The Concept of Shares.pptx

Reviewing the Concept of Shares: Towards A Dynamic Legal Perspective Toseef Azid 02-03-2024 Introduction It is argued that equity finance is the most desired way of Islamic finance and investment because it involves the profit and loss sharing mode of finance which is the real Islamic one (Uthmani,...

Reviewing the Concept of Shares: Towards A Dynamic Legal Perspective Toseef Azid 02-03-2024 Introduction It is argued that equity finance is the most desired way of Islamic finance and investment because it involves the profit and loss sharing mode of finance which is the real Islamic one (Uthmani, 2003:3). Unfortunately, the contribution of stock in the investment world is minimal as compared to other financial products available. In the USA it amounts to 2% only. Reasons: Why Islamic There are many reasons why the same situation prevails within the arena of Islamic finance The first one is the existence of differences of opinion among Muslim scholars regarding the permissibility of shares. Secondly, the building of Islamic indexes is a complicated issue. Scholars are still grappling with the filtration criteria and there is demand for further improvements regarding the criteria for incorporating listed companies in the Islamic Indexes. (Zarka, n.d., Resolution 310 of Rajihi Bank, 1419/4/6). Important Questions Hence, due to the importance of the stock exchange markets for economic development and for fund raising to develop projects, a deeper study of the above mentioned conflicting views become necessary. Two important questions that need attention are: firstly, whether this dilemma of investing in common stocks (shares) need to be resolved or do we accept the views expressed in some conferences and fatwa ? Important Questions Secondly, whether Muslims can invest on the London Stock Exchange Market (or any exchange market) according to the FTSE Islamic Index or should the indices be monitored in a more Islamic way due to the high involvement of riba (interest), gharar, (uncertainties and speculation), ghaban (fraud and deception) etcetera on the An Analysis of the Concept of Stock Exchange and Shares Due to the role of the stock exchange market in enhancing the economy, Muslim scholars have been looking at stock exchange market from different angles. El Gari (1993) advocates stock exchange market as a necessity for present day economies. However, he argues that it would not be possible to restrict ourselves to identifying the permissible “ ” transactions and conclude that an Islamic model should be limited to them. He made an attempt to offer solutions to the problem raised in contracts on the stock exchange to suit the Islamic law. An Analysis of the Concept of Stock Exchange and Shares However, one wonders if all these are practical because he does not pay attention to the regulatory framework of stock exchange markets, which vary from country to country. What is important to understand is that it is not easy to develop Islamic model outside the secular law. Either one should abide to the law of the land or else one can militate for the amendment of the law as has been the case with removal of the double stamp duty to accommodate the Islamic mortgages in UK. Also, stock exchange market is becoming a globalised transaction due to the fast growing information technology in this field. An Analysis of the Concept of Stock Exchange and Shares Tag El-Din (1996), on the other hand, has tried to be more practical in considering the economic dimension of the stock exchange market. He focuses on the general principles and the special constraints which characterize what he calls the normative Islamic Stock Exchange, and he also deals with the issue of the efficiency hypothesis. But what is more important, is that he raises a very important juristic issue regarding the permissibility of shares and limited liability companies. An Analysis of the Concept of Stock Exchange and Shares It is submitted that this should in fact be the starting point regarding the whole debate surrounding the Islamicity “ ” of the stock exchange market. He has based his argument on the so called consensus “ of jurists” and claims that the maxim accepted “ customs is like explicit conviction.” It is submitted that this debate has not been settled yet. An Analysis of the Concept of Stock Exchange and Shares For example, the All India fiqh Academy held a conference on this issue of shares and companies. From the papers delivered it is clear that there is no complete consensus on its permissibility (Mujahidul Islam, 2000:24). Nizam Yaqubi (2000) has elaborated on the different views of the Arab Jurists and still one can see that conflicting views still persist. Uthmani (1999a:182) has dealt with different approaches between the Shawafi and the Ahnaf. Again it is clear from his writings that according to the original Shawafi stance shares are not allowed due to the mixing of riba and other prohibited elements a company is involved in (Uthmani, 1999a:185). An Analysis of the Concept of Stock Exchange and Shares The concept of shares emanated in a given historical context to encourage the heavy oriented risky ventures needed for the expansion of the British economy in the 17th century. However, the reality of the legal persona of a company was devised to limit the risk of entrepreneurs; but nobody was clear about it until 1897 when the House of Lords gave a seminal judgement in the Solomon v/s Solomon Ltd, that the share holders are different persons from the company (Bourne, 1998:9). Further evolution took place since then. Corporate law became one of the most amended laws due to the intricacies associated with the concept of legal personality of company created by subscription of