Irwin2003)
191
‘Definition of Price Risk’, BusinessDictionary
<http://www.businessdictionary.com/definition/price-risk.html>
192
accessed 15 October 2011
For details, see A. Alizadeth and N.Nomikos, Shipping Derivatives and Risk Management
(Palgrave MacMillan 2009)
70
control or accurate prediction of anyone. However, with the proper risk management,
some of the damages and losses related to profit risk could still be contained.
Minimization of cost is essential to maximize profit. Briefly, ship-owners alone have
to face at least 5 different types of cost 193:
1.
2.
3.
4.
5.
Operating cost; essentially crews, stores, and maintenance
Periodic maintenance cost; eg ship is dry-docked for major repair
Voyage cost; including fuel, port charges and canal dues
Capital cost; depends on the way ship has been financed
Cargo handling cost; expense of loading, stowing and discharging cargo
Cost and price of maritime trade nowadays have actually been significantly reduced.
For example, sea transport is actually so cheap that the cost of freight is not a major
issue anymore in deciding when to source or market goods. 194 This is partly due to
the advancement of transportation technology and the availability of better ships.
Sometimes, price risk can be mitigated with the proper use of derivative. According to
Kolb:
In discussing price discovery, we have seen that the futures market serves society by
providing a means for market observers to form assessment about the future price of
commodities. Futures prices are, in essence, a market consensus forecast about the
future price of the underlying commodity. Compared to alternatives, the futures price
provides a good, perhaps the best forecast. 195
Financial products can be used as protection from price risk. For example, those
involved in agriculture trade protect against rising prices by buying futures. This will
enable the party to control their cost by planning ahead of time. 196
193
Martin Stopford, Maritime Economics (3rd edn, Routledge 2009) 221
194
Martin Stopford, Maritime Economics (3rd edn, Routledge2009) 73
195
Robert W. Kolb, Understanding Futures Markets (5th edn, Blackwell Publishers 1997) 120
196
For example, company XXX need to take delivery of soybean oil by December 2012. Company
XXX can start by tracking the futures prices daily. Once Company XXX purchase the forward contract
from the supplier, Company XXX can offset its position by selling the same amount and type of futures
contract purchased earlier. In other words, the price risk has been managed by two ways. The first one
is the company can accept delivery of the commodity in accordance with the agreement. The price risk
has been reduced as the company managed to get the commodity at the fixed price. The second way,
and also the most common way, is for the company to merely offset its futures position. This way, the
parties can protect themselves against volatile or high price. At the same time, the party can also secure
71
Price risk can also be managed by purchasing a call option. This will enable the
party to purchase the underlying futures contract before the expiry of the option at the
strike price. By using option, the party will have more flexibility in managing price
risk. The party will be able to create a price ‘ceiling’ and create a safe maximum
purchase price. Contrary to futures contract, margin capital is not required. However,
the premium cost has to be paid in full.
The second type of risk is the credit risk. According to Boyle and Boyle;
Credit risk is as pervasive in business as snow in the Canadian winter and has existed
since humans first began to trade. It is the risk that one party in the transaction is unable
to or unwilling to fulfill the terms of the contract. The development of a standard legal
system with appropriate remedies for non-performance helped the growth of commercial
trade and business activities, and reduced some of the risks. 197
This type of risk is also known as counter-party risk, in reference to the possibility
that the opposite party will default in payment. Examples of credit risk include the
failure of parties to repay a loan or to receive full payments for product and
services. 198 In modern maritime trade, the credit risk is often transferred between the
parties, subject to payment of such services. For a large-scale trade, the normal
practice is to transfer the credit risk to the financial institutions via the use of
documentary letter of credit.
Credit risk occurs when there is uncertainty related to the payment or
non-payment of parties. The nature of credit risk can drastically differ based on the
decision of the parties eg choice of financing. For example, during recessions,
ship-owners who fund investment with equity are largely safe as long as freight
revenue is sufficient to cover operating and voyage cost but ship-owners who finance
their trade based on debts must ensure that regular payment to the bankers to cover
the purchase price without committing to one specific supplier. The price risk is also reduced as the
clearinghouse will guarantee the performance of futures contract. There are some disadvantages as well.
The party will not be able to benefit from possible lower market price in the future as the price has
been fixed.
197
Phelim Boyle and Feidhlim Boyle, Derivatives: the Tools that Changed Finance (Risk Books 2001)
155
198
Scott
E.
Harrington
and
Gregory
R.
Niehaus,
Risk
Management
and
Insurance
(Mc-Graw-Hill/Irwin, New York, 2003); A. Alizadeth and N. Nomikos, Shipping Derivatives and Risk
Management (Palgrave MacMillan 2009)
72
interest and capital repayment are met. 199 It might be inadequate and insufficient and
the business might collapse, unless extension is given. The importance of managing
credit risk should not be underestimated. According to Brian Gillespie et al from
PricewaterhouseCoopers:
Most major producers have managed to make it through the global financial crisis
without a significant level of payment default. However establishing new credit risk
governance procedures has become a priority for many. A good credit risk policy should
result in the implementation of system that encourages the measured and controlled risk
necessary to sell target volumes at healthy prices. Developing a good credit culture
means embedding credit risk awareness and processes throughout the sales and finance
functions. This is an important steps to avoid the inevitable conflict between the sales
team trying to sale the product, the finance team trying to manage debtors and the
treasury team managing working capital requirements. 200
There are various ways to manage credit risk. According to Boyle and Boyle:
The most popular type of credit derivative is known as a credit default swap. A credit
default swap is a contract that provides a payment if a particular event occurs. The party
that buys the protection pays a fee or premium to the party that sells the protection. If
the credit event occurs within the term of the contract a payment is made from the seller
to the buyer. If the credit event does not occur within the term of the contract, the buter
receives no monetary payment but the buyer has benefitted from the protection during
the tenure of the contract. 201
Credit-default instrument is a clear example of risk-transfer:
Credit-default instruments disassociate the risk of default on credit obligations. They are
often presented in the form of either credit-default swaps or credit-default options. In
general, when there is a credit event by the reference credit, then according to the terms
of the credit default swap, the bank pays the counterparty an agreed default payment.
199
200
Martin Stopford, Maritime Economics (3rd edn, Routledge2009) 241
Brian Gillespie, John Hackwood and Chris Mihos, ‘Managing credit risk for global
commodity producers’ PricewaterhouseCoopers (March 2010)
<http://www.pwc.com/gx/en/energy-utilities-mining/risk-management/pdf/credit-risk-commodity-prod
ucers.pdf> accessed 17 October 2011
201
Phelim Boyle and Feidhlim Boyle, Derivatives: the Tools that Changed Finance (Risk Books2001)
163
73
The counterparty pays a periodic fee and benefits from the protection of the risk of
default on the reference credit. This credit derivative structure is based on the replication
of the total performance of the underlying asset (a reference bnd, a loan). The swap is
done between an investor and the bank. The investor assumes the risks of the reference
bond. 202
Credit risk can also be managed more properly using external credit ratings from
international rating agency information like Moodys and S&P. Checking credit
worthiness is an important practice in maritime trade. For example, according to
Hapag-Lloyd Annual Report 2010 (p.73):
In order to prevent or reduce bad debt losses, Hapag-Lloyd operates a uniform,
centrally steered receivables management system across the Group. Its components
include a standardized approval procedure for granting loans, including a
creditworthiness risk check by Dun & Bradstreet, securing the customer receivables
by means of credit insurance from Atradius, and a centrally managed monthly
reporting system for monitoring the outstanding amounts, including their age
structure and the guidelines and rules of receivables management. 203
However, recent global recession shows that such rating is not always a
comprehensive or good indicator of the actual credit worthiness of the parties. A clear
credit limit is also necessary to manage risks. The suggestion from PcW is relevant
for those in the maritime trade:
Other methods that can be used to manage the internal limits include retaining title and
control of the cargo for longer eg changing from FOB to DES terms. However, in this
situation, marine insurance arrangements will then be recommended. Trade finance and
credit insurance may also be used to sell down risk to trade banks and credit insurers
which can involve discounting receivables. However, each of these options has an
associated cost. 204
202
203
Mondher Bellalah, Derivatives, Risk Management & Value (World Scientific 2010) 934
‘Hapag-Lloyd Annual Report 2010’
<www.hapag-lloyd.com/.../hapag_lloyd_annual_report_2010_en.pdf> accessed 10 January 2012
<http://www.hapag-lloyd.com/downloads/news/hapag_lloyd_annual_report_2010_en.pdf> accessed 10
January 2012
204
Brian Gillespie, ‘Managing credit risk for global commodity producers’,
<http://www.pwc.com/gx/en/energy-utilities-mining/risk-management/pdf/credit-risk-commodity-prod
ucers.pdf> accessed 17 October 2011
74
The third type of risk is pure risk. This includes real risk eg loss of goods due to fire,
and is largely insurable in nature. Pure risk refers to the risk of loss in the value of the
assets, due to physical damage, loss, accidents etc. Technical failure, management
mistakes and human errors in the operation can also be considered as pure risk. For
maritime trade, pure risk usually includes the risk of collision, accidents or liability
from oil or chemical spillage. 205 Some authors include legal risk under the pure risk
but it is proposed that legal risk merit its own category due to the distinctive nature of
the risk.
The opposite of pure risk is speculative risk. Sometimes, in the field of risk
management, risks are classified into pure risk and speculative risk. Pure risk is
negative in nature. It covers situation involving a chance of loss or no loss, but
definitely no gain. Therefore, no one wants to increase pure risk as it is not beneficial.
For example, a tsunami is a serious pure risk and almost everyone will wish for its
avoidance. However, speculative risks are gambles in nature. Excessive speculative
risk can be dangerous as parties with interest might want to increase the speculative
risks to increase their gains. Playing poker in casino is a typical example of
speculative risk. The party might win a huge sum of money but all can be lost as well.
The recent financialization of the commodity market and the shipping industry shows
that the risks are shifting from mere pure risks into speculative risks.
The fourth and last category is the legal risk. Legal risk is related to legal
uncertainty and can be seen in matters ranging from international trade to space
tourism. 206 For the purpose of this research, legal risk refers to the risks and
uncertainties involving or focusing on the legal aspect of maritime trade. For example,
it covers the risk that certain contract might be considered null and void. The risk of
law violation can ba a serious risk for shipping companies. For shipping company,
breach of anti-monopoly law can occur if legal risk is not managed properly.
Furthermore, legal risk covers risks related to the validity and status of the carriage of
goods by sea contract and the interpretation of its clauses. Taxation is a common area
for legal disputes. 207Legal risk is also one of the main risks associated with exports:
205
A. Alizadeth and N.Nomikos, Shipping Derivatives and Risk Management (Palgrave MacMillan
2009)
206
Zhao Yun, ‘Legal Regime for Space Tourism: Creating Legal Certainty in Outer Space’ (2009)
Journal of Air Law and Commerce 74, 959
207
APM Annual Report 2010
<http://www.apmterminals.com/uploadedFiles/corporate/About_Us/Financials/Annual%20Report%20
2010%20APMT.pdf> accessed 6 January 2012
75
Legal risk: Differences in law … can be expected in overseas countries. These may
have an impact in such areas as import procedures, taxation, employment practices,
currency dealings, property rights, the protection of intellectual property and
agency/distributorship arrangements. Obtaining advice from respected legal
practitioners in the countries concerned is imperative. 208
A proper legal risk management must be based on comprehensive understanding of
the objectives of the party. Overall supervision and regular in-house legal audit is
necessary. Usually, parties involved in maritime trade often delegate legal risk matters
to the in-house counsel. It is essential that proper communication between the
in-house counsels and other component of the business is well organized as in-house
legal counsel cannot manage the risk alone. Many of the legal risks are connected to
other type of risks from price risk to pure risk, although there are legal risks that
stand-alone.
Maritime arbitration is one of the main methods of handling unexpected legal
risks. 209 The use of maritime arbitration significantly reduce legal risk but recent
research indicates that some legal risks remain despite the inclusion of arbitration
clause eg in relation to illegality and bribery issues. 210
An efficient legal risks management team with clear scope of responsibilities
will be able to significantly reduce unnecessary legal risk. For example, the legal risks
management or in-house counsel can ensure that the amount of damages payable for
breach of contract is specified in advance. This provision on liquidated damages will
assist the party in avoiding unnecessary litigation. Party observing good legal risk
management will make sure that all transactions are properly documented in
compliance with law. In-house counsel will ensure that the provision on the choice of
law and exclusive jurisdiction is clear. The party will be able to reduce unnecessary
costs by settling future legal disputes in a legal framework familiar to the party.
The legal team should also ensure that the liability of the party is limited. This
can be done by limiting the types of claim that can be recovered under the contract.
208
Risk Management <http://www.austrade.gov.au/Risk-management/default.aspx> accessed 17
October 2011
209
For details, see John F Wilson, Carriage of Goods by Sea (6th edn, Pearson Longman 2008);
Micheal J. Moser and Teresa Y.W. Cheng, Hong Kong Arbitration: A User Guide (2nd edn, CCH Hong
Kong Limited2008); Stephen Girvin, Carriage of Goods by Sea (Oxford University Press 2007); Felix
WH Chan, Jimmy JM Ng and Bobby KY Wong, Shipping and Logistics Law: Principles and Practice
in Hong Kong (Hong Kong University Press 2002)
210
For example, see Felix WH Chan and Zhao Liang ‘Enforcing an Arbitration Agreement tainted by
Bribery: Cautions and Controversies (2009) The Business Review, Cambridge, Vol.12, No.1
76
As alternative, the legal team can make sure that an explicit indemnification clause is
included in the contract. The in-house counsel should also observe the time-limit
carefully. A time bar can be an absolute defense to legal suit.
3.1 Legal Framework regulating maritime trade
There are numerous different legal frameworks regulating the maritime trade
industry. 211 The shipping law of commonwealth countries and most jurisdictions
broadly covers the areas of carriage of goods by sea, admiralty law and merchant
shipping legislation. English law is widely used. Common law principles and
statutes like the Carriage of Goods by Sea Act and the Bills of Lading Act, usually
form the body of the law on carriage by sea. Legislation usually cover diverse areas
such as the powers of the port authorities, registration of mortgages, registration of
ships and rights of crew.
One of the defining characteristics of modern Western-based legal framework
that regulated modern maritime trade is the desire to achieve international uniformity:
… the earliest efforts at international uniformity were promoted by the ILA
[International Law Association], earlier known as the Association for the Reform and
Codification of the Law of Nations. Although the Association abandoned the
Conference Form developed in Liverpool, it did so in favour of a set of rules, known as
the ‘Hamburg Rules of Affreigtment’, which were developed in 1885 and were intended
to be incorporated into bills of lading by reference. These Rules were rescinded in 1887
at the Association’s London Conference, when the Conference Form was reaffirmed.
Nevertheless, the principle of seeking to achieve uniformity through the development of
uniform rules had been established. 212
This is followed by the Hague Rules, Visby Protocol, the SDR Protocol, the Hamburg
Conference and the Rotterdam Rules. In order for the Islamic financial industry to
replicate the success of modern maritime trade industry, it is necessary to balance the
competing interest of the parties. According to Baughen:
The Hague and the Hague-Visby Rules embody a compromise between the interests of
shipowners and those of cargo owners. By an large, this compromise has succeeded in
211
As mentioned earlier on in the literature review, there are numerous high-quality works on shipping
law. In depth and comprehensive researches on this aspect are already available and will not be
repeated in this chapter.
212
Stephen Girvin, Carriage of Goods by Sea (2nd edn, Oxford University Press 2011)
77
imposing a clear and uniform regime for dealing with cargo claims arising out of sea
carriage. 213
The scope of the latest convention, the Rotterdam Rules is very ambitious. According
to Wilson:
The new Convention envisages a regime applicable from door-to-door rather than the
port-to-port coverage favoured in previous conventions, provided only that the carriage
includes a sea leg and that sea leg involves cross-border transport. Accordingly, the
carrier’s period of responsibility will run from the time of receipt of the goods to the
time of delivery to the consignee, and will include liability for loss, damage or delay
during inland carriage preceding or subsequent to the sea leg… The extension of
coverage from door-to-door increases the potential for conflict between the new
Convention and other exisiting conventions. 214
The complexity of modern legal framework regulating maritime trade industry can be
attributed to various reasons. The first one is the fact that a simple maritime trade
transaction can involve different branches of law. For example, Company A decided
to charter a ship from Company B to deliver its good from country A to country B.
The branches of law can include contract law, insurance law, and employment law,
shipping law, agency law and banking law. The second reason for this complexity is
the fact that there are so many information and variables to be considered in each
transaction. To certain extent, standardization of certain shipping documents is useful
but there are still many unexpected loopholes. Nowadays, all of BIMCO 215's most
widely used charter parties, bills of lading and other standard agreements are even
available in an electronic format. The agreements include Bareboat Chartering, Bills
of Lading, Booking Note, Container, Contracts of Afreightment, Dangerous Goods,
Pooling, Sale and Purchase, Salvage, Security, Ship Agency, Ship Management, Ship
Repair, Sundry Other Forms, Time Charter Parties, Towage, Voyage Charter Parties,
Waybills and Cargo ReceiptsHowever, despite in depth analysis by the in-house
counsel working for the shipping company or other related party, there is still a very
real possibility that the party will be held accountable for something unexpected since
the contract occasionally failed to comprehensively reflect the intention of the parties.
In maritime trade industry, unexpected charges and fees can easily amount to tens of
millions, if not more.
213
Simon Baughen, Shipping Law (4th edn, Cavendish 2004)
214
John F Wilson, Carrriage of Goods by Sea (7th edn, Pearson 2010) 231
215
The Baltic and International Maritime Council (BIMCO) is currently the largest international
shipping association representing shipowners with members in more than 120 countries.
78
3.2 Conclusion
The main idea of this research is that the application of Islamic principles to the
maritime trade industry is practical, useful and beneficial. Simple cosmetic changes
are not sufficient. The hypothesis is not directly tested in this chapter as this chapter
serves different purpose. In a way, this chapter is a challenge to the hypothesis. This
chapter highlighted the difficulty, complexity and the depth of modern maritime trade
industry. One might wonder whether the application of Islamic principles that are
mostly based from sources revealed around 1,400 years ago is still feasible and
practical, in the era of modern complexity. It is proposed that the answer is yes. There
are many reasons for this. Firstly, Islamic principles are not exclusive in the sense that
they are generally accommodative and permissive. Useful shipping law or legal
principles from any jurisdictions can be included and harmonized with Islamic
principles that insist on fairness and justice. In other words, Islam is not against
Western-based legal system or Western-based maritime trade industry as long as the
element of fairness and justice are observed.
In order to apply Islamic principles to maritime trade industry, it would be most
unwise to start from scratch. It is more effective to analyze the current practice in
maritime trade industry and see whether there is still room for improvement. It is
proposed that the ethical elements stressed in Islam are much needed in modern trade
and commerce.
The analysis on risks associated with maritime trade industry in this chapter is
introductory in nature. In depth study of the feasibility of actual application of Islamic
principles to maritime trade industry, especially in the field of risk management is
available in later chapter. Subsequent chapters will also elaborate on Islamic finance
and its principles.
79
CHAPTER 4
ISLAMIC FINANCE AND PROHIBITED ELEMENTS IN TRANSACTIONS
(WITH SPECIAL FOCUS TO SOUTHEAST ASIA)
4.0 Introduction to Islamic finance
Islamic finance challenges the core and fundamentals of current conventional
financial systems. Its rejection of usury and interest (often the backbone of
conventional financial systems) along with excessive speculation and unethical trade
could bring stability to global trade and finance. Some scholars, including Irving
Fisher, have already noted that the overinvestment and excessive speculation seen in
conventional finance are important contributors to the resultant financial crises, and
argue that these crises would have been less serious if trade had been financed by
equity as opposed to borrowing money under the usury system.
This chapter elaborates on Islamic principles. The main concepts and principles
of Islamic finance are analyzed. It is unsafe and misleading to proceed with a study on
the application of Islamic principles without first explaining its nature, sources and
characteristics. The doctrine of gharar and the prohibition of excessive uncertainty are
also analyzed as part of the study on Islamic finance.
Currently, some Southeast Asian countries, such as Malaysia and Brunei, are
attempting to develop into strong global Islamic financial hubs. Others, such as
Singapore and Hong Kong,are making concentrated efforts to include Islamic
financial products in their diversified financial portfolios.
This chapter focuses on the development of Islamic finance in Southeast Asia,
particularly Malaysia, Singapore and Hong Kong. However, in depth study of other
jurisdictions, including Indonesia and Brunei, is also included. In a way, this part is an
extension of earlier research by Angelo M Venardos on Islamic finance in Southeast
Asia. The hypothesis will be partly tested in this chapter by analyzing the growth of
Islamic finance in Southeast Asian countries to see the feasibility of applying Islamic
principles to modern banking industry. If the result is positive, the extension of such
principles to other industry like maritime trade will be more likely.
The benefits and advantages of Islamic finance are also explored. Contrary to
common misconceptions, Islamic finance is not limited to Muslims and its growing
acceptance among non-Muslim traders is a strong indicator that Islamic finance offers
something more or, in financial terms, ‘adds value’.
This chapter reveals the secrets behind Malaysia’s rise in the Islamic financial
world. It also highlights the current direction of Islamic finance in Southeast Asia and
proposes that the practice of making simple cosmetic changes to conventional
80
financial products to ensure Shariah-compliance no longer sufficiently addresses the
evolving commercial needs of involved parties and consumers.
Modern Islamic finance originated in the twentieth century. In 1963, the
MitGhamr Savings project was established in Egypt to conduct savings based on
Islamic principles, particularly profit-sharing. By 2007, the size of this
Shariah-compliant asset alone is around US$640 billion, as suggested by Wilson:
The value of shariah-compliant assets is impressive in the GCC, as total assets are worth
over US$262.6 billion when the figures for Saudi Arabia, Kuwait, the United Arab
Emirates, Bahrain and Qatar are aggregated, compared with $235.3 billion in the Islamic
Republic of Iran. As total shariah-compliant assets worldwide amounted to around $640
billion at the end of 2007, this implies that the GCC countries accounted for around 41
per cent of the total. 216
Islamic finance – an emerging form of alternative finance characterized by its
profit-risk-sharing feature and total rejection of usury or interest – was estimated to
have been a more than US$1 trillion-dollar industry in 2011. It promises considerable
commercial and social benefits, including the encouragement of real trade and
business over mere speculation, partnership relationships between capital providers
and managers rather than creditor-debtor relationships and the promotion of a fair and
equitable finance system. Furthermore, the rejection of certain speculative elements in
contracts under Islamic finance makes them more resilient to global financial disasters,
such as the recent global recession. These benefits, among others, are responsible for
the dramatic growth of Islamic finance.
In countries such as Malaysia where Muslims are the majority, Islamic law has
been partially applied towards the Muslims and Shariah courts have been established.
The jurisdiction of a Shariah court is clearly limited to Muslims. Meanwhile, as part
of the Malaysian government’s policy, Islamic finance has been introduced in the
country as an alternative to conventional finance. This policy is fully supported by the
private sector, particularly the banking and insurance sectors. Therefore, in Malaysia,
most conventional banks also possess Islamic finance windows. This means that
conventional banks typically offer Islamic finance alongside common conventional
services.
There is no coercion for non-Muslims to accept or use Islamic banks or other
Islamic financial products in Malaysia. Around 40 percent of Malaysia’s total
216
Rodney Wilson, ‘The Development of Islamic Finance in the GCC’ (2009) Kuwait Programme on
Development, Governance and Globalisation in the Gulf States
<http://www2.lse.ac.uk/government/research/resgroups/kuwait/documents/Wilson.pdf> accessed 6
January 2011.
81
population is non-Muslim. The fact that so many non-Muslims voluntarily choose
Islamic banks and traditional financial institutions that offer Islamic finance windows
is an indication of the competitiveness and profitability of Islamic finance. Its
competitiveness is largely based on a series of fixed principles and prohibitions that
lend more certainty to the system.
Islamic commercial law also offers a competitive and practical alternative to
conventional commercial law. Rather than being rigid or inflexible, it is very adaptive
to modern environments because it consists of various useful and general principles
that uphold morality, fairness and justice. This is reflected in the following hadith on
Islam’s respect for freedom in trade and commerce:
When the prices of goods have increased, the people come to the Prophet (s.a.w.) and
said to him: Messenger of Allah, control the price for us! To this the Prophet said:
‘Allah is the Controller of prices, the Taker, the Disposer, and I hope that when I met
(Him) none of you will claim against me for having committed injustice to him in blood
and property. 217
This illustrates that the concept of a free market is upheld in Islam as long as it
remains just for the people.
Islamic principles differ from their secular financial counterparts because there
are some basic principles and prohibitions that cannot be changed, including the
prohibitions on taking riba or interest (common in conventional banking) and the
presence of uncertainty or gharar in trading. It is also unique because alternatives to
conventional loan systems are offered, including financing and profit-sharing, with
certainty and risk-sharing as alternatives to uncertainty.
Understanding and appreciating the subject of Islamic commercial law has
proven difficult in the past because the materials are typically only available in
classical Arabic books. 218 Very few books on the subject had been written in
English. 219 Due to the more recent emergence of Islamic banking system as a
217
Imam Malik, al-Muwatta, p.297 as quoted in Razali Hj. Nawawi, Islamic Law on Commercial
Transactions (CERT Publications SdnBhd 2009) 36. Hadith to similar effect was reported by Ahmad,
Abu Dawud, al-Tirmidhi, Ibn Majah, al-Dari and Abu Y'ala.
218
219
Razali Hj. Nawawi, Islamic Law on Commercial Transaction (CERTS Publications SdnBhd 2009).
For example, see N.D Coulson, Commercial Law in the Gulf States (Graham &Trotman 1984) and
Ernest Kay, Legal Aspect of Business in Saudi Arabia (Springer, 1979). For an introduction to Islamic
law, see Mohammad Hashim Kamali, Shari’ah Law: An Introduction (One World Publications 2008).
82
competitive and profitable alternative to conventional banking, however, a great deal
of research on Islamic commercial law is now available.
Many challenges still exist, however. The rapid advance and commercialization of
Islamic finance presents numerous complex policy and legal considerations that will
definitely test the existing international and national framework as it processes the
substantial differences between Islamic and conventional finance systems. For
example, the collection of interest or usury has long been the backbone of
conventional finance, as reflected by the creditor-debtor relationship between bankers
and their clients, whereas the rejection of interest or usury is one of the defining
features of Islamic finance.
Another challenge is the modern economic environment, which involves heavy
speculations and manipulations. For example, the current monetary system has
departed from the traditional monetary system, which was based on gold and silver.
Uncontrolled and unmonitored monetary systems in which paper money can be
printed almost without limit are conducive to conventional interest-based or
usury-based systems, but their sustainability has been questioned. The selective
application of Islamic finance in a largely conventional financial system has its own
challenges. Legal concepts such as separate legal entity also complicate the
application of Islamic principles, particularly profit-sharing, because an Islamic
financier has to consider the fact that financing or ‘investing’ activity must take into
consideration the moral hazards of the separate legal entity concept because the
allocation of risk might be difficult to balance in reality. In other words, to truly
adhere to a principle such as profit-sharing, there should be a shift in an advisor’s role
from mere financier to investor and risk-taker, although this is easier said than done.
However, this research proposes that the short-term and long-term benefits of a better
risk allocation system, as promoted by Islamic finance, well outweigh the
disadvantages.
For clarity, this chapter will not discuss the monetary system and associated
issues in depth despite its fundamental role in maritime trade. This important aspect
will be discussed in a more comprehensive manner in subsequent chapter.
83
4.1 Development of Islamic Finance
Modern Islamic finance is relatively new, having originated in the 1970s. However,
the actual history of Islamic finance can be traced back to the beginning of Islam. 220
Table 1: Growth of Modern Islamic Finance
No Time
Event
1
1960s Egypt and Malaysia proceed with pioneering ventures
2
1963
The Pilgrims Fund Board is set up in Malaysia to assist pilgrims with
their savings for pilgrimage expenses. The fund is managed using a
Shariah-compliancemethod
3
1963
The modern Islamic banking system begins in Egypt with the
introduction of MitGhamr
4
1975
The Islamic Development Bank is established in Jeddah, Saudi
Arabia to promote Islamic finance
220
5
1975
The first commercial Islamic bank, Dubai Islamic Bank, is established
with over 30 similar banks initiated over the next decade
6
1977
Kuwait Finance House is established in Kuwait
7
1977
Faisal Islamic Bank of Sudan is established
8
1979
Pakistan attempts to ‘Islamize’ its whole banking system at the state
level
9
1979
Bahrain Islamic Bank is established
10
1980
Malaysia enacts the Islamic Banking Act in 1983 and the Takaful Act
in 1984 (for Islamic insurance), respectively. This establishes a proper
legal framework for Islamic finance
11
1982
Al-Barakah Group is established
12
1983
Malaysia introduces its first official Islamic bank, Bank Islam
Malaysia SdnBhd (BIMB). Sudan introduces an Islamic banking
system in northern Sudan. Islamic Bank Bangladesh and Qatar
Islamic Bank are established
13
1983
The Islamic Republic of Iran introduces legislation to make its entire
banking system Shariah-compliant
Islamic finance is based on Islamic principles with the main sources being the Qur’an and the
Sunnah. The daily actions of Prophet Muhammad in conducting trade and commerce is part of the
Sunnah because the Prophet was a businessman before his prophethood. Throughout history, financial
systems based on Islamic principles have been adopted by various Muslims empires, from the
Umayyad Empire to the Ottoman Empire.
84
14
1984
Dar al Mal al Islamic Trust (Geneva) is established
15
1985
By this time, Islamic financial products are offered by more than fifty
conventional banks
16
1989
Global Islamic Finance UK is established
17
1990
Accounting and Auditing Organization for Islamic Financial
Institutions, Bahrain is established
18
1991
Indonesia establishes its first Islamic bank, Bank Muamalat
19
1993
Islamic Bank of Brunei is established
20
1994
Islamic Inter-Banks Money Market, Malaysia is established
21
1999
Bank Muamalat Malaysia Berhad is established
22
2000
At this time, about 200 Islamic financial institutions exist. The
deposit is more than US$100 billion while assets managed is more
than US$160 billion
23
2001
Malaysia's Financial Sector Masterplan is introduced. It sets a target
of Islamic finance making up to 20 percent of Malaysia’s finance
sector by 2010
24
2002
International Islamic Financial Market, Bahrain is established
25
2002
Islamic Financial Services Board, Malaysia is established in Kuala
Lumpur with Malaysia to maintain and regulate international
standards of Islamic finance
26
2004
Islamic Bank of Britain opens in London
27
2004
From 2004 until 2008 a steady increase in oil prices and petrodollars
increases global interest in Islamic finance and Shariah-compliant
transactions
28
2008
Global recession and financial crises occur, and while Islamic
financial institutions do not suffer as much as conventional financial
institutions (due to prohibitions against excessive speculative
activities), the global demand for Islamic finance is temporarily
reduced
29
2009
Singapore introduces its first Islamic bond programme and Indonesia
sells its first Islamic bond
30
2010
The International Swaps and Derivatives Association and the
International Islamic Financial Market (IIFM) unveil the
Shariah-compliant tahawwut (hedging) master agreement for Islamic
derivatives
85
Table 2: Shariah-compliant financial assets by country
Rank Country
Assets
Growth, 2007
(US$ billion) (%)
1
Iran
235.3
27.5
2
Saudi Arabia
92.0
26.1
3
Malaysia
67.1
32.3
4
Kuwait
63.1
44.3
5
United Arab Emirates 49.1
35.9
6
Bahrain
37.4
42.8
7
Qatar
21.0
77.5
8
United Kingdom
18.1
60.7
9
Turkey
15.8
65.5
10
Pakistan
6.3
39.0
Source: The Banker, Supplement on the Top 500 Islamic Financial Institutions, October 2008,
p. 24. The data refer to December 2007. 221
4.2 Sources of Islamic principles and laws
Islamic principles are based on the Qur’an, the Muslim holy book, and the Sunnah,
the actions and sayings of Prophet Muhammad. For example, if something is
expressly forbidden in the Qur’an, such as gambling or taking advantage of an
orphan’s property, the Islamic principles are as stated in the Qur’an. However, there
are matters on which the Qur’an and Sunnah do not elaborate in detail. The wisdom
of humankind is often expressed in its flexibility, and although many matters are not
specified, there is always some relevant guiding principle in the Qur’an or Sunnah. In
the absence of a direct ruling from the Qur’an or Sunnah, people are advised to make
choices that support justice and fairness. For matters that are not expressly covered in
the Qur’an and Sunnah, scholars will resort to ijtihad. Ijtihadis the making of a
decision in Islamic law (sharia) by personal effort of the scholar.
221
As quoted in Rodney Wilson, ‘The Development of Islamic Finance in the GCC’ (2009) Kuwait
Programme on Development, Governance and Globalisation in the Gulf States, 4
<http://www2.lse.ac.uk/government/research/resgroups/kuwait/documents/Wilson.pdf> accessed 17
November 2011.
86
Below are some elaborations on the aforementioned Islamic sources:
 The Qur’an
The Qur’an is the primary source of guidance in Islam. For Muslims, it is direct proof
from God of the truthfulness of the teachings of Islam as revealed to the illiterate
Prophet Muhammad. The Qur’an is not merely a legal document and only a small
portion is composed of legal sanctions because the Qur’an is meant as guidance for
all of humankind. The present-day Qur’an is the same as that revealed during the time
of Prophet Muhammad:
During the lifetime of the Prophet, the text of the Quran was preserved not only in
memories, but also in inscriptions on such available materials as flat stones, wood
and bones, which would explain why it could not have been compiled in a bound
volume. Initially, the first Caliph, Abu Bakr, collected the Quran soon after the
Battle of Yamamah which lead to the death of at least seventy of the memorisers of
the Quran. Zayd b. Thabit, the scribe of the Prophet, was employed on the task of
compiling the text which he accomplished between 11 and 14 Hijrah. 222
Muslims believe that the Qur’an is the divine word of God, as revealed to and
transmitted by the last of the prophets, Prophet Muhammad. As the primary source of
Islamic law, all other sources must be considered alongside the Qur’an and are
referred to only when a matter is not clarified in detail in the Qur’an. The Qur’an
consists of more than 6,000 verses (in 114 chapters) that were gradually revealed over
twenty-two years. The first verse is ‘Read in the name of your Lord’ (al-Alaq (96:5)
and the last verse is ‘This day We have perfected for you your religion and I have
completed my bounties and I am pleased with the Religion of Peace’ (al-Maidah 5:3).
 The Sunnah
The Sunnahare the sayings, actions or tacit approval of Prophet Muhammad.Some of
the Prophet Muhammad’s counsel was recorded in the Hadith literature. Hadith is a
recorded collection of the sayings, actions or tacit approval of Prophet Muhammad.
Muslim scholars unanimously agree that the Sunnah and the Hadith are fundamental
to understanding the Qur’an. The detailed and comprehensive tenets recorded in the
Hadith are mostly from the eighth and ninth centuries. The six major Hadith
collections are: (1) SahihBukhari, collected by Imam Bukhari, which includes 7,275
hadiths; (2) Sahih Muslim, collected by Imam Muslim, which includes 9,200 hadiths;
(3) Sunan al-Sughra, collected by al-Nasa’i, which has about 5,270 hadiths; (4) Sunan
222
Mohamad Hashim Kamali, Principles of Islamic Jurisprudence (2ndedn, Ilmiah Publishers 2009) 17.
87
Abu Dawood, collected by Imam Abu Dawood, which has 4,800 hadiths; (5) Jami
al-Tirmidhi, collected by al-Tirmidhi, which has 3,956 hadiths; and (6)
SunanibnMajah, collected by IbnMajah, which has over 4,000 hadiths.
 Ijma’ (consensus)
Ijma’ can be defined as the unanimous agreement of the Muslim community for any
period, following the demise of the Prophet Muhammad, on any given matter and
once once an ijma’ is established, it tends to become an authority in its own right. 223
The consensus of all Islamic scholars is considered one of the sources of Islamic law
because Prophet Muhammad explained that the Muslim community would not be in
consensus regarding something wrongful.
 Qiyas (analogy)
If a matter is not directly mentioned in the two major sources of Islamic law, analogy
can be used as the next source of law. For example, drinking wine is prohibited in the
Qur’an because drinking wine can lead to intoxication. Therefore, drinking beer is
also prohibited by way of extension.
4.3 Secondary Sources:
Although some scholars agree that the items in the following list are the secondary
sources of Islamic law, there are others who question their applications. Hence, these
secondary sources are not unanimously accepted by Muslim scholars.





Istihsan (juristic preference)
Urf (customs)
Masalih al-Mursalah (consideration of public interest)
Sadd al-Dharai (blocking/preventing (evil) means)
Amalahl al-Madinah (the practice of the people of Madinah)
The correct hierarchy of the sources of Islamic principles can be seen in the following
hadith:
Narrated Mu'adhibnJabal: Some companions of Mu'adhibnJabal said: When the
Apostle of Allah (peace be upon him) intended to send Mu'adhibnJabal to the Yemen,
he asked: How will you judge when the occasion of deciding a case arises? He
replied: I shall judge in accordance with Allah's Book. He asked: (What will you do)
223
Brian Kettell, Islamic Finance in a Nutshell (Waley 2010) 93
88
if you do not find any guidance in Allah's Book? He replied: (I shall act) in
accordance with the Sunnah of the Apostle of Allah (peace be upon him). He asked:
(What will you do) if you do not find any guidance in the Sunnah of the Apostle of
Allah (peace be upon him) and in Allah's Book? He replied: I shall do my best to
form an opinion and I shall spare no effort. The Apostle of Allah (peace be upon him)
then patted him on the breast and said: Praise be to Allah Who has helped the
messenger of the Apostle of Allah to find something which pleases the Apostle of
Allah. 224
The development of Islamic law is largely a result of the effort or ijtihad of the
scholars. According to Kamali:
Ijtihad is the most important source of Islamic law next to the Qur’an and the Sunnah.
The main difference between ijtihad and the revealed sources of the Shariah lies in the
fact that ijtihad is a continuing process of development whereas divine revelation and
Prophetic tradition discontinued upon the demise of the Prophet. In this sense, ijtihad
continues to be the main instrument of interpreting the divine message and relating it to
the changing conditions of the Muslim community in its aspirations to attain justice,
salvation and truth. Since ijtihad derives its validity from divine revelation, its propriety
is measured by its harmony with the Qur’an and the Sunnah. 225
Under Islamic law, a ruling or decision must be based on the Qur’an or the Sunnah
whenever possible. When a matter is not directly mentioned, it should be decided
based on the general guidelines prescribed in the two sources.These primary sources
of Islamic law are akin to modern statutory provisions and legislations, while the
secondary sources of Islamic law are similar to the interpretations of those provisions
and legislations made by scholars and experts. Islamic teaching goes beyond law to
include moral and ethical considerations as reflected in the following hadith:
Yahya related to me from Malik from HishamibnUrwa from his father from
ZaynabbintAbiSalama from Umm Salama, the wife of the Prophet, may Allah bless
him and grant him peace, that the Messenger of Allah, may Allah bless him and grant
him peace, said, ‘I am but a man to whom you bring your disputes. Perhaps one of
you is more eloquent in his proof than the other, so I give judgement according to
224
Ahmad Hasan (translator), ‘Partial Translation of Sunan Abu Dawud, Book 18, Number 3585’
<http://www.iium.edu.my/deed/hadith/abudawood/018_sat.html> accessed 10 January 2012.
225
Mohamad Hashim Kamali, Principles of Islamic Jurisprudence (2ndedn, Ilmiah Publishers 2009)
366.
89
what I have heard from him. Whatever I decide for him which is part of the right of
his brother, he must not take any of it, for I am granting him a portion of the Fire’. 226
Different perspectives are common among scholars. However, mutual respect is
necessary. Even the most revered scholars, including the leaders of the main school of
Islamic jurisprudence and the individual schools of thought, entertain differences of
opinion. For example, Imam Shafi’i, the founder of the Shafi’i school of thought,
wrote a book in which he criticized some of the views of his teacher, Imam Malik, the
founder of the Mālikī school of thought.
Many scholars have written detailed and comprehensive books on various
matters from faith to Islamic finance. While this literature is are very useful, on
certain matters regarding financial transactions many of the recorded views suit the
unique needs of the time and place in which they were written. Therefore, as long as
the matter is not expressly stipulated in the Qur’an or Sunnah, the scholars of later
generations are free to depart from the earlier views.
This research argues that the application of certain Islamic principles would
strengthen global maritime trade. The relevant Islamic principles have been developed
by experts and scholars to create a legal and economic framework that is just and
useful to the community while still adhering to the guidelines prescribed in Islamic
sources such as the Qur’an and Sunnah. This long endeavor has resulted in a detailed
and valuablebody of literature.
Regarding maritime trade and commerce, Muslim countries have yet to achieve
the level of excellence found in leading maritime trade centers such as London, Hong
Kong and Singapore. However, with the incorporation of the lessons learned from
other leading maritime trade centers (including the eradication of corrupt behaviour)
and adherence to the relevant Islamic principles laid down in the Qur’an and Sunnah
(as further developed by the scholars), the maritime trade sectors of Muslim countries
could emerge as strong maritime nations in their own rights. Such an event would be
of mutual benefit to Muslims and non-Muslims alike.
226
A'isha `Abdarahman at-Tarjumana and Ya`qub Johnson (translators), ‘Translation of Malik’s
Muwatta, Book 36 Number 36.1.1’
<http://www.iium.edu.my/deed/hadith/malik/036_mmt.html>
90
accessed 6 January 2012.
4.4 Modern Islamic Finance and its benefit
Islamic finance is a financial system that is consistent with or is based on and adheres
to the teachings prescribed in Islam. The use of Islamic finance is gaining momentum
among non-Muslim investors and traders, which further indicates that the future of
Islamic finance appears bright and sustainable. For example, non-Muslims now make
up half of Malaysia’s OCBC Al-Amin Bank’s Islamic banking customers. 227
Muslims believe that Islam is not only a religion, but also a comprehensive way
of life that covers everything from trade and commerce to marriage and inheritance.
Even the Prophet Muhammad, for example, was a successful businessman during his
lifetime. Principles and prohibitions based on Islamic finance have largely been used
from the first caliphate, the Rashidun Caliphate (632-661), until the last of the Muslim
empires, the Ottoman Empire in 1923. After the Ottoman Empire’s collapse the
principles and prohibitions of Islamic finance were temporarily abandoned as the
various Muslim countries struggled for independence from Western colonialism. The
end of World War II marked the restorationof independence and a period of poverty
in most Muslim countries as, eventually, Western colonialism ended.
The world then saw the emergence of new generations of educated Muslims that
insisted on a socio-economic approach to improving poor Muslim communities,
adhering to the principles laid down in Islam. This socio-economic approach was
inspired by the writings of the Islamic thinker, Abu al-A'la al-Mawdudi, and the
Egyptian Islamists and leaders of the controversial Muslim Brothers Movement,
Hassan al-Banna and SayyidQutb. 228 Modern Islamic finance, although originally
intended to improve the socio-economic condition of the Muslim community,
eventually gained acceptance among both Muslims and non-Muslims. This gradual
voluntary acceptance of Islamic finance, particularly Islamic banking systems, among
the non-Muslims is definitely not due to religious sentiment, but rather to economic
and commercial reasoning. For example, Islamic finance is widely used by
non-Muslim Chinese traders in Malaysia for its competitiveness and the certainty
associated with the transactions, particularly related to exact payment amounts that
are not, strictly speaking, based on interest.
227
‘More non-Muslims trying Islamic banking: OCBC’ Business Times (1 December 2008)
<http://www.btimes.com.my/Current_News/BTIMES/articles/20081201152232/Article/> accessed 6
January 2012.
228
Walid S. Hegazy, ‘Contemporary Islamic Finance: From Socioeconomic Idealism to Pure Legalism’
(2006-2007) Chicago Journal of International Law 582.
91
Present-day global finance is virtually unimaginable without capitalism, 229 and
contemporary Islamic financial services have demonstrated commercial success
within such capitalist frameworks. It has been proposed that Islamic finance does not
innately conflict with capitalism if injustice is not involved. Socioeconomic objectives
such as sustainability, shared value, equity and human welfare can be reconciled
under Islamic finance through traditional financial metrics, including maximization of
profit, shareholder value and market share.
One might wonder how a financial system based on a holy book revealed more
than 1,400 years ago (in the seventh century from 610 to 632) can still be relevant in
this era of financial complexity and capitalism. This research proposes that there are
at least four explanations for this. The first is the fact that many of the principles and
prohibitions involved are universal, flexible and can be tailored to suit the needs of
the community. For example, under Islamic finance principles certain elements are
encouraged, including real trade and commerce, free market and trade systems, 230
proper payment of debt and kindness in loan reclamation, 231 helping the needy,
229
According to the Oxford Advanced Learner’s Dictionary (7thedn, Oxford University Press 2007),
‘Capitalism is an economic system in which a country’s business and industry are controlled and run
for profit by private owners rather than by the government’.
230
A simple example is the following hadith, narrated by Abu Hanifah: ‘A man came and said:
Apostle of Allah, fix prices. He said: (No), but I shall pray. Again the man came and said: Apostle of
Allah, fix prices. He said: It is but Allah Who makes the prices low and high. I hope that when I meet
Allah, none of you has any claim on me for doing wrong regarding blood or property.’ Ahmad Hasan
(translator), ‘Translation of Sunan Abu-Dawud, Book 17, Number 3433’
<http://www.iium.edu.my/deed/hadith/abudawood/017_sat.html> accessed 6 January 2012. See also
Muhammad Lawal Ahmad Bashar, ‘Price Control in an Islamic Economy’ (1997) JKAU: Islamic
Econ., Vol.9, 29-52 <http://www.kau.edu.sa/Files/320/Researches/50909_21046.pdf> accessed 6
January 2012.
231
The Prophet refused to pray for those who died without settling their debts. However, kindness in
loan reclamation is strongly encouraged: ‘Hudhaifa (Allah be pleased with him) reported : A servant
from amongst the servants of Allah was brought to Him whom Allah had endowed with riches. He
(Allah) said to him: What (did you do) in the world ? (They cannot conceal anything from Allah) He
(the person) said: O my Lord, You endowed me with Your riches. I used to enter into transactions with
people. It was my nature to be lenient to (my debtors). I showed leniency to the solvent and gave
respite to the insolvent, whereupon Allah said : I have more right than you to do this to connive at My
servant. ‘Uqba b. ‘Amir al-Juhani and Abu Mas’ud said: This is what we heard from Allah's Messenger
(may peace be upon him).’ Abdul Hamid Siddiqui (translator), ‘Translation of Sahih Muslim, Book 10,
Number 3791’ <http://www.iium.edu.my/deed/hadith/muslim/010_smt.html> accessed 6 January 2012.
92
proper documentation and witnesses,full disclosure and honesty. 232 Meanwhile, other
elements are prohibited, including causing harm or injustice, unfair monopolies or
oppression, cheating, misrepresentation and deception.
The second thing that makes Islamic finance relevant is the vast body of
literature available. Scholars from all over the world have adapted the principles of
Islamic finance to suit their local and geographical needs and modern scholars benefit
from this collective wisdom gathered over the past 1,400 years.
Third, strong support and coordination between countries and institutional bodies
make it possible for Islamic finance to emerge both systematically and competitively.
This standardization process is also fundamental to ensuring that the confidence of
modern investors remains high.
Fourth, Islamic finance is supposed to be ethical and fair. Although many current
Islamic financial products do not yet incorporate the true spirit of that emphasis on
kindness, real trade and profit-sharing, the fact that they are based on principles that
do not separate morality and trade means that both previous and subsequent products
will have to gradually improve via creative innovation.
Islamic finance has emerged as one of the most positive symbols of Islam in the
twenty-first century, a time otherwise characterized by a cultural clash between
Muslims and Western civilizations. Since the tragedy of 11 September 2001, which
resulted in the loss of more than 3,000 innocent lives, Muslims have been stereotyped
in Western media as violent people incapable of integration while Islam has been
perceived as either medieval or prone to terrorism. While being anti-Semitic is
currently shunned, as reflected by legal actions against those discriminating against
Jewish people or questioning the Holocaust, being anti-Islam or anti-Muslim is
largely tolerated in Western media.
The majorities of the Muslims that compose one-fifth of the world community,
on the other hand, reject such discrimination, humiliation or forced assimilation and
refuse to ignore their principles as detailed in the Qur’an and Sunnah. Many Muslims
feel discriminated against and are convinced that many Muslim countries are being
unjustly targeted due to their Islamic identities. The wars in Iraq and Afghanistan that
resulted in the recorded death of 107,369 innocent civilians (until October 2010) and
34,000 innocent civilians, respectively, have been interpreted by many Muslims as
clear evidence of Western hypocrisy and arrogance. Clashes of values have also
232
There are various verses on this. For example, (1) ‘God commands you to render trusts to whom
they are due, and when you judge between people, judge with justice…’ (Qur’an 4:58); (2) ‘O you who
believe! Stand out firmly for justice, as witnesses to Allah, even if it be against yourselves, your
parents, and your relatives, or whether it is against the rich or the poor...’ (Qur’an 4:135) and (3) ‘God
commands justice and fair dealing...’ (Qur’an 16:90).
93
occurred. Under the pretext of freedom of expression, some Western people have
publicly burned the Qur’an, a provocative and unnecessary act that has resulted in
massive demonstrations and protests in Muslim-populated countries. Some
governments, including the Dutch, have even attempted to ban halal food for the
Muslims and kosher food for the Jewish community in an act that echoes the Nazis’
initial actions during the Holocaust. 233
The suggestion made by some scholars that Islam advocates violence, supported
by misinterpretations of the Qur’an, is unfortunate and provocative. All modern
Islamic states have accepted the provisions of Article 2(4) of the United Nations
Charter prohibiting aggression and the use of force. Furthermore, Saudi Arabia and
Pakistan (the most staunchly Islamic countries) are the keenest allies of the United
States. 234
Despite these conflicts, Islamic finance is clear proof that with mutual
understanding and constructive cooperation, it is possible for civilizations to gradually
free themselves from hatred, bias and discrimination. For example, London is
currently one of the leading Islamic finance centers in the West, despite its initial
rejection of Islamic banks twenty-seven years ago. There are numerous reasons for
the rise of Islamic finance in London, although they differ from those in Southeast
Asia. For example, the BBC News reported:
And with the Patriot Act, which made investments in the US difficult for many Islamic
investors, there was a significant increase in Islamic investors choosing to invest in
Islamic institutions and Islamic products.’ So while groups in the US were investigating
terrorist connections with Islamic banks, Muslim investors pulled their money out of
America. Some of the money got diverted to London, which had traditionally been a
banking centre. The British government then helped further by changing regulations to
give sharia-compliant funds a level playing field with conventional ones. 235
Before the image of Islam was tainted by false accusations of terrorism, some of the
initial concerns related to Islamic finance had already been addressed by the former
governor of the Bank of England, Mr. Robin Leigh Pendleton. On 2 October 1984 Mr.
233
‘Halal and kosher hit by Dutch ban’ News Europe (6 November 2011)
<http://www.bbc.co.uk/news/world-europe-15610142> accessed 17 November 2011.
234
Javaid Rehman, ‘Islam, ‘War on Terror” and the Future of Muslim Minorities in the United
Kingdom: Dilemmas of Multiculturalism in the Aftermath of the London Bombings’ (2007) Human
Rights Quarterly, Volume 29, Number 4, November, 842.
235
Emily Buchanan and Bhasker Solanski, ‘Steady rise of Islamic finance’ BBC News (23 September
2009) <http://news.bbc.co.uk/2/hi/business/8270490.stm> accessed 17 November 2011.
94
Pendleton stated that Islamic banking or similar institutions could not be allowed to
operate for the following reasons: (1) unsettled details, (2) Islamic banking had not
been subjected to testing for large-scale use, (3) there appeared to be no capital
certainty for depositors, (4) deposits were not taken as defined under the Banking Act
and (5) it would cause numerous supervisory problems. 236
Present-day Islamic finance, including Islamic banking systems, have managed
to overcome the concerns initially expressed by the former governor. For example,
although risk-and-profit sharing are some of the most inspired aspects of Islamic
finance, customers’ deposits, eg into their saving accounts, can be guaranteed by
following the Wadiah-yad-dhamanah contract, a form of safe-keeping contract under
Islamic finance in which the Islamic bank guarantees the safety of deposits while not
promising any fixed interest (although profits, if any, can be shared with the
customer).
Previously, critical attitudes towards Islamic finance were due to its allegedly
risky nature and the uncertainty associated with the risk-and-profit sharing system.
New literature has reversed the trend, with Islamic finance now regularly criticized as
being too similar to conventional finance in its refusal to take real risks and for its
alleged failure to adhere to the spirit or objective of the Shariah, which include the
promotion of justice and fairer, more ethical financing, eg via partnership and real
trade.
There have been a series of constructive criticisms (and condescending remarks)
made by scholars regarding the unexpected rise of Islamic finance. Islamic financial
products have been accused by many of being unnecessarily complicated and too
similar, in essence, to their conventional counterparts. Islamic finance and Islam on a
large scale have also been described by many as medieval and outdated. Attempts
have been made to deny Islamic banks status due to their ‘failure to fulfill the criteria
of a bank’. 237In addition, there are various studies suggesting that Islamic finance is
either only for Muslims, or should only be for Muslims. In contrast, there is also the
belief that no financial system should be based on religion because finance should be
secular in nature to avoid bias and inefficiency. Worse, while 1.57 billion Muslims are
stereotyped as uncompromising people who are prone to terrorism, Islamic finance
has also been attacked by those who propose that Muslim terrorists might use it.
236
Statement of Mr. Robin Leigh Pendleton, Governor of the Bank of England, October 2, 1984
reprinted in ‘London’s Attitude Remains Cautious’ The Financial Times Survey (London October 15
1984) at 8, col.5.
237
Statement of Mr. Robin Leigh Pendleton, Governor of the Bank of England, October 2, 1984
reprinted in ‘London’s Attitude Remains Cautious’ The Financial Times Survey (London15 October
1984) at 8, col.5.
95
Muslim minorities have also suffered discrimination. 238 Understandably, because
Islam and Muslims seem to be easy targets, Islamic finance is also
ridiculed.According to one writer:
Unfortunately, even with Sharia Boards (who have had their share of scandals),
Islamic banks are known for lacking regulatory oversight, and the unclear guidelines for
the use of interest make Islamic banks a possible source of funding for Al Qaeda. 239
This reflects a deep misunderstanding of Islamic finance because Islam prohibits
interest or usury. The same writer explains:
Current U.S. financial regulations used to target terrorist financing are incompatible
with the international financial system and foreign banking systems. Unfortunately,
even if international systems could follow the U.S. lead and develop self-regulating
capabilities that were agreeable across nations, Al Qaeda could still easily transfer
funds through the global Islamic banking network and correspondent banks or the
unregulated hawala system. 240
This prompts a question, specifically if a member of Al Qaeda, a terrorist organization,
is found to have an HSBC or Citibank savings account, does that mean that HSBC or
Citibank should be closed as well? Such logic is very questionable. The suggestion
that Islamic banks are unmonitored and unregulated is without foundation. Islamic
finance is subjected to more examination and scrutiny, comparatively, than its secular
counterparts. The suitability of the profit-loss-sharing (PLS) model proposed by
Islamic banks has also been questioned:
Unfortunately, as might be expected of a legal system developed with scant concern for
discretionary preference or practical reality, this model is commercially unworkable as
238
For example, see Javaid Rehman, ‘Islam, “War on Terror” and the Future of Muslim Minorities in
the United Kingdom: Dilemmas of Multiculturalism in the Aftermath of the London Bombings’ (2007)
Human Rights Quarterly, Volume 29, Number 4, November, 831-878.
239
Mark Basile, ‘Going to the Source: Why Al Qaeda’s Financial Network is Likely to Withstand the
Current War on Terrorist Financing’ (2004) Studies in Conflict & Terrorism, 27, 175.
240
Mark Basile, ‘Going to the Source: Why Al Qaeda’s Financial Network is Likely to Withstand the
Current War on Terrorist Financing’ (2004) Studies in Conflict & Terrorism, 27, 179.
96
an alternative to the conventional bank system because it offers neither the liquidity nor
the minimal risk of loss that would be expected of a bank. 241
Dr. Zeti Akhtar Aziz, governor of Bank Negara in Malaysia and recipient of Global
Finance’s Best Central Banker Award (2010) and Best Bank Award (2011), strongly
disagrees that Islamic finance is not sustainable:
Islamic finance is becoming very much a part of the journey to bring the world towards
a new level of stability, prosperity and international integration that is inclusive… The
total Islamic financial assets size is estimated to be more than US$1 trillion. Such
dynamic growth has been driven by two key factors: firstly, the pace of innovation in
Islamic finance has been able to provide the extensive range of financial solutions to
households, businesses and governments with attractive pricing and innovative
structures; and secondly, the resilience derived from its inherent features which has
provided the foundations for financial stability in the Islamic financial system. 242
Despite the dramatic rise of Islamic finance, some of its critics deserve to be
addressed honestly and constructively. However, where terrorism is concerned,
Muslims should not be treated unfairly. Islam is against terrorism, although the right
to self-defense is clearly specified in its tenets. Islamic financial institutions, similar to
their conventional counterparts, are subjected to supervision and scrutiny by the
authorities. In addition, the legal systems of various Muslim countries, including
Malaysia and Brunei, adopt both anti-terrorism and anti-money laundering acts.
There is a long list of verses from the Qur’an that promote peace. 243 However,
both the Qur’an and the Sunnah have attached great importance to the
241
Haider Ala Hamoudi, ‘Muhammad's Social Justice or Muslim Cant: Langdellianism and the Failures
of Islamic Finance’ (2007) 40 Cornell Int'l L.J. 116 .
242
Zeti Akhtar Aziz, ‘Welcoming Address: The Development of Islamic finance’ (The Global Islamic
Finance Forum 2010, Kuala Lumpur, 25 October 2010) <http://www.bis.org/review/r101028c.pdf>
accessed 6 January 2012.
243
From the Qur’an: [2:256: Let there be no compulsion in religion. Truth has been made clear from
error. Whoever rejects false worship and believes in Allah has grasped the most trustworthy handhold
that never breaks. And Allah hears and knows all things.]; [16:82: But if they turn away from you, (O
Prophet remember that) your only duty is a clear delivery of the Message (entrusted to you).]; [6:107:
Yet if God had so willed, they would not have ascribed Divinity to aught besides him; hence, We have
not made you their keeper, nor are you (of your own choice) a guardian over them.]; [4:79, 80: (Say to
every one of them,) ‘Whatever good betides you is from God and whatever evil betides you is from
your own self and that We have (O Prophet) sent you to mankind only as a messenger and all sufficing
97
often-misinterpreted concept of jihad, which means to struggle to the utmost degree.
It must be appreciated at the outset that this word is used to describe non-violent
struggle as opposed to violent struggle. 244 Harming innocent people is contrary to
Islam, regardless of the excuse. The Prophet explained that the highest form of jihad
is for someone to speak the truth in front of an evil ruler, even if the speaker dies as a
result. In Islam, non-violence should never be confused with inaction or passivity. 245
Bakar suggested that Islamic finance has the potential to become a successful
financial industry if it is willing to venture into equity financing along with debt
financing. 246 According to Bakar, if Islamic banks were to venture into
mudharabah 247 and musharakah 248 financing (with necessary modifications to
minimize risks), it might open a new chapter in the history of banking.
It has been suggested that, despite various attacks against it, Islamic finance is
here to stay. While it is true that most Islamic financial institutions and banks still fail
to adhere to the high standards set by the religion, particularly regarding kindness and
an effective profit-loss-sharing system that upholds justice, there is no denying that
is God as witness. Whoso obeys the Messenger, he indeed obeys God. And for those who turn away,
We have not sent you as a keeper.’].
244
A growing tendency has been noted of late in which Western and anti-Semitic writers selectively
quote a few verses from the Qur’an out of context to claim that Islam promotes violence and terrorism,
and that the more than 1 billion Muslims are inferior people incapable of rational dialogue and mutual
understanding. This is most unfortunate because it not only degrades, but also paves the way for
increased hostility and hatred. This thesis proposes that the only way forward is together.
245
When there is a real threat, eg external attack or invasion, it is perfectly permissible for Muslims to
defend themselves. However, the general policy is always to avoid unnecessary fighting and conflict.
Even then, it is strictly prohibited to harm the public and innocent people in war. The Prophet
frequently reminded his followers to avoid fighting and warned them not to pray to meet enemies in
battle.
246
Mohd Daud Bakar, ‘Riba and Islamic Banking and Finance’ in Mohd Daud Bakar and Engku Rabiah
Adawiah Engku Ali (eds), Essential Readings in Islamic Finance (CERTS Publications Sdn. Bhd
2008).
247
Mudharabah is the financing of a sale with a determined mark up (cost plus profit margin). It is a
limited partnership in profit, but not in liability. One party provides the capital while the other provides
the expertise. There are a number of principles, but the general rule under Islamic law is that the
mudharib (manager) cannot guarantee the return and is only liable upon negligence.
248
Musyarakah is a partnership structure with profit-loss sharing implications. Instead of charging
interest as creditor, the capital provider/financier shares a return in the form of actual profit based on a
predetermined ratio. It is a joint-venture finance structure with two or more partners who each
contribute capital or labor and share the venture’s profits and losses.
98
Islamic finance is paving the way for more ethical finance systems that are not based
on usury or interest, but rather on actual trade and commerce. This is contrary to
conventional financial systems because the legal relationships between the parties are
often no more than creditor-debtor relationships with the creditor’s focus on regaining
capital and interest as opposed to the performance or financial well-being of the
borrower.
However, it is noted that for Islamic banks to venture into equity financing in
addition to debt financing, a new mentality is needed. The Islamic banks would have
to think and act as smart entrepreneurs and investors with proper risk management
rather than as idle financiers. Furthermore, due to the complexity of modern
regulatory regimes and different legal principles, eg the separation of legal entities
and companies, it would be of utmost importance for such Islamic banks or financiers
to meticulously analyze all relevant factors to avoid unnecessary loss. When such a
balance is found, this direction will indeed open a new chapter in the history of
banking.
The most well-known principles of modern Islamic finance are as follows:
1. The prohibition of usury
2. The prohibition of excessive speculation
3. The encouragement of real trade and commerce (stronger link between
financing and real trade)
4. A prohibition on dealing with certain sectors that are contrary to Islam, eg
wine and pornography
5. The introduction of zakat, or Islamic tax
Table 3: Differences between Islamic and conventional finance
No Conventional finance
Sources of principles: Purely
man-made. Conventional financial
systems are basically secular in
nature and religion is totally
separated
from
trade
and
commerce
Islamic finance
Sources of principles: Based on the
Qur’an and Sunnah and developed with
the ijtihad or reasoning and efforts of
experts and scholars if consistent with the
guiding principles in the Qur’an and
Sunnah
Nature of contract: The legal Nature of contract: The legal
relationship
is
typically
a relationship cannot be usury or
creditor-borrower relationship in interest-based and should involve
99
which the creditor is assured of elements of risk sharing, partnership or
predetermined usury or interest
investment. Concerning loans, the interest
should not be stipulated in the agreement
Zakat: It is not compulsory to pay Zakat: Islamic financial institutions have
zakat
to pay zakat or Islamic tax. Sometimes,
they also act as zakat collection centers
Purpose: Maximization of profit
Purpose: Maximization of profit in
accordance with Islamic principles
Default and penalty: It is
common to charge penalties in
cases of default. These penalties
can be a lucrative source of
income, eg for credit card
companies, with the creditor
benefitting when the borrower
defaults (via interest)
Default and penalty: Islamic financial
institutions cannot accept usury, and
penalties are often strictly interpreted as
constituting usury if taken. Therefore, in
cases of default, penalties go to charity
and no parties benefit from defaults
Relationship to productivity:
The creditor’s main concern is the
repayment of the loan and the
interest. The performance of the
borrower,
eg
business
or
company, is not the primary
concern
Relationship to productivity: Growth
and productivity are vital, and because the
main objective is profit, profit should be
generated from real trade and commerce
while encouraging all parties to
experience growth and productivity
Nature of products: All financial Nature
of
products:
Only
products that are legal can be used Shariah-compliant products can be used
Selection of client: The main Selection of client: The creditworthiness
focus is the creditworthiness of of the client will be considered, but the
the clients
main focus is the feasibility and
profitability of the project
The nature of risk-allocation: The nature of risk-allocation: The
The concept is based on concept should be investment, risk
risk-transfer
sharing or partnership
Profit/Interest Guarantee: It is a
common
characteristic
of
conventional financial institutions
to
guarantee
interest,
eg
fixed-income deposits
Profit Guarantee: The guarantee of any
profit or future income is prohibited.
Deposits can be guaranteed using certain
contracts, such as waadiah,but the profit
can only be shared if it exists and it
cannot be guaranteed in advance
100
Volatility: Conventional finance
can be very volatile and fragile as
the result of excessive speculative
activities
Volatility: While Islamic finance is less
volatile due to some of its prohibitions on
speculative activities, it can still be
exposed to bubbles, such as asset bubbles.
Furthermore, because it is exposed to
conventional monetary systems, problems
in these conventional systems do have an
effect on Islamic finance
4.5 Encouraged elements in Islamic finance
One of the beauties of Islamic finance is its insistence on good morality and kindness.
Some elements are required and binding e.g. honesty, transparency, clarity and
fairness as discussed in subsequent chapters. In addition to the basic elements, other
good elements are also encouraged. These elements, if used wisely, will make Islamic
financial products and Islamic finance in general much more attractive. These
elements includes:
•
•
•
•
Kindness in re-claiming loan
Immediate or fast payment of salary
Good and effective risk allocation mechanism
Flexibility in giving and claiming loan
4.6 Prohibited elements in Islamic finance
Islam in general, and Islamic finance in particular, is actually permissive in nature.
The idea of Islam is not to cause hardship or burden to the people. It is stated in the
Holy Quran:
We have not sent down the Qur'an unto you to cause you distress, But only as a
Reminder to those who fear (God). A revelation from Him (God) Who has created the
earth and high heavens.
(Chapter Ta-Ha, Holy Qur’an).
The general theory is that everything is permissible in Islam except those expressly
prohibited in the primary sources of Islam. Muslims believe that only bad and evil
things are prohibited in Islam. Under Islam, the final say whether an action is bad and
evil or good and permissible is only with God.
101
Basically, the following are some of the prohibited elements in Islam:
•
Usury: Usury is strictly prohibited in Islam. People are encouraged to make
money by working or from business and it is prohibited to make money
simply by giving loan to those in need and then charge them interest. In
other words, money should be earned by honest effort.
•
•
Gambling: Gambling is strictly prohibited in Islam.
Excessive uncertainty: People are requested to avoid things or transactions
that contain excessive uncertainty. In a way, this prohibition is an extension
of the prohibition of gambling.
•
Cheating and other deceptive practice: Cheating, deceptive practice and
similar practices will cause enmity and hatred. All these practices are
prohibited in Islam.
4.7 The doctrine of gharar
Excessive uncertainty in contractual matter is prohibited in Islam as this can leads to
enmity and hatred between the parties. Excessive speculative activities, similar to
gambling, are also prohibited under Islam. Currently, speculative activities in the
maritime trade industry can take numerous forms, including derivatives. Derivatives
arecurrently being used by those with real interest in the maritime industry to hedge
and thus protect their interest. For example, a carrier might need to hedge against an
unexpected increase in the price of oil. Such sudden increases can have a significant
impact on operational costs so, understandably, the carrier wants to avoid losses by
hedging against such a risk. This is similar to a party having insurance that protects its
interest. Things become problematic when those with no real interest to protect also
get involved in maritime trade through speculative activities. While it is legally
prohibited for speculators or those without real interest to purchase marine insurance
(as this is akin to gambling or gaming), speculators have found a loophole in the
increase of ‘financialization’ or financial engineering in maritime trade. This research
proposes that this increase of speculative activities within maritime trade could be
detrimental to the shipping industry in the long-term, despite the fact that it might
increase liquidity in the short-term.
According to the former chairman of the Hong Kong Shipowners Association,
global shipping markets have become a ‘“speculators’ heaven” feeding a frenzy of
new ship orders and explosive shipbuilding capacity that has put the international
maritime industry in crisis’. He stressed that a series of actions, including tougher
102
regulatory controls (on crew training and greenhouse gas emissions) and harsher
penalties, eg to combat oil spills, have failed to secure the barriers against the entry of
speculators. 249
Maritime trade is an essential element of modern living. Around 90 percent of
the world’s commodities are transported using maritime transportation. Reforms and
drastic revolutions in the field of maritime transportation technology have led to the
existence of better ships. Overall, shipping commodities is easier than ever before.
The worldwide adoption of containerization has further accelerated global trade
because the entire shipping process is now more simplified. Rapid advancements in
fields such as maritime transportation technology and communication have not,
unfortunately, always been extended to the legal field. There are still numerous legal
uncertainties related to maritime trade. For example, the introduction of maritime
electronic commerce has, to certain extent, introduced significant benefits, including
simplifications, ease of use, environmental responsibility and improved coordination.
However, the legal uncertainties surrounding maritime electronic commerce are far
from settled. On the one hand, business is about taking risks. Therefore, there will
always be some element of uncertainty in business. For clarity, standard and common
or unavoidable uncertainty in business is not gharar.On the other hand, business is
not gambling. While taking calculated risks based on informed decisions is noble,
efforts must be taken to reduce the element of unnecessary risks and uncertainties.
This concept is in line with the Islamic prohibition of excessive gharar or excessive
speculation and uncertainty.
Some scholars have been very skeptical about the practicality of applying
Islamic principles in the modern age. For example, according to Coulson:
… in the subject of civil transactions, the doctrine expounded by the classical jurists was
of a highly idealistic character; for the two prohibitions of riba and gharar or uncertainty
had been developed to a degree of systematic rigour which eliminated any form of
speculative risk in contracts, and which postulated standards totally unrealistic in the
light of practical demands of commercial dealings. 250
The assumption that the application of Islamic principles is ‘totally unrealistic’,
however, is arguably mistaken. Modern Islamic financial systems have proven
capable, competitive and profitable despite the fact that there is still much room for
improvement. For example, the size of modern Islamic finance has reached around
249
‘Speculators blamed for shipping industry crisis’ Cargonews Asia (11 November 2011)
<http://www.cargonewsasia.com/secured/article.aspx?article=27065> accessed 19 November 2011.
250
N.J. Coulson, A History of Islamic Law (Edinburg University Press 1964) 138.
103
US$1 trillion in approximately 40 years. Furthermore, financial products based on
Islamic principles have been accepted by non-Muslim traders and customers without
any religious sentiment whatsoever, purely for financial reasons. Additional evidence
of the resilience of Islamic finance was evident in the recent global financial crisis and
recession. Most of the banks that adopted Islamic financial systems performed
significantly better because they were able to avoid the huge losses that resulted from
financial products tainted by excessive speculation and other elements prohibited by
the Shariah.
The application of Islamic principles that promote fair and just systems is not
limited to financing. Instead, it has been argued that many Islamic principles are
directly related to actual trade and commerce, and not merely financing. This chapter
analyzes the concept of gharar or uncertainty in Islamic jurisprudence to provide a
background for subsequent chapters that focus on the removal of uncertainty in
maritime trade, particularly in relation to risk management.
4.7.1
Introduction to the doctrine of gharar
What is gharar? The word gharar comes the root verb gharar/gharra (Gh.R.R.)
signifying ‘to reveal oneself and one’s property to destruction without being aware of
it (ardnafswamali-hi li halak min ghayr an ya’raf)’. 251Literally, gharar can mean to
‘deceive’ or be ‘cheated’. This is in line with gharar’s meaning as stated in the
Qur’an. For example:
(1) ‘magharraka bi rabbika al-karim?’ [82:6]. The literal meaning is ‘what has
deceived you from your gracious Lord?’.
(2) ‘wa la yaghurranakabiLlah al-gharur’ [35:5]. The literal meaning is ‘neither
let the deceiver [the devil] deceive you concerning God’.
The general approach adopted by Islamic scholars is to define gharar as having the
same meaning as khatar, which generally means ‘hazard’, ‘risk’, ‘jeopardy’, ‘danger’
or ‘peril’.
Gharar has also been defined as ‘uncertainty’, ‘speculation’ in addition to things
related to the elements of gambling. Gharar as speculation or gambling is forbidden
251
Ibn Manzur, Lisan al-‘Arab, Egypt, 1300H., vol. vi, p.314 as quoted in Ahmad Hidayat Buang,
Studies in the Islamic Law of Contracts: The Prohibition of Gharar (International Law Book Services
2000) 30.
104
in Islam. 252 Islam encourages risk-taking in business transactions, but it prohibits
speculative activity and gambling. Not all types of uncertainty are prohibited,
considering that the very idea of trade involves risk and some elements of uncertainty.
For example, the concept of gharar is not applicable to business risks such as making
an investment in a company. However, gharar can exist when someone professionally
advises a client to purchase shares in a company that is currently the subject of a
takeover bid.
Any transactions involving elements of gross uncertainty and speculation,
such as purchasing something that might or might not exist, are typically prohibited.
For example, the sale and purchase of fish that have not yet been taken from a lake or
sea (if the amounts cannot be estimated or measured) would be considered the sale of
something with disputable ownership. In relation to maritime trade, the elements of
uncertainty can be seen in activities such as the complicated transfer of rights and
liabilities between parties and the coverage of insurance.
The simultaneous use of multiple contracts with different effects can also lead
to uncertainty. Difficulties usually arise when the effects of charter parties and bills of
lading are being distinguished when both are being used at the same time. 253 The
rights and liabilities of parties are often not clear in such situations. For example, time
charters will confer the charterer the right to issue bills of lading, creating the residual
problem of deciding whether, under the bills of lading, the shipowner or charterer is to
be treated as the carrier under the Hague or Hague/Visby Rules. 254
Gharar is also defined as the risk or jeopardy inherent in the state of being
near to destruction or wreckage. 255 Generally, the definition of gharar or uncertainty
under Islamic jurisprudence can be divided into the following sub-definitions: (1)
gharar as uncertainty, 256 (2) gharar as ignorance 257 and (3) gharar as unknown and
doubtful. 258
252
Abdus Samad, ‘Performance of Interest-Free Islamic Banks vis-à-vis Interest-Based Conventional
Banks of Bahrain’ (2004) IIUM Journal of Economics and Management 12, no.2, 3-4.
253
John F. Wilson, Carriage of Goods by Sea (Pearson/Longman 2008) 6.
254
John F. Wilson, Carriage of Goods by Sea (Pearson/Longman 2008) 7.
255
Abdul Rahim Al-Saati, ‘The Permissible Gharar (Risk) in Classical Islamic Jurisprudence’ (2003)
J.KAU: Islamic Econ., Vol. 16, No. 2.
256
This view is shared by the Hanafi and Shafi’i schools of thought. Islamic law is usually divided into
two major schools of thought, the Sunni and Shi’i. The Sunni school of thought is divided into the
Hanafi, Maliki, Shafi’i and Hanbali schools.
257
This view is shared by the Zahiri alone. Zahiri is a minor school of thought.
258
This view is held by the majority of Muslim scholars.
105
Recent studies have attempted to find contemporary meanings and applications
for uncertainty or gharar under Islamic commercial law. However, according to
Vogel (1998), 259 jurists have been unable to clearly define the exact scope of gharar.
This is not a significant issue, however, because although a specific and
comprehensive meaning for gharar has not been made available, a general
understanding of the features and characteristics has been sufficient for Islamic
scholars and experts to derive proper rulings. There are many abstract things in life
that cannot be comprehensively defined, such as love, but a lack of definitive meaning
does not decrease a concept’s value.
4.7.2
Gharar in the Qur’an
The word gharar and its derivatives, including gharra, gharrahum, gharrathum,
gharraka, gharrakum, gharratkum, yaghrurka, yaghurrannaka, yaghurannakum,
taghrannakum, gharur and ghurur, occur repeatedly in the Qur’an, at least 27
times. 260 In most instances, these words are used to refer to someone being ‘deceived’
or ‘cheated’ with one party experiencing a loss as the result of the element of gharar
being involved. If a win-win situation is being described, gharar will not be used. It
has been noted that the word and concept of gharar in the Qur’an is focused on
matters pertaining to faith, while the word and concept of gharar in the Hadith (the
second major source of Islam) deals with uncertainty in commercial matters.
Therefore, the scholars of Islamic jurisprudence tend to define gharar from the
Hadith perspective when constructing rulings related to commercial matters.
The following are some examples:
 ‘Lo! the hypocrites say, and those in whose hearts is a disease: “These people,their religion has misled them.” But if any trust in Allah, behold! Allah is Exalted
in might, Wise’. [8:49]
 ‘This because they say: “The Fire shall not touch us but for a few numbered days”:
For their forgeries deceive them as to their own religion’. [3:24]
 ‘Leave alone those who take their religion to be mere play and amusement, and
are deceived by the life of this world. But proclaim (to them) this (truth): that
every soul delivers itself to ruin by its own acts: it will find for itself no protector
259
Frank E. Vogel and Samuel L. Hayes, Islamic Law and Finance: Religion, Risk and Return
(Kluwer Law International 1998) 91-93
260
Quranic verses: (8:6), (3:24), (6:70 and 130), (7:51), (82:6), (54:14), (45:35), (40:4), (3:196),
(31:33), (35:5), (4:120), (33:12), (52:64), (35:40), (7:22), (67: 20), (57:14), (3:185), (57:20), (31:33)
and (35:5).
106









or intercessor except Allah: if it offered every ransom, (or reparation), none will
be accepted: such is (the end of) those who deliver themselves to ruin by their
own acts: they will have for drink (only) boiling water, and for punishment, one
most grievous: for they persisted in rejecting Allah’. [6:70]
‘O ye assembly of Jinns and men! came there not unto you messengers from
amongst you, setting forth unto you My signs, and warning you of the meeting of
this Day of yours? They will say: “We bear witness against ourselves.” It was the
life of this world that deceivedthem. So against themselves will they bear witness
that they rejected Faith’. [6:130]
‘“Such as took their religion to be mere amusement and play, and were
deceivedby the life of the world.” That day shall We forget them as they forgot the
meeting of this day of theirs, and as they were wont to reject Our signs’. [7:51]
‘O man! What has seduced thee from thy Lord Most Beneficent?’ [82:6]
‘“This, because ye used to take the Signs of Allah in jest, and the life of the world
deceived you:” (From) that Day, therefore, they shall not be taken out thence, nor
shall they be received into Grace’. [45:35]
‘None can dispute about the Signs of Allah but the Unbelievers. Let not, then,
their strutting about through the land deceive thee’. [40:4]
‘Let not the strutting about of the Unbelievers through the land deceive thee’.
[3:196]
‘O mankind! do your duty to your Lord, and fear (the coming of) a Day when no
father can avail aught for his son, nor a son avail aught for his father. Verily, the
promise of Allah is true: let not then this present life deceive you, nor let the chief
Deceiver deceive you about Allah’. [31:33]
‘O men! Certainly the promise of Allah is true. Let not then this present life
deceive you, nor let the Chief Deceiver deceive you about Allah’. [35:5]
‘Satan makes them promises, and creates in them false desires; but satan’s
promises are nothing but deception’. [4:120]
 ‘And behold! The Hypocrites and those in whose hearts is a disease (even) say:
“Allah and His Messenger promised us nothing but delusion!”’ [33:12]
 ‘“Lead to destruction those whom thou canst among them, with thy (seductive)
voice; make assaults on them with thy cavalry and thy infantry; mutually share
with them wealth and children; and make promises to them.” But Satan promises
them nothing but deceit’. [17:64]
 ‘Say: “Have ye seen (these) ‘Partners’ of yours whom ye call upon besides Allah?
Show Me what it is they have created in the (wide) earth. Or have they a share in
the heavens? Or have We given them a Book from which they (can derive) clear
107




(evidence)? - Nay, the wrong-doers promise each other nothing but delusions”’.
[35:40]
‘So by deceit he brought about their fall: when they tasted of the tree, their shame
became manifest to them, and they began to sew together the leaves of the garden
over their bodies. And their Lord called unto them: “Did I not forbid you that tree,
and tell you that Satan was an avowed enemy unto you?”’ [7:22]
‘Nay, who is there that can help you, (even as) an army, besides (Allah) Most
Merciful? In nothing but delusion are the Unbelievers’. [67:20]
‘(Those without) will call out, “Were we not with you?” (The others) will reply,
“True! but ye led yourselves into temptation; ye looked forward (to our ruin); ye
doubted (Allah’s Promise); and (your false) desires deceived you; until there
issued the Command of Allah. And the Deceiver deceived you in respect of
Allah”’. [57:14]
‘Every soul shall have a taste of death: And only on the Day of Judgment shall
you be paid your full recompense. Only he who is saved far from the Fire and
admitted to the Garden will have attained the object (of Life): For the life of this
world is but goods and chattels of deception’. [3:185]
 ‘Know ye (all), that the life of this world is but play and amusement, pomp and
mutual boasting and multiplying, (in rivalry) among yourselves, riches and
children. Here is a similitude: How rain and the growth which it brings forth,
delight (the hearts of) the tillers; soon it withers; thou wilt see it grow yellow; then
it becomes dry and crumbles away. But in the Hereafter is a Penalty severe (for
the devotees of wrong). And Forgiveness from Allah and (His) Good Pleasure (for
the devotees of Allah). And what is the life of this world, but goods and chattels of
deception?’ [57:20]
In summary, these Qur’anic verses that contain the root word or equivalent of gharar
address matters related to faith and belief and urge people not to be deceived by
worldly matters or the devil, but to focus on their search for God. Although the word
gharar in the Qur’an mainly deals with deception in matters regarding faith, the
rejection of excessive speculation or gambling is also clearly mentioned in various
verses of the Qur’an. For example:
 ‘They will ask thee about intoxicants and games of chance. Say: In both there is
great evil as well as some benefit for man; but the evil which they cause is greater
than the benefit which they bring’. [2:219]
108
 ‘By means of intoxicants and games of chance Satan seeks only to sow enmity
and hatred among you, and to turn you away from the remembrance of God and
from prayer. Will you not, then, desist?’ [5:90]
There is no direct prohibition on gharar in trade, or on uncertainty in the Qur’an
(although gambling is clearly prohibited), but uncertainty as a type of vanity has been
prohibited. For example:
‘And do not eat up your property among yourselves for vanities, nor use it as
bait for the judges’. [2:188]
‘O ye who believe! Eat not up your property among yourselves in vanities; but
let these be amongst you traffic and trade by mutual good will’. [4:161]
4.7.3
Gharar in the Hadith
The Hadith is a report on the tradition or Sunnah of the Prophet. The Sunnah is the
second most important source of Islam. Technically, the Sunnah is the sayings,
actions or tacit approval of the Prophet. Its position is second only second to the
Qur’an. In most circumstances the Sunnah provides an accurate interpretation of the
Qur’an. The role the Sunnah plays in understanding the Qur’an is very important
because it elaborates on the principles and prohibitions set forth in the Qur’an. For
example, the Qur’an orders Muslims to avoid transactions tainted by usury or riba
and encourages Muslim involvement in trade and commerce. However, the details
regarding what constitutes usury are not specified in the Qur’an. Instead, they are
explained in the Sunnah.
Muslims believe that the authenticity of the Qur’an is guaranteed because it is
expressly mentioned in the Qur’an. In other words, the Qur’an used by present-day
Muslims is the same one that was used in the time of the Prophet because the Qur’an
was already preserved in writing in the time of the Prophet. However, the same cannot
be said about the Sunnah. Although some of the sunnah were preserved in writing
during the time of the Prophet, many were transmitted orally. Only after the demise of
the Prophet were comprehensive efforts made to collect all of the hadith in a single
volume. These collections of hadith or sunnah are known as Shahih. The most
authentic and well-known Shahih are the Shahih Bukhari and the Shahih Muslim.
In the Shahih Muslim, the word gharar and its derivatives appear at least 23
times. However, the main benefits that can be derived from the Sunnah on matters
regarding gharar are explanations of the rejection of uncertainty or speculative
elements in trade. There were numerous occasions where the Prophet prohibited
109
transactions tainted by uncertainty. For example, the Prophet prohibited mozabana 261
and mu’awama 262 transactions.
The prohibition of excessive uncertainty can be found both in the Qur’an, and
in the practice of the Prophet. While the Prophet did prohibit dealings involving
uncertainty or gharar on various occasions, not all gharar or uncertainty is prohibited
because there will always be elements of risk and uncertainty in trade and business.
Only excessive uncertainty has been prohibited. The following are some examples of
excessive uncertainty prohibited in Islam: 263
1. Selling an unborn animal without its mother
2. Selling the fetuses or embryos of animals
3. Selling fruit before its emergence
4. Selling a diver’s finds in advance
5. Selling an unborn animal (Habal-al-Habalah)
6. Selling an object of unknown identity without the buyer having the right to
specify it
7. Selling an object of unknown genus
8. Deferment of a price to an unknown future date
What follows are some of the relevant hadith and their explanations:
•
It was related that Ibn Abbas said: “The Messenger of God came to Madinah
while the people were paying for the fruit a year or two in advance. Then he
said: Whoever pays in advance for dates should pay for a specified weight
and measure.” And it was related that: “In an appointed time.” 264
[Explanation: This confirms that the element of excessive uncertainty should be
avoided in Islam. When the transaction involves a future contract, the parties are
required to specify the exact terms].
261
Mozabana is a commercial transaction that has been tainted by uncertainty in quality and number.
This typically involved the exchange of fresh fruit for dry. While the exact quality and number of dry
fruit was measured and fixed, there existed uncertainty regarding the quality and quantity of fresh fruit
still on the trees.
262
Mu’awama is a commercial transaction that has been tainted by uncertainty in delivery. It usually
involved the sale of fruit on the tree one or two years or more before its emergence. This was
prohibited because it might cause injustice due to failure to deliver.
263
Abdul Rahim Al-Saati, ‘The Permissible Gharar (Risk) in Classical Islamic Jurisprudence’ (2003)
J.KAU: Islamic Econ., Vol. 16, No. 2.
264
Ahmad Zidan and Dina Zidan (translators), Mokhtaser Sahih Bukhari (A.S. Nordeen 2002) 206
110
 Abu Hurairah narrated that the Messenger of Allah [Prayers & peace be upon him]
forbade a transaction determined by throwing stones, and the type involving
deception. 265
[Explanation: This describes a type of transaction that way very similar to gambling.
The one who threw the stone would get what the stone hit. This kind of game has
become very popular].
•
Ibn Abbas narrated that the Messenger of Allah said: “He who purchases
food should not sell until he takes possession of it”. (Bukhari 2136). Ibn
Abbas said: Every sale is subjected to this condition. 266
[Explanation: This transaction is prohibited due to the uncertainty in whether the
seller will be able to deliver as agreed].
•
It was related that Ibn Umar said: “The people used to buy food from the
caravans during the Prophet’s lifetime. The prophet (Prayers & peace be
upon him) forbade them to sell it at the place they had bought it but to take it
to the market where provisions were sold. Ibn Umar said: “The Prophet
(Prayers & peace be upon him) also forbade the re-sale of provisions by the
one who had bought it unless he had received it in exact full measure’.” 267
[Explanation: This is an example of how Islam encourages real trade over mere
financial techniques. Although there is certainty because the seller already possesses
the goods, the seller is still encouraged to make the effort to try and sell the goods at a
better place. Otherwise, the sellers are just guessing that they will be able to sell their
goods at higher prices than the previous sellers from whom they bought the goods,
and without putting any adds-value to the commodity].
 Sahih Muslim, Book 10, Number 3649:
265
Al-Hafiz Zakiuddin Abdul-Azim Al-Mundhiri (compiler), The Translation of the Meanings of
Summarized Sahih Muslim Volume 1 (Darussalam 2000) 479
266
Al-Hafiz Zakiuddin Abdul-Azim Al-Mundhiri (compiler), The Translation of the Meanings of
Summarized Sahih Muslim Volume 1 (Darussalam 2000) 469
267
Ahmad Zidan and Dina Zidan (translators), Mokhtaser Sahih Bukhari (A.S. Nordeen 2002) 199
111
Ibn Umar (Allah be pleased with them) reported that they were beaten during the
lifetime of Allah’s Messenger (may peace be upon him) if they had bought
foodgrains in bulk and then sold them in the spot without shifting them (to some
other place). 268
[Explanation: Another example of Islam’s preference for real trade. Re-selling the
exact goods at the same place increases the selling price without bringing any extra
value to the goods or other parties. The end user pays an unnecessarily high price.
This concept has been popularized in present-day conventional financial systems in
which parties continue selling discounted debts to others].
 Sahih Muslim, Book 10, Number 3654:
Jabir b. Abdullah (Allah be pleased with them) is reported to have said that
Allah’s Messenger (may peace be upon him) forbade the sale of a heap of dates
the weight of which is unknown in accordance with the known weight of
dates. 269
[Explanation: This is an example of how transactions tainted by gross uncertainty are
prohibited in Islam if they might cause injustice].
 Sahih Muslim, Book 10, Number 3656:
Ibn Umar (Allah be pleased with them) reported Allah’s Messenger (may peace
be upon him) as saying: Both parties in a business transaction have the right to
annul it so long as they have not separated; except in transactions which have
been made subject to the right of parties to annul them. 270
[Explanation: This is an example of how Islam encourages mutual understanding in
trade and commerce. One of the parties might realize, after signing the document, that
the contractual terms are actually different from what he/she had expected. In a
conventional system, acceptance is considered valid as soon as a signature has been
obtained. However, the uncertain party would feel cheated because the transaction
was not in line with his/her wishes. Under Islamic principles, if the parties have not
268
Abdul Hamid Siddiqui (translator), Translation of Sahih Muslim, Sahih Muslim, Book 10, Number
3649<http://www.iium.edu.my/deed/hadith/muslim/010_smt.html> accessed 10 January 2012.
269
Abdul Hamid Siddiqui (translator), Translation of Sahih Muslim, Sahih Muslim, Book 10, Number
3654<http://www.iium.edu.my/deed/hadith/muslim/010_smt.html> accessed 10 January 2012.
270
Abdul Hamid Siddiqui (translator), Translation of Sahih Muslim, Sahih Muslim, Book 10, Number
3656<http://www.iium.edu.my/deed/hadith/muslim/010_smt.html> accessed 10 January 2012.
112
left the meeting place, either party has the right to annul, which erases or at least
reduces the possibility that the transaction might prove unfair. There is more certainty
that the transaction reflects the commercial wishes of both parties].
 Sahih Muslim, Book 10, Number 3663:
Abdullah b. Dinar narrated that he heard Ibn Umar (Allah be pleased with them)
saying: A man mentioned to the Messenger of Allah (may peace be upon him)
that he was deceived in a business transaction, whereupon Allah’s Messenger
(may peace be upon him) said: When you enter into a transaction, say: There
should be no attempt to deceive. 271
[Explanation: This illustrates how Islam encourages mutual understanding in trade
and commerce and shuns deception. If either party is unclear about the terms of the
transaction, clarification can be demanded by either party and each has the right to
remind the other of the prohibition against attempts to deceive].
 Sahih Muslim, Book 10, Number 3675:
Abu Huraira (Allah be pleased with him) reported Allah’s Messenger (may
peace be upon him) as saying: Do not sell the fruits until their good condition
becomes evident. 272
 It was related that Anas ibn Malik said that the Messenger of God prohibited the
sale of fruit until it was almost ripened. It was said to him: “How do we know
when it is ripe?” He said: “When it becomes red.” The Messenger of God said: “If
God fated that the fruit did not ripen, then for what would any of you take the
money of his brother?”. 273
[Explanation: This confirms that uncertainty regarding the condition and quality of
the goods should be avoided].
This series of hadith on gharar highlights some important elements. Because the
characteristics of gharar are not always crystal-clear and are frequently open to
interpretation, jurists understandably have multiple views on its effect on trade. The
271
Abdul Hamid Siddiqui (translator), Translation of Sahih Muslim, Sahih Muslim, Book 10, Number
3663<http://www.iium.edu.my/deed/hadith/muslim/010_smt.html> accessed 10 January 2012.
272
Abdul Hamid Siddiqui (translator), Translation of Sahih Muslim, Sahih Muslim, Book 10, Number
3675<http://www.iium.edu.my/deed/hadith/muslim/010_smt.html> accessed 10 January 2012.
273
Ahmad Zidan and Dina Zidan (translators), Mokhtaser Sahih Bukhari (A.S. Nordeen 2002) 203
113
following are some of the defining characteristics of gharar that have led to its
prohibition:
 The gharar can cause harm to one/some of the parties
There is no issue of gharar when all parties benefit from a transaction and no one gets
hurt or suffers losses. For example, in takaful or Islamic insurance contracts, the
parties are protected because the contract mutually helps all parties. If there is
uncertainty regarding whether the parties will need the takaful (because the events
covered by the takaful might or might not happen), jurists are in agreement that
takaful is in accordance with the Shariah because the contract is valid and no one has
been harmed. The same concept can be applied to the professional and indemnity
insurance used in maritime trade, to a certain extent.
 The gharar is not necessary
If uncertainties or risks are something that must be faced by the parties due to the
nature of a specific trade, then they are permissible. For example, there is always the
risk that a shipment might be damaged due to events beyond the control of either
party, such as the occurrence of a tsunami. However, the involved parties are allowed
to take such risks because they are in the nature of the trade and are considered
necessary.
 The gharar is a major factor
Minor or small uncertainties do not invalidate a contract under the Shariah. Only
when the subject matter is something fundamental will the doctrine of gharar be
invoked. Examples of something major include the existence of the subject matter,
quality and deliverability.
4.7.4
Scholarly Views on Gharar
As long as a matter is not clearly specified in the Qur’an or the Sunnah, scholars are
allowed to interpret in line with the best interests of their community at the time.
Therefore, it follows that the decisions and views of the scholars, while perfectly valid
at the time they were made, might not be currently suitable for literal adoption.
However, in almost all situations people can benefit from the wisdom of the
traditional scholars. While some of their views may need to be modified to suit
modern needs, the rationale behind their views are always useful because the aim is to
uphold justice and serve the best interests of the community.
114
Some of the Views of the Early Generation
a) Imam Awza’i (707–774)
Imam Awza’i’s full name was Abu Amr Abd al-Rahman ibn Amr al-Awzai. He
was born in 707 and founded the Awza’i school of Islamic jurisprudence. This
school of thought was popular in Syria and Spain (which was a Muslim country at
that time), although it was later replaced by the Mālikī school. Awza’i (d. 157H)
held the view that the sale of an absent object is void under the Shariah due to the
element of gharar in such contracts. 274 The lack of certainty and the ignorance of
the buyer were the reason behind this prohibition.
b) Imam Abu Hanifa
Imam Abu Hanifa’s full name is Nu’mān ibn Thābitibn Zutāibn Marzubān. He
was born in 699 and founded one of the four most well-known Sunni Muslim
schools of thought. Imam Abu Hanifa was born 67 years after the demise of
Prophet Muhammad and it was Hanifa’s view that the sale of something whose
performance is to occur at an unknown future time is invalid due to uncertainty. 275
He also believed that a contract of employment that failed to specify or estimate
the time of salary payment was voidable. This confirmed that uncertainty should
be avoided.
c) Imam Malik
Imam Malik was the founder of the Mālikī school of jurisprudence, one of the
four main Islamic schools of thought. His full name was Mālik ibn Anas ibn
Malik ibn 'Āmr al-Asbahi. He was born in 771 and was the teacher of Imam
Shafi’i, another founder of the four schools. The collections of hadith narrated by
Imam Malik are highly appreciated in Islam and considered to be among the most
authentic. These narrations include Imam Malik, who narrated from Nafi’, who
narrated from ibn Umar, who narrated directly from Prophet Muhammad.
274
Abdullah Muhammad al-Jaburi (ed), Fiqh al-Imam Awza’I, Baghdad, 1977, vol.ii, pp.171-172 as
quoted in Ahmad Hidayat Buang, Studies in the Islamic Law of Contracts: The Prohibition of Gharar
(International Law Book Services 2000) 66.
275
Abu Yusuf, Ikhtilaf, p22 as quoted in Ahmad Hidayat Buang, Studies in the Islamic Law of
Contracts: The Prohibition of Gharar (International Law Book Services 2000) 67.
115
The prohibition of gharar was addressed systematically by Imam Malik in his
famous book, the Muwatta. 276 He listed all contracts that had been prohibited due
to gharar and then provided clarifications on the reasons behind these prohibitions.
To summarize, gharar is prohibited due to the lack of knowledge regarding the
object and the high degree of speculation involved.
d) Imam Abu Yusuf
Imam Abu Yusuf was a famous student of Imam Abu Hanifa. His full name was
Yaqub ibn Ibrahim al-Ansari. He was the Chief Judge or Grand Qadi in Baghdad
and was known to be an advisor to the caliph (the head of a Muslim empire) in
various matters, including the application of Islamic principles to financial
matters.
One of Imam Abu Yusuf’s most interesting works on gharar addressed the
permissibility of conducting transactions in which the element of gharar could be
removed. For example, the Prophet clearly prohibited the sale of fish still in the
water and birds still in the sky because the deliverability of the transactions was
uncertain. However, Yusuf also pointed out that the sale of fish from a restricted
place, such as a small tank, was allowed because the uncertainty had been
removed, 277 making such a sale permissible. In other words, the doctrine on the
prohibition of gharar is not absolute.
e) Imam Shafi’i
Imam Shafi’i’s full name was Abū Abdullāh Muhammad ibn Idrīs al-Shafiī. He
was born in 767 and founded the Shafi’i school of thought, one of the four most
well-known schools of Islamic thought. He was also known as the founder of
Islamic jurisprudence due to his efforts to devise clear and systematic ways of
deducing rulings and decisions according to Islam. He authored more than 100
books, but the most famous are the al-Risala, the Kitab al-Umm and the Musnad
ash-Shafi’i.
His works indicated that he held the view that gharar is prohibited partly due the
possible inability of the seller to deliver as agreed.
276
Malik ibn Anas, al-Muwatta’, pp. 412-413 as quoted in Ahmad Hidayat Buang, Studies in the
Islamic Law of Contracts: The Prohibition of Gharar (International Law Book Services 2000) 67.
277
Abu Yusuf, Kitab al-Kharaj, Egypt, 1302H, p. 87 as quoted in Ahmad Hidayat Buang, Studies in
the Islamic Law of Contracts: The Prohibition of Gharar (International Law Book Services 2000) 68.
116
Summary of Views
An expert in the Islamic doctrine of gharar, Buang’s work Studies in the Islamic Law
of Contracts: The Prohibition of Gharar analyzes the definitions adopted by Islamic
jurists from the early generation, those from the Companions and Successors, those
from the formative period of the Islamic School of Law, namely Awaza’i, Abu Hanifa,
Ibn Abu Layla, Malik, Abu Yusuf, Shaybani, Shafi’i, Muzani, Sahnun and Ali Ibn
Zayd and the classical jurists, including the Hanafis: Saghadi, Sarakhsi, Samarqandi,
Ibn Huamm, Ayni, Karlani and Afghani; the Mālikī: Ibn Abi Zayd, Khalid ibn Ishaq,
Ibn Rushd, Qarafi and Sawi; the Shafi’is: Shirazi, Nawawi, Ibn Hajar, Shirbini
al-Khatib and Bajuri; the Hanbali: Ibn Qudama, Ibn Taymiyya and Ibn al-Qayyim; the
Sunni extinct school: the Zahiri – Ibn Hazm; the Shi’is: the Ithna Ashari, the Ismaili
and the Zaydi and the Ibadi: Basyani and Shammakhi. 278 Buang concluded:
… [I]t can be suggested that there is no general comprehensive statement on
what can be best described as gharar in the contracts, as far as the traditional
jurist are concerned. The jurists of the early period of Islamic law did not
elaborate the meaning of gharar. Their work on the prohibition of gharar was
mainly the elaboration and extension of the contracts prohibited by the hadith
believed for the reasons of gharar. 279
Modern Interpretations of Gharar
After analyzing the definitions forwarded by scholars, it can be concluded that
scholars generally agreed that gharar refers to unacceptable uncertainty or risk
although literally, gharar should not be interpreted as speculation. However, as a
concept, excessive speculative activities are prohibited. Discussion on whether
excessive speculative activities fall under the prohibition of gharar or under the
prohibition of gambling is theoretical in nature. On literal definition, an expert on the
doctrine of gharar, Buang concluded as follow:
The literal meaning of the word gharar can be divided in two: the act of deception; and
a situation of danger, risk, peril and destruction. The Qur’an appears to use the first
meaning while hadith appears to use the second meaning. The lexicographers in defining
the noun-word gharar seem to prefer the meaning used by the hadith. This variation in
278
Ahmad Hidayat Buang, Studies in the Islamic Law of Contracts: The Prohibition of Gharar
(International Law Book Services 2000) 63-98.
279
Ahmad Hidayat Buang, Studies in the Islamic Law of Contracts: The Prohibition of Gharar
(International Law Book Services 2000) 98.
117
language has no difference in practical terms as both meanings eventually can lead into
what can be said to be gharar. 280
Buang’s definition seems to be the most accurate. The definition of gharar that has
been adopted in the modern era, e.g. by the Hong Kong Legislative Council
Secretariat, is also quite comprehensive:
Gharar refers to unacceptable uncertainty or risk caused by a lack of clarity regarding
the subject matter or terms in a contract or exchange. A sale or any other business
contract entailing an element of gharar is prohibited. Such prohibited activities include
any transaction of probable items whose existence or characteristics are not certain at the
time of contract, due to the lack of information, ignorance of essential elements in the
transaction to either party, or uncertainty of the ability of one party to honour the
contract. In Islamic finance, the prohibition of gharar is the basis for disallowing
financial products/practices such as short selling, speculation, insurance and
derivatives. 281
4.8 Classification of Gharar
Scholars are not unanimous concerning the classification of uncertainty or gharar in
contracts and financial transactions. Generally, minor uncertainty is allowed under
Islamic commercial law. Major uncertainty is sometimes allowed if it is unavoidable
and benefits both parties, provided that it is not contrary to other principles of Islamic
law. The difficulty is classifying minor and major uncertainties. For example,
according to Muslim scholar, Al-Baji, minor uncertainty is that which cannot be
avoided or is barely avoidable in a contract and excessive uncertainty is that which is
so great that the uncertainty characterizes the contract. Al-Baji 282states:
…On the other hand, minor gharar does not render a sales contract defective, since no
contract can be entirely free of gharar. Thus, the [legal] scholars differ in determining
280
Ahmad Hidayat Buang, Studies in the Islamic Law of Contracts: The Prohibition of Gharar
(International Law Book Services 2000) 60
281
‘Fact Sheet: Overview of Islamic Finance’ Legislative Council Secretariat
<http://www.legco.gov.hk/yr09-10/english/sec/library/0910fs19-e.pdf> accessed 8 November 2011.
282
Al-Baji, Al-Muntaqa Sharh al-Muwatta. (Dar Al-Kutub Islamiyyah) as quoted in Mahmoud A.
El-Gamal, ‘An Economic Explication of the Prohibition of Gharar in Classical Islamic Jurisprudence’,
(The 4th International Conference on Islamic Economics in Leicester, UK, 13-15 August 2000)
<http://www.ruf.rice.edu/~elgamal/files/gharar.pdf> accessed 30 October 2009.
118
which contracts are defective due to differences in opinion regarding the extent of
gharar inherent in each: sic. Whether it is substantial and invalidates the contract, or
minor and retains the contract’s validity.
Four different rules concerning gharar have been created under Islamic commercial
law: 283 (1) prohibited gharar includes voluntary and deliberate gross uncertainty that
might result in enmity and hatred, (2) gharar is considered permissible when there is
no general agreement between the schools of thought that the specified transactions
are prohibited, (3) acceptable gharar is defined by a state in which the main sources
of uncertainty are endogenous and exogenous 284 and (4) gharar is considered
mandatory when the uncertainty is a prerequisite of the contract’s validity. Risk has
also been divided into the following components: (1) controllable risk can be
controlled and influenced by decision makers and (2) uncontrollable risk cannot be
controlled by decision makers. 285
Al-Darir listed four necessary conditions for uncertainty to invalidate a
contract: (1) it must be major, (2) the contract must be commutative, ie not a gift, (3)
it must affect the principal components or subject matter of the contract and (4) there
must be no need met by the contract that cannot be met otherwise. 286
Mahmud A. El-Gamal classified uncertainty into three categories: (1)
ambiguity in the contract regarding the price and nature of the object for sale, (2)
uncertainty regarding delivery and (3) uncertainty regarding the object being sold. 287
Previous research has also pointed to the relationship between the causality approach
to decisions made under uncertainty and the prohibition of gharar. 288 It has been
283
Abdul Rahim Al-Saati, ‘The Permissible Gharar (Risk) in Classical Islamic Jurisprudence’ (2003)
J.KAU: Islamic Econ., Vol. 16, No. 2.
284
This is explained by the Western comprehension of uncertainty that follows.
285
Sami Ibrahim Al-Suwailem, ‘Decision-making under uncertainty: An Islamic Perspective’ in
Munawar Iqbal and David T. Llewellyn, Islamic Banking and Finance (Edward Elgar Publishing
Limited 2002).
286
Siddiq Al Dareer, Al-Gharar in Contracts and its effects on Contemporary Transactions (IRTI1997).
287
Mahmoud A. El-Gamal, ‘An Economic Explication of the Prohibition of Gharar in Classical
Islamic Jurisprudence’ (The 4th International Conference on Islamic Economics in Leicester, United
Kingdom, 13-15 August 2000) <http://www.ruf.rice.edu/~elgamal/files/gharar.pdf> accessed 30
October 2009.
288
Sami Ibrahim Al-Suwailem, ‘Decision-making under uncertainty: An Islamic Perspective’ in
Munawar Iqbal and David T. Llewellyn, Islamic Banking and Finance (UK: Edward Elgar Publishing
Limited 2002).
119
shown that uncertainty typically stems from the involved parties exhibiting passive
behaviour and reliance on chance.
New research has been made available on the application of Islamic
commercial law in modern trade, including e-business. 289 The general view shared by
Muslim scholars is that modern and conventional trade is permissible as long as it
does not breach the principles laid down in the Shariah and assuming that contracts
are free from uncertainty and other prohibited elements.
Over the past 1,400 years, Muslim scholars have differed in their
understanding of the prohibition of gharar. However, some notable features have
been highlighted. First, if a transaction is tainted by uncertainty that results in one of
the parties suffering an injustice, such a transaction is usually prohibited. For example,
if one party agrees to purchase an agricultural commodity such as apples without first
confirming their quality, and the quality of the commodity proves to be very bad, the
uncertainty in the initial contract (concerning the quality of the commodity) breaches
the doctrine of gharar because it results in injustice for the party that has purchased a
commodity of poor quality.
Second, Islamic principles generally prohibit dealing with transactions tainted
by gambling. For example, is a carrier loses a shipment of silver or gold in the ocean
during a tsunami the carrier, in consideration of the payment of US$1 million from a
party, agrees that the party may take the gold and silver if it is recovered. This
breaches the doctrine of gharar because it includes an element of gambling. Therefore,
the parties would be encouraged to adopt a different contract. For example, the party
interested in the gold and silver could pay the carrier US$1 million for the right to
collect it, provided that a real effort is made to discover and reclaim it. This
transaction would not be construed as gambling because a real and productive effort
would be made. Although there is risk, the risk is balanced by the effort.
Third, transactions must not be avoidable. In other words, if the uncertainty or
risk is something that cannot be avoided, then the doctrine of gharar is not breached.
For example, there is uncertainty involved in whether a shipment of goods will make
it to its destined location because there is always the possibility that shipments might
be lost at sea for a variety of reasons outside anyone’s control. However, such risk is
inherent in maritime trade and therefore contracts for shipment are valid regardless of
such risk and uncertainty.
289
Hanudin Amin, ‘E-Business from Islamic Perspectives: Prospects and Challenges’ (2008) Journal
of Internet Banking and Commerce, December, Vol. 13, no. 3.
120
4.9 The Benefits and Advantages
Although Islamic finance offers numerous benefits, its full potential has yet to be
tapped. To truly benefit from Islamic finance, the core of the Islamic financial system
must be gradually strengthened alongside a change in mentality from choosing
cosmetic changes to ensure minimum Shariah-compliance to a comprehensive
adherence to Islamic principles that encourages real trade and commerce. Below are
some of the noted benefits of Islamic finance:
i.
ii.
iii.
iv.
v.
vi.
vii.
Flexibility
Resilience
Stability
Ethically fair and just
Diversification
Fulfills religious needs
Huge market
i. Flexibility
Islamic finance is simple and straight forward, yet flexible enough to meet the
commercial needs of the involved parties. According to Kuwaiti economist, Hajjaj
Bukhdur:
Islamic finance already has around 30 different types of products and instruments,
giving it a large degree of flexibility to meet investors’ demand and continue to expand
rapidly… But it has two major shortcomings: there are different regulatory systems ...
and managements have been less competent to realize the full potential. 290
The recent introduction of Islamic bonds known as sukuks and Islamic derivatives is
further indication of the flexibility of Islamic finance. 291 This flexibility allows a
variety of different Islamic financial products to be created for a single purpose.
However, the level of risk associated with each product and the benefits to the
290
Omar Hasan, ‘Islamic finance should diversify, analyst say’ Agence France-Presse (Kuwait 5
September 2010)
<http://www.hurriyetdailynews.com/n.php?n=islamic-finance-should-diversify-analysts-say-2010-09-0
5> accessed 17 November 2011.
291
See Asmadi Mohamed Naim, ‘Chapter 9 Shari'a Criteria: Issues in Company Investment and Sukuk
issuance in mixed activities’ in Humayon A. Dar and Umar F. Moghul (editors), The Chancellor Guide
to the Legal and Shari’a Aspects of Islamic Finance (Harriman House 2010)
121
involved parties differ. Currently, many scholars are considering the viability of
equity financing compared to debt financing. The general principle under Islamic law
is that everything is permissible and allowed unless it is expressly and clearly
prohibited. Therefore, Islamic law is always suitable for implementation because of
its flexibility. 292 The problem is that there can be uncertainty regarding the validity of
some of the financial products, such as whether they are Shariah-compliant. To avoid
this a clear hierarchical structure is required. For example, such uncertainty is
eliminated by a clear hierarchical structure at the international level or as reflected in
the terms of the contract. It if the products are deemed valid by those holding the final
say, be it a committee or a respected scholar, there should be no further disputes
concerning issues of validity or Shariah-compliance.
ii. Resilience
Islamic finance has often proven more resilient to financial crisis as the result of its
guiding principles and because transactions tainted by excessive uncertainty are
prohibited. For example, according to Askari et al:
The reason that Islamic financial institutions and capital markets were not directly
affected by the subprime financial crisis was that they did not have any exposure to toxic
assets (largely debt-based) and therefore, were immune to the crisis during its early
stages. However, as the financial crises led to economic recession and global slowdown,
the values in the real sector also began to deteriorate, putting pressure on Islamic
financial institutions too. 293
However, Islamic finance is not risk-free. It can, and has suffered loss. According to
Islamic finance experts, a business transaction that only guarantees ‘profit’ and rejects
any possibility of loss is often usury in disguise. Such transactions are typically not
sustainable and tend to involve some element of injustice, eg oppression due to lack
of bargaining power or unfair allocation of risks between the parties.
Islamic finance has emerged relatively unscathed from the subprime crisis and the
credit default swaps debacle for the following reasons (among others):
Islamic law forbids many of the products and transactions related to those specific
aspects of the meltdown-the securitization of debt, the bets inherent to credit default
292
293
Mohd Akram Laldin, Islamic Law: An Introduction (IIUM Press 2009) 40.
Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor, The Stability of Islamic
Finance (John Wiley & Sons (Asia) Pte. Ltd 2010) 199.
122
swaps, the excessive leverage, and more generally the sheer complexity and opacity of
the derivatives and their distance and disconnection from real assets. 294
Islamic finance is not immune to the ‘bubble’ dynamic and, indeed, it has started to
feel the effects of a different kind of bubble caused primarily by a decrease in asset
prices. 295To truly make the global system more resilient, Islamic financial institutions
must depart from the current practice of simply making cosmetic changes because the
benefits and add-values expected of Islamic finance cannot be realized in such
situations. As long as the attitude and mentality towards risk is similar to that of
conventional practices there will be no real benefit. In fact, such an environment
might be just as volatile as conventional situations, as reflected by research conducted
on the Islamic index. 296
iii. Stability
There have been numerous works on the stability of Islamic finance, including the
work of Askari et al. 297 The recent global recession highlighted the fragility and
instability of the modern conventional financial system. To quote Warren Buffett,
‘you only learn who has been swimming naked when the tide goes out, and what we
are witnessing at some of our largest financial institutions is an ugly sight.’ 298
According to Dr. Zeti:
Islamic finance has, thus far, remained positive, despite the current challenging global
financial environment. The strengths in Islamic finance are derived from the Shariah
principles, the key pillar of Islamic finance that has contributed towards its overall
294
Ibrahim Warde, ‘The Relevance of Contemporary Islamic Finance’ (2009) Berkeley J. Middle E. &
Islamic L., 164.
295
Ibrahim Warde, ‘The Relevance of Contemporary Islamic Finance’ (2009) Berkeley J. Middle E. &
Islamic L., 164.
296
Amélie Charles, Adrian Pop and Olivier Darné, ‘Is the Islamic Finance Model More Resilient than
the Conventional Finance Model? Evidence from Sudden Changes in the Volatility of Dow Jones
Indexes’ (International Conference of the French Finance Association (AFFI),11-13 May 2011)
<http://ssrn.com/abstract=1836751> accessed 17 November 2011.
297
Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor, The Stability of Islamic
Finance: Creating a Resilient Financial Environment for a Secure Future (John Wiley & Sons (Asia)
Pte. Ltd 2010).
298
Francesco Guerrera and Justin Baer, ‘Buffett defends sovereign wealth funds’ Financial Times (29
February 2008).
123
stability and resilience. The Shariah injunctions require that the financial transactions
be accompanied by an underlying productive activity thus giving rise to a close link
between financial and productive flows. 299
The strength of the largely interest-based conventional financial systems, tainted
with occasional excessive speculative activities, has been tested during the recent
global recessions and financial crises. Although Islamic finance is flexible in most
areas, the fundamentals or core principles remain clear, and this results in a more
stable system. For example, due to the prohibition of interest, Islamic finance
encourages real trade and business activities that generate legitimate income and
profit. The prohibition of dealings with transactions tainted by gharar or major
uncertainties means that speculative activities and excess leverage are avoided.
Islamic finance is generally safe from the uncertainties and fragility created by the
gambling-like speculations that occur in conventional finance, particularly in relation
to short selling, sales on margin and debt-based securities. Islamic finance keeps the
financial sector in sync with real-world sectors, such as trade and commerce by
insisting on a stable and fair market. A strong perception exists that the distribution of
income and wealth are generally unfair and that inequality is increasing, as reflected
by the growing gap between the rich and the poor.
Conventional financial systems based on debt can be extremely volatile and their
sustainability is questionable, as reflected by the European governmental debt crisis.
In 2010, Europe’s Finance Ministers had to approve a rescue package amounting to
€750 billion to ensure financial stability in Europe (via the creation of the European
Financial Stability Facility). During such financial crises the instability of
conventional systems is more apparent. For example, in relation to the European debt
crisis, financial speculators and hedge funds engaged in selling the euro, which
worsened the crisis, as suggested by Greek and Spanish Prime Ministers. 300
To achieve better stability, Islamic principles can also be applied to monetary
systems. Islamic monetary systems are not against paper money per se. However, they
insist on a just system in which stability exists and manipulations and injustice are
avoided. Understandably, during the eighth to fourteenth centuries when Muslim
299
Zeti Akhtar Aziz, ‘Governor’s Keynote Address: Islamic Finance: A Global Frowth Opportunity
Amidst a Challenging Environment’ (State Street Islamic Finance Congress 2008, Boston USA, 6
October 2008).
300
Sean O'Grady, ‘Soros hedge fund bets on demise of the euro’ The Independent (London 2 March
2010)
<http://www.independent.co.uk/news/business/news/soros-hedge-fund-bets-on-demise-of-the-euro-191
4356.html> accessed 17 November 2011.
124
empires peaked, gold and silver were the main currency. It would be difficult to
achieve the desired stability from modern Islamic finance under current monetary
systems. Details on this matter are included in subsequent chapters. Briefly, Islamic
finance encourages a stable and fair monetary system that is not easily manipulated.
Present-day monetary systems are allegedly tainted by manipulations and
uncertainties. It is a well-known fact that countries can currently produce money
without any practical limitations and without the backing of a gold reserve. Islamic
finance scholars have long claimed that paper money or currency that is not backed by
anything, eg gold, can be dangerous. During World War II gold holdings peaked at
around 20,205 metric tonnes (in the United States alone). The United States still has
the largest gold reserve in the world, estimated at 8,133.5 tonnes in 2010. In
comparison, China’s gold reserve is estimated to be around 1,054 tonnes. 301 The PRC
has also indicated its intention to increase its gold reserve in response to the
uncertainty of global monetary systems. An analysis of the gold supply showed that
around 160,000 tonnes of gold has been mined from the beginning of recorded history
through the end of 2008. Furthermore, the gold demand for jewelers, industrial and
central bank reserves equates to approximately 100,000; 30,000 and 30,000 tonnes,
respectively. 302 It has been proposed that the world’s gold supply is sufficient to
regulate and accommodate global trade and commerce, although the world’s wealth
will be more limited because gold cannot be printed like paper money. It is, however,
more sustainable. While gold currency, unpegged to paper money, can be effective,
gold is not necessarily a good investment.
Although Islamic finance is not against fiat money or paper money per se,
Islamic financial experts have long voiced that a system in which money can be
printed at will and is easily manipulated is vulnerable to injustice and uncertainties.
They have proposed that a time will come when fiat money finally loses its value and
that the application of Islamic principles to monetary systems, if observed, could
provide a cushion at such a time.
Islamic finance experts have different views concerning the use of gold and
silver (even the gold standard) as a medium of exchange and its relation to stability.
For example, eminent Islamic finance scholar, Bakar, stated, ‘I don’t believe in the
301
‘Gold Reserve: Tough for China to Beat US’ International Business Times (Beijing 13 April 2010).
302
Shahriar Shafiee and Erkan Topal, ‘An Overview of Global Gold Market and Gold Price Forecasting’
(2010) Resources Policy 35, 178-189.
125
gold standard for currency… for me it’s not practical… There could even be wars
over gold – it’s just creating another issue.’ 303
iv. Ethically fair and just
The concept of profit-loss-sharing, if utilized properly, would lead to an ethically fair
and just trade and finance system. According to Zaher and Hasan:
The Islamic community has rationalized the elimination of riba (interest) based upon
values of justices, efficiency, stability and growth. In terms of justice, the removal of
riba results in the sharing of the risk of a project between the borrower and the lender.
In addition, by tying the reward to the performance of the business venture, the
resulting returns are more equitable during the good times and bad times. 304
Islamic finance has the potential to bring a wide range of economic benefits to society
through the mobilization of savings, productive investments and general economic
development. 305 There is strong evidence that Islamic finance is actually paving the
way for a more ethical type of trading and financing. Contrary to the claims made by
various writers that Islamic finance is nothing more than cosmetic changes to
conventional finance, the facts indicate that some Islamic finance products actually
challenge the core of conventional finance (including usury and interest), albeit in a
slow and progressive manner. For example, as an important financial trade centre,
Singapore followed in the footsteps of other countries and passed legislation in 2005
that enabled banks to engage in non-conventional banking activities, eg real trade and
commerce, as a way of further facilitating Islamic finance products. Before the
emergence of Islamic finance, most relationships between financiers and their
customers were reflected by a creditor-lender relationship in which the financiers’
only real concern was to get the principal and the interest or usury without taking any
major risks. This research proposes that a shift to superior financial products with
better risk allocation systems within Islamic financial institutions is possible, but
would be easier if it was supported by established international institutions.
303
Talal Malik, ‘Scholar urges Islamic finance standardization,’ Arabianbusiness.com (15 April 2008),
<http://www.arabianbusiness.com/property/article/516581-scholar-urges-islamic-finance-standardisatio
n> accessed on 14 November 2011.
304
Tarek S. Zaher and M. Kabir Hassan, ‘A Comparative Literature Survey of Islamic Finance and
Banking’ (2001) Financial Markets, Institutions and Instruments, V.10, No.4 (November).
305
Ibrahim Warde, ‘The Relevance of Contemporary Islamic Finance’ (2009) Berkeley J. Middle E.
and Islamic L., 166.
126
Some critics argue that Islamic banks use the same rates, such as the London
Interbank Offer Rate (LIBOR), to determine their profit, similar to those used by
commercial banks 306. However, Islamic banks have not historically had their own
benchmarks for establishing profitability and, as such, have had to use conventional
benchmark rates. With the growing demand for Islamic finance, Islamic countries
have begun to develop instruments, including Malaysian Islamic Benchmark bonds
that allow Islamic banks to have their own benchmarks. 307
Islamic and conventional finance diverge in the case of default. In conventional
finance, the interest continues to compound until all of the principal and interest is
paid. However, under Islamic finance, because the transaction is not a loan there is no
interest or compounding interest. Therefore, the accusation that Islamic finance is the
same as conventional finance is inaccurate.
Conventional debt financing that is collateralized and earns a fixed interest-rate
can appear unjust with an unequal distribution of risk. 308 This inequality is even more
pronounced when Western governments use public funds to bail out banks, as during
the recent global recession. However, Islamic financial systems cannot be introduced
by merely eliminating the usury system. It should be done by adapting and fusing the
Islamic principles of social justice as an alternative alongside its rules, practices,
regulations and instruments to help realize equity and fairness. 309 In other words, a
dual system in which the customers and clients can choose the product they prefer
should be promoted.
One of the defining characteristics of Islamic finance is its profit-and-risk
sharing feature, as reflected in the popular mudharabah and musyarakah contracts.
Conventional financial systems are characterized by interest or usury, which have
become their backbones. Under the concept of interest or usury, the relationships
between financial institutions such as banks and their clients are legally those of
creditor and borrower. The creditors do not concern themselves with the borrowers’
problems because their main concern is to get the money and the interest. Under
Islamic finance, the primary relationship cannot be that of creditor and debtor because
306
Beng Soon Choong and Ming-Hua Liu, ‘Islamic banking: Interest-free or interest based?’ (2009)
Pacific Basin Finance Journal, Volume 17, Issue.1 (January) 125-144
307
Gohar Bilal, ‘Islamic Finance: Alternatives to the Western Model’ (1999) The Fletcher Forum of
World Affairs, Vol.23, 158.
308
Ataul Huq Pramanik (ed), Islamic Banking: How Far Have We Gone (Malaysia: IIUM Press, 2009)
14.
309
Sudin Haron and Wan Nursofiza Wan Azmi, Islamic Finance and Banking System: Philosophies,
Principles & Practices (McGraw-Hill (Malaysia) Sdn. Bhd, 2009) 97.
127
interest is forbidden. Therefore, Islamic financial institutions such as Islamic banks
must take on some real risks. For example, under conventional banking systems
parties interested in buying a home will go to the bank and ask for loan. Let us say
that the price of the house is HK$10 million. Under conventional systems, the buyer
will enter a loan with the bank and pay, perhaps, HK$18 million over twenty years.
The extra amount (after the capital) paid by the buyer to the bank is considered usury.
Because usury or interest is prohibited under Islamic finance, an Islamic bank
cannot simply give loans to such buyers. Ideally, an Islamic bank would purchase the
house and resell it to the buyer for profit. For example, the Islamic bank might
purchase a house for HK$10 million and sell it to an interested buyer for HK$18
million in monthly installments paid over twenty years. While these two scenarios
might appear to be the same, the differences are significant. If the house has defects or
worse, construction is not completed, the client of a conventional bank will still have
to pay the loan, in full, to the bank. However, under Islamic finance the client will
have a counter claim against the Islamic bank for selling defective goods.
Accordingly, the Islamic bank can sue the real culprit, the developer. Therefore, under
true Islamic finance, the clients’ protection is more comprehensive. Islamic banks
should also take adequate measures to ensure the credibility of the developers and
projects they endorse through proper investigation.
Furthermore, Islamic finance is competitive and profitable. The market for
Islamic finance was around US$1 trillion in 2008 and the estimate for 2010 is almost
US$1.5 trillion. In conventional finance, the creditors lending the money are only
concerned with the return of that money. Failure to repay on agreed terms requires
creditors to push borrowers into bankruptcy, at which point they take all available
assets without consideration for other involved parties. However, under Islamic
finance, if the financier is also a partner, he/she will be less willing to get rid of the
other party. This is the entire construct behind products such as the musharakah
contract. 310
To be more specific, failure to repay loan should not be a primary problem under
Islamic finance because the contractual relationship between the parties is not
debtor-creditor relationship to begin with. The real risk faced by Islamic financial
institution in this situation is the failure of the project or the incapability of the parties
to perform their part. Therefore, due diligence and comprehensive risk assessment is
necessary. An ideal Islamic financial institution cannot be passive as their role is not,
strictly speaking, a mere financier.
310
Oliver Agha, ‘Islamic Finance in the Gulf: A Practitioner’s Perspective’ (2008) Berkeley J. Middle
E. & Islamic L., 183.
128
v. Diversification
Many Western financial institutions are attracted to the diversification offered by
Islamic finance, especially with the emergence of new Islamic financial institutions
and markets, including international project financing, private equity, the issuance of
Islamic bonds (known as sukuk) and various asset, funds and wealth management
strategies. 311 This is consistent with the global nature of Islamic finance.
Product development for Islamic financial services has generally been limited to
the reengineering of conventional financial products to meet the formal requirements
of Islamic finance. To make a substantive contribution to the development of Islamic
finance, a wider view of Shariah-compliance and a new generation of competitive and
innovative products will be required.
Although Islamic finance products can be tailored to meet the needs of the
involved parties, some of the basic principles cannot be changed. Successful products
must also observe certain criteria limitations, and even with these, a broad range of
companies is eligible for investment. For example, as of June 2006, theDow Jones
Islamic Market Index listed 1,937 companies as being eligible for investment.
vi. Fulfills religious needs
Islamic finance enables Muslims to conduct their daily transactions in ways that are
Shariah-compliant.
vii. Huge market
Moody's Investors Service believes that the full potential is at least US$5 trillion
although currently, it only accounts for around 5 percent of the global financial
industry. 312 There is a huge market for Islamic finance. The first being Muslims,
which compose about 20 percent of the world population. James Hume, executive
vice president of the Dubai International Financial Centre, noted:
311
For example, see Tarek S. Zaher and M. Kabir Hassan, ‘A Comparative Literature Survey of
Islamic Finance and Banking’ (2001) Financial Markets, Institutions and Instruments, V.10, No.4,
November.
312
Omar Hasan, ‘Islamic finance should diversify, analyst say’ Agence France-Presse (Kuwait 5
September 2010)
<http://www.hurriyetdailynews.com/n.php?n=islamic-finance-should-diversify-analysts-say-2010-09-0
5> accessed 17 November 2011/11/17.
129
An increasingly educated populace with growing self-assuredness and awareness of their
Islamic roots is becoming alert to the shortcomings of conventional finance and more
vocal in demands for alternatives. 313
Similarly, according to the Hong Kong Legislative Council Secretariat:
Islamic finance has expanded rapidly in recent years, as evidenced by the growth in
Shariah-compliant financial assets worldwide by over 10% per annum during the past
decade1. At present, Islamic finance represents a small growing segment of the global
finance industry. Measured by Shariah-compliant assets held by financial institutions,
the global Islamic finance industry was estimated at US$822 billion (HK$6.4 trillion) in
2009. This figure is projected to reach US$1 trillion (HK$7.8 trillion) in 2010 and
US$1.6 trillion (HK$12.4 trillion) by 2012. 314
In the Middle East alone at least US$1.5 trillion in project financing is expected in the
next ten years, and most of it will have strong Islamic financing aspects. 315
Rehman’s work highlighted the following facts related to high-profile investments
made by the Gulf States and Islamic institutions: 316
•
The Gulf States control around 40 percent of the world’s known oil reserves and
nearly a quarter of global natural gas reserves.
•
By 2006, the foreign assets of the Gulf Cooperation Council (GCC) had already
reached US$1.9 trillion.
•
The net capital outflows from the Gulf States in 2006 alone were US$200 billion.
•
The McKinsey Global Institute estimated that the GCC’s accumulated foreign wealth
could reach US$8.3 trillion by 2020.
Islamic finance’s huge market potential is, however, severely limited by Islamophobia.
Following the attacks on 11 September 2001, all things Islamic came under a cloud of
suspicion, and Islamic finance and Islamic banks were certainly no exception.
Discrimination against Muslims increased significantly following the September 11
attacks, with Muslims stereotyped as violent and prone to terrorism without any
313
314
315
James Hume, ‘Islamic Finance: Provenance and Prospects’ (2004) Int'1FinL Rev 48.
< http://www.legco.gov.hk/yr09-10/english/sec/library/0910fs19-e.pdf> accessed 8 November 2011.
Oliver Agha, ‘Islamic Finance in the Gulf: A Practitioner’s Perspective’ (2008) Berkeley J. Middle
E. & Islamic L., 190.
316
Aamir A. Rehman, Gulf Capital & Islamic Finance: The Rise of the New Global
Players(McGraw-Hill 2010).
130
opportunity to rebut. There are around 1.3 billion Muslims in the world, and that
means that one out of every five or six people on the planet is Muslim. However, the
equity and wealth shared by Muslim communities is just around 4 percent and many
Muslim countries such as Indonesia, Bangladesh, Afghanistan and Pakistan are
largely poor with no media power. Furthermore, almost all of the eminent media is
owned and controlled by Western countries with much of it significantly contributing
to the negative perceptions and images of Islam that have become so commonplace. A
case study of American network news coverage post 9/11 supported the view that
objective coverage of Islam is a myth, not just in America, but around the world. 317
Muslims, especially those from the Middle East, are almost always portrayed as
terrorists with the intention to kill the innocent populations of Western countries in
Hollywood movies. As a consequence, hatred towards Islam and Islamophobia are on
the rise. Mosques in various places have been defaced and burned and Muslims are
treated suspiciously, especially those trying to adhere to the Islamic dress code.
Requests have also been made by some politicians to refuse citizenship to followers
of Islam. Applications to build non-Islamic places of worship have typically been
freely granted, but applications to build mosques have become sensitive and many
have been rejected. Therefore, it is not surprising that the negative perceptions
towards Islam and strong hatred for Muslims have contributed to the various attacks
on Islamic finance, many of which have been based on prejudice and bias. Virtually
every work in the abundant ‘secrets of terrorist financing’ literature has alleged that
the purpose of Islamic finance is to fund terrorism. 318
Sandy Berger, the National Security Adviser during Bill Clinton’s second term
and the top official in charge of the surveillance of Bin Laden’s networks at the time,
allegedthat “it would be difficult to track down Osama Bin Laden’s money because it
was hidden in ‘underground banking, Islamic banking facilities.” 319 Blanket
accusations that Muslims are terrorists, or even violent people, are unwarranted and
unjustifiable, but that has not stopped individuals from insisting that Islamic finance
should be discouraged because ‘terrorists might use it’. Conflicting logic plagues
these accusations because real terrorists do not want their money to be easily
identifiable and would definitely shy away from Islamic finance, which is subjected to
a great deal of scrutiny from the authorities. Those involved in terrorism are more
likely to receive their funding from other sources including piracy, money-laundering
317
See Dina Ibrahim, ‘The Framing of Islam on Network News Following the September 11th Attacks’
(2010) The International Communication Gazette, Volume 72, No.1.
318
Ibrahim Warde, ‘The Relevance of Contemporary Islamic Finance’ (2009) Berkeley J. Middle E.
and Islamic L., 160.
319
Gene J. Koprowski, ‘Islamic Banking is Not the Enemy’ (2001) Wall Street Journal Europe. 1.
131
and secret donations and it would be highly counterintuitive to attempt to use Islamic
finance for such activities.
Despite this discrimination, in the years following the September 11 attacks, the
Islamic finance industry did not crumble and collapse. Instead, it experienced
dramatic growth and major transformations while progressively shifting to better
products. Criticisms and condemnations of Islamic banks were no doubt a motivating
factor in the serious efforts to standardize, rationalize and streamline Islamic finance.
Blanket discrimination against Muslims and Muslim countries, particularly those in
the Middle East, have also contributed to the development of Islamic finance in
certain jurisdictions such as Southeast Asia and particularly Malaysia because some
wealthy Muslims and Muslim countries decided to diversify their wealth outside
Western countries due to the prevalence of poor treatment and negative perceptions.
Furthermore, the risk that their assets might be unfairly frozen merely because they
were Muslims also contributed to the shifting of assets and investments outside
Western countries. Islam is one of the most misunderstood religions and its negative
portrayal in media and much of society has been detrimental to the development of
Islamic finance.
According to the 2009 survey on religious attitudes, a shocking 58 percent of the
Americans interviewed agreed that Muslims face more discrimination than any other
religious group in the United States. 320
With a proper strategy for improving the relationships between Muslims and
non-Muslims in place and a more efficient use of the media to reduce negative
perceptions, it is possible to ensure a brighter future in which kindness and mutual
understanding leads the way. Due to the strong and systematic bias and discrimination
in the West towards Muslims, especially those from the Middle East, many wealthy
investors and Middle-Eastern Muslim countries are looking for alternatives. This has
contributed to the growing Islamic finance market outside the United States.
Furthermore, non-Muslim investors have also contributed to this expansion with the
market for sukuk increasing from close to zero in 2001 to US$100 billion in 2007, in
part because non-Islamic investors have acquired a substantial percentage of the sukuk
market. 321
320
Jina Moore, ‘Post 9/11, Americans say Muslims face most discrimination: But many also see Islam
as a violent religion, according to a Pew Forum survey’ The Christian Science Monitor (11 September
2009) <http://www.csmonitor.com/USA/2009/0911/p02s19-usgn.html> accessed 18 November 2011.
321
Ibrahim Warde, ‘The Relevance of Contemporary Islamic Finance’ (2009) Berkeley J. Middle E.
and Islamic L., 165.
132
4.10 Regulation and Standardization
Regulators must eventually acknowledge the presence of an industry handling in
excess of US$1 trillion with an annual growth of more than 10 percent and huge,
untapped market potential. The regulations on Islamic finance should accommodate
its differences, although in areas where there are similarities, similar frameworks can
be used. According to El-Hawari et al:
Given the close affinity of prevailing practice of established Islamic finance and
conventional banking, the regulatory framework in the transition should be mostly
similar to the one applying to the regulatory framework of conventional banks. One
overarching issue that needs to be addressed is the standardization of contracts and
major financial instruments across the industry to facilitate growth, ease access to
liquidity and enhance risk assessment capabilities. Transparency enhancements are
also essential for the development of the industry. 322
The regulation, standardization and harmonization of fiqh opinion can be traced back
to the Ottoman Empire with the creation of the Mejelle, which is composed of 1,851
articles based on the Hanafi school of jurisprudence. Islamic financial institutions that
find themselves in a situation that has not yet been standardized should adhere to the
Shariah view to avoid legal disputes in relation to Shariah-compliance. According to
Khan:
A declaration from the Islamic banks with respect to which aspects of fiqh rulings are
being utilized in their operations would give a clearer view of the Shariah
compatibility of their products to the satisfaction of their clientele. This codification
could also be an important element in defining the standards for corporate governance
in the Islamic finance industry in the context of Shariah application. As already
mentioned, codification is a big and too complex task, and the industry cannot wait
for it for too long. Some more feasible arrangements have to be developed quickly. 323
The absence of standardization is serious in this modern and global era, a problem
that is highlighted in the work of Ghoul:
322
Dahlia El-Hawary, Wafik Grais and Zamir Iqbal, ‘Regulating Islamic Financial Institutions: The
Nature of the Regulated’ (World Bank Policy Research Working Paper No. 3227, 25 February 2004)
39.
323
M. Fahim Khan, ‘Setting Standards for Shariah Application in the Islamic Financial Industry’ (2007)
Thunderbird International Business Review, Vol. 49(3) (May–June) 293-294.
133
In 2007 Mufti Usmani shocked the Islamic finance industry by announcing that 85%
of non-Ijarahsukuk issues were not Shariah-compliant and had gone too far in
imitating conventional debt. The sukuk market took a serious hit and as a result
Ijarah-based sukuks came to the forefront. Since then, product developers i.e. bankers
and lawyers have had to abide by Shariah standards when structuring sukuks … YSing and Richter (2010) report that in 2008 sales of sukuks declined 50% partly due
to an AAOIFI ruling that prohibited borrowers from making an upfront promise to
pay back the face value at maturity in sukuk-Mudaraba and sukuk-Musharaka
contracts. The authors also report criticisms of sukuks’ fixed-income cash flows. 324
There are many reasons for standardization. The first is to uphold Shariah and legal
certainty. Dr. Mohammed Daud Bakar, a prominent member of the AAOIFI, 325 put it
succinctly when he stated that the ‘aim of having a standard is to bring the market into
harmonious practice, bring costs down, and to make it clearer for investors’.
Proponents of standardization also argue that the introduction of standards into
Islamic finance would lead to the firm establishment of financial transaction methods
and, consequently, transaction costs would be reduced through the clear integration of
Islamic finance principles that, once documented, would assist not only practitioners
of Islamic finance, but also the investors. 326 There are many other benefits as well. 327
While there are numerous international Islamic institutions, the leading ones
include AAOIFI, IIRA, IFSB and the Liquidity Management Center (LMC). They are
partly responsible for maintaining the high standards of the Islamic financial industry.
Despite the existence of these numerous bodies, the legal and regulatory practices
related to Islamic finance have not been standardized.
324
Wafica Ali Ghoul, ‘The Dilemma Facing Islamic Finance and Lessons Learned from the Global
Financial Crisis’ (2011) Journal of Islamic Economics, Banking and Finance, Vol. 7 No. 1
(January-March) 60.
325
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is
responsible for the development of international Islamic banking and finance standards while Fiqh
Academy is involved in the issuances of major fatwas on Islamic banking and financial products.
326
Rahail Ali and Mustafa Kamal, ‘Standardizing Islamic Financing: Possibility or Pipe Dream?’,
Business Law International, 19 (2009) 20.
327
For example, Islamophobia and strong hatred towards the Muslim community are occasionally
extended to Islamic finance. As a result, the scholars of Islamic finance must coordinate with each
other in this time of great challenge to mount a more focused international coordination and
standardization effort. Proper regulation, supervision and standardization are necessary to ensure the
efficiency of the Islamic financial industry.
134
The following are are some of the main relevant institutional bodies related to
the regulation, coordination or standardization of the Islamic financial industry:
Table 4: Key institutions in Islamic Financial industry
Organization
Function
Accounting and Auditing
Organization for Islamic
Financial Institutions [AAOIFI]
Accounting and Shari’ah standard setting body
General Council of Islamic Banks Association of Islamic banks to improve
and Financial Institutions
member institutions’ ability to better serve
customers with good banking practices
Islamic Development Bank [IDB]
Development institution aiming at promoting
economic development and Islamic finance
Member Organization
-Islamic Corporation for the Development of the
Private Sector [ICD]
-Islamic Corporation for the Insurance of
Investment and Export Credit [ICIEC]; Islamic
insurance company
-Islamic Research and Training Institute [IRTI];
Training and research
-International Islamic Trade Finance
Corporation [ITFC]
-Solidatory Fund; aiming at the eradication of
poverty in OIC countries
-Arbitration and Reconciliation Centre for
Islamic Financial Institutions [ARCIFI]
Islamic Financial Services Board
[IFSB]
Regulators and standard-setting institution
International Islamic Financial
Markets [IIFM]
Trade association to promote capital market
Islamic International Rating
Agency
Rating agency for Islamic finance
Liquidity management Center
Institution to improve liquidity in Islamic
finance
135
4.11
ISLAMIC FINANCE IN SOUTHEAST ASIA
The selection of Southeast Asia as the focus of this research is logical. This research
aims to answer whether the application of Islamic principles to maritime trade is
feasible, practical and beneficial. Many of the countries that together form Southeast
Asia are maritime nation. The population is diverse, and contrary to the MENA region
(also known as Middle East), the population is multiracial and multireligion and Islam
is not necessarily the religion of the majority. Despite this background, Islamic
finance still gain acceptance amongst the non-Muslim and Muslim, due to the
competitiveness of the products offered. The idea proposed in this chapter is that
Islamic principles can also be used to strengthen the maritime trade industry, similar
to what happened to the banking and financial industry. Furthermore, one of the
countries in Southeast Asia, Malaysia, is also one of the most developed Islamic
financial hubs.
The development of some Southeast Asian countries has been remarkable. While
many Asian countries were poor in the 1960s, their primary education systems were
good, fertility rates were low, life expectancy was high and the equality in both land
and income was improving. 328 Since 1960, Asia, the largest and most populous of the
continents, has grown richer faster than any other region in the world. In terms of
GDP in Southeast Asia, economic growth increased roughly 2 percent per year in the
Philippines and 3 to 5 percent per year in Indonesia, Malaysia and Thailand. Hong
Kong and Singapore experienced even higher growth rates of no less than 6 percent
per year. 329
As one author states:
Southeast Asia has experienced significant political and economic changes since the
mid-1980s. Economically, some Southeast Asian countries (e.g. Singapore, Malaysia,
Thailand, Indonesia, etc.) have achieved high economic growth rates during the
1980s until the mid-1990s, which have improved the living standards of ordinary
citizens. Countries like Burma, Vietnam, Laos, and Cambodia were once isolated, but
they have all opened their doors to the world since the end of the 1980s, thus helping
their economic improvement in the 1990s. Although the 1997 financial crisis hit
328
David Anthony Hollingsworth, The Rise, the Fall, and the Recovery of Southeast Asia’s
Minidragon (Lexington Books 2007) 1.
329
David Anthony Hollingsworth, The Rise, the Fall, and the Recovery of Southeast Asia’s
Minidragon (Lexington Books, 2007) 1.
136
Southeast Asia’s economy badly, most countries have gradually started their
economic recovery since early 2000. 330
Southeast Asia is home to a plethora of emerging economies and economic giants, but
none managed to escape the disastrous impact of the recent financial crises and global
recession. The 1997 Asian financial crisis sparked the devaluation of the baht
(Thailand’s currency) by mid-July of 1997. The baht, which was originally pegged to
the US dollar at an official exchange rate of 25 baht per dollar, was devalued under
international pressures and speculators until by January 1998, the value was 54.75
baht per US dollar. 331 This led to a series of financial disasters that created a domino
effect that extended to other Southeast Asian countries that ultimately managed to
emerge intact from the Asian financial crisis, albeit having suffered heavy losses.
August 2007 marked the beginning of a global financial crisis and recession
estimated by many to be the worst since the end of World War II. While the various
impacts were suffered globally, the consequences to developing countries were
particularly severe. This crisis has significantly slowed economic growth in Southeast
Asia, increased unemployment to unprecedented levels, triggered energy and food
crises and imposed extraordinary fiscal costs with unparalleledgovernment bailouts.
The financial stress that saturated the latter part of 2008 even surpassed the peaks
experienced in the 1997-1998 Asian financial crisis with 70 percent of the financial
stress in advanced economies transmitting to emerging economies in just one to two
months. 332
Generally, Asia responded to the global economic crisis better than other regions.
The strong reserves of rich economies such as Singapore and Hong Kong enabled
them to survive this crisis, but if its root cause is not addressed, it will only be a
matter of time before the next one hits. Albert Einstein, one of the world’s greatest
minds, defined insanity as doing the same thing repeatedly while expecting different
results.
The root cause of the financial crisis can be traced back to the nature of
conventional financial systems. Excessive speculation, unfair and unethical
distribution of risks in which the risks are largely shifted to the party with less
bargaining power, manipulation of financial engineering, derivatives, inadequate
330
Samuel C.Y. KU (ed), Southeast Asia in the New Century (Center for Southeast Asian Studies
2002) 1.
331
David Anthony Hollingsworth, The Rise, the Fall, and the Recovery of Southeast Asia’s
Minidragon (Lexington Books, 2007) 12.
332
John Malcolm Dowling and Pradumna Bickramrana, Asia and the Global Economic Crisis:
Changes in a Financially Integrated World (Palgrave MacMillan 2010) 36.
137
supervision and regulation and fraudulent behavior finally led to the collapse of
conventional financial systems in 2007. For example, Warren Buffet claimed that
‘derivatives are financial weapons of mass destruction, carrying dangers that, while
now latent, are potentially lethal’. 333
The instability of conventional financial systems has been increased through the
global use of fiat or paper money that can be printed without the backing of gold or
silver reserves. Monetary systems have, consequently, become open to the
conjectureand attacks of currency speculators. The 1997 Asian financial crisis was
evidence of the fragility of conventional monetary systems.
Islamic finance has been currently estimated at around US$1 trillion. This
chapter provides an overview of Islamic finance, particularly its development in
Southeast Asia.
Islamic finance challenges the core and fundamentals of current conventional
financial systems. Its rejection of usury and interest (which are the backbone of
conventional financial systems) and the prohibition of excessive speculation and
unethical trade bring a certain amount of stability. Islamic finance also emphasizes
real trade, partnership and proper risk allocation systems, all of which have made it
more innovative, interesting and resilient.
Fisher (1993) noted that the presence of overinvestment and over speculation in
conventional finance were important contributors to the financial crisis, but that they
would have been less serious if trade had been financed by equity as opposed to
borrowing money under the usury system.
Currently, some of the countries in Southeast Asia are following Malaysia’s lead
and attempting to become Islamic financial hubs. Others, such as Singapore and Hong
Kong, are not trying to become hubs, but they are making concentrated efforts to
include Islamic financial products in their diversified financial portfolios.
333
Warren Buffet (2002) as quoted in Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas
Mirakhor, The Stability of Islamic Finance (John Wiley & Sons (Asia) Pte. Ltd 2010) 153.
138
4.11.1
Malaysia
Malaysia is a mix of modern world and developing nation. With its moderate oil
wealth and investment in high technology industries, Malaysia has established itself
as one of the richer nations in Southeast Asia. Before World War II the Malay
peninsula was governed by the British, first as the Federated Malay States and then as
the Unfederated Malay States and the Straits settlements, which were crown colonies.
After World War II the three regions were federated to form a single British colony
known as the Malayan Union, but widespread opposition from the multiracial
population led to the creation of the Federation of Malaya. Malaya gained
independence in 1957 and Malaysia was formed on 16 September 1963 by the merger
of Malaya, Singapore and the East Malaysian states of Sabah and Sarawak (also
known as North Borneo). Singapore left the federation on 9 August 1965.
Malaysia was originally a combination of various states in peninsular Malay
with Singapore, Sabah and Sarawak. Singapore eventually left Malaysia and received
independence. With a population of over 27.5 million, Malaysia’s diversified
economy includes large exports of petroleum, raw materials, manufacturing, services
and tourism. Malaysia is attempting to achieve high-income status by 2020 by
attracting investments in Islamic finance, biotechnology, high technology industries
and the service sectors. 334 However, exports of oil and gas, electronics, palm oil and
rubber oil are still the driving force of its economy, with 40 percent of government
revenue coming from Petronas, the state oil producer.
Size and nature
Central Bank of Malaysia elaborated that Malaysia's Islamic finance industry has been
in existence for more than 30 years. 335The enactment of the Islamic Banking Act 1983
enabled the country's first Islamic Bank to be established and thereafter, with the
liberalization of the Islamic financial system, more Islamic financial institutions have
been established in Malaysia. 336 Malaysia, which is aiming to become a global hub
for Islamic finance, has a $444 billion program to build roads and power plants over
the next 10 years. 337 One of the methods is by using Islamic bonds. Sukuk, or Islamic
334
Central Intelligence Agency, ‘The World Factbook: East & Southeast Asia: MALAYSIA’
<https://www.cia.gov/library/publications/the-world-factbook/geos/my.html> accessed 6 January 2012.
335
Bank Negara Malaysia, ‘Islamic Banking & Takaful’
< http://www.bnm.gov.my/index.php?ch=fs_mfs&pg=fs_mfs_bank> accessed 20 November 2012
336
‘Bank Negara Malaysia, Islamic Banking & Takaful’
< http://www.bnm.gov.my/index.php?ch=fs_mfs&pg=fs_mfs_bank> accessed 20 November 2012
337
Khalid Qayum, ‘Dubai’s Noor Islamic Bank Seeks Business in Singapore, Malaysia’ Bloomberg (6
June 2012)
139
bonds, pay asset returns to comply with the religion’s ban on interest. 338 Furthermore,
Malaysian companies have already sold 15 billion ringgit ($4.7 billion) of Islamic
bonds in 2012, 8 percent more than the same period in 2011, according to data
compiled by Bloomberg. 339
Strong domestic market
Malaysia's extensive track record of building a successful domestic Islamic financial
industry of over 30 years gives the country a concrete foundation - financial bedrock
of stability that adds to the richness and diversity of the financial system. 340Nowadays,
Malaysia's Islamic banking assets already reached USD65.6 billion with an average
growth rate of 18-20% annually. 341 Malaysia is currently of one of the world’s most
established Islamic financial hubs. Long before modern Islamic finance emerged as a
popular and viable alternative to conventional finance, Malaysia had integrated it and
begun to pioneer its development.
Efficient legal and regulatory framework
The efficiency of Bank Negara has contributed to the success of Islamic finance in
Malaysia. Islamic finance in Malaysia has been properly and systematically
developed. For example, although there are currently no final authorities for the
Islamic finance industry on an international level, the standardization of Shariah rules
has been underway in Malaysia for some time.
The Shariah Advisory Council of the Malaysian Central Bank is the final
authority on Shariah matters pertaining to Islamic banking in Malaysia and it acts as a
reference point for courts and arbitrators in disputes involving Shariah issues in
<http://www.bloomberg.com/news/2012-06-06/dubai-s-noor-islamic-bank-seeks-business-in-singapore
-malaysia.html> accessed 20 November 2012
338
Khalid Qayum, ‘Dubai’s Noor Islamic Bank Seeks Business in Singapore, Malaysia’ Bloomberg 6
June 2012
<http://www.bloomberg.com/news/2012-06-06/dubai-s-noor-islamic-bank-seeks-business-in-singapore
-malaysia.html> accessed 20 October 2012
339
Khalid Qayum, ‘Dubai’s Noor Islamic Bank Seeks Business in Singapore, Malaysia’ Bloomberg 6
June 2012
<http://www.bloomberg.com/news/2012-06-06/dubai-s-noor-islamic-bank-seeks-business-in-singapore
-malaysia.html> accessed 20 October 2012
340
Bank Negara Malaysia, ‘Islamic Banking & Takaful’
< http://www.bnm.gov.my/index.php?ch=fs_mfs&pg=fs_mfs_bank> accessed 20 November 2012
341
Bank Negara Malaysia, ‘Islamic Banking & Takaful’
< http://www.bnm.gov.my/index.php?ch=fs_mfs&pg=fs_mfs_bank> accessed 20 November 2012
140
Islamic banking cases. The Council’s decisions are binding for arbitrators and are to
be ‘taken into consideration’ by the court. 342
The legal foundation for the establishment of Malaysia’s Islamic banking
system is the Islamic Banking Act of 1983 (IBA). Bank Negara Malaysia (the Central
bank of Malaysia) has been entrusted with the responsibility of regulating Islamic
banks in Malaysia, in addition to conventional banks and financial institutions. The
high quality of the Islamic financial industry is maintained by this Act, which requires
Islamic banks in Malaysia to establish a Shariah Advisory Body to advise on Shariah
matters. It is also compulsory that the Articles of Association of Islamic financial
institutions incorporate such provisions.
Conventional banks are also allowed to participate in Islamic banking systems
and are subjected to the same supervision and monitoring:
… conventional banks, which are governed by the Banking and Financial Institutions
Act (BAFIA), have also been allowed, through a 1996 amendment to the Act, to carry
out the Islamic banking business in addition to the existing licensed business (of
conventional banking). These conventional banks are required to comply with any
written directives, issued from time to time by the BAFIA, relating to Islamic banking
business. The directives are issued by the BNM in consultation with its Central
Shariah Advisory Council. Any conventional bank, licensed under the BAFIA,
carrying out Islamic banking business in addition to its conventional licensed
business may from time to time seek advice from the Central Shariah Advisory
Council of the BNM in its Islamic business operations in order to ensure that it does
not involve any element that is not Shariah-compatible. The provisions relating to the
Islamic banking business in the BAFIA do not apply to Islamic banks because they
are governed by the separate IBA, which requires Islamic banks to have their own
Shariah advisory body to advise them on their business operations. 343
The legal and regulatory framework governing Islamic finance in Malaysia is quite
comprehensive, although there is still significant room for improvement. Despite
Malaysia’s efforts to strengthen its legal and regulatory framework, Venardos noted
the following three issues: 344
342
Rahail Ali and Mustafa Kamal, ‘Standardizing Islamic Financing: Possibility or Pipe Dream?’(2009)
Business Law International, 19, 23.
343
M. Fahim Khan, ‘Setting Standards for Shariah Application in the Islamic Financial Industry’ (2007)
Thunderbird International Business Review, Vol. 49(3) (May–June) 293-294.
344
Angelo M. Venardos, Islamic Banking and Finance in South-East Asia: Its Development and Future
(3rd edn, World Scientific Publishing Company 2011) 150-151.
141
1. Legislation forIslamic finance (IBA and part of BAFIA) is very brief and regulatory
in nature and does not offer substantive law
2. The issue of double taxation as a rebate from the taxable amount only applies to
individual Muslims who paid zakat, but no such rebate is given to an ‘Islamic’
corporation or company that pays zakat.
3. The extent to which the provisions in IBA and BAFIA prevail over other legal
requirements is not clear
A large pool of experts, workforce and talent
Nowadays, Malaysia's Islamic finance continues to grow rapidly, supported by a
conducive environment that is well-known for continuous product innovation and
enchancement, a diversity of financial institutions from across the world, a broad
range of innovative Islamic investment instruments, a comprehensive financial
infrastructure and adopting global regulatory and legal best practices. 345Furthermore,
Malaysia has also emphasis strongly on human capital development alongside the
development of the Islamic financial industry to guarantee the accessibility and
availability of Islamic finance talent. 346
Table 5: Development of Islamic finance in Malaysia
Year
Development
1940s Small-scale, interest-free financial systems are introduced in some of the
peninsular Malaysian states, but they fail. The states are still under Western
colonial power at this time
1963
A pilgrim’s corporation fund is established to assist Muslims with their
pilgrimages. The fund is managed using Islamic principles
1983
The first Islamic bank in Malaysia, Bank Islam Malaysia, commences
operation
1985
The first Islamic insurance operator, Syarikat Takaful Malaysia, commences
operation
1990
Malaysia’s Islamic bond (the sukuk) is introduced with a modest issuance of
345
Bank Negara Malaysia, ‘Islamic Banking & Takaful’
< http://www.bnm.gov.my/index.php?ch=fs_mfs&pg=fs_mfs_bank> accessed 20 November 2012
346
Bank Negara Malaysia, ‘Islamic Banking & Takaful’
< http://www.bnm.gov.my/index.php?ch=fs_mfs&pg=fs_mfs_bank> accessed 20 November 2012
142
US$39 million by Shell MDS SdnBhd
1996
Kentucky Fried Chicken Holdings Malaysia Berhad (KFCH) issues RM150
million in Islamic debt securities
1997
Malaysia becomes the first country to issue Islamic benchmark bonds. The
initial tranche of RM794.4 million (with a face value of RM1 billion) is
issued by Khazanah Nasional Berhad
2000
The Central Bank of Malaysia and the Security Commission set up a 10-year
master plan for Malaysia’s financial sector that includes the direction of
Islamic finance
2000
A global sovereign Islamic bond worth US$600 million is issued
2000
A global corporate Islamic bond worth US$150 million (RM540 million) is
issued in an ijarah transaction by Kumpulan Guthrie Bhd
2002
Malaysia becomes the founding member and host country of the IFSB
2002
Guthrie Group is reported to issue a global Islamic bond worth US$150
million
2002
Malaysia issues the first Islamic dollar bonds (followed by Qatar, which
issues US$700 million in global bonds)
2004
Ingress Corporationissues a domestic corporate Islamic bond worth US$44
million
2004
The International Finance Corporationissues a ringgit-denominated Islamic
bond worth US$139 million
2004
The World Bank issues US$211 million ringgit-denominated Islamic bonds
that will mature in 2010
2005
PG Municipal Assets Bhd issues an Islamic bond valued at US$22 million
2005
Musharakah One Capital Bhd issues an Islamic bond worth US$694 million
2006
INCIEF is established
2006
MIFC is established
2006
Dow Jones & Co., Inc. and RHB Capital Bhd launch the Dow Jones RHB
Islamic Malaysia Index, a co-branded Islamic index
2006
The Global Sukuk Index – Dow Jones Citigroup Sukuk Index is launched
2006
Khazanah Nasional
exchangeable bonds
2007
Binariang issues the world’s largest corporate Islamic bond to date, valued at
US$4.8 billion, to facilitate the privatization of a cellular phone operator
2007
i-Valuecap Management initiates the first Asian Islamic exchange traded
fund
2007
Saudi company dar al-Arkan International Sukuk Co. lists its US$1 billion
Islamic bond at the Labuan International Financial Exchange (LFX)
Berhad
raise
143
US$750
million
using
Islamic
2007
Tesco Stores (Malaysia) raises US$204 million using Islamic bonds for its
expansion in Malaysia
2008
Telekom Malaysia issues the largest sukuk to date, amounting to US$310
million
2008
The Islamic Development bank issues US$155 million sukuk to finance its
infrastructure project
2008
The Industrial Bank of Korea and the Export-Import Bank of Korea propose
the set-up of a US$0.9 billion Islamic medium-term notes programme
2010
The International Islamic Liquidity Management Corporation (IILM) is
established
2011
The Bloomberg AIBIM Bursa Malaysia Sovereign Shariah Index (BMSSI)
is developed by the Association of Islamic Banking. Institutions Malaysia
(AIBIM), Bursa Malaysia and Bloomberg are launched as part of an
enhancement of the Islamic finance platform. 347
347
‘Bloomberg Releases Comprehensive Islamic Finance Platform’ Bloomberg (24 February 2011)
<http://www.bloomberg.com/news/2011-02-23/bloomberg-releases-comprehensive-islamic-finance-pla
tform.html> accessed 20 November 2012
144
4.11.2
Indonesia
Islamic finance in Indonesia is a curious case. Indonesia has the highest number of
Muslims population but the development of Islamic finance there seems to be
surprisingly slow, with market control of just around 2 percent. Still, there are good
reasons to believe that Islamic finance will eventually penetrate the market in
Indonesia. The recent support given by the government together with the green light
should not be underestimated. Indonesian President Susilo Bambang Yudhoyono in
2009 has called on Islamic banks to take a leadership role in the global economy,
amid the financial crisis. Islamic financial institutions, he said, had not been hit as
hard as their western counterparts because they did not invest in toxic assets. 348
Size and nature
According to the Bank of Uganda deputy legal counsel Titus W. Mulindwa (during
his visit to Indonesia), sharia banking assets in Indonesia grew at a remarkable rate of
47 percent in 2010 to Rp 100.26 trillion (US$11.14 billion), and there were
expectations of another 45 percent growth this year. 349 Indonesia’s Islamic banking
assets total Rp 147.9 trillion ($15.7 billion), trailing Malaysia’s 355 billion ringgit
($114 billion), central bank data show, even though the former nation has 12 times as
many Muslims. Shariah lending in Indonesia increased by an average of 38 percent
each year over the last five, compared with 21 percent in Malaysia. 350
Domestic market
Indonesia has one of the biggest domestic markets for Islamic finance, with its more
than 200 millions population. During the 3rd World Islamic Banking Conference Asia,
Edy Setiadi, Executive Director of Islamic Banking for Bank Indonesia, told Islamic
Business & Finance that ‘in the last two years alone it (Islamic finance) has grown
around 50 per cent and in five to six years, the number of full-fledged Islamic banks
348
Lucy Williamson, ‘Islamic banks 'better in crisis'’ BBC News, Jakarta 2 March 2009
<http://news.bbc.co.uk/2/hi/asia-pacific/7918129.stm> accessed 13 October 2012
349
Esther Samboh, ‘Uganda asks for Indonesia advice on sharia banking’ The Jakarta Post 14
February 2011
<http://www.thejakartapost.com/news/2011/02/14/uganda-asks-indonesia-advice-sharia-banking.html>
accessed 13 October 2012
350
‘Indonesia to Allow Currency Hedging for Banks: Islamic Finance’ Jakarta Globe 7 August 2012
<http://www.thejakartaglobe.com/business/indonesia-to-allow-currency-hedging-for-banks-islamic-fin
ance/536154> accessed 13 October 2012
145
has grown from just three full-fledged banks to eleven full-fledged banks, and around
24 conventional banks have an Islamic window.’ 351
Improved legal and regulatory framework
The legal and regulatory framework in Indonesia is being revamped. In 2012, it was
announced that Indonesia will let Shariah-compliant banks hedge against
exchange-rate movements to spur growth in Islamic financial assets and narrow the
gap with Malaysia’s industry, which is seven times larger. 352The same news reported
that Bank Indonesia, the National Shariah Board and the Indonesia Institute of
Accountants have approved the instruments, available in Malaysia since 2006.
Strong Institutional support
In Indonesia, the relevant bodies include Bank Sentral Republik Indonesia (formulates
and issues Islamic laws and regulations), Dewan Shariah Nasional (National Shariah
Council of Indonesia (issues guidance (fatwa) as basic laws for proposed Islamic laws
and regulations to be issued by Bank Indonesia), Dewan Pengawas Shariah (Shariah
Supervisory Council) (DNS is required to appoint any member of DPS for each
Shariah financial institution and is responsible for overseeing the implementation of
Shariah principles and fatwa in Shariah financial institutions) ,Dewan Departmen
Keuangan Republik Indonesia and Badan Pengawas Pasar Modal.
Bank Sentral Republik Indonesia, Indonesia’s central bank, regulates the
issuance of Indonesian currency and is responsible for the country’s banking and
financial sectors. The Departmen Keuangan Republik Indonesia is responsible for
assisting the President in managing state finance. The Badan Pengawas Pasar Modal –
Bapepam (Capital Market Supervisory Agency) is the central regulatory body for the
Indonesian capital markets. Majelis Ulama Indonesia (Indonesian Islamic Scholar
Assembly) has set up Badan Arbitrase Shariah Nasional (Basyarnas).
Technically, Bank Indonesia has been involved in a number of international
initiatives including the establishment of several Islamic regulatory bodies, like
Islamic Financial Services Board and the International Islamic Financial Market, and
351
‘Indonesia to Allow Currency Hedging for Banks: Islamic Finance’ Jakarta Globe 7 August 2012
<http://www.thejakartaglobe.com/business/indonesia-to-allow-currency-hedging-for-banks-islamic-fin
ance/536154> accessed 13 October 2012
352
‘Indonesia to Allow Currency Hedging for Banks: Islamic Finance’ Jakarta Globe 7 August 2012
<http://www.thejakartaglobe.com/business/indonesia-to-allow-currency-hedging-for-banks-islamic-fin
ance/536154> accessed 13 October 2012
146
has been proactive by sending its experts to the groups responsible for developing a
number of regulatory standards.
Through these collaborative efforts, it is expected that the industry might use
the same regulatory framework and at the same time gain substantial recognition from
the international community. Although cross border collaboration and
interconnectivities to enhance further growth in Islamic finance is critical, it should be
understood that certain disparities may still remain.
Strong cooperation with other countries
Indonesia is also assisting others in developing their Islamic financial markets. For
example, The Ugandan central bank is currently struggling to address demands for the
first sharia bank in the East African country. 353Jakarta Post reported that the Bank of
Uganda, the republic’s central bank, has sent delegates to Indonesia, home to the
world’s largest Muslim population, to learn more about Islamic finance. The visit of
the Ugandan central bankers underscored the world’s acknowledgement of the rapid
development of Indonesia’s Islamic banking industry, a Bank Indonesia (BI) official
said. Bank of Uganda is expecting the first sharia bank in the ‘pearl of Africa’ in early
2012 after the nation’s parliament is expected to pass a law permitting the
establishment of Islamic banks. As the Ugandan central bank is working to secure
parliamentary approval, several delegates are learning from a seven-day comparative
study visit thousands of miles away in Indonesia, where 90 percent of the 237 million
citizens are Muslim and where Islamic finance has been growing at rates never before
seen. 354
It was also reported that the delegates have visited three different types of
sharia banks in Indonesia, namely sharia commercial banks (Bank Syariah Mandiri),
sharia business unit (Bank CIMB Niaga Syariah) and sharia people’s credit bank.
Grace Stuart Ndyareeba said demand for Islamic banks was high in Uganda, where
only 17 percent of 30 million citizens are Muslim. 355
353
Esther Samboh, ‘Uganda asks for Indonesia advice on sharia banking’ The Jakarta Post 14
February 2011
<http://www.thejakartapost.com/news/2011/02/14/uganda-asks-indonesia-advice-sharia-banking.html>
accessed 13 October 2012
354
Esther Samboh, ‘Uganda asks for Indonesia advice on sharia banking’ The Jakarta Post 14 February
2011
<http://www.thejakartapost.com/news/2011/02/14/uganda-asks-indonesia-advice-sharia-banking.html>
accessed 13 October 2012
355
Esther Samboh, ‘Uganda asks for Indonesia advice on sharia banking’ The Jakarta Post 14
February
2011
147
Challenges
Some of the main challenges that Indonesia faces include alleviating poverty,
implementing economic and financial reforms and promoting democracy and
tolerance. The bigger challenges include rooting out terrorism, cultivating education,
fighting rampant corruption and improving human rights. Inflation and volatile food
prices are also serious concerns. 356
The need for more experts and scholars
Indonesia’s Sharia-compliant banking industry currently needs 36,933 professionals,
Harisman Sidi, director at the International Centre for Development in Islamic
Finance at the Indonesian Banking Development Institute in Jakarta, said in an
August 2012 email, citing data from the country’s monetary authority. 357 Bank
Indonesia is encouraging Sharia-compliant lenders to put more resources into staff
training to help meet its objective of expanding Sharia-compliant banking assets to 10
per cent of the total by 2020.
Controversial stand revised
The previous slow progress of Islamic banking in Indonesia can be attributed to a lack
of planning, the absence of a comprehensive and proper framework and instruments
for supervision and regulation, a highly limited public understanding, the lack of an
efficient structure to support efficient Islamic banking operations, poor support from
the international community due to high levels of corruption and operational and
managerial inefficiency.Many scholars have been critical about the future
development of Islamic finance in Indonesia. For example, according to Pramanik:
Although Indonesia is the largest Muslim country in the world, it has declared itself a
secular country espousing the Pancasila ideology, which makes no specific reference
to Islam. The Indonesian legal system is also secular with religious courts having
limited jurisdiction. … Islam as an ideology and way of life has no place in the
<http://www.thejakartapost.com/news/2011/02/14/uganda-asks-indonesia-advice-sharia-banking.html>
accessed 13 October 2012
356
Central Intelligence Agency, ‘The World Factbook: East & Southeast Asia: INDONESIA
<https://www.cia.gov/library/publications/the-world-factbook/geos/id.html> accessed 15 November
2011.
357
‘Skill shortage stymies growth of Islamic finance’ Gulf News 20 August 2012
148
Indonesian polity under the current conditions. Thus, the question of injecting Islamic
values into economics and politics in the Indonesian context does not arise. 358
However, one of the major and defining reasons for the slow development of Islamic
finance in Indonesia is actually the prevailing view among their scholars that banks’
interest is either not usury, or is usury but is allowed in an emergency. This
conceptual conflict has effectively prevented the development of Islamic finance as
we understand it because a real shift will be deemed unnecessary as long as the
current conventional finance is Shariah-compliant enough, a controversial view
shared by many Indonesian scholars in the past. For example, discussions on usury in
Indonesia were conducted in 1927 by Nadhatul Ulama in Surabaya, again in
Magelang in 1939 and in Cilacap in 1981 and the views expressed regarding banks’
interest were inconsistent. Some have argued that it is forbidden while others claim
that it is permissible or propose that it is merely shubhah (doubtful) and therefore
permissible. Research conducted by Antonio (2004) on the opinions of 45 renowned
Indonesian scholars revealed that 24 out of the 45 believed that banks’ interest or
usury is not forbidden. 359 This is despite the hadith that there are 70 types of usury
and the sin of dwelling with even the smallest type of usury is equivalent to
committing adultery with one’s own mother. 360
For example, Kasri and Kassim explained:
In Indonesia, studies on potency, preference, and people’s behavior toward Islamic bank
have also been done by the central bank in year 2000 to 2005. The study is performed
with collaboration with several universities to cover at least 11 provinces in
Indonesia.(8) The studies reveal that although religiosity is perceived as one of the main
reasons in dealing with Islamic banks in Indonesia, the perception on interest rate is
ambiguous. While most of the respondents agreed that interest rate is prohibited in Islam,
they are not strongly against the interest rate application in the banking system (Bank
Indonesia, 2005). 361
358
Ataul Huq Pramanik (ed), Islamic Banking: How far Have We Gone? (IIUM Press 2009).
359
Sudin Haron Azmi and Wan Nursofiza, Islamic Finance and Banking System: Philosophies,
Principles & Practices (McGraw-Hill (Malaysia) Sdn. Bhd (2009).
360
Hadith Al-Tirmidhi No. 2826 as narrated by Abu Hurairah.
361
Rahmatina A. Kasri and Salina Hj. Kassim, ‘Empirical Determinants of Saving in Islamic Banks:
Evidence from Indonesia’ (2009) Journal of King Abdul Aziz University Islamic Economies, Vol. 22,
No.2, 10.
149
However, the attitude has now changed. There is more support from the government
and from the industry. One of the main challenges is the lack of support from
investors, especially those from Middle East.
According to Dr. A. Riawan Amin, Chairman of the Indonesian Sharia Bank
Association, Indonesia will not be competing for investment from the Middle East
because the region has shown no faith in its young Islamic finance industry. 362 ‘We
will not be going to the Middle East for money because they have no faith in us,’
Amin told Islamic Business & Finance at the Global Islamic Finance Forum in Kuala
Lumpur. ‘If they want to come to us, they are welcome, but we will not wait for them.’