shares. An Analysis of the Concept of Stock Exchange and Shares Originally, shares were considered as a pro rata ownership of the assets of the company (Bourne, 1998:35). Based on this concept Muslim scholars have debated the permissibility of shares, and ultimately the issue of stock exchange market. But very few scholars have paid attention to the evolution of corporate law and that the stance regarding shares is changing. In fact experts in corporate law argue that a literal construction of the word share “ ” is apt to be misleading in relation to present day registered company. The purchase of shares in a company does not mean a shareholder has a share “ ” in the property of the company. An Analysis of the Concept of Stock Exchange and Shares The company’s ’ property is owned both legally and beneficially by the company (Goulding, 1996:163). And this is far from being a mudarabah as propounded by many shari’ah experts! So, legally shareholders are not joint owners of the company’s ’ assets, nor can a shareholder even be said to have an equitable interest in the company’s ’ property. According to the definition of share given by Farwell J in Borlands’ Trustee v Steel (1901 1 Ch 2791”) shares “ are characterized as a bundle of rights stemming from section 14 contract (UK LAW). No doubt from this bundle of contracted rights the share has emerged as a price of personal rights which is an intangible property, that is to say it is a chose “ in action.” Therefore, it can be owned, bought and sold, mortgaged and it will form part of the estate of a deceased person. An Analysis of the Concept of Stock Exchange and Shares However, in the same case law, the court also pointed out that “[T]he share is the interest of the shareholder in the company measured by a sum money, for the purpose of liability in the first place, and of interest in the second” (emphasis added). The paradigm shift is no more on ownership but on liability. One has to differentiate the legal concept of personal right of the shareholder and the real right of the company. The legal consequences that flow are consequential ( Important) for Islamic law. This issue has not been debated at length so far in academic works! Hence, it needs to be covered in the debate in considering the permissibility of shares and the corporation because it affects the concept of dealing “ in shares” and stock market. An Analysis of the Concept of Stock Exchange and Shares Besides the fiqh and legal aspects of shares and legal persona of corporations, the regulatory framework of listing companies and the development of Islamic indices also warrant a parallel research. Investors need to be protected, and also to ensure that their investments are canalized in the proper Islamic direction. Certain conditions need to be abided to in order to be listed on the London Stock Exchange. The Islamic index as well lays down certain criteria in order to filter companies in formulating the index. Scholars have discussed the Islamic Stock Exchange Model. But nobody has discussed the possibility of establishing an Islamic Securities House that could operate within the secular stock exchanges where most of the investment takes place! However, based on the article by George (2003) one can work towards this as proposed by Tellner (1425 AH). The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital As mentioned previously, the starting point for this lecture is to elaborate on the nature of shares which emanates from Western legal sources. A brief historical review will be drawn over here. The first British joint stock companies began to emerge in the sixteenth century. They were not however public in the full modern sense of the term but were more in the nature of extended partnership. The relatively few joint stock companies in existence were divided into very few large denomination shares, and clauses restricting and regulating their transfer were common. The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital Although from the outset (at the beginning) shares were sold outside personal acquaintances, there was no basis for a developed public market in them. In the eighteenth century when the stock exchange grew rapidly the basis of its growth in increasing government debt, trade in company shares forming a negligible part of its businesses (Ireland, 1987: 158). The number of companies quoted in the Castaings ’ course of Exchange actually fell from seven in 1753 to six in 1775 and to five in 1800 (Ireland, 1987:158). The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital The numerous joint stock canals, insurance and other companies formed in the late eighteenth and early nineteenth centuries generated few changes in this respect. Studies of the canal companies reveal limited number of relatively large denomination shares, few share holders and considerable stability of large shareholdings. The prices of canal dock, insurance and water works shares were included in the official list for the first time in 1811, followed later by those of other miscellaneous companies, but there “ was no really widespread interest in them as an outlet for savings. [T]here are no statistics on daily share turnover, [but] indirect evidence suggests that it was very limited” (Gayer, 1953:376). Exchange businesses continued to be concerned almost exclusively with government stock. So far as the legal nature of the share was concerned, the underdeveloped state of the market was crucial. The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital By this time the great majority of shareholders were simple rentiers (a person whose income consists primarily of fixed unearned amounts, such as rent or bond interest ) who played a little active part in management