Approaching the conventional banks
One of the key problems is the prohibition towards conventional bank against entering
the Islamic financial market. Dr. A. Riawan Amin, Chairman of the Indonesian Sharia
Bank Association explained that Indonesia, the world’s more populous Muslim
country, has the population to create a thriving Islamic finance industry, but first they
must overcome hurdles such as infrastructure. Amin believes that, to overcome this,
Islamic banking should not remain separate from conventional banking: 363
The retail segment needs to be developed – in retail you need a lot of outlets. There are
only 1500 Islamic banking outlets, whereas there are 20,000 for conventional banks. One
single gesture from the central bank, to offer Islamic banking alongside conventional
banking, would solve a big problem. 364
Indonesia is coming up with more products. For example, HSBC Amanah, the
Shariah-compliant unit of HSBC Holdings, will offer cross-currency hedging and
362
‘Middle East has no faith in Indonesia's Islamic banks, says leading figure.’ CPI Financial 19
September 2012
<http://www.cpifinancial.net/news/post/15775/middle-east-has-no-faith-in-indonesias-islamic-banks-sa
ys-leading-figure> 20 November 2012
363
‘Middle East has no faith in Indonesia's Islamic banks, says leading figure.’ CPI Financial 19
September 2012
<http://www.cpifinancial.net/news/post/15775/middle-east-has-no-faith-in-indonesias-islamic-banks-sa
ys-leading-figure> 20 November 2012
364
‘Middle East has no faith in Indonesia's Islamic banks, says leading figure.’ CPI Financial 19
September 2012
<http://www.cpifinancial.net/news/post/15775/middle-east-has-no-faith-in-indonesias-islamic-banks-sa
ys-leading-figure> 20 November 2012
150
foreign-exchange forwards after receiving central bank approval and the new rules
will help Indonesia achieve 50 percent annual growth in Islamic loans through
2015. 365
The need for stronger legal and regulatory framework
Lack of clear regulation will be detrimental to the development of Islamic finance in
Indonesia. For example, recent news stated that Bank Islam Malaysia Bhd is still
interested on buying a stake in a Islamic financial institution in Indonesia, but is
awaiting further clarification on the country's shareholding regulations for commercial
banks. 366 Indonesia’s legal system initially prevented the development of Islamic
finance. According to Banking Act No.14/1968, a bank can only operate using usury
or interest. Only after the introduction of a new banking act, Banking Act 7/1992, was
Islamic finance allowed to operate.
Indonesia’s financial goals differ from those of Malaysia. Malaysia aims to
become a regional and global Islamic financial centre. Indonesia, however, aims to
focus on its own large domestic market. The population of Indonesia alone is more
than 200 million and the huge majority is Muslim. An Islamic financial system that
rejects corruption and focuses on the fair allocation of risk will be a competitive
alternative to conventional finance in Indonesia. To strengthen Islamic finance in
Indonesia, both the legal and regulatory frameworks must be improved in addition to
a reformation of the overall economic environment:
The World Bank says special care needs to be taken in Indonesia given its recent
banking fiasco. The progress of Islamic banking in Indonesia is impeded by the lack
of comprehensive and appropriate framework and instruments for regulation and
supervision, limited market coverage, lack of knowledge and understanding by the
public, lack of efficient institutional structure supporting efficient Shari’ah banking
365
‘Indonesia to Allow Currency Hedging for Banks: Islamic Finance’ Jakarta Globe 7 August 2012
<http://www.thejakartaglobe.com/business/indonesia-to-allow-currency-hedging-for-banks-islamic-fin
ance/536154> accessed 13 October 2012
366
Thomas Huong, ‘Bank Islam remains interested in buying a stake in an Islamic bank in Indonesia’
the Star online 9 May 2012
<http://biz.thestar.com.my/news/story.asp?file=/2012/5/9/business/11255283&sec=business> accessed
13 October 2012
151
operations; operational inefficiency, domination of non-share base financing and
limiting capability to comply with international Shari’ah financial standards. 367
In June 2008, the country took its first major step with the passing of the Sukuk Law.
This law established a body called the DSN, which is charged with approving all
Sharia products and services issued the country. 368 It is reported that it is modelled on
Malaysia's Sharia Advisory Council, and the DSN will not rule only on the
acceptance of sukuk structures but on any and all Islamic instruments so its creation is
an important step for the development of Islamic finance in Indonesia as a whole. 369
Stronger government support
Previously, lack of government support is a serious concern. However, it seems that
the government has changed its approach and is now supporting the Islamic financial
sector. It has been reported that Indonesia could utilize the potential of Islamic finance
to fulfil its ambitious infrastructure plans, Standard & Poor's said in a report. The poor
state of infrastructure is hindering the growth of Southeast Asia's largest economy, the
report said, while noting that the government is planning to spend more than $200
billion through 2014 to upgrade and expand infrastructure.
Education and training
Southeast Asian universities are adding Islamic finance courses as Bank Negara
Malaysia’s Sharia Advisory Council warns a skill shortage in the industry is
hampering growth. Universitas Muhammadiyah in Malang, Indonesia and Kuala
Lumpur-based International Centre for Education in Islamic Finance (INCEIF) said in
August 2012 they plan to start new programmes. Malaysia needs 40,000 more
qualified people in the industry by 2020, Dzuljastri Abdul Razzaq, head of the
International Islamic University Malaysia’s finance department, said. Indonesia will
require 17,000 more over three to five years, according to a central bank survey. 370
367
Angelo M. Venardos, Islamic Banking and Finance in South-East Asia: Its Development and Future
rd
(3 edn, World Scientific Publishing Company 2011) 172-173.
368
Nachum Kaplan, ‘Indonesia makes strides’ IFR Islamic Finance Report 2009
<http://www.ifre.com/indonesia-makes-strides/578647.article> accessed 20 November 2012
369
Nachum Kaplan, ‘Indonesia makes strides’ IFR Islamic Finance Report 2009
<http://www.ifre.com/indonesia-makes-strides/578647.article> accessed 20 November 2012
370
‘Skill shortage stymies growth of Islamic finance’ Gulf News 20 August 2012
152
The way forward
Indonesia’s strong performance during recent financial crises underpinned by
increasingly positive expectation of global economic recovery since late 2010, spurs
more optimism both in domestic and global market that Indonesia economy will enjoy
higher growth in the incoming years. This situation will in turn boost further
development of Islamic finance industry in Indonesia.
The prospect for Islamic finance in Indonesia is very exciting. For example,
Muzaffar Hisham, CEO of Maybank Islamic Berhad elaborated that in 2011 alone,
there was a spike in Islamic fundraising in Indonesia, between US$400 to 500 million
out of 4 or 5 transactions and that is amazing because in the previous year, it was
zero. 371
Table 6: Development of Islamic finance in Indonesia
YEAR
EVENT
1990
A conference is held by the Indonesian Jurist Council (Majelis Ulama
Indonesia) in West Java, with Indonesia highlighting Indonesian
Muslim demand for Shariah-compliant and interest-free banking
products
1992
The issuance of a new banking act, Banking Act No.7/1992, paves the
way for Islamic finance in Indonesia under the concept of
‘profit-sharing banking’. Under previous banking Act No.14/1968,
only interest-based banks were allowed to operate
1997
1stShariah-based mutual fund launched by PT Danareksa Investment
Management
1998
Bank Indonesia and the National Shariah Board (affiliated with the
Indonesian Council of Ulama) work together to clarify the
permissibility of Indonesia’s financial products
1998
Banking Act No.7/1992 is amended by Banking Act No.10/1998 to
expressly recognize Islamic banking. Conventional banks are also
allowed to operate within Islamic finance. The target is to capture 5
percent of the total market share of Indonesia by 2009
2000
Shariah investor benchmark for equity investment launched
2002
Bank Indonesia launches the Blueprint of Islamic Banking
371
Linette Lim, ‘Islamic finance looks to be viable alternative amid uncertainty’ Channel Asia News (5
June 2012)
<http://www.channelnewsasia.com/stories/singaporebusinessnews/view/1205753/1/.html>
153
Development in Indonesia
2002
PT Indosat Tbk offered Shariah-compliant Islamic bond
2006
Islamic Mutual Fund Index launched
2008
By this year, there exists three full-fledged Islamic banks, 28 Shariah
banking units, 128 BPRS and 1,394 Islamic bank offices (in
conventional bank branches)
2008
Indonesia’s Parliament ratifies a new bill on Islamic bonds
2008
Indonesia’s Parliament passes a new Islamic banking law
2008
Islamic Banking Act No.21/2008 is issued to provide a clear legal
basis for the future development of Islamic finance in Indonesia
2010
The Indonesian government auctions US$109 million in sukuks
2010
PT Bank Maybank Syariah Indonesia (MSI) is established on 11
October 2010. MSI is totally Shariah-compliant
154
4.11.3
Brunei
Brunei is a sovereign state located on the north coast of the island of Borneo, in
Southeast Asia. Brunei’s revenue is almost entirely dependent on royalties from oil
and gas (reserves that some have predicted will be gradually exhausted by 2025), but
since the 1980s various efforts have been made to diversify and improve its
agriculture and manufacturing sectors. 372 The major challenges in Brunei include
high labor costs, a shortage of skilled labour, a small domestic market and a large
bureaucracy but small entrepreneurial class. 373
Brunei has the second highest Human Development Index among the South
East Asia nations after Singapore, and is classified as a developed country. 374
Furthemore, according to the International Monetary Fund (IMF), Brunei is ranked
5th in the world by gross domestic product per capita at purchasing power parity. 375
Forbes also ranks Brunei as the fifth richest nation out of 182 nations due to its
extensive petroleum and natural gas fields. 376
Size and nature
Having introduced the Islamic finance option more than two decades ago,
Syariah-compliant banking now accounts for around 40 per cent of the local market, a
figure some experts believe would rise to 60 per cent by 2017, the OBG said in its
latest economic update on the country. 377
Brunei entered the Islamic finance sector around 1993. The Islamic finance
sector accounts for 40 percent of the total banking market in the country. Islamic
financial products already play a defining role in the domestic economy, with
Shariah-compliant banking holding around half (40 percent) of the market share and a
total forecast of between 55 and 60 percent in the next five years. The performance of
the Sultanate’s Islamic banks compares favorably to that of its neighbors’. The
segment, for instance, holds a 20 percent market share in Malaysia, widely seen as an
372
Peter Church (ed), A Short History of South-East Asia (5thedn, Wiley 2009) 8.
373
Peter Church (ed), A Short History of South-East Asia (5thedn, Wiley 2009) 8.
374
‘Brunei’ <http://en.wikipedia.org/wiki/Brunei> accessed 20 November 2012
375
‘Brunei’ <http://en.wikipedia.org/wiki/Brunei> accessed 20 November 2012
376
Debbie Too, ‘Forbes ranks Brunei fifth richest nation’ The Brunei Times (Bandar Seri Begawan 25
February 2012)
<http://www.bt.com.bn/news-national/2012/02/25/forbes-ranks-brunei-fifth-richest-nation> accessed
20 November 2012
377
‘Investing in the future of Islamic finance’ The Brunei Times 24 June 2012
<http://www.bt.com.bn/business-national/2012/06/24/investing-future-islamic-finance> accessed 13
October 2012
155
international leader in Islamic finance, and accounts for just 2 percent of financial
services in Indonesia.
Despite a large Muslim majority (about 67 percent of the population), this
oil-rich nation did not see much development in the area of Islamic finance until 2006
when its ministry of finance launched the Banking and Insurance Orders, established
the Brunei International Financial Centre, launched its first sukuk and introduced the
Shariah Financial Supervisory Board at a national level.
4.3.2
Domestic market
Islam is Brunei's official religion with 64 percent of the population being Muslim,
mostly Sunnis of Malay origin who follow the Shafi school of Islamic law, similar to
Malaysia. Since the 1930s sultans have used rising oil revenues to provide an
extensive social welfare system and promote Islam, including subsidizing the Hajj,
building mosques, and expanding the Department of Religious Affairs. 378 The
domestic market for Islamic finance is however not that big since the population is
only around 408,000, and only half is local.
Legal and regulatory framework
According to report, the Ministry of Finance in 2008 introduced the Islamic Banking
Order 2008, intended at expanding the Islamic banking sector in Brunei at the same
time increasing the competitiveness among players by creating a level playing field as
well as strengthening the supervision and regulation of Islamic banking activities. 379
This new legislation also aims to attract foreign participants to strengthen the industry
as a whole and to nurture local knowledge and expertise. Additionally, in September
2008, new Takaful Order 2008 was introduced. The Order is a new comprehensive
legislation to govern the activities of the domestic takaful industry and provide the
legal platform for a level playing field between conventional insurers and takaful
operators. 380
378
‘Islam in Brunei’
<http://www.muslimpopulation.com/asia/Brunai%20Darussalam/Islam%20in%20Brunei.php>
accessed 20 November 2012
379
‘Brunei approves Islamic Banking Order 2008’
<http://islamicfinanceupdates.wordpress.com/2008/11/28/brunei-approves-islamic-banking-order-2008
/> accessed 20 November 2012
380
‘Brunei approves Islamic Banking Order 2008’
<http://islamicfinanceupdates.wordpress.com/2008/11/28/brunei-approves-islamic-banking-order-2008
/> accessed 20 November 2012
156
Stronger institutional support
In January 2011 a new unified monetary authority was established. Before the
creation of the Autoriti Monetari Brunei Darussalam or ‘Monetary Authority of
Brunei Darussalam’ (AMBD) in 2011, the regulatory bodies included the Ministry of
Finance, the Financial Institutions Devisions, the Brunei Currency and Monetary
Board, the Brunei Investment Agency, the Revenue and International Research
Divisions and the Brunei International Financial Centre (BIFC).
The AMBD is a statutory body that acts as the central bank of Brunei. Its core
functions include the formulation and implementation of Brunei’s monetary policies,
the supervision of Brunei’s financial sector and currency management.
Tax issue
Regulatory treatment is necessary to ensure the success of Islamic finance. Tax
incentives have played an important role in creating a level playing field for Brunei’s
Islamic finance industry. Previously, the taxation imposed on Islamic banking was
similar to that levied on its conventional counterparts, resulting in Islamic financial
institutions being subjected to a 30 percent corporate tax and an additional 2.5 percent
zakat contribution.
Urgent need for more experts
Brunei needs to address the limited pool of human resources to further the
development of the Islamic finance sector. Brunei Darussalam is training more staff to
work in the sector and welcoming talent from all over the world while the Universiti
Islam Sultan Sharif Ali’s (Unissa) 2010 International Conference on Islamic Finance
attracted experts who collectively agreed that ‘human resource development is a key
factor in helping boost Brunei’s Islamic finance sector’. This resulted in Unissa
offering an undergraduate degree programme in Islamic finance. Local online
educational and consultancy service provider, Crescent, developing a graduate degree
in Islamic banking and finance to complement its existing list of courses dealing with
the various aspects of Shariah-compliant finance. Brunei will have to wait for some
time before human resource investments in Islamic finance begin to pay full dividends
despite the sector already profiting from 20 years of experience and a generation of
professionals that have grown up inside the industry. 381
381
‘Investing
in
the
future
of
Islamic
finance’
The
Brunei
Times
24
June
2012
<http://www.bt.com.bn/business-national/2012/06/24/investing-future-islamic-finance> accessed 13
October 2012
157
Stronger interest from the industry
Islamic financial products are quite limited in Brunei but there are reasons to believe
that the situation will change soon. For example, STANDARD Chartered Bank
Brunei (SCB) has plans to introduce Islamic banking products by 2013 to cater for the
growing demand in Syariah-compliant banking services in Brunei, its chief executive
officer said. 382 Standard Chartered was the first international bank in Malaysia to
offer Islamic banking products in 1992 and since 2003, in the UAE, Pakistan and
Bangladesh, according to the bank's website.
Besides Standard Chartered Bank Brunei, the AmBank Group is also eyeing
Brunei. THE AmBank Group are working towards establishing an Islamic bank in
Brunei. Speaking to The Brunei Times, the chairman of the AmBank Group, Tan Sri
Azman Hashim, said the Bank is hoping that the Brunei government will issue the
Malaysian financial house with a license.
A report from The Edge, stated that AmCapital (B) Sdn Bhd would bring
expertise in funds management, Islamic finance and investment advisory to Brunei,
tapping on the vast resources, and over three decades from the group's investment
banking arm, AmInvesment Bank Group.
Education and training
Brunei Darussalam's leading educational facilities seek to support the government's
policy of developing the Sultanate as a centre of Islamic financial excellence. The
CIBFM, which was established by the Ministry of Finance to tackle key challenges in
Islamic financial practice and to assist in the development of human resources for the
sector, as well as other institutions, are also working to deepen the pool of qualified
personnel in Brunei Darussalam. 383The Universiti Brunei Darussalam (UBD), along
with the Sultan Sharif Ali Islamic University and other centres, also offer a range of
courses on various aspects of Islamic finance and in mid-April 2012, the UBD
announced it would be reviewing its curriculum for its Islamic finance courses to
382
Fitri Shahminan, ‘Standard Chartered Brunei may introduce Islamic banking in 2013’ The Brunei
Times 12 October 2012
<http://www.bt.com.bn/business-national/2012/10/12/stanchart-brunei-may-introduce-islamic-banking2013> accessed 13 October 2012
383
‘Investing in the future of Islamic finance’ The Brunei Times 24 June 2012
<http://www.bt.com.bn/business-national/2012/06/24/investing-future-islamic-finance> accessed 13
October 2012
158
ensure their content was relevant to the sector, a process that would also include
seeking input from the industry itself. 384
Table 7: Development of Islamic finance in Brunei
1991 Tabung Amanah Islam, the country’s first Islamic trust fund, is established to
help Brunei’s local Muslims undertake their pilgrimage to Mecca. This is
followed by the establishment of the Islamic Bank of Brunei
2006 The Ministry of Finance issues Brunei’s first sovereign sukuk
2006 The 2006 Syariah Financial Supervisory Board Order is introduced to
regulate and approve the offering of Islamic financial products and business
services to the public
2008 Legislative reform begins with the introduction of the 2008 Islamic Banking
and Takaful Orders
2009 The Bank Islam Brunei Darussalam (BIBD) launches its Musyarakah
Corporate Financing
2009 The BIBD is appointed joint lead manager of the US$500 million sukuk
offered by the General Electric Capital Corporation
2011 The Monetary Authority of Brunei Darussalam is established
384
‘Investing
in
the
future
of
Islamic
finance’
The
Brunei
Times
24
June
2012
<http://www.bt.com.bn/business-national/2012/06/24/investing-future-islamic-finance> accessed 13
October 2012
159
The inclusion of Islamic Finance in developed jurisdictions
Hong Kong and Singapore are the most developed maritime trade centers in Southeast
Asia. Both are important shipping ports and established international financial centers.
To complete their positions as the main financial and wealth management centers in
Southeast Asia, they have included Islamic financial products in their financial
portfolios. Singapore has a head start compared to Hong Kong in relation to Islamic
finance. The Muslim community in Singapore is much more extensive than that in
Hong Kong, but this is not a determining factor because neither are focusing on their
domestic markets. The accelerated development of Islamic finance in Singapore is
due to its leadership’s efficient and systematic planning combined with an
environment that is particularly conducive to Islamic finance due to legislation that is
consistently updated to accommodate its principles. Furthermore, Singapore has
benefitted from neighboring Malaysia’s long history and experience with Islamic
finance.
4.11.4
Singapore
Recent years have witnessed a growing motivation for Islamic financial services to
become part of Singapore’s continuing development as an international financial
centre. 385 Financial institutions have been encouraged to include Islamic financial
products and services into the colorful range of conventional financial services and
products that are already available in Singapore. 386 There are many reasons behind
this. Over the last three decades, Islamic finance was marked with exponential growth
globally. Islamic finance has since its inception in the late 1960s become one of the
fastest growing segments of the global financial system. To maintain Singapore’s
competitive edge, Islamic finance must be included. Financial services are a very
important of Singapore’s economy and it directly contributes to around 12 percent of
its GDP.
Islamic finance in Singapore can be traced back to 1995 when HSBC
(Singapore) launched its Takaful Global Fund. In 2001, Malaysia’s largest bank,
Maybank introduced its Shariah-compliant Unit Trust Ethical Growth Fund. Four
years later, in 2005, Shariah compliant saving account was also introduced. In 2007,
DBS Bank launched the first Islamic bank in Singapore, Islamic Bank of Asia after
receiving official approval from the Monetary Authority of Singapore for a full bank
licence. The Islamic Bank of Asia's founding shareholders include majority
385
‘Banking & Finance’ < http://www.singaporelaw.sg/content/BankingandFinance.html> accessed 20
November 2012
386
‘Banking & Finance’ < http://www.singaporelaw.sg/content/BankingandFinance.html> accessed 20
November 2012
160
stakeholder DBS and 34 Middle Eastern investors from prominent families and strong
industrial groups from Gulf Cooperation Council (GCC) countries. DBS has also
placed a significant portion of large, landmark equity IPOs and securitisations in the
Middle East and was among the first few Asia-based banks to receive a banking
licence from the Dubai International Financial Centre. 387
In August 2010, Malaysian state investor Khazanah sold S$1.5 billion in
Islamic bonds, Singapore largest sukuk sale, in a transaction that drew a demand of
4.3 times its book size. The big demand for alternative financial products is not that
surprising. According to Dr Zeti Akhtar Aziz, Governor Of Bank Negara Malaysia:
While the Islamic banking sector has been important in intermediating cross border
financial flows, the sukuk market has become an important segment of Islamic
finance that offers a distinct platform upon which international inter-linkages are
fostered. The sukuk market has demonstrated its ability to effectively intermediate
funds across borders, contributing towards the efficient allocation of funds in the
global financial system. The sukuk epitomises a truly global product for international
fund raising and investment activities. An increasing number of multilateral agencies,
sovereigns, Government agencies and corporations, including multinational
corporations have relied on the sukuk market as a source of financing. And the
diverse composition of the sukuk investors across continents has added further depth
to the international dimension of the sukuk market.
In Malaysia, the sukuk market
has evolved into a multi-currency denominated sukuk market with pioneering sukuk
issuances in U.S dollars, Singapore dollar and the Renminbi. 388
Size and nature
Singapore is currently home to at least nine financial institutions and banks offering
Islamic financial services: the Islamic Bank of Asia, OCBC, Standard Chartered,
CIMB, Maybank, Tokio Marine ReTakaful, Daiwa Asset Management, Arcapita
Bank, and most recently Emirates NBD. 389 The city state offers favorable prospects
in terms of ease of doing business, and enjoys strong strategic connections to the
387
The Islamic bank of Asia, ‘DBS Bank and Prominent Middle Eastern Investors Launch the Islamic
Bank of Asia’ <http://www.islamicbankasia.com/news/2007/Pages/pr070507.aspx>
388
Welcoming Address By Dr Zeti Akhtar Aziz, Governor Of Bank Negara Malaysia, ‘Global Islamic
Finance Forum 2012: Internationalisation of Islamic Finance: Bridging Economies’ (20 September
2012)
389
Nazneen Halim, ‘Singapore: The Merlion’s Share’ Islamic Finance Asia March 2011
<http://www.islamicfinanceasia.com/article.asp?nm_id=18840>
161
world`s economic giants such as Hong Kong and London. Judging by recent market
entrants Arcapita and Emirates NBD, the Middle East is also beginning to discover
Singapore`s potential. According to Kuwait Finance House Research, Shariah
compliant banking services were available in Singapore (either via windows or as
Takaful products) as early as 1995. In 2005, Mr. Ong Chong Tee, the Monetary
Authority of Singapore’s Deputy Managing Director, clarified Singapore’s position
on Islamic finance:
This is … not the same as expecting Singapore to be an Islamic banking hub. With
our small domestic market, the larger opportunity for the financial industry in
Singapore is to leverage off the infrastructure we have in place, to offer wholesale
market activities, in the areas of wealth management and capital markets activities.
We are thus looking at financial institutions here to add Islamic financial products
and services, to the broad range of services that are already available. 390
This position was reiterated five years later by the Singapore Minister of Trade and
Industry, Lim Hng Kiang:
We don’t set out with clear target that we want to established ourselves as
Islamic financial centre, or ask ourselves what we can do. Basically, we see
this as an extension of our development as a financial services centre. 391
It seems that the main target in Singapore is to include Islamic finance into its
financial portfolio, and act as intermediary or wealth/asset manager. The domestic
market should not be ignored. About 20 percent of Singapore’s population is Muslims.
With proper Islamic financial products, it is possible to capture the attention of the
non-Muslims as well provided that the products must be really good and competitive.
According to an expert on Islamic finance in Southeast Asia, Angelo M.Venardos,
Singapore’s efforts to develop Islamic finance should not be constrained by the fact
that it is not a Muslim state as Islamic finance is already taking off in many
non-Muslim countries including Australia and European countries. 392
390
Ong Chong Tee, Deputy Managing Director, Monetary Authority of Singapore, ‘Opening Keynote
Address: Singapore's Perspective on Islamic Finance’ (The Asian Banker Summit 2005, 16 March
2005).
391
Jumana Al Tamimi, ‘Singapore eyes Islamic finance’ Gulf News (Singapore June 25 2010).
392
Angelo M Venardos, Islamic Banking & Finance in Southeast Asia: Its development and future (2nd
edn, World Scientific Publishing Co.Pte Ltd 2006)
162
Furthermore, even industry leaders agree that Islamic finance, with its focus
on transparency, price certainty and risk-sharing can offer a viable alternative to both
muslims and non-Muslims and one such example is Singapore-listed Sabana Shari'ah
Compliant REIT, which counts three-quarters of its investors as conventional
investors. 393
It is noted that there is some conflicting news concerning the progress of
Islamic finance in country like Singapore. For example, HSBC announced in October
2012 that except for wholesale banking operations, it would no longer offer Islamic
products in Britain, the United Arab Emirates, Bahrain, Bangladesh, Mauritius and
Singapore. 394 However, four days after the announcement, the National Bank of
Abu Dhabi revealed a very different plans: it aims to triple the contribution of its
sharia-compliant operations over the next eight years. The contrast suggests that
rather than being a sign of weakness in the Islamic finance sector, HSBC’s decision
reflected its own business priorities.
In any event, there is a strong demand for financing, even in the Asian region and
some investors preferred to use Shariah-compliance methods. According to Mr. Ng
Nam Sim, Assistant Managing Director (Development), Monetary Authority of
Singapore:
As Asia expands, its demand for financing and investment into real economic
activities including corporate, trade and infrastructure financing will be large.
The
region is expected to account for one-third of global trade and would require
infrastructure financing of US$8 trillion up to 2020.
world’s Muslims live in Asia,
As more than 60% of the
and coupled with its increased affluence, the
conditions are ripe for Islamic finance to ride on Asia’s growth.
Indeed, the
Banker’s annual survey of Islamic financial institutions shows that Asia’s
Shariah-compliant assets grew at a robust 23% this year.
Notwithstanding the
promising potential for Islamic finance in Asia, Shariah-compliant financial
institutions like their conventional counterparts have to learn from the global crisis. 395
393
Linette Lim, ‘Islamic finance looks to be viable alternative amid uncertainty’ Channel Asia News (5
June 2012)
<http://www.channelnewsasia.com/stories/singaporebusinessnews/view/1205753/1/.html>
394
‘Gulf Islamic banks to step in as HSBC pulls back’ Reuters 18 October 2012
<http://www.khaleejtimes.com/kt-article-display-1.asp?xfile=data/international/2012/October/internati
onal_October549.xml&section=international>
395
Ng Nam Sin, Assistant Managing Director (Development), Monetary Authority of Singapore,
‘Opening Keynote Address’ (The 17th Annual World Islamic Banking Conference, Bahrain, 24
November 2010)
163
Strong legal and regulatory framework
The aim of the authority in Singapore is to ensure fairness in the legal and regulatory
framework. Lim Hng Kiang, Singaporean Minister of Trade and Industry elaborated
as follow:
[W]e see ourselves as offering a range of facilities. First of all, financial services are
very important part of our economy. It contributes around 11 per cent to 12 per cent
of our GDP, and as we built up Singapore as a financial services centre, it is natural
for us to extend this to Islamic finance as well, for several reasons ... One, we should
offer the full (financial) services. We have very important clients who see this as an
important offering. Therefore, I think, institutions here want to provide this service,
and so does the regulatory authority. I think our job is to try to meet this level, and
remove any disadvantages that may be in our regulatory or tax framework with regard
to Islamic finance. So we don't set out with clear target that we want to establish
ourselves as Islamic finance centre, or ask ourselves what we can do. Basically, we
see this as an extension of our development as a financial services centre. 396
In Singapore, the Banking Regulations issued under the Banking Act have been
amended so that, with effect from 29 September 2005, banks in Singapore have been
able to offer an important form of Islamic finance known as Murabaha. Murabaha
(which essentially involves the bank purchasing the relevant asset and selling it to the
customer on ‘cost-plus’ deferred payment terms) is commonly used for short-term
financing and in trade finance.
The amendment was necessary as, pursuant to section 30 of the Banking Act
(Cap 19, 2003 Rev Ed), banks in Singapore were not allowed to engage in
non-financial businesses (including trading). Following the amendment, a bank in
Singapore may carry on a business which involves the purchasing and selling of
assets if such business is carried out under certain specified arrangements.
In 2006, the Monetary Authority of Singapore (MAS) reviewed its banking
and financial regulations, subsequently reviewing its existing tax framework to create
a level playing field for Islamic financial institutions, and creating a new legislative
infrastructure to encourage participation. 397 Some of the incentives afforded to
institutions entering the market included the removal of double taxation or reduced
taxes on Islamic transactions and products; the waiving of stamp duties on Islamic
real estate financing and Sukuk payouts; a 5% concessionary tax rate for Islamic
396
397
Jumana Al Tamimi, ‘Singapore eyes Islamic finance’ Gulf News (Singapore 25 June 2010).
Nazneen Halim, ‘Singapore: The Merlion’s Share’ Islamic Finance Asia March 2011
<http://www.islamicfinanceasia.com/article.asp?nm_id=18840>
164
lending, fund management, and Takaful and re-Takaful activities; and the introduction
of training programs linked to Singapore-based educational institutes. 398
The financial authorities in Singapore have decided that both Islamic and
conventional banking shall be accommodated within a common regulatory framework.
Towards this end, some legislative changes have taken place to facilitate the growth,
within that current framework, of Islamic banking in Singapore. This approach hope
to simplify and ease the process.
The regulatory bodies in Singapore include the Ministry of Finance (MOF),
the Monetary Authority of Singapore, the Securities Industry Council and the
Accounting and Corporate Regulatory Authority (ACRA). The MOF issues and
regulates policies related to the financial sector. The MAS is the central bank of
Singapore and is responsible for monetary policies. The Securities Industry Council
regulates issues related to mergers and acquisitions and the ACRA regulates the
establishment of companies and business firms.
To ensure the success of Islamic finance in Singapore affirmative actions have
been taken. In developing the regulatory framework of Islamic banking and finance in
Singapore, the MAS has embedded new provisions relating to Islamic banking and
finance into the existing legislation (often the Banking Act and Securities and Futures
Act) and regulations where necessary
To establish a level playing field, the income tax legislation and regulation in
Singapore have also been fine-tuned to accord Islamic financing arrangements with
the same tax treatments and incentives as that of conventional financing
arrangements.Notwithstanding these regulatory efforts by MAS, there are a number of
hurdles that needs to be overcome before Singapore can be further developed as an
international financial centre for Islamic banking and finance.
Firstly, there is still a lack of familiarity of issuers and investors in Singapore
with the detailed components and mechanics of Islamic financial products. Thus,
there may need to be additional financial incentives offered to issuers to attract them
to invest time and resources in educating themselves on Islamic financial products.
Secondly, Singapore’s legal framework in relation to Islamic banking and
finance has largely been untested. In Malaysia, the Central Bank of Malaysia Act
2009 renders the Central Bank of Malaysia’s Shariah Advisory Council as the sole
authority on disputes relating to Islamic banking and finance in Malaysia. Conversely,
due to Singapore’s position as a non-Muslim secular state, the legislation and
regulations touching on Islamic financial instruments are sterilised from religious
398
Nazneen Halim, ‘Singapore: The Merlion’s Share’ Islamic Finance Asia March 2011
<http://www.islamicfinanceasia.com/article.asp?nm_id=18840>
165
reference. Singapore also does not have a central body regulating the compliance with,
and standards of, the application of Shariah principles in the Islamic banking and
finance sector. These give rise to a pertinent issue: To what extent, if at all, would
Singapore’s secular common law courts be able or willing to give effect to Shariah,
given Shariah consist of Islamic precepts which are religious by nature and beyond
the common law corpus?
Given Singapore’s natural advantage due to its strong banking regulatory
framework, political stability and highly-skilled professional workforce, upon the
resolution of the factors highlighted above, and after further development and
maturing of the Islamic banking and finance sector in Singapore, Singapore can then
leverage on its competitive strengths and flourish into an international financial centre
which comprehensively offers both conventional and Islamic financing products to
global investors.
Expertise, workforce and talent
One of the biggest challenges in the landscape of Islamic finance in Singapore is
talent development. There are not enough scholars, practitioners and experts who
truly understand the market of Islamic finance.Singapore is actively growing its talent
pool with the introduction of Islamic finance programs across the country, including
Singapore Management University`s establishment of an international Islamic finance
and law center, as well as HSBC Insurance`s Takaful training program catered to
Singapore`s Islamic religious teachers. 399
Strong cooperation with other countries
The existence of a well-established Islamic finance hub nearby has provided
Singapore with a great opportunity in this respect and a series of cooperative projects
have been initiated. In addition to its dealings with Malaysia, Singapore has also
cooperated with other Islamic finance hubs, including Dubai, to ensure the mutual
prosperity of all parties. Although Singapore is relatively new to Islamic finance, it
has a large pool of talent and a long history dealing with conventional finance.
Learning Islamic finance will be a great addition to its already colorful large pool of
talent.
Singapore is also involved the standard setting. For example, Since becoming a
full member in 2005, MAS has contributed to IFSB’s work through its participation in
its standard setting Technical Committee and various task forces. Singapore is also
399
Nazneen Halim, ‘Singapore: The Merlion’s Share’ Islamic Finance Asia March 2011
<http://www.islamicfinanceasia.com/article.asp?nm_id=18840> accessed 10 January 2012
166
part of IFSB’s working groups on supervisory review, capital adequacy, Islamic
money markets and solvency requirements for Takaful operators. 400
Economic challenges
To strengthen its position as a leading international financial centre, Singapore
pursued diversification, recognizing the benefits of including Islamic finance in its
financial portfolio. Worldwide Muslim population is more than 1 billion and the
current Islamic finance market is estimated to be around US$1 trillion. True to the
initial plan of slicing a bigger share from the market, a series of actions have been
taken by Singapore’s government and private sector to make a name for Singapore as
a strong alternative for Islamic finance. For the time being, neighboring Malaysia has
already established itself as an international Islamic finance hub, partly due to its early
start, strong government, local support and efficient planning.
The way forward
Singapore can use its position as a global financial hub to accelerate and benefit from
the development of Islamic finance. Angelo M Venardos concluded that Singapore
has established a highly credible brand name in global banking and financial world
due to its strong political stability, common law English legal system, efficient
regulatory regime and solid financial infrastructure. 401
Singapore government has played an important role in promoting and
developing Islamic finance. In June 2012, MAS hosted the third annual World Islamic
Banking Conference. Previously in 2009, MAS has set up the Islamic bond
programme. The aspiration to create conducive environment for Islamic finance in
Singapore can be seen. For example, in June 2012, the President of the Islamic
Development Bank Group, Dr. Ahmad Mohamed Ali, lauded Singapore for the
commitment it has shown towards the Islamic financial industry as illustrated by the
issuance of the required laws by the Singapore authorities and by the country’s active
membership in the Islamic Financial Services Board (IFSB). 402 It was also reported
that discussion is being made on ways to strengthen the existing cooperation between
400
‘6th Islamic Financial Services Board Summit in Singapore’
<http://www.mas.gov.sg/en/Singapore-Financial-Centre/Value-Propositions/~/media/resource/fin_deve
lopment/manpower/MAS%20Islamic%20LR.ashx>accessed 10 January 2012
401
Angelo M Venardos, Islamic Banking & Finance in Southeast Asia: Its development and future (2nd
edn, World Scientific Publishing Co.Pte Ltd 2006) 209
402
‘Islamic Development Bank Group President Lauds Singapore’s Continuous Support for the
Islamic Financial Industry’ Islamic Development bank Group Business Forum (7 June 2012)
< http://www.idbgbf.org/portal/detailed.aspx?id=429>
167
the Islamic Development Bank Group and Singapore in general and in particular
between the IDB Group and Singapore Management University (SMU) which has
shown genuine interest in the fields of Islamic finance and banking and the possibility
to make use of IDB expertise in that framework. 403
The prospect of Islamic finance in Singapore seems positive provided that the
necessary reforms are made. Ravi Menon, Managing Director, Monetary Authority of
Singapore elaborated as follow:
‘… Islamic finance will have to contend with is the ongoing global regulatory
reforms.
The scale and scope of these reforms are probably unmatched in recent
history.
Islamic financial institutions will have to devote considerable resources to
meet the new international standards.But there are certain inherent characteristics of
Islamic finance that will stand it in good stead in the emerging regulatory
environment.
Take for example, banking, where the emphasis of regulatory reform
is on more capital and more liquidity.
Islamic banks have consistently held higher
levels of capitalisation vis-à-vis conventional banks, by some 2.5 percentage points
on aggregate, according to research from the World Bank.
Islamic banks also start
off with a higher level of liquid assets compared to their conventional counterparts.
Islamic finance is also well placed to meet the increased ‘return-to-basics’ investor
demand.’ 404
403
‘Islamic Development Bank Group President Lauds Singapore’s Continuous Support for the
Islamic Financial Industry’ Islamic Development bank Group Business Forum (7 June 2012)
< http://www.idbgbf.org/portal/detailed.aspx?id=429>
404
Ravi Menon, Managing Director, Monetary Authority of Singapore, Opening Address at the 3rd
Annual World Islamic Banking Conference: Asia Summit, Grant Hyatt Singapore, 5 June 2012.
<http://www.mas.gov.sg/en/News-and-Publications/Monetary-Policy-Statements-and-Speeches/2012/T
he-Next-Phase-in-Islamic-Finance.aspx> accessed 20 July 2012
168
4.11.5
Hong Kong
The consistent and sustainable growth of the Islamic finance market by 15 to 25 per
cent per annum is understandably viewed as attractive by many. In 2007, the former
Chief Executive of Hong Kong announced a plan to include Islamic finance in the
suite of financial services offered in the territory, and various steps to bring this plan
to fruition followed. The Hong Kong Monetary Authority (HKMA) has also
expressed its full support in drawing up legislative proposals to modify Hong Kong’s
tax laws to level the playing field between Islamic and conventional financial
products, and reiterated that it would continue to build international links and enhance
Hong Kong’s international profile by working closely with Bank Negara Malaysia,
Malaysia’s central bank, to explore collaborative initiatives. 405
In delivering the 2012-13 Hong Kong Budget, the Financial Secretary, Mr
John Tsang Chun-wah, announced that the Hong Kong Government was finalising
legislative amendments to promote Islamic finance. 406 This is to be followed by a
consultation on Islamic bonds, also known as sukuk. 407 The Hong Kong Government
aims to provide a level playing field between common types of Islamic bonds and
conventional financing instruments regarding profits tax, property tax and stamp duty.
Other major Asian countries including South Korea, Japan, Thailand and Australia
have also considered moving into the sukuk markets, but none has gone beyond mere
talk. Hence, Hong Kong’s move to consult the market is a step in the right
direction. 408
The promotion of Islamic finance is part of the Hong Kong Government’s
diversified financial policy as expressed in the 2007 Policy Address. 409 This policy
was reiterated in the 2011 Policy Address. Hong Kong is a resilient city-state that
survived the Asian financial crisis, the SARS threat and the global financial recession,
405
Anthony Chan, ‘Hong Kong: The Gatekeeper’, Islamic Finance News, 16 February 2012,
<http://www.islamicfinancenews.com/listing_article_ID.asp?nm_id=25619> accessed 17 July 2012.
406
‘Update on Islamic Finance in Hong Kong’, KPMG Tax Alert, Issue 3, February 2012,
<http://www.kpmg.com/cn/en/issuesandinsights/articlespublications/newsletters/tax-alert/pages/tax-ale
rt-1202-03-islamic-finance.aspx> accessed 17 July 2012.
407
‘Consultation Paper on the Proposed Amendments to the Inland Revenue Ordinance (Cap. 112) and
the Stamp Duty Ordinance (Cap. 117) to Facilitate Development of an Islamic Bond (i.e. Sukuk)
Market in Hong Kong’, <www.fstb.gov.hk/fsb/ppr/consult/consult_sukuk.htm> accessed 20 July 2012.
408
‘P&M: HK Prepares for Islamic Bond Market’, International Financing Review, 29 March 2012,
<http://www.ifre.com/pm-hk-prepares-for-islamic-bond-market/21008826.article> accessed 17 July
2012.
409
Ringo Chan, ‘A New Silk Road Paved by Islamic Finance’, China Daily, 16 July 2012,
<http://www.chinadaily.com.cn/hkedition/2010-07/20/content_11021377.htm> accessed 17 July 2012.
169
although it suffered some setbacks along the way. The current global economic
downturn has had a dramatic impact, even on exports from the southern coastal
provinces of China, and this in turn has had a negative effect on Hong Kong’s
economy. 410
Hong Kong is finalizing the steps to be taken to introduce Islamic finance.
This has been well-received in the Gulf and by wealthy private Muslim investors, and
will not go unnoticed. Countries around the world have adopted different stances
towards Gulf capital, with several adopting active strategies to attract more GCC and
Islamic investors. Such measures bring comfort to Gulf-based investors and should
not be underestimated. 411
While Muslims might prefer Islamic finance primarily for religious reasons,
its acceptance by a growing number of non-Muslims indicates Islamic finance is both
competitive and profitable. The resilience of Islamic finance in the face of the recent
global recession is further proof of its true potential.
In 2007, Hong Kong’s Financial Secretary, John Tsang Chun-wah, confirmed
that Hong Kong wanted a slice of the US$1 trillion Islamic finance market and was
taking steps to develop a local Islamic bond market, among other things. 412 In his
policy address, the former Chief Executive, Donald Tsang, confirmedthat it was the
government’s official policy to develop Islamic finance and that its firm commitment
was beyond doubt. There are many impediments to the development of Islamic
finance in Hong Kong, taxation in particular. The Financial Secretary elaborated by
stating that ‘Islamic finance is an important element of the global financial system.
For Hong Kong to be a major international financial center, not just in the region, but
globally, then Islamic finance must be among our portfolio of products and
services.’ 413
In the same year, the first Islamic fund 414 in Hong Kong was introduced by a
local bank. In December 2007, the Hong Kong Mortgage Corporation signed a joint
venture agreement with Cagamas Berhad (Malaysia’s national mortgage corporation
410
John Malcolm Dowling and Pradumna Bickram, Asia and the Global Economic Crisis: Changes in
a Financially Integrated World (Palgrave MacMillan, 2010) 165.
411
Aamir A. Rehman, Gulf Capital and Islamic Finance: The Rise of the New Global Players
(McGraw-Hill, 2010) 266.
412
‘Hong Kong Seeking Slice of Trillion-Dollar Islamic Finance, Tsang Says’, Thompson Financial
(Hong Kong, 9 October 2007).
413
Hong Kong Seeking Slice of Trillion-Dollar Islamic Finance, Tsang Says’, Thompson Financial
(Hong Kong, 9 October 2007).
414
An index-tracking fund that tracks the performance of the Dow Jones Islamic Market China/Hong
Kong Titans Index.
170
and leading securitisation house) to establish a company to develop a
shariah-compliant mortgage guarantee business to add to its conventional offering. 415
In 2008, a new Dow Jones Islamic Market Index was launched to track
China-related equities listed on the Hong Kong Stock Exchange. 416 Hong Kong then
introduced the Hang Seng Shariah-compliant China Index Fund/Islamic Investment
Series to further attract Muslim investors. 417 This encompassed the thirty largest
shariah-compliant companies and their primary operations within Hong Kong and
mainland China. By March 2008, the Stock Exchange of Hong Kong listed a US$550
million convertible sukuk backed by shares listed on the exchange. 418 Five months
later, the Hong Kong Monetary Authority (HKMA) approved the first Islamic
banking window and the first commodity Murabahah deposit was launched in
November.
The Dubai Financial Services Authority also announced a joint regulatory
initiative with the Securities and Futures Commission of Hong Kong to enhance
access to Islamic financial products in Hong Kong and the Dubai International
Financial Centre (DIFC). 419 This plan was announced in Hong Kong in the context of
a memorandum of understanding (MoU) between the two regulators that outlines a
mutual commitment to promote and develop their respective Islamic capital market
segments and work together to facilitate the distribution of Islamic funds in the DIFC
and Hong Kong.
In early 2009, the Hong Kong Government announced that it was introducing
new tax laws that would facilitate the introduction of Islamic finance and place it on
par with equivalent conventional products. 420 In April 2009, a Hong Kong bank sold
Islamic bonds through its selected Hong Kong branches and offered two
415
‘Cagamas Berhad and the Hong Kong Mortgage Corporation Limited Sign JV for Development of
Mortgage Guarantee Business’, <www.cagamas.com.my/caga-docs/pictures/pr_20dec07.pdf> accessed
20 July 2012.
416
Eddie Yue, Deputy Chief Executive of the Hong Kong Monetary Authority and Executive Board
Chairman of the Treasury Markets Association, ‘Welcome Address’ (Hong Kong Showcase on Islamic
Finance, Dubai and Amman, 11-12 May 2008) 2,
<http://www.bis.org/review/r080515c.pdf>
accessed 20 July 2012.
417
Andrew Sheng, ‘Is Islamic Finance the New Challenge to Wall Street?’,The China Post, 7
November 2010.
418
419
‘The Appeal of Islamic Finance’, Islamic Finance Asia (June/July 2009).
‘DFSA Launches Islamic Finance Initiative with Hong Kong’, AMEinfo.com, 3 April 2008
<http://www.ameinfo.com/152312.html> accessed 15 November 2011.
420
Mushtak Parker, ‘Hong Kong Eyes Islamic Finance Products’, Arab News, 23 February 2009
< http://www.arabnews.com/node/321247> accessed 8 September 2012.
171
short-to-medium-term secondary market sukuk targeting Islamic investors. Later in
the same year, an MoU was signed between the Hong Kong Monetary Authority and
Bank Negara Malaysia. The parties agreed to strengthen their cooperation in the area
of Islamic finance, particularly regarding the development of human capital and
financial infrastructure and the promotion of cross-border financial activities. 421
A deeper analysis reveals that the earlier plan to introduce proper tax laws
governing Islamic finance in 2009 failed, perhaps partly due to the series of problems
associated with the global recession. However, this failure was costly, as the
opportunity to secure huge reserves and funds that Gulf states and wealthy Muslim
investors could have made available was lost. The proposal to remove the relevant tax
impediments was revived in 2012.
The Benefits of Islamic Finance for Hong Kong
Islamic finance has been a feature of the global arena throughout the history of Islam.
The development and application of Islamic finance was temporarily halted after the
fall of the last Muslim empire, the Ottoman Empire, which lasted from 1299 to 1923.
Interest in modern Islamic finance resurfaced in the 1970s, largely due to the
petrodollars accumulating in Arab countries. Its benefits go beyond investment from
the MENA 422 region. An Islamic financial system is expected to be more stable than
a conventional one because it inherently matches assets and liabilities for the
following reasons: (1) the term and structure of assets and liabilities of economic units
are closely matched through profit-sharing agreements; (2) the liabilities of each
economic unit comprise equities and/or are fully amortised with an underlying future
income flow; and (3) the payment commitments of firms and financial institutions are
to be paid only if profits are received. 423 Some of the major benefits of including
Islamic finance in Hong Kong’s financial portfolio are outlined below.
421
Edmond Lau, Executive Director (Monetary Management) of the Hong Kong Monetary Authority,
‘Opening Keynote’ (Hong Kong Islamic Finance News Roadshow, Hong Kong, 11 May
2010)<http://www.hkma.gov.hk/eng/key-information/speech-speakers/eyplau/20100511.shtml>
accessed 15 November 2011.
422
The term MENA, which stands for ‘Middle East and North Africa’, is an acronym often used to
cover an extensive region extending from Morocco to Iran, including the majority of both Middle
Eastern and Maghreb countries.
423
Zamir Iqbal and Abbas Mirakhor, An Introduction to Islamic Finance: Theory and Practice (2nd
edn, Wiley 2011) 144.
172
(i)
Gateway for Islamic finance
Hong Kong has a free market economy and is highly reliant on international trade and
finance: the value of trade in goods and services, including the sizable share of
re-exports, is about four times GDP. 424 Hong Kong is also one of the world’s leading
financial centres, known for its capitalist service economy, low taxation and free trade.
The addition of Islamic finance is likely to strengthen its position in the global
economy. According to Professor K.C. Chan, Hong Kong has an unrivalled role in
providing a bridge between the international market and the Mainland, the world’s
fastest growing economic giant. 425 He further explained that by matching investment
needs from the Middle East with capital needs in the Mainland, Hong Kong could
serve as a trusted platform linking East and West – the new Silk Road. John Gale,
Managing Partner at Stephenson, Harwood and Lo, highlighted that it is not Muslims
in the streets who would be driving demand to Hong Kong, but investors with
petrodollars who want to invest in China. 426
Muslim states and wealthy individual investors from the Middle East keen to
tap into China’s booming market can use Hong Kong as a launching pad for such
strategic plans. China’s economy has been growing rapidly, attracting investors from
around the world. Still, its true potential has not yet been realised. According to the
Ministry of Commerce website, rich countries from the Middle East such as Saudi
Arabia and the United Arab Emirates are not yet among China’s top ten foreign
investors. If Hong Kong manages to position itself as a leading Islamic financial hub,
it will attract a wealth of lucrative deals from the Middle East and other Muslim
states.
The benefits will be mutual. ‘Mutually beneficial cooperation between China
and the Muslim world are extremely important to China,’ stated Ma Hongjian,
President of the Beijing-based China-Arab Council for Investment Promotion. He
explained that since 9/11, trade partnerships between the two have skyrocketed
because many Muslim businesspeople were unable to obtain visas to the West and
instead started going to China in droves. 427
424
‘The World Factbook – Hong Kong’, Central Intelligence Agency (CIA)
<https://www.cia.gov/library/publications/the-world-factbook/geos/hk.html> accessed 20 July 2012.
425
‘Press Release: Hong Kong to Seize Islamic Finance Opportunity’,
<http://www.info.gov.hk/gia/general/200911/11/P200911110232.htm> accessed 17 July 2012.
426
Gregory Glass, ‘Hong Kong – An Islamic Finance Centre?’,Asialaw, December 2007,
<http://www.asialaw.com/Article/1970852/Hong-Kong-An-Islamic-Finance-Centre.html?Print=true&S
ingle=true> accessed 17 July 2012.
427
Massoud Hayoun, ‘Can China Make Its Cuisine – and Finance – Friendly to Muslims?’,TIME, 4
April 2012
173
Hong Kong acts as a notable bridge linking two powerhouses – fast-growing
China and the petrodollar-rich Middle East. 428 The addition of Islamic finance to
Hong Kong’s repertoire would make it a truly international financial centre.
Countries outside the MENA region are also interested in Islamic finance. Other
Muslim nations such as Kazakhstan have been key players in the Greater China
Region’s economy, both by fueling China’s expanding economy with natural
resources and in providing cash inflows. Several Khazakstani companies launched
IPOs on the Hong Kong Stock Exchange (HKSE) in 2011. 429 Cross-country joint
ventures will also be useful in enabling the transfer of expertise. The Mainland has a
sizeable Muslim community in certain areas, including the Xinjiang Uyghur
Autonomous Region in the northwest, where Islamic banking could find ready
takers. 430
(ii)
More attractive to Muslims and Middle Eastern investors
There is now at least US$800 billion invested in Islamic banking funds, US$100
billion in the sukuk (Islamic bond) market and another US$100 billion in takaful
(Islamic insurance) and fund management businesses. 431 The Islamic finance and
Gulf investment markets are not small. When General Electric (GE), a well-known
<http://www.time.com/time/world/article/0,8599,2110979,00.html> accessed 17 July 2012.
428
Heda Bayron, ‘Hong Kong Tries to Lure Islamic Funds’, Arabian Business, 30 December 2007
<http://www.arabianbusiness.com/property/article/506911-hong-kong-tries-to-lure-islamic-funds>
accessed 8 September 2012
429
Massoud Hayoun, ‘Who's Afraid of Islamic Finance?’,The Atlantic, 15 July 2012
<http://www.theatlantic.com/business/archive/2012/03/whos-afraid-of-islamic-finance/255265/>
accessed 17 July 2012.
430
By opening Islamic branches in this area, banks will actually do a great service to the local
community. Although this area can sometimes be somewhat volatile, the opening of Islamic banks will
be a very positive step and, according to experts, will have three major benefits. First, it will improve
economic development among both Muslims and non-Muslims. Second, it will increase understanding
between people from different religions, as non-Muslim traders will also be attracted to Islamic
financial services as long as they are competitive and cater to their needs. Third, the market in China is
booming, and there is great potential for growth. If international Islamic banks dare to seize the market
opportunity at this stage, they will be rewarded for their important role in developing the region as the
economy prospers.
431
Andrew Sheng, ‘Is Islamic Finance the New Challenge to Wall Street?’,The China Post, 7
November 2010
<http://www.chinapost.com.tw/commentary/the-china-post/special-to-the-china-post/2010/11/07/27893
3/Is-Islamic.htm> accessed 20 July 2012.
174
titan of US business, decided to sell its plastics business in 2007, the most attractive
buyer was not a European conglomerate, but the Saudi Basic Industries Corporation
(SABIC), a leading industrial conglomerate that once had a market capitalisation of
$135 billion. 432 When Citigroup, one of the largest banks in the world, began to feel
the effects of the credit crisis in 2008, relief was initially provided by the Abu Dhabi
Investment Authority (ADIA) and Prince Alwaleed Bin Talal (a Gulf-based private
investor). 433
With the exception of Saudi Arabia, Gulf states are relatively small in
geographical terms and tend towards thinly populated countries with inhabitants who
already enjoyed high incomes before the oil boom. 434 Therefore, these countries have
a limited capacity to absorb the large foreign reserves resulting from the dramatic
increase in oil prices.
In addition to acting as a bridge or gateway, Hong Kong will be able to attract
more funding from Muslims and Middle Eastern investors to Hong Kong.
Furthermore, non-Muslim companies are now also attracted to Islamic finance,
making its markets larger and more lucrative.
(iii) Career opportunities and transfer of expertise
More career opportunities will become available if Hong Kong is serious in its plans
to strengthen its Islamic finance portfolio. Hong Kong must increase its efforts to
attract the best brains in Islamic finance, an action that will be beneficial in the long
term. The expertise brought by such experts will be shared with others over time. The
flawless execution of comprehensive, detailed plans will speed up the development of
Islamic finance in Hong Kong. However, a lack of manpower will be problematic
unless properly addressed.
432
Aamir A. Rehman, Gulf Capital & Islamic Finance: The Rise of the New Global Players
(McGraw-Hill, 2010) 2.
433
Ibid., p3.
434
Hazem Bedlawi, The Arabic Gulf Economy in a Turbulent Age (St Martin’s Press, 1984), 9 and 66.
175
Challenges and Issues
In 2008, the Hong Kong Monetary Authority highlighted four issues associated with
Islamic finance: 435
(i)
Risk management While conventional banking is based largely on an
interest-based debtor-creditor relationship, Islamic financial transactions are more
complex given the diverse contractual relationships between banks and their
customers, ranging from lease-based to equity-based modes of finance;
(ii)
Shariah-compliance banks are responsible for ensuring that Islamic products or
services are shariah-compliant both before and after launch. It is important to
maintain the integrity of products and avoid possible subsequent disputes.
Shariah compliance can be effectively monitored through suitable internal
shariah audit processes and by developing more knowledge and expertise among
staff members;
(iii)
Contractual documentation It is generally understood that the enforceability of
an Islamic financial contract depends on the governing law of the contract.
Therefore, it is advisable that contracts evidencing Islamic financial transactions
be carefully drafted to reduce the potential for disputes and clearly set out the
governing law of the contract;
(iv)
Disclosure of risk and return to depositors Most deposits placed with an
Islamic bank or IBW are in the form of investment deposits. Depositors adopt the
role of quasi-shareholders who are not only entitled to share in the profits of the
Islamic banking business, but are also exposed to the risk of losing their capital in
the event of a loss. As matters currently stand, investment deposits are not
regarded as ‘protected deposits’ under the Deposit Protection Scheme Ordinance
or the temporary Exchange Fund deposit guarantee announced on 14 October
2008.
In countries such as the UK, the legal framework has sometimes proved unable to
deal efficiently with challenges, such as the role of the Sharia Supervisory Board and
the legal position of investment account holders – issues that might have a negative
impact on the local development of Islamic finance. 436
The Hong Kong Government would be wise to clarify such matters by
introducing clear legislation to avoid uncertainty. Important institutions, including the
435
‘Quarterly Bulletin’, Hong Kong Monetary Authority,
< http://www.hkma.gov.hk/eng/publications-and-research/quarterly-bulletin/> accessed 17 July 2012.
436
Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A Comparative Look
at the United Kingdom and Malaysia (Routledge, 2011).
176
Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI),
should be consulted.
Hong Kong also faces a series of unique challenges and issues in developing
Islamic finance. The first is one of timing. While Hong Kong’s late start in Islamic
finance can be remedied, any further delay would prove detrimental. The HKSAR’s
greatest potential is as an alternative Islamic finance gateway to China. The Muslim
community in China is currently attempting to introduce Islamic finance. For example,
Shenyang, the largest city in northeast China, has sought help from the Islamic
Banking and Financial Institute Malaysia (INFIM) to establish an Islamic banking
centre and realise its aspiration of becoming a leading Chinese Islamic banking and
financial hub. 437
The second challenge is the small size of the local Muslim community. 438
This small Muslim population can be misinterpreted to suggest that the potential
domestic market for Islamic finance is insignificant. This is very different from the
situation in countries such as Malaysia and Indonesia, both of which have large
Muslim populations. 439However, this should not prove an insurmountable problem.
Hong Kong’s small population has never undermined its capabilities in conventional
capital markets. Furthermore, the focus is not to match Islamic product demand and
supply from the domestic angle, but rather to turn Hong Kong into a platform for
international Islamic finance intermediation activities. 440 At the same time, any
Islamic financial institution or bank that decides to open a Hong Kong branch to cater
to the domestic needs of the local Muslim community will establish itself as a serious
contender in Islamic finance, and will realise that the current lack of domestic
competition may be highly advantageous for those willing to seize the market.
The third challenge is to ensure that robust legislation and regulations are in
place. This is actually a far more urgent and important issue than those mentioned
437
‘The Appeal of Islamic Finance’, Islamic Finance Asia, June/July 2009.
438
The population of the HKSAR is around 7 million. There are currently around 200,000 Muslims in
the HKSAR, including some 30,000 Pakistanis; 60,000 Muslim Chinese; and more than 100,000
Muslims from Indonesia, most of whom work as housekeepers and nannies. These figures do not
include Muslims from mainland China or Muslims from elsewhere visiting Hong Kong on business.
439
Islam is the official religion of Malaysia, with 60.4 per cent of the total population (28 million)
identifying themselves as Muslim. Islam is also a dominant religion in Indonesia, which has the largest
Muslim population in the world (more than 202 million).
440
Eddie Yue, Deputy Chief Executive of the Hong Kong Monetary Authority and Executive Board
Chairman of the Treasury Markets Association, ‘Welcome Address’, (Hong Kong Showcase on
Islamic Finance, Dubai and Amman, 11-12 May 2008), <http://www.bis.org/review/r080515c.pdf>
accessed 20 July 2012.
177
above. For example, among the first measures the Malaysian Government took in
relation to Islamic finance was the introduction of supporting legislation, including
the Islamic Banking Act. Reference can also be made to the UK in the legislative
context. In 2003, the UK Government established a fiscal and regulatory framework
appropriate for Islamic finance. It has since removed the double tax on Islamic
mortgages and extended tax relief for Islamic mortgages to companies and individuals.
Furthermore, problems related to the issuance of Islamic bonds/sukuk have been
avoided by restoring the previous arrangement whereby returns and income payments,
as core features of Islamic bonds, receive the same treatment as interest.
Hong Kong must develop proper legislation that details the requirements of
financial institutions, including the appointment of qualified shariah scholars as
advisors to ensure credibility. Failure to put proper legislation in place would make
Islamic finance very unattractive, because the differences between Islamic and
conventional finance are not always cosmetic. Taking tax as an example, Islamic
financial products would be subject to double taxation or extra taxes. The differences
between conventional and Islamic instruments are substantial, and their effects are
far-reaching. One of the defining characteristics of Islamic finance is the prohibition
of interest or usury as specified in the Qur’an:
Those who eat usury will not stand (on the Day of Resurrection) except like the
standing of a person beaten by the Devil leading him to insanity. That is because they
say: ‘Trading is similar to usury’, whereas God has permitted trading and forbidden
usury.
(Qur’an 2:275)
The prohibition of interest and usury is clearly outlined in the primary sources
of Islamic finance. The subject is also addressed in the Last Sermon: 441
O People, lend me an attentive ear, for I don't know whether, after this year, I shall
ever be amongst you again. Therefore listen to what I am saying to you carefully and
take these words to those who could not be present here today. O People, just as you
regard this month, this day, this city as Sacred, so regard the life and property of
every Muslim as a sacred trust. Return the goods entrusted to you to their rightful
owners. Hurt no one so that no one may hurt you. Remember that you will indeed
meet your Lord, and that He will indeed reckon your deeds. God has forbidden you to
take usury (Interest), therefore all interest obligation shall henceforth be waived...
441
Prophet Muhammad’s Last Sermon was delivered on the ninth day of Dhul Hijjah 10 A.H in the
Uranah Valley of Mount Arafat.
178
Usury, or interest, is the backbone of modern financial systems because the legal
relationship between bankers and their clients is that of creditor and borrower. The
main source of income for modern financial systems, particularly for banks, is the
interest paid by customers/borrowers. Although Islamic finance is steadfast in its
opposition to usury, it encourages trade and risk-and-profit sharing. Legislative
hurdles including double taxation might drive away investors, especially wealthy
Muslim investors from the Middle East who might be uncertain of the validity of
transactions. This would be most unfortunate considering the large size of the
prospective investment market.
Oil-rich GCC countries have benefited from the recent buoyancy in oil prices,
receiving a huge amount of oil revenues that have resulted in a vast accumulation of
regional wealth. 442 According to estimates made by the Sovereign Wealth Fund
Institute, the combined value of total assets managed by the sovereign wealth funds of
GCC countries amounted to about US$1.4 trillion at the end of March 2010,
representing more than one-third of global sovereign wealth funds and nearly
one-fifth of global foreign exchange reserves. 443
To avoid uncertainty, countries such as Malaysia have enacted relevant
legislation that specifies, among other things, the authority of the committee
responsible to ensure products are shariah-compliant.
The pace of the legislative process in the HKSAR is slow, not because the
government has a lot of new legislation in the pipeline, but due to the complicated
legal procedures that must be followed. Kenneth Leung from the law firm Clifford
Chance in Hong Kong explained the situation:
The sitting of the Legislative Council is limited and the government has no vote in the
legislature. The chief executive who appoints his cabinet members, does not
command any vote in the Legislative Council. The Legislative Council seats are
occupied by members elected from either directly elected seats or functional
constituencies while the chief executive is nominated and elected by an election
committee consisting of 800 members. 444
Professor K.C. Chan, Secretary for Financial Services and the Treasury in the Hong
Kong Government, confirmed in his keynote speech at the inaugural Asia Sukuk
442
Edmond Lau, Executive Director (Monetary Management) of the Hong Kong Monetary Authority,
‘Opening Keynote’ (Hong Kong Islamic Finance News Roadshow, Hong Kong, 11 May 2010).
443
444
Ibid.
‘The Appeal of Islamic Finance’, Islamic Finance Asia, June/July 2009.
179
Summit held in February 2009 that the Hong Kong Administration ‘is putting in place
tax neutrality measures to facilitate the development of Islamic finance’. 445
The development of Islamic finance in Hong Kong will come to a halt if the
necessary changes to the HKSAR’s regulatory and legal frameworks are not made
soon. While the urgency of the matter is clear, Hong Kong faces another unique
problem. Lord Edwin Hitti, President of Hong Kong’s Arab Chamber of Commerce
and Industry, suggested that the the HKSAR has a way to go regarding elements such
as infrastructure before it succeeds in creating an environment Islamic investors
would find truly comfortable. 446 It has also been suggested that Hong Kong must
establish banking, accounting and tax regulations to properly govern Islamic
investments, similar to a process Malaysia began in the 1980s.
Hong Kong could follow some of the measures adopted by Malaysia to
accelerate the development of Islamic finance in its jurisdiction. The development of
Malaysia’s legal framework is one of the main factors contributing to the
competitiveness of Islamic finance in Malaysia. The legal infrastructure consists of a
combination of effective regulatory and substantive laws alongside committed
adjudicative platforms for addressing legal problems arising from disputes related to
Islamic financial transactions. 447
The legal infrastructure in Malaysia has consistently evolved over the years.
Malaysia initially established substantive laws that enabled Islamic finance,
particularly the Islamic Banking Act 1983 and the Takaful Act 1984. The enactment
of these basic laws provided the platform for a dual regulatory framework and, more
importantly, established the foundation of a shariah governance framework through
the following key provisions: (1) requirements imposed on Islamic banks and takaful
operators to ensure that their business aims and operations are shariah-compliant; and
(2) the need to form separate shariah boards within their respective institutions. 448
Amendments made to the Malaysia Banking and Financial Institutions Act
1989 to allow conventional banks to operate Islamic windows have brought new
players into the industry. The National Shariah Advisory Council (SAC) was
established as the highest authority on shariah matters related to Islamic finance in
445
Mushtak Parker, ‘Hong Kong Eyes Islamic Finance Products’, Arab News, 23 February
2009<http://www.arabnews.com/node/321247> accessed 21 July 2012.
446
Heda Bayron, ‘Hong Kong Tries to Lure Islamic Funds’, Arabian Business, 30 December
2007<http://new.arabianbusiness.com/hong-kong-tries-lure-islamic-funds-157842.html> accessed 21
July 2012.
447
Muhammad bin Ibrahim, ‘Islamic Finance and Malaysia’s Role’, (21st Conference of Presidents of
Law Associations in Asia, Kuala Lumpur, 27 July 2010).
448
Ibid.
180
Malaysia, and a tax neutrality policy was introduced for Islamic financial instruments
and transactions. 449
Another recent development in Malaysia’s legal infrastructure for Islamic
finance was the enactment of the Central Bank of Malaysia Act 2009, which accords
formal recognition to the dual financial system practiced in Malaysia and mandates
the development of Malaysia as an international financial centre. The Act also
formally recognises the SAC’s role as the highest authority on shariah issues related
to Islamic finance transactions and as a consultative body to the Malaysian judicial
system. 450
An additional challenge Hong Kong must tackle is the shortage of skilled
Islamic finance professionals. In Malaysia, academic subjects related to Islamic
finance have been taught in universities for more than two decades. As a result, the
number of Islamic financial experts in Malaysia has grown. Furthermore, Malaysia
has already been exposed to the various aspects of Islamic finance, including in the
banking 451 (as reflected in its dual system) and insurance 452 fields. Once Islamic
finance scholars and experts find an equitable, safe and fair alternative to derivatives,
the widespread application of Islamic finance in various industries, such as shipping,
will become both possible and more probable. David Barzilai, a partner at Norton
Rose, was positive on this issue: ‘Any good banking lawyer can make a good Islamic
finance lawyer even if they are not necessarily familiar with Islamic drivers and lack
knowledge of Islamic finance. That could be trained.’ 453
Education and Research
In April 2010, the Hong Kong University of Science and Technology’s Business
School introduced an Islamic finance elective as part of its MBA programme. John
Wei, the programme’s director, said that the university was determined to offer the
449
Ibid.
450
Ibid.
451
Almost all of the major banks in Malaysia including HSBC, CIMB and Maybank offer Islamic
finance products alongside their conventional products. For example, most banks offer wadiah savings
accounts as an alternative to conventional savings products.
452
Islamic insurance (takaful) is popular in Malaysia. Conventional insurance is generally regarded as
contrary to Islamic law due to the element of uncertainty or gharar, which is prohibited under Islam.
453
‘Good
Islamic
Finance
Lawyers
Are
Hard
to
Find,
says
Norton
Rose
Lawyer’,
<http://www.legaljobscentre.com/job-market-news/good-islamic-finance-lawyers-are-hard-to-find-says
-norton-rose-lawyer/47089> accessed 21 July 2012.
181
elective after observing the increasing influence and economic potential of Islamic
countries. 454
To increase the number of Islamic financial experts, Hong Kong’s Treasury
Markets Association (TMA) has been providing relevant education programmes,
seminars and workshops. The TMA has also collaborated with other Islamic financial
centres, such as Malaysia, to explore ways of strengthening cooperation to position
Hong Kong as a preferred Islamic gateway for China.
The Chinese University of Hong Kong has also collaborated with Kuwait-Asia
University to set up a business school in Kuwait City. In addition to offering an
Islamic finance distance-learning course through the Hong Kong branch of the
Chartered Institute of Management Accountants, the institute also collaborates with
the Hong Kong University School of Professional and Continuing Education to offer
programmes in Islamic finance.
The Chartered Institute of Management Accountants (CIMA) has also
introduced subjects on Islamic finance. CIMA’s Diploma in Islamic Finance is a
self-study course that allows participants to study at their own pace. The syllabus
comprises Islamic banking and takaful, Islamic capital markets and instruments, and
accounting for Islamic financial institutions. 455
Hong Kong also faces additional challenges that are more global in nature and
not limited to the local setting. For example, many Muslims are not fully satisfied
with the performance and character of various Islamic financial institutions due to
their alleged failure to adhere to true Islamic principles and lower efficiency in
comparison with their conventional counterparts. Thus, the HKSAR should not leave
its Islamic financial markets unsupervised or unregulated. As with other financial
systems, supervision and regulation are necessary and an effective and efficient
mechanism should be put in place to ensure the smooth operation of Islamic finance
in Hong Kong.
To seal its position, the HKSAR should also invest in research and
development (R&D) because the introduction of innovative financial products that
comply with Islamic principles will make Hong Kong more attractive. Therefore,
there should be proper collaboration between shariah scholars and practitioners and
academic researchers. The HKSAR should also ensure adequate cooperation with
regulators from other jurisdictions.
454
‘Asia-Pacific Universities Adding Islamic Finance Courses’, The New York Times, 26 September
2010.
455
Diploma in Islamic Finance, Hong Kong Institute of Certified Public Accountants,
<http://www.hkicpa.org.hk/en/cpd-and-specialization/cpd/cpd-and-learning-resource-centre/online-cou
rses/cima-cert/> accessed 17 July 2012.
182
Sukuk (Islamic Bonds) in Hong Kong
The Islamic alternative of resource mobilisation through Islamic bonds is not only
possible, but has also proven practical through the successful implementation of
several projects using Islamic bonds as monetary management tools. 456
Since the 2007 announcement of the plan to introduce Islamic finance in Hong
Kong, the only sukuk dim sum bond to have hit the market was an RMB500m
(US$79m) three-year 2.9% issue from Khazanah in October 2011. However, the deal
was part of Khazanah’s existing sukuk issuance programme set up in Malaysia, and
more significantly, the underlying assets are in Malaysia. Therefore, no Hong Kong
tax or stamp duty applied. 457
In early 2012, the Financial Services and the Treasury Bureau launched a
two-month consultation on proposed amendments to the Inland Revenue Ordinance
and the Stamp Duty Ordinance to promote the development of an Islamic bond, or
sukuk, market in Hong Kong. 458 A lack of Islamic bond-friendly legislation has
previously hindered the creation of a sukuk market in Hong Kong, despite Chief
Executive Donald Tsang’s strong support for the city’s development as an Islamic
financial centre. 459
Although the existing tax framework still enables market players to make use of
administrative mechanisms to confirm the Hong Kong tax treatment of certain
transactions, because these operate on a case–by-case basis, it takes time for the
Commissioner of Inland Revenue (CIR) to process such applications. Thus, the
proposal to amend the Inland Revenue Ordinance (IRO) makes sense. 460
456
Muhammad Al Bashir Muhammad Al-Amine, ‘The Islamic Bonds Market: Possibilities and
Challenges’, in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Readings in
Islamic Finance (CERTS Publications Sdn. Bhd, 2008), 526.
457
‘P&M: HK Prepares for Islamic Bond Market’, International Financing Review, 29 March 2012
<http://www.ifre.com/pm-hk-prepares-for-islamic-bond-market/21008826.article> accessed 17 July
2012.
458
Mary Swire, ‘Hong Kong Begins Islamic Bond Tax Consultation’, Tax-News.com, Hong Kong, 30
March 2012
<http://www.tax-news.com/news/Hong_Kong_Begins_Islamic_Bond_Tax_Consultation____54732.ht
ml> accessed 17 July 2012.
459
‘P&M: HK Prepares for Islamic Bond Market’, International Financing Review, 29 March 2012,
<http://www.ifre.com/pm-hk-prepares-for-islamic-bond-market/21008826.article> accessed 17 July
2012.
460
‘Law Society’s Submissions - Financial Services and the Treasury Bureau’s Consultation Paper
Proposed Amendments to the Inland Revenue Ordinance (Cap.112) and the Stamp Duty Ordinance
(Cap.11) to Facilitate Development of an Islamic Bond (i.e. Sukuk) Market in Hong Kong’.
183
Under the legislative proposals, the government intends ‘to adopt a
prescriptive and religion-neutral approach, in line with that adopted by other major
financial markets such as the United Kingdom, as prescriptive legislative provisions
without specific reference to Shariah principles would provide more certainty in
implementation to market players in Hong Kong’.
A significant and growing volume of the business currently generated in
Islamic finance takes the form of shariah-compliant assets or equity-based securities
known as sukuk. Consistent with its role as an international financial centre, Hong
Kong is taking steps to develop its own sukuk market. The HKMA’s supervisory
policy for holdings of sukuk is based on the principles of a level playing field and
economic substance. The supervisory standards to be applied to exposures to sukuk
will be the same as those applying to their conventional equivalents. 461 In deciding
on specific supervisory treatment, the HKMA will consider whether sukuk,
irrespective of their legal form, can be regarded as the economic equivalent of
conventional bonds. This determination will, in turn, govern how sukuk should be
treated under existing laws and regulations.
The legislative proposals have generally drawn positive feedback. The Law
Society of Hong Kong supports the Government’s policy initiative to develop Islamic
finance in Hong Kong to enhance Hong Kong’s status as an international finance
centre. 462 Its Revenue Law Committee has reviewed the consultation paper published
by the Financial Services and the Treasury Bureau, and has found that the Bureau has
prepared a clear overview of the concept of Islamic finance and the need to amend the
existing tax regime to support the development of Islamic financing in Hong Kong.
The Law Society of Hong Kong highlighted that it would be vital for the government
to educate the public and the financial services industry on Islamic financing
principles, namely the prohibition on the payment and receipt of interest under
Islamic law. 463
Among other recommendations, the Law Society of Hong Kong also proposed
that the Bureau consider adopting a flexible approach to structures; that it, issue
Stamp Office interpretation and practice notes (SOIPNs) to assist market players, and
461
‘Quarterly Bulletin’ Hong Kong Monetary Authority
< http://www.hkma.gov.hk/eng/publications-and-research/quarterly-bulletin/> accessed 17 July 2012.
462
‘Law Society’s Submissions- Financial Services and the Treasury Bureau’s Consultation paper
Proposed Amendments to the Inland Revenue Ordinance (Cap.112) and the Stamp Duty Ordinance
(Cap.11) and to Facilitate Development of an Islamic Bond (i.e. Sukuk) Market in Hong Kong’.
463
‘Law Society’s Submissions- Financial Services and the Treasury Bureau’s Consultation paper
Proposed Amendments to the Inland Revenue Ordinance (Cap.112) and the Stamp Duty Ordinance
(Cap.11) and to Facilitate Development of an Islamic Bond (i.e. Sukuk) Market in Hong Kong’.
184
that such DIPNs and SOIPNs be circulated for comment before the amendment bill is
introduced into Legco. This proposal also highlights the need to use the right
terminology in various situations.
In addition, some of the suggested sukuk structures merely cater to the stricter
Middle East approach. A more flexible approach, such as that adopted by Malaysia
following the Shafi school, has been largely ignored and may be a matter worthy of
further clarification. 464 In contrast, almost all of the domestic Islamic debt paper
issued in Malaysia in the past has been based on the principles of murabahah and bay
bi al-thaman ajil,despite the controversy surrounding the issuance of tradable bonds
based on the above two contracts in the secondary market from the shariah
perspective. 465 In other words, Hong Kong might want to balance its plan to attract
Gulf investment by ensuring that the needs of other potential clients are also met.
To reduce litigation and legal uncertainty, it would be wise to clarify who has
the final say on shariah-compliance issues, similar to the practice of other developed
Islamic financial centres such as Malaysia. It is necessary that an efficient dispute
resolution mechanism be established before proceeding further into this uncharted
territory.
The way forward
Islamic finance is here to stay. It is a huge market in which the insistence on ethical
financing makes it attractive to non-Muslims and Muslims alike. Although Muslims
make up 20 to 25 per cent of the world’s population, the Islamic finance market
currently accounts for less than 0.5 per cent of total worldwide financial assets. While
there is no doubt that there is still much room for growth, proper legal and regulatory
frameworks must be put in place, and the industry must be promoted as an attractive
alternative. The Islamic financial products currently available also lack simplicity, and
more R&D is needed. As Islamic finance moves towards becoming an integral part of
the international financial system, systematic planning and continuous efforts are
required to develop Hong Kong as a viable alternative for Islamic finance in Asia.
The decision to accommodate Islamic finance in Hong Kong should be welcomed for
the various short and long-term benefits it offers. An important aspect of the
development of Islamic finance in leading countries such as Malaysia is a sound legal
464
‘Law Society’s Submissions- Financial Services and the Treasury Bureau’s Consultation paper
Proposed Amendments to the Inland Revenue Ordinance (Cap.112) and the Stamp Duty Ordinance
(Cap.11) and to Facilitate Development of an Islamic Bond (i.e. Sukuk) Market in Hong Kong’.
465
Muhammad Al Bashir Muhammad Al-Amine, ‘The Islamic Bonds Market: Possibilities and
Challenges’, in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Readings in
Islamic Finance (CERTS Publications Sdn. Bhd, 2008) p 498.
185
and regulatory structure, which has been shown to attract major Islamic financial
services players. 466 Given Hong Kong’s determination to secure a bigger slice of the
Islamic finance market, it must devise a long-term plan and follow it up with
meticulous execution. Tax issues should be settled, or investors will continue to shy
away. Hong Kong should not delay the decisive actions and systematic planning
required to put the necessary legislation in place. It will then be able to gradually
develop new financial products by collaborating with conventional and Islamic
finance experts to design creative financial products that are more competitive, stable
and profitable.
Possible Contributions to Other Southeast Asian Countries
With the exception of Singapore and Hong Kong (both of which are developed
jurisdictions), all of the other Southeast Asian countries are developing nations and
some are progressing faster than others. Countries such as Malaysia and Brunei are
financially better prepared than the rest largely due to significant oil reserves.
Countries such as Cambodia, Laos, Myanmar, Thailand, Vietnam, East Timur and the
Philippines are currently financially weak because their potential has not yet been
explored.
Islamic finance can be used to assist development, even outside the Muslim
world. For example, Islamic finance has been used in commercial real estate projects
in Texas and Maryland. It has been proposed that Islamic finance would contribute
significantly to the development of Southeast Asia, particularly through ethical and
progressive financing. For example, although poverty is rampant in Cambodia, its
recent economy has a good growth record at an average of 6 percent for the past ten
years. Cambodia’s economic growth is partially contributed to its agriculture,
construction and the tourism, garment and textiles industries. Furthermore, as the
result of oil and natural gas deposits discovered beneath Cambodia’s water in 2005
(followed by a commercial extraction process in 2011), experts have estimated that its
economy can be significantly improved. The population of Cambodia is around 14
million, while its GDP is only US$1,040 per capita. In comparison, the GDP for
Singapore is US$43,867 per capita.
Cambodia’s economy is being gradually strengthened. Cambodia joined the
Association of Southeast Asian Nations in 1999 and the WTO in 2004. To assist and
strengthen Cambodia’s economy, a proper infrastructure must be established,
466
Sudin Haron and Wan Nursofiza Wan Azmi, Islamic Finance and Banking System: Philosophies,
Principles & Practices (McGraw-Hill (Malaysia) Sdn. Bhd, 2009), p iii.
186
including efficient and capable transportation and telecommunication systems, good
education systems tailored to suit the economy and basic welfare. Islamic finance can
provide an ethical method of serving Cambodia’s needs because it stresses
profit-sharing and efficient partnership.
There are many sectors in which investments can be made, including
agriculture, 467 banking, education, garments, 468 healthcare, minerals, 469 oil and
gas, 470 power, property, telecoms, transport and tourism.
Islamic finance can also be used to finance large-scale development projects.
For example, various large-scale projects in Abu Dhabi have adopted Islamic finance,
including the US$3.5 billion Dolphin Energy project (using istisna’/ijarah) and the
US$1 billion Zayed University New Campus project. There are numerous examples
from other jurisdictions, including the Saudi Chevron Petrochemical project (using a
rahn-adl collateral security feature), the utility power project in Saudi Arabia (using
mudaraba-murabaha financing) and the Sohar Aluminium project in Oman (using
istisna’/ijarah). 471
Islamic financial practices do have their pros and cons. For example, according to
Alexander:
When undertaking Shari´ah compliant projects that attempt to fit Western debt
tranches alongside of Islamic debt tranches, there are at least four potential sources of
problems: (1) uncertainty regarding the somewhat unpredictable and subjective nature
of the decisions of Shari´ah boards, (2) the lack of an overarching regulatory body for
Islamic banking and finance, (3) the Islamic need to retain title in the project assets
and the Western lender’s need for a security interest in those same assets, and, (4) the
467
Agriculture contributes about one-third of Cambodia’s product and 75 percent of the population is
involved in the agriculture industry. In Cambodia, the agriculture sector grew by 4.1 percent in 2010.
468
Garment exports from Cambodia to the United States in 2010 alone totaled US$2.99 billion. There
is also a growing demand from European and Asian buyers.
469
The Ministry of Industry, Mines and Energy claimed that copper, gold, iron ore, zinc, lead, tin,
bauxite, sapphires, rubies, kaolin and limestone are among the currently untapped resources in
Cambodia.
470
The Overlapping Claims Area (between Thailand and Cambodia) spans around 27,000 square
kilometres and is thought to contain significant oil and gas reserves.
471
Alan J. Alexander, ‘Shifting Title and Risk: Islamic Project Finance with Western Partners’ (2011)
Michigan Journal of International Law, Vol. 32, No.3, 571.
187
Islamic requirement that the lender bear some of the project risk compared to the
Western lender’s risk aversion. 472
Islamic finance could strengthen and diversify the economy of Thailand, although it
would require strong central regulation, effective banking practices and a conducive
trade environment:
In Thailand, the state intervened 32 times between 1983 and 1996 in order to support
individual institutions (see Ammar Siamwalla, 2001:7-10). These recurrent crises
were indicative of the weakness of central regulation and baking practices that no
government had been able, or perhaps, willing to confront. Despite this, the state was
always able to contain the crisis and maintain the stability of the system as a whole. 473
The application of Islamic principles that focus on risk-and-profit sharing, fairness
and justice would be a good alternative to the common financial package offered by
international bodies such as the IMF:
All in all, it was the poor who were most severely affected by the economic downturn,
with a movement of wealth and saving from the already poor to the already wealthy.
This situation meant increased social conflict. While all workers suffered during the
crisis, it was the lowest paid workers who suffered the most. Workers responded
vigorously to their deteriorating situation and, while there were few strikes, officially
reported grievances rose substantially (see Brown et. al. 2002). As the economic crisis
worsened, a widespread and popular opposition to the IMF's strictures developed. This
resulted in a loose alliance of workers, intellectuals, NGOs, politicians, domestic
businesses, and even the country’s monarch, drawn together in a broadly nationalistic
opposition to a perceived loss of sovereignty over economic policymaking, negative
social impacts, and a fire sale of local assets to foreign interests. 474
472
Alan J. Alexander, ‘Shifting Title and Risk: Islamic Project Finance with Western Partners’ (2011)
Michigan Journal of International Law, Vol. 32, No. 3, 571.
473
Rajah Rasiah and Johannes Dragsbaek Schmidt (eds), The New Political Economy of Southeast
Asia (Edward Elgar Publishing Limited 2010) 110.
474
Garry Rodan, Kevin Hewison and Richard Robison, The Political Economy of South-east Asia:
Market, Power and Contestation (Oxford University Press 2006) 98.
188
Islamic finance can also be used as an agent of peace in conflicting areas. Thailand
and the Philippines both have their share of problems with terrorism and rebellion, 475
and economic inequality and poverty make it easier for those who intend violence to
get support. Improving the economy would make both of these areas less attractive to
people involved in violent activities. It is not a coincidence that Muslim countries
with better economic performance, such as Malaysia and Brunei, suffer far fewer
violent threats, eg terrorism and rebellion, compared to other poorer countries. Islamic
finance promote peace in a number of ways. The introduction of Islamic finance can
serve as an acknowledgment of the Muslim community and their identity. Offering
Muslims a financial system that is based on their religious beliefs sends a strong
message that the involved government is not hostile towards Islam or Muslims and is
looking forward to building a peaceful, prosperous long-term relationship with the
Muslim community.
Furthermore, the introduction of Islamic finance would create more job
opportunities for Muslim and non-Muslim communities alike. Steady sources of
income and the families they support are, in turn, less prone to becoming involved in
criminal or violent activities. Incorporating Islamic finance into a dual financial
system would enable Muslim and non-Muslim communities to gradually break down
the barriers between them. As previously mentioned, the non-Muslim community’s
strong support of Islamic finance in Malaysia is one of the main reasons behind its
successful integration of Islamic finance.
More importantly, the introduction of Islamic finance can help accelerate the
development of Southeast Asia because through its ability to finance large-scale
infrastructure/development projects. For example, various large-scale modern
infrastructure projects have been using Islamic finance including the Equate
Petrochemicals Company (a US$2 billion petrochemical plant using the istisna
contract structure), Jimah Energy Ventures (a US$1.6 billion construction capital
raised mostly by Islamic bond), Thuraya Satellite (a US$1.1 billion satellite project
using Islamic financing) and the Dolphin Gas Project (a gas extraction, processing
and pipeline construction project that secured US$1 billion from
istisna’/ijarahfinancing). 476
475
For detail, see Syed Serajul Islam, ‘The Islamic Independence Movements in Patani of Thailand
and Mindanao of the Philippines (1998) Asian Survey, Vol. 38, No. 5, May.
476
Jasper Camacho, ‘Islamic Financing for Large Infrastructure Projects’(2005) International Financial
Mgmt, Section 1, Fall.
189
4.11.6
Thailand
The history of Islamic financial system in Thailand started with the establishment of a
cooperative society, Pattani Islamic Saving Cooperative, that operates based on
Shariah in 1987. 477 Thailand’s close neighbor, Malaysia plays a defining role in
assisting the establishment of full-fledged Islamic bank in Thailand:
The idea of establishing the full-fledged Islamic bank in Thailand was initiated in 1994
when the Thai government signed the Indonesia-Malaysia-Thailand Growth Triangle
Project (IMT-GT Project) with a view to promote banking services specific to the needs
of Muslims, in particular those in the four southern provinces. Islamic banking services
in accordance with Islamic precepts (Syariah) was first provided by a commercial bank
in late 1997, but closed down as a result of the financial crisis. The next major step in
the progress of Islamic bank in Thailand was the setting up of a fully fledged Islamic
branch by state-owned Krung Thai Bank in 2002. 478
Camacho explained that the end of 2001, four other Islamic saving cooperatives
were established in Southern Thailand, i.e. Ibnu Affan Saving Cooperative (Pattani),
As-Siddiq Saving Cooperative (Songkla), Saqaffah Islam Saving Cooperative (Krabi),
and AlIslamiah Saving Cooperative (Phuket). These Islamic cooperative societies
have successfully established themselves as viable financial institutions in managing
and mobilizing Muslims funds in this region. 479 For example, total assets for Pattani
Islamic Saving Cooperative at the end of 2001 were 90 million baht, while total assets
for the Ibnu Affan Islamic Saving Cooperative were 60 million baht as at the end of
2002. 480
Size and nature
Islam is the second largest religion in Thailand with over six million followers, most
of whom are located in the southern region in the provinces of Yala, Pattani,
Narathiwat, Satun and Songkla. The Islamic Bank of Thailand already has a
477
Sudin Haron & KuMajdi Yamirudeng, ‘Islamic Banking in Thailand: Prospects and Challenges’,
International Journal of Islamic Financial Services Vol. 5 No.2.
478
Kamal Khir, Lokesh Gupta and Bala Shanmugam, Islamic Banking: A Practical Perspective
(Pearson Longman 2008) 200
479
Jasper Camacho, ‘Islamic Financing for Large Infrastructure Projects’(2005) International Financial
Mgmt, Section 1, Fall.
480
Sudin Haron & KuMajdi Yamirudeng ‘Islamic Banking in Thailand: Prospects and Challenges’,
International Journal of Islamic Financial Services Vol. 5 No.2.
190
nationwide branch network with various Shariah-compliant products. According to
Sudin Haron and KuMajdi Yamirudeng:
Currently, there are about 128 Islamic private schools with 69,412 students
operating in the five southern border provinces (Office of Educational; 1999).
Similarly, there are more than 3,018 mosques and 33 Islamic committee
provinces out of the 74 provinces in Thailand. These statistics serve as an
indicator that there is potential for Islamic banking in Thailand. 481
Currently, Islamic Bank of Thailand is the only bank that offers Islamic banking and
finance (after it acquired the Islamic banking windows of the Government Savings
Bank and Krungthai Bank). Large domestic banks in Thailand are still hesitant to
offer Islamic finance, mostly because they don’t have the expertise and the risk
appetite to build up this segment. 482
Domestic market
Thailand faces formidable challenges in finding a niche in a market dominated by
petrodollar rich Gulf Co-operation Council (GCC) countries and, nearer to home,
banking sophisticates such as Malaysia with a small but majority Muslim population
and Indonesia, the world’s largest concentration of Muslim people. 483 Set against that,
just 4 per cent of Thailand’s population – six million people are Muslims, and most of
them live in the country’s most troubled and poorest provinces. What’s more, the
banking regulatory system, while adequate to the task of ordinary international
commercial banking, is far from geared up to deal with the intricacies and
idiosyncrasies of the Islamic banking and finance sector. 484
However, the existence of a strong Islamic financial institution there is also an
important consideration. The Islamic Bank of Thailand has a very healthy balance
sheet. Its assets amount to 100 billion baht, and the 2012 profit was 1.13 billion
481
Sudin Haron & KuMajdi Yamirudeng, ‘Islamic Banking in Thailand: Prospects and Challenges’,
International Journal of Islamic Financial Services Vol. 5 No.2
482
Arno Maierbrugger, ‘Thailand’s Shariah banking grows quickly’ Inside Investor 26 February 2012
< http://investvine.com/thailands-shariah-banking-expanding-quickly/> accessed 20 October 2012
483
‘Islamic
banking
in
Thailand’
Business
Report
Thailand
28
April
2011<http://businessreportthailand.com/islamic-banking-thailand-12420> accessed 20 November 2012
484
‘Islamic
banking
in
Thailand’
Business
Report
Thailand
28
April
2011<http://businessreportthailand.com/islamic-banking-thailand-12420> accessed 20 November 2012
191
baht. 485 There is also plan for a stock exchange listing in Thailand in about two years
to finance future expansion, whereby the majority of the government shares will be
sold to private investors.
The legal and regulatory framework
Currently, two bodies regulate the financial institutions in Thailand, The Ministry of
Finance and The Bank of Thailand (the central bank). 486 Haron and Yamuruding
explained that with regard to the existing institutions, which offer Islamic banking
products and services, they are regulated by two different authorities. For example,
both GSB and BAAC are under the supervision of the Ministry of Finance through the
Government Savings Bank Act, B.E. 2489 (1946) and The Bank for Agriculture and
Agricultural Cooperatives Act, B.E.2509 (1966). However, Krung Thai Bank, which
was established under the Commercial Banking Act B.E. 2505 (1962), is within the
ambit of the Bank of Thailand. 487
Realizing the huge success of Islamic banking in its neighboring country
Malaysia, Thailand reworked its banking regulations in 2002 and took action to set up
the country’s first Islamic-only bank to cater mainly, but not exclusively to the seven
million Muslim in the country. The Thai Ministry of Finance issued the Islamic Bank
of Thailand Act in the same year, which constituted the establishment of the Islamic
Bank of Thailand one year later. This state-run bank is administered by a board of
governors and an advisory council on Islamic banking, which allows it to operate in
accordance with Shariah rules on all transactions. It is owned by the government.
Today, the Islamic Bank of Thailand operates more than 100 branches countrywide
under the brand name of iBank.
Tax issue
In 2009, it was reported that Thailand was planning to ease taxation rules to attract
more investors. Due to Islamic finance’s strict prohibition on making money based on
loan transaction (usury), Islamic financial products operate under different basis. The
usual basis is to shift it to sale and purchase transaction, whereas the Islamic banks or
financiers will make profit based on business transaction and not loan transaction. The
485
Arno Maierbrugger, ‘Thailand’s Shariah banking grows quickly’ Inside Investor 26 february 2012
< http://investvine.com/thailands-shariah-banking-expanding-quickly/> accessed 20 October 2012
486
Sudin Haron & KuMajdi Yamirudeng, ‘Islamic banking in Thailand: Prospect and Challenges’,
International Journal of Islamic Financial Services Vol. 5 No.2
487
Sudin Haron & KuMajdi Yamirudeng, ‘Islamic banking in Thailand: Prospect and Challenges’,
International Journal of Islamic Financial Services Vol. 5 No.2
192
taxation framework for business transaction and loan transaction differs under the
conventional framework. Various tax exemption or at least a lesser amount of tax is
allocated for loan transaction. Therefore, if the legal and regulatory framework is not
modified to ensure a fair playing field for Islamic finance, people will eventually shy
away from Islamic finance due to extra taxation and costs. Shariah-compliant
products should not be disadvantaged in terms of regulatory and tax treatment where
the economic substance and risks are similar to conventional products. Currently, tax
issue is still a major challenge in Thailand. Potential tax liabilities and tax
inefficiencies may drastically affect the development of Islamic finance. Incentives
that place Islamic and conventional finance on equal footing should be introduced.
For example, eliminating double taxation where the structure of an Islamic financial
product would lead to extra taxation compared to a similar conventional product that
would be subject to lower taxes.
The lack of human resource
Skill shortage is a challenge in Thailand:
Regarding skill shortages, Thailand recognizes its particular need for development. The
country’s higher education system does not yet provide adequate opportunities to
acquire such skills. However, neighboring Malaysia has developed an extensive skills
base, with an expanding range of educational institutions and a widening resource of
expertise. Cooperation between Malaysia and Thailand has already commenced and will
undoubtedly expand in the future. Islamic finance also needs specialized accounting and
information technology services. These should not be neglected in the educational
process. 488
The way forward
Islamic finance is expanding in Thailand. For example, Islamic Bank of Thailand will
be opening a branch of the bank in Dubai that will offer the full range of their
products there. 489 There is also a plan to expand to Malaysia and Indonesia, countries
with huge potential in Islamic banking, and to China.
Table 8: Development of Islamic Finance in Thailand
488
Sudin Haron & KuMajdi Yamirudeng, ‘Islamic banking in Thailand: Prospect and Challenges’,
International Journal of Islamic Financial Services Vol. 5 No.2.
489
Arno Maierbrugger, ‘Thailand’s Shariah banking grows quickly’ Inside Investor 26 february 2012
< http://investvine.com/thailands-shariah-banking-expanding-quickly/> accessed 20 October 2012
193
Time Event
1998
The Islamic banking system in Thailand begins when the Government
Savings Bank (GSB) introduces an Islamic window
2003
The Islamic bank of Thailand is established by a special act of Parliament
under the supervision of the Ministry of Finance. Initially, the move is made
to cater to the Muslim majorities in the country’s southernmost border
provinces
2006
Krung Thai Asset Management Co. forms its first Shariah- compliant
retirement fund for equity investors
2008
Cooperation with Islamic banking is high on the agenda in meetings between
the prime ministers of Malaysia and Thailand. Former Prime Minister
Abdullah Ahmed Badawi says that Malaysia is prepared to offer the
necessary assistance (including technical aspects) to establish
Shariah-compliant banks in Bangkok and southern Thailand
2008
Thailand makes plans to issue its first US$500 million Islamic sovereign
bonds, but abandons them because more preparation is needed
2009
The IBT announces plans to expand its lending portfolio by 20 billion baht in
the south in line with the government’s policy of rehabilitating the economy
and curbing unrest in the southern border provinces
2010
The Thai Securities and Exchange Commission’s spokesperson, Charuphan
Intararoong, announces plans to publish guidelines in the subsequent quarter
for companies issuing Shariah-compliant securities. These changes follow
Prime Minister Abhisit Vejjajiva’s pledge in 2009 to let four southern
provinces adopt more Shariah laws
2010
The Islamic Bank of Thailand plans to raise 5 billion baht (US$155 million)
in the nation’s first Islamic bond/sukuk sale.
194
4.11.7
Philippines
The Philippines, officially known as the Republic of the Philippines, is a sovereign
state in Southeast Asia in the western Pacific Ocean. It is endowed with various
natural resources and is one of the richest areas of biodiversity in the world. The
Philippines is divided into Luzon, Viyas and Mindanao, with Manila as the capital.
It is also a famous tourists destination, being an archipelago with more than
7,000 islands, some are among the most beautiful in the world.
With a population of more than 92 million people, the Philippines is the 7th most
populated Asian country and the 12th most populated country in the world. It is
estimated that 11% of the population work overseas. Remittances account for about
10% of the country's GDP, which totaled $225 billion in 2011. 490
According to Peter Church:
The Philippines is different from the rest of South-East Asia in a number of ways. It
shares with Indonesia and Malaysia, a Malay ethnic base (its underlying animistic
beliefs have much in common with other countries in the region), and it has, for many
centuries, been part of regional trading networks, albeit in a minor way. Yet unique
among South-East Asian countries, it was unaffected by Hinduism or Buddhism. The
great majority of the Philippines’ 88 million people are Roman Catholic. 491
The majority of the Filipinos are Christians but interaction with the Filipinos Muslims
in southern Philippines is limited. However, interaction with overseas Muslim is
common, especially by those working in the Middle East. The Middle East has the
largest portion of the Philippines' overseas labor force, with 61% working there. Asia
is the next highest, with 27%, followed by the 6% in Europe. 492 In total, around
400,000 to 600,000 Filipino works in the United Arab Emirates and every year they
send billions of dollars to Philippines. The government in Manila estimates that
490
Vanessa Ko, ‘What is driving the Philippines' surprisingly strong growth?’ CNN (Edition:
International) 21 July 2012
<http://edition.cnn.com/2012/07/12/world/asia/philippines-surprise-surge/index.html>
accessed
20
October 2012
491
Peter Church (ed), A Short History of South-east Asia (5th edn, John Wiley & Sons (asia) Pte Ltd
2009) 124-125
492
Vanessa Ko, ‘What is driving the Philippines' surprisingly strong growth?’ CNN (Edition:
International) 21 July 2012
<http://edition.cnn.com/2012/07/12/world/asia/philippines-surprise-surge/index.html>
October 2012
195
accessed
20
Filipinos around the world sent home more than $20 billion in 2011. The Philippine
embassy in Abu Dhabi has now even started a program to educate migrant workers
how to wisely use the cash they make abroad. 493
Currently, attempts are being made to introduce Islamic finance into the
Philippines. The introduction of Islamic finance to Philippines is natural and is
expected to bring many benefits to everyone. Mr. Stephen Lillie, the United
Kingdom’s Ambassador to Philippines elaborated as follow:
It may not be immediately obvious to many people why Islamic finance would be
relevant to Asia’s largest Christian country... There are in any case clear reasons why
Islamic finance merits careful consideration in the Philippines. The first is the
country’s wish to attract more FDI.
Providing Sharia-compliant investment
opportunities could have a potentially important impact in attracting liquidity from
private and instutional investors in the Middle East, including the sovereign wealth
funds.
The Philippines is part of a global network of trade and investment links with
Muslim countries, not just in the Gulf, but in its own neighbourhood with ASEAN
partners like Malaysia and Indonesia.
It’s that same global dimension which has
been important in driving London’s own emergence as an Islamic finance centre. 494
Size and nature
The concept of Islamic finance is an alien notion to the Filipino community as the
overwhelming majority of Filipinos are Catholics. However, Muslims are the majority
in certain areas, such as Mindanao. Five to nine percent of the 93 millions population
of Philippines are Muslims and the potential domestic market is not small.
Furthermore, if the Islamic financial products offered are competitive and attractive,
the non-Muslims will also consider the Islamic financial products on commercial
basis. The true potential of Islamic finance is yet to be explored. Islamic finance can
be used in the mining industry for financing and partnership. One of the sectors
drawing interest from investors is mining since the Philippines is rich in natural
resources. 495
493
‘Filipino migrants invest in the future’ CNN (Business) 31 May 2012
<http://business.blogs.cnn.com/2012/05/31/filipino-migrants-invest-in-the-future/>
accessed
October 2012
494
Stephen Lillie, ‘Enabling Islamic finance in the Philippines’ 9 September 2012
<http://blogs.fco.gov.uk/stephenlillie/2012/03/09/enabling-islamic-finance-in-the-philippines/>
accessed 20 October 2012
495
‘The Philippines' economic prospects’
BBC News, 30 August 2012
<http://www.bbc.co.uk/news/business-19419194> accessed 20 October 2010
196
20
Domestic market
The domestic market for the Philippines is not small, with a population of around 93
million. The Philippines has one of the highest birth rates in Asia, and forecasters say
the population will double within three decades. Governments generally avoid taking
strong measures to control the birth rate for fear of provoking the Catholic Church,
which opposes artificial methods of contraception. 496
The biggest domestic market is southern Philippines, home to the
Muslim-majority population. Conflicts between the Muslims rebels and the
Philippines military, to certain extent, hinder the development of Islamic finance in
Philippines. However, in October 2012, the Philippines has signed a framework peace
plan with the country's largest Muslim rebel group, the Moro Islamic Liberation Front
(MILF). 497 The deal follows lengthy negotiations aimed at ending a 40-year conflict
that has cost an estimated 120,000 lives. It provides for a new autonomous region the
south where Muslims are a majority. 498The situation used to be fragile although it is
definitely moving towards the right direction with the signing of peace deal in late
2012.
This is a largely unchartered territory for Islamic finance. Those who managed
to seize the market at this stage will be amply rewarded once the economy prospers.
Attempts to seize the market has already began. For example, the Philippines
government expects to privatize Al-Amanah Islamic Investment Bank of the
Philippines (AAIIBP) (the only bank in the country authorized to offer Islamic
banking services) in 2012-2013 as two Middle Eastern banking institutions have
shown serious intention to purchase. AAIIBP, now a subsidiary of Development Bank
of the Philippines, has been put on sale by the government since 2010. 499
During the signing of the Framework Agreement, President Aquino was
quoted saying that investments in banking aside from food and education are expected
to flow into the region. AAIIBP is given the mandate to promote and accelerate the
socio-economic development of the Autonomous Region of Muslim Mindanao
496
‘Philippines profile’ BBC News 15 October 2012
<http://www.bbc.co.uk/news/world-asia-15521300> accessed 20 October 2012
497
‘Philippines and Muslim rebels sign key peace plan’
BBC News, 15 October 2012
<http://www.bbc.co.uk/news/world-asia-19944101> accessed 17 October 2012
498
‘Philippines and Muslim rebels sign key peace plan’
BBC News, 15 October 2012
<http://www.bbc.co.uk/news/world-asia-19944101> accessed 17 October 2012
499
Bernie Cahiles-Magkilat, ‘Middle East banks Eye Al-Amanah’ Manila Bulletin 17 October 2012
<http://www.mb.com.ph/articles/377572/middle-east-banks-eye-alamanah#.UH-XBrRqmzc> accessed
20 October 2012
197
(ARMM) through banking, financing and participating in agricultural, commercial
and industrial ventures using shariah-compliance methods. 500
By mid-1990, three of Al-Amanah Islamic Investment Bank’s branches,
Cotabato, Marawi and Jolo, have been transformed into accepting Islamic deposits. Its
branches offer both conventional and Islamic banking products, services and
facilities. 501
In addition to getting large scale funding via shariah-compliant investment for
development from wealthy foreign investors, the domestic market should not be
ignored. Islamic banking and financial institutions can make full use of the Asian’s
attitude that generally prefer to save money:
Savings is a key variable in economic development, particularly in the Third World.
Generally, sustained economic growth is accompanied by sufficient domestic savings
that are efficiently channeled to investments. The investment-savings gap reflects not
only the private sector’s capacity to mobilize saving but also the foreign exchange
constraint facing the country, and fiscal constraint that limits the government’s
capacity to undertake infrastructure-building and other vital government investment.
Investment is at the heart of economic growth, representing the accumulation of
capital stock, one of the major factors of production. The ability of the economy to
undertake investment projects productively and to finance these projects through
savings and external borrowings lies at the core of the accumulation behavior. 502
Islamic finance is currently standing at an exciting moment as its true potential can
finally be explored as various obstacles have been removed. The sizeable Muslims
community also show that the domestic market for Islamic finance in Philippines is
promising.
500
Bernie Cahiles-Magkilat, ‘Middle East banks Eye Al-Amanah’ Manila Bulletin 17 October 2012
<http://www.mb.com.ph/articles/377572/middle-east-banks-eye-alamanah#.UH-XBrRqmzc> accessed
20 October 2012
501
Bernie Cahiles-Magkilat, ‘Middle East banks Eye Al-Amanah’ Manila Bulletin 17 October 2012
<http://www.mb.com.ph/articles/377572/middle-east-banks-eye-alamanah#.UH-XBrRqmzc> accessed
20 October 2012
502
Rob Vos, The Philippine Economy: East Asia’s Stray Cat? (MacMillan Press Ltd 1996) 65
198
Cooperation with other countries
There is reason to believe to Islamic finance will prosper in Philippines soon, starting
from the southern Philippines. For example, Malaysia and the Philippines have even
agreed to reconvene a joint committee that will draw up socio-economic projects in
Mindanao following the signing of the framework peace agreement for the Southern
Philippine region. 503The Philippines-Malaysia Joint Committee on Assistance for the
Socio-economic Advancement of Muslim Filipinos (JCASAMF) will focus on
madrasah education, halal industry, tabung haji, Islamic banking, university twinning
and student-exchange programmes. The JCASAMF will be placed under the auspices
of the Philippines-Malaysia Joint Commission Meeting (JCM) framework for bilateral
cooperation between the two countries. 504
Tax issue
Due to Islamic finance’s strict prohibition on making money based on loan transaction
(usury), Islamic financial products operate under different basis. The usual basis is to
shift it to sale and purchase transaction, whereas the Islamic banks or financiers will
make profit based on business transaction and not loan transaction. The taxation
framework for business transaction and loan transaction differs under the
conventional framework. Various tax exemption or at least a lesser amount of tax is
allocated for loan transaction. Therefore, if the legal and regulatory framework is not
modified to ensure a fair playing field for Islamic finance, people will eventually shy
away from Islamic finance due to extra taxation and costs. Shariah-compliant
products should not be disadvantaged in terms of regulatory and tax treatment where
the economic substance and risks are similar to conventional products.
Currently, tax issue is still a major challenge in Philippines. Potential tax
liabilities and tax inefficiencies may drastically affect the development of Islamic
finance. Incentives that place Islamic and conventional finance on equal footing
should be introduced. For example, eliminating double taxation where the structure
503
Razak Ahmad, ‘KL-Manila to reconvene committee to draw up socio-economic projects in
Mindanao’ The Star Online 15 October 2012
<http://thestar.com.my/news/story.asp?file=/2012/10/15/nation/20121015163648&sec=nation>
accessed 20 October 2012
504
Razak Ahmad, ‘KL-Manila to reconvene committee to draw up socio-economic projects in
Mindanao’ The Star Online 15 October 2012
<http://thestar.com.my/news/story.asp?file=/2012/10/15/nation/20121015163648&sec=nation>
accessed 20 October 2012
199
of an Islamic financial product would lead to extra taxation compared to a similar
conventional product that would be subject to lower taxes.
The lack of human resource
One of the advantages of the Philippines is the quality of Filipino workers. They are
among the best in the world, literate, English-speaking, easy to train, hardworking and
friendly. However, the Philippines lack the workforce for Islamic finance at this
moment but this is not a big problem. For the short-term, experts and scholars from
other jurisdictions can be used. Cooperation with other Islamic financial hubs will
lead to transfer of expertise. However, to truly address this challenge, it would be best
if Islamic finance is included into universities’ syllabus as elective subject or if proper
Islamic finance courses are introduced. This way, there will be more local experts in
the long run.
Legal and regulatory framework
Since late 1990s, the Government has taken important steps to strengthen the financial
sector, especially banking, including revamping the regulatory and supervisory
framework. Although foreign ownership of domestic banks has increased since
1999, foreign banks, including branches, accounted for only 14% of total bank assets
at the end of 2004, far below the 30% allowable limit (majority domestic-owned
banks must hold at least 70% of total bank assets). 505
To accelerate the development of Islamic finance, a proper legal and
regulatory framework that can cater to the uniqueness of Islamic finance must be in
existence. This is not a very difficult task as numerous jurisdictions have modified
their legal and regulatory framework to cater to the need of Islamic finance.
Philippines can adopt the legal and regulatory framework of other established
jurisdictions.An expert in Islamic finance, Abdul Karim Aldohni explained the
rationale for proper legal and regulatory framework:
In the context of banking, the legal aspect, in its broad sense, encompasses the
relevant legislative and regulatory frameworks. In relation to Islamic banking there is
another layer that must be added, which is Islamic law (‘shaira’). Among the other
unique characteristics brought by Islamic law, the prohibition of interest can be
described as the most distinctive feature. Islamic banking transactions are based on
the principles of profit-and-loss sharing (PLS) rather than interest. Therefore, the
505
‘Report by the Secretariat - WTO’ <www.wto.org/english/tratop_e/tpr_e/s149-4_e.doc> accessed
20 November 2012
200
application of Islamic law results in the creation of different financial products than
those used by the conventional banks. 506
The prospect that Philippines will come out with good legal and regulatory framework
is positive. For example, Islamic Financial Services Board (IFSB) has won the help of
a strong entity, Asian Development Bank 507 (based in Manila) to make its standards
easily available for member countries and persuade them to adopt the standards for
bringing uniformity in the Islamic Finance sector throughout the globe. 508 IFSB
guidelines are widely used in the Islamic finance industry, but they are not mandatory.
It is up to national regulators to decide whether to adopt them.
The need for stronger support
The growth of Islamic financial services in Philippines has been hampered by
double-taxation, lack of products and general misunderstanding that it's not for
non-Muslims. Stronger political will and support from the Philippines government are
also necessary. One of the major reasons for the success of Islamic finance in
Malaysia was the strong support from the government and industry players.
Support from the industry is increasing in Philippines. For example, in
October 2012, a Memorandum of Understanding (MOU) to facilitate international
cooperation between the Islamic Financial Services Board (IFSB) and the Asian
Development Bank (ADB) in promoting the development of Islamic finance in
common developing member countries was signed at the ADB headquarters in
Manila. 509
The IFSB is an international standard-setting organisation that promotes and
improves the soundness and stability of the Islamic financial services industry by
506
Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A comparative look
at the United Kingdom and Malaysia (Routledge 2011)
507
The ADB provided its first fully shariah-compliant financing in May 2012, assisting the
Jeddah-based Islamic Development Bank with two partial credit guarantees worth up to $66 million for
two wind farms in Pakistan.
508
Farhan Iqbal, ‘Manila’s ADB to help spread IFSB standards’ IslamOnline 17 October 2012
<http://www.islamonline.com/news/articles/81/Manilas-ADB-to-help-spread-IFSB-standards.html>
accessed 17 October 2012
509
‘Islamic Financial Services Board and Asian Development Bank Sign Agreement to Promote
Islamic Finance’ Islamic Financial Services Board 2 October 2012
< http://www.ifsb.org/preess_full.php?id=203&submit=more> accessed 17 October 2012
201
issuing global prudential standards and guiding principles for the industry, broadly
defined to include banking, capital markets and insurance sectors. 510
On the other hand, Asian Development Bank, based in Manila, is dedicated to
reducing poverty in Asia and the Pacific through inclusive economic growth,
environmentally sustainable growth and regional integration. Established in 1966, it is
owned by 67 members – 48 from the region. In 2011, ADB approvals including
co-financing totalled $21.7 billion. The main devices for assistance offered by Asian
Development Bank are loans, grants, poliy dialogue, technical assistance and equity
investments.
The MOU provides an effective basis for joint activities and general cooperation
in areas of common interest, with the following objectives specified 511:
•
Enhancing cooperation in the form of joint technical assistance and/or policy-based
work in Common Developing Member Countries;
•
Promoting the development of Islamic finance, in particular strengthening the
capacity of regulating and supervising Islamic financial services institutions, Islamic
capital markets and Islamic liquidity management in Common Developing Member
Countries; and
•
Stimulating joint research and exchange of information, which will be used as critical
evidence to support policy areas of mutual interest, as well as to enhance
knowledge-sharing between both organisations.
The way forward
The introduction of Islamic finance would, to an extent, promote peace and prosperity
in the Philippines. Poverty and dissatisfaction tend to spark dissatisfaction, enmity
and hatred. The incorporation of Islamic finance would not only create more job
opportunities, but also would express respect and recognition of the Muslim
community and their beliefs. Currently, Al-Amanah, headquartered in Zamboanga, is
focusing on the banking needs of the Autonomous Region in Muslim Mindanao’s
(ARMM) government and intends to offer financing assistance mainly for
infrastructure projects. Al-Amanah is also pursuing funds and partners from the
Middle East and Malaysia to inject additional capital and help promote Islamic
banking in the Philippines.
510
511
‘Islamic Financial Services Board’< http://www.ifsb.org> accessed 20 November 2012
‘Islamic Financial Services Board and Asian Development Bank Sign Agreement to Promote
Islamic Finance’ Islamic Financial Services Board 2 October 2012
< http://www.ifsb.org/preess_full.php?id=203&submit=more> accessed 17 October 2012
202
The gradual introduction of Islamic finance is also expected to increase
investments from wealthy Middle-Eastern countries and prosperous individual
companies that intend to invest in Shariah-compliant environments. The Philippines’
state-owned Al-Amanah Islamic Bank has also expressed its intention to sell the
nation’s first Shariah-compliant bonds to finance development in the ARMM. 512
To accelerate the development of Islamic finance in the Philippines, stronger
support from the government and international investors is needed. Without
government support, expressed with the introduction of a proper legal and regulatory
framework that do no discriminate Islamic finance, it would be difficult to push the
growth of Islamic finance. The public and traders should also be educated on the
benefits of Islamic finance. International Islamic financial institutions, especially
international banks should also consider opening branches in Philippines, including
the volatile area. For long term, investments in this area will be rewarded as the
economy prospers. However, the stability, safety and security of the area must also be
improved.
The conventional banks should also be given more exposure on Islamic
finance. The fastest way to develop Islamic finance at a large scale is usually to allow
the conventional banks to open the Islamic ‘windows’. By offering Islamic financial
products alongside their conventional products, the public will get better access to
Islamic finance while the banks can also maximize their profits. This diversification
will also make the financial institutions in the Philippines more resilient.
512
Clarissa Batino and Khalid Qayum, ‘First Philippines Sukuk Planned by Al-Amanah: Islamic
Finance’ Bloomberg (26 July 2010)
<http://www.bloomberg.com/news/2010-07-27/first-philippine-sukuk-to-fund-growth-in-muslim-mind
anao-islamic-finance.html> accessed 15 November 2011.
203
4.12 Conclusion
This chapter analyzes the application of Islamic principles to the banking sector of
Southeast Asian countries. If the analysis reveals that such application is not
sustainable or rejected by the traders, financiers and customers, this will be a
challenge to the hypothesis. If the application to modern banking sector failed, any
application to other industry should be seriously reconsidered. However, the finding
of this chapter is that the application of Islamic principles to the modern banking
sector is successful although there is still a big room for improvement.
The rise of Islamic finance in Southeast Asia is surprising and unexpected.
However, it is not always accidental. The development of Islamic finance in Malaysia,
for example, was carefully and meticulously planned and the strength of Malaysia’s
Islamic financial is partly due to the comprehensive package that Malaysia offers.
While other countries tend to selectively choose a few Islamic financial products to
include in their portfolios, Malaysia attempted to harmonize Islamic finance and their
conventional system. As a result, Islamic finance in Malaysia is booming because it
has slowly but steadily penetrated the banking and insurance industries along with
trade and commerce, among other sectors. If better Islamic financial products can be
offered, management and leadership can be improved and corruption can be reduced,
Malaysia will have a very promising future. The gradual development of Islamic
finance in other Muslim-majority Southeast Asian countries, including Brunei and
Indonesia, also appears consistent and promising. Hong Kong and Singapore’s
adoption of Islamic financial products is expected to further accelerate the rise of
Islamic finance in Southeast Asia. Another reason for being optimistic is the ability of
Islamic finance to accommodate large-scale development projects using
equity-financing instead of debt-financing. This will be most useful for developing
countries such as Vietnam, Laos, Cambodia and the Philippines. Islamic finance can
also be used as an agent of peace in places of conflict, eg certain areas in Thailand and
the Philippines, because it indicates the governments’ long-term commitment to
establishing peaceful relationships with Muslim communities.
This research is based on the idea that the removal of unnecessary
uncertainties and risks are indispensable to strengthen the legal framework of global
maritime trade and Islamic principles will be significant in strengthening global trade.
However, to truly profit global trade, Islamic financial products have to be truly
different rather than simply making cosmetic changes to conventional products.
This chapter focuses on Southeast Asian countries. The gradual adoption of
Islamic finance in Southeast Asian countries indicates a promising future for Islamic
finance, but it actually represents more than that. Countries such as Hong Kong and
204
Singapore are already developed and respected global financial centres with a large
pool of experts and professionals. Including Islamic finance into their financial
portfolios will provide more exposure for Islamic finance among experts and
professionals, many of whom are already world-renown experts on global trade and
commerce. This will, in turn, spark important changes to the legal and regulatory
frameworks, albeit gradually, because the great knowledge amassed by these experts
and professionals will work to strengthen Islamic finance, and vice versa.
Furthermore, the current defects related to the Islamic financial industry, from a legal
and regulatory perspective, can be better addressed once the complete picture is clear.
In other words, not only will global trade and commerce benefit from the application
of certain principles that are rooted in Islamic finance, but also the Islamic finance
world will benefit tremendously from the wisdom and expertise of the experts and
professionals that represent secular jurisdiction. This research proposes that such
mutual cooperation and symbiotic relationships will be good for the future.
This chapter reveals that the development of the legal and regulatory
frameworks governing Islamic finance is directly related to the development of the
Islamic finance industry in any particular country. While subsequent chapters deal
more comprehensively with legal and regulatory frameworks, this chapter also
highlights the benefits and obstacles that can be derived or faced from the inclusion of
Islamic finance.
This chapter also proposes that the benefits of adopting Islamic principles,
particularly the rejection of excessive speculative activities and extreme uncertainties,
outweigh the challenges the process presents.
205
CHAPTER 5
ISLAMIC FINANCE AND MARITIME TRADE
5.0 Islamic principles and maritime trade
The universe of Islamic finance is not restricted to banking and financing. The goal is
a comprehensive legal, regulatory and economic framework that is competitive,
resilient and Shariah-compliant. The partial application of Islamic principles to a
largely non-Islamic conventional financial system has its benefits and drawbacks.
This chapter will test the hypothesis on a few different perspectives. The possible
application of Islamic principles to monetary system is briefly covered,not only due to
its fundamental role in maritime trade, but also because it has been attempted in the
past by Malaysia. However, detail study on this important issue will have to be the
subject of different research in the future due to the monumental size of the associated
issues. This chapter will however cover the actual application of Islamic principles to
modern maritime trade. In country like Malaysia, Islamic financial products that
catered to the need of maritime trade industry has been introduced recently. This is in
line with recent introduction of other Islamic financial products like Islamic derivative.
However, this chapter will not analyze each and every Islamic financial products
currently available because such researches are already available.
This chapter highlights the difficulties of incorporating Islamic principles
onmonetary system, and its effects on maritime trade. This research argues that the
adoption of Islamic principles, particularly the doctrine of gharar,can positively
contribute to the global maritime trade sector. However, such applications cannot be
made hastily. Many present-day Muslim and non-Muslim scholars urge an immediate
return to the gold dinar or an equivalent, gold-based currency. 513 It is commonly
perceived to be more stable and many Muslims find it to be more Islamic in nature
because it was used in the time of Prophet Muhammad and during various past
Muslim empires. Using gold dinar or gold currency is also believed to be positive
because the elements of gharar or uncertainty and ambiguity related to the unlimited
money creation associated with ‘fiat’ or paper money can be avoided.
Attempts have also been made in countries such as Malaysia to settle their
international trade differences with other OIC countries using gold, although such an
513
Ahamed Kameel Mydin Meera, Islamic Gold Dinar (Pelanduk Publication SdnBhd 2002); Detlev S.
Schlichter, Paper Money Collapse: The Folly of Elastic Money and the Coming Monetary Breakdown
(Wiley 2011); Nathan Lewis, Gold: The Once and Future Money (Wiley 2007); Zamir Iqbal, Abbas
Mirakhor, Noureddine Krichenne and Hossein Askari, The Stability of Islamic Finance: Creating a
Resilient Financial Environment for a Secure Future (Wiley 2010).
206
attempt has largely failed due to lack of support. Malaysia, during the leadership of its
former Prime Minister, Tun Mahathir, attempted to use dinar/gold-based money for
import and export between Muslim countries, but the plan did not gain support from
other Muslim countries and failed as a result. Tun Mahathir was known as a strong
supporter of dinar/gold-based money. 514 The impact of the use of gold on
international trade (including global maritime trade) would be immense. According to
Tun Mahathir:
The place for gold is the settlement of international trade, which involves large sums of
money. Payment in physical gold would be inconvenient because of its bulk. The actual
payment in gold could be minimized by a clearinghouse system where the trade between
two countries would be by contra in which the deficit country will be indebted to the
surplus country. Obviously the amount would be quite small relative to total trade and
can be paid in gold. Even then it should be by crediting and debiting in the books of the
central banks operating the clearinghouse. Carried forward to the following month, or
year, the payment can be through the deficit country exporting to the trading partner the
amount of goods or services worth the amount owed in the books. 515
One of the states in Malaysia, Kelantan, has also introduced dinar, initially as an
alternative currency to the ringgit although its adoption at the national level is
impossible due to opposition from the Federal Government, perhaps as the result of
political differences. 516
The use of gold as a medium of exchange or money is no longer theoretical in
nature. Its adoption has already begun in some parts of the world. The use of fiat
514
‘Dr Mahathir urges use of gold standard’ Halal Media (22 November 2010) <
http://halalmedia.my/dr-mahathir-urges-use-of-gold-standard> accessed 6 January 2012; ‘Use of gold
dinar will stop currency war – Dr Mahathir’ Halal Media (7 November 2010)
<http://halalmedia.my/use-of-gold-dinar-will-stop-currency-war-dr-mahathir>
accessed
6
January
2012; ‘Many don't understand importance of gold dinar: Tun M’ New Straits Times (Kuala Lumpur, 14
December 2011)
<http://www.nst.com.my/latest/many-don-t-understand-importance-of-gold-dinar-tun-m-1.19183>
accessed 10 January 2012.
515
Mushtak Parker, ‘Mahathir urges use of gold standard’ Arab News (London, 21 November 2010) <
http://arabnews.com/economy/article197573.ece> accessed 10 January 2010.
516
‘Kelantan makes dinar and dirham legal tender’ New Straits Times (Kota Bharu 12 August 2010)
<http://www.asiaone.com/News/AsiaOne+News/Malaysia/Story/A1Story20100814-232042.html>
accessed 10 January 2012.
207
money that is not backed by anything valuable and vulnerable to manipulation has
often been deemed dangerous and is considered contrary to the Islamic prohibition of
gharar or excessive uncertainty. However, it does provide countries with more
control over monetary supply and demand and improve liquidity, and international
guidelines such as those issued by the Basel Committee on Banking Supervision offer
some stability. This chapter analyzes the pros and cons of this important issue.
The application of Islamic principles to modern global trade and commerce,
including maritime trade, has already started. Present-day Islamic finance is estimated
to be somewhere between a US$1 trillion to US$2 trillion dollar enterprise. Granted,
this size is humbled by conventional global finance, which stands at no less than
US$232 trillion (not including a US$700 trillion notional value of derivatives), yet the
achievements of Islamic finance should not be underestimated, considering that it was
almost unheard of 40 years ago. The dramatic yet consistent growth of Islamic finance
at a rate of 15 to 20 percent per annum is astonishing, but its true potential remains
largely untapped. Initially, the scope of Islamic financial products only covered
simple financial products such as interest-free savings accounts. Currently, Islamic
finance has penetrated a variety of different sectors, including the banking and
insurance sectors. The complexity of Islamic financial products has also increased.
The recent addition of Islamic bonds or sukuks and Islamic derivatives is further
evidence of this complexity. Because the true ideals of Islamic finance include real
trade backed by real assets the shipping sector, and indeed maritime trade as a whole,
is an obvious choice for the next expansion of Islamic finance. There are currently
over 50,000 merchant ships trading internationally, transporting every kind of
imaginable cargo. Indeed, around 90 percent of modern global trade is carried by the
international shipping industry.
2009 witnessed the worst global recession in over seven decades. While no
shipping segment was spared, minor dry bulks and containerized trades suffered the
most severe reductionsdue to weak consumer confidence and decreased capital
investment. However, in the previous global recession, the maritime trade sector
merely suffered the consequences of a series of financial crises and global recession.
The situation would have been different if the crises had originated in the maritime
trade sector.
There has been genuine fear that the economies of multiple countries would
collapse to the point of mass starvation if the maritime trade sector was suddenly
halted. Currently, because the financial sector has been establishing a stronger
presence in the shipping industry, as indicated by the steadily increasing number of
clearing houses and the recent introduction of various complicated financial products,
there have been valid concerns that the shipping industry is becoming more
208
disconnected from real trade. There has been even more concern that the excessive
speculations that once resulted in the collapse of the financial market and the
subsequent global recession will spread to the shipping sector.
During the previous global recession, Islamic finance emerged as a strong
alternative because its unique characteristics demonstrated resilience in the event of a
financial crisis. These characteristics include the rejection of transactions tainted by
excessive speculation and uncertainty and the rejection of usury or interest.
Furthermore, its insistence on the fair allocation of risks illustrated by the
profit-loss-sharing mechanism and an emphasis on real assets and capability of
delivery have paved the way for more ethical methods of trade and finance. Despite
its name, Islamic finance does not only cater to the needs of Muslims. Any interested
party is free to use it. For example, around 25 percent of Islamic finance consumers in
Malaysia are non-Muslims. They have selected Islamic finance for its competitiveness
and profitability. However, Islamic finance is not free from losses, as evidenced by
the Dubai crisis. It is in the nature of trade and commerce to occasionally suffer losses.
What is important is the creation of an efficient system in which the risk of loss is
minimized. The Hong Kong Monetary Authority has concurred that the previous loss
in the Dubai crisis was not due to any conceptual or system flaws, but rather to a
simple supply-demand issue.
More recently, the financial sector has been advancing towards the maritime
trade sector through the introduction of clearing houses, derivatives, forwards
contracts, freight forwards agreements (FFA) and swaps. There is no denying that
there are tremendous benefits associated with all of these elements. For example,
larger funds would be available with the involvement of a hedge fund and other
speculators. Exporters and importers would also be able manage their risks more
prudently by pre-planning the price of future freights. The risks are said to be
transferred to those willing to absorb it, for an adequate price.
However, as speculators march into the maritime trade sector, there is real
concern that the tragedy that previously befell the global financial sector will merely
repeat itself in the maritime trade sector, but with more severe consequences because
90 percent of world’s trade is transported via maritime sector.
Conventional financial products have been designed over a long period of time
to meet the sophisticated demands of the different parties involved in maritime trade,
including sellers, buyers, consignees, consignors, shipowners, charterers, insurance
companies and banks. Many of these products have been tested and their contractual
terms carefully scrutinized and interpreted by court of law. Therefore, conventional
financial products have a huge advantage compared to Islamic financial products:
legal certainty. The level of legal certainty associated with the conventional products
209
is currently higher than ever as various legal issues ranging from the interpretation of
indemnity clauses to the scope and extent of the rights and responsibilities of parties
are brought to court and settled.
However, this is not necessarily a disadvantage for Islamic financial products.
Rather than starting from a scratch, Islamic financial scholars will benefit from the
extensive experience and history offered by conventional products, which can also be
tailored to ensure Shariah-compliance as a temporary solution. As a long-term
strategy, Islamic financial experts who are well-versed in conventional finance must
attempt to synergize their knowledge to create newer and better financial products that
are not only Shariah-compliant, but also more ethical, profitable and competitive.
This should not prove to be a serious problem because the general rule under Shariah
is that everything is permissible with the exception of those things that are clearly
prohibited.
5.1 Applicability of Islamic Financial Products to Maritime Trade
The shipping industry has recently become more detached from its core businesses,
and speculative activities and volatility are increasing. Islamic financial products, in
theory, are supposed to be more resistant to such volatility due to their insistence on,
among other things, real assets, proper observation of delivery time and existence of
subject matter. This increasing volatility is generally recognized in the shipping
industry. According to Kenneth Koo, the 2010-11 Chairman of the Hong Kong
Shipowners Association:
The shipping industry is changing, and, to my mind, the ‘ship’ is being taken out of
‘shipping’. Freight markets have become commoditized, ships are ‘flipped’ like real
estate, and the barriers to entry, especially to the dry bulk markets, become lower and
lower. New players in the industry are banks and even courier companies, whose
speculative spending spree now includes shipyards! The emphasis being projected
seems no longer on shipping, but shipping derivatives. Shipping derivatives that
would appear to be founded on China’s continuing and increasing demand for raw
materials. The commoditization of shipping has several consequences. One is the
question of sustainability, both of the unprecedented new building order books and
the total dependence on China’s physical demand for raw materials, especially with
the new players declaring that volatility is the name of the game. This results in
unprecedented challenges that are poised to knock out the platform that traditional
owners operate on; sustainability, long term cashflow, partnership and emphasis on
210
quality of management. Secondly, the commoditization of shipping reduces ships to
the status of a commodity, where the only variable is price. 517
However, Islamic finance has also been commanding a stronger presence in the global
trade industry. While the maritime trade industry is growing more volatile due to
increases in ‘financialization’, Islamic finance based on real trade and commerce is
also gradually being adopted. However, the rate at which Islamic finance is being
adopted is much slower compared to the dramatic increase in excessive speculative
activities within maritime trade. In some countries, such as Malaysia, Islamic
financial products are being introduced in the maritime trade industry as well.
It is not sufficient to have Islamic financial products. The essence of the products
must also be more beneficial to the parties. While shariah-compliant might be a
motivation for religious Muslims, people at large, especially non-Muslims will only
opt for Islamic financial products if the products actually deliver. In other words,
there must be add-value. If the changes are cosmetic in nature, many potential
customer will just shy away.
There is a real need to have proper Islamic financial products that catered to the
maritime trade industry. Daud Vicary Abdullah and Keon Chee elaborated as follow:
At the heart of trade finance is the basic need for exporters and importers to exchange
capital and goods across borders. Without instruments such as LCs and participation of
banks, financiers, carriers and many other parties, it would be impossible for
entreprenuers to trade, and for countries to exchange capital, goods and services across
the world. International trade represents a significant share of GDP (gross domestic
product) of a country and directly affects the developments of nations. It was with this
important understanding that the International Islamic trade Finance Corporation (ITFC)
was set up in 2007. The ITFC is the trade arm of ADB and its mandate is to develop and
expand intra-trade between member countries of the Organization of the Islamic
Conference (OIC). By providing Shairah-compliant trade financing, OIC member
countries and the rest of the Muslim world can expect to establish new trade links
among themselves as well as with non-Muslim countries. 518
Below is a list of some of the financing concept/ products available in the market;
517
Hong Kong Shipowners Association, Yearbook 2010/2011
<http://www.hksoa.org/association/yearbook2011/HKSOAYearbook-2010-11.pdf>accessed
15
November 2011.
518
Daud Vicary Abdullah and Keon Chee, Islamic Finance: Why It Makes Sense (Marshall Cavendish
Business 2011)
211
Debt Financing
Bai’ as-Salam (future delivery)
Bai’ Al-Istijrar (supply contract)
Ar-Rahnu (collateralised borrowing/Pawn Broking)
Bai' al 'inah (sale and buy-back agreement/Credit Card/personal financing)
Al-Bai' Bithaman Ajil/Bai' Muajjal (Deferred Payment Sale)
Al-Murabahah (Cost Plus)
Tawarruq (Commodity Murabahah)
Al-Qard (benevolent loan)
Lease Financing
Al-Ijarah Thumma al-Bai’ (leasing and subsequently purchase)
Al-Ijarah (leasing)
Al-Istis'na Ijarah
Debt Trading
Bai’ al-Dayn (debt trading/block discounting)
Equity Financing
Al-Mudharabah (profit-sharing)
Musyarakah Muntanaqisah (Diminishing Musyarakah)
Al-Musyarakah (joint venture)
Trade Finance
Letter of Credit (Wakalah/Musharakah/Murabahah)
Trust Receipts (Murabahah)
Al-Kafalah (Bank Guarantee)
Export Credit Refinancing (Murabahah/Al-Dayn)
Accepted Bill (Murabahah/Al-Dayn)
Fee/Commission
Al-Hiwalah (remittance)
As-Sarf (foreign exchange)
Al-Ujr (fee)
Al-Hibah (gift)
212
Capital Market
Islamic Derivatives
Sukuk (Debt/Lease/Wakalah)
Islamic Unit Trust
Islamic REITS
Structured Products
In addition to those products, Islamic financial products that catered to the maritime
trade industry are also available nowadays. For example, one of the largest bank in
Malaysia, Maybank offered the following products 519:
•
Murabahah/Wakalah Letter of Credit-i
•
Murabahah Trust Receipt-i
To finance domestic or international trade documents drawn against Murabahah
Letter of Credit/Wakalah Inward Bills for Collection.
•
Bills of Exchange Purchased-i
To finance exporters/sellers who need funds immediately in exchange for export
documents.
•
Bank Guarantee-i
To guarantee payment to the beneficiary in the event of customer's non-performance
of contract with beneficiary.
•
Shipping Guarantee-i
To assist importers in securing delivery of goods immediately before receipt of the
shipping documents.
•
Accepted Bill-i
To finance underlying domestic or foreign trade transaction as per Bank Negara
Malaysia's guidelines, and is formulated on Murabahah (cost plus profit sale) and
Bai Al-Dayn (debt trading) principles.
•
519
Export Credit Refinancing-i
Maybank, ‘Islamic trade financing’
<http://www.maybank2u.com.my/mbb_info/m2u/public/personalDetail04.do?cntTypeId=0&cntKey=B
FIN02.05&programId=BFIN02.05-IslamicTrade&chCatId=/mbb/Business/BFIN-Financing/BFIN02-T
radeFinancing> accessed 20 November 2012
213
To finance domestic suppliers and manufacturers who export permissible
commodities as per Exim Bank's guidelines and is formulated on Murabahah (cost
plus profit sale) and Bai Al-Dayn (debt trading) principles.
Despite numerous products offered by Islamic financial institutions, keen observers
noted many of the products are merely modified or enhanced. In other words, many of
the products were merely modified from the conventional and were not properly
developed. One observer, a true expert in Islamic finance revealed that conventional
products can also be mere product enhancement:
Product development is essentially an exercise to create a new product or instrument to
meet a specific requirement, be it the customer’s, regulator’s, industry’s or all of these
factors. In most cases, the creation of a new product, other than for diversification
purposes, is to satisfy the needs of the customer under certain circumstances of the legal
framework, taxation treatment and the like. Therefore, we find that financial institutions
have constantly developed and launched new products in order to have a competitive
edge over the financial institutions in the industry. However, it is the writer’s personal
observation that in the conventional banking industry, all of those developments are
more of product enhancement rather than product development. This is simply because
all financing as well as deposits products in conventional banking, are simply based on
loan contract as indicated by the leading case of Foley v Hill. 520
Numerous scholars including Iqbal, Mirakhor, Askari, and Aldohni have also urged
the Islamic financial industry to come up with better products. The author proposes
that a better financial product must have a better risk allocation system. In other
words, if the risk is unfairly shifted to the party with less bargaining power, this will
not be the optimum situation. In order to develop better Islamic financial products, the
following conditions should be taken into consideration:
•
•
520
The product must be Shariah-compliant.
The allocation of risk must be proper. Therefore, experts in risk
management must also be consulted to ensure efficiency. On one hand,
the financier/party must not shift all real risks to the other party. On the
other hand, the financier/party must take into consideration various
elements like moral hazard and the doctrine of separate legal entity
before taking real risk.
Mohd Daud Bakar, ‘in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential
Reading in Islamic Finance (CERT Publications Sdn. Bhd, Malaysia, 2008) 124
214
•
The product must take into consideration the tax regime etc. The legal
and regulatory framework must be analyzed properly first.
•
•
In depth study on the demand of such product is necessary
To strengthen the product, it is necessary for the new product to take into
consideration the numerous guidelines issued by standard-setting body
like AAOIFI.
Some scholars attempted to classify the types of contract in Shariah. For example,
Venardos proposed that there are seven types of contract recognized by Shariah law
and they are as follows: 521
(i)
Al-tamlikat (acquiring of ownership)
(ii)
Al-Isqatat (relate to the dropping of rights against others with or without
exchange).
(iii)
Al-Itlaqat (similar to the contract of agency or appointment)
(iv)
Al-Taqyidat (contracts that prevent or terminate the performance of certain
functions)
(v)
Al-Tauthiqat (contracts meant to secure debts)
(vi)
Al-Ishtirak (contracts relate to sharing in projects and profits.
(vii)
Al-Hifz (safe custody)
With respect, the classification is arguably inaccurate since the general rule in Islam is
that every contract is valid, except those expressly contrary to the primary sources of
Islam. To create new Islamic financial products that are truly beneficial to the
maritime trade industry, high level of creativity and collaboration are necessary.
This research will not repeat analysis on each Islamic financial products since
such works are already available. For example, Khir, Gupta and Shanmugam already
elaborated the concepts of Islamic deposits and Islamic finance in detail, ranging from
analysis on savings account, current account, investment account, toBBA, murabahah,
ijarah, ijarah thummal-bai, musharakah, diminishing musharakah, bai salam, istisna’,
qardh Hassan, rahnu, bai inah andtwo-tier mudaharabh model. 522
521
Angelo M Venardos, Islamic Banking & Finance in South-East Asia (2nd edn, World Scientific
2006)
522
Kamal Khir, Lokesh Gupta and Bala Shanmugam, Islamic Banking: A Practical Perspective
(Pearson Longman 2008)
215
5.2 Benefits and Challenges of Islamic Financial Products
Islamic financial products have expanded beyond the needs of Muslim communities
as they have gradually entered the global arena. Islamic products and services for the
maritime sector have also evolved over time. Basic account services have given way
to the need for more complex solutions. Historically, a small range of Islamic
financing, investment, cash management and treasury solutions limited a corporate
treasury’s ability to mitigate foreign exchanges, rates, funding, payments, commodity
prices and business protection risks in a Shariah-compliant manner, which prompted
an unnecessarily high degree of business risk. Over time, the Islamic finance industry
has witnessed the development of product suites designed to meet the more advanced
financial needs of the maritime sector. The present-day Islamic finance industry can
cater to complex corporate requirements such as debt capital markets and equity and
derivatives. These increasingly sophisticated products are normally structured using
the building blocks of Islamic financing: murabaha, mudaraba, musharaka and ijara.
To improve the quality of Islamic financial products associated with international
trade in general and the maritime sector in particular, a dedicated institutional body
with such aims should be introduced. The costs involved would be partly offset by
cooperation with institutions such as the IDB and its organs, such as the IFSB and the
AAOIFI.
A detailed outline of the benefits and advantages of Islamic financial products
has already been covered in previous chapters. However, concerning maritime trade,
this research proposes that the true benefit of the application of Islamic principles can
only be achieved if the parties, including Islamic financial institutions, shippers and
carriers, are willing to adopt a different approach concerning the allocation of risk. It
has been proposed that under a system in which the burden or risk can simply be
transferred to others (albeit at some price), the moral hazard can be high. Moral
hazard can also be high due to uncertainty, such as that related to information:
When information is not perfectly distributed, one party might be able to pursue its
interest at the expense of the other. Of course, the other party has an incentive to
design contracts that control this risk, and sometimes the intervention of the
government may be necessary. 523
523
Donald Marron (ed), 30-Second Economics (Ivy Press Limited 2010) 150.
216
As an alternative, a system in which the parties constructively share the risks would
be more positive, provided that it was meticulously executed due to the complexity
involved, including the separation of legal entity, among other things.
Beyond Islamic financial products, a more pressing issue related to monetary
systems must also be addressed. There has been growing concern that the application
of Islamic financial principles (as reflected in Islamic financial products) would prove
too difficult within a paper-based monetary system. The following analysis will
address this issue.
5.3 The Effects of Global Recession and Financial Crises on Maritime Trade
There is a growing body of literature that suggests that global trade and commerce,
including maritime trade, is negatively affected by conventional global monetary
systems that are based on unlimited money creation in the form of fiat or paper money,
which has been alleged to accelerate states of global recession and financial crises.
The disastrous effects of global recessions and financial crises are evident in the
high rate of unemployment, the collapse of countries’ economies, the breakdownof
various financial institutions, bankruptcies and the increasing number of
finance-related suicides. Many of the views that have been commonly taken are not
preventive in nature and the cycle of recession and crisis will continue to repeat itself
if changes are not made. In other words, the current approach only addresses the
symptoms without curing the real illness or disease. Cosmetic policy and product
changes do not sufficiently deal with the root cause. Change must begin by
identifying these root financial problems and taking a fresh look at the current global
trade and commerce system to question its core effectiveness. Some have proposed
that these core problems can be traced back to unfair and unstable monetary systems
and the unfair allocation of risk in global trade and commerce.
Recessions and financial crises share a few common attributes and consequences.
However, it has been proposed that recessions and financial crises are not the core
issues or ‘illnesses’, but merely the symptoms of a more primary problem. More often
than not, actions taken by governments are aimed at temporarily curing such
symptoms without addressing the real problems. As such, the real problem with
global trade and its related financial systems will continue to repeat itself.
The world has been globalized to the extent that the collapse of one economy
directly affects those of others. However, there are many benefits to globalization.
According to the World Bank:
217
Globalization generally reduces poverty because more integrated economies tend to
grow faster and this growth is usually widely diffused. As low-income countries
break into global markets for manufactures and services, poor people can move from
the vulnerability of grinding rural poverty to better jobs, often in towns or cities. In
addition to this structural relocation, integration raises productivity job by job. 524
Globalization has resulted in a network of connected economies among the world’s
nations, and the collapse of one can cause a domino effect among the others. The
collapse of one country’s monetary system can have the same type of chain reaction.
5.4 Reasons behind Global Recessions and Financial Crises
Experts have been studying the reasons for global recession and financial crisis for a
long period. 525The following are some of the noted reasons behind financial crises
and global recessions:
1. Easy money
2. Excessive speculation and manipulation
3. Unstable international monetary regime
4. Interest-based system resulting in monetary excess
5. Lack of adequate market disciplines, regulations and supervision
6. Lack of transparency
7. Cronyism, corruption and nepotism
8. Financial volatility
9. Liquidity preference
10. Aggregate demand failure
11. Fundamental asymmetries of the dollar-based international monetary system
12. Inefficient global financial markets
13. Excessive and imprudent lending by banks
14. The inability to recover loans
524
‘Globalization, Growth, and Poverty: Building an Inclusive World Economy’ (2002) World Bank
Policy Research Report
<http://www.wds.worldbank.org/external/default/WDSContentServer/IW3P/IB/2002/02/16/000094946
_0202020411335/Rendered/PDF/multi0page.pdf> accessed 6 January 2011.
525
For example, see John Bellamy Foster and Fred Magdoff , The Great Financial Crisis: Causes and
Consequences
(Monthly Review Press 2009) and Micheal Chossudovsky and Andrew Gavin
Marshall, The Global Economic Crisis: The Great Depression of the XXI Century (Global Research
Publishers 2010)
218
15. The absence of risk/reward sharing, which reduces market discipline
16. Gross uncertainty in the investment market
17. Misallocation of resources
18. Ineffective government actions and policies
One of the most significant foundations of such recessions and crises is the fragility of
paper-based monetary systems. Many present-day monetary systems can easily create
money that is not based on anything of concrete value. Fisher found that
over-borrowing is largely due to the easy availability of money, which has resulted in
booms fueled by over-indebtedness in relation to equity, gold and income, followed
by deflation that ignites states of financial crisis, recession and depression. 526 He
proposed that the Great Depression, in the decade preceding World War II, was
triggered by debt liquidation.
Generally recognized causes of financial crisis also include excessive and
imprudent lending by banks, the inability to recover loans, an absence of risk/reward
sharing that reduces market discipline, uncertainty in the investment markets the and
misallocation of resources. 527 Friedman and Schwartz conceived financial instability
to be a monetary phenomenon described as faster money expansion resulting from
unchecked credit expansion. 528
Ledoit and Lotz recently suggested that some countries are considering
alternatives to paper money:
Recently, political representatives of various Countries and States have introduced
proposals to make Commodity Money coexist with Fiat Money within current Monetary
Systems. In Malaysia, on August 12, 2010, Kelantan — a State of the Malaysian
Federation — introduced the Gold Dinar and the Silver Dirham as parallel currencies
alongside the Malaysian Ringgit. Similarly, in the US, on March 25, 2011, Utah
Governor Gary Herbert signed into law a bill recognizing not one but two (Gold and
Silver) Commodity Monies as legal tender for all transactions conducted within the
526
As quoted in Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor, The Stability
of Islamic Finance: Creating a Resilient Financial Environment for a Secure Future (John Wiley &
Sons (Asia) Pte. Ltd 2010).
527
M. Umer Chapra, ‘The Global Financial Crisis: Can Islamic Finance helps minimize the severity
and frequency of such a crisis in the future?’ (Forum on the Global Financial Crisis, Islamic
Development Bank, 25 October 2008).
528
Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor, The Stability of Islamic
Finance: Creating a Resilient Financial Environment for a Secure Future (John Wiley & Sons (Asia)
Pte. Ltd 2010).
219
State of Utah — in parallel with the U.S. Dollar. The bill legalizes currency competition
in Utah as the Gold and Silver coins may be used, and accepted voluntarily, as an
alternative to the Dollar. Within the U.S., a dozen other States are considering similar
legislation. 529
Consider the other aforementioned triggers. Lack of transparency contributes
significantly to financial crises and global recessions. Transparency is the key
instrument in preventing market abuse, including insider dealing and market
manipulation, money laundering, terrorism financing and corruption. 530 Therefore, a
financial system that lacks transparency risks more than mere efficiency because it
also exposes the whole system to serious threats and dangers.
During financial crises, banks are generally more cautious and move slowly
when granting loans. This can lead to a further fall in credit or the ‘vanishing credit
effect’. 531 A lack of liquidity during financial crises is also relevant. 532
Many Islamic finance 533 scholars have expressed the view that the main causes
of recessions and financial crises include excessive credit and excessive speculation,
both of which are clearly prohibited under the prohibition of riba and gharar
(excessive speculation or uncertainty). The severance of an equitable link between
financial and real economies under the conventional financial systems is frowned
upon under alternative financial systems, including Islamic finance.
The effects of recessions and financial crises cannot be underestimated. History
and recent events have all shown that the far reaching consequences of recessions and
financial crises can be felt by all countries and at all levels of society. Global financial
crises are not new. One of the first international financial crises was the crisis of 1825,
in which a sudden stop of capital flow from London led to debt defaults, banking
529
Olivier Ledoit and Sebastien Lotz, ‘The Coexistence of Commodity Money and Fiat Money’
(2011) Working Paper No. 24, Department of Economics, University of Zurich, 1
<http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1939036> accessed 20 November 2011.
530
Christine Kaufmann and Rolf H. Weber, ‘The Role of Transparency in Financial Regulation’ (2010)
Journal of International Economic Law 13 (3), 779-797.
531
Peter B. Kenen and Alexander K. Swoboda (eds.), Reforming the International Monetary and
Financial System (The International Monetary Fund 2000).
532
Michael M. Hutchison, Ilan Noy, and Lidan Wang, ‘Fiscal and monetary policies and the cost of
sudden stops’ (2010) Journal of International Money and Finance, 1–15.
533
The Islamic financial system is based on the Qur’an (the Muslims’ Holy Book), the Sunnah (the
actions, speech and tacit approval of the Prophet) and the ijtihad (the personal reasoning, view or
interpretation of scholars based on the two major sources).
220
panics, currency crashes across Latin America and a panic in London that spread to
the continent and, according to some sources, reached the United States. 534
It has been proposed that global recessions and financial crises do not belong to
an inevitable trade and commerce cycle. It is possible to minimize or perhaps
eliminate the recession and crisis cycle altogether if the proper approach is taken. In
its current form, the financial sector can corrupt other sectors, including the
manufacturing sector, the agriculture sector and even the shipping sector, due to the
inherent defects of the current system. While it has been recognized that any proposal
for reforms is usually met with strong opposition from parties who feel that their
interests are being threatened, this research proposes that gradual reforms will prove
beneficial to all parties.
Different ideas have been presented regarding ways to deal with recessions and
financial crises. For Keynesian economists, the often-quoted solution is that
governments increase spending to accelerate economic growth. John Maynard Keynes
diagnosed the Great Depression as a failure to aggregate demand and proposed that
the government boost aggregate demand to fill its absence in the private sector. 535
Regarding strategies, solutions mostly depend on the efficiency of government
policies. Some economists have suggested that promoting healthy business capital
investment, eg by cutting taxes, could be a possible resolution. Most supporters of
alternatives such as Islamic finance have suggested that the answer lies in a more
equitable financial system that promotes fairyet competitive transactions and profits
are obtained commensurate to the amount of effort expended and risk taken. However,
a comprehensive and reliable study on successful ways of preventing recessions and
financial crises has yet to be found. This research proposes that successful solutions
must strike at the core of the problem, at the very center of the global trade and
finance systems, to prevent recessions and financial crises. To achieve this, a stable
and fair monetary system is necessary.
Any reform efforts should consider the long-term effects. Short-term policies
aimed at economic recovery can ultimately be disruptive in the long-run, as seen in
developing countries with policies aimed at generating inflation, devaluing exchange
rates, subsidizing credit or even nationalizing strategic industries that set the stage for
534
Michael D. Bordo and John S. Landon-Lane, ‘The Global Financial Crisis of 2007-08: Is it
Unprecedented?’ (2010) National Bureau of Economic Research (NBER) Working Paper Series <
http://www.nber.org/papers/w16589.pdf> accessed 14 November.
535
Donald Marron (ed), 30-Second Economics (Ivy Press Limited 2010) 46.
221
crony capitalism or worse, ‘kleptocracies’ (despite the possible short-term
benefits). 536
There have been increasing requests for better monetary systems to strengthen
global trade and commerce. For example, according to Lee:
The Malaysian state of Kelantan has made a historical launch of Gold Dinar and Silver
Dirham on 12th August 2010. For the first time in almost 100 years since the fall of the
Ottoman Caliphate, a Muslim government introduces Shariah currency. In the eyes of
many Muslim scholars, the present interest-based fiat monetary system is flawed as it is
incompatible with the objectives of the Islamic law or the Shariah. There have been calls
for the resurgence of Islamic Gold Dinar (together with the silver dirham) as it is
deemed to be the most appropriate medium of exchange to be used in the Islamic
economies. 537
5.5 Maritime Trade and International Monetary Systems
The majority of financial crises suffered around the world are generally of a serious
nature and have recurred persistently, suggesting that cosmetic changes in the existing
systems may not be sufficient. 538 There have been a series of excessive uncertainties
in the current fragile international monetary systems that have significantly increased
unnecessary risks, despite the existence of important international guidelines, such
Basel I, Basel II and Basel III. There has been a growing call for the return to a gold
standard or gold currency because paper-based currency that is not backed by gold
has been deemed too risky, fragile and vulnerable to problems linked to fixed
exchange rates, among others.
Currently, the literature on silver and gold as currency is quite abundant. The
situation is summarized in the work of Ibrahim:
According to proponents of Gold Dinar particularly Meera and Aziz (2002), termed
as Dinarists’, the fiat monetary system is inherently unstable. In providing an
empirical perspective on this contention, this paper investigates monetary dynamics
of a Muslim economy, Malaysia. To this end, the paper adopts a vector
536
Kris James Mitchener and Joseph Mason, ‘Blood and treasure’: exiting the Great Depression and
lessons for today’ (2010) Oxford Review of Economic Policy, Volume 26, Number 3, 510–539.
537
Grace H.Y. Lee, ‘Gold Dinar for the Islamic countries?’ (2011) Economic Modelling 1573-1586.
538
M. Umer Chapra, ‘The Global Financial Crisis: Can Islamic Finance helps minimize the severity
and frequency of such a crisis in the future?’ (Forum on the Global Financial Crisis, Islamic
Development Bank, 25 October 2008).
222
autoregressive (VAR) framework to document dynamic interactions between money
supply and various macroeconomic variables including real output, price level,
interest rate and stock prices. The results seem to provide some support for the
Dinarists’ contention. First, the results portray clearly an important causal role of
money supply for other macroeconomic variables. Second, we document some
evidence that expansion in money supply is inflationary. Lastly, money supply –
interest rate and money supply – stock price interactions are destabilizing. More
importantly, expansion in money supply has the potential of breeding asset price
bubbles. However, apart from the above findings, we also find that money supply
reacts positively to increase in real output. Since the accommodative role of money
supply is necessary or a pre-condition for expansion in production, arguments for
Gold Dinar need to be qualified. Moreover, the viability of Gold Dinar comes into
question when political and international aspects of monetary standards are
considered. 539
Despite what appears to be a long history, paper money (also known as fiat money) as
it is understand today, eg freely printed by countries or authorized financial
institutions without compulsory links to a gold reserve, is relatively new.
The Case for Gold Reforms
Maritime trade, being a major part of global trade, is highly affected by global
monetary systems. This research proposes that the application of Islamic principles
would strengthen global monetary systems by reducing instability, uncertainty and the
excessive risks currently associated with paper money.
Gold dinar or gold currency should not be confused with the Islamic
Development Bank’s (IDB) Islamic dinar. Islamic dinar (ID), the unit of accounting
used by the IDB, has existed in the multilateral development bank (MDB) of the
Muslim world since 1975. Technically, the ID is similar and equivalent to the IMF’s
Special Drawing Right (SDR). However, SDR is not currency, but rather
supplementary foreign exchange reserve assets that are defined and maintained by the
IMF. SDR represents a claim to currency and was initially created in 1969 to
supplement the shortfall of the US dollar and gold. To simplify, SDR’s value is
defined by the weighted portfolios of the US dollar, the British pound, the Japanese
yen and the Euro, all of which are paper-based currencies.
Islamic financial and monetary experts have held two main views on the issue of
dinar or gold money. The first group has urged a return to gold or a gold standard.
539
Mansor H. Ibrahim, ‘Monetary Dynamics and Gold Dinar: An Empirical Perspective’ (2006)
Journal of King Abdul Aziz University Islamic Economics, Vol.19, No.2, 3-20.
223
This group has proposed that money creation through the printing of fiat money is
dangerous because there is no real core of value for such monetary systems. The
proponents of this view have also suggested that such systems are easily manipulated,
suffer increased exposure to inflation and are aimed at catering to a usury-based
system because high liquidity and the unlimited power of money creation are required
to maintain a system that must continually expand (due to the need to pay interest).
The second group has argued that a return to gold or a gold standard would
cause more harm than benefit to society, particularly the worldwide Muslim
community. The proponents of this second view have proposed that, among other
things, Islam is not against paper or fiat money and the return to dinar or a gold
standard in the current system would create inflation and increase exposure to usury
practices.
Regarding the first view, people have historically preferred to use gold or silver
currency due to the general acceptance of gold and silver. Gold and silver are limited
resources and cannot be printed or created. Furthermore, the acceptance of gold and
silver is not limited by place or time. If someone found a chest of gold treasure from
the seventh century, that person would be rich, regardless of where or when he/she
lived, because the value of gold does not diminish with the passing of time or based
on location. However, if someone found a chest of treasure containing Japanese paper
money from the 1940s, that person would not be rich because Japanese paper money
from the 1940s is no longer accepted as valid currency. Furthermore, the paper money
would most probably be of very poor quality due to the fact that paper simply does
not last as long as gold. In addition, because the Japanese printed paper money in
large quantities in the 1940s, there is still an abundance of it, which means that it is
not even valuable to individuals who collect old banknotes. Paper money or
banknotes can usually last for an average of only three years. In contrast, despite an
inevitable attritionin the quality of gold money due to tear and wear, such erosion is
minimal and gold money can usually survive for a long time.
Gold and silver possess real value. They can always be melted and minted, but
not created. Because gold and silver cannot be created, there is no risk of them being
manipulated. Paper money, however, can be printed and created from nothing. For
example, because the creation of paper money is no longer backed by gold, countries
and authorized financial institutions can print it in large sums without any effective
regulations. There are guidelines, but their efficiency is still subject to discussion, eg
Basel II. The reality is that a country can print as much paper money as they want,
although unmonitored and inefficient printing will lead to inflation, increased interest
rates and, eventually, the decline of the currency.
224
Paper money has no real value of its own, contrary to gold and silver. It is
nothing more than the promise of payment. Its validity depends on the approval and
conditions laid down by the issuer, usually state governments. Because paper money
is no longer backed by gold, there is no certainty or limit concerning the amount of
paper money that can be printed. Furthermore, the existence of such paper money
opens the gates for currency speculators to attack the currency they desire to make
short-term profits.
Although paper money is circulated and used by the masses as a valid currency,
the reality remains that its value is extremely fragile, as indicated by the occasional
collapse of currency in various countries over time. For example, Zimbabwe’s
present-day currency is almost worthless. Gold, however, has never lost its value.
Gold-based paper money was introduced at one time, but the link was eventually
severed. Some of the reasons behind this severance included better liquidity and the
need to support an interest-based system. Under the previous practices of discount
houses, discounts or interest were earned on gold. Therefore, to pay the interest, more
money had to be printed or more gold had to be produced. It proved much easier to
print paper money than to actually mine more gold.
In the relatively recent past, rather than adopting gold as international currency,
various countries across the globe have decided to adopt the US dollar because the
fact that it was guaranteed to be fully-backed by goldseemed to make it as effective as
gold. This was because the US dollar could, initially, be converted into gold.
Furthermore, it is arguably easier to carry it around. Another attraction of the US
dollar in the past has been the fact that it earned interest. Two important views have
emerged concerning the future of the international monetary regime. Keynes (who
drafted the plan for the British treasury) proposed a system that encouraged economic
growth. Keynes’ proposals, if accepted, would have created a world reserve currency.
An efficient and effective world reserve currency never created, however, and rather
than resorting back to gold and silver as currency, countries decided to stick with
paper money. Many Islamic finance scholars and experts have also urged a return to a
gold currency to remove the unnecessary risks associated with paper money.
Requests have also been made by some of the leaders in Muslim countries for a
return to gold currency, at least among Muslim states. For example, one such leader
remarked that if the countries in the European Union can resort to the Euro as their
standard currency, there is no reason for Muslims countries not to resort to gold
money as their standard currency.
Some have proposed that a dual system be introduced to revive the use of gold as
currency. For example, in Malaysia, a dual system has been adopted in the banking
institutions, with Islamic finance windows opened within the conventional banking
225
system. Currently, almost all of Malaysia’s conventional banks offer Islamic finance
windows. The previous conventional banking system was not abolished or terminated.
Instead, Islamic finance is offered as a simultaneous alternative to interested parties.
Many of the customers of Malaysia’s Islamic banks and Islamic finance windows are
non-Muslim, which indicates the competitiveness and profitability of Islamic finance.
The same concept can be applied in relation gold currency. Instead of attempting
a drastic return to gold, which might cause economic shocks, this research proposes
that it would be more practical to adopt a gradual reintroduction of gold currency that
would be used alongside paper money.
The fourth Prime Minister of Malaysia (who held the post from 1981 to 2003)
was a vocal advocate of the return to gold currency. He claimed that the Malaysian
government’s attempt to reintroduce gold as the currency failed because there was no
support from other Muslim countries. However, it has been noted that when one of the
states in Malaysia introduced gold currency in 2006 (the Kelantanese dinar) and again
in 2010 and attempted to give the dinar legal tender status, the federal government of
Malaysia vetoed its use. Therefore, it can be concluded that despite the official image
of the federal government of Malaysia as a body that desires the reintroduction of
gold as a global currency in the Muslim world, in reality its support is questionable, as
reflected by its surprising objection to the use of gold or dinar as an alternative
currency in Malaysia.
It can also be concluded that, without strong cooperation and political will, a
return to gold as currency or even the reintroduction of gold as an alternative currency
alongside paper currency will fail, or at least progress slowly. Due to the size of the
matter, it has been recognized that further research is necessary to ensure the smooth
and efficient acceptance of gold as currency.
However, realistically, any reform of the current financial system will take time.
Even recovery from financial crises can be slow. For example, Mitchener and Mason
(2010) showed that a full exit from the Great Depression (defined as the point at
which interventionist credit- and capital-market policies and institutions were wound
down) did not occur in the 1930s, but that it actually took until the 1950s for the
Federal Reserve to regain its independence and return, unfettered, to its long-term
objectives. 540
Various Islamic finance scholars and experts, together with their conventional
finance counterparts have urged a return to a more stable international currency,
particularly gold, to strengthen the currently fragile systems. The present-day
monetary regime has established a system in which money creation is possible even
540
Kris James Mitchener and Joseph Mason, ‘Blood and treasure’: exiting the Great Depression and
lessons for today’ (2010) Oxford Review of Economic Policy, Volume 26, Number 3, 510–539.
226
without anything of value backing it up. In the past, currency could only be printed
commensurate to the amount of gold that a country or financial institution had.
Furthermore, there is currently no effective way to regulate or determine the amount
of fiat money or currency that can be printed. There are no generally recognized or
efficient international conventions on the matter. From time to time countries enter
disputes concerning currency policies, because they are often deemed to be highly
unfair.
There are three important features of the current monetary and economic
systems: 541 (1) the creation of fiat or paper money that is not backed by gold, (2)
fractional reserve requirements that compelbanks to keep a fraction of the deposits
made by its customers as reserves and (3) interest that is normally computed on a
compounded basis.
There have been an increasing number of voices raised against the use of
unregulated currency in its current form, due to the hidden and apparent dangers. For
example, Meera (2002) argued that a weaker nation cannot completely liberate itself
from foreign dominance unless it adopts gold currency and rejects interest. 542
The present-day international monetary arrangementas shaped by the Bretton
Woods system encourages an interest-based system in which excessive speculation is
common yet, at the same time, effectively curtails a country’s ability to pursue
alternative policies. According to Askari, Iqbal, Krichene and Mirakhor (2010):
Exchange rate regimes can impart discipline or afford total freedom to central banks
and government decision makers. Fixed exchange rates, as under the Bretton Woods
system, limit a country ability to pursue independent monetary and fiscal policy.
Under fixed exchange regimes, a country’s ability to pursue an independent policy is
dictated by the maximum differential between the domestic rate of interest and the
rate in other countries that can be achieved before reserves began to flow out. 543
Meera also proposed that the root problem ‘lies in the nature of money as defined in
the existing monetary system’. 544One possible method would be to use gold as an
541
Ahamed Kameel Mydin Meera, The Islamic Gold Dinar (Pelanduk Publications (M) SdnBhd 2002)
542
Ahamed Kameel Mydin Meera, The Islamic Gold Dinar (Pelanduk Publications (M) SdnBhd 2002)
102.
543
Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor, The Stability of Islamic
Finance: Creating a Resilient Financial Environment for a Secure Future (John Wiley & Sons (Asia)
Pte. Ltd 2010)
544
Ahamed Kameel Mydin Meera, The Islamic Gold Dinar (Pelanduk Publications (M) SdnBhd 2002)
227
alternative global currency. Unlike paper money, gold is limited in nature and cannot
be printed or produced without limitation or reserve.
However, researchers have also noted that when the world used the gold standard
both before and after World War I, crises were transmitted by fixed exchange rates
and in the ‘interwar’ realm when credibility was low and the ‘golden fetters’
prevented many countries from offsetting them and the alternating waves of inflation
and deflation that reflected the automatic operation of the pre-1914 gold standard may
have triggered the financial instability that led to crises. 545
In other words, a return to a gold standard is not sufficient on its own, but must
be accompanied by a series of assertive actions to ensure the smooth transfer to a new
system. Meera also proposed that, in a dual system in which Islamic banks operate
using paper/fiat money within an interest-based financial system, the Islamic bank
would also contribute to the main problem by being involved in creating money via
its link to the conventional banking system, ie fiat money, fractional reserve
requirements and interest rates. 546
Even if a gradual return to gold and silver money is not made, other efforts to
reduce uncertainty in the global monetary system should still be pursued. For example,
according to Ibrahim:
Moreover, while we note that money supply has a stochastic trend and does not play
the role of disequilibrium adjustment, it does not imply that money supply is
uncontrollable. Indeed, there are various studies supporting the ability of monetary
authorities to control the stock of money supply through the use of monetary
instruments or to institute rules that support monetary stability. Thus, with the strong
link between money supply growth and inflation, the monetary authorities can ensure
monetary stability. Indeed, the various mechanisms and rules that have been adopted
by many nations such as European Monetary Union, currency board, or inflation
targeting are attempts made to ensure price stability. In other words, the main issue
seems not to be the forms of monetary standards but the choice between rules and
discretion. The gold standard contains a set of credible rules to ensure price stability
but at the expense of discretion, which might be needed during the time of crisis. By
contrast, the monetary policy under the fiat system as practiced suffers from time
inconsistency problem due to discretionary power given to the monetary authority.
545
Michael D. Bordo and John S. Landon-Lane, ‘The Global Financial Crisis of 2007-08: Is it
Unprecedented?’ (2010) National Bureau of Economic Research (NBER) Working Paper Series.
546
Ahamed Kameel Mydin Meera, The Islamic Gold Dinar (Pelanduk Publications (M) SdnBhd 2002)
42.
228
The issue is thus on how to design set of rules within the fiat system that can alleviate
time-inconsistency problems. 547
A number of advantages have been offered for returning to gold dinar, as identified
by Meera and Aziz (2002): 548
i.
ii.
iii.
iv.
v.
Stable money
Excellent exchange medium
Minimization of speculation, manipulation and arbitrage
Minimization of business cycle effects
Dinar promotes trade
Furthermore, attempts to legitimize the use of gold as money have not been limited to
Muslim countries or Muslim scholars. For example, according to Ledoit and Lotlz:
The primary objective of the Swiss parliamentary initiative is clear: to make Gold
become Commodity Money if people want it, i.e. to monetize Gold. This is done by
developing a legislative framework where Gold coins can legally be bought, sold, and
minted (and presumably melted) tax- free. Standardization of Gold coins and
certification of Gold contents by a trusted authority are important also as it should
reduce cognitive costs as well as verification costs. Furthermore, if one Gold Franc is
defined as 0.1 gram of gold, which is a very small quantity, then minting coins of 1, 2,
5, 10, 20 and 50 Gold Francs (containing respectively 0.1 gram, 0.2 gram, 0.5 gram, 1
gram, 2 grams and 5 grams of Gold) would greatly enhance the divisibility of Gold,
which is the primary, and required characteristic of any object that may be used as
money. 549
The Case against Gold Reform
Despite the problems with and objections against fiat money, many scholars have
admitted that the present-day monetary systems are here to stay. For example,
according to Dooley, Folkerts-Landau and Garber:
547
Mansor H. Ibrahim, ‘Monetary Dynamics and Gold Dinar: An Empirical Perspective’ (2006)
Journal of King Abdul Aziz University Islamic Economics, Vol.19, No.2, 3-20.
548
As quoted in Grace H.Y. Lee, ‘Gold Dinar for the Islamic countries?’ (2011) Economic Modelling,
1575.
549
Olivier Ledoit and Sebastien Lotz, ‘The Coexistence of Commodity Money and Fiat Money’
(2011) Working Paper No. 24, Department of Economics, University of Zurich
< http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1939036> accessed 20 November 2011.
229
The severe common shock to global demand and expectations and uncertainty about its
size and duration will for some time dominate the overall performance of both industrial
and emerging market economies. There certainly will be important changes in the
structure of financial intermediation within and between national markets. This certainty
follows from the quasi-nationalization of key financial centre banking systems. All
intermediation, including that for the international capital flows that support the Bretton
Woods II system, will be ‘taxed’ by risk aversion and higher intermediation spreads as
financial institutions are forced by market and prudential regulation to increase capital
relative to assets. However, there is no reason we can think of that suggests that this fact
favours an alternative international monetary system over Bretton Woods II. Financial
intermediation will eventually recover, and with it the incentives that made the US
private sector willing and able to borrow from emerging markets will again shape the
structure of current account imbalances. Meanwhile, government intermediation of the
financial system and government absorption of savings will carry the water for the
continuation of the system. 550
There are numerous objections to using the dinar from Muslim scholars as well. For
example, Cizakca is strongly against the return to gold:
At this point we may ask, if there is any fiqhi objection to the use of paper money.
Some of the most respected classical Muslim scholars, particularly Mohammad
al-Shaybani, Ibn Kayyim and Ibn Taymiyah did not limit currency to gold and silver
coinage only. Ahmad Ibn Hanbal ruled that there was no harm in adopting as
currency anything that is generally accepted by the people. Thus, these scholars,
among themselves, wide opened the way for Muslims of future centuries to use paper
money. Leading contemporary scholars like Yusuf al-Qaradawi and Muhammad Taqi
Usmani are also of the same opinion. 551
His arguments can be summarized as follows: 552
1. Islam is not against paper money
550
Michael Dooley, David Folkerts-Landau and Peter Garber, ‘Bretton Woods II still defines the
International Monetary System’ (2009) Pacific Economic Review, 14: 3, 310.
551
Murat Cizakca, ‘The case against Islamic Gold Dinar’ (2010) 5
< http://mpra.ub.uni-muenchen.de/26645/> accessed 20 November 2011.
552
Murat Cizakca, ‘The case against Islamic Gold Dinar’ (2010) 5
< http://mpra.ub.uni-muenchen.de/26645/> accessed 20 November 2011.
230
2. The Islamic view that money is not a commodity but purely a medium of
exchange has been vindicated
3. With paper money it is possible to reach a state of zero percent interest rate,
but with coinage it would be much more difficult to reach this state
4. The supply of coinage was never fixed, as the dinarists claim
5. Coinage cannot avoid inflation
6. Introducing dinar would create unshared uncertainty
7. Introducing the Islamic gold dinar would be harmful to the Islamic world
because, among other reasons, not many Muslim countries have large gold
reserves
8. A common currency for all Muslim countries accepted throughout the world is
a noble idea providing that the currency in question is made of paper, not gold
or silver
Furthermore, according to the keen observation of Muhayiddin, Ahmed and Ismail:
Although gold (dinar) offers very good purchasing power, however there exist a few
physical constraints with the precious metal. The first of such constraints is it is
physically heavier and thus difficult to be carried around for normal daily transactions.