and treated their shares as mere rights to revenue. However, in the absence of a public share market, shares could not develop as fictitious capital with a value in themselves. As a consequence, they inevitably retained a direct link to a company's productive assets and were legally conceptualized not as property in their own right but as equitable interests in those assets realty or personality. In short while the share incorporated title to revenue it was considered to be so inextricably connected to the assets of companies that it could yet be constituted as a separate form of property (Millon, 1990:206). The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital It was rather peculiar ( Special) legal amalgam ( Mixture) of money and legal industrial capital which had yet not been juridically separated within the joint stock company. Such a legal distinction had already been drawn in respect of other titles revenue such as loans. In these circumstances shareholders could not be completely separated from their companies. This was reflected in the contemporary view of joint stock companies, incorporated and unincorporated, as entities composed of shareholders merged into one body; as aggregate of people; as they. “ ” People still formed themselves’ into companies (Ireland, 1987:159). The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital In the period after 1825 the nature of the share was transformed. The principal cause was the rapid development of the railway system. Railways involved massive outlays on fix capital requiring the aggregation of large amount of money capital. The smaller denomination ( Face Value), freely transferable share was the chosen form of centralisation. The railways brought, therefore, a dramatic increase both in the number of shareholders and in the number of shares available for trading. The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital Dealings in railway shares involved an extra-ordinary volume of transactions by previous standard. By the second railway boom of the 1840s ’ the stock exchange had been “perfectly revolutionalised,” and was “geared. To handle a growing range of company securities.” Stock exchanges even emerged in provincial centres, and gradually a national investment press developed. Joint stock company shares had become much more widely held:. A class of property had been, if not created, then vastly expanded” (Mitchell, 1964:331). The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital The effects of these developments on shares, however, were qualitative as well as quantitative. Shares were not only much more numerous, as they were now marketable commodities, liquid assets, easily converted by their holders into money. They were titles to the new revenue capable of being capitalised; a form of fictitious capital separated from the productive capital of the company. Legally, they were judicially redefined as objects of property in themselves. Shares, said Bacon C.J. In 1871, are “ not things in action at all but are as much part of a bankrupts ’ estate as if they had been freehold property” (Ex parte Union Bank of Manchester 12 Eq.354.) The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital Most important of all for the future development of company law with the legal constitution of this new form of property a gulf emerged between companies and their shareholders and between shareholders and shares. Companies owned the productive capital, the actual assets; shareholders own the fictitious share capital, the shares, which they could now sell at will. Shareholders were now completely “ separate” from their companies. They no longer form themselves into companies but formed companies, objects external to them. A company was no longer a plural entity, a they, “ ” people merged into one body; it was now a singular entity, an it, “ ” an object emptied of people. Both the company and the share had been reified. The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital The conditions now existed for the emergence of the modern version of the principle of separate personality, and gradually the meaning attached to incorporation changed. In the 1870s ’ Seward Brice, reflecting on Kyds ’ 1793 definition of a corporation as a “collection of many individuals united into one body,” commented: it is fairly accurate but sufficient stress is not laid upon that which is its real characteristic in the eye of the law, viz. The Historical Emergence of the Joint Stock Company Share as a New Form Fictitious Capital Its existence separate and distinct from the individual or individuals composing it ” (Ireland, 1987:160). Modern company law was emerging. However, companies can only exist if shares are issued. Therefore, the nature of shares and its conceptual evolution need to be discussed from an Islamic perspective. However, first the British legal position should be understood in order to make any discourse analysis of the fatwas issued regarding the status of shares in shari’ah. An Analysis of the Fatawa Regarding Shares After the above brief discussion regarding the nature of shares, now an analysis of shares is warranted from an Islamic perspective due to the importance of stock exchange plays in the modern world. First the fat w will be discussed followed by the criteria laid down by shari’ah scholars for allowing the purchase of shares. As can be seen from the case laws, a share is not a pro rata representation of the ownership vested in the assets of the company. This is a shortcoming in the fat was will be discussed soon. A case law will illustrate on this point. In the case Macaura v Northern Assurance Co. Ltd (1925 AC 619) Mr Macaura took an insurance policy against fire on a forest where trees