Secondly, due to its softness (malleability), the physical dinar would be subjected to
continuing “wear and tear” process if it were to be used repeatedly among the masses;
be it to be done intentionally or otherwise. It was reported in … that during the
civilization of the Roman Empire, their ordinary citizens would clip the precious
metal from the empire’s coins perimeter in order to steal some of the value stored in
the coins. The author further wrote that slaves during that time “sweated” the coins by
jiggling them in woolen bags hour after hour in order to wear-off some of the gold.
The third constraint that needs to be addressed would be how to identify the purity of
dinar denominations in each transaction such that fraud and cheating cases would be
minimized and if possible, to- tally prevented. The fourth is divisibility constraint
associated with the dinar. In today’s price, the value of 1 dinar is in the range of
RM800-RM850 a piece, thus making it impractical for buying of small-priced items.
The last constraint of physical dinar is the possible consumer losses due to the
existence of buying and selling prices (known as spread) imposed by dinar traders.
Shop owners will accept the value of physical dinar at buying prices (lower) instead
of at selling prices (higher). Therefore those issues of portability, wear and tear,
231
purity concern, divisibility and the dinar spread—all of them must be properly
addressed in order for dinar to be widely accepted by the public. 553
One solution would be the gradual adoption of gold money alongside paper money.
Therefore, the benefits of gold money could be maintained together with the benefits
of paper money. However, a few important rules would have to be observed. For
example, gold and paper money each have their own intrinsic value. In a market in
which paper money is used alongside gold money, currency speculators will attack
the value of the paper money to get the gold at a cheaper price. Therefore, the holder
of gold money or dinar should not exchange it for paper money when the value falls
below the intrinsic value for the gold. More research is required to elaborate on this
concept, but it would be possible to have separate markets for gold and paper money,
if required.
Another interesting solution has been offered by some scholars, specifically the
adoption of a gold dinar-based electronic payment system. This would basically be a
combination of a gold monetary system and electronic commerce somewhat similar to
the gold standard concept. According to the research of Muhayiddin, Ahmed and
Ismail, most of the people in a country like Malaysia generally agree with the idea of
using the proposed gold/dinar-based payment system. 554
There are benefits and disadvantages to adopting gold currency or a gold
standard. The same can be said for paper money. The Islamic principles regarding
monetary systems include the rejection of usurious elements alongside the rejection of
manipulations, injustice, unfairness and excessive speculation. While the views
among scholars and experts differ, all unanimously agree that a monetary system
should be just and fair. It has been proposed that a monetary system in which paper
money can be printed without real limitation, while it may have its benefits including
liquidity, create an overall effect that is more harmful than beneficial. Furthermore,
gold and silver have been successfully used from the seventh to the fifteenth centuries
by various Muslim empires without serious difficulty. While it is true that inflation
and other issues can still occur due to supply-demand issues, such problems are not
due to the use of gold or the dinar. Furthermore, for Muslims, the use of gold and
silver is part of the Sunnah because the Prophet, himself, conducted trade and
commerce using gold and silver.
553
Mohd-Nazri Muhayiddin, Elsadig Musa Ahmed, Hishamuddin Ismail, ‘Technology Acceptance of
a Gold Dinar Based Electronic Payment System’ (2011) iBusiness, 3, 297.
554
Mohd-Nazri Muhayiddin, Elsadig Musa Ahmed, Hishamuddin Ismail, ‘Technology Acceptance of
a Gold Dinar Based Electronic Payment System’ (2011) iBusiness, 3, 295-301.
232
5.6 Conclusion
Avoidable uncertainties and risks must be eliminated to strengthen the legal
framework of global maritime trade. The various Islamic financial products that are
applicable to modern maritime trade reflect that Islamic principles are appropriate in
strengthening global trade, partly due to their prohibition of transactions tainted by
excessive speculation (gharar) and the fairer risk allocation they require.
This chapter highlights that although their adoption and popularity are still
relatively small, many Islamic financial products are already applicable in the
maritime trade industry. Although they are technically Shariah compliant, Islamic
financial products do not add value in other respects. To be truly attractive, financial
products must consist of better and fairer risk allocation. An in-depth analysis of
every Islamic financial product is outside the scope of this study. However, it remains
apparent that current Islamic financial products that cater to the needs of the maritime
trade industry are made with the same mentality applied to other modern Islamic
financial products. Products are modified rather than developed or enhanced. While
simplistic and minor changes that ensure Shariah compliance may serve the
short-term purposes of Islamic financial institutions, the true benefits of Islamic
principle application can only be obtained through meticulous and in-depth research
to develop new and better products.
This chapter also notes that excessive speculative activities are not exclusive to
maritime trade, but are also found in global trade and commerce in general. The
overall pervasiveness of excessive speculative activities is massive, and the harm
these activities cause has lately seemed to outweigh the benefits. International
monetary systems also present elements of uncertainty.It has been proposed that the
adoption of Islamic principles, including the rejection of excessive speculative
activities in areas such as monetary systems, must be meticulously implemented to
avoid unnecessary harm.
A growing body of literature is calling for a return to gold money, popularly
known in Muslim literature as dinar or gold currency. The essence of the argument is
that gold cannot be created or printed at will and is therefore more stable because it is
less vulnerable to excessive speculative activities.
Furthermore, gold has intrinsic value and, contrary to paper or fiat money,
always will have. However, one detailed study reveals that the gradual reintroduction
of gold should not be rushed and must be planned and executed carefully.
The benefits and harm of introducing gold are discussed in this chapter. Attempts
to use gold to settle import and export differences between Muslim countries, as
233
proposed by Malaysia, have failed due to an alleged lack of support from other
Muslim countries.
There has been an interesting development in this area. The Government of
Kelantan in Malaysia introduced the gold dinar in 2008 to be circulated and used for
trade and commerce alongside fiat or paper money. It was the first commercial
introduction of gold money by a Muslim state since the fall of the Ottoman Empire
almost 100 years ago. While the move was well received by the population, a lack of
support from the federal government due to perceived political differences has limited
its use.
Gold money creates its own uncertainty and doubts, particularly due to the
difficulty with verifying its origins. Contrary to paper or fiat money, gold is generally
more difficult to authenticate. However, in February 2012, Kelantan announced the
introduction of new gold money or dinar with an extra holographic security feature
that makes authentication easier. It is necessary to go beyond the current legal and
regulatory frameworks to benefit from Islamic finance. Although such frameworks
play an important role, economic and commercial realities must also be observed.
One of the major findings of this chapter is that scholars on both sides of the
monetary-system debate present strong arguments. The general perception by
Muslims that it is more Islamic to use gold currency is not entirely accurate. The
application of selective Islamic monetary principles to maritime trade must be made
meticulously. In a world where Muslim countries collectively own only around 4% of
the world’s gold, it may be dangerous and very unwise to insist on a return to gold
currency.
This chapter also covers an overview of the Islamic financial products currently
available in the maritime trade industry. The decision of a conventional bank such as
Maybank in Malaysia to offer Islamic financial products to the maritime trade
industry indicates its confidence in Islamic finance and its regulating principles. It
supports the hypothesis that such an application is feasible.
The actual benefit of and support for such products can only be measured after
time has passed. Future product enhancement or new product development research
must consist of collaboration between Islamic financial experts, conventional
financial experts, risk management teams and interested parties.
234
CHAPTER 6
RISK MANAGEMENT (AND ISLAMIC PERSPECTIVE)
The fact that people are full of greed, fear, or folly is predictable. However, the
sequence is not. Proper risk management is necessary. Risk cannot be totally
eliminated. However, it can be shifted to another party e.g. using insurance policy or
forward contract. It can be reduced with good management and proper internal control,
or avoided altogether, by avoiding risky transactions. Risk can also be shared in
suitable environment.
This chapter will first test the hypothesis at a much deeper level. The main
argument of this research is that the application of Islamic principles to the maritime
trade sector is realistic, useful and advantageous although simple cosmetic changes
are not adequate. To be more specific, this chapter analyzes the actual challenges and
risks faced by maritime trade industry and Islamic financial industry. As mentioned in
earlier chapter, there are four major risks associated with maritime trade; price risk,
credit risk, pure risk and legal risk. The analysis reveals that the application of Islamic
principles to maritime trade, in all four categories is possible although the actual
benefits will depend on the proper application of those principles.
This chapter can be classified into two parts; Part A and Part B. Part A discusses
the four risks associated with maritime trade while Part B is associated with legal risk
accompanyingIslamic finance. This chapter willstudythe complexity of the obstacles
and challenges. This chapter also shows that haste application of Islamic principles,
without meticulous consideration, can be harmful. A simple illustration is on the
analysis of Islamic finance in Malaysia as the dangerous effect of the legal risk is
revealed. The wrongful application of Islamic principles in the early stage of the
introduction of Islamic finance to the banking industry was costly to the
end-consumers. This should be avoided.
The ways in which the Malaysian and UK courts have decided on Islamic
finance cases reveal fundamental explanations of how its legal and regulatory
framework have developed along different economic agenda despite some similarity
in the legal system. The case analysis is crucial in the post-global recession world
where legal practitioners, experts and scholars who work across borders and from
diverse background need to understand how the system can be improved.
235
PART A: MANAGING RISK IN MARITIME TRADE
6.0 Introduction to risk management
A ship is safe in harbor, but that is not what ships are for. It is in the nature of
maritime trade to take calculated risks. Price, credit, pure and legal risks are some
factors that must be manage meticulously by parties brave enough to venture into this
fragile, risky yet lucrative industry. Proper risk management, particularly the correct
use of financial products like derivative instruments, insurances, documentary letter of
credits and efficient dispute resolution mechanism eg arbitration is essential to ensure
the maximization of profit in maritime trade while reducing unnecessary risks.
The previous chapters highlighted the possible application of Islamic finance on
global maritime trade. This chapter goes beyond that. It examines the risk
management system in maritime trade, with special focus on an Islamic
perspectivetowards risk management. Harmonization with Islamic principles is
possible and managing risks in ways that are consistent with the principles and
safeguards provided in Islam will significantly reduce maritime trade risks.
This chapter concludes that risk management is an important aspect that cannot
be ignored in maritime trade. For those insisting on the adoption of
Shariah-compliantproducts and methods, various alternatives are now possible. To
benefit from the principles laid down in Islam, it is necessary to take concentrated and
coordinated effort, perhaps through the collaboration between established Islamic
financial institutions and risk management centers, to reform the concept from risk
transfer to efficient risk sharing.
The recent financial crisis is considered by many economists to be the worst
financial crisis since the Great Depression of the 1930s. The International Monetary
Fund estimated that the loss suffered by large US and European banks from 2007 to
2009 on toxic assets and bad loans alone are a few trillions. According to Simkovic:
To stabilize the financial system, as of November 2008, the federal government
committed over $3.5 trillion in taxpayer money. To put the scale of this commitment in
context, it is roughly 1.5 times the size of the federal government’s entire annual tax
receipts for 2007. 555
555
Michael Simkovic, ‘Secret Liens and the Financial Crisis of 2008’ (2009) American Bankruptcy
Law Journal, Vol. 83, 253
236
By the middle of 2010, the International Monetary Fund forecasted that“global bank
losses from the financial crisis will total $2.28 trillion” (a drop of $533 billion from
the earlier estimate made in October 2009) 556.
With proper risk management, the negative impacts can be reduced. For example,
China emerged from the downturn as one of the world’s biggest economic powers and
according to 2009 economic data, it replaced Germany as the world’s leading exporter,
with 10.7 percent growth in the fourth quarter of 2009. 557Prudent risk management
and business strategy will significantly reduce unnecessary risks during the up and
down of shipping cycle. For example, according to Lorenge:
In order to develop better strategies, shipping companies must focus on understanding
the underlying factors that affect global economic growth, supply and demand. It
seems to have been a tradition in the industry to focus more on the supply side availability of ships, shipyard capacity and so on. However, experience has shown
that it is the demand side that counts the most. The development of world trade and
economic activities are key[s]. With a better understanding of crucial underlying
factors, management should be able to forecast more accurately those that will truly
matter for their company and, therefore, be in better position to manage risk and
reduce the cost of capital. 558
According to Kluman:
For organizations, both profit and non-profit, a new need has arisen for an internal
function that continually asks the three questions, "what can go wrong?" "what can
we do about it?" and "how can we pay for it" and acts on the answers. This is risk
management, a discipline for living with the possibility that future events may cause
harm. 559
556
Martin Crutsinger, ‘IMF trims loss estimate from financial crisis’Associated Press (20 April
2010)<http://www.msnbc.msn.com/id/36662585/ns/business-world_business/t/imf-trims-loss-estimatefinancial-crisis/>accessed 15 October 2011
557
Liz Wells, ‘How Global Shipping Has Overcome the Recession’, Industry Focus: Logistics and
Distribution’, 27 August 2010,
<http://www.supplychaindigital.com/industry-focus/logistics-and-distribution/how-global-shipping-has
-overcome-recession>
558
Peter Lorange, Shipping Strategy: Innovating for Success (Cambridge University Press 2009) 35
559
H. Felix Kloman, ‘Risk and Response Beyond 2000,’ Risk Management (April 1995)68 as quoted
in Mark S. Dorfman, Introduction to risk management and insurance (7th edn, Prentice Hall 2002) 8
237
Risk management can be a complicated subject. However, there are many advantages
and benefits of having proper risks management in maritime trade. It will provide for
a defensive mechanism against foreseeable and unforeseeable problems. For example,
marine insurance can absorb some of the losses related to damages of goods while
derivatives and hedging can deal with some of the uncertainties related to freight rate
and other operational costs. Efficient documentary credit will enable a better
allocation of risks related to default of payment. The establishment of clearinghouse
further reduces credit risks and eliminates counterparty risk related to future freight
derivatives etc.
Efficient risk management will also be useful for correct calculation of profit and
possible loss. Time and cost can also be put to a better use eg by avoiding
unnecessary and lengthy litigations. Furthermore, it will enable the shifting,
transferring or sharing of risks to parties more suitable and equipped to face it.
Maximization of profit will happen as the operational cost can be minimized.
On the other hand, failure to use proper risk management is fatal. Firstly, there is
the risk of loss revenue and profit. Some of the unnecessary loss is actually avoidable
in nature. There will be extra costs eg to carrier due to lost opportunities or increase in
operational costs. It will also disturb the cash flow and liquidity of the parties. In the
worst scenario, the parties’ business might end up with huge amount of debts and it
has towind up.
6.1 Classification of maritime trade risk
As mentioned in earlier chapter, there are 4 major types of risk; price risk, credit risk,
pure risk and legal risk. Before proceeding, reference can first be made to the concept
of risk management or risk assessment by PricewaterhouseCoopers:
Risk assessment is a systematic process for identifying and evaluating events
(i.e.,possible risks and opportunities) that could affect the achievement of
objectives,positively or negatively. Such events can be identified in the
external environment(e.g., economic trends, regulatory landscape, and
competition) and within anorganization’s internal environment (e.g., people,
process, and infrastructure). Whenthese events intersect with an organization’s
objectives—or can be predictedto do so—they become risks. Risk is therefore
defined as “the possibility that anevent will occur and adversely affect the
achievement of objectives.” While organizations have been conducting risk
assessments for years, many still find it challenging to extract their real value.
238
The linkage of risk assessment todrivers of shareholder value and key
objectives has sometimes been lost. Riskassessments can be mandated by
regulatory demands—for example, anti-moneylaundering,Basel II, and
Sarbanes-Oxley compliance all require formalized riskassessment, and focus
on such processes as monitoring of client accounts,operational risk
management, and internal control over financial reporting. Riskassessments
can also be driven by an organization’s own goals, such as
businessdevelopment, talent retention, and operational efficiency. Regardless
of the scopeor mandate, risk assessments must bring together the right parties
to identifyevents that could affect the organization’s ability to achieve its
objectives, ratethese risks, and determine adequate risk responses. 560
6.1.1
Price Risk
In 2004, the total value of the world import trade was estimated at $9.2 trillion while
the cost of freight was merely $270 billion (representing only 3.6% of the total value
of world trade). 561 By 2010, world merchandise exports alone were estimated as
$15.2 trillion, despite global recession. 562 To benefit from this huge global trade, it is
important for all parties to manage price risk accordingly. Price risk includes the
changes and uncertainties in freight rate, operational cost, and basic demand and
supply. To a certain extent, price risk is also related to legal risk eg rules and
regulation as the cost and price can be seriously affected by changes in law. If a
country prohibited the shipment of its sand to a specific neighboring country, the price
of sand in the neighboring country will usually increase. Besides that, price risk can
also involve uncertainties related to exchange currency risk. 563
560
PricewaterhouseCoopers, ‘A Practical Guide to Risk Assessment’ (December 2008)
<http://www.pwc.com/en_us/us/issues/enterprise-risk-management/assets/risk_assessment_guide.pdf>
accessed 20 November 2012
561
United Nation, Review of Maritime Transport, 2006 (Table 41) as quoted in Martin Stopford,
Maritime Economics, 3rd edition (Routledge 2009) 73
562
‘World Trade Report 2011: The WTO and preferential trade agreements: From co-existence to
coherence’ WTO Publications (Switzerland 2011)
<http://www.wto.org/english/res_e/booksp_e/anrep_e/world_trade_report11_
e.pdf> accessed 17 October 2011
563
For alternatives on reducing currency risk and strengthening global monetary system, see Ahamed
Kameel Mydin Meera, The Islamic Gold Dinar (Pelanduk Publications (M) Sdn Bhd2002); Lucio
Sarno and Mark P. Taylor, The Economics of Exchange Rates (Cambridge University Press 2002);
239
While price risks that are due to basic supply and demand is largely beyond the
control of the parties, price risks that are related to operational costs and freight rates
can often be managed using derivatives. The use of derivative by shipping company is
very common nowadays. For example, according to Pacific Basin Annual Report
2010:
The Group’s activities expose it to a variety of financial risks: market risk (including
charter rate risk, interest rate risk, bunker price risk, foreign exchange risk and equity
securities price risk), credit and counterparty risk and liquidity risk. The Group’s
overall risk management programme seeks to manage and minimise potential adverse
effects on the Group’s financial performance whilst leaving the Group exposed to
levels of risk that are considered acceptable. The Group uses derivative financial
instruments to mitigate certain risk exposures. 564
Jacque defined derivatives as “financial contracts, whose value is “derived” from the
future price of an underlying asset such as currencies, commodities, interest rates,
and stock price indices”. 565
The most common forms of derivatives include swaps, forwards, futures and
options. In the shipping industry, derivatives are used to provide leverage, to hedge or
mitigate risk, to speculate and make profit, and also to create option. Poitras defines
an option contract as “an agreement between two parties in which one party, the
writer, grants the other party, the purchaser, the right, but not the obligation, to
either buy or sell a given security, asset, or commodity at a future date under stated
conditions" 566.
Global maritime trade was already very successful in maintaining operational
cost even when the cost of commodities it carried increased by 10 to 20 times. 567The
Nathan Lewis, Gold: The Once and Future Money (John Wiley & Sons, Inc2007); Hossein Askari,
Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor, The Stability of Islamic Finance: Creating a
Resilient Financial Environment for a Secure Future (John Wiley & Sons (Asia) Pte. Ltd2010)
564
‘Pacific Basin Annual Report 2010’
<http://www.pacificbasin.com/UserFiles/upload/FinancialReporting/e2343_Annual_Report2010.pdf>
accessed 10 January 2012
565
Laurent L Jacque, Global Derivative Debacles: From Theory to Malpractice (World Scientific
Publishing Co. Pte. Ltd 2010) 2
566
Geoffrey Poitras, Risk Management, Speculation, and Derivative Securities (Academic Press 2002)
7
567
Martin Stopford, Maritime Economics (3rd edn, Routledge2009)74
240
use of derivative to mitigate pure risk is nowadays a standard practice. For example,
according to Pacific Basin Annual Report 2010:
The Group’s operating revenue principally comprises income from voyages carried
out by its fleet of vessels and this income is highly dependent on the prevailing
market conditions, as reflected in freight rates. In order to mitigate part of its future
freight exposure, the Group enters into Forward Freight Agreements (“FFAs”). These
FFA contracts, coupled with cargo contracts for the movement of cargoes, form part
of the Group’s overall revenue cover for its physical fleet of vessels. This cover is
expected to be at least 50% of the next 12 months’ vessel voyage capacity. The
Group enters into FFAs on a limited basis under the policy approved by the Board of
Directors to manage its exposure to charter rate risk arising from uncovered tonnage
and outstanding cargo commitments. 568
Different parties in maritime trade will face different types of price risk. For example,
a ship-owner usually trades in at least four different markets 569:
1.
2.
3.
4.
The new-building market where he ordered the ships.
The freight market where he chartered them and concludes FFAs.
The sale and purchase market where he tried to sell the ship.
In some cases, the demolition market where he actually sell the ship (in the
event where he failed in the sale and purchase market).
The price risk for the ship-owner will include the uncertainty in the amount that the
ship-owner can get when he chartered the ship. The price risk will also include the
uncertainty related to the selling price of the ship and other operational costs. For
shippers of goods eg sellers of commodities, the price risk will include the
uncertainties related to the selling price of the commodities, the cost of chartering a
ship etc.
Different parties will adopt different methods to manage their price risk. Often,
parties will also use financial products eg derivative instrument to secure their interest.
The first attempt at freight derivatives trading was via the Baltic International Freight
Futures Exchange (BIFFEX) set up in 1985. Derivatives allow risks eg those related
to freight risk to be transferred from one party to another. For example, a shipper and
568
Pacific Basin Shipping Limited’s Annual Report 2010, 101
<http://www.pacificbasin.com/UserFiles/upload/FinancialReporting/e2343_Annual_Report2010.pdf>
accessed 10 January 2012
569
Martin Stopford, Maritime Economics (3rd edn, Routledge2009)175
241
a carrier could sign a futures contract to exchange a specified amount of cash for a
specified freight rate in the future. This is beneficial to both: for the carrier, the
availability of cash and client while for the shipper, the future risk related to the
uncertainty of freight rate can be reduced. The problem with using derivatives to
manage pure risk in its current form is it increases speculative risk as speculators and
those who traditionally have no real interest in maritime trade and commerce joined
the market to speculate.
Derivatives can be used to acquire and speculate on risk, rather than to insure or
hedge against risk. This is quite similar to betting and gambling, albeit at a larger
scale. For example, only around 2.7% of total derivatives are used by end users, i.e.
corporations assumed to hedge their risks, while the majority, the remaining 97.3% is
used by dealers. 570This leads to a few controversial questions: Is the benefit of
speculative activities eg encouragement of large volume of trading, liquidity etc,
outweigh its harms and dangers? Will the financialization of the maritime trade
industry make it stronger and more resilient, or will it make it more volatile and
fragile? Is risk-transfer better than risk-sharing? All these questions are not merely
theoretical but have actual practical implications.
Speculators can make profit while the market is crashing. According to Guth:
Economists have sometimes conjectured that speculators profit from buying low and
selling high and thus tend to stabilize market prices. Others contend that speculators can
earn profits and simultaneously destabilize markets. The possibility of profitable
destabilizing speculations (PDS) affects the operation of competitive markets under
uncertainty. For if speculators may profitably destabilize, then clearly real world
markets can be unstable. However, if destabilizing speculators always lose money, then
in Darwinian sense they will fail to survive. 571
There are usually 3 main players in conventional derivatives; hedgers, arbitrageurs
and speculators; (1) Hedgers are those who use derivative market to manage or reduce
their risk, (2) arbitrageurs use derivative markets to obtain a profit from price
570
Asyraf Wajdi Dusuki, ‘Shariah Parameters on Islamic Foreign Exchange Swap as Hedging
Mechanism in Islamic Finance’ (International Conference on Islamic Perspectives on Management and
Finance, University of Leicester, 2-3 July 2009) 19
571
Michael A.S. Guth, Speculative Behaviour and the Operation of Competitive Markets under
Uncertainty (Avebury 1994) 7
242
differentials between market, and (3) speculators are those who expose themselves to
risk in the market in anticipation of profit from their taken speculations. 572
Under insurance contract, only those with insurable interest are allowed to
participate to avoid the element of gambling and gaming from creeping in. According
to Dorfman:
For insurance to operate efficiently, the insured should have an incentive to prevent or at
least regret the loss. If the insureds are indifferent to losses, the insurance pool will
experience greater losses than predicted. The increased losses in turn will require higher
insurance premiums. Soon many insureds will not be able to afford the insurance, and
the whole system will collapse. For this reason, our law requires insureds to demonstrate
insured events represent a loss to them personally. This requirement is known as the
doctrine of insurable interest?. 573
Therefore, one might wonder why those without any real interest to protect are
allowed to participate in freight derivative instruments. The answer is because the
total volume of trading will be bigger with the participation of these speculators and
their huge funds. This will in turn create more liquidity (and volatility).
Corporate losses arising from derivatives trading are huge. For example, below
are some of the corporate losses arising from derivatives trading 574:
572
Sherin Kunhibava, ‘Flexibility versus Fairness Conventional Derivatives and Islamic Derivatives’
in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Reading in Islamic
Finance (CERT Publications Sdn. Bhd, Malaysia, 2008) 563
573
Mark S. Dorfman, Introduction to risk management and insurance (7th edn, Prentice Hall 2002) 27
574
Chance (1998), Jorion (2001), Williams (1995) and McCarthy (2000) as quoted in Geoffrey Poitras,
Risk Management, Speculation, and Derivative Securities (Academic Press, 2002) 26
243
Table 9: Corporate losses from derivatives trading
No Year Company
575
Losses
Type
$132 million
Silver futures
1
1979 Minpeco S.A. Peru
2
1980 Hunt
companies 576
3
1988 Hammersmith
Fulham 577
4
1993 Showa Shell Sheikyu 578
¥166 billion
Currency
forward
5
1993 Metallgesellschaft 579
$1.89 billion
Oil futures and supply
(Energy derivatives)
6
1994 Codelco, Chile 580
$207 million
Copper futures
$1.45 billion
Currency derivatives
$423 million
Interest rate swap
7
1994 Kashima Oil
Brothers' $1.1
(est)
billion Silver Futures
and £500
to Swaps
£600million
581
582
options
8
1993 Proctor and Gamble
9
1994 Piper Jaffrey Companies
$700 million
Mortgage Derivatives
10
1994 Sears
$237 million
swaps
11
1994 Orange
California 583
575
County, $1.8 billion
and
Reverse Repos
For details, see Jerry W. Markham, ‘Manipulation of Commodity Futures Prices – The
Unprosecutable Crime’ (1991) Yale Journal on Regulation, Vol.8, 281
576
Jerry W. Markham, ‘Manipulation of Commodity Futures Prices – The Unprosecutable Crime’
(1991) Yale Journal on Regulation, Vol.8, 281
577
Adam Tickell, ‘Creative finance and the local state: the Hammersmith and Fulham swaps affair’
(1998) Political Geography, Vol. 17, Issue 7, September, 865-881
578
Brandon Becker and Jennifer Yoon, ‘Derivative Financial Losses’ (1995-1996) Journal of
Corporation Law, Vol.21, 215-241
579
Brandon Becker and Jennifer Yoon, ‘Derivative Financial Losses’ (1995-1996) Journal of
Corporation Law, Vol.21, 215-241
580
Paul Stonham, ‘Whatever happened at Barings? Part one: The lure of derivatives and collapse’
(1996) European Management Journal, Vol.14, Issue.2, 167-175
581
Paul Stonham, ‘Whatever happened at Barings? Part one: The lure of derivatives and collapse’
(1996) European Management Journal, Vol.14, Issue.2, 167-175
582
Paul Stonham, ‘Whatever happened at Barings? Part one: The lure of derivatives and collapse’
(1996) European Management Journal, Vol.14, Issue.2, 167-175
244
12
1995 Barings Bank, PLC 584
£800 million
13
1996 Sumitomo Corporation 585
$1.8 to $2.62 Copper futures
billion
14
1998 Long-term
Management
15
1999 Ashanti, Ghana
$570 million
Glod exotic derivatives
16
2001 Enron 586
$1.2 billion
Energy derivatives
Capital $4.4 billion
Stock index futures and
options
Numerous positions
There are benefits associated with speculating although the harms seem to outweigh
the benefits. According to Angell:
Futures speculation serves to permit risks to be undertaken by those who are willing and
able to assume them by separating the risk-bearing function (borne by the speculator)
from the production and marketing function (borne by the hedger). A farmer, who may
excel at growing corn, wheat, or soybeans, yet who may not be inclined to let
indeterminable market conditions dictate his profit or loss, can transfer the risk involved
in growing commodities to those who will voluntarily accept those risks: the speculators.
Both participants, therefore, operating in their own self-interest, derive value from their
trading operations in the futures markets. In this manner, speculator and hedger
complement one another- and both stand to benefit from the relationship. 587
Derivatives have its benefits although it can be a really risky business. For example,
in the Barings bank case, a single man in Singapore could single handedly devastate
583
Edward S. Adams and David E. Runkle, ‘The easy case for derivatives use: Advocating a corporate
fiduciary duty to use derivatives’ (1999-2000) William and Mary Law Review, Vol. 41, 595
584
Paul Stonham, ‘Whatever happened at Barings? Part one: The lure of derivatives and collapse’
(1996) European Management Journal, Vol.14, Issue.2, 167-175
585
Bill Dorman, ‘Corporation hikes its original loss estimate from $1.8 billion to $2.6 billion’ CNN
Money (Tokyo, 19 September 1996) < http://money.cnn.com/1996/09/19/companies/sumitomo/>
accessed 10 January 2012
586
Gerald Vinten, ‘The corporate governance lessons of Enron’ (2002) Corporate Governance, Vol. 2
Issue.4, 4 - 9
587
George Angell, Winning in the Futures Market (Probus Publishing Company 1990) 25
245
one of the oldest (1762 to 1995) and largest bank in England by trading in Japan using
derivative instruments. 588
The use of derivatives in maritime trade will nonetheless continues as derivatives
offer various ‘adds-value’ previously unavailable. However, the use of derivatives
should not be due to misconception that freight rate is inevitably high as commodity
freight is now a much smaller proportion of costs than it were 30 years ago. 589 For
example, in 1960 the oil freight was 30% of the cost of a barrel of Arabian light crude
oil delivered to Europe but it had fallen to less than 5% in 1990 and remains more less
the same until 2004. 590
Currently, the main objection against derivative comes from Islamic finance
scholars, particularly due to ‘excessive uncertainties’ found in some of the derivative
instruments. However, strong criticism also comes from experts and scholars of
conventional finance. 591 For example, the history show that futures, options and
derivatives trading were banned numerous times in Europe and Japan and even in the
United States in the state of Illinois in 1867. 592 The reason of the ban is partly due to
its anomaly; created to manage and hedge risk but largely used for speculation and to
gamble for profit. 593
The rationale of using current derivatives instrument in managing price risk is
due to the various benefits and ‘added-value’ that it has to offer. According to Blanco
and Aragones:
A 2005 study by the New York Merchantile Exchange (see Nymex 2005)
concluded that hedge-fund activity was overall positive for crude-oil and
natural-gas markets. The hedge funds comprised a relatively modest share of open
interest and trading volume. In addition they found that hedge funds hold positions
588
Sherin Kunhibava, ‘Flexibility versus Fairness Conventional Derivatives and Islamic Derivatives’
in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Reading in Islamic
Finance (CERT Publications Sdn. Bhd2008)572
589
Martin Stopford, Maritime Economics (3rd edn, Routledge2009)74
590
Martin Stopford, Maritime Economics (3rd edn, Routledge 2009)74
591
For example, see Satyajit Das, Extreme Money: Masters of the Universe and the Cult of Risk (FT
Press 2011) and Nicholas Dunbar, The Devil’s Derivatives (Harvard Business Review Press 2011)
592
Sherin Kunhibava, ‘Flexibility versus Fairness Conventional Derivatives and Islamic Derivatives’
in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Reading in Islamic
Finance (CERT Publications Sdn. Bhd2008)562
593
Sherin Kunhibava, ‘Flexibility versus Fairness Conventional Derivatives and Islamic Derivatives’
in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Reading in Islamic
Finance (CERT Publications Sdn. Bhd2008) 562
246
significantly longer than the rest of the market, which seems counterintuitive given
the short-term nature of many of the hedge fund strategies. The study concluded
that hedge funds are non-disruptive source of liquidity to the market, and their
increasing presence is not the cause of increased price volatility (the Nymex study
actually claims that the "data strongly indicate that changes in Hedge Fund
participation result in decreases in price volatility. 594
Two main derivatives instrument are forward contracts and future contract. Forwards
are basically a “legally-binding contracts calling for the future delivery of an asset in
an amount, at price and at a date agreed upon today”. 595
In a forward contract, the parties conducting maritime trade will agree
tocomplete a transaction at a future date but at a price agreed today. For example, the
parties can be a furniture company (the shipper) and a carrier (a shipping company).
The shipper needs to ship a few cargos of high quality furniture from Indonesia to
Hong Kong in 9 months. Both parties are faced with price risk. If the freight rate
increases, the shipper will suffer loss. However, if the freight rate decreases, it is the
carrier whichwill suffer loss. If both parties enter into a forward contract, the price
risk will be reduced. Since both parties have ‘locked-in’ their price, they would be in
a better position to plan their business activities. 596
The need to have a proper allocation of risks has long been recognized. In the
past, those in the agriculture sector especially the farmers were fully aware of the risk
that the prices of agricultural products might fall due to a few predictable reasons. 597
During the harvest time, the price of the agricultural product will fall due to the
abundance of supply. If the product is supplied in a large quantity, perhaps due to
good weather, the price might fall even more. This is a simple demand-supply theory.
594
Carlos Blanco and Jose Ramon Aragones, ‘Risk Management Best Practices forInvestments in
Energy and Commodity Markets' in Hilary Till and Joseph Eagleeye (eds), Intelligent Commodity
Investing: New Strategies and Practical Insights for Informed Decision Making (Riskbooks2007) 455
595
Laurent L Jacque, Global Derivative Debacles: From Theory to Malpractice (World Scientific
Publishing Co. Pte. Ltd 2010) p2
596
Obiyathulla Ismath Bacha, ‘Derivative Instruments and Islamic Finance: Some Thoughts for a
Reconsideration’ in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Reading
in Islamic Finance (CERT Publications Sdn. Bhd, Malaysia, 2008) 582
597
M. Fahim Khan, ‘Islamic Futures and Their Markets: With Special Reference to their Role in
Developing Rural Financial Market’ (2000) Research Paper No.32, Islamic Development Bank (IDB)
Islamic Research and Training Institute
<http://islamfinland.files.wordpress.com/2009/08/idb-islamic-futures-and-their-markets.pdf>
accessed 15 November 2011
247
To protect themselves from the risk that the price will fall (perhaps to the extent that
loss might be suffered) the farmers and those in the agriculture products enter into
sale contracts specifying the future price of the products. This eventually led to the
concept of forward trading in the West during 18th and 19th century, which later
changed into contemporary futures market 598.
History has highlighted that forwards can act as “the financial weapon of mass
destruction” as reflected by its disastrous consequence towards Showa Shell, Citibank,
Bank Negara (the Central bank of Malaysia) and numerous other examples. 599
Although various benefits exist, there are arguably many problems with forward
contract in their current form including unfair price due to different bargaining power
between parties. Another major problem is the counterparty risk as there will be
tendency for the opposite party to default in their obligation once they suffer heavy
loss due to unexpected large movement in price. While a forward contract is legally
binding, it is a well-known fact that legal remedy is time-consuming and costly.
Hedge fund managers have become increasingly important player in commodity
derivatives trading, especially in market like crude oil. 600 These money managers
tend to maximize profit by alternating short and long-term position. The hordes of
hedge fund managers’ influx bring possible benefits and tremendous dangers at the
same time. Due to the huge size of their fund, it is expected that there will be a bigger
volume of trade. However, the dangers are more. The short term position often taken
by the hedge fund managers relies on automatic trading, determined by pre-defined
algorithms based on standardized strategy tends to combined and forced multiple
responses to their desirable directions. 601 In simple words, the speculators are not
598
M. Fahim Khan, ‘Islamic Futures and Their Markets: With Special Reference to their Role in
Developing Rural Financial Market’ (2000) Research Paper No.32, Islamic Development Bank (IDB)
Islamic Research and Training Institute
<http://islamfinland.files.wordpress.com/2009/08/idb-islamic-futures-and-their-markets.pdf>
accessed 15 November 2011
599
Laurent L Jacque, Global Derivative Debacles: From Theory to Malpractice (World Scientific
Publishing Co. Pte. Ltd 2010) p2
600
For example, see R.K Kaufman, ‘The Role of market fundamentals and speculation in recent price
changes for crude oil’ (2011) Energy Policy, Volume 39, Issue 1 (January)
601
‘World Economic Situation and Prospects 2011: A Joint Report of United Nations Department of
Economic and Social Affairs (UN/DESA), the United Nations Conference on Trade and Development
(UNCTAD) and the five United Nations regional commissions (ECA), (ECLAC), (ESCAP) and
(ESCWA)’
<http://www.un.org/en/development/desa/policy/wesp/wesp_current/2011chap2.pdf>
October 2011
248
accessed 17
merely speculating anymore. They are pushing or forcing their desired outcome based
on their large fund and standardized strategy.
There have been calls for stricter regulation of derivative, mostly from the
academic world although in the past, these calls seem to be unappealing due to the
benefits that these financial products offer to some of the parties. However, the recent
global recession and financial crises might force the politicians (due to public
demand) and regulators to adopt a stricter approach to prevent further abuse.
The idea that arbitrage activity will assist those in maritime trade achieve the
best price has also been questioned. For example, since risk increase with the degree
of perceived under-pricing or overpricing, individual arbitrageur might lack the
necessary fund to hedge against large risks, contrary to hedge fund managers, which
typically have no or less funding constraint and are able to manipulate the market. 602
Another big problem with derivatives is that it might severe the link between the
real price of the commodity. For example, recent study has refuted the proposition
that increased demand for commodities in emerging market was the main reason for
the sudden commodity price hike in 2006 to 2008 and strongly supported the
hypothesis that financialization was at least equally as important. 603
In addition to using derivative instrument to reduce price risk, some of the risks
associated with cost can be avoided by adopting efficient business strategy. For
example, taxation should not be a prominent figure in the account of most bulk
shipping companies as it is possible to avoid tax by registering a company under one
of the open registry flags which exempt shipping companies from tax 604. Proper
business management and excellent business strategy will significantly reduce
unnecessary price risk.
602
For example, see A. Shleifer and R.W Vishny, ‘The limit of arbitrage’, Journal of Finance, Vol. 2,
No.2,737-783
603
Peter Wahl, ‘Food Speculation: The Main Factor of the Price Bubble in 2008’ (2009) World
Economy, Ecology & Development Research Paper
<http://www2.weed-online.org/uploads/weed_food_speculation.pdf> accessed 10 January 2012
604
Martin Stopford, Maritime Economics (3rd edn, Routledge 2009)241
249
6.1.2
Credit Risk
All the perplexities, confusions, and distresses in America arise, not from defects in their
constitution or confederation, not from a want of honor or virtue, so much as from
downright ignorance of the nature of coin, credit, and circulation. 605–John Adams, the
second President of the United States (1797-1801)
The uncertainty and risk related to the capability and willingness of the other party to
make timely and full payment is, needless to say, very serious. Liquidity and proper
cash flow must be strictly observed in any business. For small-scale business, it is
possible to get paid up front, or cash in advance before shipping the goods. However,
few customers will be agreeable to such payment terms. There is also a possibility
that the delivered goods are defective or loss.
Modern global trade operates based on credit. The issue nowadays is not whether
a party to maritime trade should get a credit or not but on the proper techniques to
manage the credit risk. This is despite the fact that the dangers of credit are long noted.
According to Daniel Webster in his remarks to the senate in 1834:
Credit is the vital air of the system of modern commerce. It has done more, a
thousand times, to enrich nations, than all the mines of all the world. It has excited
labor, stimulated manufactures, pushed commerce over every sea, and brought every
nation, every kingdom, and every small tribe, among the races of men, to be known to
all the rest. It has raised armies, equipped navies, and, triumphing over the gross
power of mere numbers, it has established national superiority on the foundation of
intelligence, wealth, and well-directed industry. Credit is to money what money is to
articles of merchandise. As hard money represents property, so credit represents hard
money; and it is capable of supplying the place of money so completely, that there are
writers of distinction, especially of the Scotch school, who insist that no hard money
is necessary for the interests of commerce. I am not of that opinion. I do not think any
government can maintain an exclusive paper system, without running to excess, and
thereby causing depreciation. 606
605
John Adams, letter to Thomas Jefferson (August 25, 1787) in John Adams and Charles Francis
Adams, The Works of John Adams, Second President of the United States: With a Life of the Author,
Notes and Illustrations, John Adams (Little Brown 1856)
606
Daniel Webster, remarks in the Senate in favor of continuing the charter of the Bank of the United
States (March 18, 1834) in Daniel Webster, The Writings and Speeches of Daniel Webster: Diplomatic
Papers and Misellaneous Letters (Kessinger Publishing 2006)
250
Credit risk is often managed using financial products. For example, Pacific Basin
Annual Report 2010 stated:
The functional currency of most of the operating companies within the Group is United
States Dollars as the majority of the transactions are denominated in this currency. The
Group operates internationally and is exposed to foreign exchange risk arising from
non-functional currency transactions. In addition, foreign exchange risk arises from the
purchase of vessels in foreign currencies. To mitigate such exposure, the Group enters
into forward foreign exchange contracts to hedge its future purchase payments with
terms that match the payment schedules of the vessels. The Group has limited exposure
to the fluctuation of foreign exchange rate. 607
Credit risk will cause losses if not managed properly. According to the China
Shipping Container Lines Company Limited Annual Report 2010 (pg.20-21):
Most of the revenues of the Group are settled in USD. The Group recorded a net
exchange loss of approximately RMB27, 822,000, which was mainly due to
fluctuations of exchange rate in Euro Zone and the exchange difference which
charged to shareholders’ equity amounted to RMB245,347,000. The Group will
continue to watch closely the exchange rate fluctuation of RMB and major
international currencies and convert net foreign cash inflow from operating activities
into RMB in a timely manner so as to minimize the losses brought by foreign
exchange fluctuations, and take appropriate measures where necessary to reduce its
foreign exchange risk. 608
There are various ways to manage credit risk. Firstly, to reduce credit risk, the parties
should do credit check on their customers to ensure their credit worthiness. Credit
agencies, legal and accounting firms and sometimes government agencies can aid in
determining the credit worthiness of the parties. 609
The status report of potential customers’ credit worthiness can be purchased
from credit agencies. Such reports usually include the details of the potential
customers, their payment history with other suppliers/traders, court judgments (if any)
607
‘Pacific Basin Annual Report 2010’
<http://www.pacbasin.com/UserFiles/upload/FinancialReporting/e2343_Annual_Report2010.pdf>
accessed 10 January 2012
608
‘China Shipping Container Lines Company Limited Annual Report 2010’
<http://www.cscl.com.cn/uploadfile/prospectus/11050901en.pdf> accessed 10 January 2012
609
Teresa Chew, The Art of Shipping (Times Edition- Marshall Cavendish2005)
251
and a recommendation of credit rating. However, credit rating is just a professional
opinion, not a guarantee. According to S&P:
Credit ratings are not absolute measures of default probability. Since there are future
events and developments that cannot be foreseen, the assignment of credit ratings is not
an exact science … Instead, rating express relative opinions about the credit worthiness
of an issuer or credit quality of an individual debt issue, from strongest to weakest,
within a universe of credit risk. 610
Secondly, the management of credit risk is largely dependent on letter of credit as it
offers a high degree of security. The guarantee of payment from the bank via the letter
of credit is usually sufficient. Documentary letters of credit will reduce the credit risks,
as it does not rely on the ability of the opposite party to pay. Since letter of credit is
internationally recognized, it is even possible to use it to set up discounting or loan
arrangement.
There are various motivations for parties using letters of credit. For exporters,
the letters of credit guaranteed payment (upon presentation of the documents). The
letters of credit will transfer the credit risk from the buyer/importer to the issuing bank.
For example, even if the buyer goes bankrupt, the bank is still obliged to pay. It will
also assist in obtaining financing. It will further reduce credit risk as the buyer cannot
refuse payment by complaining about the goods. Since the buyer must raise
complaints (if any) separately from the letter of credit, there will be better chance of
settling arising matter peacefully as the buyer cannot withhold payment by using this
as excuse. For importers or buyers, using letters of credit will enable the party to
structure its payment plan. The importer can avoid pre-payment by using letters of
credit. There is also certainty that the payment will only be released upon arrival of
the shipment and upon presentation of proper documents.
The level of protection afforded by documentary credit is arguably higher
compared to mere bills of exchange when it is merged with negotiable instruments
like bills of lading. This is because the banks will efficiently and properly handles the
collecting and release of the documents, and the procedure is largely standardized.
The credit risk will increase if the parties fail to secure their interest properly.
For example, in the event of non-payment, the issue of priority will be fatal. Beside
the previous illustrations, the bigger problem is related to the uncertainty with the
priority or ranking of the contracts. Contrary to carriage of goods by land, the
610
Standard&Poors, ‘Guide to Credit Rating Essentials: What are credit ratings and how do they
work?’
<http://img.en25.com/Web/StandardandPoors/SP_CreditRatingsGuide.pdf>
October 2011
252
accessed
18
ownership and legal titles of the goods in carriage of goods by sea often change hands
during the shipment.
There is currently no error-free way to see the overall legal effect of the carriage
of goods by sea’s contracts (including its position, ranking or priority). The traders
involved will not be able to see with absolute certainty their overall risk nor to guess
confidently whether their interests are fully protected. 611
Lack of care in preparing documentary credit is sometimes rectifiable, but it will
be a waste of time and cost. About 60% of letters of credit are rejected at first
presentation due to incomplete or incorrect details on the related documents especially
on the bills of lading. 612 It is importance for parties to ensure that their staff are
trained and equipped with proper shipping knowledge.
Various precautionary measures can be adopted to reduce problems related to
documentary credit. For example, in addition to stipulating an expiry date for the
presentation of documents, all letters of credit should also stipulate a time limit after
the date of shipment for presentation of the documents and the deadline should be
within the validity date of the letters of credit and compliance with the terms and
conditions stipulated in the letter of credit. 613
Thirdly, credit risk is affected when the parties use derivative like freight
forward. The credit risk related to freight derivatives and the likes has been largely
reduced via the introduction of derivative and clearing house. There is a great credit
risk in the physical market where the time-charter contracts can be terminated if the
charterer does not pay his hire and some system is needed to ensure that on the
settlement date, the contracting parties will meet their obligations 614. This is where the
clearinghouse comes into picture.To effectively deal with credit risk issue related to
derivatives, traders were registered with a clearinghouse and their portfolio was
‘marked to market’ at the close of trading each day. 615
611
For comparison, this is different with other area of laws which value certainty more, like Torrens
land system. Under the Torrens system, there exists a registry, which listed all interests of the parties,
and interested purchaser (or anyone else) doesn’t have to go beyond the registry to see all the interest.
While system like BOLERO is capable to act as registry, its acceptance among the international traders
community is still low due to a few reasons.
612
Teresa Chew, The Art of Shipping (Times Edition- Marshall Cavendish 2005)
613
Teresa Chew, The Art of Shipping (Times Edition- Marshall Cavendish2005) 43
614
Martin Stopford, Maritime Economics (3rd edn, Routledge 2009)195
615
Martin Stopford, Maritime Economics (3rd edn, Routledge2009)196
253
According to Lorange:
Capital used to come from traditional shipping banks and "friends of friends". More
recently, however, capital increasingly has been coming from new sources, including
private equity, investment funds, professional investors, etc. The influx of new capital
changed the shipping industry significantly. As a result, financial performance, based
on conventional shipping industry criteria, is no longer as relevant. Instead,
performance expectations are increasingly dictated by the professional investment
community, as they are in other industries. 616
6.1.3
Pure Risk
Pure risk is a category of risk in which there is no beneficial outcome, only loss. Pure
risk includes the uncertainty that certain negative events, beyond the control of the
risk-takers can occur. Pure risk in maritime trade refers to actual physical damages
and other physical or real risks. It can be towards the ship, shipment, cargo, container
or the goods.
Using insurances, various type of risks related to maritime trade can be
effectively transferred to the insurance company. There are limitations. For example,
if the carrier failed to ensure that the ship is seaworthy in the first place, the carrier
might be liable and the damages and loss suffered during the voyage might not be
recovered from the insurance companies. There are many scenarios in which a ship
can be defective and unseaworthy:
616
•
•
•
•
Leaking hull: Lyon v Mells [1805] 1 KB 697
Leaking hatch covers: The Gundulic [1981] 2 Lloyd’s Rep 511
Leaking sea valve: McFadden v Blue Star Line[1905] 1 KB 697
porthole not capable of being closed at sea: Steel v State Line; Dobell v
Steamship Rossmore Co [1905] 2 QB 408
•
•
•
•
•
•
•
•
Neglecting to put in a nail: Havelock v Geddes (1809) 10 East 555
Crankshaft with flaw in weld: The Glenfruin (1885) 10 PD 103
Defective propeller: SNIA v Suzuki (1924) 29 Com Cas 284
Unsuitable spare parts: The Kamsar Voyager [2002] 2 Lloyd’s Rep 57
Sludge in lubricating oil: The Kriti Rex [1996] 2 Lloyd’s Rep 373
Insufficient supply of fuel: The Vortigern [1899] P 140
Contaminated fuel: The Makedonia [1962] P 190
Contaminated cargo tanks and lines: Vinmar v Theresa[2001] 2 Lloyd’s Rep
1
Peter Lorange, Shipping Strategy: Innovating for Success (Cambridge University Press 2009) 217
254
•
Inadequate charts and navigation aids: The Isla Fernandina [2000] 2 Lloyd’s
Rep 15
The claimant in respect of physical loss or damage to goods in transit will be the party
who has ended up bearing that loss or damage and this includes buyer at the ends of a
chain of sale contracts or a seller (if the buyer has defaulted or if the terms of the
contract vary the usual transfer of risk on loading) or a bank that has financed a
purchase under a letter of credit and which has been unable to obtain reimbursement
from the buyer. 617 While the main remedy for any breach of contract is damages, in
some circumstances, breach of an express or implied duty to provide a seaworthy ship
may entitle the innocent party to terminate the contract as illustrated in The Hong
Kong Fir. 618The issue of pure risk and seaworthiness of the ship can involve a web of
legal issues as well. 619
Most pure risks are generally covered under the various insurance contracts.
Marine insurance will cover damages of ships, terminals, cargo, and any transport or
cargo by which the shipment is transferred or held between the points of origin and
the final destination. Marine or maritime insurance can be traced back to Greek and
Roman maritime loan. By the 19th century, standardized clauses for the use of marine
insurances were developed by Lloyd’s and the Institute of London Underwriters.
Currently, marine insurance like the protection and indemnity insurance (P&I
insurance) is popular. This type of insurance is usually a mutual and co-operative
insurance association that provides protection for its member, who will typically be
ship-owners.
Insurance is largely about the transfer of risk from the insured party to the
insurance company. However, using certain type of marine insurance like P&I
insurance, the risks are shared among the members of the insurance association.
617
Simon Baughen, Shipping Law (4th edn, Routledge-Cavendish2004)18
618
Martin Dockray, Cases and Materials on the Carriage of Goods by Sea, 3rded (USA and Canada:
Routledge.Cavendish, 2004) 59. See judgment by Diplock L.J in Hong Kong Fir Shipping v Kawasaki
Kisen Kaisha [1962] 2 QB 26, CA
619
Legal issues are often directly related to pure risk. For example, documentation issue generally falls
under legal risk and strictly speaking, not pure risk. For illustration, The Derby case decided that a ship
might be seaworthy even where the ship-owner does not provide a document that is needed if the ship
is to carry on her business without hindrance.
[Alfred C Toepfer Schiffahrtsgesellschaft mbH v Tossa
Marine Co Ltd (The Derby) [1985] 2 Lloyd’s Rep. 325]
The issue cans often overlaps; pure risk and legal risk at the same time. One distinctive feature between
pure risk and legal risk is the insurability of the matter. Pure Risk eg risks against fire and piracy can be
insured while Legal Risk eg uncertainties of legal interpretation of clause cannot be insured.
255
The law has long recognized the responsibilities of parties related to pure risk in
maritime trade. Holt CJ in Coggs v Bernard [1703] 2 Ld Raym 909, 918 stated:
The law charges this person, thus entrusted, to carry goods against all events, but acts
of God, and the enemies of the king. For though the force be never so great, as if an
irresistible multitude of people should rob him,
nevertheless he is chargeable. And this
is a politick establishment, contrived by the policy of law, for the safety of all persons,
that they may be safe in their ways of dealing; for else these carriers might have an
opportunity of undoing all persons that had any dealings with them, by
combining
with thieves… and yet doing it in such a clandestine manner, as would not be possible to
be discovered. And this is the reason the law is founded upon in that point.
Not all pure risks can be privately insured, as there are ideally certain requirements of
an insurable risk like a sufficiently large number of homogenous exposure units to
make the losses reasonably predictable or measurable. 620
6.1.4
Legal risk
Legal risk refers to the risks and uncertainties related to the legal aspect of maritime
trade. 621 Failure to address legal risk properly will expose the parties to more than
mere commercial or profit loss as it might involve criminal elements as well. The
parties might end up facing a huge amount of debts and even imprisonment due to
carelessness in handling legal risk.
To manage and reduce legal risk, different approach is taken by parties. For
bigger companies like comprehensive logistic providers, large shipping companies or
ship liners, usually an internal legal department or unit will be established to vet all
documents and ensure compliance with law. This department is responsible to ensure
that the contracts are made in accordance with the express and implied wishes and
intention of the company while adhere strictly to any laws and regulations. Such legal
department or unit normally consists of former law practitioners eg advocate and
solicitor, or other experts in shipping law.
620
Wan Marhaini, ‘Some Issues of Gharar (Uncertainty) in Insurance’ in Mohd Daud Bakar and
Engku Rabiah Adawiah Engku Ali (eds), Essential Reading in Islamic Finance (CERT Publications
Sdn. Bhd, 2008)259
621
Legal risk will often overlap with the previous three major types of risks (Price risk, Credit Risk
and Pure Risk). For example, uncertainty on the interpretation of certain contract terms and its
implication is a legal risk but it can also be a credit risk as it will also have credit implication eg the
buyer will not pay or the amount of payment might differ.
256
When commercial or legal dispute arises, the parties in maritime trade often
opted to settle the dispute outside court to ensure fast and efficient settlement, usually
through arbitration. This is because arbitration awards are bindings and the parties
will have more control and autonomy. For this to happen, usually the parties will enter
into arbitration agreement or will include arbitration clause in the main agreement
before the disputes arise. Attempts to enter into arbitration contract after the dispute
has arisen are often unwise and indeed risky as the other party might oppose
arbitration to gain business advantages eg delaying payments.
To reduce legal risk, it is important to, among others; ensure the existence of a
valid and enforceable arbitration agreement. Assistance from court in certain matter is
also important. For example, sometimes, arrest of ship is needed and timely court
assistance is required. To do so, legal documentation should be proper and immediate
legal action should be taken.
The adoption of comprehensive and clear contracts that reflects the wishes and
desires of the parties should not be underestimated. While many of the carriages of
goods by sea contract are standard, it is importance to ensure that it is also tailor made
to suit the cases. Despite best attempt to avoid legal dispute, sometimes it occurs
anyway. Maritime arbitration is the preferred dispute settlement mechanism, as it will
prevent a series of undesirable consequences usually related to legal proceeding. This
includes bad publicity due to lack of confidentiality, waste of time, lack of control,
and uncertainty over the actual expertise of the judge, fear of national bias by judges
of national courts and lengthy litigation.
While the adoption of maritime arbitration as the preferred mode of dispute
settlement will significantly reduce legal risk related to maritime trade, new cases and
researches have indicated that part of the legal risk remain. For example, in Fiona
Trust v. Privalov 622, the issue of whether arbitration agreement tainted by illegality eg
bribery is still enforceable has been questioned. 623
Legal risk includes uncertainty related to the validity of the contract,
inconsistency of contract terms, indemnity issue, fraud conversion and misdelivery,
and also grey area of law particularly payment of ransom to pirate and other
pirate-related matters. The issue of legality and enforceability of indemnity is also an
important yet controversial area of law. 624 Generally, the court holds the view that the
622
623
[2007] UKHL 40
see Felix WH Chan and Zhao Liang‘Enforcing an Arbitration Agreement tainted by Bribery:
Cautions and Controversies (2009) The Business Review, Cambridge, Vol.12, No.1
624
In Brown Jenkinson & Co Ltd v Percy Dalton (London) Ltd [1957] 2 QB 621, CA, Per Morris L.J.
stated: 'Can A, who does what B asks him to do, enforce against B a promise made in the following
terms:'If you will at my request make a statement which you know to be false and which you know will
257
promise of indemnity for falsifying the bills of lading or for misdelivery without the
proper production of bills of lading is not enforceable and akin to fraud.
Below are some of the legal risks occasionally faced in maritime trade:
i.
Inconsistency of Contract terms
To be more accurate, one of the biggest problems faced by parties in maritime is not
just on the inconsistency of contract terms (as each and every contract need to be
tailored to face its own circumstances) but rather, it is on the unexpected effect of the
contract terms. For illustration, there are numerous situations in which the parties e.g.
charterer, shipper or carrier, have to be responsible for unexpected fee and payment,
due to different interpretation of the meaning of the contracts’ terms and conditions.
The carriage of goods by sea’s document regulates the rights and responsibilities of
the parties. It is true that many of the documents share some standard terms (as many
are issued from the same body like BIMCO) but the fact remains that unexpected
charges, usually involving big amount still happen despite meticulous check by the
in-house counsel. It is common practice for parties involved in maritime trade to
appoint external legal consultant to double-check the document to see whether the
in-house counsels failed to address any important point.
There are various different contracts used during maritime trade. 625 The terms
and the actual wording must be construed properly to avoid undesirable consequences.
For example, the words of qualification must be express and precise. 626 If the
be relied upon by others and which may cause them loss, then, if they hold you liable, I will indemnify
you'? In my judgment, the assistance of the courts should not be given to enforce such a promise.'
625
This includes bills of lading (Straight bill of lading, Order bill of lading, Bearer bill of lading,
Surrender bill of lading), Sea waybill, Multimodal Transport Documents and Delivery Order. Even
before the time of shipment, a series of documents are commonly issued which include booking notes,
tally clerks receipts and mate receipts. The carriage of goods by sea contracts occasionally suffers
uncertainties due to various reasons including multiplicity of contract and other complicated legal
issues.
626
In Attorney-General of Ceylon v Scindia Steam Navigation Co Ltd [1962] AC 60 (PC), the bills of
lading stated that a total of 100,652 bags had been shipped in an apparent good order while the ‘weight,
contents and value when shipped unknown’. In this case, the appellants claimed short delivery of of
235 bags of rice.
Lord Morris of Borthy-Gest stated that: “Their Lordship consider that, though these
statements in the bills of lading as to the number of bags shipped do not constitute conclusive evidence
as against the shipowner, they form strong prima facie evidence that the stated numbers of bags were
shipped unless it be that there is some provision in the bills of lading which precludes this result.. Their
Lordship cannot agree with the view.”
258
qualifying words are not related to the number of subject matter eg bags shipped, the
evidence as to contents have to be proved independently of the bill of lading.
The uncertainty related to the contract’s terms and languages can be minimized
by adopting a standard contract terms like Incoterms. Chew elaborated as follow:
Incoterms (short for International commercial terms) refers to a set of standard trade
definitions frequently used in international sales contracts. By clearly defining the
respective roles of the buyer and seller, Incoterms makes cross-border trade easier,
helping traders from around the world understand one another. The internationally
accepted set of terms was first published in 1936 by the International Chamber of
Commerce (ICC). 627
The Incoterms rules (or the International Commercial terms) are published by the
International Chamber of Commerce (ICC). These commercials terms include a series
of three-letter trade terms that clearly specified the tasks, costs and risks associated
with transportation and delivery of goods. The adoption of Incoterms significantly
reduce legal uncertainties and ambiguity in international trade. The development of
the Incoterms rules started in 1921 and the final Incoterms rules was published in
January 2011.
It is noted that having a comprehensive contract terms and adopting standard
term will only prevent uncertainty to certain extent. There are still a few complicated
areas that cannot be avoided by merely having a comprehensive contract. To deal with
the problem of inconsistent terms, many bills of lading contain a clause by which the
terms of the previous contract are expressly superseded by the terms of the bill of
lading and such a clause may also provide for a supersession of the carrier on issue of
the bill of lading eg the replacement of a time charterer by a ship-owner.’ 628
Inconsistency between printed terms and written terms also occasionally exists.
Greater weight is, in case of inconsistency 629, given to a written than to a printed
clause. 630 Printed words will, therefore, be considered as struck out if they are
completely inconsistent with the written words, or if it is clear that the latter were to
627
Teresa Chew, The Art of Shipping (Federal Publications Sdn Bhd 2005) 10
628
Simon Baughen,Shipping Law (4th edn, Routledge-Cavendish2004)23
629
Gumm v Tyrie (1864) 4 B & S 680 at 707 per Crompton J; affd (1865) 6 B & S 298, Ex Ch.
630
Robertson v French [1803] 4 East 130 at 136; Joyce v Realm Marine Insurance Co [1872] LR 7 QB
580 at 583 per Blackburn J; Dudgeon v Pembroke [1877] 2 App Cas 284 at 293, HL, per Lord
Penzance; cf G H Renton & Co Ltd v Palmyra Trading Corp of Panama [1957] AC 149at 168, [1956]
3 All ER 957 at 965, HL, per Lord Morton of Henryton; and Glynn v Margetson & Co [1893] AC 351,
HL
259
be in substitution for the former. 631 For a similar reason, no effect will be given to a
printed clause in a policy where it is inconsistent with the object and purpose of the
insurance.
Bills of ladings and charter parties are ‘contracts’ of a very special kind and most
of their terms, other than time, price and a few other variables, are worked out by the
industries consensus or practices, which sometimes have been used for centuries 632.
Confusion over terms still exists. The actual status of a contract depends substantially
on the complete terms of the contract, and not the mere name. For example, according
to Girvin:
The exact status of any document of carriage issued by a forwarder will be determined
by a number of factors.. Putting this another way, mere description of a ‘freight
forwarder’, ‘principal’, ‘agent’, or ‘forwarding agent’, is not determinative; it is the
substance of the obligation undertaken which is often pivotal in answering the
question. 633
The issue of liabilities and responsibilities will also arise in such legal dispute. The
situation can be more complicated when it involved ‘combined’ or ‘multimodal’
transport. To begin with, some authors mention that even the linguistic distinction
between combined transport bills of ladings and multimodal transport bill of ladings is
difficult to pin down as both terms are used interchangeably and very imprecisely 634.
The main legal risk related to multimodal contract is the uncertainty related to
the extent of each party’s liabilities and responsibilities. The status of a ‘combined
transport’ bills of lading as a document of title is arguably in doubt since it is likely to
be a ‘received for shipment’ bill and doubts has also been expressed whether a bill of
lading (in which sea carriage is not the predominant component) can be regarded as
such. 635
Fortunately in maritime trade, most of the time, the parties’ liabilities and
responsibilities are clearly stipulated in some of the contract terms:
631
Cf G H Renton & Co Ltd v Palmyra Trading Corp of Panama [1956] 1 QB 462 at 501, [1956] 1 All
ER 209 at 222
632
Grant Gilmore and Charles L.Black Jr, The Law of Admiralty (2nd edn, The Foundation Press, Inc
1975) 15
633
Stephen Girvin, Carriage of Goods by Sea (Oxford University Press 2007)38-39
634
Stephen Girvin, Carriage of Goods by Sea (Oxford University Press2007)40
635
Simon Baughen, Shipping Law (4th edn, Routledge-Cavendish2009)181
260
Uncertainty about the nature of the liability of a sea carrier at common law might seem
to be a serious problem. But for most part this is a theoretical rather than an important
practical difficulty, since most cargoes are carried today, not on bare common law terms,
but under contracts (called ‘special contracts’ or ‘special carriage’ in the older cases)
which deal expressly with the carrier’s obligations. 636
Sometimes, the uncertainty is not due to the inconsistency of contract terms or
between multiple contracts but due to the inherent inconsistencies concerning
interpretation of the Rules. Interpretation of the various Rules (Hague Rules,
Hague-Visby Rules, Hamburg Rules and Rotterdam Rules) can vary and there is a
bulk of cases with complicated and unexpected outcomes. For example, the Hague
Visby Rules provides that the information provided in the bill of lading shall be prima
facie evidence of the receipt but there is some uncertainty as to the effect of the failure
of a carrier to comply with a request from a shipper to provide such information as
required by Art III rule 3 637. The effect is sometimes not intended:
‘[c]harterparties, as we have seen, are contracts which are entered into between
shipowners and charterers, with their terms designed to regulate this relationship. The
Hague and the Hague Visby Rules, on the other hand, are designed to regulate the
relationship between carriers and shippers. Potentially, the incorporation of the Rules
may have the effect of giving them a wider application than was intended.” 638
There is little that the parties can do to limit legal risks related to unexpected
interpretation of the law. Fortunately, the tendency of the judges is to maintain
consistency and certainty in law whenever possible. For example, the court has
consistently held that shipper liability in relation to dangerous good can be absolute.
Lord Lloyd in Effort Shipping Co Ltd v Linden Management SA (The Giannis NK)
[1998] AC 605 stated:
The dispute between the shippers and the carriers on this point is a dispute which has
been rumbling on for well over a century. It is time for your Lordships to make a
decision one way or the other. In the end that
decision depend mainly on whether the
majority decision in Brass v Maitland, which has stood for 140 years, should now be
overruled. I am of the opinion that it should not. I agree with the majority in that case
636
Martin Dockray, Cases and Materials on the Carriage of Goods by Sea (3rd edn,
Routledge-Cavendish2004)28
637
John F Wilson, Carriage of Goods by Sea (Pearson/Longman2008)117
638
Stephen Girvin, Carriage of Goods by Sea (Oxford University Press2007)253
261
and would hold that the liability of a shipper for shipping dangerous goods at common
law, when it arises, does not depend on his knowledge or means of knowledge that the
goods are dangerous.
For conclusion, the legal risk associated with inconsistency or uncertainty with
contract terms can be reduced by the adoption of standardized documentation and by
the adoption of Incoterms. The court also tries to reduce legal uncertainty in this
aspect by trying to ensure consistency in court interpretation.
262
ii.
Validity of contract
To reduce unnecessary legal risk, it is important for the parties to carefully vet the
carriage of goods contracts to ensure compliance with law. If the party does not have
their own internal legal department to undertake this important duty, it will be
necessary for them to get the assistance from external experts, commonly in the form
of shipping consultant or law firm specializing in maritime trade. For example, the
legal uncertainty related to the validity of carriage of goods by sea’s contract can be
found in the switch bills. Concerning switch bills, the original set of bill of lading
under which the goods have been shipped is surrendered to the carrier or his agents in
exchange for new set of bills in which some of the details are altered 639. This is done
for commercial reasons including attempt to conceal the source of the goods, or for
fraudulent purposes eg to avoid custom duties or to misrepresent date 640. Not only this
create opportunities for fraud, this also lead to confusion on the part of the carrier in
determining the identity of the rightful claimant since the carrier is now aware of the
existence of the two sets 641.
The validity of most contract and contract terms has been settled. For example,
the law is now clear that contract of indemnity for falsifying the accuracy of bills of
lading is null and void. Concerning the validity of limitation clause, the courts are
inclined to apply restrictive interpretation to limitation clause unless it is really clear.
If there is uncertainty as to the meaning, the court will not recognize it. For example,
a clause exempting the ship-owners from liability due to unseaworthiness is invalid
unless it is in clear and unambiguous words as in the case of The Irbenskiy
Proliv[2005] 1 Lloyd’s Rep 383. 642.
The uncertainty related to the legal nature of some of the carriage of goods by
sea contracts has been put to rest through court decisions and amendment in law.
Illustration can be made on the contract of sea waybill. Since its introduction, there
was a lot uncertainties noted in relation to sea waybill. 643 A common question is
whether a sea waybill is the same as a straight bill of lading. 644 In Voss Peer v APL
639
John F. Wilson, Carriage of Goods by Sea (Pearson/Longman 2008)171
640
John F. Wilson, Carriage of Goods by Sea (Pearson/Longman 2008)171
641
John F Wilson, Carriage of Goods by Sea (Pearson/Longman,
642
John F Wilson, Carriage of Goods by Sea (Pearson/Longman2008)10
643
The legal uncertainty whether a consignee could sue under a contract of carriage by sea waybill
2008)171
(since the sea waybills were not documents to which the Bills of Ladings Act 1855) has finally been
removed by the new Carriage of Goods by Sea Act 1992 which applies to sea waybill and clearly
define sea waybill.
644
Stephen Girvin, Carriage of Goods by Sea (Oxford University Press2007)49
263
Co Pte Ltd [2002] 3 SLR 176, Judith Prakash J from the Singapore Court of Appeal
elaborated that:
The entire argument of the appellants is that a straight BL is the same as a sea waybill.
While it is true that a BL, devoid of the characteristic of negotiability, is substantially
similar in effect to that of a sea waybill, that is not to say that they are the same. If the
parties had intended to create a sea waybill they would have done so.
The House of Lords also stated that:
[I]n the hand of the named consignee the straight bill of lading is his document of title.
On the other hand, a sea waybill is never a document of title. No trader, insurer or
banker would assimilate the two. The differences between the documents include the
fact that a straight bills of lading contains the standard terms of the carrier on the
reverse side of the document but a seaway bill is blank and straight bills of lading are
invariably issued in sets of three and waybills not. 645
It is very important for the parties to ensure that they adopted the proper carriage of
goods by sea contract that reflected their intentions. In J I MacWilliam Co Inc v
Mediterranean Shipping Co SA (The Rafaela S) [2003] EWCA Civ 556, Rix LJ
clarified the issue by stating that the carriers should not use bills of ladings forms
when they intended to invite the shippers to enter into a sea waybill type of contract.
The amendment to law that clarifies the matter finally put a rest to the issue. It is
important for the parties to be alert of any changes in law. Contrary to other trade,
maritime trade is international in nature. To reduce legal risk, the parties must be
aware of any changes in international trade law.
For example, legal dispute initially exists over the validity of the shipment and
sale of oil from Libya by the rebels, which were backed by international community
via the United Nations. The legal issue is largely put to a rest by the legal guarantee
and assurance by the Qatar government over the validity of such transaction.
In the past, it was proposed that the use of electronic documentation would
remove unnecessary legal risk related to carriage of contracts by sea contract and
strengthen global maritime trade. For example, it was proposed that:
The advent of advanced communications technology and the Internet makes paper bills
of lading extremely outmoded. The aim of electronic bills of lading is to completely
645
J I MacWilliam Company Inc (Respondents) v. Mediterranean Shipping Company SA (Appellants)
[2005] UKHL 11; [2005] 2 AC 423
264
remove the paper element of international trade transactions. The need to present the
paper bills of lading at the port of discharge means the bill must be sent to the consignee
physically by air before at the same time as the cargo. With speedier vessels and quicker
turn-around times, this is no longer guaranteed. 646
It is proposed that the legal risk related to the validity of the contract and the rights
and liabilities of the parties in maritime trade can be significantly reduce by using
proper electronic documentation, which can also act a registry.
Electronic documentation eg bill of lading is very tempting because of a few
reasons. First, there is no more need for papers, which commonly is very bulky in
relation to maritime trade and insurance. Accordingly, it will save space and cost.
Furthermore, electronic bill of lading is often associated with registry, and it will
provide more certainty as to the rights and responsibilities of the parties.
However, a few problems remain and there are rooms for improvement. For
example, while the development in computer cryptography has made it possible to
substitute the paper bill of lading or waybill with an electronic one, electronic
documentation system is often regarded as insecure and many traders were unhappy at
the important role played by the carrier in the process of endorsement, a process that
had not involved them at all when a paper bill of lading was used. 647
There is also some uncertainty relating to the comprehensiveness of electronic
bills of ladings. While electronic bill of ladings can clearly fulfill the first two
functions of bill of lading, namely, as receipt and as evidence of terms, it not clear
whether it can fulfill the function as document of title 648. There is doubt as to whether
an electronic bill of ladings would qualify as document under the Carriage of Goods
by Sea Act 1971 and 1992 649. The survey by UNCTAD revealed a lack of confidence
in the use of electronic bills of lading on the ground that the existing systems were not
secure and that the underlying legal framework was not clear or inadequate 650.
646
Felix WH Chan, Jimmy JM Ng and Bobby KY Wong, Shipping and Logistics Law: Principles and
Practice in Hong Kong (Hong Kong University Press 2002)237
647
Simon Baughen, Shipping Law(4th edn, Routledge-Cavendish2009)25
648
John F. Wilson, Carriage of Goods by Sea (Pearson/Longman2008)165
649
John F. Wilson, Carriage of Goods by Sea (Pearson/Longman 2008)165
650
John F. Wilson, Carriage of Goods by Sea (Pearson/Longman 2008)170
265
iii.
Evidence Issue
One of the legal risks in maritime trade is to ensure the burden of proof required under
law is adequately fulfilled. This is not always clear and can be complicated and tricky
as:
The use of containers causes considerable evidential problems to cargo claimants in
proving that the goods packed inside the container were damaged during the custody of
the carrier. If the shipper loads them into the container, which is then sealed, the carrier
will have no means of verifying what is inside the container. Accordingly, when it issues
the bill of lading or sea waybill, it will protect itself by qualifying any statement as to
the contents of the container with words such as ‘said to contain’. The effect of these
words is to oblige the cargo claimant to prove by independent evidence exactly what
was in the container at the time that the carrier took it over and the condition in which it
then was. In many cases, this will prove to be an insurmountable evidential burden. 651
Generally, the statements as to quantity of the goods shipped or the weight of goods
shipped in a bill of lading have an evidential purpose in the sense that they provide
strong prima facie evidence (of the weight or quantity of the goods shipped). 652 The
inference from the bills of lading is strong and it is not easy to defeat it. 653
In general, the common law treated the carrier as a ‘bailee’ of the goods. The
burden of proof on the carrier is summarized by Lord Denning in Levison v Patent
Carpet Cleaning Co.Ltd [1977] 3 All E.R. 498 at p. 505, [1978] Q.B. 69 at p. 82
(C.A.):
... I am clearly of opinion that, in a contract of bailment, when a bailee seeks to escape
liability on the ground that he was not negligent or that he was excused by an exception
or limitation clause, then he must show what happened to the goods.
He must prove all
the circumstances known to him in which the loss ordamage occurred.
If it appears
651
Simon Baughen,Shipping Law (4th edn, Routledge-Cavendish2004)15
652
Stephen Girvin, Carriage of Goods by Sea (Oxford University Press2007)62
653
According to Lord Shand in Henry Smith & Co v Bedouin Steam Navigation Co Ltd [1896] AC 70,
70: “it will not be sufficient to show that fraud may have been committed, or to suggest that the
tallymen may have made errors or mistakes, in order to meet a case of positive proof on the other side.
It must be shown that there was in point of fact a short shipment – that is, the evidence must be
sufficient to lead to the inference not merely that the goods may possibly not have been shipped, but
that in point of fact they were not shipped. Any proposition short of this would appear to me to give
less effect to the evidence of the shippers that that evidence ought to have, and unwarrantably to
diminish the onus which that evidence has thrown on the shipowner.”
266
that the goods were lost or damaged without any negligence on his part, then, of course,
he is not liable.
If it appears that they were lost or damaged by a slight breach – not
going to the root of the contract – he may be protected by the exemption or limitation
clause.
But, if he leaves the cause of loss or damage undiscovered and unexplained –
then I think he is liable....
The carrier can shift the burden of proof to the plaintiff, usually the shipper after
showing that the losess and damages falls under the excepted perils eg Hague Rules.
This concept is reiterated in the Canadian case of Kruger Inc. v. Baltic Shipping Co
(1989), 57 D.L.R. (4th) 498 at p. 502 (Fed. C.A.), that relied upon in Canstrand
Industries Ltd. v. Ship Lara S [1993] 2 F.C. 553 at p. 574, (1993):
The carrier can then shift the burden of proof back to the plaintiffs by establishing that
the loss or damage is attributable to one of the excepted perils set out in Article IV of the
Hague Rules.
To minimize legal uncertainty on evidentiary matters, the parties must make sure
what is required from them in relation to proving loss and damages. Sometimes, the
goods are damaged upon arrival but the stage when the damage occurs cannot be
determined precisely. This will cause a few issues especially in determining the
liabilities of the parties. This problem is reduced by the modern use of container but a
few problems remained. For example, if the goods are in good condition at the start of
delivery but damaged upon arrival, the obvious presumption is the goods must have
been damaged during delivery. The problem is the exact time the damage occurs
might be uncertain and since the responsibility between the parties might differ
between different stages of the delivery, this will cause confusion. This often happen
in multimodal transport.
The parties must understand the nature and consequences of different damage and
loss to reduce their risks. Freight is sometimes not payable if the damage is so severe
that it transforms the goods into a different type of goods altogether 654. This issue has
been put to rest to certain extent. 655
654
655
Asfar & Co v Blundell [1896] 1 QB 123
Such problem was faced in The Caspian Sea [1980] 1 Lloyd’s Rep 91 whereby the charterers
alleged that the delivery of a cargo of Bachaquero Crude was contaminated.
Donaldson J clarified the
matter: “The arbitrators will have to consider what is meant by the description ‘Bachaquero Crude’.
Does it mean a paraffin free crude? If it does, ‘Bachaquero Crude contaminated by paraffin’ is a
contradiction of terms and the owners will not be entitled to freight. Or does it mean a ‘crude from the
Bachaquero region’ which in its natural state contains no paraffin? If so, there is no necessary
267
iv.
Piracy-related matter
Piracy and terrorism is a serious challenge to maritime trade:
The threat of terrorism is another dimension that has been heightened, particularly
since the attacks on the United States on September 2001. Despite the effort of many
of the established world powers, it seems to be difficult to limit the threat of terrorism,
anywhere in the world. An immediate sense of violence and political instability is the
result. The risk of global terrorism and the cost of security measures to combat it will
continue to be an ongoing concern. These issues are sure to have an impact on the
shipping industry. How can safety be ensured in container shipping, for instance?
Piracy, particularly from seas in Somalia, also represents a serious problem for world
shipping - with respect to both safety and cost. 656
Risk involving piracy is largely managed using insurance contract. However, legal
uncertainty relating to piracy still exists even in developed nation. This is cited by
Passman in the following excerpt:
The American cases interpreting piracy clauses in insurance contracts are not completely
consistent but there are certain factors that the cases generally agree are indicia of piracy.
However, there are still several loose ends under American law that the courts have not
addressed. Because the British law of marine insurance is more developed in this area
and marine insurance contracts are commercial documents used in international trade,
American courts should apply British law in those areas where no American precedent
exists. However, the inconsistencies in the case law and the multitude of noninsurance
definitions of piracy invite confusion. Therefore, insurers should seriously consider
defining "piracy" and "pirates" in their insurance policies using the factors described
above. Both the insurer and the insured can better price risk if they fully understand
exactly what their insurance contracts cover. 657
contradiction in ‘Bachaquero Crude contaminated by paraffin’. In that event, the fact of contamination
will not of itself deprive the owners of their right to freight. However, the arbitrators would have to
consider the degree of contamination. They would have to ask themselves the question: ‘Is the oil so
contaminated that it has ceased to even be contaminated Bachquero Crude?’ If so, the right to freight
has gone. No doubt a relevant factor will be the cost and practicability of extracting the paraffin, but
there may well be other criteria.”
656
Peter Lorange, Shipping Strategy: Innovating for Success (Cambridge University Press 2009) 9
657
Michael H. Passman, ‘Interpreting Sea Piracy Clauses in Marine Insurance Contracts’ (2009)
Journal of Maritime Law & Commerce, Vol. 40, No.1 (January) 88
268
IMB defines piracy as:
An act of boarding any vessel with the intent to commit theft or any other crime and
with the intent of capability to use force in the furtherance thereof. 658
Many consider this definition not precise. According to Clark:
The lack of precision in the IMB’s definition allows for disputes as to actual rates of
piracy. It is clear however, that piracy has become an increasingly lucrative trade wih
each passing year. In 1996, 194 crewmembers were taken hostage by pirates carrying
guns and knives. By 1997, that figure reached 400 (International Chamber of Commerce
Report, January 1998). 659
Piracy is a major problem in few part of the world for centuries 660. The size and effect
of global piracy can be misleading. For example, the volume of the world maritime
trade in 2006 is estimated by some to worth around US$380 billion, in 47,681 ships of
some 650,000,000 gross tonnage with 1.19 million crew but the number of reported
incidents of piracy in 2004 were only 329 and in 2005 only 276 661.
According to IMB Piracy Reporting Centre, from January 2011 to October 2011,
the number of piracy attacks worldwide is 367 while total hijacking worldwide is
merely 36. Out of this figure, total incidents reported for Somalia is 207 with 24 cases
of hijacking, a total of 400 hostages with 15 killed. 662
It would be tempting to suggest that piracy is relatively rare and the effect is not
so severe but such suggestion failed to consider the fact that the size of ransom related
to piracy is high, and the accumulative wealth obtained from piracy is used to
purchase more sophisticated weapon which in turn increase the rate of piracy. In any
case, not all cases of piracy are reported. In percentage terms, only 0.1% of shipping
658
IMB 200 Anuual Report as quoted in Robert C. Beckman, ‘Combating Piracy and Armed Robbery
Against Ships in Southeast Asia: The Way Forward’ (2002) Ocean Development & International Law,
33: 317-341
659
Karen K. Clark, ‘Maritime Piracy: Nature, Impact and Legal Frameworks for Prosecution’ (2009)
International Journal of Criminal Justice Sciences Vol 4 Issue 1 (January-June)
660
Piracy and the World of Zhang Baozai (Stanley, Hong Kong: Hong Kong Maritime Museum, 2006)
40
661
Piracy and the World of Zhang Baozai (Stanley, Hong Kong: Hong Kong Maritime Museum, 2006)
p40
662
ICC Commercial Crime Services
<http://www.icc-ccs.org/piracy-reporting-centre/piracynewsafigures> accessed 19 October 2011
269
is affected by piracy and initially, this is not even sufficient to increase insurance
premiums 663.
Piracy still cause major disturbance to trade and commerce, and there have been
many cases where the whole crew of a ship have been murdered when the pirates
boarded to steal their ship. Piracy is a high level legal risk since there are many
uncertainties in law related to piracy. For example, the actual legal status of parties in
relation to the payment of ransom to pirate is not clear. If the parties agreed to share
the payment of ransom to pirate, and then one of the party refused to reimburse the
other party after the other party made full payment to the pirate, it would be difficult
to bring the matter to court or arbitration as the issues are complex and tainted with
illegality.
On the other hand, if the payment of ransom to pirate is made purely legal; this
will open the backdoor to money-laundering and other activities. It is noted that the
traditional challenges due to piracy in various straits including the Straits of Malacca
have now escalated to a new level with advanced weapon of the pirates. For example,
the Somali pirates shock the world with their ability to capture commercial ships from
all over the world and demanding ransom. The uncertainty and legal risk caused by
piracy can be substantial. The bigger problem is the unavailability of comprehensive
legal solution to deal with the matter. Due to the alarming rate of piracy, it is
important for shippers and carriers to have a clear policy concerning piracy and
ransom. 664 Piracy is on the rise and is causing huge problem in some sea lines:
Piracy had gradually evolved from coastal raids to long range interdictions at more
than 500 nm from the Somalian coast. These are no means feat and would pose a
challenge even for more sophisticated navies. The pirates of Somalia are getting
bolder, venturing further, and upping the ante. The number of pirate attacks in the
Gulf of Aden increased sharply from forty-one in 2007 to 111 in 2008. In the first
quarter of 2009 alone, there have been sixty-one attempts, of which nine were
successful. Hefty ransoms are being demanded, insurance premiums are climbing,
663
Piracy and the World of Zhang Baozai (Stanley, Hong Kong: Hong Kong Maritime Museum, 2006),
p40
664
However, having such policy might also put the companies and its official at risk. For illustration,
let’s assume that Somali pirates have hijacked a ship worth HKD 50 million and a ransom of HKD 5
million is requested.
The shippers and carriers might not be in agreement as to whether to pay the
ransom and secure the ship, or not. Unfortunately, any contract terms related to the parties’ agreement
to pay or not pay ransom in advance might put the ship and its crew at risk if publicly known. If the
contract to such effect is made in secret, there will still be problems with documentary credit etc.
Currently, the best method is to use piracy insurance.
270
and some shipping companies have chosen to-route around the Cape of Good Hope.
All these will potentially increase the cost of goods transported by sea. 665
In theory, the existence of international co-operative bodies should improve
international coordination and reduce the risks associated with piracy. However, in
reality the opposite is suggested. One writer writes:
The existence of the ASEAN [Association of South East Asian Nations] ironically
enough, hinders rather than helps progress on the anti-piracy front. The organization is
all about friendship and avoiding diplomatic spats, making it extremely difficult for
Singapore and Malaysia to put pressure on the Indonesians. If governments cannot
easily point the finger at each other, that in essence leaves the shipping industry to do so,
or at least take the initiative (Beckman, 1999). 666
To reduce the legal risk concerning piracy-related matter, the use of insurance will do
to certain extent. However, a clear legal position on the matter from the government
side will further decrease the legal risk in the matter. The effect to calculation of
taxation etc should be verified. The validity or non-validity of paying ransom and the
subsequent legal consequences to the parties should be clarified to avoid unnecessary
legal uncertainties.
The adoption of maritime arbitration will also significantly reduce legal
uncertainty in various areas. It ensures a speedier settlement of dispute which is
legally binding and one in which the parties have autonomy and control over the
proceeding.
Challenges and Limitation
There are risks and costs to a program of action. But they are far less than the long-range
risks and costs of comfortable inaction.
-John F. Kennedy (1917 - 1963)
Risk should not be avoided altogether. The essence of conducting trade and
commerce is to gain profit by taking reasonable and calculated risk. For centuries,
global maritime traders have faced the challenges brought by the sea in its various
665
Chew Men Leong, ‘Chapter 2: Realising Safe and Secure Seas for All’ in Joshua Ho (ed), Realising
Safe and Secure Seas for All: International Maritime Security Conference 2009 (Select Publishing
2009)
666
Karen K. Clark, ‘Maritime Piracy: Nature, Impact and Legal Frameworks for Prosecution’ (2009)
International Journal of Criminal Justice Sciences Vol 4 Issue 1 (January-June)
271
forms; from pirates to natural disasters, also known as act of God. These risks and
challenges are balanced with the huge profits that await these courageous traders.
However, the increased use of financial products in managing maritime trade risks has
its benefits and disadvantages.
According to Poitras:
Derivatives security trading is definitely not a modern development. The implicit and
explicit embedding of derivative features was common in the types of securities traded
in early markets. Early examples of securities with derivatives features include claims
on the 14th century Florentine mons that had a provision for redemption at 28% of par,
though that provision was seldom exercised. 667
To manage their risk, there exist multiple methods. Maritime traders are familiar with
the various types of marine insurances. The risk management system can actually be
divided into two simple classifications. The first type is through risk re-allocation or
risk transfer while the second type is through risk sharing. Nowadays, the first type is
much more popular compared to the second type.
Under the first type, the parties will attempt to shift the burden of risk to another
party. This is especially common for price risk, credit risk and also for pure risk. As
illustration, the carrier is afraid that the operational cost will increase due to the
increase of the oil price. It is noted that Zahar, the Offshore Representative of
Shipowners’ Association, and Vice President of Offshore Business, MISC Bhd,
Malaysia’s national shipping line previously highlighted ‘the concern of shipowners
by stressing that fuel cost represents as much as 60% of total ship operating cost
(depending on the type of ships and services) and warned that such an increase cannot
be taken lightly.’ 668
Therefore, the carrier will use freight derivative to shift the risk to other party.
Another example can be given in relation to pure risk. The carrier and shipper are
afraid that the shipment will be lost due to natural disaster during voyage. Therefore,
to safeguard their interest, they will shift klhe risk to the insurance companies by
insuring the shipment.
It is proposed that risk transfer has its own limitation. In any case, it is not
necessarily the best method. Risk sharing can be a better alternative compared to risk
667
Geoffrey Poitras, Risk Management, Speculation, and Derivative Securities (Academic Press 2002)
4
668
‘High Oil Price and Its Impact on the Shipping Industry’ MIMA Seminar Report (Kuala Lumpur 6
August 2008)
272
transfer. To mitigate risks by adopting risk sharing concepts, substantial alteration
must be made.
In general, the use of derivatives instruments to handle various maritime trade
price risk, documentary letter of credit to reduce credit risk eg non-payment,
insurances to reduce pure risk and maritime arbitration to solve legal disputes have
contributed significantly to the development of modern global maritime trade.
However, one should bear in mind that the use of risk management is no
substitute for smart and efficient business strategy when it comes to maximization of
profit. For example, the party must ensure that the suitable ship is used to maximize
profit while avoiding unnecessary price, credit, pureand legal risks. A 330,000 dwt
tankers only costs twice as much as an 110,000 dwt vessel but it carries three times as
much cargo so the cost per tonne of shipping a 110,000 parcel of oil is much higher
than shipping a 330,000 tonne parcel. 669 While prudent risk management can reduce
risk, it must always be consistent with good corporate ethics and smart business
strategy.
6.2 The Limitation of Insurance
The defining role of marine insurance in maritime trade industry cannot be disputed.
The marine insurance policy or the marine insurance certificates forms important part
of the shipping documents:
In an export transactions, the terms of the contract of sale normally provide whether the
costs of marine insurance shall be borne by the seller or by the buyer. If goods are sold
on f.o.b. terms, these costs have to be paid by the buyer and that is true even if the f.o.b.
seller, by request of the buyer, has taken out the policy. If the goods are sold on c.i.f.
terms, it is the duty of the seller to take out the policy and pay the costs of insurance. In
a c. and f. contract, the seller need not insure, nor need the buyer (at whose risk the
goods are carried), but if the c. and f. contract contains a clause ‘insurance to be effected
by the buyer,’ or a clause in similar terms, that will normally place the buyer under a
contractual obligation to insure and has not merely a declaratory effect. 670
669
Martin Stopford, Maritime Economics(3rd edn,Routledge2009)76-77
670
Carole Murray, David Holloway and Daren Timson-Hunt, Export Trade: The Law and Practice of
International Trade (11th edn, Thomson Sweet & Maxwell 2007)
273
The hypothesis that the application of Islamic principles to modern maritime trade is
feasible is challenged in this aspect. Marine insurance is necessary yet conventional
insurance in general is prohibited under Islamic law.
The existence of marine insurance has assisted in the distribution of risk in
maritime trade to parties specially designed to handle the specific kind of risk. Marine
insurance is one of the arrangements by which the risks can be transferred by parties
which are involved in transport or logistics, eg shippers, consignors, consignees,
ship-owners, airlines, charterers, logistic operators, freight forwarders, warehouse
operators and barge owners, to a professional risk carrier, i.e. an insurance
organization or insurance company.’ 671
The dominant role of insurance in maritime trade cannot be denied and is now deeply
rooted. According to Dorfman:
Ocean marine insurance is one of the earliest forms of insurance. Commerce by ship was
well established in the Mediterranean’s Sea 2,000 years before the birth of Christ. The
Babylonians, Phoenicians, Greeks and Roman were great sea traders. Coincident with
the development of this trade, insurance transactions emerged as distinct commercial
agreements. Bottomry was a transaction protecting an owner from financial loss if his
ship was destroyed. If the shipowner acquired the ship by means of a loan, an interest
rate was paid to a moneylender. The moneylender, for a premium beyond the ordinary
interest rate, would forgive the loan if the ship was destroyed. The bottomry loan was an
early forerunner of ocean marine insurance. 672
The modern insurance procedure is also simply and straightforward. Shipping risk
insurance generally covers door-to-door delivery, policies are purchased on a
shipment-by-shipment basis and this type of insurance is usually available through the
freight forwarder. 673 Furthermore, commercial risk insurance covers losses due to
non-payment by the seller on the goods and by purchasing such an insurance plan,
one can even extend credit to foreign buyer. 674
However, there are challenges and limitation with insurance. For example,
insurance premium is determined by the risks posed collectively, and not just by
671
Felix WH Chan, Jimmy JM Ng and Bobby KY Wong, Shipping and Logistics Law: Principles and
Practice in Hong Kong (Hong Kong University Press2002)
672
Mark S. Dorfman, Introduction to risk management and insurance (7th edn, Prentice Hall 2002) 364
673
Teresa Chew, The Art of Shipping (Times Edition- Marshall Cavendish2005)81
674
Teresa Chew, The Art of Shipping (Times Edition- Marshall Cavendish 2005)81
274
individual ship/company performance. For example, according to Nippon Yusen
Kabushiki Kaisha Annual Report 2010 (pg.67):
Insurance premiums are not determined solely by the claim history of the NYK
Group itself. Rather, they also may be affected by insurance claim trends among other
policyholders. In some instances, the burden of paying high insurance premiums
could impact the NYK Group’s income and operating performance. Also, although
the NYK Group recognizes that the exemptions, restrictive clauses, and exceptions
included in insurance policies are standard throughout the shipping industry, they
may limit the Group’s ability to recover its loss through insurance. 675
There are a few limitations. According to the Institute of Financial Planners of Hong
Kong:
Risk management is broader than insurance management in that it deals with both
insurable and uninsurable risks and the choice of the appropriate techniques for
dealing with these risks. Because risk management evolved from insurance
management, the focus of some risk managers has been primarily with insurable risk.
Properly, the focus should include all pure risk, insurable and uninsurable. 676
Firstly, insurance is a contract of indemnity and therefore, not an instrument for profit.
The existence of insurance in relation to carriage of goods by sea has to a large extent
reduced the uncertainty related to it. Most of the risks are reduced and mitigated. The
rights and responsibilities of parties in insurance are generally quite clear. It is
basically a valid contract of indemnity.
In Castellain v Preston (1883) 11 QBD at p.386, Mr. Justice Brett remarked:
The contract of insurance contained in a marine or fire policy is a contract of
indemnity, and of indemnity only, and this contract means that the assured, in case of
loss against which the policy has been made, shall be fully identified, but shall never
be more than fully indemnified.
For example, under Hong Kong law, the position is as follows:
675
‘Nippon Yusen Kabushiki Kaisha Annual Report 2010’
<http://www.nyk.com/english/ir/library/annual/pdf/2010.pdf> accessed 10 January 2012
676
Institute of Financial Planners of Hong Kong, Fundamentals of risk and insurance (John Wiley &
Sons (Asia) Pte Ltd 2006) 20
275
… in dealing with double insurance an assured must give credit for any money received
under other policies in respect of the same subject matters and risks, and he is bound by
the value stated in the policy under which he now claims. If he has already received
money in excess of the value stated in the policy which he is claiming under, he will not
receive anything under another policy even though the real value of the subject matter
may be far greater than the value stated in the particular policy. 677
The purpose of insurance is to insure the legit interests of the parties in the maritime
trade. Understandably, under marine insurance, gaming contract is void. Section 4 of
the Marine Insurance Ordinance, on ‘Avoidance of wagering or gaming contracts’,
clearly stated:
(1) Every contract of marine insurance by way of gaming or wagering is void.
(2) A contract of marine insurance is deemed to be a gaming or wagering contract
a.
Where the assured has not an insurable interest as defined by this Ordinance,
and the contract is entered into with no expectation of acquiring such an
interest; or
b.
Where the policy is made ‘interest or no interest’, or ‘without further proof of
interest than the policy itself, or ‘without benefit of salvage to the insurer’, or
subject to any other like term:
Provided that, where there is no possibility of salvage, a policy may be effected without
benefit of salvage to the insurer.
Secondly, there are limitations on what can be insured. There are limitations to what
insurance can cover and speculative risk is basically uninsurable. In British and
Foreign Insurance Co Ltd v Wilson Shipping Co Ltd [1921] 1 AC 188, Lord Summer
said: ‘In practice contracts of insurance by no means always result in a complete
indemnity, but indemnity is always the basis of the contract’.
6.3 The Limitation of Derivatives
There are a few limitations and important factors that are associated with derivative.
The first one is the risk due to the lack of regulation. The widespread use of derivative
is galactic yet legal regulation is barely adequate. However, steps are being taken to
677
Felix WH Chan, Jimmy JM Ng and Bobby KY Wong, Shipping and Logistics Law: Principles and
Practice in Hong Kong (Hong Kong University Press2002)515
276
improve the situation. According to Chairman Gary Gensler of OTC Derivatives
Reforms (U.S. Chamber of of Commerce, Washington D.C:
Our financial system is a complex network. It handles an enormous volume of traffic
– the U.S. over-the-counter derivatives market is approximately $300 trillion notional
amount. The volume is growing on a global scale, as is the network’s complexity.
When faced with a similar challenge, earlier generations invented traffic lights and
street lamps to lower risk and shine light on a complex and increasingly voluminous
network. Now, do yellow and red lights slow down traffic? Do street lamps bring
sunshine on otherwise dark and dangerous roads? Absolutely. Could we run a high
volume transport network safely without them? Absolutely not. Traffic lights may
add costs for all network users, but can anyone imagine a traffic system without
safety regulation? Of course not. So, to those who sincerely raise concerns about
safety and transparency measures that we recommend bringing to the derivatives
markets, think about a regulation-free highway network – no traffic lights – no street
lamps – no traffic cops – not even a stop sign – the next time you are driving in
Washington, D.C., New York City or possibly more appropriately on Main Street in
so many towns in America. 678
The second risk is due to the unreliability of the models/software used to manage the
risk. The adoption of the latest risk management tool that is based on the best models
can still be problematic. This can be seen from the experience of Kaminski:
As Kaminski sees it, the first problem is that the models these systems are based on,
while potentially useful, have serious limitations that are too often ignored. The data
that go into them, he says, are so aggregated and "averaged" that they disregard
outliers and abnormalities that turn out to be important. There are also risks -- like
risk to reputation -- that are ignored because there is no data set by which to quantify
them. 679
678
Gary Gensler, Chairman of OTC Derivatives Reform, U.S. Chamber of Commerce ‘Keynote
Address’ (Washington, March 24, 2010)
<http://www.cftc.gov/PressRoom/SpeechesTestimony/opagensler-36> accessed 15 November 2011
679
Steven Pearlstein, ‘The Art of Managing Risk’ Washington Post (28 November 2007)
<http://www.washingtonpost.com/wp-dyn/content/article/2007/11/27/AR2007112702499.html?sid=ST
2007112800648> accessed 14 October 2011
277
The third concern is that derivative only increases speculative risks in maritime trade.
It is proposed that the current global trade and financial system might be going
towards the wrong direction as the speculators march towards real trade sector
including shipping, as reflected in the sudden increase in freight forward. For
clarification, freight forward and hedging can be efficient risk management tool is
used wisely but the current system seems to be exposed to a series of dangerous
problems.
Freight Derivatives are financial instruments for trading in future levels of
freight rates, for containerships, for tankers and dry bulk carriers. Examples of Freight
Derivatives include Forward Freight Agreement (FFA) 680, freight swap agreements
and options.
In the late 1990s, FFAs took over from future contract as the main form of
freight derivative, and by 2006 FFA market had already reached an estimate of $56
billion, with 287,745 lots traded over the counter and 32,200 cleared through clearing
houses. 681
Fourthly, it is noted that clearinghouse role is limited. Although in theory the
clearinghouses will ensure the credit worthiness of the parties, in reality the credit
houses are not responsible for mistakes in their valuation about the credit worthiness
of the parties. There are various clearing houses for freight including NOS Clearing,
LCH.Clearnet, NYMEX (NY Mercantile Exchange) and Singapore Stock Exchange
(Singapore). Ship-owners and operators, trading companies, charterers, oil companies
and also grain houses are attracted to use freight derivatives to manage freight rate
risk. If used properly, freight derivatives can be an effective tool for shipping risk
management.
Fifthly, the derivative market is currently open for all, including speculators.
There have been calls to limit the market to those with real interest only. The benefit
of hedging, forward trading and the likes have long been recognized. Initially,
transaction like forward trading was applied to properly redistribute the risk of
producers of agricultural commodities. However, under the current system, it has
turned into means for speculators to derive speculative gains. 682 Currently, even the
680
For simplicity, FFA allows ship owners, charterers as well as speculators to buy and sell the price
of freight for future dates.
681
FFA Brokers Association reported in Baltic Exchange Pres Release, January 2007
682
M. Fahim Khan, ‘Islamic Futures and Their Markets: With Special Reference to their Role in
Developing Rural Financial Market’ (2000) Research Paper No.32, Islamic Development Bank (IDB)
Islamic Research and Training Institute
<http://islamfinland.files.wordpress.com/2009/08/idb-islamic-futures-and-their-markets.pdf>
accessed 15 November 2011
278
most developed Futures markets are simply being used for mere speculation rather
than helping farmers or producers.
Sixthly, there is a concern that derivative market will harm the actual commodity
market. Khan (2000) warned that the increasing volumes of transactions in the
interest-rate Futures market would divert funds away from cash market and will harm
the governments financing schemes for mobilization of resources, the private capital
formation process in the economy and if Futures are allowed to continue on this
pattern, they will increase their turnover in paper dealings to the extent that cash and
physical trading will not be merely adversely affected but the commodity market may
even collapse altogether and be put out of business. 683
Seventhly, speculative activities increase moral hazards. The actions of the
investment banks and hedge funds operators are unpredictable. Most of the time, their
actions are speculative, based on their best guess or estimate concerning the direction
of the market. The problem with investment banks and hedge fund operators is not
their motivation, which is the maximization of profit. The problem is with the unfair
allocation of risk since in a way, it is very similar to gambling. The speculative nature
of the activity can and has been very detrimental in the long term. Worse, those
involved are not speculating with their own money, but by using other people money
(their clients). In other words, the risks are shared among the clients while the
operators will usually walk free if everything collapses.
Freight derivatives effect the allocation of risk in the shipping industry
substantially. Ship-owners will be attracted to use freight derivative as the risk
relating to cargo contaminations and collisions can be shifted to certain extent.
Furthermore, there are no bunker clauses, delivery or redelivery issues. There are
downsides as well since anyone who sold on a forward eg a ship-owner who put his
ship on time-charter, will lose possible profit if the market goes up and the ship-owner
will not be able to benefit from the rising market.
The Future Freight Derivatives market is very large as the shipping sectors as
basically a large commodity market with certain high volatility in spot and long term
price (as in Tanker and Dry bulk chartering) 684. This will enable speculators to make
huge profit if the speculation is correct.
683
M. Fahim Khan, ‘Islamic Futures and Their Markets: With Special Reference to their Role in
Developing Rural Financial Market’ (2000) Research Paper No.32, Islamic Development Bank (IDB)
Islamic Research and Training Institute
<http://islamfinland.files.wordpress.com/2009/08/idb-islamic-futures-and-their-markets.pdf>
accessed 15 November 2011
684
The size of the dry freight derivatives in 2007 alone was estimated to be around $200 billion.
279
In the past, the parties involved in global maritime trade will just enter into some
binding contract eg the shipowners will put his ships out on time-charter. However,
nowadays, as more shipowners are exposed to the derivatives market, there is an
increasing tendency to go into hedges and speculations.
6.4 Risk management in Islam
Risk management or hedging which is compliant to Shari’ah principles is a must in
Islamic finance industry
- Shaikh Dr. Mohammed Daud Bakar 685
To minimize risk in maritime trade, parties must ensure that they are using efficient
business strategy and must understand the nature of maritime trade comprehensively.
Terrible trader managing risk in accordance with Islamic risk management will most
probably loss more than an efficient trader managing risk using conventional risk
management. The nature of the supply and demand, the size of the commodity and its
relation to the cost must be understood. For example, crude oil can be transported
12,000 miles from the Arabian Gulf to the USA for less than $1 per barrel using a
280,000 dwt tanker whereas the cost of shipping a small parcel of lubricating oil from
Europe to Singapore in a small parcel can be as high as over $100 per barrel. 686
However, efficient management alone might not sufficient to safeguard ones
business due to the prevailing unfairness in allocation of risk in general. Basically,
since the nature of conventional risk management seems to be based on the transfer or
the shifting of risk, and not risk-sharing, risk management is becoming a zero-sum
game.The huge sums made by one party eg through derivative or insurance is usually
made at the detriment of others. On the other hand, Islamic risk management urge for
a better allocation of risk among the parties through ethical, profitable and sustainable
way.
The concept behind Islamic risk management shares some similarities with the
concepts governing Islamic finance. The essence is profits should be gained by taking
risk in real trade and commerce, and not by unfair risk transfer or by idle or
unproductive activities like usury-based activities or excessive speculations.
Conventional banks rarely lend money to customers who are really in financial
difficulties and if they do, it is usually on a very disadvantageous term. 687 Nowadays,
a better system to re-allocate risk properly is necessary. Nowadays, most relationship
685
The Chairman of the Central Shari’ah Advisory Council of the Central Bank of Malaysia and a
member of Shariah Advisory Council of Securities Commission of Malaysia
686
Martin Stopford, Maritime Economics (3rd edn, Routledge 2009)77
687
Martin Stopford, Maritime Economics (3rd edn, Routledge2009)257
280
is one-sided and unfair and the risks are shifted almost completely to the party with
less bargaining power. For example, at international level, financial assistance and
loans are usually given to poor countries at interest. The poor countries will have to
struggle to repay the loan and the interest while the rich countries concern will be the
repayment of the loan altogether with the interest. If repayment cannot be made, the
assets might be confiscated.
Instead of a mere creditor-debtor relationship with questionable allocation of risk,
it is proposed that a proper risk-sharing relationship will be more equitable and
competitive. For example, instead of interest-based relationship, a risk-and-profit
sharing relationship will be more beneficial to both sides as profits and incomes
should come from increased productivity or higher actual profit margin. This can be
reflected in equitable investment by the rich countries in the poor countries. The poor
countries will not be pressured to repay excessive amount of money while the rich
countries will be able to take its share of the profit in the investments. There will also
be more initiative and motivation for the rich country to assist and ensure the success
and development of the poor countries.
On one hand, this ‘partnership’ concept may not seem attractive to the rich
countries since under the former system (interest-based system), the rich countries
seem to benefit more with only artificial risk as almost all of the risks have been
shifted to the poor countries.
In reality, the unfair allocation of risks towards the poor country will be
detrimental both to the rich country and the poor country. In the event the poor
country failed to make repayment or its economy collapse, there would be a lot of
chaos and dissatisfaction. This is now known to lead to a lot of problems including
riots, terrorism and also piracy. For example, it is now a well known that fact that
piracy in the Somali water has become international threat to global trade. Moreover,
the increase of terrorism originating from poor countries and dissatisfied individuals
is becoming a bigger problem each day.
There has been calls for more equitable and fairer financial system and Islamic
finance are occasionally considered as Islamic finance emphasizes on ethical and fair
allocation of risks while rejecting unfair monopoly, excessive speculations and
unnecessary risks. Askari, Iqbal, Krichene and Mirakhor (2010) emphasize that
Islamic finance ‘embodies the principles of social and economic justice, economic
efficiency and economic growth, as set out in the Qur’an and sunnah’. 688
688
Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor, The Stability of Islamic
Finance: Creating a Resilient Financial Environment for a Secure Future (John Wiley & Sons (Asia)
Pte. Ltd: Singapore, 2010)
281
It is stated in the primary source of Islamic finance:
We sent aforetime our messengers with Clear Signs and sent down with them the Book
and the Balance (of Right and Wrong), that men may stand forth in justice; and We sent
down Iron, in which is (material for) mighty war, as well as many benefits for mankind,
that Allah may test who it is that will help, Unseen, Him and His messengers: For Allah
is Full of Strength, Exalted in Might (and able to enforce His Will). (Quran 57:25) 689
In essence, Islamic finance as part of Islamic legal system intends to protect five
important objectives, also known as maqasid shairah, namely, life, intellect, faith,
lineage and property. Islamic risk management shares similar features.Islamic risk
management urged a return to ethic and morality. This is shown in the following
sayings of the Prophet:
1. The truthful merchant (is rewarded by being ranked) on the Day of Resurrection
together with the Prophet, the truthful ones, the martyrs and the pious people.
2. May God’s mercy be on him who is lenient in his buying, selling and in demanding
back his money (or debts).
3. God will let the man enter the paradise who is an easy purchaser (in bargaining), an
easy vendor (in selling), an easy debtor (in repaying the debts) and an easy creditor
(in lending and demanding back the loans).
Furthermore, Islamic risk management offers a more stable and a more certain system
with less speculative or gambling-like activities while urging for a balanced and fair
relationship between parties. 690
The current global trade revolves excessively around a series of speculations and
risky promises. For example, there is no effective or comprehensive law governing
banks and financial institutions as reflected in the collapse of various banks during
recession and financial crises. Instead on making profits based on real production and
real trade, rich individual and financial institutions can simply make money by
making speculations (often with other people money) using mechanism like large
hedge fund or simply by earning interest. Despite all that, when the economy
collapses and the government decides to bail-out all these companies, banks and
financial institutions, the money that actually belongs to the taxpayer will be used.
689
Yusuf Ali (translator), The Noble Qur’an <http://quran.com/57/25> accessed 10 January 2012
690
For details on the inherent stability of Islamic finance, see Hossein Askari, Zamir Iqbal,
Noureddine Krichene and Abbas Mirakhor, The Stability of Islamic Finance: Creating a Resilient
Financial Environment for a Secure Future (John Wiley & Sons (Asia) Pte. Ltd: Singapore, 2010)
282
There is a real fear that if adequate steps are not taken to ensure efficient
management of risks in the global maritime trade, and the excessive speculative
activities continue unchecked, the previous financial system disaster will spread to the
maritime trade industry. The effect will be more detrimental as the shipping industry
is a real industry dealing with real goods.
The disastrous effects of high-scale unfair allocation of risks in other area should
be learnt. Before the recent subprime mortgage crisis which leads to financial crisis
and global recession, the geniuses on Wall Street figured out a method to maximize
income by shifting the risks in manipulative and unjust methods. First, loan was given
to subprime borrowers (people with inadequate financial capability or qualification)
with very low initial ‘teaser’ rate to purchase houses. In theory, the borrowers will be
able to establish credit history, qualify for refinancing with a fixed interest mortgage
and the subsequent increase or appreciation of the properties’ value will enable to
proper payment. The burden or risk is then shifted to others as the creditors sell the
‘debt’ to each other. When the borrowers failed to make proper repayment, the whole
system then collapsed. 691
While the existence of clearinghouse has significantly reduced problems related
default of payment in maritime-related derivatives, it is proposed that the effect of
large-scale speculative activities can still be hard to contain.
6.4.1
Authorities
Risk management is highly emphasized in Islam. Muslims are not allowed to take
risks lightly by using fate as excuse. The concept of proper risk management can be
seen from the sirah or history of the prophets and can be traced in the major sources
of Islam including Quran and Sunnah. Many of the prophets were successful
businessman during their lifetime including Prophet Muhammad.
In Surah Al-Imraan, it is stated:
Those who devour usury will not stand except as stand one whom the Evil one by his
touch Hath driven to madness. That is because they say: "Trade is like usury," but Allah
hath permitted trade and forbidden usury. Those who after receiving direction from their
Lord, desist, shall be pardoned for the past; their case is for Allah (to judge); but those
691
Muhammad Shahid Ebrahim, ‘Discussion Forum: The Financial Crisis: Comments from Islamic
Perspectives’ (2008) IIUM Journal of Economics and Management 16, No.2, 111-138
283
who repeat (The offence) are companions of the Fire: They will abide therein (for ever).
(Quran 2: 275) 692
While parties to business transactions are permissible to conduct their affairs as they
deem fit, there are limitations under Islam. Conventional derivatives, conventional
loans, insurances and other methods of mitigating risk that contained the element of
usury or interest are generally forbidden under Islam. There are usually two solutions
forwarded by the scholars. The first solution is under the doctrine of dharurah or
necessity. 693 However, the doctrine of necessity or emergency cannot be easily
invoked in Islam. One of the legal maxims in Islam said;
Indeed, what is permissible under dharurat indeed needs confidence of the existence of
the situation after attempts (to find what is halal/permissible).
The second method is by introducing a new alternative, particularly financial products
or risk management methods that are Shariah-compliance.Risk management will be
Shariah-compliant if the risks are managed without using methods that are prohibited
by the shariah. That involves products tainted with usury or interest, excessive
speculations or things akin to gambling. The methods must also be just and does not
inflict injustice or harmful effects to others.
There are around 500 verses in the Quran containing legal injunctions and principles.
This includes:








10 verses on constitutional laws
13 on jurisdictions and procedures
20 verses on economic and finance
25 verses on international law
40 verses on Penal law
50 verses on the sources of law in general
70 verses on family law
70 verses on civil law
Below are some of the relevant concepts found in the Quran and Sunnah;
692
Yusuf Ali (translator), The Noble Qur’an <http://quran.com/2/275> accessed 10 January 2012
693
Under this doctrine, things that are prohibited can be allowed during emergency situation. For
example, Muslims are prohibited from drinking wine. However, if there is no other drink and there is a
risk of starvation, Muslims are allowed to consume it in such situation.
284
i.
And do not swallow up your property among yourselves by false means, neither
seek to gain access thereby to the judges, so that you may swallow up a part of the
property of men wrongfully while you know. (Qur’an 2:188) 694
This Quran verse explains that it is forbidden in Islam to devour the property or
wealth of others by wrongful or unethical mean. For example, by speculating
excessively and by manipulation, it is possible for a party to make a huge fortune at
the detriment of others. This zero-sum game is forbidden in Islam.
ii.
O ye who believe! Eat not up your property among yourselves in vanities: But let
there be amongst you Traffic and trade by mutual good-will: Nor kill (or destroy)
yourselves: for verily Allah hath been to you Most Merciful! (Qur’an 4:29) 695
This Quran verse explains that profits should be made by real trade with mutual
consent and not by speculating or by manipulating financial products.
iii.
Asked what form of gain is the best? [the Prophet] said, a man’s work with his
hands, and every legitimate sale (Hadith: Ahmad, No: 1576)
This shows that Islam encourages people to conduct real business and trade, or to
work in the manufacturing business.
iv.
Leave what makes you doubt for things that do not make you doubt. (Hadith,
Tirmidhi, No: 2442)
This Quran verse explains that people are supposed to avoid things that are doubtful
in nature. For example, if certain financial products or if certain risk management
method might cause unnecessary hardship or harms to others, it is better to leave it
and find another product or method in which others will not suffer
v.
It was related that Abu Huraira said that The Prophet (Prayers & peace be upon
him) said: “There is a time coming when no one will care how they earn their
money, whether lawfully or unlawfully.” 696
694
Shakir (translator), The Noble Qur’an <http://quran.com/2/188> accessed 10 January 2012
695
Yusuf Ali (translator), The Noble Qur’an <http://quran.com/4/29> accessed 10 January 2012
696
Ahmad Zidan and Dina Zidan (translators), Mokhtaser Sahih Bukhari (A.S. Nordeen 2002) 195
285
This hadith actually warns the people that there will come a time when people do not
care about the sources of his money anymore. Basically, this hadith reminds the
followers of Islam to not become one of these people.
There are also numerous verses on good conduct and morality including honesty
while conducting trade etc. There are also various useful guidelines concerning risk
management in Islam. These guidelines on risk management are made by the scholars
in accordance with the spirit laid down in the Quran and sunnah.
6.4.2
Benefits of Islamic Risk Management
Harmonization with Islamic principles can be beneficial for both Muslims and
non-Muslims. Modern risk management can be consistent with Islamic principles
provided that some efforts are taken. For Muslims, compliance with the religious
teaching can be the motivation. For non-Muslims, adoption of products or methods
that are Shariah-compliance can be commercially feasible. This is because there are
often various commercial benefits behind the guidelines and prohibitions laid down
under the shariah principles. For example, 25% of the customers who adopted Islamic
finance in Malaysia are non-Muslims. This shows that Islamic principles are
commercially practical.
Islamic principles do not recognize the separation between ethics, morality and
trade. Islamic finance is supposed to be an ethical finance. There are many authorities
in major source of Islam that emphasis on morality and ethics while conducting trade
and commerce:
a. It was related that Jabir ibn Abd Allah said that the Messenger of God said: “May
God have mercy on the one who is lenient in his buying, selling and when he demands
his money back.” 697
b. It was related that Abd Allah ibn Umar said: “A man came to The Prophet (Prayers &
peace be upon him) and told him that he was always cheated when buying. The Prophet
(Prayers & peace be upon him) told him to say when buying: ‘No cheating’.” 698
c. It was related that Hakim ibn Hizam said that The Prophet (Prayers & peace be upon
him) said: “The one who buys and the one who sells have the option to cancel or to
confirm the deal, as long as they have not parted or until they part, and if they have been
honest and described what they sell truthfully, then there will be blessings in their
697
Ahmad Zidan and Dina Zidan (translators), Mokhtaser Sahih Bukhari (A.S. Nordeen 2002) 196
698
Ahmad Zidan and Dina Zidan (translators), Mokhtaser Sahih Bukhari (A.S. Nordeen 2002) 198
286
bargain. But if they were dishonest and concealed the truth, then the blessing of their
bargain would be wiped out.” 699
Islamic principles are against unfair and unsustainable commercial practice including
practice tainted by usury, speculation, unfairness and injustice. Commercial practice
that is ethical and just is proposed to be more sustainable compared to current practice
that is often a zero-sum game.
.… derivatives are zero-sum games and what one side of a derivative contract loses the
other side gains. Unlike physical destruction brought about by Mother nature such as
Hurricane Katrina or the Kobe earthquake, derivative debacles are at worst wealth
transfer rather than wealth destruction. 700
While the objections from Islamic scholars seem to be religion-based, the alternatives
offered from Islamic finance do make good commercial sense, both to Muslim and
non-Muslim traders. 701 While many of the current alternatives seem to be cosmetic
changes from the conventional, there is good reason to believe that better alternatives
are going to be introduced due to the strong demand from the customers and scholars.
This is due to a few factors: (1) Islamic principle is based on the rulings and principles
found in the primary sources of Islam, some of which are fixed and this leads to
certainty. These principles include rejection of unfair trade practice and any unjust
conduct; (2) With the exception of a few basic and fixed principles under Islamic
finance eg prohibition of usury and gambling, most of the principles are flexible and
in line with the general value shared by most, and (3) Islamic risk management is
competitive and resilient; it offer diversification to the parties and is more stable as it
emphasis on asset-backed transactions and reject excessive speculations and
uncertainties.
699
Ahmad Zidan and Dina Zidan (translators), Mokhtaser Sahih Bukhari (A.S. Nordeen 2002) 196
700
Laurent L Jacque, Global Derivative Debacles: From Theory to Malpractice (World Scientific
Publishing Co. Pte. Ltd 2010) 8
701
For details on the benefits of Islamic finance, see Ahamed Kameel Mydin Meera, The Islamic Gold
Dinar (Pelanduk Publications (M) Sdn Bhd, Malaysia, 2002); Ataul Huq Pramanik (editor), Islamic
Banking: How Far have We Gone (IIUM Press, Malaysia, 2009); Kamal Khir, Lokesh Gupta and Bala
Shanmugam, Islamic Banking: A Practical Perspective (Longman, Malaysia, 2008); Mohd Daud Bakar
and Engku Rabiah Adawiah Engku Ali (eds), Essential Reading in Islamic Finance (CERT
Publications Sdn. Bhd, Malaysia, 2008)
287
6.4.3
Legal framework governing Islamic risk management
Risk management involves multiple methods tailored to suit its purpose. There are
different methods to deal with price risk, credit risk, pure risk and legal risk.
Accordingly, the legal framework governing Islamic risk management depends on the
methods that are being applied. This includes insurance, derivatives, and maritime
arbitration. The legal framework concerning Islamic insurance or takaful is clearly
established. There are abundance detailed researches on takaful. The legal framework
and legal issues concerning maritime arbitration is dealt with in the next chapter.
Therefore, this part will discuss the legal framework governing Islamic derivatives.
What are the differences between conventional derivative and Islamic
derivative? There are a few. For example, according to Kunhibava:
The first difference between conventional derivatives and Islamic derivatives would
be the main common feature which conventional derivative share and Islamic
derivative do not have. This is the flexibility to be used not only by hedgers but also
for arbitrage and speculation as well. The very nature of Islamic derivatives and the
need to minimize gharar (excessive risk) in Shari’ah dictate that speculation and even
arbitrage would be very difficult to perform with Islamic derivatives. Whereas in
conventional finance a derivative is flexible enough to be used not only for true
hedgers, but also by speculators and arbitrage. In Islam speculation per se is not
prohibited, Kan, M.A. (1988). However gambling and games of chance are prohibited.
If speculation is excessive to such an extent that it is a gamble then it would be
prohibited, Obaidullah. (2001). 702
Legal framework governing derivative is usually established at international and
national level. For international level, international association are usually involved in
issuing guidelines. For national level, the role of the Central Bank is usually crucial.
For example, the Governor of the Central Bank of Malaysia, Dr Zeti Akhtar Aziz
said:
On a preemptive note, in response to a series of derivative debacles that was sparked off
by the Barings crisis in 1994, Bank Negara Malaysia has taken steps to enhance
prudential regulations on the derivatives business of banking institutions. In 1996, the
Guideline on Minimum Standards on Risk Management Practices for Derivatives was
issued to provide a framework that outlines the minimum risk management standards for
702
Sherin Binti Kunhibava, ‘Flexibility versus fairness: Conventional Derivatives and Islamic
Derivatives’ in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Readings in
Islamic Finance (CERT Publications Sdn Bhd 2008) 567
288
the derivatives business of banking institutions. It requires banks to ensure that risk
management controls and procedures are in place before engaging in derivatives
business. The guidelines also ensure that derivatives can be offered to customers for
hedging purposes only. In May 2003, as a step towards a more liberalized financial
market, banking institutions are allowed to embed derivatives into investment
instruments to enhance yields. The investment has to be principal protected, and may be
offered to high net worth or corporate clients and for a minimum transaction amount of
one million Ringgit. As part of the prudential requirements, no leveraging is allowed on
the structure. Gradual liberalization allows the banking industry and the regulator to
work in a collaborative manner in developing an innovative yet stable financial
system. 703
The area of law governing derivative is a complicated one involving contract law,
insolvency law, conflicts of law and also involving netting and set-off. Most of the
over-the-counter (OTC) derivatives are documented under master agreements. The
International Swaps and Derivatives Association (ISDA) Master Agreement is the
most common one.
The International Swaps and Derivatives Association (ISDA) is a trade
organization of participants in the market for the over-the-counter derivatives with
more than 825 members in 57 countries. The membership consists of derivatives
dealers, service providers and also users etc. ISDA is also responsible for creating the
industry standards for derivatives. The list of legal definitions for various complicated
legal products is also created by ISDA. ISDA work has helped to significantly reduce
credit and legal risk:
Since its founding in 1985, the International Swaps and Derivatives Association
has worked to make over-the-counter (OTC) derivatives markets safe and efficient.
ISDA’s pioneering work in developing the ISDA Master Agreement and a wide
range of related documentation materials, and in ensuring the enforceability of
their netting and collateral provisions, has helped to significantly reduce credit and
legal risk. The Association has been a leader in promoting sound risk management
practices and processes, and engages constructively with policymakers and
legislators around the world to advance the understanding and treatment of
703
Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, ‘Keynote Address: The nature of risks
involved in dealing with OTC financial derivatives’ (The 4th Banking and Financial Law School
Seminar,Kuala Lumpur, 19 February 2004)
289
derivatives as a risk management tool … ISDA’s work in three key areas –
reducing counterparty credit risk, increasing transparency, and improving the
industry’s operational infrastructure – show the strong commitment of the
Association toward its primary goals; to build robust, stable financial markets and
a strong financial regulatory framework. 704
Established international association like ISDA is not only responsible for creating the
policy and guidelines for conventional derivative. ISDA, in collaboration with
International Islamic Financial Market, has also drafted a Tahawwut Master
Agreement, with the aim of standardizing derivatives transactions under Islamic law.
The collaboration between ISDA and IIFM in creating a Master Agreement for
Islamic derivatives shows that harmonization is possible. This collaboration and
subsequent development is a major breakthrough in Islamic risk management. This is
the first standardized documentation for privately negotiated Islamic hedging
products.
To ensure compliance with Shariah, the development of the Tahawwut
documentation was supervised by the IIFM Shari’ah Advisory Panel. The
documentation was meticulously done. According to Ijlal Ahmed Alvi, Chief
Executive Officer, IIFM:
A record number of drafts - 24 drafts – were developed during the industry consultation
and Shari’ah guidance process before ultimately reaching the final version, which is
comprehensive as well as practical in terms of usage with no compromise to Shari’ah
principles.
It was indeed a pleasure to work with such an experienced and dedicated
execution team and the efforts were supplemented by exemplary understanding and
cooperation shown by ISDA, our joint partner. We express our heartfelt thanks to the
Central Bank of Bahrain for their continuous support and to all who were involved in
completing this important project. 705
To strengthen the legal framework governing Islamic derivatives, standardization is
necessary. This is to avoid uncertainty concerning the status or validity of the methods
or the financial products.
This multiplicity of views is due to different interpretation adopted by different
parties. Some of the parties are more permissive in their interpretation while some
adopted a very strict interpretation.
704
‘About ISDA’ <http://www2.isda.org/about-isda/> accessed 12 October 2011
‘IIFM and ISDA Launch Tahawwut (Hedging) Master Agreement’News Release (1 March 2010)<
http://www2.isda.org/attachment/MjUxMA==/press030110.html> accessed 12 October 2011
705
290
To ensure that the Islamic financial industry is moving towards the right
direction, it is important to have finality. In other words, there must be certainty
concerning the validity of the fatwa or view. One of the solutions is to adopt the fatwa
or view proposed by established Islamic financial institutions after consultation with
the experts and scholars. As long as the majority of the scholars agree, the guidelines
or view should be upheld.
6.4.4
Objections and Suggestions from Islamic scholars
Risk management is about controlling and reducing the possibility of losses.
Financial derivatives such as futures and options, as well as commodity trading are
the main instruments used today in managing risk. These mechanisms enable the
parties to hedge their risk while providing liquidity at the same time.
There are many objections from Islamic scholars against some of the financial
products used to manage risks in maritime trade. Before proceeding, it is noted that
there are many benefits of using derivatives and other conventional financial products
to manage and reduce risks. For example, according to Boyle and Boyle:
By using credit derivatives an institution can separate interest rate risk from credit risk.
This means that an institution can reduce or take on more credit exposure to a given firm
or industry or country without dealing directly in the underlying physical assets. Credit
derivatives can be used under a cloak of anonymity. A bank might not want to publicise
that it was buying credit protection on his largest customer and credit derivatives can
accomplish this objective. 706
There are four type of risks commonly associated with maritime trade:
i.
ii.
iii.
iv.
Price Risk
Credit Risk
Pure Risk
Legal Risk
Many of the risks can be managed using insurance. By using insurance, it serves to
transfer the pure risk from the trading parties to the insurance operator. Another
common ways to manage risks is by using derivative. The use of conventional
insurance and derivative are objected by many Islamic scholars due to non-compliant
with Shariah although alternatives are given.
706
Phelim Boyle and Feidhlim Boyle, Derivatives: the Tools that Changed Finance (Risk Books,
2001) 168
291
The reasons for the prohibition of conventional insurance are partly due to the
element of gharar or uncertainty, altogether with the element of maisir or gambling
found in the insurance contract. By changing the nature of the contract, the scholars
come forward with a Shariah-compliant contract that is based on mutual benefit and
guarantee. For example, under the takaful concept, the idea is mutual assistance and
risk-sharing, and not risk transfer. According to Arbouna;
The question that may be asked is why Islamic insurance, when the objective of takaful
can be achieved by the practice of conventional insurance companies. The answer to this
is that the scholars have studied insurance practices from various aspects. There has
been difference of opinion as to whether or not insurance business is an acceptable
transaction from an Islamic perspective. This debate has stayed for a long period until
the issuance of a resolution by the Jeddah-based International Islamic Fiqh Academy in
1406 Hijri (1985 A.C). The resolution states that “commercial insurance contract, which
earns fixed premium as practiced by commercial insurance companies, involves
significant gharar that causes contract to be null and void.” 707
Concerning the derivative, there are various reasons for its prohibition. This is also
due to the hadith which says, “Sell not what is not with you”. This is due to avoid
injustices and uncertainties that it entails.
The speech by the Governor of Malaysia Central Bank on Islamic derivative,
although originally aimed at financial institutions, is relevant in understanding the
obstacles and challenges:
There are unique challenges to manage in developing derivative products for Islamic
banking and finance because the end product must not only be Syariah compliant, in
form and substance but also be globally attractive to all customers. While Islam
encourages risk management in financial transactions, the tools or instruments used in
such management must not have the prohibited elements of riba (interest or usury),
gharar (uncertainty) and maysir (gambling). Certain basic Islamic financial products
already exist that offer the benefits of hedging. The Bai’ as-Salam contract, for instance,
is essentially a forward contract where two parties agree to carry out a sale/purchase of
an underlying asset at a pre-determined future date, but at a price negotiated and fully
paid today. The Istisna contract is an example of a futures contract where a buyer
707
Mohammed Burhan Arbouna, ‘Regulation of Takaful Business: A Shari’ah overview of contractual
aspects of takaful models’ in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential
Readings in Islamic Finance (CERT Publications Sdn Bhd 2008) 217
292
contracts with a manufacturer to manufacture a product at a future date. A more
interesting example is the Istijrar contract, introduced in Pakistan, which includes the
characteristics of a put and call option, allowing the buyer to cap the purchase price, and
the seller to set a floor for the selling price. 708
6.4.5
Avoiding harm
Using conventional financial products that are based on usury and excessive
speculations to manage trade risk are strictly forbidden in Islam:
O you who believe! Be afraid of Allah and give up what remains (due to you) from Riba
(usury) (from now onward), if you are (really) believers. And if you do not do it, then
take a notice of war from Allah and His Messenger but if you repent, you shall have
your capital sums. Deal not unjustly (by asking more than your capital sums), and you
shall not be dealt with unjustly (by receiving less than your capital sums). (Qur’an
2:278-279) 709
This shows that usury is strictly forbidden to Muslims. According to Islamic scholars,
the harms and hardships caused by some of the conventional financial products in
managing trade risk can be as much as, if not more than, the benefits that it has to
offer. The essence of the objections are that such instruments can be easily
manipulated, cause hardships and harms and are contrary to the religious teaching
which encourages real trade and commerce via partnership and risk-sharing. The
hardships and harms caused are evidenced through a dozens of cases.A simple
example is the Showa Shell Sekiyu K.K. case that caused huge losses to the company.
Showa Shell Sekiyu K.K case
Showa Shell Sekiyu K.K. is one of Japan’s most established oil refiners and distributors
of oil petroleum products. In early 1993, Showa Shell Sekiyu K.K, a 50%-owned
Japanese subsidiary of the oil giant Royal Dutch Shell announced a foreign exchange
loss amounting to as much as $1.07 billion (five times the company’s pretax profit) due
to forward contract. 710 The company losses ¥166.3 billion from $6.4 billion worth of
speculative foreign-exchange contract. This is partly blamed on the wrong strategy
708
Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, ‘Keynote Address: The nature of
risks involved in dealing with OTC financial derivatives’ (The 4th Banking and Financial Law School
Seminar,Kuala Lumpur, 19 February 2004)
709
Muhsin Khan (translator), The Noble Qur’an <http://quran.com/2/278> accessed 10 January 2012
710
Laurent L Jacque, Global Derivative Debacles: From Theory to Malpractice (World Scientific
Publishing Co. Pte. Ltd 2010) 16
293
adopted by the company in taking the position that dollar would rise instead of decline.
This leads to the question whether Showa Shell was actually hedging or merely
speculating in order to recoup losses. Scholars suggested that at least 4 important
reasons contributed to the huge loss: (1) failure to control, (2) failure to report, (3)
failure to audit and (4) failure to communicate. 711
Another example is the huge losses suffered by Bank Negara Malaysia (the Central
Bank of Malaysia) in the past. It is unexpected that one of the leading countries in
Islamic finance also participates in such speculative activity.
Bank Negara Malaysia’s Foreign Exchange Losses (1992 and 1994)
In 1992, the Bank Negara made a speculative bet that the Bank of England will
withstand the speculator’s attack by speculating on the future of pound sterling. On
March 1994, it was reported that Bank Negara Malaysia suffered a foreign exchange
losses of RM5.7 billion. This is in addition to the previous loss of RM9 billion in 1992.
The previous Bank Negara’s governor is forced to resign on April following the
disclosure of the huge losses.
According to Millman:
Bank Negara clearly chose to be a central bank with a difference: by trading for
profit. Bank Negara committed apostasy against the creed of central banking.
Instead of working to ensure global financial stability, Bank Negara repeatedly
shoved huge sums of money into the most vulnerable market situations in order
to stabilize exchange rates for its own profit ... Bank Negara’s market
speculation was so egregious that one American central banker said,” if they
tried this on any exchange in the world they’d go to jail”. However in the
unregulated currency markets, there were neither police nor jailers. The only rule
was the rough justice of the vandals, and it was this rule that eventually bought
Bank Negara down. 712
Perhaps the most well known collapse in 90s is the Barrings Bank’s unexpected
demise.
711
Laurent L Jacque, Global Derivative Debacles: From Theory to Malpractice (World Scientific
Publishing Co. Pte. Ltd 2010) 26
712
Millman as quoted in Laurent L Jacque, Global Derivative Debacles: From Theory to Malpractice
(World Scientific Publishing Co. Pte. Ltd 2010) 43
294
Barrings Bank’s collapse (1995)
Barings Bank (1762 to 1995) was one of the oldest merchant banks in London. The
Barings Bank managed to survive the Great Depression, World War I and World War II.
However, the bank was brought to its feet in 1995 due to excessive speculative activities.
The bank collapsed in 1995 when Nick Leeson, one of the bank's employees, caused a
loss of £827 million ($1.3 billion). During the massive trading loss, Leeson's duty was to
arbitrage and to seek profit from the differences in the prices of Nekkei 225 futures
contracts listed on the Osaka Securities in Japan and the Singapore International
Monetary Exchange. Instead, he was involved in a series of speculative activities,
beyond of his original scope of duty. This huge loss is due to speculative activities,
especially in futures contracts, concealment of accounts, failure to ensure segregation of
duty and due to lack of oversight and supervision. Barings Bank was declared insolvent
on February 1995. This case shows how a relatively unknown employee working in
Singapore can cause one of the largest banks in England to fall simply by secretly
conducting a series of excessive speculative activity.
Recent losses after the global recession are even more disastrous and are at a much
larger scale.
American International Group (AIG)'s huge loss
American International Group (AIG) is an American multinational insurance
corporation. It is one of the largest public companies in the world. According to 2011
Forbes Global 2000 list, it is the 29th largest in the world. AIG previously loss more
than US18 billion due to Credit Default Swaps (CDS) alone following its liquidity crisis
in 2008. A CDS can be defined as “a privately negotiated contract where one party (the
"protection seller"), in exchange for a fee, agrees to compensate another party (the
"protection buyer") if a specified "credit event" (such as bankruptcy or failure to pay)
occurs with respect to a company (the "reference entity") or debt obligation (the
"reference obligation")”. 713 The US Federal Government, through the US Federal
Reserve Bank on September 2008 then gave AIG US$85 billion (via credit facility) in
order to "stabilize the economy" although the stock market crashed anyway.
By May
2009, the United States Treasury increased the financial support to AIG with another
$70 billion (investment), and a $60 billion credit line and $52.5 billion to buy
713
William K. Sjostrom Jr., 'The AIG Bailout' (2009) Washington and Lee Law Review, Vol 6,
947-948
295
mortgage-based assets owned or guaranteed by AIG.
In 2009, the AIG's loss was
around $99 billion although the company reported a profit of $9.3 billion in 2007. 714
According to Sjostrom Jr:
AIG's collapse was caused largely by its $526 billion portfolio of credit default
swaps (CDSs), a type of credit derivative widely used by financial institutions
but, up until recently, largely unknown by the general public. 715
6.5 Derivative in Islam
The majority of Muslim scholars is against conventional derivative in its current form,
partly due to the speculative nature of some derivative. Conventional derivatives are a
very controversial topic in Islamic finance with most scholars disapproving its use,
some examples include Uthmani, T (1996), Khan, M.A (1988), Mahmoud A.El-gamal
and Rosly S.A (2005). 716Andreas A. Jobst and Juan Sole summarized the reasons
behind the rejection of derivatives as follow:
Shari’ah law requires contractual certainty regarding the generation and distribution
of
profits arising from mutual contributions of transacting agents. Any financial
transaction
under Islamic law binds contractual parties to mutual obligations arising
from clearly
identifiable rights and obligations for which investors are entitled to
receive commensurate
return in the form of unsecured, state-contingent payments
based on direct participation in
asset performance. While the reliance on a real or
nonmonetary asset, or “asset-backing,” might imply risk-sharing between contractual
parties as an end result, shari’ah law discourages risk-taking per se regardless of
economic significance. While shari’ah does not object to payment for the use of an
asset, the manner in which
profits are generated is pre-defined and immutable while
profits themselves are not
guaranteed ex ante but accrue only if the investment itself
yields income. Payment and
delivery obligations arise from the use of existing or
future (contractible) assets as part of a
legitimate sale and not from exchange of
homogenous goods, such as money, at different
714
David
Ellis,
'US
takes
another
crack
at
AIG
Rescue',
points in time, making
CNN
Money
(3
March
2009)<http://money.cnn.com/2009/03/02/news/companies/aig/index.htm> accessed 11 October 2011
715
William K. Sjostrom Jr., 'The AIG Bailout' (2009) Washington and Lee Law Review, Vol 6, 945
716
Sherin Kunhibava, ‘Flexibility versus Fairness Conventional Derivatives and Islamic Derivatives’
in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Reading in Islamic
Finance (CERT Publications Sdn. Bhd2008)562
296
asset-backing (in the form of tangible investment) an essential
element of any
commercial transaction under shari’ah law (Jobst, 2007a; Jobst and others,
2008).
Islamic finance aims at the creation of heterogeneous goods and/or services by two or
more
participating parties (“co-generation”) while prohibiting activities that involve
profits from exchanges of the same goods and/or services. Thus, shari’ah law rules
out the (back-to-back) trading of the same object at different prices (or quantities)
between buyer and seller (bay alinah), which also extends to the trading of debt (or
promises) (bay dayn bi-dayn) at a price different than its face value (regardless of
whether the transaction occurs spot or in the future. 717
The element of uncertainties, speculations and its occasionally strong resemblance to
gambling make most Islamic scholars skeptical about the permissibility of current
conventional derivative. However, the conventional maritime trade is also said to be
very similar to a gambling game:
… [L]ike poker, each player must assess his opponents, take a view on how they will
play the game, and work out who will be the loser this time.. It is a gambling game.
Shippers turn to the shipping market because they do not know how much shipping
capacity they will need in the future. Nobody does. The job of the shipowner is to make
the best estimate he can and take a gamble. If he is wrong, he loses. 718
However, it is noted that taking real trade risks, although it have minor speculative
risk, is not a gamble. In Islamic finance, many contemporary Islamic scholars advise
against the use of derivatives while conventional law experts even voiced its
objections to some derivatives as early as the 17th century. 719 Although
contemporary Islamic scholars such as Kamali have argued that futures and options
can be permissible in Islam, the overwhelming majority of scholars believe that
forwards, futures, and options, as they are currently traded in conventional finance,
are strictly not permissible in Islamic finance. 720
The purpose of derivatives varies. There is huge difference between hedging and
speculating. For example, hedging uses a derivatives contract to secure the cost of a
717
Andreas A. Jobst and Juan Sole, ‘Operative Principles of Islamic Derivatives: Towards a Coherent
Theory’ (2012) IMF Working Paper WP/12/63
718
Martin Stopford, Maritime Economics (3rd edn, Routledge2009)133
719
Sherin Kunhibava and Balachandran Shanmugam, ‘Shari’ah and Conventional Law Objections to
Derivatives: A Comparison’ (2010) Arab Law Quarterly 24, 319-360
720
Sherin Kunhibava and Balachandran Shanmugam, ‘Shari’ah and Conventional Law Objections to
Derivatives: A Comparison’ (2010) Arab Law Quarterly 24, 319-360
297
physical position but if there is no physical position, the derivative contract is then a
mere speculation on the shipping cycle. 721
Established Islamic finance experts, Hashim Kamali addressed the concerns of
other Islamic finance scholars eg that the non-existence of any counter-values in
futures or option contracts will not lead to uncertainty or gharar because clearing
houses function as a guarantee that uncertainty and therefore gharar will be prevented
and contracts fulfilled. 722
Kamali also contends that derivatives lack the vital element of gambling (which
is strictly prohibited under Islamic finance), i.e., the wrongful misappropriation of
someone else’s property but this contention is questionable as it is now well-known
that speculators including hedge fund operators does misappropriate other’s property
(especially the investors) by speculating excessively.
Many scholars are skeptical over the use of conventional derivative. The reasons
behind the view of the majority is closely related to the apparent discouragement and
prohibition of selling things that are not yet in the owner’s possession, as there is
uncertainty, among others, about the availability and quality of the subject matter.
The scholars’ view in relation to derivatives differs based on their interpretation.
For example, the Sharīah Advisory Council of the Malaysian Securities Commission
resolved that the futures contracts for crude palm oil were permissible and clarified
that the buying non-existent assets are prohibited only in the presence of excessive
uncertainty.
The reason for the apparent discouragement includes the following hadith:
Hakim b. Hazzam relates that he asked the Prophet: “A man comes to me and asks me to
sell him something that I do not have. Should I sell it to him and then go and acquire it
for him from the marketplace?” The Prophet (pbuh) replied: “Do not sell what you do
not have.[Sunān al-Tirmidhī (1232), Sunān Abū-Dāwūd (3503), Sunān al-Nasāī (4611),
and Sunān Ibn Mājah (2187)].
Bacha summarized the position of derivative in Islam:
Financial derivative instruments which have become hugely popular in conventional
finance, appear to be at a crossroad in Islamic finance. There appears to be little
coherence nor coordination in what ought to be the right place for derivative instruments
721
Martin Stopford, Maritime Economics (3rd edn, Routledge 2009)195
722
Sherin Kunhibava and Balachandran Shanmugam, “Shari’ah and Conventional Law Objections to
Derivatives: A Comparison, Arab Law Quarterly 24 (2010) 319-360
298
in Islamic finance. The Islamic viewpoint is undoubtedly mixed. Any review of the
relatively scant non-Arabic literature in this area clearly points to a difference in opinion
among Islamic jurists. Even where ulamas have agreed on their non-permissibility, their
stated reasons for the non acceptance is often based on very different grounds. This is
further clouded by the differences among the madhahib. The Maliki and Hanbali school
appear relatively more liberal. Most of the works in this area have been of highly
juridical nature. The objective being mostly to examine these instruments in a
contractual framework of the Shari’ah. 723
Some Sharia scholars proposed that hedging is generally permissible as the aim is to
protect the investor against a volatile market. However, many objected. For example,
Mufti Taqi Usmani of the Fiqh Academy of Jeddah in an article answering a set of
posed questions on the topic (New Horison, June 1996, pp 10-11), argues that futures
contracts are invalid because:
Firstly, it is a well recognized principle of the Shariah that purchase or sale cannot be
effected for a future date. Therefore, all forward and futures contracts are invalid in
Shariah; secondly, because in most futures transactions delivery of the commodities
or their possession is not intended. In most cases the transactions end up with the
settlement of the difference in price only, which is not allowed in the Shariah.
On the contrary, Khan states that:
We should realize that even in the modern degenerated form of futures trading, some
of the underlying basics concepts as well as some of the conditions for such trading
are exactly the same as were laid down by the Prophet (PBUH) for forward trading.
For example, there are clear sayings of the Prophet (PBUH) that he who makes a
Salaf (forward trade) should do that for a specific quantity, specific weight and for a
specified period of time. This is something that contemporary futures trading pays
particular attention to." (Fahim Khan does go on, however, to criticize the modern
futures contract for its exploitation of small farmers.) 724
723
Obiyathulla Ismath Bacha, ‘Derivative Instruments and Islamic finance: Some thoughts for a
reconsideration” in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential
Readings in Islamic Finance (CERT Publications Sdn Bhd 2008) 579
724
M. Fahim Khan, ‘Islamic Futures and Their Markets: With Special Reference to their Role in
Developing Rural Financial Market’ (2000) Research Paper No.32, Islamic Development Bank (IDB)
Islamic Research and Training Institute
299
Under Islamic finance, those interested to make a forward trade (known as salaf in
Islamic finance) are instructed by the Prophet to do so for a specific quantity, specific
weight and for a specific period of time. 725 Kunhibava argues that while conventional
derivatives may be more flexible in nature, Islamic derivatives are fairer. 726
Islamic derivatives i.e. Salam, istisna’ and urbun do not function in the same way
as conventional ones. The salam contract allows delivery of an asset at a
predetermined future date but the price is paid in full today; only one party is
deferring his obligation, contrary to forward contract where both differ their
obligations. 727
6.6 Insurance in Islam
The western concept of managing trade risk using insurance is no stranger to the
modern Muslims community. According to Bakar:
The Ottoman Caliphate was the first Islamic regime to introduce the western concept of
insurance within an Islamic jurisprudence via its Maritime Code of 1863.
Notwithstanding this fact, the scheme of combining the resources of members of a
particular group in one common pool to mutually help and protect fellow members from
defined risks is very much Islamically oriented. 728
<http://islamfinland.files.wordpress.com/2009/08/idb-islamic-futures-and-their-markets.pdf>
accessed 15 November 2011
725
M. Fahim Khan, ‘Islamic Futures and Their Markets: With Special Reference to their Role in
Developing Rural Financial Market’ (2000) Research Paper No.32, Islamic Development Bank (IDB)
Islamic Research and Training Institute
<http://islamfinland.files.wordpress.com/2009/08/idb-islamic-futures-and-their-markets.pdf>
accessed 15 November 2011
726
Sherin Kunhibava, ‘Flexibility versus Fairness Conventional Derivatives and Islamic Derivatives’
in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Reading in Islamic
Finance (CERT Publications Sdn. Bhd, Malaysia, 2008) 561
727
Sherin Kunhibava, ‘Flexibility versus Fairness Conventional Derivatives and Islamic Derivatives’
in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Reading in Islamic
Finance (CERT Publications Sdn. Bhd, Malaysia, 2008) 565
728
Mohd Daud Bakar, ‘Making Takaful Mandatory Justification from Objectives of Shari’ah (Maqasid
al-Shari’ah) Perspective’ in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential
Readings in Islamic Finance (CERT Publications Sdn Bhd 2008) 195
300
There are various views concerning the permissibility of conventional insurance in its
current form. The prevailing view is that it is contrary to shariah and modification is
required because it can be allowed.
The use of conventional insurance is largely prohibited under Islam if the
element of excessive uncertainties or gharar is not removed and if there is alternative.
For example, in 1972, the Fatwa Committee of the Malaysian National Religious
Council decreed that the conventional insurance as practised under the Insurance Act
1963 in Malaysia is a wrong/fasid practice because it contains the prohibited elements
of gharar, maysir and riba. 729
In 1985, a ruling was made on conventional insurance by Fiqh Academy.
Resolution No. (9) Concerning Insurance And Re-Insurance (The 1985 Islamic
Fiqh Academy ruling)
The Islamic Fiqh Academy, emanating from the Organization of Islamic Conference,
meeting in its Second Session in Jeddah, Kingdom of Saudi Arabia, 22-28 December
1985) gave the view that:
“The Commercial Insurance Contract, with a fixed periodical premium, which is
commonly used by commercial insurance companies, is a contract, which contains
major element of risk, which voids the contract and, therefore, is prohibited (Haram)
according to the Sharia. The alternative contract, which conforms, to the principles
of Islamic dealings is the contract of co-operative insurance, which is founded on the
basis of charity and co-operation. Similarly is the case of re-insurance based on the
principles of co-operative insurance. The Academy invites the Muslim countries to
work on establishing co-operative insurance institutions and co-operative entities for
the re-insurance, in order to liberate the Islamic economy from the exploitation and
violation of the system, which Allah has chosen for this Ummah.”
It is noted that professional & indemnity insurance commonly used in maritime trade
shares some similarity with the takaful concepts. According to James:
P&I clubs are insurance associations of shipowners and charterers who operate on a
mutual basis. They originated in order to underwrite liability risks not covered by
marine polices usually available in the insurance market. Of the world's marine
insurance markets, London is the largest for P&I clubs, with about 70% of such
729
Wan Marhaini, ‘Some Issues of Gharar (Uncertainty) in Insurance’ in Mohd Daud Bakar and
Engku Rabiah Adawiah Engku Ali (eds), Essential Reading in Islamic Finance (CERT Publications
Sdn. Bhd, Malaysia, 2008) 247
301
global business directed through London (International Financial Services London
2004). 730
The uncertainties or gharar in conventional insurance is said to take place in four
ways, in the contract and compensation’s existence; in the contract outcome; in the
length of the contract period and finally in the amount of compensation and
premium. 731
It is noted that there is already abundance of detailed literature on Islamic insurance,
also known as takaful. For simplicity, takaful is one of the the Islamic way to reduce
financial risk of loss. Literally, takaful means solidarity or mutual guarantee.
Malaysia Takaful Act 1984 defined takaful as:
A scheme based on mutual assistance, which provides for mutual financial aid and
assistance to the participants in case of need whereby the participants mutually agree to
contribute for the purpose.
How does Islamic insurance or takaful act? What are the differences with
conventional insurance? These are some of the common questions. Under Islamic
insurance or takaful, the takaful operators act as entrepreneur while the clients act as
investors. The operators will use the pool of funds generated from the payment of the
premium and will specify how the profits will be shared among the clients. When the
clients suffer loss as prescribed in the contract, protection and assistance will be given
from the pool of funds based on the concept of tabarru’. Tabarru’ literally means to
contribute or to donate.
The general view is that takaful is fully consistent with shariah. This view is
upheld by numerous resolutions and legislations:
i.
ii.
iii.
iv.
730
Islamic Fiqh Week Conference, Damascus, 1961
Second Conference of Muslim Scholars, Cairo, 1965
Symposium on Islamic Jurisprudence, Libya, 1972
The Islamic Conference, Mecca, October 1976
Julian James, 'Lloyd's and the London Insurance Market: An Overview' in J. David Cummins and
Bertrand Venard, Handbook of International Insurance: Between global dynamics and local
contingencies (Springer 2007) 906
731
Wan Marhaini in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential
Reading in Islamic Finance (CERT Publications Sdn. Bhd2008)260
302
v.
vi.
vii.
viii.
ix.
First International Conference on Islamic Economics, Mecca, February
1976
Council of Saudi Ulama (1977) resolution.
Fiqh Council of Muslim World League (1978) resolution.
Takaful Act 1984, Malaysia
Fiqh Council of Organization of Islamic Conference (1985)
The use of takaful in managing pure risk is consistent with the principles of Islam.
According to Siddiqi:
Pure risk, i.e. danger of financial loss incurred by a person in an unforeseeable
accident could be borne by a group of people. Man has always sought to adopt all
possible measures to meet the challenge of pure risk. He tries to safeguard against fire
and theft in house and vehicle, and against accidents involving his vehicle and
premature death. But human experience readily confirms that in spite of all
preventive and precautionary measures, accidents do occur. In the face of such
situations, Muslims are exhorted to sympathize and co-operate with the victims and
their families. 732
Therefore, it is clear that the use of takaful is consistent with Islamic risk management.
Furthermore, the use of professional and indemnity insurance can also be considered
although there will be some uncertainty in some of the aspect particularly the nature
of investment etc. As alternative, Muslims traders can establish a proper professional
and indemnity insurance tailored to meet the religious requirement of the Muslims
traders’ community. Useful innovation is necessary. According to Islamic insurance
expert, Siddiqi:
I do not want to debunk the various Islamic insurance products available in the
market. Let a hundred flowers bloom. What I am lamenting is a failure to accept
anything that does not fit in the old mould despite its obvious wisdom. In trying to
abide by derived rules we have distanced ourselves from the very source of rules. We
have already noted the anomaly of Islamic economic research relegating poverty
732
Siddiqi, Insurance in an Islamic Economy, The Islamic Foundation, 1985, p.44 as quoted in
Mohd Daud Bakar, ‘Making Takaful Mandatory Justification from Objectives of Shari’ah (Maqasid
al-Shari’ah) Perspective’ in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential
Readings in Islamic Finance (CERT Publications Sdn Bhd 2008) 201
303
removal to the backburner and bringing investing rich peoples’ surpluses for making
them richer to the fore. That is how essence is overwhelmed by the peripheral. 733
6.7 The way forward
It is proposed that the various guiding principles and concepts formulated by Islamic
scholars worldwide for more than 1,400 years are beneficial in strengthening the risk
management system adopted by parties involved in maritime trade,
There are various parties involved in maritime trade including the seller, the
buyer, the shipper, the carrier, the financial institutions particularly the banks,
clearinghouses, hedgers, arbitrageurs, and speculators.
Lately, there is a dramatic increase in the use of innovative financial products to
hedge and manage such risks. With the exception of legal risk 734, all remaining risks
including price risk, credit risk and pure risk can usually be managed using financial
products.Thefinancialization of the maritime trade has its benefits and disadvantages.
According to many, the maritime trade is getting more volatile due to this
financialization. It is proposed here that proper legal regulation should be put in place
to govern the financialization of the maritime trade industry to ensure protections
towards the public.
As alternative, the adoption of risk management methods that are
shariah-compliant can also be used to strengthen global maritime trade and make it
more resilient. Harmonization with Islamic principles will be useful to all. Basically,
harmonization with Islamic principles means the adoption of methods or techniques
that are consistent with the guidelines provided under Islam. To make harmonization
easier, it will be more effective if clear guidelines are issued by established Islamic
financial institutions. Such guidelines should include a clear list about the methods
and financial products that are compatible with Islamic principles and those that
aren’t.
733
Mohammad Nejatullah Siddiqi, ‘Obstacles of Research in Islamic Economics’, Journal of King
AbdulAziz University Islamic Economics’ (2008) Vol. 21, No.2, pp83-95
734
Legal risk is usually managed using legal mechanism including the inclusion of efficient legal
department to scrutinize the documents to ensure conformity to law and the adoption of maritime
arbitration to ensure speedy resolution of legal conflict.
304
6.8 Summary
Risk management is a fundamental part of trade. Failure to adopt proper risk
management technique will be costly. During the recent global recession, many
companies collapsed due to poor risk management. For example, Air Asia, a budget
airline managed to substantially reduce its operational cost by hedging properly
against the increase of oil price. On the other hand, Malaysia Airlines (MAS) suffered
substantially due to their failure to hedge.
The idea for most parties involved in maritime is to make profit. When the input
is more than the output, the parties make profit. For example, the total operational
cost for a shipping company is USD100 millions and the total cost altogether is
USD150 million. The shipping company manages to make a total of USD200 million.
The profit enjoyed by the company is basically around USD50 million. If for example,
the oil price increases significantly and the operational cost becomes more than what
the shipping company can make, this mean that the shipping company has suffered
loss. In order to manage such risk, parties usually use financial products and
techniques including hedging and derivatives to safeguard their position.
Parties in maritime trade also suffer pure risk including natural disasters. The
whole carriage might be loss. To safeguard their position, the adoption of marine
insurance and professional and indemnity insurance are common. The use of
insurance in managing risks is now so integrated into the maritime trade industry.
The use of maritime arbitration by the inclusion of proper provisions or clause in
the contract can also be an important method of managing legal risk, depending on the
situation.
It is noted that the literature on Islamic risk management is very limited. The
small number of literature on Islamic risk management focus only on the risk
management for Islamic banks or Islamic financial situations. There are many reasons
for this. The main reason is due to the shortage of scholars in Islamic finance and law.
For example, according to Ng Nam Sin, the Assistant Managing Director
(Development ) for Monetary Singapore of Singapore:
… the number of financial professionals who are well-versed in
Shariah-compliant products is still relatively small. We need more universities
and training institutes to offer better quality education and training in Islamic law
305
and finance in order to meet the rising demands of the industry as it embarks on
the next phase of growth. 735
There are many benefits of adopting a risk management system that is Shari’ah
-compliant and Islamic in nature. Firstly, Islamic risk management will be an
interesting choice to Muslims parties or those interested in ethical trade and
commerce. In other words, if a company offers an Islamic risk management service,
such services will be very attractive to some parties, including large corporations from
Middle East and other Muslim countries. In order to ensure consistency and quality
control, it would be better if established and respected international Islamic financial
bodies like AAOIFI introduced proper accreditation or recognition to interested and
qualified parties. Currently, some training course is being offered to such effect.
Secondly, Islamic risk management shares the benefits associated with Islamic
finance. For example, the parties adopting Islamic risk management will not be
exposed to extreme or excessive risk due to involvement with excessive speculative
activities. This doesn’t mean that hedging or the use of financial products to mitigate
risk is not available. Currently, there are many financial products that are
shariah-compliant.
Thirdly, Islamic risk management encourages ethical and fair methods that are
more sustainable. In other words, it is not a zero-sum game. The essence of Islamic
risk management is not the maximization of profit at any cost. Observance to ethics
and morality are highly emphasized in Islamic risk management.
The removal of unnecessary uncertainties and risks are necessary in order to
strengthen the legal framework of global maritime trade. Islamic principles, as seen in
various Islamic financial products applicable to modern maritime trade will be
relevant in strengthening global trade. This is due to, among others, its prohibition
from dealing with transactions tainted with excessive speculations and due to the
fairer allocation of risks that it required. To truly benefit global trade, Islamic
financial products must not be a mere cosmetic change to conventional products but
its essence must also be different.
From this chapter, it is noted that many of the maritime trade risks are managed
using methods that are not shariah-compliants. For the non-Muslims, this seems to
cause no problem and there seems to be no need to check or revise the legal and
regulatory framework governing global maritime trade or global trade and commerce
at large. However, at a deeper look, it can be seen that the interest of the parties are
735
Ng Nam Sin, Assistant Managing Director (Development), Monetary Authority of Singapore,
‘Opening Keynote Address’ (The 17th Annual World Islamic Banking Conference, Bahrain, 24
November 2010)
306
sometimes not adequately protected under a system that seems to be based on the shift
and transfer of risks and harms, rather than risk minization or risk-sharing.
Furthermore, a system that seems to be based on a zero-sum game, in which one party
wins at the expense of others, can be risky for the long-term, as there will be initiative
and motivation to increase the volatility in order to make profit. Gradual shift in the
risk management system into a new system that attempts to reduce volatility will be
very beneficial and useful.
307
PART B: MANAGING LEGAL RISK IN ISLAMIC FINANCE
6.9 Managing risk in Islamic finance
This research proposes that the application of Islamic principles will be beneficial and
practical. However, in this second part, it will be highlighted that selective and bias
application of some of the principles will be detrimental and dangerous. For example,
during the early stage of the introduction of Islamic finance in Malaysia, there exists
uncertainty as to whether some of the so-called Islamic financial products are truly
Shariah-compliant since some of the products are controversial. 736The hypothesis will
be tested at a deeper level in this part. To ensure successful application, legal risk
must be properly managed. Proper regulation is fundamental for the success of any
financial system. According to Mwenda:
The term regulation refers to a set of binding rules issued by a private or public body.
Generally, these can be defined as those rules that are applied by all regulators in the
fulfillment of their functions; in the financial services area, they include such
prudential rules as those influencing the conditions of access to the market (intended
to prevent the emergence of entities with doubtful reputation or without the financial
capacity necessary for the operations they intended to implement) and those aimed at
controlling the risks associated with financial services, corporate-governance and
internal control systems, conduct-of-business rules, and methods of supervision. 737
At present, there is no international convention (or treaty) governing Islamic finance
so the regulatory framework for Islamic financial services is frequently comprised of
a combination of the following: (a) primary enabling legislation; (b) secondary
legislation (issued in addition to the enabling statute); (c) principles, rules, and codes
issued by regulators; and (d) guidance or policy directives issued by the regulatory
736
A simple example is on the effect of default. The customers have to pay an exorbitant amount of
money in the event of default, since the financing is cosmetically changed into a sale and purchase
agreement. Basically, if the contract is a sale and purchase contract, the party will be obliged to pay the
full amount of the purchase price in the event of default. As comparison, if the customers have chosen
conventional loan instead, the amount will be cheaper since the customers will have to pay less since
consideration will be given to fact that the payment is settled at an earlier stage.
737
Kenneth Kaoma Mwenda, Legal Aspect of Financial Services Regulation and the Concept of a
Unified Regulator (The World Bank 2006)
<http://siteresources.worldbank.org/INTAFRSUMAFTPS/Resources/Legal_Aspects_of_Financial_Sce
s_Regulations.pdf> accessed 6 January 2012
308
authority. In some jurisdictions, primary legislation provides that these ‘guidelines’
should be treated as law.’ 738
Ensuring proper regulatory and legal framework is important, although a bit
challenging, as the rise of Islamic finance is quite unexpected. According to
DeLorenzo and McMillen, in many areas the secular law is favorable to the
continuing growth of Islamic finance but these successes should not deflect attention
from the tasks that lie ahead, in particular the reform of secular law in jurisdictions
within Islamic economic sphere in order to bring Islamic finance to the next height of
development and sophistication and to allow explosive growth in the Islamic
economy.’ 739
The legal and regulatory frameworks for Islamic financial industry in numerous
countries have improved a lot compared to its humble start, although there is still a
long way to go. Country like Malaysia takes the gradual and precautionary approach
in developing its framework. In 1980s, a single fully Islamic bank was allowed to
operate after an enabling Act was put in place. After it is clear that Islamic finance is
feasible and will not disrupt the financial system, various steps were put in place to
strengthen Islamic finance in Malaysia. Ten years from the establishment of Bank
Islam, permission is given to the conventional banks to include Islamic banking into
their financial portfolio by amending the relevant legislation, the Banking and
Financial Institutions Act (BAFIA). By 2010, almost all financial institutions in
Malaysia, particularly banks have included Islamic financial services into their
portfolio of services. Although the percentage is still small, around 20 percent of the
market, Islamic finance nonetheless makes a firm, expanding and established
existence. On the other hand, country like Iran and Pakistan dramatically ‘Islamize’
the whole economy in a short period. The political scenario, economic condition and
the religion and aspirations of the people will be crucial factor in shaping the legal
and regulatory framework of Islamic finance in the country.
Due to the globalization of Islamic finance, countries will benefit a lot from
international Islamic financial bodies that indirectly acted as international regulators
for Islamic finance. Khan and Porzio elaborated as follow:
738
Kenneth Kaoma Mwenda, Legal Aspect of Financial Services Regulation and the Concept of a
Unified Regulator (The World Bank 2006)
<http://siteresources.worldbank.org/INTAFRSUMAFTPS/Resources/Legal_Aspects_of_Financial_Sce
s_Regulations.pdf> accessed 6 January 2012
739
Yusuf Talal DeLorenzo and Michael J.T. McMillen, ‘Law and Islamic Finance: An Interactive
Analysis’ in Simon Archer and Rifaat Ahmed Abdel Karim, Islamic Finance: The Regulatory
Challenge(Wiley 2007) 183
309
… The AAOIFI (Accounting and Auditing Organization for Islamic Financial
Institutions) and the Islamic Financial Services Board (IFSB) help in giving
transparency and general credibility to the industry. Other challenges the industry
faced during its early stages included the need for benchmarks to promote the sharing
of information. The launch of the International Islamic Indexes series, by FTSE and
Dow Jones, has helped promote the industry in the last decade. The Dow Jones
Islamic Market Index was launched in February 1999 as part of the Dow Jones
Global Index Series (DJGI). The DJGI, which includes stocks, analyses companies in
47 countries covering 10 economics sectors and 122 industrial groups. Out of this
general index a Shariah supervisory board applies the above-mentioned criteria, on
which the Shari’ah universe is formed. 740
This is not always the case. In 1970s, modern Islamic finance as we understand it
today is almost unheard of. The collapse of the last Muslim Empire, the Ottoman
Empire on 29 October 1923 did not lead Islamic financial principles into oblivion
although it remains temporarily dormant until its recent revival.
It was, during its early stage of revival, merely a theory, untested and viewed
skeptically by many. After all, how can a financial system based on the elimination of
interest (and usury) and some other religious principles and prohibitions, survive in
the face of the massive global secular conventional financial system, with hundreds of
years of history? Since many Muslims themselves were skeptical about the feasibility
of Islamic finance in its early introductory stage, many thought that Islamic finance
would never go mainstream and would only be limited to a small sector of
conservative Muslims. This assumption was mistaken. By 2011, the size of Islamic
financial industry is estimated to be more than US$ 1 trillion. Furthermore, the
non-Muslim community, looking for competitive and profitable financial products
and diversification, also accepts it. However, the rapid advance and
commercialization of this new branch of the global financial family, present a myriads
of complex policy considerations that promise to test existing national and
international frameworks.
While the primary focus of Islamic finance continues to be the introduction of
shariah-compliant products to the public and private investors, there is increasing
attention being paid to the wider impact of Islamic finance. This has included
questions on how to regulate Islamic finance. Arguably, the recent inconsistent fatwas
on the permissibility of some of the Islamic financial products and its actual benefits
740
M. Fahim Khan and Mario Porzio, Islamic Banking and Finance in the European Union: A
Challenge (Edward Elgar 2010) 138
310
to the investors, customers and subscribers has acted as catalyst for the ‘Islamic
finance-regulation’ debate.
The benefits of Islamic finance are numerous and a proper legal and regulatory
framework is warranted. While the inclusion of Islamic finance into a country
financial portfolio will make it more attractive for Muslim investors and client’s eg
oil-rich Middle East countries, it is inaccurate to assume that that it is the limit,
although its role cannot be denied:
One of the most important factors in the revival of Islamic fortunes in the twentieth
century has been the discovery of enormous oil deposits in the Middle East, a
serendipitous event which coincided with increasing dependence upon oil in the West.
Money from oil has created enormous opportunities for development in those
countries where it is concentrated, such as Saudi Arabia, Kuwait, Bahrain, the United
Arab Emirates, Qatar, Iraq, Iran and Algeria. States without significant oil resources
has also benefited from sending labourers to work in richer states. The money these
workers send home has contributed significantly to the economies of place like the
West bank and Gaza, Egypt and Jordan. 741
One-fifth of the world population are Muslims, but non-Muslims are also important
players in Islamic finance. For some banks, around 50 percent of the Islamic financial
products are used by non-Muslims customers.
Furthermore, Islamic finance, in theory (and gradually in reality), strives to forge
a stronger root for the global trade and financial system, by ensuring better and
stronger link between financing and real trade, and by ensuring ethical transactions.
At the same time, the benefits must be balanced with the risks that Islamic finance, as
a new financial system, imposes. New untested financial products, if left unmonitored
and unregulated, may disrupt and cause harm to the whole financial system.
There are a few different legal regimes on Islamic finance with different
outcomes; (1) fully-Islamic, in which the country desires to adopt Islamic financial
system in its entirety; (2) dual-system (with inclination to Islamic finance), in which
the country accommodates both Islamic and conventional finance although the plan is
to gradually strengthen Islamic finance; (3) neutral, in which the country attempt to
provide a level-playing field for everyone.
In Malaysia, the Banking and Financial Institutions Act 1989 (BAFIA) regulates
and enables the application of Islamic finance by conventional banks while the
741
Angelo M Venardos, Islamic Banking & Finance in Southeast Asia: Its Development and Future
(World Scientific 2007) 20
311
Islamic Banking Act 1983 provides for the licensing and regulation of Islamic
banking business. Concerning Islamic insurance (also known as takaful), Takaful Act
1983 provide for the regulation of takaful business in Malaysia and for other purposes
relating to or connected with takaful. Furthermore, established Islamic financial center
like Malaysia also adopted Anti-Money Laundering and Anti-Terrorism Financing
Act 2001, and this is crucial to avoid false allegation that Islamic finance can be a
façade for financing illegal activities and terrorism. At the same time, the Central
Bank of Malaysia (formally known as Bank Negara Malaysia) issued a series of
relevant guidelines on various aspects of Islamic finance from the governance of
Shariah Committee to Islamic financial products. The legal framework of Islamic
finance in Malaysia is further strengthened by the various resolutions provided by the
Shariah Advisory Council of Bank Negara Malaysia. Despite the comprehensive legal
framework governing Islamic finance in Malaysia, Malaysia actually adopted the
‘dual systems’ regime, as conventional finance worked alongside Islamic finance.
The previous illustration of Malaysia shows an example of a country adopting a
dual-system regime, in which the country implemented various actions to strengthen
its Islamic finance, although conventional finance are allowed to flourish. The
selection of the specific legal and regulatory framework will be largely determined by
the political scenario, aims and ambitions.
There are advantages and disadvantages of the different models for regulating
Islamic finance. 742 The important thing for any government aspiring to introduce
Islamic finance into their country is to understand the aim or purpose of such action.
This is because different countries have different agendas. For a country like Malaysia,
the purpose is to become an international Islamic financial hub that caters to the
global, foreign and domestic demands. Since the majority of Malaysians are Muslim,
the domestic market for Islamic finance is large and it makes sense for the
government to focus not just on the foreign or outside market, but also the domestic
one. On the other hand, the number of Muslims in places like Hong Kong is just
around 2.5 percent. The purpose of the introduction of Islamic finance in Hong Kong
is mainly to serve as a gateway to the People Republic of China, aiming mostly at
investment from Middle East and other Muslim countries (as well as wealthy
corporations). Therefore, a different legal framework is adopted.
For Singapore, its ambition to become a truly international financial center will
not be realized unless Islamic finance is also included in its colorful financial
portfolio. For Brunei, the aspiration seems to be a great offshore location for
shariah-compliant investment. For Iran and Pakistan, Islamizing the whole banking
742
However, due to the characteristic of Islamic finance, self-regulation and co-regulation will still be
an important aspect for the key players.
312
and financial system is necessary to give political legitimacy to these two countries,
consistent with the Islamic image that both aspire and intend to portray. For a country
like Indonesia, attempts to replicate Malaysia’s success by establishing a strong legal
and regulatory framework for Islamic finance will be difficult despite its large number
of Muslims. In Malaysia, the Muslim identity is already firmly established and there
is a strong support toward Islamic finance. In Indonesia, there is still a strong hostility
towards Islamic finance and this, to a certain extent, hampers its legal and regulatory
development. Although there are a few different regimes governing the legal
framework of Islamic finance, some aims should be common. For example, the legal
framework must not cause unfairness to any parties.
The core of Islamic finance is actual trade and commerce, and the rejection of
unfair allocation of risk through usury or interest. To make money and wealth, people
are expected to do some productive work, or to get involved in real trade and
commerce or by sharing real risk. Under Islamic finance philosophy, people are not
supposed to make money simply by giving loan and then charge interest. There
should be some element of risk-taking, profit-sharing etc. As consequence, many
Islamic financial products do not fall into the standard category of ‘financing’.
Therefore, if the conventional financial system is forced upon Islamic finance in its
entirety, there will be harsh and extra taxation. Furthermore, tax deduction and
exemption is allocated for ‘interest’, something that is prohibited under Islamic
finance. Therefore, if the legal framework is not tailored to cater to Islamic finance,
those participating in Islamic finance will be at an disadvantage.
In the past, governments had remained passive to the issue of Islamic finance
regulations due to its small size. This eventually provides for an unfair and
discriminatory (albeit unintentionally) playing field for Islamic finance. The few
countries that proceed with the suitable and fair regulatory and legal framework on
Islamic finance manage to seize the massive market for Islamic finance. Many
countries are now revising their legal framework to ensure fair playing field for
Islamic finance. Among the questions posed for regulators are:
1. Should Islamic finance be treated differently?
2. To what extent ought Islamic finance be treated differently eg compared to the
existing conventional laws and regulations in related arena?
3. What are the relevant lessons in the regulation of other recent advancing
financial system?
4. What are the high priority legal, ethical and regulatory issues?
5. What forms of regulatory and legal arrangements might be most effective to
achieve the aims and objectives of the regulators?
313
Literature Review
There are abundant of literatures on Islamic finance studied from various angles today.
New angles are also covered. For example, Islamic Finance: Why It Makes Sense 743by
Daud Vicary Abdullah and Keon Chee is unique work that also focuses on the appeal
of Islamic finance to non-Muslims. One of the authors is non-Muslim and this
provides for a unique angle in this work, as the concerns of the non-Muslims on
Islamic finance are also addressed.
An Introduction to Islamic Finance: Theory and Practice 744 by Zamir Iqbal and
Abbas Mirakhor is an important contribution to the Islamic finance literature as the
work also re-thinks the role of Islamic financial institutions in the aftermath of the
disastrous global financial crisis. Previously, the same authors (with another two
authors) in The Stability of Islamic Finance: Creating a Resilient Financial
Environment for a Secure Future 745have demonstrated the feasibility and stability of
modern Islamic finance.
There are also numerous detailed literatures on the legal and regulatory aspects
of Islamic finance. 746 The Legal and Regulatory Aspects of Islamic Banking: A
Comparative Look at the United Kingdom and Malaysia by Abdul Karim Aldohni
discusses the legal and regulatory aspects of Islamic finance and examines the latest
743
Daud Vicary Abdullah and Keon Chee, Islamic Finance: Why It Makes Sense (Marshall Cavendish
Corp 2010)
744
Zamir Iqbal and Abbas Mirakhor, An Introduction to Islamic Finance: Theory and Practice (Wiley
Finance 2011)
745
Zamir Iqbal, Abbas Mirakhor, Noureddine Krichenne and Hossein Askari, The Stability of Islamic
Finance: Creating a Resilient Financial Environment for a Secure Future (Wiley Finance 2010)
746
This includes Amr Mohamed El Tiby Ahmed, Islamic Banking: How to Manage Risk and Improve
Profitability (Wiley 2011); Angelo M. Venardos, Islamic Banking and Finance in South-East Asia: Its
Development and Future (3rd edn, World Scientific Publishing Company 2011); Abdul Karim Aldohni,
The Legal and Regulatory Aspects of Islamic Banking: A Comparative Look at the United Kingdom
and Malaysia (Routledge 2011); Fuad Abdullah Al-Omar, Islamic Banking: Theory, Practice and
Challenges (Zed Books 1996); M. Fahim Khan, Islamic Banking and Finance in the European Union:
A Challenge (Studies in Islamic Finance, Accounting and Governance) (Edward Elgar Pub 2010);
Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds), Essential Readings in Islamic Finance
(CERT 2008); Rifaat Ahmed Addel Karim and Simon Archer, Islamic Finance: The Regulatory
Challenge (Wiley Finance 2007); Sudin Haron, Islamic Banking: Rules & Regulations (Pelanduk
Publications 1997); Zamir Iqbal and Abbas Mirakhor, An Introduction to Islamic Finance: Theory and
Practice (Wiley Finance 2011)
314
Malaysia and United Kingdom regulatory frameworks on Islamic finance. 747 This
work provides for some insights into the regulatory and legal aspect, although the
discussion on cases is quite brief.
Another relevant work is the Current Issues in Islamic Banking and Finance:
Resilience and Stability in the Present System by Angelo M. Venardos. 748 Vernados’
work provides for a timely review of the different financial markets from capital
(Sukuk), retail, wealth management and it also includes comparative study on the
legal and regulatory aspect of Islamic finance in Malaysia (the front-runner),
Singapore (the regional financial hub), Brunei (an offshore Islamic market player)
Indonesia, as well as newly emerging participants such as Japan and the United States.
A detailed study on Islamic banking and finance in Southeast Asia, although not
focusing on the legal and regulatory aspect, is provided by the same author in his
work entitled Islamic Banking and Finance in South-East Asia: Its Development and
Future. 749 The author manages to provide for a broad overview of the landscape of
Islamic finance in Southeast Asia in this slim volume while maintaining depth
analysis at the same time.
The literature can be classified into a few categories. Firstly, there are numerous
literatures that compare the different legal and regulatory regimes, and their
consequences and performances. Aldohni’s comparative examination on the legal and
regulatory framework of Islamic banking in the United Kingdom and Malaysia
provides a comprehensive critique on how existing regulatory mechanisms will assist
a country achieving its objectives and policies on Islamic finance. Some argue that
regulatory framework will not be adequate for protecting the interest of all parties.
While greater coordination between international Islamic financial regulatory bodies
may reduce and decrease the inconsistency and regulatory issues, new international
Islamic finance-specific convention or legislation may offer a better alternative.
In examining the current regulatory framework for Islamic finance, some author
suggests that the inclusion of Islamic financial products without proper legal
framework resulted in the blurring of traditional regulatory boundaries. Some of the
literature is country-specific. For example, Theory and Practice of Modern Islamic
747
Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A Comparative Look
at the United Kingdom and Malaysia (Routledge 2011)
748
Angelo M. Venardos, Current Issues in Islamic Banking and Finance: Resilience and Stability in
the Present System (World Scientific Publishing Company 2010)
749
Angelo M. Venardos, Islamic Banking and Finance in South-East Asia: Its Development and
Future (3rd edn, World Scientific Publishing Company 2011)
315
Finance: The Case Analysis from Australia 750 by Abu Umar Faruq Ahmad examines
the extent of divergence in the practice of Islamic financing from the traditional
Shari`ah in the Australian context.
Secondly, there are also some credible literature proposing on the future
direction of Islamic finance and the suitable legal and regulatory framework to
accommodate it. The work of two professors, Prof. Rifaat Ahmed Addel Karim and
Prof. Simon Archer, Islamic Finance: The Regulatory Challenge is a very useful
literature on understanding the legal and regulatory obstacles. 751 This work addresses
various issues and clarifies the reasons why the frameworks devised for the
conventional financial sector is unsuitable for Islamic financial services and
elaborated on the nature of risks in Islamic banking. This work also analyzed the
regulatory challenges face Islamic financial services and the potential for growth on
the Islamic financial service sector. Furthermore, existing legal frameworks for
Islamic financial products and the specific corporate governance and supervision
issues are also covered in this comprehensive work.
Mahmoud A. El-Gamal in his Islamic Finance: Law, Economics and Practice 752
provides for an excellent overview of the practice of Islamic finance, its historical root
and proposed that ‘Islamization’ of conventional financial practice is not the correct
future direction of Islamic finance. Instead, it is argued that the proper direction is to
refocus on the substance rather than the form.
Essential Readings in Islamic finance by Mohd Daud Bakar and Engku Rabiah
Adawiah Engku Ali is an excellent literature on Islamic finance, although not so much
focus is given to the legal aspect. Focusing on the potential truly equity-based
financing, Bakar suggests that true reform in Islamic financial sector will occur if the
parties are willing to shift the current approach of imitating conventional financial
products (by ensuring that the minimum requirement of shariah-compliant is
achieved) to a truly Islamic financial products that adhere to the values promoted by
the religion eg fairness, justice for all etc.
Iqbal and Mirakhor also note the following:
750
Abu Umar Faroq Ahmad, Theory and Practice of Modern Islamic Finance (Brown Walker Press
2010)
751
Rifaat Ahmed Addel Karim and Simon Archer, Islamic Finance: The Regulatory Challenge (Wiley
Finance 2007)
752
Mahmoud A. El-Gamal, Islamic Finance: Law, Economics, and Practice (Cambridge University
Press 2008)
316
For IFIs that follow strict risk sharing principles, there would be minimal
regulation required. There would be less emphasis on capital requirements,
and more on transparency and disclosure, management screening, and
licensing of business lines; that is, regulation equivalent to conventional
banking. There would be greater reliance on direct market discipline and less
on “command and control” regulation. 753
According to Venardos:
Equity represents an investment exposed to all kinds of business risks and
sharing in the profits of the business. It may be of permanent nature, that is,
redeemable only upon liquidation of the business – or earlier by mutual
agreement – but not on demand. Debt on the other hand, is a contractual
obligation to pay a specific value, whether in cash or kind, on an agreed date
or demand, for value consideration received, with the important proviso that
value at the both ends of the transaction must be equal in terms of whatever
commodity or currency they are dominated in. 754
However, it is noted that such shift must be made meticulously by taking into account
the unique challenges faced under the current conventional system. For example, the
role played by the financiers nowadays is actually similar to creditors. Indeed, for
conventional finance, there are numerous cases that have firmly established that the
main nature of the legal relationship between financial institutions like banks and their
customers are mostly creditor-debtor relationship.
To incorporate the Islamic principle of profit-and-risk sharing, the role of the
financiers will have to evolve from creditors to some sort of investors, most probably
passive (but informed) investor. Under such arrangements, the Islamic financial
institutions will have to take extra and real risk, and the profits that it shares will be
more reflective with its involvement.
While such arrangements might seem noble in theory, failure to address
numerous legal and economic issues will be disastrous. For example, the concept of
the separation of legal entity is a firmly established concept and there is a genuine fear
that the parties will try to shift a huge portion of the risk to the bank. Secondly, due to
753
Zamir Iqbal and Abbas Mirakhor, An Introduction to Islamic Finance: Theory and Practice (2nd
edn, Wiley 2011) 303
754
Angelo M Venardos, Islamic Banking & Finance in Southeast Asia: Its Development and Future
(World Scientific 2007) 44
317
information asymmetry, the Islamic financiers will not be able to truly appreciate the
level of risks involved in the business/project. Thirdly, by switching their roles from
mere creditors to actual ‘investors’, the Islamic financiers will be exposing themselves
to more risks eg litigation, legal issues, business risks etc.
Thirdly, there are a growing number of critical literatures on the defects of
current Islamic financial products. Proposals on how to strengthen such products are
also included but the focus of such literature rarely covers the legal and regulatory
framework in detail.
Market entry to date has been relatively unconstrained due to a distinct absence
of Islamic finance-specific regulatory frameworks. It is noted that while numerous
governments have supported Islamic finance with some investing heavily, most seem
to lack interest in implementing new Islamic finance-specific regulatory frameworks
for risk minimization.
A survey on the literature on Islamic finance reveals that there are still some gap
on the legal and regulatory aspect of Islamic finance. For example, there is still a gap
on literature analyzing the comparative aspects of the different legal and regulatory
framework governing Islamic finance and the consequences of adopting these legal
and regulatory regimes. At the same time, the number of literature that deals with the
current defects of modern legal and regulatory system on Islamic finance is still
inadequate. For example, for conventional banks and other conventional financial
institutions, the central banks of various governments usually acted the ‘lender of the
last resort’. Currently, there is no similar institution for Islamic finance and the legal
and regulatory framework for such matter is not adequately discussed at current stage.
A proper legal and regulatory framework for Islamic finance should, at minimum,
address a few matters. For example, the legal scope of definition of Islamic finance
should be clear. The characteristics of a firm, institution or company to be considered
Islamic must not be vague. Furthermore, the issue of shariah-compliant, particularly
who should have the final say in the matter should also be obvious. Currently, the
literature on the above matter is still minimum.
6.10 Importance of Proper Legal and Regulatory Framework for Islamic
Finance
There are many benefits of having adequate legal and regulatory framework for
Islamic finance but it must be understood that there are many things beyond its reach:
The success of and spread of a product or of an institutional-operational model for the
financial industry must not be allowed to depend on the rules. It is not the regulator’s
or supervisor’s job to determine the economic needs of the market, the products and
318
the services that firms and households need. Selection of the enterprises that offer
financial services and products is up to the market. Market participants, for their part,
must observe the rules, whose objective in the financial sector is to ensure stability,
transparency, investor protection, and hence a level playing field among financial
institutions. 755
The legal framework of conventional finance, unmodified, is not always suitable to
cater to Islamic finance, in certain aspect. This does not mean that that a new separate
regulatory and legal framework for Islamic finance is needed in all aspects. Where
similarity exists, the principles and concepts can be extended to Islamic finance eg in
matters like transparency, accountability, conflict of interest etc. This assistsIslamic
finance, as the regulators do not have to start from scratch.
Singapore focuseson only one legal and regulatory framework for Islamic
finance. In Malaysia, although the dual-system regime is adopted, the legal; and
regulatory framework is not truly dual. The same regulators are still responsible and
most of the circulars and guidelines issued are applicable to both the Islamic and
conventional financial institutions. This kind of arrangement has its benefits.
According to Aldohni:
The partial or the the incomplete application of Islamic finance principles under the
conventional economic system has enriched the Islamic banking experience. The
significant development in the Islamic banking sector could not have been achieved if
the Islamic banking were still only a theory. The translation of Islamic banking
principles from theoretical to the practical sphere, in the early 1970s, showed the
weaknesses and where the theory needed to be developed. Also, it helped to discover
new financial products that fit the present situation. All of these benefits could not
have been achieved if Islamic banks had waited until they could be applied in a full
Islamic economy that only upholds Islamic finance rules. 756
There are many benefits and advantages of updating and revising the laws and
guidelines and having adequate regulatory and legal framework for Islamic finance at
international and national level. Below are some them:
755
M. Fahim Khan and Mario Porzio, Islamic Banking and Finance in the European Union: A
Challenge (Edward Elgar 2010) 196
756
Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A Comparative Look
at the United Kingdom and Malaysia (Routledge 2011) 19-20
319
• Different core: Equity-based, not debt-based
Islamic finance has a different core from the conventional finance. Although
maximization of profit is one of the aims of conducting trade and commerce, under
Islamic finance, it cannot be done ‘at any cost’. Ethical principles must be observed,
particularly the rejection of the usury-based system as Islamic finance held it to be
unjust and unfair.
The legal relationship between the parties also differs. At the core of the
conventional finance are usually a financier in the form of a creditor, and a borrower
in the form of customer. Court cases have firmly established that the nature of the
legal relationship between a conventional bank and its customers are usually
creditor-debtor relationship. This is because at the core of the transaction is the
intention of the customer to get a loan while the intention of the conventional
financial institutions is to get the principal together with interest, also known as usury.
However, such arrangement is not feasible for Islamic finance as usury and
interest are forbidden. Instead of loan, the transaction must be a sale or purchase
transaction, or partnership, or investment or other permissible methods. In general, the
main concept is trade is permissible while usury is forbidden.
Failure to have a proper legal framework for Islamic finance will cause
unfairness. According to Tai Boon Leong, Executive Director, Monetary Authority of
Singapore:
MAS has undertaken several initiatives in recent years to create a conducive
environment for Islamic Financial activities in Singapore.
Our policy intent has
been to create a level-playing field between Islamic and conventional finance.
In
this way, investors and users as well as financial institutions engaged in Islamic
Finance will not be disadvantaged in terms of tax or regulation.
Since we first
started working with the industry to develop Islamic Finance in 2003, we have
increased the number of Shariah-compliant financing arrangements which
Singapore-based financial institutions can enter into.
The latest two structures
announced in January were the Ijara wa Igtina and Murabaha Interbank placements.
We will continue to work closely with industry players to review other Islamic
financing structures so as to broaden the choice of Shariah-compliant instruments. 757
This requires Islamic financial institutions to have different methods of conducting
transaction, although the level of risks that it exposed itself to will varies based on its
757
Tai Boon Leong, Executive Director, Monetary Authority of Singapore, ‘Opening Remarks’ (The
Singapore Islamic Finance News Roadshow 2009, 17 March 2009)
320
selected method. Some of the guidelines on conventional finance can be extended to
Islamic finance but some need to be modified:
… effective prudential supervision on banks is just as necessary and desirable in
Islamic banking as it is in conventional banking. To help reach this goal, a number of
standards and best practices established by the Basle Committee on Banking
Supervision are useful and provide a valuable reference. These standards, however,
are not always applicable to Islamic banking. An appropriate regulatory framework
governing Islamic banks need to place a greater emphasis on the management of
operational risks and information disclosure issues than is normally the case in
conventional banking.’ 758
Legal and regulatory framework for Islamic finance must address the issues caused by
the different nature of the financial system.The true aspiration of Islamic finance, to
encourage real trade and commerce based on fair allocation of risks like
profit-loss-sharing is noble and it would be unfortunate if its development is halted to
due technical matter.
Various countries, including Singapore and perhaps Australia in the near future,
are taking the functional approach. In other words, instead of merely looking at the
label attached to the financial product, the regulator will actually look at the true
nature of the transaction. Instead of imposing the higher tax allocated for investment
or sale and purchase of commodity, Singapore actually impose the standard and lower
tax commonly imposed on loan transaction, for Islamic financial products that
resemble sale and purchase but are actually merely financing in nature.
The blur in the legal and regulatory aspect will eventually be wider as Islamic
financial institutions proceed from their passive role as financier to actual participant
with more active role in the trade and commerce eg in the form of partner or investor.
• Taxation (modus operandi/double taxation)
The conventional financial system differentiates equity-based financing and
investments, and credit financing or loan. Since under Islamic finance, usury or
interest is prohibited, this cause some obstacles when it operates in a system tailored
for the conventional system as the regulatory and legal framework favor credit
financing and loan by providing many initiatives:
758
Luca Errico and Mitra Farahbaksh, ‘Islamic Banking: Issues in Prudential Regulations and
Supervision’, IMF Working Paper, WP/98/30 <http://www.nzibo.com/IB2/IMFprs.pdf> accessed 6
Janury 2012
321
More specifically, tax law could be quite problematic to Islamic banks, especially
since tax law has always treated equity finance and debt finance differently. This
means that Islamic banks will not have the same tax treatment as conventional banks,
which are based on debt finance. There are two aspects of the taxation problem
regarding the financial products of Islamic banks: first, the extra taxes generated by
Islamic bank transactions; and second differentiation made between interest and
profits … 759
A new legal framework is needed for Islamic financial product to avoid extra
taxation:
… [T]he Murabaha (mark-up) contract is used by Islamic banks to replace personal
loans offered by conventional banks. The Murabaha agreement includes two
purchasing options, which are taxable transactions. Although both purchased
contracts belong to on transaction, it is still due double stamp duty. This means that
the cost of this service offered by Islamic banks is far more than that which a
customer of a conventional bank would pay for the same service. The same problem
can be addressed with regard to Islamic mortgages, where stamp duty land tax will be
charged twice: once when the Islamic bank buys the property; and again when the
customer completes purchasing all ‘units’ from the banks and obtains the legal title.
There could also be stamp duty land tax on the lease to occupy the property. 760
Under conventional legal framework, interest is given special treatment, can be offset
against the payment of tax and in other words, it is tax deductible. Since the interest
element is totally eliminated from Islamic finance Islamic banks have no deductions
to make in their tax bill. Furthermore, the rewards achieved by equity finance
structures to offer similar services to conventional banks, are taxable.
In order to avoid extra taxation and unfair treatment to Islamic financial
institutions, established Islamic financial hubs like Malaysia and Iran has long created
a level playing field by taking initiatives to ensure fairness.
However, other jurisdictions that are relatively new to Islamic finance are still
developing the legal and regulatory framework in relation to taxation. One example is
Australia.
759
Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A Comparative Look
at the United Kingdom and Malaysia (Routledge 2011) 109
760
Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A Comparative Look
at the United Kingdom and Malaysia (Routledge 2011) 109
322
On 26 April 2010, the then Australia’s Assistant Treasurer and the Minister for
Financial Services, Corporate Law and Superannuation announced that a
comprehensive review of Australia's tax laws on Islamic finance will be made. 761 On
18 May 2010, the then Assistant Treasurer announced the terms of reference for the
Board's review and the Discussion paper elaborated that the Board has been asked
to 762:
•
‘Identify impediments in current Australian tax laws (at the Commonwealth, State
and Territory level) to the development and provision of Islamic financial products in
Australia;
•
Examine the tax policy response to the development of Islamic financial products in
other jurisdictions (including the United Kingdom, France, South Korea and relevant
Asian jurisdictions); and
•
Make recommendations (for Commonwealth tax laws) and findings (for State and
Territory tax laws) that will ensure, wherever possible, that Islamic financial products
have parity of tax treatment with conventional products.’
In conducting the review, it was reported that the Board should consider the
following 763:
•
The tax treatment should be based on economic substance of the products rather than
form.
•
Where an Islamic financial product is economically equivalent to a conventional
product, the tax treatment should be the same.
761
‘Review of the Taxation Treatment of Islamic Finance: Discussion paper’, The Board of Taxation,
Australian Government, October 2010
<http://www.taxboard.gov.au/content/content.aspx?doc=reviews_and_consultations/islamic_finance_p
roducts/default.htm&pageid=007> accessed 6 January 2012
762
‘Review of the Taxation Treatment of Islamic Finance: Discussion paper’, The Board of Taxation,
Australian Government, October 2010
<http://www.taxboard.gov.au/content/content.aspx?doc=reviews_and_consultations/islamic_finance_p
roducts/default.htm&pageid=007> accessed 6 January 2012
763
‘Review of the Taxation Treatment of Islamic Finance: Discussion paper’, The Board of Taxation,
Australian Government, October 2010
<http://www.taxboard.gov.au/content/content.aspx?doc=reviews_and_consultations/islamic_finance_p
roducts/default.htm&pageid=007> accessed 6 January 2012
323
• Globalization
Globalization refers to the increasingly global interaction between people, culture, and
also economic activity. The advantages, and also harms, associated with globalization
are numerous. From the economic point of view, globalization can be very beneficial
when it resulted in more employment, better transfer of skill and knowledge, better
financial assistance and cheaper and more affordable price for commodities. On the
other side, the collapse of one country, sometimes just one large corporate, in a
globalized world will trigger a chain of events that are so catastrophic in nature that it
is totally unexpected at the initial stage.
Islamic finance has gone global. According to Dr. Zeti Akhtar Aziz, the
Governor of Malaysia Central Bank:
The globalisation of Islamic finance has gained significant momentum in this recent
five years. While the early development of Islamic finance was domestic centric, its
internationalisation is now manifested by increased cross border flows, greater
participation in international Islamic financial markets, the increased presence of
financial institutions in new jurisdictions and more recently, the increased number of
Islamic financial institutions which have shareholders from multiple jurisdictions.
Greater financial integration has essentially been facilitated by the more rapid pace of
liberalisation that has been supported by the progress that has been achieved in the
development of the international Islamic financial infrastructure. This trend has also
been prompted by the need for greater diversification of risks in the management of
funds. In the current international financial environment, this trend has become more
pronounced prompting investors to consider other asset classes and markets that
provide stability. Thus far, the global financial crisis has had limited direct effects on
Islamic finance. While Islamic finance by its very nature only engages in transactions
that have underlying tangible productive activities, the slower overall growth and the
increased uncertainties have affected pricing and activity in certain market segments.
However, this in part reflects the shift in activity from the financial markets to the
Islamic financial institutions. 764
Throughout this research, it has been proposed that the rejection of excessive
uncertainty and excessive speculative activities, as promoted by Islamic principles
will strengthen global trade and commerce.
764
Zeti Akhtar Aziz, ‘Governor’s Keynote Address: Islamic Finance: A Global Frowth Opportunity
Amidst a Challenging Environment’ (State Street Islamic Finance Congress 2008, Boston USA, 6
October 2008)
324
This is partly due to the nature of globalization itself. In a globalized world,
parties will have easier access to each other, although the bargaining powers of the
parties will differ. If proper legal and regulatory framework is not in place, there will
be those who will take advantages of others, by trying to manipulate the loophole in
the system. For example, as can be seen from the incoming case analysis, that many
parties who defaulted in their obligation with Islamic banks in Malaysia will attempt
to raise the issue of shariah-compliant. So far, the allegation of non-compliant of
shariah seems to be a mere afterthought, or worse, a mere delay tactic that often failed
in court. The reason is because Malaysia has a quite clear legal and regulatory
framework in the matter, in which the decision of the Shariah Advisory Board of
Malaysia (concerning the issue of Shariah-compliant) is acknowledged and in a way,
binding. On the other hand, the legal and regulatory framework on this matter, for the
global scale, or at international level, is still vague.
A weak legal and regulatory system will also lead to a lot of wasted opportunity:
… [A]weak banking system is likely to prevent the economy from benefitting from
the ongoing process of globalization and the liberalisation of capital markets,
particularly in developing and emerging market countries (which are often the ones
where Islamic banking principles are followed) where banks are the major (or even
the sole) players in domestic financial markets. As in the case of conventional
banking, an appropriate regulatory framework for an Islamic financial system should
aim, therefore, at reinforcing the operating environment of banks, as well as their
internal governance, and market discipline. To help develop such a regulatory
framework, standard and best practices established by Basle Committee on banking
and Supervision are useful and provide valuablke reference. However, these
standards cannot always be applied to Islamic banking in the same way that they are
in conventional banking systems. 765
Suitable legal and regulatory framework is important to ensure that the negative
elements of globalization are not extended to Islamic finance. In other words, by
having a strong and clear legal and regulatory framework, it will be easier to manage
the Islamic financial industry in difficult times.
The effect of globalization and financial crises has been extended to Islamic
financial industry before, and failure to have good legal and regulatory framework
will be disastrous:
765
Angelo M Venardos, Islamic banking & Finance in Southeast Asia: Its Development and Future
(World Scientific 2007) 106
325
Against the backdrop of this global financial crisis, Islamic finance is inevitably
affected and subject to challenging conditions reflected by a steep slowdown in
activities such as sukuk issuance and declines in equity value managed by Islamic
funds. New sukuk brought to the market in the first three quarters amounted to some
US$13 billion, down 40% from the same period last year1. But the pullback in new
sukuk issuance and the widening of sukuk yield spreads are generally in line with
what has been happening in the conventional market. This broadly suggests that the
global sukuk market slowdown has more to do with the general market conditions
and a general reluctance to issue US dollar instruments. Observers say that while
there are still those who wish to issue sukuk, investors would prefer to stay on the
sidelines in the current volatile market environment. It is true that the industry is
experiencing a temporary setback, but this also reflects how closely integrated
Islamic finance is with the global financial system, which is not at all bad news for
the industry because when global markets stabilise and take a turn for the better - as
they must in the long run - Islamic finance will ride on that curve and excel. 766
Under modern finance, trade and commerce, the collapse of the financial system of
one country can have profound impact on the global financial community. Indeed,
even the collapse of one large corporation can trigger a chain of events, akin a domino
effect, to the whole industry. As the fate of the global financial community is more
tied to each other than ever, it is fundamental to have a proper regulatory and legal
framework so that unnecessary losses can be minimized and immediate actions can be
taken when required:
First, financial markets around the globe have become more exposed to systematic
failure due to the intertwined nature of their transactions. Systematic risk in this new
era has a more extensive impact than ever before, and a banking crisis is not a
domestic problem anymore. This is, in particular, because the failure in one financial
market could have a contagious effect on the other linked financial markets around
the world. Second, securing effective baking supervision has become a very
necessary and challenging task at the same time. Therefore, supervisory authorities
have begun to issue guidelines that address the risky areas in the banking sector and
identify the best methods of supervision in an attempt to set comprehensive
766
‘Eddie Yue, Deputy Chief Executive of the Hong Kong Monetary Authority, ‘Keynote Address’
the (Hong Kong Islamic Finance Forum 25 November 2008)
326
supervisory guidelines. However, such attempts were not enough to create the
required harmonized banking supervision at the international level. 767
By ensuring that proper legal and regulatory framework is in place, it will be easier to
prevent the ‘domino’ collapse of the financial system. Furthermore, a standardized
framework will be more attractive for the global trade community:
… there is a fundamental need for further standardization and harmonization of both
regulatory and Shariah standards across the Middle East and Asia.
The greater use
of standardized legal documentation will increase efficiency, certainty, transparency
and liquidity.
This would allow for easier cross-border offering of financial
products that would reach a wider investor base and thereby bring about greater
economies of scale and reduce transaction costs.
Standardisation will also enable
better risk management by ensuring that risks are clearly identified and appropriately
mitigated between financial institutions and their counterparties. 768
• Conducive legal framework
The introduction of Islamic finance into a national market will be hindered if there is
no enabling Act in place. The enabling Act can be simple and brief, but it should exist.
Enabling Act will remove doubts and uncertainty surrounding the establishment of
Islamic financial institution from the regulatory and supervisory aspect. An example
of such enabling Act is the Islamic Banking Act 1983 in Malaysia that enables the
introduction of fully-fledged Islamic banks in Malaysia and the amendment to
Banking and Financial Institutions Act (BAFIA) that enables the introduction of
Islamic windows by conventional banks.
Malaysia’s experience reveals that consistency and uniformity in decisions is
easier to achieve by having clear legal and regulatory framework. For example, the
role of the Shariah Advisor Committee is clearly elaborated in Malaysia and this leads
to a conducive legal framework for Islamic finance, as dispute concerning the validity
of Islamic financial products eg shariah-compliant etc, is easier to be settled.
767
Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A Comparative Look
at the United Kingdom and Malaysia (Routledge 2011) 109
768
Lim Hng Kiang, Minister for Trade and Industry and Deputy Chairman, Monetary Authority of
Singapore, ‘Opening Remark’ (2nd World Islamic Banking Conference: Asia Summit 2011, Pan
Pacific Hotel Singapore, 8 June 2011)
327
• Reducing risk, uncertainty & ambiguity
Another important reason to have adequate legal and regulatory framework for
Islamic finance is to remove uncertainty and ambiguity concerning the structure and
requirement. For example, some legislation specified the requirement needed from the
Shariah Committee Board including the credentials etc. Some other elaborated in
detail regarding the Islamic financial products and the issue of corporate governance
eg using guidelines. Without adequate regulatory and legal framework, the parties
venturing in Islamic finance will be left alone in an unchartered territory, and this
should not be the case.
Beyond that, a proper regulatory and legal framework will reduce the level of
risk exposed the parties. For example, the global standard principles on banking
regulations, as reflected in the Principle 6 of the Core Principles for Effective Banking
Supervision dictated that minimum capital requirement must be observed.
Principle 6 stated that ‘the banking supervisors must set prudent and appropriate
minimum capital adequacy requirements for all banks. Such requirements should
reflect the risks that banks undertake, and must define the components of capital,
bearing in mind their ability to absorb losses’.
One of the problems with the global standard principles, even Basel Capital
Accord is that the guidelines and regulations are made without including the input
from the Islamic financial industry. According to Khan and Porzio:
… to date Islamic finance has been at the margin of the consultation process on he
rules of Basel 2. This is due not only to the modest weight in financial market that
Islamic banks have relative to conventional ones, but also to insufficient ‘political
representation’ within the Bsel Committee, worsened by the fact that in reality, there
is not one model of Islamic bank but many, often very different from the original
‘pure’ version. Rules and supervisory practices differ among the various Islamic
countries; the accounting standards used for financial contracts and their associated
risks are reported and measured for regulatory purposes very differently; there are
five schools of thought, each with its own interpretation of financial transactions and
banking products compatible with the Shariah rules (El-Hawary, Grais and Iqbal
2004). 769
769
M. Fahim Khan and Mario Porzio, Islamic Banking and Finance in the European Union: A
Challenge (Edward Elgar 2010) 113
328
• More attractive to investors and customers
Any country that have committed regulators that are known to provide the proper and
suitable legal framework for Islamic finance will be at an advantage as the country
will be more attractive to investors and customers. This is because Islamic finance can
sometimes involve complicated as well as unprecedented legal and regulatory issues.
Without the proper will power from the regulators and those in charge of the financial
affair, the investors and customers will shy away.
For example, in early 2008, Muhammad Taqi Usmani, a well-known Islamic
finance scholar, made the shocking announcement that 85 percent of Islamic bonds
issued in Middle East were not shariah-compliant.
• Reducing legal risk and unnecessary litigation
Failure to have adequate legal and regulatory framework will be time and cost
consuming, as the parties will sometimes have to resort to court litigation to settle
conflicts and issues. This can be avoided by having a proper legal and regulatory
framework. For example, in Malaysia, the Kuala Lumpur Regional Arbitration Center
has come up with detailed arbitration rules on settling disputes related to Islamic
finance that is the first in the world. This will assist in reducing legal risk and
unnecessary litigation.
• Better supervision and monitoring
There are allegations that Islamic finance can be used as a mode of financing illegal
activities:
The problems get more complicated in Western countries where there are some
Muslim minorities who, for religious reasons, are reluctant to deal with conventional
banks. The absence of formal Islamic banks in this case would create opportunities
that underground financial bodies purporting to be Islamic can exploit. In fact, those
who deal with these underground banks may have no idea about the real nature of
their business, their main concern being that they are dealing with ‘allegedly’ Islamic
banks. Investing or transferring any money through these organizations, over which
the authorities have no supervisory powers, may be a real threat to any government. It
is worth noting that controlling underground Islamic banking and investigating their
practice is also an Islamic legal requirement: Islamic law stresses the importance of
addressing any abuse in the Islamic banking practice, including money laundering. 770
770
Fath E. Rahman Abdalla El Sheikh, ‘The Underground Banking System and their Impact on
Control of Money Laundering: With Special Reference to Islamic Bank’ (2002) 6, 1 Journal of Money
Laundering Control 42
329
By having a comprehensive legal and regulatory framework, it will be easier to
monitor and supervise the whole industry. However, it is worthy to note that
allegation that global Islamic finance (contrary to unregulated underground ‘banking’
system) can be used to finance illegal activities is a simplistic allegation, often not
based on facts, but sentiments. This is due to a few reasons. First of all, due to the
nature of Islamic finance, Islamic finance is often viewed more skeptically and in a
more hostile manner compared to others. Therefore, Islamic finance is actually
subjected to more supervision and monitoring. Secondly, the allegation that Islamic
finance will be attractive to bad people like criminal or terrorists is not strong. This is
because people like terrorists departed from the mainstream or traditional Islamic
view on various matters. For example, the harming of innocent people, even animals
and trees are prohibited under Islam. Therefore, for those who have blatant disregard
for Islamic principle, it is unlikely that they will all choose to adopt Islamic finance
instead. Furthermore, this will make their criminal activities easier to expose.
Concerning supervision and monitoring, there are a few challenges and obstacles.
For example, although there are a few international Islamic bodies that are responsible
to oversee and ensure the proper performance of the Islamic financial industry, their
role is more voluntary in nature and they don’t have any jurisdiction or power.
International Islamic bodies issue many of the guidelines on Islamic finance with
no actual binding powers. In a way, this is actually similar to conventional finance.
Acceptance is voluntary although common since the regulations provided are very
beneficial and assists in maintaining high quality and standardization:
Concerning the problem of adopting the same prudential regulations as western
countries, the Islamic Financial Services Board on 15 March 2005 published two
draft papers: Guiding Principles for Risk Management and Capital Adequacy. The
first document points out 15 principles for implementing risk management procedures
in the Islamic banks. The approach adopted considers the risks of the prevailing
banking activity and the risks of the different types of contracts offered by Islamic
banks. In particular the principles have been grouped with reference to six different
risk categories; credit, equity investment, market, liquidity, operating and rate or
return… The second document, instead represent a successful attempt at the
homologization of Islamic finance to the requirements established by Basel II. 771
771
M. Fahim Khan and Mario Porzio, Islamic Banking and Finance in the European Union: A
Challenge (Edward Elgar 2010) 106
330
6.11 Types of Legal Framework on Islamic Finance
There are many different legal and regulatory regimes governing the framework of
Islamic finance. The legal and regulatory regimes can be classified and divided on
various methods. For example, they can be classified based on the nature of the
Islamic financial products eg Islamic bond or sukuk, Islamic derivatives, musharakah,
mudharabah etc. They can also be classified based on the regulatory bodies that issued
the guidelines and enact the legislations.
However, for this research, the
classification will be made based on countries general practice and approach. This
provides for a simpler approach, although the depth of study can still be maintained.
The proper legal and regulatory framework to govern Islamic finance has to address
numerous important questions. According to Khan and Porzio:
In conclusion, it can be asked: should Islamic banks gradually become equivalent to
western commercial banks? Or should they become specialized financial institutions
favouring the areas of business where Islamic law is most congenial: mutual fund
investments, venture capital, investment funds, services and trade finances? From the
theoretical point of view, considering the economic functions typically carried out by
banks, is an intermediation process different from the conventional one, typically
based on the interest rate, possible and feasible? 772
The legal and regulatory framework for Islamic finance adopted by the various
countries all around the world can be classified into three:
a. Fully Islamic
b. Dual systems
c. Neutral & Partial Inclusion
This brief and simplistic analysis is made with the realization that many countries in
the world failed to have any legal and regulatory framework to accommodate Islamic
finance. Detailed and comprehensive study on certain aspects of the legal and
regulatory framework is already available 773. Below is the introductory analysis on
the three different legal and regulatory regimes:
772
M. Fahim Khan and Mario Porzio, Islamic Banking and Finance in the European Union: A
Challenge (Edward Elgar 2010) 108
773
See Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A Comparative
Look at the United Kingdom and Malaysia (Routledge 2011); Hossein Askari, Zamir Iqbal and Abbas
Mirakhor, New Issues in Islamic Finance & Economics: Progress & Challenges (Wiley Finance
2009); Mohamad Illiayas Seyed Ibrahim, ‘The Regulatory Framework and Legal Aspects of Islamic
331
6.11.1
Fully Islamic
Fully Islamic refers to countries that only accept banking and financing practice that
complies with the country’s interpretation of Islamic principles. These countries
include The Islamic Republic of Iran and Pakistan.According to Khan and Mirakhor:
A distinction has been made between the concept of Islamic banking implemented as
a profit-making enterprise operating in an interest-based system and Islamic banking
implemented as an integral part of a complete Islamic system. Each will face different
sets of problems. In most of the Muslim world (and in some Western countries)
Islamic banks compete with the conventional banks. The problems faced by these
banks will be the type experienced by all attempts at transplanting parts of one system
into another. Aside from problems of contradictions and conflict in basic values,
these institutions will have to meet the challenges emanating from the legal and
regulatory framework of the environments in which they wishes to operate, as well as
those generated by the requirements of security, viability, and profitability which
conventional banking systems have tried to meet. 774
The hypothesis of this research that Islamic principles can applied to modern global
trade in general, and maritime trade in particular, should not be construed as
suggesting that conventional finance should abolished. It is proposed that the gradual
adoption of useful Islamic principles will strengthen global trade ( and maritime trade)
and both systems can mutually co-exists. There are numerous challenges faced by the
countries adopting the fully Islamic regime, although history has shown that the
challenges can be tacked:
The ban on riba severely restricts a central bank’s grip on the economy and may lead
to harmful consequences. A central bank that cannot use interest-based measures to
control the commercial banking sector’s lending activities and money creation may
easily be tempted to resort to measures that undermine the efficiency of financial
markets, in particular direct credit controls. However, it is not entirely without
indirect instruments, as variable cash and liquidity ratios can still be applied
(Chandavarkar 1996, ch.9). How did countries that fully Islamized their financial
system deal with the problem? The Central Bank of Iran (CBI) is authorized to
Banking and Finance in Malaysia’ in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds),
Essential Readings in Islamic Finance (CERT Publications Sdn Bhd 2008); Simon Archer and Rifaat
Ahmed Abdel Karim, Islamic Finance: The Regulatory Challenge (Wiley 2007)
774
Mohsin S. Khan and Abbas Mirakhor, Theoretical Studies in Islamic Banking and Finance (Islamic
Publications International 2005)
332
impose ceilings on the banks’ loan and credit volumes, not only in a global sense but
for individual economic sectors as well. It may also used required reserve ratios, with
different rates for different liabilities and for different fields of activity. 775
Any country adopting the fully Islamic regime must consider the fact that the global
finance and trade, and global monetary system are mostly conventional in nature.
However, these should not be a problem if the regulator, commonly in the form of
monetary authorities, is flexible enough:
The monetary authorities operating in an Islamic framework continue to have the
power to regulate banking and financial operations in the economy, both to allocate
resources in conformity with the priorities of the society, and to direct monetary
policy toward specific goals. To achieve its policy objectives, the central bank has
control over the supply of ‘high-powered’ money (that is, currency plus deposit
liabilities of the central bank to commercial banks), the reserve ratios on different
types of liabilities, and the maximum amounts of assets that banks can allocate to
their profit-sharing activities. A further control is available to the central bank
through its purchases of equity shares of banks and other financial intermediaries. 776
Pakistan
Pakistan adopts the fully-Islamic regime. Pakistan, officially the Islamic Republic of
Pakistan is a sovereign country with a population of around 177 million. During
1979-1980, the Islamization of Pakistan banking system was initiated by permitting
banks to accept deposit on profit-loss sharing basis. By June 1984, the government of
Pakistan announced a gradual plan to transform the entire financial system to
non-interest bearing Islamic financial modes. According to Khan and Mirakhor:
As of July 1, 1984, all financial institutions were allowed to carry out
transactions on the basis of either Islamic or interest-based modes, on
condition that interest-based accommodation for working capital would not be
provided or renewed for more than six months. Since January 1, 1985, all
transactions with the Federal and Provincial Governments, public sector
corporations, and public or private joint stock companies have been based on
775
Hans Visser, Islamic Finance: Principles and Practice (Edward Elgar 2009)
776
Mohsin S. Khan and Abbas Mirakhor, Theoretical Studies in Islamic Banking and Finance (Islamic
Publication International 2005) 7
333
Islamic modes and, from April 1, 1985, all financing to all entities and
individuals was required to be on an Islamic basis. 777
There are benefits and disadvantages. For example, comparison can be made with
Malaysia. In Malaysia, legal disputes will be argued according to the English common
laws. Islamic finance-contracts will be interpreted according to concepts of the
English common laws should there be disputes but this differ from a fully Islamized
country like Pakistan. In Pakistan, its Banking Ordinance and Mudarabah 1980
provides provisions for the central bank to determine the maximum and minimum
profit margin that Islamic financial institution can use and no reference to English
common laws are necessary.
Harmonization between common law principles and Islamic principles are
possible, provided that the legal and regulatory framework as provided by the
legislation is clear. The common law court will generally respect the wishes of the
parties eg to incorporate Islamic principles, provided that the terms or principles are
clearly and expressly stipulated in the contract. In any event, it is not the
responsibility of the court to ensure such harmonization.
Iran
Similar to Pakistan, Iran also adopts the fully-Islamic regime. Iran, officially the
Islamic Republic of Iran is a country with a population of around 75.3 million. The
country is the only theocratic Muslim country adopting Shia as the official religion
while the highest state authority is the Supreme Leader. The size of Iran is
approximately equal to France, Spain, Germany and the United Kingdom combined.
Based on GDP, the economy of Iran is the 18th largest in the world with many of its
income come from oil 778 , agriculture, large enterprises and trading and services
venture.
After the Iran Revolution in 1978, steps were taken to transform the banking
system by first nationalizing the system. The banking system in Iran was immediately
nationalized after the revolution. The reasons forwarded are the inefficiency of the
financial institutions and the need to protect public interest. Prime Minister Bazargan
stated that ‘We respect private property but in view of the undesirable and
unprofitable conditions in the banks, to protect national rights and wealth and get the
wheels of the economy moving, we deemed it necessary to nationalize the banks’
while the head of the Plan and Budget Organization added that ‘Many of the owners
777
Mohsin S. Khan and Abbas Mirakhor, Theoretical Studies in Islamic Banking and Finance (Islamic
Publication International 2005) 9-10
778
Iran ranks third in world oil reserves and it ranks second it world natural gas reserve.
334
of private banks did not have good record and did not play their fundamental role in
preserving the national wealth and rights’. 779 Wilson elaborates the Islamization
process:
The implementation of the Islamization policy had been piecemeal and took six years
to be fully introduced. More than 20,000 staff had to be put through courses in
Islamic banking. The lengthy process of Islamization was constrained by various
economic developments associated with the nationalization of the banking system,
political upheavels, the freezing of Iranian assets abroad, acute economic recession,
and the Gulf War. It is important to note that at the time of revolution, the banking
system in Iran was near collapse. A large number of newly established banks were
burdened with high levels of non-performing assets and debts to both Bank Markazi
(the Central bank) and foreign creditors. The position of these banks was in particular
due to lack of banking and management experience compounded by inadequate
regulatory control. 780
The legal and regulatory framework permit two kinds of partnership: civil and legal.
The civil partnership is based on the contribution of cash or non-cash capital by
several legal persons to a common pool on a contractual basis to make profit while the
second form of partnership is concerned with firms in which the banks provide a part
of the capital of a new joint-stock company or buys part of the shares of an existing
joint-stock company. 781
The participation of the bank is only permissible if, after analysis on the
technical, economic and financial viability of the firms, the appraisal indicates that
minimum expected rates of return could be achieved. 782 Home to more than 70
million people, Iran might become one of the hottest market for Islamic finance due to
young population and a need for more infrastructure projects. However, due to bad
relationship between Iran and some Western countries, particularly the United States,
and due to the serious accusation that Iran is creating nuclear weapon, the
779
Hosssein Aryan, ‘Iran: The impact of Islamization on the financial system’ in Rodney Wilson,
Islamic Financial Market (Routledge 1990) 155
780
Hosssein Aryan, ‘Iran: The impact of Islamization on the financial system’ in Rodney Wilson,
Islamic Financial Market (Routledge 1990) 157
781
Hosssein Aryan, ‘Iran: The impact of Islamization on the financial system’ in Rodney Wilson,
Islamic Financial Market (Routledge) 159
782
Hosssein Aryan, ‘Iran: The impact of Islamization on the financial system’ in Rodney Wilson,
Islamic Financial Market (Routledge) 159
335
development of Islamic finance in Iran is temporarily halted as international traders
and investors are a bit reluctant to get involved. The U.N. Security Council has
already imposed rounds of sanctions on Iran since late 2006 for refusing to halt
sensitive nuclear enrichment activities, while the United States has added sanctions to
curb business with the Islamic Republic.
Reuters reports as follows:
Granted, investing in Iran still presents problems. GFH's Kazerooni said legal
and political uncertainties were an obstacle after past ownership deals or terms
in privatizations were changed after being signed. "Iran doesn't have a good
track record, people are a bit wary," he said.
While the Gulf Arab region has attracted many international banks seeking to
tap opportunities in the world's top oil-exporting region, many Western banks
have halted or reduced Iran-related business as a result of U.N. and U.S.
sanctions. 783
If the diplomatic relationship between Iran and other countries, particularly Western
countries and other Muslim countries improved, the development of Islamic finance
in Iran will be accelerated.
6.11.2
Dual system
The regime refers to countries that adopt Islamic finance alongside the conventional
finance. These countries include Malaysia and Bahrain. The conventional finance as
represented by conventional banks and conventional financial institutions are free to
practice but the legal and regulatory frameworks are tailored to cater to the interest of
Islamic finance as well.
One of the differences between this legal and regulatory regime compared to
others is the usual policy to strengthen Islamic finance while maintaining the
conventional finance. There are numerous advantages for this regime. Firstly, Islamic
finance can be introduced with less risk. One of the benefits is the introduction of
Islamic finance can be smoothly and without interrupting the current conventional
system. Furthermore, these countries do not have to start from the beginning as the
783
Ulf Laessing, ‘Islamic banks see Iran opportunities’ Reuters US Edition (Manama, 16 April 2009)
<http://www.reuters.com/article/2009/04/16/us-islamicbanking-summit-iran-idUSTRE53F3T62009041
6> accessed 30 December 2011
336
conventional financial institutions can just include Islamic finance in their financial
portfolio.
Secondly, the Islamic finance industry can benefit and learn from the long and
useful experience of the conventional finance. Usually, in the dual systems regime,
the government will made various initiatives to strengthen Islamic finance and the
conventional financial institutions will usually be attracted to benefits from these
incentives, in addition to diversification.
Thirdly, this kind of regime is suitable for countries where there are significant
numbers of non-Muslims or where a large number of foreign non-Muslim investors
are needed. These will ensure that the interest and desire of all parties are respected.
Fourthly, this kind of regime will make a country more resilient to financial
crisis due to its comprehensive legal and regulatory regime.
Malaysia
Malaysia adopts the dual system. Malaysia is a country with long tradition of Islamic
banking, where nearly 50 percent of clients of Islamic financial institutions are
non-Muslim. 784This can be justified simply on the basis that the religion of the
participating parties has never been an important issue for consideration in any
Islamic financial transaction. 785 The situation in Malaysia is unique. The population
of Malaysia is around 28 million, with the percentage of Muslim at around half.
Malaysia has a strong tradition with Islam in which the Federal Constitution states
that Islam is the religion of the Federation and therefore other religion can be freely
practised. Being a multiracial country, the conventional finance flourished to cater the
needs of the community. Islamic finance is also popular in Malaysia at the domestic
level, among the Muslims and the non-Muslims alike, due to strong support form the
government, lack of bias towards Muslims due to long exposure and also due to
strong and clear legal and regulatory framework:
In order to have this unique combination of banking systems, the Malaysian
government enacted the Islamic Banking Act 1983 and the Banking and Financial
Institutions Act 1989, which worked together to regulate the Islamic banking sector.
784
Malaysia International Financial Centre, ‘Islamic Finance: Lower Risk But at What Cost’ (9
November 2009)
<www.mifc.com/index.php?ch=menu_med_ifcnews&pg=menu_med_ifcnews_int&ac=429>
accessed 20 January 2011
785
Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A comparative look
at the United Kingdom and Malaysia (Routledge 2011) 6
337
While the Islamic banking Act 1983 provides the guidelines for licensing and the
general regulatory requirements, the Banking and Financial Institutions Act 1989
allocates the supervisory bodies for the conventional and Islamic bank… Islamic
banking was initially introduced into Malaysia by the Islamic Banking Act 1982. The
scope of Islamic banking business is generally defined in the Act as ‘banking
business whose aims and operations does not involve any elements which is not
approved by the religion of Islam’. This enables the Islamic bank to provide certain
facilities for instance leasing, which is strictly non-banking business under the
Banking and Financial Institutions Act 1989. 786
Bank Islam Malaysia Berhad was incorporated as a limited company under the
Companies Act, 1965, on 1st March 1983. Its memorandum of association states that,
‘All businesses of the company will be transacted in accordance with Islamic
principles, rules and practices’. The Bank’s Articles of Association provides that:A Religious Supervisory Council, whose members would be made up of Muslim
religious scholars in the country, shall be established to advise the company on the
operations of its banking business.
The level of efficiency of Islamic banks in Malaysia is not lower than conventional
banks despite its limitation:
The study finds that there is no statistically significant difference in the level of
efficiency between Islamic and conventional banks operating in Malaysia based on
data for the priod of 1993-2000. There is also no evidence to suggest that bank
efficiency is a function of ownership status (public/private or foreign/local). The
study does, however, find that inefficiency is related to bank size and in a non-linear
fashion. Increasing size initially provides some scale economies before diseconomies
of scale set in once a critical size is reached, thus suggesting a U-shaped average cost
function. 787
The regulatory bodies in Malaysia include the Ministry of Finance, Bank Negara
Malaysia, Securities Commission, Malaysia Securities Exchange Bhd and the Labuan
786
Abdul Munir Yaacob and Hamiza Ibrahim, Islamic Financial Services and Products (Institute of
Islamic Understanding Malaysia 2002) 113
787
Mariani Abdul Majid, Nor Ghani Mohammed Nor and Fatin Faezah Said, ‘Efficiency of Islamic
Banks in Malaysia’ in Munawar Iqbal and Ausaf Ahmad (eds), Islamic Finance and Economic
Development (Palgrave Macmillan 2005)
338
Offshore Financial Securities Authority. The MOF is responsible for policies related
to fiscal and monetary issues (in addition to managing government-related contracts).
Bank Negara Malaysia is the regulatory and supervisory authority over Malaysian
financial institutions and insurance companies. It is also responsible for the issuance
of currency in Malaysia. The Security Commission has authority over stock
exchanges (and stock brokers) although it has to reports to MOF. Labuan LOFSA is
created as a unified agency for the registration of offshore companies, and to
administer and enforce related legislation.
In Malaysia, the legal and regulatory framework governing Islamic finance is
largely shaped by legislations, particularly Islamic Banking Act 1983 and BAFIA,
circulars and guidelines issued by the Central Bank of Malaysia, decisions and
guidelines by Shariah Advisory Council and court cases. The Islamic Banking Act
1983 consists on 60 sections covering issues ranging from the licensing of Islamic
banks, financial requirements and duties of Islamic banks, ownership, control and
management of Islamic banks, restrictions on business, regulations on international
Islamic banking business, power of supervision and control over Islamic banks and
other miscellaneous matters. BAFIA is also an important Act in Malaysia, although it
is more for the conventional finance. However, some of the sections touch on Islamic
finance. Banking and Financial Institutions Act 1989 is an Act to provide new laws
for the licensing and regulation of institutions carrying on banking, finance company,
merchant banking, discount house and money-broking businesses, for the regulation
of institutions carrying on certain other financial businesses, and for matters incidental
thereto or connected therewith.
Besides Islamic Banking Act 1983 and BAFIA, the Central Bank of Malaysia,
Bank Negara Malaysia (BNM) also issued a series of guidelines and circulars. These
are very important in the legal and regulatory framework of Islamic finance in
Malaysia as these guidelines and circulars are comprehensive and very useful.
In addition to BNM, in Malaysia, Malaysia International Islamic Financial
Centre also issued guidelines in order to strengthen Islamic finance legal and
regulatory framework. The judiciary also plays important role in the development of
the legal and regulatory framework of Islamic finance in Malaysia. For example,
Zulkifli Hasan classified the evolution of Islamic banking cases in Malaysia into three
phases; (1) 1994-2002 phase, where the court was more inclined to rule in favor of the
Islamic bank holding that the parties were bound by the express terms of the contract,
(2)2003-2007 phase, where the court indicated its intention to examine more
critically the underlying principles behind the Islamic financial products like BBA,
and (3) 2008 onward, where the court took more pro-active attitude in examining the
339
Islamic financial products, to the extent of declaring some of the products are not
Shariah-compliant. 788
c. Neutral
The third legal and regulatory regime is the neutral and partial inclusion. This regime
takes the neutral approach and includes some Islamic financial product into their
financial portfolio. Examples include United Kingdom, Singapore and Hong Kong.
This regime differs from the former regimes due to the aims and objectives. The fully
Islamic regime intends to Islamize the whole system. The dual-system regime intends
to gradually increase the market of the Islamic finance industry in the country, often
with a targeted percentage eg 15%, 20%. On the other hand, the third regime merely
intends to provide for a fair and neutral playing field for all parties, without
inclination to strengthen or favor Islamic finance, but at the same time without bias eg
by revising the legal and regulatory framework to ensure fairness and avoidance of
extra taxation etc.
There are a few unique challenges faced by this regime as noted by Archer and
Karim:
The salient point is that making the Shariah-compliant investments in the
United States and Europe was a broad international and more globalized trend.
The transactions involved multiple jurisdictions and participants from a broad
range of countries and religious, cultural, and legal systems. Many of the
transactional participants, including the financing entities in the United States
and Europe, had little or no familiarity with Islam or the Shari’ah. Yet, to give
effect to the desires of the Muslims investors, the legal systems in the Western
economic sphere had to address the issue of enforcing contracts in accordance
with the Shariah, and because the structure of those legal systems, had to do
so within the context of enforcement of conventional secular law, substantive
and procedural, in those purely secular jurisdictions. 789
Singapore
Singapore adopted the neutral and partial regime. Singapore is an important global
trade and financial center. The inclusion of Islamic finance into secular country like
Singapore is understandable as its potential is huge. For example, according to
788
Zulkifli Hasan, ‘Shariah and Legal Issues in Al-Bay’ Bithaman Ajil Facility in the case of
Arab-Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Or’ [2008] 5 MLJ
789
Simon Archer and Rifaat Ahmed Abdel Karim, Islamic Finance: The Regulatory Challenge
(Wiley 2007) 156-157
340
Professor Samuel L. Hayes, of Harvard Business School, “I do not think there is any
limit to how big the Islamic banking can get”. 790
In Singapore, a single regulatory approach is applied:
MAS applies a single regulatory framework to both conventional and Islamic
banking because our regulations address prudential issues of liquidity, credit,
market, operational and concentration risks. These are relevant to both
conventional and Islamic banks. While Islamic funding and financing
structures are different, we consider the economic substance the underlying
risk of these structures, and apply the regulatory treatment that is consistent
with the risk. Our regulatory framework therefore provides a level playing
field for Islamic and conventional banking. MAS has for some time now
issued regulations to clarify the regulatory treatment of various Islamic finance
structures under our rules. 791
It is noted that some authors have criticized the efficiency of the single approach:
The current practice is to treat Islamic and conventional banks in a similar way
when it comes to supervision but this practice is not optimal. Islamic
institutions have different contractual agreements and, without understanding
the underlying contracts, supervision can overlook areas of potential problems.
Although standards for exposure, governance, and supervision have been
issued by the IFSB, these standards have yet to be adopted formally by the
regulators and national authorities. 792
The development of Islamic finance in Singapore is largely shaped by the guidelines
issued by Singapore MAS as these guidelines aim to provide banks with legal
certainty and guidance on the regulation of Islamic banking in Singapore.
To strengthen the legal and regulatory framework of Islamic finance in
Singapore, MAS has been cooperating with other important players in the industry.
Tai Boon Leong, Executive Director, Monetary Authority of Singapore, ‘Speech’
790
Nicholas Bray, ‘Islamic Banking Grows to Meet Religious Laws: While Sector is in Infancy, Some
Western Giants are Expanding in Field’, The Wall Street Journal, 11 March 1996, A9
791
Heng Swee Keat, Managing Director, Monetary Authority of Singapore, ‘Welcome Address’ (The
6th Islamic Financial Services Board Summit, Singapore, 7 May 2009)
792
Zamir Iqbal and Abbas Mirakhor, An Introduction to Islamic Finance: Theory and Practice (2nd
edn, Wiley 2011) 321-322
341
(IFSB Seminar on Strategies for Development of Islamic Capital Markets, Singapore,
7 June 2011)
6.12 Analysis of Cases on Islamic Finance
Critical analysis of cases on Islamic finance in Malaysia and United Kingdom reveals
the flaw of the hypothesis. The hypothesis that Islamic principles can be applied to
maritime trade industry is indirectly tested in this chapter as the effects of the
application of Islamic principles to modern banking industry are analyzed. The result
is a bit startling. A blind support for products labeled as Shariah-compliant by the
judiciary, without adequate consideration to public interest and without critical
analysis on the true nature of the products is harmful. The problem is not with the
principles. The actual problem is the wrongful or mistaken application of the
principles. An active judiciary is required.
Hasan and Asutay’s analysis on the courts’ decision on Islamic finance disputes
in Malaysia leads them to classification based on three phases: 1. First Phase:
1979-2002, 2. Second Phase: 2003-2007 and 3. Third Phase: 2008-2010 (onwards). 793
i.
First Phase: 1979-2002: During this phase, the Malaysian court applied the
classic common law interpretational approach by looking at the express terms
and conditions laid down in the contract. 794 The issue of actual
Shariah-compliant etc was not tackled and the approach was basically to
admit the legality of the contracts, together with their express terms, regardless
of how arbitrary some might be.
ii.
Second Phase: 2003- 2007: In this stage, the Malaysian courts gradually
shifted from their earlier approach by giving more critical examination on
Islamic finance cases. In some cases, the courts held that unearned profit could
not be claimed by Islamic banks due to its similarity in calculation to
interest. 795 The aim is to ensure justice to the customers.
793
Zulkifli Hasan and Mehmet Asutay, ‘An Analysis of the courts’ decisions on Islamic finance
disputes’ (2011) ISRA International Journal of Islamic finance, Vol.3, Issue 2, 41
794
Zulkifli Hasan and Mehmet Asutay, ‘An Analysis of the courts’ decisions on Islamic finance
disputes’ (2011) ISRA International Journal of Islamic finance, Vol.3, Issue 2, 41
795
Zulkifli Hasan and Mehmet Asutay, ‘An Analysis of the courts’ decisions on Islamic finance
disputes’ (2011) ISRA International Journal of Islamic finance, Vol.3, Issue 2, 41
342
iii.
Third Phase: 2008-2010: The Malaysian courts adopted a pro-active attitude
while recognizing that the court should not rewrite the terms of the contract
between parties. The Malaysian government finally stepped in by passing the
Central Bank of Malaysia Act that covered important matters on Islamic
finance which significantly improve the legal and regulatory framework on
Islamic finance. 796 The aim is to ensure justice to customers while
maintaining legal and regulatory certainty.
Below is the analysis on some of the Islamic finance cases in Malaysia and United
Kingdom. The cases are mostly from Malaysia, unless stated otherwise.
•
Tinta Press Sdn Bhd v Bank Islam Malaysia Bhd [1987] 2 MLJ 192
•
Glencore International AG v Metro Trading International Inc [2001] 1 Lloyd’s Rep
284 [English case]
•
Islamic Investment Company of the Gulf (Bahamas) Ltd v Symphony Gems and others
[2002] WL 346969
•
Bank Kerjasama Rakyat Malaysia Bhd v Emcee Corporation Sdn Bhd [2003] 2 MLJ
408
•
Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd and Others [2004] 4 All
ER 1072 [English case]
•
Tahan Steel Corp Sdn Bhd v Bank Islam Malaysia Bhd [2004] 6 MLJ 1
•
Malayan Banking Bhd v Marilyn Ho Siok Lin [2006] 7 MLJ 249
•
Affin Bank Bhd v Zulkifli bin Abdullah [2006] 3 MLJ 67
•
Malayan Banking Bhd v Ya’kup bin Oje & Anor [2007] 6 MLJ 389
•
Arab-Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Ors (Koperasi Seri
Kota Bukit Cheraka Bhd, third party) [2008] 5 MLJ 631
•
Tan Sri Abdul Khalid bin Ibrahim v Bank Islam Malaysia Bhd and another suit
[2009] 6 MLJ 416
•
Sea Oil Mill (1979) Sdn Bhd & Anor v Bank Kerjasama Rakyat Malaysia Bhd [2009]
3 MLJ 237 [English case]
•
The Investment Dar Company KSCC and BLOM Developments Bank Sal [2009]
EWHC 3545 (Ch) [English case]
•
Bank Islam Malaysia Bhd v Lim Kok Hoe & Anor and other appeals (2009) 6 CLJ 22
•
Bank Kerjasama Rakyat Malaysia Bhd v Sea Oil Mill (1979) Sdn Bhd & Anor [2010]
2 MLJ 740
796
Zulkifli Hasan and Mehmet Asutay, ‘An Analysis of the courts’ decisions on Islamic finance
disputes’ (2011) ISRA International Journal of Islamic finance, Vol.3, Issue 2, 41
343
•
Arab-Malaysian Merchant Bank Bhd v Silver Concept Sdn Bhd [2010] 3 MLJ 702
•
Bank Islam Malaysia Bhd v Azhar bin Osman and other cases [2010] 9 MLJ 192
•
Mohd Alias bin Ibrahim v RHB Bank Bhd & Anor [2011] 3 MLJ 26
•
Al Rajhi Banking & Investment Corp (M) Bhd v Hapsah Food Industries Sdn Bhd &
Ors and another action [2012] 1 MLJ 115
344
Case Analysis:
CASE 1: Tinta Press Sdn Bhd v Bank Islam Malaysia Bhd [1987] 2 MLJ 192
In this important case, the court accepted Islamic financial product on its face value,
without attempting to go beyond it. This case highlighted the earlier trend of the
Malaysian court to be accommodative to Islamic finance.
Despite the phenomenal growth of Islamic finance in Malaysia in the 1980s,
there were only two reported cases on Islamic finance in Malaysia. 797 This is one of
the leading cases in Malaysia during the early years of the introduction of Islamic
finance. This Supreme Court case is quite unique. Most of the cases during the early
day involved BBA contract which was basically a financing facility based on the
concept of sale with deferred payment. The bank would purchase a commodity or
subject-matter and simultaneously sell it to the customer at a higher price (to be paid
in installment), in order to avoid the prohibition ofriba’ or usury. However, this
case involved the Ijarah or leasing facility. The respondents in this case had leased
certain printing equipment to the appellants using Islamic financing facility known as
Ijarah. The appellants then defaulted in their obligations to make the monthly rentals
payment. The respondent then brought a legal action to recover the rent, to recover
possession of the equipment. An ex parte application for a mandatory injunction to
enable possession of the equipment was also made and accepted. Attempt by the
appellants to set aside the mandatory injunction was rejected and the appellants
appealed. The judges in this case, Salleh Abbas LP, Syed Agil Barakbah J and Wan
Hamzah SCJJ held that:
(1) the court has a discretion to grant an interlocutory mandatory injunction before trial
but the discretion must be exercised and an
injunction granted only in exceptional
and extremely rare cases. The case must be unusually strong and clear in that the
court must feel assured that a similar injunction would probably be granted at the trial
on the ground that it would be just and equitable that the plaintiff's interest be
protected by the immediate issue of an injunction, otherwise irreparable injury and
inconvenience would result. Where the case is one of urgency an application can be
made ex parte;
797
Samsar Kamar Bin Hj Ab Latif, ‘Legal Aspect of Interest-free banking in Malaysia’ (1997) 2 MLJ
xcii; [1997] 2 MLJA 92
345
(2) the learned Judge on the facts and circumstances of the case rightly concluded that
this was an exceptional case where the court was justified in granting a mandatory
injunction on an ex parte application before the trial;
(3) the learned judge rightly concluded from the documents and the affidavit evidence
that the agreement in this case was a lease agreement and not a loan agreement;
(4) there was a clear breach of the lease agreement in this case by the appellant and the
respondent therefore became entitled to immediate possession of the equipment. The
learned Judge was confident that the court would grant a mandatory injunction at the
trial of the suit and rightly held that if the injunction had not been granted earlier the
respondent would suffer irreparable damage and greater hardship. The balance of
convenience was very much in favour of the respondent and the application was one
of urgency. There was no unreasonable delay on the part of the respondent in filing
the writ and the ex parte application for injunction;
(5) this was a case where the learned Judge was more than justified in granting a
mandatory injunction on an ex parte application. 798
The legal impact of this case is strong. Since the court recognized that the nature of
the contract is a lease contract, also known as Ijarah, the lessor owned the equipment
and the appellants do not have right to the equipment until full payment is made. This
case highlighted that Islamic finance do have technical differences with conventional
finance due to the nature of the contract. It is noted that the judges in this case mostly
deal with the issue of mandatory injunction, without elaborating much on Islamic
finance issues. This case is observed not just in the area of Islamic finance, but also in
other legal area as well. For example, the plaintiff’s counsel in B-Trak Sdn Bhd v
Bingkul Timber Agencies Sdn Bhd & Anor [1989] 1 MLJ 124 relied on the case of
Bank Islam Malaysia Bhd v Tinta Press Sdn Bhd & Ors [1986] 1 MLJ 256 for the
definition of a lease.
One researcher, Illiayas highlighted a peculiar fact that, despite the extraordinary
growth in the operations of Bank Islam despite the severe recession that hit Malaysia
in the mid-1980s, there have been only two reported court cases in which Bank Islam
featured as a party. He proposed that the small number of litigation involving this
Islamic bank at this stage is perhaps attributable to its adherence to the Quran,
particularly Chapter 2: 280 which read as follows: ‘If the debtor is in a difficulty,
Grant him time Till it is easy For him to repay.’ 799
798
799
Tinta Press Sdn Bhd v Bank Islam Malaysia Bhd [1987] 2 MLJ 192
Mohd Illiayas, ‘Islamic/Interest-free Banking in Malaysia: Some Legal Considerations’ (1995) 3
MLJ cxlix; [1995] 3 MLJA 149
346
The application of Islamic principles that focus on kindness in reclaiming payment is
partly evidenced in this case. In this case, Syed Agil Barakbah SCJ (delivering the
judgment of the court) stated as follow:
The learned Judge came to the conclusion that the respondent had been “helpful and
extremely polite” to the appellant. They had attempted to recover the money due to
them step by step by acting diligently and prudently. It was only after they had failed
to get rentals due from the appellant that they decided to take possession of the
equipment according to the terms of the lease agreement. When that failed, they
sought legal remedy by filing a writ applying for an injunction. We agree with respect
with the learned Judge that there was no unreasonable delay on the part of the
respondent in filing the writ and the ex parte application for injunction. 800
In this important case, the court upheld the validity of the Islamic financial product
called ‘ijarah’ and clarified that this is a leasing contract and not loan. However, no
reference was made to the Islamic law relating to ijara or leasing. Similar
accommodative attitude from the court can be seen in subsequent cases like Bank
Islam Malaysia Berhad v Adnan Bin Omar [1994] 3 CLJ 735/ [1994] MLJU 221
where the court upheld the BBA contract and stated that the defendant is estopped
from denying that the plaintiff is entitled to the total sale price since the defendant
voluntarily enters to the contract. In that case, there was no attempt to deal with the
matter from the Islamic view point that stress on fairness and justice. Such simplistic
approach failed to critically consider the interest of the customers of Islamic bank.
Rebate or discount was not implied into these cases. The customers were burdened
with heavy amount of repayment ‘because the purchase price has been agreed’
although the transactions were basically financing in nature (and not true sale and
purchase) and the real risks were mostly allocated to the customers. This trend
continues in Dato’ Hj Nik Mahmud Daud v Bank Islam Malaysia Bhd [1998] 3 CLJ
605, and Bank Islam Malaysia Bhd v Shamsudin Bin Haji Ahmad [1999] MLJU 450.
The hypothesis that Islamic principles can be successfully applied to modern
banking and modern maritime trade is seriously challenged by these earlier cases.
These cases revealed some fundamental flaws on the legal and regulatory framework
of Islamic finance in its early stage in Malaysia. Innocent customers have to pay a
large sum of money just because they opted for Islamic financial products and
defaulted. Financially, they would perform better by opting for conventional financial
products. Rebate and discount were not implied into the contract although there is no
express clause on this important matter.
800
Tinta Press Sdn Bhd v Bank Islam Malaysia Bhd [1987] 2 MLJ 192
347
Due to the serious consequences of these cases, the legal and regulatory
framework were changed afterwards. Judges refused to entertain claim for full
‘purchase price amount’ and implied rebate etc. Later on, the Shariah Advisors also
elaborated on the permissibility of rebate and discount and the matter was put to rest
when the Central Bank ordered rebate and discount in all similar cases.
348
CASE 2:
Islamic Investment Company of the Gulf (Bahamas) Ltd v Symphony
Gems and others [2002] WL 346969
This case was the first Islamic finance case heard and decided by the English court. It
is one of the earliest Islamic finance cases decided by a secular court in non-Muslim
country. The claimant in this case is the Islamic Investment Company of the Gulf
while the first defendant was Symphony Gems. The two other defendants were
guarantors to the first defendant. The parties in this case have entered into an Islamic
financing agreement on January 2000 by way of an Islamic financial product known
as Murabahah. The purpose of the contract is to get Shariah-compliance financing.
The claimant in this case will purchase some commodities, precious gems and stones
from the supplier at the price of USD15 million and sell it to the first defendant,
Symphony Gems at the price of USD15.8 million. There are numerous legal issues in
these case including governing law clause and governing jurisdiction clause. The
court held that the parties would be governed by the principle of murabahah but the
court will be English court. The judge in this case refuses to take into consideration
the expert opinion of two Islamic finance experts. The judge held that the court will
only construe it according to its term and based on English law contract. In this case,
Mr. Justice Tomlinson stated as follow:
The Morabaha contract is intended in Islamic law to be a contract which complies
strictly with the requirements of the Shariah. However, it is important to note -indeed, in my judgment, it is absolutely critical to note -- that the contract with which
I am concerned is governed not by Shariah law but by English law. Indeed, it is
equally critical to note that Dr. Samaan, after examining the nature and terms of the
contract with which I am concerned, comes to this conclusion: "I have therefore come
to the conclusion that the Agreement in issue does not have the essential
characteristics of a Morabaha contract." He then goes on, insofar as he has not
already done so, to explain why that is so. 801
Experts have commented this case. For example, an Islamic finance expert Professor
Dr Norhashimah Mohd Yasin, questioned the logic and reasoning for calling Islamic
financial experts to express their professional opinions if the court held that their
801
Islamic Investment Company of the Gulf (Bahamas) Ltd v Symphony Gems and others [2002] WL
346969, 4
349
professional opinion have no effect what so ever to the case. 802 Another Islamic
finance expert, Professor Dr Engku Rabiah Adawiyah Bt Engku Ali, highlighted that
this case is a clear example where contract that is not compliant to Shariah and is
expressly contrary to the wishes of the parties were validated by the court by simply
stating that the term is valid according to English law. 803
However, it is also noted that in this case, the contracting parties have expressly
chosen English law as governing law while it could be foreseen that the English court
will have difficulty venturing into the Islamic or Shariah aspect of the contract. This
case should be distinguished from Shamil Bank of Bahrain E.C. v Beximco
Pharmaceuticals Ltd and others [2004] 4 All ER 1072. In the subsequent case, the
governing law clause expressly stated that English law shall apply subject to the
principles of Shariah.
Adawiah explains that the refusal by the courts in both cases to use Islamic
principles is understandable since English courts apply Common Law and in the
absence of substantive codified code on Islamic banking, incorporation of Islamic
principles would not be feasible.
802
Norhashimah Mohd Yassin, ‘Islamic Commercial Contract Cases Heard in Civil Courts under
Common Law: A Case Study of Malaysia and England’ (2007) Journal of Islamic Law Review, Vol. 3,
104.
803
Engku Rabiah Adawiyah bt Engku Ali, ‘Constraints and Opportunities in Harmonization of Civil
Law and Shari’ah in the Islamic Financial Services Industry’ (2008) Malayan Law Journal, 4 MLJ i.
350
CASE 3:
Bank Kerjasama Rakyat Malaysia Bhd v Emcee Corporation Sdn
Bhd [2003] 2 MLJ 408
The ratio of this case is that the law applicable to Islamic banking facility can
generally be the same with the law applicable under conventional banking. The
appellant in this case granted an Islamic facility known as BBA to the respondents. As
security for the repayment of the sale price under the second agreement, the
respondents charged to the appellant 15 pieces of land. When the respondent
defaulted, the appellant issued the form 16D notice (a procedure under the National
Land Code) and then for an order for sale. The High Court dismissed the application
of the appellant and the appellant appealed to the court of appeal. The Court of
Appeal allowed the appeal and stressed that the same legal framework will be
applicable.
The court in this case held as follow:
‘Although the facility was an Islamic banking facility, that did not mean that the law
applicable in this application was different from the law that was applicable if the
facility was given under conventional banking. The charge was a charge under the
National Land Code. The remedy available and sought was a remedy provided by the
Code. The procedure was provided by the National Land Code and the Rules of the
High Court 1980. The court adjudicating it was the High Court. So, it was the same
law that was applicable, the same order that would be, if made, and the same
principles that should be applied in deciding the application (see p 411G -I).’
In Malayan Banking Bhd v Marilyn Ho Siok Lin [2006] 7 MLJ 249, David Wong J
referred to the above passage and stated as follow:
Not only do I agree with the sentiments stated in the above case, I am bound by them
under the principle of stare decisis.
This case has been cited with approval in various cases including Bank Islam
Malaysia Bhd v Pasaraya Peladang Sdn Bhd [2004] 7 MLJ 355, Affin Bank Bhd v
Zulkifli bin Abdullah [2006] 3 MLJ 67, Malayan Banking Bhd v Marilyn Ho Siok Lin
[2006] 7 MLJ 249, Tan Sri Abdul Khalid bin Ibrahim v Bank Islam Malaysia Bhd and
another suit [2009] 6 MLJ 416, Bank Islam Malaysia Bhd v Lim Kok Hoe & Anor and
other appeals [2009] 6 MLJ 839, and Bank Islam Malaysia Bhd v Azhar bin Osman
and other cases [2010] 9 MLJ 192.
351
However, the warning given by Rohana Yusuf J in the case of Bank Islam Malaysia
Bhd v Azhar bin Osman and other cases [2010] 9 MLJ 192 must be noted:
In Bank Kerjasama Rakyat Malaysia Bhd v Emcee Corporation Sdn Bhd [2003] 2 MLJ
408; [2003] 1 CLJ 625, the Court of Appeal enforces a BBA contract. Abdul Hamid
Mohammad JCA (as he then was) in that case states that ‘though the facility given by
the appellant to the respondent was an Islamic banking facility. But that did not mean
that the law applicable in this application was different from the law applicable if the
facility was given under conventional banking’. This remark cannot be taken literally. It
cannot be taken to mean that the law of contract which recognises the sanctity of a
contract and the right to enforce the contract to its letter, as a ratio decidendi that the sale
price is enforceable. Reading it contextually, the observation is made by His Lordship in
that case to show that the Islamic banking contract is subject to the same law and legal
system as any banking contract. It is true that the Court of Appeal in Lim Kok Hoe
acknowledges these cases which ultimately resulted in granting and enforcing payment
of the full sale price under the PSA, however none of the cases had in the judgment
treated it to be the ratio decidendi of the decision.
352
CASE 4:
Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd and
Others [2004] 4 All ER 1072
This English case involved an Islamic financial product known as murabahah. One of
the parties, Beximco Pharmaceuticals Ltddefaulted in its obligations and then raised
the issue of governing law clause as defense. In this case, the parties to the agreement
agreed that the contract shall be governed by English law subject to its consistency
with Shariah law. Beximco Pharmaceuticals Ltd argued that the agreement is contrary
to Shariah principal and should be declared null and not enforceable.
The agreement in this case contained the following wording regarding the choice
of law – “Subject to the principles of Glorious Shariah, this agreement shall be
governed by and constructed in accordance with the laws of England.” Potter LJ
rejected this argument and held that the contract was only govern by the English law
and not the Shariah law. The judge also held that a contract could only be governed
by one legal system or law at the same time. The only way for the parties to
incorporate the provision of a foreign law into their contract is by expressly including
a clear black letter provision of the foreign law but not the whole foreign law per say.
The reception of the legal community on this case differs, with some approving
and many criticizing. DeLorenzo and McMillen highlighted four aspects of reasoning
in the case of Shamil Bank v Beximco case. 804 Firstly, in accordance with conceptions
of national sovereignty and the concepts of nations, the near universal principle is that
the law governing a contract is the law of a nation as precisely defined in that nation.
Second, the laws of many nations allow the parties to a contract to choose the law that
will be applicable to the enforcement of that contract. Third, as a general matter, the
laws of many nations allow the parties to a contract to incorporate foreign laws, codes,
and rules into a contract governed by the laws of such nation, although they also
require some degree of specificity to effect that incorporation. However, the court in
Shamil Bank v Beximco do implied that it would have no objection to the
incorporation of the French Civil Code, the Hague Rules, or the Harter Act, if there
were adequate specificity of the terms to be incorporated.’ 805
804
Yusuf Talal DeLorenzo and Michael J.T. McMillen, ‘Law and Islamic Finance: An Interactive
Analysis’ in Simon Archer and Rifaat Ahmed Abdel Karim, Islamic Finance: The Regulatory
Challenge (Wiley 2007) 167-168
805
Yusuf Talal DeLorenzo and Michael J.T. McMillen, ‘Law and Islamic Finance: An Interactive
Analysis’ in Simon Archer and Rifaat Ahmed Abdel Karim, Islamic Finance: The Regulatory
Challenge (Wiley 2007) 167-168
353
In the subsequent appeal of this case, Shamil Bank of Bahrain EC v Beximco
Pharmaceuticals Ltd and others [2004] EWCA Civ 19, Potter, Laws and Arden LJJ
of the Court of Appeal affirmed the previous decision of Morison J in this case. The
judges held as follow:
The financing agreements were governed by English law alone. The intention of the
parties at the outset had been for the agreements to be binding, and the court should lean
against a construction which would or might defeat that commercial purpose. The
reference to the principles of Sharia'a was simply intended to reflect the Islamic banking
principles according to which the bank held itself out as doing business, rather than
incorporating a system of law intended to 'trump' the application of English law as the
law to be applied in ascertaining the liability of the parties under the terms of the
agreement. Having chosen English law as the governing law, it would have been
unusual and improbable for the parties to have intended the English court to proceed to
determine and apply the principles of Sharia'a in relation to the legality and
enforceability of the obligations clearly set out in the agreement, and the appeal would
therefore be dismissed (see [47], [54], [62], [63], below). 806
This kind of legal issue can actually be avoided if the legal and regulatory framework
similar to the one recently adopted by Malaysia is used.The suggestion by the judge in
this case that reference to Islamic principles does not have any legal significant since
it is ‘unusual and improbable for the parties to have intended the English court to
proceed to determine and apply the principles of Shariah’ merits serious
consideration. One of the scholars commented as follows:
It is important for parties intending to deal on Islamic principles to incorporate the
law of an Islamic country which most closely gives effect to those principles of
Sharia that they are concerned with. It is neither enough to choose Sharia law per se,
nor English law as guided by an Islamic board (in the present case, it was the bank’s
own Religious Supervisory Board). It is clearly open to the parties to ensure that the
decisions and recommendations made by the Board to be taken seriously by
contractually providing for appropriate sanctions; where Sharia principles are
considered to be fundamental, the parties may provide for a more active involvement
of such a Board. In the present case, the system of supervision was of little help
806
Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd and others [2004] EWCA Civ 19
354
because it was not the specific agreements which were subject to religious
supervision, only the general activities of the bank. 807
The universe of Islamic finance is big, with numerous different views by various
scholars and experts. In the absent of a clear codified law on Islamic finance, and
without express clauses elaborating on the principles agreed, it would not be practical
to expect judges from English court to determine and decide on Islamic principles.
807
Jason Chuah, ‘Private International Law – Choice of Law: Islamic law’ (2004) Journal of
International Maritime Law, 10(2), 125-127
355
CASE 5:
Tahan Steel Corp Sdn Bhd v Bank Islam Malaysia Bhd [2004] 6
MLJ 1
The plaintiff in this case had undertaken the development and construction of Steckel
Hot Strip Mill Plant. The plaintiff had secured RM97 million worth of financing
facility from the defendant bank using an Islamic financial product known as
al-Istisna’. The defendant then refused to release the balance of the facility amounting
to RM38.7 million. The plaintiff took a legal action against the defendant. The
defendant contended that the plaintiff had failed to meet condition precedents of the
al-Istisna’ facility, namely to secure facilities totaling approximately US80 million
from EXIM banks as agreed. The defendant also alleged that the plaintiff had
defaulted in its obligation to make repayment. The court dismisses the application and
held that the defendant was right in its action. The plaintiff has failed to observe its
obligations, and has unilaterally tried to vary the terms of the contract. Abdul Malik
Ishak J held as follow:
The conditions precedent imposed on the plaintiff of obtaining the EXIM loan was
neither whimsical nor belligerent, they were based on sound commercial basis. The
plaintiff adopted a rather lackadaisical attitude
towards the express term and essential
condition, namely, securing the EXIM loan. The plaintiff was not entitled to depart from
the requirement of the EXIM loan condition without the written and signed consent of
the defendant. The defendant was within its rights to refuse to allow the disbursal of the
third tranche of the facility to the plaintiff since the plaintiff has by their own admission
failed to secure the EXIM loan (see paras 45, 53, 70, 77).
One of the important issues from the legal and regulatory aspect is the court statement
on the loss that will be suffered by the Islamic financial institution if injunction was
granted wrongly, due to the rejection of interest. In other words, the court cannot
compensate the Islamic financial institution by awarding any sort of interest as
commonly awarded to conventional banks. The court in this case answered the
question on whether the bank will suffer irrecoverable damage as follow:
I would answer this question in the positive. It must be recalled that the defendant is a
licensed Islamic Bank governed by the Islamic Banking Act 1983 and is regulated by
Bank Negara Malaysia -- the Central Bank of Malaysia. It is not allowed to
participate nor to conduct any business that contravenes the Syariah unlike a
conventional bank. The defendant does not charge penalty interest by whatever name
one wishes to call it for late payment. Every single installment that is paid late to the
356
defendant is a loss of use of money owed to the defendant for the period of delay. The
defendant has been losing and continues to lose the use of its installments since 31
January 2002. Whilst this may not appear to be a significant loss it is still a loss for
which the defendant cannot be compensated. Viewed in this context, the grant of an
injunction to the plaintiff would cause irreparable damage to the defendant. Moreover,
the strict Islamic banking system as alluded to in the beginning of this judgment
mirrors the unenviable position of the defendant bank. This is the crucial factor that
differentiates this case from the rest. It is not the run of the mill type of cases. 808
In this case, Abdul Malik Ishak J also quoted the statement of Tan Sri Nor Mohamed
Yakcop, the Second Minister of Finance of Malaysia (as he then was) in his paper
entitled “Reflections on the Islamic Financial System” to show the real nature of
Islamic finance:
If we are to look at the Islamic financial system, it is natural that we look at the core
of Islam itself. Unlike many other religious systems, we see Islam as a deen, or as a
complete way of life. Beyond basic religious beliefs and practices, Islam shows us
how to best conduct ourselves in everyday matters. This code of best conduct is
called the Shariah, and it is the basis of the Islamic financial system. But the Shariah
has been put there not as a set of rituals to make life difficult. It serves several
important purposes. Firstly, the Shariah is a means for us to approach and seek the
pleasure of the Creator. Secondly, a positive side effect of complying with Shariah is
that it brings about human success and harmony -- allowing man to attain excellence.
It is through the strong adherence of the Shariah that the Muslims of earlier
generations achieved their magnificence and global success. Thus, the Islamic
financial system, being a part of this Shariah system, ought to be treated in the same
light. Just as the Shariah is a means to an end, so too is the Islamic financial system.
The implementation of an Islamic financial system is not the end goal. It is, in fact, a
means and a tool of competitive advantage for the Ummah's success, including
economic success. 809
This case was cited with approval in Amazing Place Sdn Bhd v Couture Homes Sdn
Bhd & Anor [2011] 7 MLJ 52 (on the issue of damages) and in Affin Bank Bhd v MMJ
Exchange Sdn Bhd & Anor [2011] 9 MLJ 787 (on the issue of judicial notice).
808
Tahan Steel Corp Sdn Bhd v Bank Islam Malaysia Bhd [2004] 6 MLJ 1
809
Tahan Steel Corp Sdn Bhd v Bank Islam Malaysia Bhd [2004] 6 MLJ 1
357
CASE 6:
Affin Bank Bhd v Zulkifli bin Abdullah [2006] 3 MLJ 67
The defendant in this case bought a double storey link house using an Islamic
financial product known as BBA from the plaintiff. The financing was to be repaid
over 18-year tenure by 216 monthly installments and a charge was registered against
the title. After making several payments, the defendant defaulted and the plaintiff took
legal action. The issue faced by the court is the exact amount that the defendant has to
pay. The court grants the order for the sale of the property and held that the remaining
balance has to be repaid by the defendant. However, the court also held that the
amount of repayment must be reduced as the termination was made earlier.
The judge, Abdul Wahab Patail J held as follow:
(1) If the customer is required to pay the profit for the full tenure, he is entitled to
have the benefit of the full tenure. It follows that it would be inconsistent with his
right to the full tenure if he could be denied the tenure and yet be required to pay the
bank's profit margin for the full tenure. To allow the bank to also be able to earn for
the unexpired tenure of the facility, means the bank is able to earn a profit twice upon
the same sum at the same time (see para 29).
(2) The profit margin that continued to be charged on the unexpired part of the tenure
cannot be actual profit. It was clearly unearned profit. It contradicted the principle of
Al-Bai Bithaman Ajil as to the profit margin that the provider was entitled to.
Obviously, if the profit had not been earned it was not profit, and should not be
claimed under the Al-Bai Bithaman Ajil facility (see para 29).
(3) The profit margin could be calculated and derived with certainty. Even if the
tenure was shortened, the profit margin could be recalculated with equal certainty
(see para 34)…
(4) Once it was established that there had been a default, then unless there was cause
to the contrary, the order for sale must be given since a charge is an ad rem right to
dispose of the security to recover a secured debt (see para 45). 810
One of the biggest significant of this case is it had restricted the plaintiff, typically
Islamic bank, suing under BBA facility from recovering the full amount of profit that
they can claim under the full tenure of the agreement.
810
Affin Bank Bhd v Zulkifli bin Abdullah [2006] 3 MLJ 67
358
In this case, the court also stated as follow:
Since the question before the court is the interpretation and application of the terms of
the contractual documents between the parties and of the decisions of the courts,
reference of this case to another forum for a decision would be an indefensible
abdication by this court of its function and duty to apply established principles to the
question before it. It is not a question of Syariah law. It is the conclusion of this court,
therefore, that there is no necessity to refer the question to another forum. 811
This case highlighted the common problem from the legal and regulatory aspect when
the issue of discount or rebate is not properly addressed in the legal framework. Since
Islamic finance prohibits interest and usury, many of the transactions are shifted from
interest-based loan into financing methods that involve sale and purchase. The
problem is that when default occurs, the risks and harms exposed to the customer
under certain Islamic financial products will be very high (if proper legal framework
is not put in place). This is because during default, under conventional finance, the
customer will usually have the repay the principal, plus some amount of interest to the
bank, measured based on the time of repayment. In any event, the customer will not
have to repay the full amount of interest that the customer has to pay originally. This
makes sense as the customer have to pay the amount earlier than originally stipulated
in the agreement. For illustration, the customer borrows $10 million to purchase a
building and use conventional finance to facilitate the purchase. The agreement is that
the customer has to pay the bank $20 million in monthly installments for 20 years.
Suddenly, the development of the building is halted due to the bankruptcy of the
developer and 80% of the loan has already been released by the conventional bank to
the developer. The customer will still have the repay the conventional bank the capital
disbursed by the bank, plus some profit. However, the total amount that has to be
repaid will never be the original $20 million, due to rebate and discount due to early
termination. However, under certain Islamic financial product like some of the BBA
offered in Malaysia, the customer will have to pay the full amount in the event of
default, as the transaction is disguised as a sale and purchase transaction. However, in
reality, it is not a real sale and purchase as the risks are always shifted to the customer
using the sale and buy-back concept.
This important case is a departure from earlier rulings in which the courts merely
follow the express terms of the contract, into a more equitable approach. While the
equitable approach of the court is understandable, some suggest that the court obiter
811
Affin Bank Bhd v Zulkifli bin Abdullah [2006] 3 MLJ 67
359
on the role of Shariah Advisory Council is disturbing since feedback from the Shariah
Advisory Council should be of great assistance. 812
The courageous approach adopted the court in this case has been summarized by
one author:
If a contract between the contracting parties becomes an instrument of injustice, a judge
cannot ignore the unfairness and insist on strict adherence to the letter of contract. Hence,
a judge is empowered to set aside a contract when the fact discloses gross unfairness on
one of the parties as Islamic system is a just and equitable system that promotes close
relationship between the banks and the customers based on cooperation and equitable
sharing of risks and rewards. 813
This case has been cited with approval in subsequent cases including Malayan
Banking Bhd v Marilyn Ho Siok Lin [2006] 7 MLJ 249, Arab-Malaysian Merchant
Bank Bhd v Silver Concept Sdn Bhd [2008] 6 MLJ 295, Bank Islam Malaysia Bhd v
Lim Kok Hoe & Anor and other appeals [2009] 6 MLJ 839 and Bank Islam Malaysia
Bhd v Azhar bin Osman and other cases [2010] 9 MLJ 192.
812
Surianom Miskam, ‘Reference to the Shariah Advisory Council in Islamic Banking and Finance
Cases: The Effect of the Central Bank of Malaysia Act 2009’
<http://www.internationalconference.com.my/proceeding/icber2010_proceeding/PAPER_106_Shariah
Advisory.pdf> accessed 6 January 2012
813
Habib Rahman bin Seni Mohideen, ‘Affin Bank Bhd v Zulkifli Abdullah — Shariah Perspective’
[2006] 3 MLJ i
360
CASE 7: Malayan Banking Bhd v Marilyn Ho Siok Lin [2006] 7 MLJ 249
In this case, the court held that, similar to the case of Affin Bank v Zulkifli, the bank
concerned was only allowed to claim its sale price minus the ‘unearned profit’, that is,
profit for the unexpired tenure of the Islamic finance facility. This is because it would
be very inequitable for any financial institution, Islamic or otherwise, to claim for the
complete agreed profit that is based for the entire tenure of the financing facility,
when the customer in fact never had the benefit of the full tenure. In this case, David
Wong J held as follow;
The court must have good reasons to ignore or put in another way rewrite the
terms in the BBA documents. This involves the process of taking into
consideration of ‘all the circumstances of the case’. That would include the
public interests, the peculiarities of the contract, and the compliances by the
parties of the agreed terms contained therein. Of course at the end of the day, the
primary aim must be to make an order as in the circumstance seems just (see
para 35). 814
The finding of the court was a departure from the earlier decision of the court
involving BBA in Bank Islam Malaysia Bhd lwn Pasaraya Peladang Sdn Bhd [2004]
7 MLJ 355 (High Court in Alor Setar), Bank Islam Malaysia Bhd v Adnan bin Omar
[1994] 3 CLJ 735, Dato’ Hj Nik Mahmud bin Daud v Bank Islam Malaysia Bhd
[1996] 4 MLJ 295 (High Court in Kota Bharu), Dato’ Hj Nik Mahmud bin Daud v
Bank Islam Malaysia Bhd [1998] 3 MLJ 393 (Court of Appeal at Kuala Lumpur) and
Bank Kerjasama Rakyat Malaysia Berhad v Emcee Corporation Sdn Bhd [2003] 1
CLJ 625 (Court of Appeal). In the earlier cases, the court upheld the bank’s
application to recover the sale price, regardless of the actual tenure.
The judge in this case, David Wong J also elaborated that this approach is also in
the public interest:
Further it is in the public interests that the Islamic Banking industry continues to
flourish in this country and abroad. Adopting the interpretation given by the
learned judge in the Affin case would enhance that process. It is common
knowledge that people have a preference to a BBA facility for the simple reason
that they are better off than that of a conventional bank loan in terms of ringgits
and cents as the amount of repayments in the nature of profits are slightly lower to
the normal interests charged in conventional loans and fixed. In conventional loans,
814
Malayan Banking Bhd v Marilyn Ho Siok Lin [2006] 7 MLJ 249
361
the interests for the loans move up and down according to market forces. That is
how it is being marketed by the banking industry and the reason for its popularity.
As such, people who take up a BBA loan should not be put in a worse position
than had they taken a conventional bank loan. If the plaintiff in this case succeeds,
there is no doubt that the defendant would be put in a worse position than had she
taken a conventional one. In a conventional bank loan, the borrower will only be
required to pay an amount outstanding as at the date of the recovery of the loan,
which is the date of the sale of the charged property. This is of course one of the
grounds which the learned judge in Affin's case relied on in coming to his
conclusion.
The decision of the judge in this case is very useful, considerate and pragmatic but the
choice of word should be improved. For example, BBA is not a loan contract and the
term ‘BBA loan’ is inaccurate. If BBA is a loan contract, this will be clearly contrary
to all school of Islamic thoughts that prohibited the element of usury in transaction.
362
CASE 8: Malayan Banking Bhd v Ya’kup bin Oje & Anor [2007] 6 MLJ 389
In this essential Malaysia High Court decision, the bank concerned was only
permitted to claim its sale price minus the ‘unearned profit’ (profit for the unexpired
/remaining tenure of the Islamic finance facility) since it would be very inequitable
for any financial institution, Islamic or otherwise, to claim for the complete agreed
profit that is based for the entire tenure of the financing facility, when the customer in
fact never had the benefit of the full tenure. At the request of the defendant, the
plaintiff in this case had granted the defendants a financing facility amounting to
RM80,000 under the BBA to finance a purchase of property. The defendant then
defaulted. In this case, the court must also consider the Sarawak Land Code and
National Land Code that stressed that equity must be exercised. The major question in
this case was whether the plaintiff was entitled as of right to the full profits in the
event that the BBA was terminated earlier.
In this case, the court held that plaintiff cannot get the full original amount, as
the principle is now established from the case of Affin Bank Bhd v Zulkifli bin
Abdullah [2006] 3 MLJ 67 and Malayan Banking Bhd v Marilyn Ho Siok Lin [2006] 7
MLJ 249. In this case, the court noted that the reason why Islamic banks do not
specified the amount of rebate or discount for earlier termination of the contract is
allegedly due to the Shariah requirement for certainty, in which the amount involved
in a transaction should be clear, and the rejection of multiple contracts when it cause
ambiguity. However, the court wisely suggested that the Islamic bank can still openly
state their policy and rates of rebate without including it in the agreement, to promote
transparency. The court in this case held as the following:
(1) Islamic contract relating to commercial transaction is not only subject to the terms
of the contract but must be decided subject to the Quranic injunctions and/or Islamic
worldview as the case may be. For this very purpose, the court can on their own
motion decide the issue or alternatively call experts to give their views.
(2) Section 148(2)(c) of the Sarawak Land Code makes it mandatory to exercise
equity and the court may not grant the order if it is going to be perverse to the
defendants. When it comes to justice and equity, similar powers is also preserved
under the National Land Code 1965
(3) As matter of practice, most of the Islamic banks do exercise their discretion and
give a rebate, thereby keeping with the true spirit and intent of justice and equity
under the Syariah law. Further, Islamic law of commercial transaction will not permit
the bank to state the rebate for default under the BBA as Islamic law of contract,
though it may appear to be similar to the secular law, is not the same. The Syariah
363
law does not generally permit conditional contract, contract upon a contract, etc.
However, this does not mean that Islamic bank cannot openly state their policy and
rates of rebate without encapsulating in BBA agreements. This will promote
transparency and equity. The fact that ' ibrar' is unilateral does not stop Islamic banks
from voluntarily relinquishing part of their claim or the court upon default by the
customer to demand that proper concessions be granted to the customer on equitable
grounds when exercising its jurisdiction and powers for order for sale under SLC or
NLC.
(4) Equity in this case applied both to the plaintiff as well as to the defendants. To
obtain a just result and without dismissing this originating summons, the court would
give an opportunity to the plaintiff to demonstrate equitable conduct by filing an
affidavit stating: (i) that upon recovery of the proceeds of sale they will give a rebate;
and (ii) specify the rebate. The amount specified must not be a nominal rebate but a
substantial one taking into account the prevailing market force by banks generally,
and the meaningful decision in the cases of Affin Bank Bhd and Malayan Banking
Bhd. If the court is satisfied that the proposed rebate is just and equitable, it shall
make an order in terms of the plaintiff's application, subject to the terms set out in the
proposed affidavit. Otherwise, the court may not make the order as prayed or may
make some other order as the justice of the case requires. 815
In this case, the court made a few important observations. Concerning the validity of
BBA, Hamid Sultan JC in this case said as follow:
‘Whether BBA is valid or invalid depends on the nature of the instruments. However,
the concept of BBA is now being widely accepted, provided it does not infringe on the
rule against riba. The Pakistan Supreme Court, in the historic judgment on interest
stated above, has held that murabahah and/or BBA transactions (sale by deferred
payment), when used as a mode of trade financing, is a borderline transaction with
interest-bearing loan. The court stated that unless the basic requirements for its legal
validity under the Syariah are strictly complied with, it might amount to
interest-bearing loan. Further, the Supreme Court took the view that the murabahah
and/or BBA concept is susceptible to misuse and is not an ideal financing system and
should only be used where musharaka and murabahah, a concept of financing
(partnership or equity financing), are not applicable. Our courts here have not ventured
into the validity of such instruments in detail, as was done in Pakistan.’
This case follows the precedent established by earlier cases.
815
•
Malayan Banking Bhd v Ya’kup bin Oje & Anor [2007] 6 MLJ 389
364
CASE 9:
Arab-Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Ors
(Koperasi Seri Kota Bukit Cheraka Bhd, third party) [2008] 5 MLJ
631
In this case (and another 11 other cases), Kuala Lumpur High Court Justice Datuk
Abdul Wahab Patail declared that the Islamic financial products known as Bai
Bithaman Ajil (BBA) in Malaysia is contrary to the Islamic Banking Act 1983 (IBA)
and the Banking and Financial Institutions Act 1989 (BAFIA). Previously, in the case
of Tahan Steel Corporation Sdn Bhd v Bank Islam Malaysia Berhad, that was decided
in the same day, he firmly rules that Istisna contracts are void ab initio (from
inception).
The same judge, Justice Datuk Abdul Wahab Patail of the Kuala Lumpur High
Court, earlier on in the the case Affin Bank v Zulkifli Abdullah (2006) 3 MLJ 67 also
shocked the Islamic finance industry in Malaysia when he ruled that in the event that
recovery proceedings are commenced prior to the expire of the agreed financing
tenure, the bank is only entitled to profit up to the date of recovery only, and not the
entire balance of the agreed sale price. While the earlier decision is highly appreciated,
the decision in this case seems to be very problematic. The decision of this court was
later overturned by the appellate court (although the written judgment seems to be not
available).
In the case of Taman Ihsan Jaya, the defendant had approached the plaintiff for
financing, to complete their purchase of a property from a third party. The plaintiff
had already paid of the purchase price to the third party. The plaintiff agreed to give
the defendant an Islamic finance facility known as BBA. Under the agreement, the
defendant will sell the property to the plaintiff (at the balance price, to be paid
immediately) and simultaneously purchase it back from the plaintiff (at higher price,
to be paid in installment). The defendant defaulted and the plaintiff took legal action.
The High Court judge in this case surprisingly said that BBA is not a bona fide sale
but a mere financing facility that is contrary to Islamic Banking Act 1984 and BAFIA.
The court ordered the parties to be return to their original position.
Below is the court decision on this case:
(1) When dealing with cases involving Islamic financing facilities, the civil
court functions strictly as a civil court and does not become a Syariah Court.
The civil court’s function, in this regard, is to render a judicially considered
decision before it according to law and not apply Islamic law
as if it were a Syariah Court. Its function is to examine the application
365
of the Islamic concepts and to ensure that the transactions in the cases before it
do not involve any element not approved in Islam (see paras F 8 & 31).
(2) In Islamic financing there is nothing that prohibits the giving of a loan. It is
only the riba element in the loan that is prohibited. Hence, loans without riba
ie benevolent loans or qard al-Hasan are allowed (see para 18).
(3) The term Al-Bai’ Bithaman Ajil is no more than a sale and deferred
payment of the price as agreed to between the parties. As such, the selling
price is ordinarily paid upon delivery. However if the payment is to be made
later, the seller is in effect extending a credit or a loan of that selling price. At
the same time it must be remembered that the deferred payment of the selling
price is a credit or a loan permissible only because no riba is charged.
Furthermore, the key to the argument that the Al-Bai’ Bithaman Ajil scheme
does not involve any element not approved by Islam is to read the PSA
independently. Therefore it is essential to maintain a bona fide sale in order
that the profit or selling price should not be an element disapproved by Islam.
Even so, an interpretation of the selling price must not be such as to impose a
heavier burden than on a loan with interest (see paras 52–56).
(4) The court has the authority to look beyond the words of the agreement to
the actual facts of the case in order to determine the substance of the
transaction between the plaintiffs and the defendants before it draw any
conclusions on the nature of the Al-Bai’ Bithaman Ajil transactions. It is
necessary to look beyond the labels used and look at the substance particularly
in the light of the fact that the interpretation advanced by the plaintiffs resulted
in the defendants being burdened with a debt far in excess of that if they had
taken interest based on a conventional loan (see para 62).
(5) Thus when the bank became the owner of the property by a direct purchase
from the vendor or by a novation from its customer, as in the present cases,
and then sold the property to the customer, the plaintiffs’ interpretation of the
selling price ought to be rejected and the equitable interpretation applied.
Where the bank purchased directly from its customer and sold back to the
customer with deferred payment at a higher price in total, the sale was not a
bona fide sale but a financing transaction and the profit portion of such an
Al-Bai Bithaman Ajil transaction rendered the facility contrary to the Islamic
Banking Act 1983 or the Banking and Financial Institutions Act 1989, as the
case may be (see paras 68–69).
(6) Since the plaintiffs’ actions resulted most likely from a misapprehension
rather than intent afterthought, the plaintiffs were entitled under s 66 of the
Contracts Act 1950 to a return of the original facility amount they had
366
extended. It was equitable that the plaintiffs seek to obtain a price as close to,
if not more than, the market price as possible, and account for the proceeds to
the respective defendants (see paras 70–71).’
There are conflicting reaction to this case, with some supporting and many objecting.
For example, according to Mohamed:
The BBA facility offered to Muslims must not be contrary to the 'religion of
Islam' and the issue whether the BBA scheme is consistent with the 'religion of
Islam' is determined not merely by reading the property sale agreement
independently but by going beyond the words of the agreement to determine
the actual facts of the case and the substance of the transaction between the
parties. Further, its determination is made with reference to the primary
sources of Islamic law namely, the al-Quran and hadith and not merely with
reference to the views of a particular mazhab alone. In Arab-Malaysian
Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Ors and Other cases, the court
held that where the bank purchased the property directly from its customer and
then sold back the same property to the customer with deferred payment at a
higher price in total, such a sale is not a bona fide sale but a financing
transaction. Therefore, where there appears gross unfairness, as in the above
case, the courts are entitled to invoke equitable principles so as to eliminate
the injustices. 816
However, another author, Azahari observed that four important issues were not
highlighted to the court attention in this case. 817 Firstly, contrary to court’s perception,
there are actually adequate legislations that may be applied in Islamic banking and
trade transaction, other than IBA and BAFIA. Secondly, Azahari highlighted that in
Malaysia, several state law enactments clearly provided for the statutory interpretation
of the term sharak which accepts any of the recognised mazhabs as part of sharak
(Shariah). Thirdly, the issue on riba’ is a complicated matter and there are many
different views on the matter. Fourthly, there is already an equitable way to calculate
the amount involved (the sale price including ibra’) in which the parties will not be
816
Ashgar Ali Ali Mohamed, ‘Al-Bai' Bithaman Ajil - Its consistency with the Religion of Islam: With
special reference to Arab-Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Ors and Other cases’
[2008] 6 MLJ xiv; [2008] 6 MLJA 14
817
Fakihah Azahari, ‘Islamic Banking: Perspective on recent case development’ (2009) 1 Malayan
Law Journal xci
367
left in unfair position. Azahari concluded that the court finding in this case, that
current BBA structure is faulty, is too harsh.
The decision in this case posed a very serious challenge to Islamic finance
industry, not merely from the legal and regulatory aspect, but also to its very existence.
Most of the Islamic financial products in Malaysia are based on the BBA contract.
The court basically held that the BBA contract as currently used in Malaysia
cannot be used. The case suggests that a bank providing Islamic finance using the
BBA cannot operate as mere financier but must instead step into the shoes of its
customer by actually purchasing the property from the developer or vendor, and not
from the customer. The implication of this case is very serious and it is fortunate that
it was overturned during the appeal.
In this case, the judge also ruled that in order for a Shariah principle to be in
accordance with Islam, it must be approved by all four madhahib (Islamic schools of
thought). This gross mistake was corrected and the decision of this case on that matter
was overruled by the Court of Appeal in the case of bank Islam Malaysia Bhd v Lim
Kok Hoe & Anor and Other Appeals [2009] 6 MLJ 839 (CA).
368
CASE 10:
The Investment Dar Company KSCC and BLOM Developments
Bank Sal [2009] EWHC 3545 (Ch)
The appellant/defendant in this case was The Investment Dar Company, an
investment company that is incorporated in Kuwait. According to Article 5 of the
memorandum, the company was established as a Shariah-compliant company.
The contract involves in this case is a wakalah contract, a type of agency
contract. The contract in this case is to be governed by English law subject to
compliant with Shariah. In this case the court initially granted a summary judgment in
favor of the claimant bank, Blom amounting to USD10.7 Million. The defendant
appeals against the summary judgment.
The main issues in this case involved trust and the issue of Shariah-compliant,
although the focus on this research will be on the latter. To summarize, when the
defendant defaulted in payment of the principal amount and the agreed profit, the
defendant raised the issue of non-compliant to the Shariah. The judge in this case,
Purle QC detailed as follow:
It is said on behalf of TID that that contract amounted to a non‑compliant Sharia
transaction because, in reality and substance, what TID was doing was taking
deposits at interest. Blom says that claim is a nonsense. It points to the undoubted fact
that the Sharia committee of (I shall assume) respected scholars had authorised and
approved of this form of contract which is a strong indication that the contract was
indeed Sharia compliant. There was put in before the master for TID at the very last
moment some rather exiguous evidence of Sharia law, which was answered overnight
and then supplemented by further evidence on the part of TID. Master Bragge was
not especially impressed by TID's evidence but nonetheless considered that there was
an arguable case that the transactions entered into pursuant to the master wakala
contract were ultra vires TID. As moreover questions of capacity of a corporate entity
are governed by the law of the place of incorporation, the fact that the master wakala
contract was governed by English law was neither here nor there. I agree with Master
Bragge that a triable issue has been shown on that score. Blom answered the evidence
with the expert opinion of a Dr Hoyle, which the master thought was much more
impressive than that of TID. I do not wish to say anything at this stage as to whose
expert evidence appears to me to be the better. It seems to me that that is a trial point.
Mr. Reed for Blom pointed out, as was not disputed, that this defence is a lawyer's
construct and the court should approach it with appropriate scepticism for that reason,
especially as the Sharia committee apparently approved of this transaction. I agree
that the court should approach the matter with some circumspection, but that does not
369
take anything away from what is essentially a simple point, albeit difficult to apply,
namely, that where one finds, as one does in this master wakala contract, a device to
enable what would at least to some eyes appear to be the payment of interest under
another guise, that is at least an indirect practice of a non‑Sharia compliant activity. I
do not think it appropriate for me to go through the expert evidence in detail because
I am satisfied that I cannot resolve which expert is correct on this application. 818
In summary, the defendant alleged, among others, that the wakalah facility was not
Shariah-compliant. The judge in this case observes that the Islamic facility has
already been approved by the shariah committee and wakalah agreement was held to
be valid and enforceable. This case has been critically scrutinized by Aldohni:
… [T]he argument of the contract validity under Islamic law was brought to the court
after the defendants defaulte without a valid ground, which means that the use of Islamic
law was purely strategic. This can, to certain extent, explain the dismissive approach
that the court adopted in deciding Shamil Bank of Bahrain v Beximco Pharmaceuticals
Ltd & ors case, which can be argued is not directed to Islamic law, but rather to its
tactical use. Nevertheless, the point that the judge made in realtino to the court’s
inability to deal with Islamic law is still a source of major concern in this context. 819
818
819
The Investment Dar Company KSCC and BLOM Developments Bank Sal [2009] EWHC 3545 (Ch)
Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A Comparative Look
at the United Kingdom and Malaysia (Routledge 2011) 121
370
CASE 11:
Tan Sri Abdul Khalid bin Ibrahim v Bank Islam Malaysia Bhd and
another suit [2009] 6 MLJ 416
The defendant, Bank Islam Malaysia Bhd provided two murabahah financingfacilities
to the plaintiff, to enable the plaintiff to redeem and acquire more shares in a company
called ‘Kumpulan Guthrie Berhad’. Due to some breaches by the plaintiff, the
defendant offered to restructure the financing facility into BBA. The plaintiff
defaulted in the first installment and then challenges the validity of the BBA facility
agreement, alleging, among –others, non-compliance to principles of Shariah. The
court decided in favor of the bank on matter regarding shariah-compliant, after
consulting the Shariah Advisory Council (SAC). The secretariat to the SAC clarified
that SAC has confirmed that BBA is Shariah-compliant. The learned judge, Rohana J
had this to say concerning the role of the SAC:
‘Taking cognisance that there will always be differences in views and opinions on the
Shariah, particularly in the area of muamalat, there will inevitably be varied opinions
on the same subject. This is mainly due to the permissive nature of the religion of
Islam in the area of muamalat. Such permissive nature is evidenced in the definition
of Islamic banking business in s 2 of the Islamic Banking Act 1983 itself. Islamic
banking business is defined to mean, banking business whose aims and operations do
not involve any element which is not prohibited by the religion of Islam. It is amply
clear that this definition is premised on the doctrine of 'what is not prohibited will be
allowed'. It must be in contemplation of the differences in these views and opinions in
the area of muamalat that the Legislature deems it fit and necessary to designate the
SAC to ascertain the acceptable Shariah position. In fact, it is well accepted that a
legitimate and responsible government under the doctrine of siasah-as-Shariah is
allowed to choose, which amongst the conflicting views is to be adopted as a policy,
so long as they do not depart from the Quran and Islamic injunction, for the benefits
of the public or the ummah. The designation of the SAC is indeed in line with that
principle in Islam.
At this stage, the court still has discretion whether to refer to the SAC or not. The
situation later change with the introduction of the new Central Bank of Malaysia Act
2009, in which section 56 requires all proceedings relating to Islamic financial
business to take into consideration the published rulings of the Shariah Advisory
Council. This is a departure from the old position in which the reference to SAC is
purely discretionary.
371
CASE 12:
BANK ISLAM MALAYSIA BHD v. LIM KOK HOE & ANOR AND
OTHER APPEALS [2009] 6 CLJ 22
This case addressed some of the fundamental issues in the legal and regulatory aspect
of Islamic finance. In this case, Per Raus Sharif JCA held as follow:
The comparison between a BBA contract and a conventional loan agreement was not
appropriate. The two instruments of financing are not alike and have different
characteristics. BBA contract is a sale agreement whereas a conventional loan
agreement is a money lending transaction. The profit in BBA contract is different
from interest arising in a conventional loan transaction. The two transactions were
diversely different and indeed diametrically opposed. Thus, the learned judge was
wrong when he equated the profit earned by BIMB as being similar to ‘riba’ or
interest. Further, the comparison between a BBA contract and a conventional loan
agreement was of no relevance. It served no purpose as the law applicable in BBA
contract was no different from the law applicable in a conventional loan agreement.
The law is the law of contract and the same principle should be applied in deciding
the cases herein. Thus, if the contract was not vitiated by any vitiating factor
recognised in law such as fraud, coercion, undue influence, etc, the court had a duty
to defend, protect and uphold the sanctity of the contract entered into between the
parties. (paras 24, 25, 26 & 27)
The Court of Appeal also stated as the following:
In this respect, it is our view that judges in civil court should not take upon
themselves to declare whether a matter is in accordance to the religion of Islam or
otherwise. As rightly pointed out by Suriyadi J (as he then was) in Arab-Malaysian
Merchant Bank Bhd v Silver Concept Sdn Bhd [2005] 5 MLJ 210 that in the civil
court 'not every presiding judge is a Muslim, and even if so, may not be sufficiently
equipped to deal with matters, which ulama' take years to comprehend'. Thus,
whether the bank business is in [*854] accordance with the religion of Islam, it needs
consideration by eminent jurists who are properly qualified in the field of Islamic
jurisprudence.
In this case, the court also commented on the role of the SAC:
‘Thus, we already have the legal infrastructure to ensure that the Islamic banking
undertaken by the banks in this country does not involve any element which is not
372
approved by the religion of Islam. The court, will have to assume that the Shariah
advisory body of the individual bank and now the Shariah Advisory Council under
the aegis of Bank Negara Malaysia, would have discharge their statutory duty to
ensure that the operation of the Islamic banks are within the ambit of the religion of
Islam.’
This case highlighted some of the problems that will occur if the legal and regulatory
framework is not clear. It is necessary to have finality on the issue of
shariah-compliant by providing for a proper and authoritative mechanism. Failure to
have such mechanism will open a floodgate of cases on Islamic finance, as defaulting
parties will be tempted to raise the issue of shariah-compliant as escape liabilities.
However, such mechanism must be sensitive and must ensure protection of all parties,
particularly the public at large.
373
CASE 13:
Bank Kerjasama Rakyat Malaysia Bhd v Sea Oil Mill (1979) Sdn
Bhd & Anor [2010] 2 MLJ 740
In this case, the appellant/plaintiff, Bank Kerjasama Rakyat Malaysia sued the
defendants/respondents (debtor/guarantor) for a claim of around RM31 million. The
plaintiff in this case gave a credit facility using bai al inah principal to the first
respondent while the second respondent acted as the guarantor. When the first
respondent defaulted, the appellant sued both respondents and obtained a summary
judgment. The appeal of the first respondent was rejected by the court as the first
respondent is already in liquidation and proper leave of court has not been obtained.
The appeal of second respondent was allowed as there was a triable issue whether the
appellant had the legal capacity to carry on Islamic finance. The learned high court
judge found that the appellant conduct were in order but the court of appeal rely on
the Development Financial Institution Act 2002 that prohibit the appellant from
carrying any Islamic banking business before obtaining the return approval of the
Central Bank.
The court in this case held that the appellant operation using the Shariah concept
was in order as it was in accordance with the resolution of its board of directors. The
court also held the questioned whether that the appellant could carry on Islamic
banking or not did not arise. The court in this case stated as follow:
The question whether the appellant could carry on Islamic banking or not does not
arise. The simple fact is that the first respondent received a large sum of money from
the appellant and then defaulted in its repayment. The second respondent was also
sued by the appellant based on his guarantee for the said revolving credit. Both the
first and second respondents were well aware of their respective contractual
responsibilities and liabilities in the event of default of repayment. From the evidence
available, we do not see any triable issue arising from the appellant's claim against the
second respondent. We also agree with the learned High Court judge that the
appellant was properly authorised to carry on its Islamic banking according to the
minutes of the meeting of its board of directors dated 29 April 1993 (see the appeal
record 344 exh ABO37 and also the minutes of the meeting of the Majlis Pengawasan
Syariah Bil 2/94 dated 29 November 1994 which clearly stated their approval to the
overdraft facility according to Shariah concept of Bai-al-Inah which was named as
al-Tarkhis (Istimewa) facility.
This case indirectly shows the support of the legal system in Malaysia of the Islamic
finance industry in which a flexible and permissive approach is taken.
374
CASE 14:
Arab-Malaysian Merchant Bank Bhd v Silver Concept Sdn Bhd
[2010] 3 MLJ 702
In this case, the defendant, Silver Concept Sdn Bhd entered into a sale and purchase
agreement with a vendor to acquire a piece of land and assets in Ulu Selangor in order
to be developed. The defendants then applied to the plaintiff, Arab-Malaysian
Merchant Bank Bhd for a BBA facility amounting to RM125 million in order to
purchase the land and a RM60 million alwujuh facility for the working capital for the
development project and a RM200 million end-financing facility to provide financing
to prospective purchases of units on the land.
At all material times, the plaintiff was the agent who arranged for the facilities
by bringing together a consortium of financial institutions to provide the financing to
the defendant. The defendant then defaulted in its repayment to the consortium and
the plaintiff then sued the defendant. The plaintiff also claimed based on the alwujuh
facility. The defendant counterclaim for damages and for losses suffered by it when
the plaintiff bank breached its fiduciary duties by not fully disbursing the facility and
also claimed that the facility agreement was null and void due to Shariah
inconsistencies. The defendant further argues that the facility was tainted by riba’ and
thus contravenes Islamic Banking Act 1983. In this case, Rohana Yusuf J stated as
follow:
‘The parties here have agreed before executing the agreement, without any undue
pressure or persuasion, to the preconditions of the Islamic based contracts. Parties
also agreed to be bound by the terms to conclude the agreement. The defendant also
agreed that the whole purpose of the sale transaction is to provide the banking facility
it required, for the capital of the purposed project. For that reason, a sale agreement
was concluded between the plaintiff. This is to ensure that the defendant becomes the
beneficial owner of the land for the purpose of the revolving al-Wujuh facility. The
facility was structured in such a way to accommodate the defendant's request for such
capital. Al-Wujuh revolving financing facility is made on the basis of a fluctuating
facility on a short to medium terms (in this case it was seven years) method of
financing via the principle of Bai Bithaman Ajil or deferred payment sale. In this case,
the purchase price was at RM60,000,000 while the sale price is predetermined at
RM96,225,000. Nothing in the agreement stipulates the interest rate as alleged by the
defendant. It is wrong for the defendant to say it is interest when they both agreed
them to be profit. The issue of validity of Bai Bithaman Ajil was earlier brought to
court in the Arab Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Ors [*710]
375
(Koperasi Seri Kota Bukit Cheraka Bhd, third party) [2008] 5 MLJ 631; [2009] 1 CLJ
419 where the learned judge in that case ruled that the Bai Bithaman Ajil agreement
is not a sale transaction but a lending agreement. The Appeal Court had however in
Bank Islam Malaysia Bhd v Lim Kok Hoe & Anor and other appeals [2009] 6 MLJ
839; [2009] 6 CLJ 22 (CA) overruled the decision and held that the Bai Bithaman Ajil
agreement is valid and an enforceable contract. I am bound by that decision to hold
that the al-Wujuh revolving financing based on BBA is valid and enforceable.’
The court in this case held that the facility is not tainted by riba. The BBA agreement
was valid and enforceable contract and other agreement involved in this case are also
valid and enforceable. Markom et al highlighted that this case is part of a series of
inconsistent decision made by Malaysian court:
This confusion and uncertainty can be seen in the conflicting judicial pronouncements.
In the case of Affin Bank Bhd v. Zulkifli Abdullah, it is observed that the banks cannot
claimed the full sale price of the property in the the event of default by the borrower.
On the contrary, in the case of Arab Malaysian Merchant Bank Bhd v. Silver Concept
Sdn Bhd the court permits the bank to claim from the borrower the profit of the full
tenure. 820
820
Ruzian Markom, Sharina Ali Pitchay, Zinatul Ashiqin Zainol, Anita Abdul Rahim, Rooshida
Merican Abdul Rahim Merican, ‘Adjudication of Islamic banking and finance cases in the civil courts
of Malaysia’ (2011) European Journal of Law and Economics
<http://www.springerlink.com/content/qn431774608k617h/fulltext.pdf> accessed 10 January 2012
376
CASE 15:
Bank Islam Malaysia Bhd v Azhar bin Osman and other cases [2010]
9 MLJ 192
In this vital case, the court decided that Islamic bank must grant discount or rebate for
BBA contract in the event of default by customer although the contract between the
parties was silent on the issue. This is a departure from some of the traditional
approaches, in which the court will not include a new term into a contract, unless it
can be implied. The issue whether ibra’ or discount was purely discretionary on the
part of the bank, was answered is negative by the court. Datuk Rohana Yusuf J
decided that due to the practices of Islamic bank of granting rebate on premature
termination, it has now ‘creates an implied term and legitimate expectation on the
part of the customer. 821’
The concept of rebate, discount or ibra’ has been considered by the Shariah
Advisory Council in Malaysia for some time and has been recognized. Under
conventional finance, the exact rebate or discount that the customer will get when the
contract is terminated earlier by earlier payment by the customer (either voluntary or
due to default) is fixed and clear. However, under current Islamic financial products,
the schedule or amount was not included in the contract agreement due to some
Shariah uncertainty over the issue.
In this case, the legal counsel for the bank proposed that the bank was entitled to
the full sale price as the transaction was not a loan transaction, as under conventional
finance but a sale and purchase transaction. The legal counsel also cited the case of
Bank Islam Malaysia Bhd v Lim Kok Hoe and Anor and others where the Court of
Appeal acknowledged the obligation of the purchasers to make full payment of the
sale price. The court in this case held, among others, as follow:
…Whilst it is true that the Court of Appeal in Lim Kok Hoe held that a BBA contract
in a way differs from conventional banking because it is a sale transaction, it cannot
however be regarded as a sale transaction simpliciter. The BBA contract is secured by
a charge and concession as ibrar is given as a matter of practice to all premature
termination. Despite the written term of the agreement, the bank in reality does not
enforce payment of the full sale price upon a premature termination. It always grants
rebate or ibrar based on 'unearned profit' (see paras 13-14).
…The court does not enforce payment of the full sale price but intervenes on
equitable grounds, albeit based on different approaches. Therefore, when an Islamic
bank practices granting of rebate on a premature termination, it creates an implied
821
Bank Islam Malaysia Bhd v Azhar bin Osman and other cases [2010] 9 MLJ 192
377
term and legitimate expectation on the part of the customer. Accordingly it is only
proper that such expectation and practice be read into the contract. Hence, where the
BBA contract is silent on issue of rebate or the quantum of rebate, the bank must, by
implied term, grant a rebate and such rebate shall be the amount of unearned profit as
practiced by Islamic banks (see paras 18, 20 & 22). 822
The judge in this case, Rohana Yusuf J held that the bank should not be permitted to
enrich itself with undue profit. The court also held that BBA was not a simple sale
transaction. Although the contract was silent on rebate, Islamic financial institutions
and banks were known to adopt a practice of granting rebate on premature termination
and this created implied term and legitimate expectation that must be observed. The
court also held that the court in only bound by the Lim Kok Hoe case on the issue of
validity and enforceability of a BBA contract.
The legal and regulatory framework in Malaysia is further strengthened by this
case as the uncertainty and doubts concerning rebate and discount are clarified.
Previously, in 2002, the Shariah Advisory Council has already resolved that ‘Islamic
banking institution may incorporate the clause on undertaking to provide ibra’ to
customers who make early settlement in the Islamic financing agreement on the basis
of public interest (maslahah)’. The court in this case has also highlighted its curiosity
on how the inclusion of a clear schedule for rebate or discount is contrary to Shariah:
The practice of the banks in deducting the unearned profit as ibrar is not ignoble. In
the same breath, it is inconceivable how stipulating the terms of the rebate will be
repugnant to Shariah. The latter however creates unnecessary anxiety in customers.
For that and other reason stated herein, I have, for the purpose of determining the
quantum of claim, taken an approach to enforce an implied term of Islamic banking
practice in the case before me. In this respect, I am guided by the Federal Court case
of Sababumi (Sandakan) Sdn Bhd v Datuk Yap Pak Leong [1998] 3 MLJ 151. In
Sababumi Zakaria Yatim FCJ (as he then was) stated in that case that the court may
infer an implied term from evidence that the parties to a contract must have intended
to include it in the contract, though it has not been expressly set out in the contract.
Therefore when an Islamic bank practices granting of rebate on a premature
termination, it creates an implied term and legitimate expectation on the part of the
customer. Accordingly it is only proper that such expectation and practice be read
into the contract.
822
Bank Islam Malaysia Bhd v Azhar bin Osman and other cases [2010] 9 MLJ 192
378
CASE 16:
Mohd Alias bin Ibrahim v RHB Bank Bhd & Anor [2011] 3 MLJ 26
This is the first case in Malaysia that deals with the issue of constitutional validity of
the new sections of the Central Bank of Malaysia Act 2009, particularly section 56
and section 57. The ratio of the case is reference to Shariah Advisory Council under
section 56(1)(b) is permissible and constitutional as the Shariah Advisory Council is
merely required to make an ascertainment, and not final determination, of Islamic
laws related to the questions posed.
Section 56 to Section 57 of the Central Bank of Malaysia Act 2009 stated as follow:
Section 56: Reference to Shariah Advisory Council for ruling from court
or arbitrator
(1) Where in any proceedings relating to Islamic financial business before any court or
arbitrator any question arises concerning a Shariah matter, the court or the arbitrator, as
the case may be, shall—
(a) take into consideration any published rulings of the Shariah Advisory Council; or
(b) refer such question to the Shariah Advisory Council for its ruling.
(2) Any request for advice or a ruling of the Shariah Advisory Council under this Act or
any other law shall be submitted to the secretariat.
Section 57: Effect of Shariah rulings
Any ruling made by the Shariah Advisory Council pursuant to a reference made under
this Part shall be binding on the Islamic financial institutions under section 55 and the
court or arbitrator making a reference under section 56.
Section 58: Shariah Advisory Council ruling prevails
Where the ruling given by a Shariah body or committee constituted in Malaysia by an
Islamic financial institution is different from the ruling given by the Shariah Advisory
Council, the ruling of the Shariah Advisory Council shall prevail.
The plaintiff in this case entered into a sale and purchase agreement to purchase some
properties situated within the Kota Warisan project and a building agreement to
construct and complete a house on the land. On January 2004, the first defendant
granted the plaintiff financing via an Islamic financial product known as Bai Bithman
379
Ajil (BBA) and cash line facility to finance the said construction project. On March
2005, the assets, rights, and liabilities of the first defendant in respect of Islamic
finance were vested in the second defendant.
The plaintiff in this case proceed with a legal action against the defendants
claiming that the financing facilities dated January 2004 were void and of no effect, in
addition to the plaintiff claim for damages for breaches of the facilities agreements
with interest and cause.
On May 2010, the first defendant’s application to strike out the plaintiff claim
was dismissed but during the process it was noted that there were some issues that
require reference to the Syariah Advisory Council pursuant to Central Bank of
Malaysia Act 2009 under section 56-58.
Similar to the case of Al Rajhi Banking & Investment Corp (M) Bhd v Hapsah
Food Industries Sdn Bhd & Ors and another action [2012] 1 MLJ 115, the plaintiff in
this case also seeks court’s determination as to whether the said sections were
inconsistence with article 121 [1] of the Federal Constitution. The Plaintiff’s main
submission was mainly premised on the view that the Parliament could not make law
to delegate the judicial power of the court to any other body without an enabling
clause or express provision in the Federal Constitution to such effect. 823
The plaintiff raised three issues:
1. whether the said sections were worded to the effect that they usurped the judicial
power of the court to decide the issue to another body [in this case SAC]
2. whether by imposing a duty on the court to refer any Syariah Banking matter to the
SAC and making the decision of the SAC binding on the court, the litigants were
deprived of any chance to be heard
3. whether the said sections could not have retrospective effects on the transactions
since they were entered into before the Central Bank of Malaysia Act 2009 come into
force.
This case is very essential as it touches a few fundamentals aspect of the legal and
regulatory system governing Islamic finance in Malaysia, particularly the finality of
the decision of the SAC. Due to the importance of the matter, the court with the
consent of the parties invited the attorney general’s chambers and the Central Bank of
Malaysia as amicus curie to forward their views on the matter.
In response it was submitted that the said sections were enacted pursuant to the
federal lists of the Ninth Schedule to the Constitution, and it is constitutional. In other
823
Mohd Alias bin Ibrahim v RHB Bank Bhd & Anor [2011] 3 MLJ 26
380
words, there is no issue of unconstitutionality. Furthermore, the Central Bank of
Malaysia and the attorney general chambers denied the proposition that the plaintiff
right to be heard was or will be denied under the current system since according to
section 51 (2) of the Act, the SAC was given full liberty to set its own process and
procedure when a Syariah matter was referred to it. Therefore, the proposal that the
plaintiff will not be able to be heard is only speculative.
There are many important decisions held by the court in this case. The judge in
this case, Mohd Zawawi Salleh J elaborated that the role of the SAC was merely to
make ascertainment, and not a final and binding legal decision:
In Malaysia, Islamic laws fall under the jurisdiction of the Shariah Court, which
derives its power under a state law enacted pursuant to art 74(2) of the Federal
Constitution, but in cases involving banking transactions based on Islamic principles
it was the civil courts that had the jurisdiction to hear these matters. However, with
the development of Islamic financial instruments it became important to establish one
supervisory authority to regulate the uniformed interpretation of Islamic law within
the sphere of Islamic finance and banking, and in Malaysia, that supervisory authority
is the SAC. Based on s 52 of the Act, which sets out the functions of the SAC, it was
clear that the SAC was established as an authority for the ascertainment of Islamic
law for the purposes of Islamic banking business, takaful business and Islamic
financial business. Thus, if the court referred any question under s 56(1)(b) of the Act
to the SAC, the latter was required to merely make an ascertainment and not a
determination of the Islamic laws related to the question. The sole purpose of
establishing the SAC was to create a specialised committee in the field of Islamic
banking to ascertain speedily the Islamic law on a financial matter. As such there was
no reason for the court to reject the function of the SAC in ascertaining which Islamic
law was to be applied by the civil courts in deciding a matter (see paras 62-63, 78 -80,
84-85, 105 & 122). 824
Secondly, the judge also clarified that the final decision was still with the court:
… in a matter where there were differences of opinion regarding the validity of a
certain Islamic finance facility, the SAC could be referred to so as to ascertain which
opinion of the jurist was most applicable. This ascertainment of Islamic law would
then be binding upon the courts as per the impugned provisions and it will then be up
to the courts to apply the ascertained law to the facts of the case. As such, the final
decision in the matter remained with the court in that it had to still decide the ultimate
824
Mohd Alias bin Ibrahim v RHB Bank Bhd & Anor [2011] 3 MLJ 26
381
issues which had been pleaded by the parties. The process of ascertainment by the
SAC had no attributes of a judicial decision and the ruling issued by the SAC was an
expert opinion in respect of Islamic finance matters and it derived its binding legal
effect from the impugned provisions enacted pursuant to the jurisdiction provided
under the Constitution (see paras 87-88, 90, 93- 94, 96 & 109). 825
The court in this case dismissed the plaintiff application with no order to cost. The
court held that the said sections were valid federal laws enacted by the parliament.
Concerning the issue of jurisdiction the court held that although the jurisdiction on
Islamic law generally fall under the jurisdiction of Syariah court, cases involving
Islamic finance fall under the jurisdiction of the civil court, as civil court have
jurisdiction over financial disputes. Furthermore, due to the development of Islamic
finance, it has become important to establish one supervisory authority to regulate the
uniformed interpretation of Islamic law and in Malaysia the supervisory authority is
the SAC.
From the legal and regulatory aspect, a few things can be learnt from this case.
Firstly, it is important to have one supervisory authority vested with the final say on
Islamic finance to ensure consistency and uniformity. If the details of Islamic finance,
particularly the interpretation of Islamic rulings were left to the court, there would be
numerous unnecessary difficulties as the judges mostly lack specialization in Islamic
finance and there would be a series of conflicting decision that will eventually halt the
development of Islamic finance. Secondly, the authority vested with the final say on
Islamic finance must ensure that the party’s right to be heard is expressly stipulated in
its procedure.
One of the lessons that can be seen from this case from the legal framework is
the court, particularly in commonwealth countries should be given the final say to
decide on legal dispute, but clear effect of reference to supervisory authority and their
views must be clarified. In this case, the court referred to following statement by
Ajaib Singh J in the case of Public Prosecutor v Oh Keng Seng [1976] 2 MLJ 125;
[1976] 1 LNS 107:
Article 4(1) of the Federal Constitution declares that the Constitution is the supreme
law of the Federation and that any law passed after Merdeka Day which is
inconsistent with the Constitution shall to the extent of the inconsistency be void.
Under the fundamental liberties provisions of the Constitution it is provided in art…
that all person are equal before the law and entitled to the equal protection of the law.
It need hardly be stressed that it is the duty of the court to jealously guard the
825
Mohd Alias bin Ibrahim v RHB Bank Bhd & Anor [2011] 3 MLJ 26
382
Constitution and to see that nothing is enacted by the Legislature which may offend
the provisions of the Constitution particularly those which relate to the fundamental
liberties of the subject. If any particular piece of legislation gives so much as a hint
that it violates the Constitution the court must unhesitatingly declare it null and void
and of no effect. On the other hand if the impugned legislation is not inconsistent
with or does not in any way violate the Constitution it is equally the duty of the court
to uphold its validity and give effect to it. 826
Concerning the issue of Shariah-compliant, the judge in this case noted that there
were numerous different views:
The freedom to interpret Islamic laws by qualified jurists and scholars has lead to a
myriad diversity of opinions (al-ra'yu) among them. These differences of opinion are
mainly due to juristic issues of the Islamic law. It could differ for various reasons
such as the use of different methodologies of Islamic jurisprudence, different
approach towards an issue, different understanding of the Quran and Sunnah etc.
Furthermore, legal opinion, to a certain extent, is influenced by characteristics of
races, societies and epochs, depending upon their customs, traditions, predilections,
peculiarities and business culture of a particular society.
The judge proceeded with the following statement concerning the need for finality so
that the diversity of views will not hinder the development of Islamic finance:
Diversity of rulings and differences of opinion are the reasons why Islamic law
continues to develop according to time. Just like common law, if there are no
differences of opinion and development of the law, it will remain like a dead coral
reef, a structure of fossil that remains still at the bottom of the ocean. In the light of
the above, to ensure that the development of Islamic financial instruments progresses
smoothly and orderly, the establishment of one supervisory authority in a country is
very important. This supervisory authority should have the power to regulate a
uniformed interpretation of Islamic law within the sphere of Islamic finance and
banking in that country and may choose the best opinion in its decision making
process after taking into consideration all of the authorities, custom of the locality etc.
In Malaysia, that supervisory authority is the SAC. The SAC was established on 1
May 1997 as the highest Shariah authority in Islamic finance in Malaysia. 827
826
Public Prosecutor v Oh Keng Seng [1976] 2 MLJ 125; [1976] 1 LNS 107
827
Mohd Alias bin Ibrahim v RHB Bank Bhd & Anor [2011] 3 MLJ 26
383
The judge in this case also held that this is the first time the court is dealing with the
new ss. 56 and 57 of the Central Bank of Malaysia Act 2009 and accordingly, there
would be no order as to costs. This indicates that in the future, parties that
unsuccessfully challenge the new sections might be given order as to costs for wasting
court’s time. The obiter given by the court in this case is very relevant and useful:
To ignore the functions of the SAC is to open a floodgate for lawyers and cause a
tsunami of applications to call any expert at their own interest and benefit, not only
from Malaysia but also from other countries who might not be familiar with our legal
system, administration of Islamic law and local conditions, just to challenge the
Islamic banking transactions in this country. 828
828
Mohd Alias Ibrahim v RHB Bank Bhd & Anor [2011] CLJ JT(2)
<http://www.cljlaw.com/public/cotw-110603.htm> accessed 10 February 2012
384
CASE 17:
Al Rajhi Banking & Investment Corp (M) Bhd v Hapsah Food
Industries Sdn Bhd & Ors and another action [2012] 1 MLJ 115
This case is actually a consolidated action of two civil suits. The dispute is due to the
failure of the Defendant, Hapsah Food Industries Sdn Bhd to pay for the “sale price”
of two Islamic financial products (known as Trade Commodity Financing-i)
disbursement and the failure to pay the outstanding amount in respect of another
Islamic financial product known as Structured Commodity Financing-i.
The purpose of these transactions was to provide financing to enable Defendant
to import rubber products from Indonesian suppliers to be sold to Mardec Processing
Sdn Bhd. Mardec Processing Sdn Bhd will then pay for the products supplied to it
under the purchase orders issued by it to the Defendant and letters of credit [LC] were
issued. The Defendant was under the legal obligation to ensure full payment of the LC
and the Plaintiff/bank’s profit. To ensure payment, the Plaintiff required an
assignment of the proceeds of the contract payable by Mardec, to be emplaced in a
sinking fund. According to the evidence tendered in this case the Defendant was
supplying to third party unauthorized customers although they did not exist any
assignment of contract’s proceeds. This is done because the Defendant wanted to
avoid selling to Mardec at lost. The Defendant then requested an additional financing
facility to finance its new contract with the unauthorized customers. The Defendant
attempted to build a case on a promissory estoppel and doctrine of forbearance. The
judge dismissed the Defendant’s claim with cost:
I am allowing the claim by the Plaintiff Bank in D-22NCC-345-2010 as prayed in its
Writ of Summons and Statement of Claim, prayers (i) and (ii) for the adjusted sum of
RM4,888,701.43 for the TCF-i facility and RM84,839.17 for the SCF-i facility with
costs of RM15,000.00 to be paid by the Defendants to the Plaintiff within one month
from the date of this Order, with judgment to be entered accordingly. As for Civil Suit
No. D-22NCC-471-2010, I am dismissing the Plaintiff’s (Hapsah Food’s) claim with
costs of RM50,000.00 to be paid by the Defendant to the Plaintiff within one month
from the date of this Order. 829
The court decided that the Defendant had disregarded its obligations not to supply to
unauthorized customers or third parties. There seems to be at least three important
relevance of this case. Firstly, the issue of complexity is touched. The court noted in
829
<http://kl.kehakiman.gov.my/sites/kl.kehakiman.gov.my/attachments/D-22NCC-345-2010.pdf>
accessed 10 February 2012
385
this case that certain Islamic financial products were sometimes complicated and
proper understanding is necessary:
Built into the mechanics of payment are several security arrangements. These facilities
are structured facilities in this sense. True enough, the structure is a complicated one
because it involves Islamic financing which requires the interposition of a supply and
exchange of commodities nominally done, but failure to comprehend the exact nature of
the facilities cannot be a reason not to comply with essential obligations on the part of
the 1st Defendant. 830
It is necessary for parties involving in Islamic finance to understand its modus
operandi and nature before proceeding. Secondly, the issue of equitable principles is
briefly touched. This case is interesting partly due to the obiter dicta said by the judge
in this case. Mohamad Ariff J stated as follow:
It is customary in common law cases to appeal to equitable principles to achieve a
legal conclusion that can be regarded as just and proper between the parties. I have to
observe in this connection that these equitable principles should be accorded an even
more heightened presence since these are Islamic facilities, where considerations of
aqad and piety in commercial relations should be regarded as primary
considerations. 831
According to the judge, Mohamad Ariff Bin Md Yusof J, equitable principle should
be given even more consideration in this case since the financial products used are
Islamic facilities. This approach, while noble, might cause some difficulties as it will
be difficult to measure or limit the scope of the equitable principles that should be
used in relation to Islamic facilities, particularly in the absence of a clear case
precedent or statutory guideline.
From the legal and regulatory aspect, a few issues can be considered from this
case. The first issue is the proper scope for the application of the equitable principle in
Islamic finance cases. Islamic financial product is often portrayed as an ethical
financial product that also focuses on ethics and morality, often associated with
fairness and equity. However, in various cases this label might be slightly misleading
830
<http://kl.kehakiman.gov.my/sites/kl.kehakiman.gov.my/attachments/D-22NCC-345-2010.pdf>
accessed 10 February 2012
831
Al Rajhi Banking & Investment Corp (M) Bhd v Hapsah Food Industries Sdn Bhd & Ors and
another action [2012] 1 MLJ 115
386
as the current Islamic financial products offered in certain country including Malaysia
are often nothing more than cosmetic changes (in relation to risk allocation) to the
conventional financial products in order to ensure minimal compliance with Shariah
requirement. More often than not, the risks associated with Islamic financial products
are more or less the same, sometimes more, than conventional products. For example,
a customer using an Islamic financial product manages to get a financing for the
purchase of a commercial building. The cost of the building is 10 millions. Under the
so called Islamic financial product, the customer will purchase the building from the
developer by paying the deposit, and then the customer [who is now vested with the
beneficial interest and ownership] will “sell” the building to the Islamic financial
institution for immediate cash and immediately at the same time repurchase the
building at a higher price eg 20 millions, paid by monthly installments for few years.
If the customer purchases the building using conventional financing, the amount
that the customer have to pay to the conventional bank in the form of usury or interest
is usually more or less the same eg 20 millions in monthly installment. The reason
why the Islamic financial institution adopts such a complicated process is to
circumvent the Islamic prohibition of usury without actually taking any extra or real
risk.
Under the current approach, in the event of default from the part of the customer
the customer will be exposed to more harm using the so-called Islamic financial
product compared to the conventional financial product under a few scenarios. For
example, let say the building was only completed 80%, and the customer defaulted,
under the conventional financing would have to pay the amount of money paid by the
conventional bank in addition to a certain amount of interest. Furthermore, the
customer would be entitled to get some rebate due to the early termination of the
contract. In other words, the customer will not have to pay the full amount that the
customer is supposed to pay under the normal period of the transaction. On the other
hand, under the previous illustrated Islamic financial product, the customer would
have to pay the full amount eg 20 millions because the contract is supposed to be a
sale and purchase contract. However, it is not a true sale and purchase contract as that
customer is the one who have to bear all the risks under this scheme. 832
Under an ideal Islamic facility, the Islamic financial institution/bank will
purchase the building at the price of 10 million and sell the building to the customer at
a price of 20 millions to be paid in monthly installment. The Islamic bank will first
have to investigate the developer to ensure the credibility of the project to avoid or
reduce the possibility of default. In the unfortunate event where the project is
defaulted and the building was not completed, the risk will not be suffered by the
832
Recent court trend in Malaysia has shifted from this approach to a more equitable approach.
387
customer alone. The customer will have a set off against the Islamic financier for
selling a defective product i.e. an incomplete building while the Islamic financier can
sue the developer for its failure to complete the project. It is clear that under the ideal
Islamic facility the allocation of risk is better in the sense that the customer is afforded
more protection. Under the ideal Islamic facility, the financier will have to take real
risks but such risks can be reduced and mitigated with proper management and
supervisory system.
However, under the current system some of the Islamic financial products can
expose the customer to more harm. In order to avoid this, it is of utmost important to
have a clear legal and regulatory framework concerning issues like rebate, discount,
etc. In order to reduce or avoid ambiguity concerning these issues, guidelines from
supervisory body like SAC will be very beneficial.
Thirdly, the issue of claims without merit was answered firmly by the court with
its strong rejection:
As for costs, counsel for Al-Rajhi pressed for higher costs to be awarded against Hapsah
in D- 22NCC-471-2010 in view of the unmeritorious claim instituted for the alleged loss
of RM55,000,264.00. Counsel urged upon this Court that a strong signal must be sent
that an unmeritorious claim such as this cannot be tolerated. Given the conduct of the
Defendants, I have no hesitation to agree with the Plaintiff Bank’s counsel. I am
therefore awarding costs of RM50,000.00 in Suit No. D-22NCC-471- 2010. 833
833
<http://kl.kehakiman.gov.my/sites/kl.kehakiman.gov.my/attachments/D-22NCC-345-2010.pdf>
accessed 10 February 2012
388
6.13 Possible Improvements to the Legal and Regulatory Framework
An in depth analysis on the Malaysian cases reveal the common legal and regulatory
challenges. Firstly, there is a trend for the court, in the initial stage of the introduction
of Islamic finance to a country, to be more accommodative to Islamic finance. While
this is sound in theory, the practical application is somewhat disturbing. It is not
proper for the court to be ‘accomodative’ by simply approving the Islamic financial
product. For example, in earlier cases, customers who defaulted under Islamic
financial products are required to pay the amount in simply full because the contract is,
on the face of it, a sell and purchase contract. For illustration, the customer get
financing from Islamic financial institution to purchase a house at the price of $10
million from an Islamic financial institution, payable in 20 years installment. The
original price of the house, purchased from the developer is $5 million. In the event of
default, the customer using certain Islamic financial product will be compelled to pay
the amount in full ($10 million) since the contract seems to be a sale and purchase
contract. As comparison, the customer will be financially better off using
conventional financial product like simple loan contract because in such situation, the
customer will not be obliged to pay $10 million to bank. The loan is $10 million and
the total amount including the interest, payable in 20 years is $20 million. But in the
event of default, the customer is not obliged to pay the total amount , $10 million
because discount will be given by the bank since the contract is terminated earlier.
The amount payable depends on the time of termination of contract. In other word, the
amount is lesser is payment is made earlier.
Secondly, it is noted that the court will take a more serious and critical approach
only after some time. After numerous complaints from the public at large, the court
will take a more critical approach by insisting that the contract must be fair to the
public and the so-called Islamic financial institution must put fairer term. For example,
discount or rebate must be given. At the same time, the government will also modify
the rules and regulation to ensure that such rebate or discount is given by Islamic
financial institution. This is a pure waste of time as the matter can be avoided
altogether if the rules and regulation are clearer in the first place.
Thirdly, failure to proper legal and regulatory framework on certain aspect like
taxation will have very serious consequences. As elaborated before, investors, traders
and customers will shy away from Islamic finance if Islamic finance is subjected to
double-taxation or extra charges.
389
i.
Removing legal uncertainty
There are numerous legal challenges faced by Islamic finance in its current form.
Aldohni sharply noted that Islamic banks cannot operate outside the applicable laws
in any financial market, from banking regulation to various other laws that are
relevant to business including company law and contract law. 834 Legal complexity is
the most difficult challenge. The legal challenges are unique. For example, the
challenges ranged from management of investment risks, consumer protection laws,
the lack of legal precedents, situations involving uncertainty, integrating Shari’ah
rulings within a conventional banking framework, to accommodating Shari’ah
references in conventional legal documents and property law issues. 835
Venardos recommends that it is important for the nature of Islamic banks and
their specific operating relationship in relation to a particular country’s central bank
and other conventional banks, if applicable, to be defined in detail by that country’s
banking laws by having comprehensive legislations relating to licensing and
permissible modes of financing, and state; clearly, legislative powers to address
compliance with laws and regulations and provides a clear qualification or conditions
to be called Islamic bank. 836
Some authors highlight that the legal framework for some Islamic countries is
still underdeveloped. For example, Iqbal and Mirakhor stress that in the MENA
region, the supervisory standards, legal institutions and insolvency issues are still
underdeveloped although there is a high concentration of Islamic financial institutions
there. 837
ii.
Removing status uncertainty
Status uncertainty is different from legal uncertainty. Legal uncertainty usually refers
to uncertainty from the legal aspect but status uncertainty mainly concerned with the
appropriateness of labeling a product as Shariah-compliant. Islamic finance is
834
Abdul Karim Aldohni, The Legal and Regulatory Aspects of Islamic Banking: A Comparative Look
at the United Kingdom and Malaysia (Routledge 2011) 2
835
Angelo M Venardos, Islamic banking & Finance in Southeast Asia: Its Development and Future
(World Scientific 2007) 104
836
Angelo M Venardos, Islamic banking & Finance in Southeast Asia: Its Development and Future
(World Scientific 2007) 104
837
Zamir Iqbal and Abbas Mirakhor, An Introduction to Islamic Finance: Theory and Practice (Wiley
Finance 2011) 321
390
expected to be Shariah-compliant. Therefore, the Islamic financial products are
supposed to adhere to the series of principles and prohibitions found in Islamic
jurisprudence. There are numerous different views forwarded by the scholars and
experts of Islamic finance concerning various aspects with no certainty. This is not a
problem by itself, since diversity of view is good and it is actually cherished in Islam.
For example, Prophet Muhammad stated to the effect that if a view were made
(ijtihad) based on the teaching of the religion and the view was correct, the person
would be awarded with two good deeds or rewards in the hereafter. If the view were
incorrect, the person will still be awarded with one good deed, for attempting it, based
on the teaching of the religion.
However, due to the existence of conflicting views, a clear legal framework on
who has the final say is warranted. In Malaysia, the legal and regulatory framework is
shaped in a way where the views forwarded by the experts in the Shariah Advisory
Council is often respected and accepted by the court. The new Central Bank Act
makes it mandatory to consider the view of the SAC. However, there are cases in
other country like United Kingdom where the court held that the professional view of
the Islamic finance experts would not be taken into consideration in deciding the case.
Failure to put an end to this issue will definitely open a floodgate of court cases with
various different and inconsistent results.
According to Venardos, an appropriate regulatory framework for banking
supervision in an Islamic environment should be designed to ensure that 838:
(i)
(ii)
(iii)
Legal foundations for the supervision of Islamic banks are proper
Investment and other risks are adequately dealt with,
Adequate information is disclosed to allow supervisory authorities
It is essential to have a clear hierarchy of role, to avoid overlap of jurisdiction and to
ensure that those with expertise deal with the matters involved. Venardos elaborated
the role of the Shariah Advisory Council as follow:
The primary objectives of the NSAC are to act as the sole authoritative body to advise
BNM on Islamic banking and takaful operations; to co-ordinate Shariah issues with
respect to Islamic banking and finance (including takaful); and to analyse and
evaluate Shariah aspects of new products/schemes submitted by the banking
institutions and takaful companies.
Guidelines pertaining to Islamic banking, issued
by Bank Negara from time to time, are as good as legal requirement because under
838
Angelo M Venardos, Islamic Banking & Finance in Southeast Asia: Its Development and Future
(World Scientific 2007) 110
391
the Bank Negara Ordinance, Malaysia’s Central Bank is vested with some powers to
regulate the market. Some examples of these Guidelines include having the Central
Bank instruct all conventional banks operating Islamic banking business and Islamic
financial business to maintain separate current accounts and clearing accounts with
the Central Bank of Malaysia as the Islamic accounts need to be used only for
transaction s which are halah and conducted according to Shari’ahlaw. 839
While it seems appropriate and efficient to have a separate supervisory body
consisting of experts in Islamic finance to decide on the matter of Shariah-compliant,
it does not mean that a separate legal and regulatory framework is necessary in all
aspect. For example, the same central authority like the Central Bank of a country
should still perform their supervisory role in general. According to Norton:
It does seem appropriate and desirable, however, that all banks should be subject to
the same kind of monitoring and minimum control system for capital adequacy. It is
also desirable that all main banking risks should be covered by such schemes. This
suggests two immediate desiderata. First, the emphasis needs to be consolidated and
enhanced of functional (versus institutional) supervision. This means that supervision
and capital adequacy concerns should reflect primarily the kind of business rather
than the historical type of institution active in a particular business sector. 840
It is evident from the analysis of previous cases that leaving the issue of
Shariah-compliant to be judged by a civil (conventional) court judge without clear
guideline (on the effect of the views forwarded by the Islamic financial experts) will
be awkward, and sometimes offensive. While commenting on the legal and regulatory
framework of Islamic finance in Malaysia, Ibrahim raised the following issue:
Civil judges hearing the cases would have no difficulty applying the relevant civil
laws. Can the same be said of them in respect of Islamic law? Civil judges (and in
most cases lawyers too) seldom hold any qualifications in the Shari’ah and rarely do
they have any meaningful experience in Islamic transactions. Some of the reported
cases show that sometimes even basic principles had not been grasped. In two
separate High Court cases on bay’ bithaman ajil, which is a sale and purchase
transaction under which the vendor permits the purchaser to settle the purchase price
839
Angelo M Venardos, Islamic Banking & Finance in Southeast Asia: Its Development and Future
(World Scientific 2007) 147-148
840
Joseph J. Norton (ed), Bank Regulation and Supervision in the 1990s (Lloyd’s of London Press Ltd
1991) 117
392
by installments, the court treated the transaction as “loans” and adopted in its
judgment other normal lending terms like “borrower” and “repayment”. Except in the
rare instance of qard al-hasan (a friendly or benevolent loan, usually given in social
rather than in a business context) under which the borrower is obliged to pay just the
principal sum), loans, which ordinarily connote interest, are taboo in Islam. 841
The table below summarized the occasional inconsistencies of the court decision on
the matter of Shariah-compliant in Malaysia:
Table 10: Cases on Islamic Finance in Malaysia
Case
Court decision on Shariah-compliant issue
Light Style Sdn Bhd v KFH
Ijarah House (Malaysia) Sdn
Bhd [2009] CLJ 370 / [2009] 1
LNS 193
The court upheld that the Islamic contract of
murabahah and declared that it does not
contravene the legislations (MLA, IBA and
BAFIA)
Bank Islam Malaysia Berhad v
Lim Kok Hoe & Anor and other
Appeals [2009] 6 CLJ 22 /
[2009]
The court upheld the BBA contract and warned
that judges of civil court should take it upon
themselves to declare whether a matter is in
accordance with Islam or not, and to leave it to
the eminent jurists who are properly qualified in
the filed of Islamic finance
Majlis Amanah Rakyat v Bass
Bin Lai [2009] 2 CLJ 433
The court upheld the Islamic contract of Bay
al-Inah
Malayan Banking Berhad v
Zainal Abidin Abdullah & Anor
[2008] MLJU 180
The BBA contract was equated with conventional
loan, and the claim for ‘unearned profit’ was
rejected. The court only granted profit up to the
date of judgment, plus penalty and daily profit
until the full settlement of the judgment sum.
Arab-Malaysia Finance Bhd v
Taman Ihsan jaya Sdn Bhd &
Ors, Koperasi Seri Kota Bukit
Cheraka Bhd (Third Party) and
Other Cases [2009] 1 CLJ 419 /
The court held that the BBA contract is not in
compliance with Shariah and law
[this case was reversed in the case of BIMB v Lim
Kok Hoe]
841
Mohamad Illiayas Seyed Ibrahim, ‘The Regulatory Framework and Legal Aspects of Islamic
Banking and Finance in Malaysia’ in Mohd Daud Bakar and Engku Rabiah Adawiah Engku Ali (eds),
Essential Readings in Islamic Finance (CERT 2008) 281
393
[2008] 5 MLJ 631
Arab-Malaysian Merchant Bank Islamic contract of BBA was upheld.
Bhd v Silver Concept Sdn Bhd
[2008] 6 MLJ 295
Bank Muamalat Malaysia Bhd v
Suhaimi Bin Md Hashin & Anor
[2007] 1 MLJ 275 / [2006] 7
CLJ 321
The BBA contract was equated with conventional
loan, and the claim for ‘unearned profit’ was
rejected. The court only granted profit up to the
date of judgment, plus penalty and daily profit
until the full settlement of the judgment sum.
Arab-Malaysia Merchant Bank
Berhad v Foreswood Industries
Sdn Bhd & 4others [2007]
MLJU 664 / [2007] 1 LNS 539
Islamic contract of BBA was upheld.
Fadzillah Ahmadi Bin Alii v
Mayban Finance Berhad [2007]
MLJU 663/ [2007] 1 LNS 536
Islamic contract of BBA was upheld.
Bank Kerjasama Rakyat
Malaysia Bhd v PSC Naval
Dockyard Sdn Bhd [2008] 1
CLJ 784 / [2007] MLJU 722
The court held the BBA contract and found that
the defendant had not raised any defence with
merits to deserve a trial. Summary judgment was
to be entered.
Malayan Banking Bhd v Ya’kup
Oje & Anor [2007] 5 CLJ 311 /
[2007] 6 MLJ 389
The court upheld the BBA contract with
condition; the claim by the bank was entertained
by the court provided that rebate was given by the
bank and the amount of rebate was to be specified
Malayan Banking Bhd v
Marilyn Ho Siok Lin [2006] 3
CLJ 796
The BBA contract was equated with conventional
loan, and the claim for ‘unearned profit’ was
rejected. The court only granted profit up to the
date of judgment, plus penalty and daily profit
until the full settlement of the judgment sum.
Affin Bank v Zulkifli Abdullah
[2006] 1 CLJ 438
The BBA contract was equated with conventional
loan, and the claim for ‘unearned profit’ was
rejected. The court only granted profit up to the
date of judgment, plus penalty and daily profit
until the full settlement of the judgment sum.
Southern Bank Bhd v Ayer
Keroh Park Sdn Bhd [2005] 6
CLJ 134 / [2005] 4 AMR 597
Islamic contract of BBA was upheld
Tahan Steel Corporations Sdn
Islamic contract of Istisna’ (manufacturing) was
394
Bhd v Bank Islam Malaysia Bhd
[2004] 6 CLJ 25 / [2004] 6 MLJ
1
upheld by court. The court focused on justice and
equity for possible losses or irreparable damage to
the defendant.
Bank Islam Malaysia Berhad v
Pasaraya Peladang Sdn Bhd
[2004] 7 MLJ 355
Islamic contract of BBA was upheld. Islamic
contract of BBA was upheld. The issues in this
case did not really involve the substance of BBA.
Oriental Bank Berhad v
Gandingan Ilmu Sdn Bhd & Ors
[2003] MLJU 485
Islamic contract of BBA was upheld.
Bank Kerjasama Rakyat
Malaysia v Sea Oil Mill Sdn
Bhd & Anor [2003] MLJU 207 /
[2003] 1 LNS 718
The court upheld the Islamic contract of bay
Al-Inah.
Bank Kerjasama Rakyat
Malaysia Bhd v Emcee
Corporation Sdn Bhd [2003] 1
CLJ 625 / [2003] 2 MLJ 408
Islamic contract of BBA was upheld. Islamic
contract of BBA was upheld. The issues in this
case did not really involve the substance of BBA.
Bank Kerjasama Rakyat
Malaysia Bhd v Nesaretnam
Samyveloo [2002] 8 CLJ 95 /
[2002] 7 MLJ 103
Islamic contract of BBA was upheld. The issues
in this case do not really involve the substance of
BBA.
Bank Islam Malaysia Bhd v
Shamsudin Bin Hj Ahmad
[1999] 1 LNS 275 / [1999]
MLJU 450
Islamic contract of BBA was upheld. The court
held that in BBA, the difference between the ‘sale
price’ is not the prohibited interest, but was
merely the profit for the plaintiff.
Dato’ Hj Nik Mahmud Daud v
Bank Islam Malaysia Bhd
[1998] 3 CLJ 605
Islamic contract of BBA was upheld
Tinta Press Sdn Bhd v Bank
Islam (M) Bhd [1987] CLJ 396/
[1987] 2 MLJ 192
Islamic contract of Ijarah was upheld by court
Bank Islam Malaysia Berhad v
Adnan Bin Omar [1994] 3 CLJ
735 / [1994] MLJU 221
Islamic contract of BBA was upheld by court.
The court held that the defendant was fully aware
of the terms of the contract and its consequences,
and the plaintiff has the right to claim for the full
‘sale price’, and it was inequitable to allow
defendant’s claim when he himself willingly enter
into the contract.
395
Table 11: Cases on Islamic Finance in United Kingdom
Case
Decision
Glencore International AG v
Metro Trading International
Inc [2001] 1 Lloyd’s Rep
284
The Court was reluctant to examine issues of Sharia
compliance when looking at the enforceability of an
English law contract.
Islamic Investment Company The Court was reluctant to examine issues of Sharia
of the Gulf (Bahamas) Ltd v compliance when looking at the enforceability of an
Symphony Gems and others English law contract.
[2002] WL 346969
Shamil Bank of Bahrain v
Beximco Pharmaceuticals
Limited and Others [2004] 2
Lloyd's Rep 1
The Court has been reluctant to examine issues of
Sharia compliance when looking at the enforceability
of an English law contract.
The Investment Dar
Company KSCC v Blom
Developments Bank SAL
[2009] EWHC 3545 (Ch)
The Court in this case examined the issus of Sharia
compliance when looking at the enforceability of an
English law contract and held that the Islamic
financial product known as wakalah is
Shariah-compliant, by accepting the view of the
shariah expert.
iii. Standardization, Convention and Treaty
From the inconsistent decisions revealed in the table, it is obvious that standardization
is necessary. The size of the Islamic financial industry is estimated to be around US$1
trillion. However, the nature and range of products varies from one country to another.
There are few important international regulatory bodies like AAOIFI and IFSB but
the level of standardization is still low. The problem is not really with uniformity.
There is no problem with coming up with better, new and a more innovative financial
products that cater to the modern need of global trade and commerce. The problem is
when some of the Islamic financial products are declared to be non-compliant to
Shariah as this can cause shock to the industry.
Venardos has highlighted some of the major problem:
396
A major problem challenging the growth of Islamic banking was the absence of
recognized guidelines on prudential, supervisory, accounting and other corporate
regulatory practices. This resulted in ineffective accounting standards and created
considerable difficulties when it came
to comparing financial statements issued by
Islamic financial institutions and those of conventional institutions. Two
organizations, namely the Accounting and Auditing Organization for Islamic
Financial Institutions ….and the Islamic Financial Services Board (IFSB), are both
involved in addressing these issues with the ultimate aim of harmonizing corporate
governance with the ethical requirements of Shari’ah law. 842
As part of a collective measure to strengthen Islamic finance, an international treaty or
convention between countries might be necessary. Right now, the issuance of
sovereign sukuk (Islamic bond) is already accelerating the growth of Islamic finance
to a new level. If there is no certainty in this matter, there might be conflicts between
countries particularly when it involves a significantly large amount of money due to
different understanding and interpretation on Islamic finance.
Another alternative is to use arbitration is such situation. It is noted that country
like Malaysia through the KLRCA is coming up with proper legal and regulatory
framework for arbitration involving international and domestic Islamic financial
products.
v. Better risk management
Proper risk management is fundamental to all financial institutions and all trading
parties. According to Norton:
It was the collapse of the West German Bankhaus Herstatt in June 1974 that
prompted more focused concern about the adequacy of national regulatory
supervisory policies unaided in an increasingly internationalised market place. The
damaging impact of the Herstatt failure and the way it was handled had market
repercussions on confidence in the international system. Unlike domestic financial
systems, the international financial system has no lender-of-last-resort. As a result,
the negative impact of a loss of confidence carries with it the potential to produce
more acute market reactions. Herstatt was not the only problem. Other European
842
Angelo M Venardos, Islamic Banking & Finance in Southeast Asia: Its Development and Future
(World Scientific 2007) 95
397
banks also reported large losses from foreign currency operations during the same
period. 843
Nowadays, it is important to have suitable legal and regulatory framework to manage
the risk as the actions of small-unregulated employee can also cause huge and
unexpected effect. A simple example is the AIG:
It is interesting to note that only 25 employees in the Financial Products division at
AIG (AIGFP) – the huge international insurance company that employed 113,000
professionals worldwide – were responsible for bringing the whole company down.
One of their tools was a product they designed to speculate on the movements in
interest rates. For example, one of their bets would result in a profit or loss of $500
billion if interest rate changed by a small percent in either direction. This loss,
realized by the company, is equivalent to paying for the loss or damage caused by 62
California-size earthquakes. Unfortunately, AIG grew so big that even with the most
sophisticated management and supervisory tools and techniques, no one could
regulate the activities of this small group of employees. 844
Furthermore, the risk faced under Islamic finance can be more serious, particularly the
risks associated with liquidity:
One of the biggest impediments for IFIs is to develop liquid markets where securities
can be traded efficiently at minimal transaction cost. Second, given the heavy
concentration of trade or commodity finance, the assets of Islamic banks are illiquid;
that is mudharabah based assets cannot be traded in the secondary market. Third
whereas conventional banks have access to liquidity provided by a lender of last
resort, Islamic bank cannot benefits from such a facility as the lending is
interest-based. This means that although an Islamic bank may be in good financial
health, it could still face additional capital requirements because of low liquidity
which could hamper its growth or efficiency. 845
843
Joseph J. Norton (ed), Bank Regulation and Supervision in the 1990s (Lloyd’s of London Press Ltd
1991) 108
844
Yahia Abdul-Rahman, The Art of Islamic Banking and Finance (Wiley 2010) 372
845
Zamir Iqbal and Abbas Mirakhor, An Introduction to Islamic Finance: Theory and Practice (2nd
edn, Wiley 2011) 319
398
6.14 Conclusion
This chapter tests the hypothesis at a much deeper level. While the application of
Islamic principles to the maritime trade sector is realistic, useful and advantageous,
simple cosmetic changes are not adequate. The systematic removal or at least
reduction of unnecessary uncertainties and risks are necessary to strengthening global
maritime trade. More specifically, this chapter analyses the actual challenges and risks
faced by the maritime trade and Islamic financial industries before testing the
hypothesis. There are four major risks associated with the maritime trade industry,
including price, credit, pure and legal risks. The analysis reveals that the application
of Islamic principles to maritime trade is possible in all four risk categories, although
the actual benefits depend on the proper application of those principles.
Chapter Six can be divided into two parts. The first part discusses the four risks
associated with maritime trade, and the second is associated with the legal risks
involved in Islamic finance.
Risk management is a fundamental part of trade. Failure to adopt proper risk
management techniques is costly. During the recent global recession, many
companies collapsed due to poor risk management. For example, budget airline Air
Asia managed to substantially reduce its operational costs by hedging properly against
oil price increases. However, Malaysia Airlines (MAS) has suffered substantially due
to its failure to hedge.
The goal of most parties involved in maritime trade is to make profit. Parties
profit when the input is more than the output. Consider a shipping company whose
total operational cost is US$100 million and total cost overall is US$150 million. If
the shipping company manages to make a total of US$200 million, it enjoys a profit
of US$50 million. If oil prices increase significantly and the operational cost becomes
more than what the shipping company can make, it suffers a loss. To manage such a
risk, parties use financial products and techniques such as hedging and derivatives to
safeguard their positions.
Parties in maritime trade also suffer pure risks such as natural disasters. In such a
case, their whole carriage may be lost. To safeguard their positions, they commonly
adopt marine, professional and indemnity insurance. The use of insurance in
managing risks has become well integrated into the maritime trade industry. The
literature on Islamic risk management is very limited and focuses only on the risk
management of Islamic banks and financial institutions, mainly due to the shortage of
Islamic finance and law scholars. According to Ng Nam Sin, the assistant managing
director (development) for the Monetary Authority of Singapore:
399
… the number of financial professionals who are well-versed in
Shariah-compliant products is still relatively small. We need more universities
and training institutes to offer better quality education and training in Islamic law
and finance in order to meet the rising demands of the industry as it embarks on
the next phase of growth. 846
There are many benefits to adopting a risk management system that is Shariah
compliant and Islamic in nature. First, Islamic risk management provides a
compelling option to Muslims or parties interested in ethical trade and commerce.
Some companies offer Islamic risk management services, and such services are very
attractive to some parties, including large corporations from the Middle East and other
Muslim countries. Established and respected international Islamic financial bodies
such as AAOIFI should introduce proper accreditation or recognition to interested and
qualified parties to ensure consistency and quality control. Some training courses are
currently being offered to this effect.
Second, Islamic risk management shares the benefits associated with Islamic
finance. For example, parties that adopt Islamic risk management are not exposed to
extreme or excessive risk due to their involvement with excessive speculative
activities. This does not mean that hedging or the use of financial products to mitigate
risk is unavailable. Many financial products are currently Shariah compliant.
Third, Islamic risk management encourages ethical and fair methods that are
more sustainable. In other words, it is not a zero-sum game. The essence of Islamic
risk management is not the maximisation of profit at any cost. Rather, the observance
of ethics and morality is highly emphasised.
The removal of unnecessary uncertainties and risks is necessary to strengthening
the legal framework of global maritime trade. The Islamic principles seen in the
various Islamic financial products that are applicable to modern maritime trade are
also relevant in strengthening global trade, partly because they prohibit transactions
that are tainted by excessive speculation (gharar) and require fairer risk allocations.
Islamic financial products cannot merely change cosmetically to ensure consistency
and quality control. Their essence must also change.
In this chapter, it is noted that many maritime trade risks are managed using
methods that are not Shariah compliant. This seems to cause no problem for
non-Muslims, and there seems to be no need to check or revise the legal and
regulatory framework that governs global maritime trade or global trade and
846
Ng Nam Sin, assistant managing director (development), Monetary Authority of Singapore,
‘Opening Keynote Address’ (The 17th Annual World Islamic Banking Conference, Bahrain, 24
November 2010).
400
commerce at large. However, upon deeper inspection, it is apparent that party
interests are not always adequately protected, as the system seems to be based on the
shift and transfer of risks and harm rather than risk minimisation or sharing.
Furthermore, a system that is based on a zero-sum game, in which one party wins at
the expense of others, can be risky over the long term, as it encourages parties to
increase volatility for profit. A gradual shift of the risk management system into a
new system that attempts to reduce volatility would be very beneficial and useful.
Chapter 6 also highlights that numerous legal and regulatory challenges have
occurred in relation to Islamic finance, even in its current form. The equitable and
pro-active approach taken by judiciaries in countries like Malaysia, in addition to the
strong support from regulators and governments, has eased the matter to a certain
extent. However, a closer collaboration between regulators, governments, Islamic
financial institutions, scholars and experts (in both Islamic and conventional finance)
is necessary if the industry is to shift from its current posi