were cultivated. An Analysis of the Fatawa Regarding Shares The land was owned by a company which he incorporated and he was the sole shareholder. It so happened that the forest caught fire. He claimed the damages from the insurance company, which refused to pay him. It was held by the court that he was not the owner of the trees but it was the company that owned them. Thus, he did not have an insurable interest in them. Consequently, the insurance company did not have to compensate him! Another interesting case is R v Philippou (1989 89 Cr App R 290) where the court held that a person who owns all the share of a company can still be convicted of stealing from the company! An Analysis of the Fatawa Regarding Shares Therefore, ownership of the company’s assets is important to be discussed because Islamic finance emerged as it aims at developing asset-backed transactions in order to eliminate the issue of rib. This is what makes the difference between conventional financing and Islamic financing. According to British law a share does not entitle a shareholder a right in the assets of the company, but to own a bundle of rights. Hence, a sale of shares is under no circumstance, under present law, an asset-backed transaction per se, but represents the sale of an intangible asset. Legally this means that if one claims that a shareholder owns the assets of a company, then he will be entitled to a real right; and if he claims a bundle of rights then he has a personal right. In other words he cannot make a real claim against a company. An Analysis of the Fatawa Regarding Shares What does this mean in law? A person’s ’ claim to an asset may be by virtue of either real right in it or a personal right to it. He has a real right where title to an interest in assets, whether absolute or limited, is vested in him. Thus, the owner of goods (in the sense of the one having the best title to them) has a real right in them, as does a mortgage, a charge, a person holding a defensible possessory title and a person in possession by way of bailment or pledge (Goode, 1982:69). An Analysis of the Fatawa Regarding Shares But claim to an asset can also be made by one who has no existing real right, merely a personal right to have the assets delivered or otherwise transferred to him. Such a person has a mere jus in personam ad rem (a right to a thing ) or more shortly, a jus ad rem, as opposed to a jus in rem (right against a thing). In a nutshell, in a real right one has a right against the commodity itself, while in a personal right it is against a person. The share registered in a registered company remains personal property regardless of the kind of property owned by a company. So, even if the company’s ’ only asset is real property, the shares will still be considered as personal property (Goulding, 1982:163). Section 182 of the companies Act 1985 confirms this by stating that the shares or other interests of any member in a company are personal estate and are not in the nature of real estate. So definitely this situation does not reflect an asset-backed scenario! An Analysis of the Fatawa Regarding Shares It seems that this is not the way the nature of shares is reflected in most fatwa. Some Muslim scholars have taken the view that shares are mainly for the purpose of creating a jointstock company which is a partnership (shir kat almus hamah) (Zuhayli, 2003:529), while others have considered it as a murabah; where the directors are considered as mudarib (Muj hidul Islam, 2000:101). The main stream Muslim scholars have considered shares as a contribution towards an asset in the view of sharing the profit like in a partnership or mudarabah. This was the case with the concept of Joint Stock Company in the initial stage (Millon, 1990:216). An Analysis of the Fatawa Regarding Shares Thus, share was representing a pro rata ownership in the assets of the company. But now the court no more adopt this stance as discussed earlier. However, modern scholars have realized that shares are also a property but not a property discussed in the previous books of fiqh. Hence, they have tried to elaborate on the nature of shares on three levels Preliminary Arguments to Explain the Nature of Shares There are three issues raised by scholars to determine the permissibility or non-permissibility of shares: ma’l, bay and milkiyyah. First, whether it is ma’l (property). Briefly stated, the scholars have described ma’l into three categories. The first category consists of those things which are well defined in shari’ah such as gold. The second category consists of those things that the scholars have moved towards the lexicography (lughah) to find a meaning. In the Arabic language the word ma’l is derived from two root words: one consists of the three alphabets mim yaa ”“ ” and lam “ ” which gives the meaning of everything towards which mans ’ heart inclines. The second is the root ’mim’ “ ” ‘waw’ and ‘lam’ “ ” which gives the meaning of a thing which has value. The third category is defined according to ‘ urf (custom). This method is adopted when something is not known in shari’ah, and that the lughah also is not clear about it (Mujahidul Islam, (1990:71). Preliminary Arguments to Explain the Nature of Shares Muslim scholars have divided the mal or ayan ‘ (property) into three classes: 1. first, those assets from which man derives benefit from the assets themselves, i.e. They are tangible assets. 2. The second are those assets that exist in the form of an intangible benefit only. They do not exist on their own but are connected to a tangible asset. For example a lease is a benefit that one enjoys through a tangible asset. 3. The third class consists of those assets that exist in the form of rights. Theseexist in two subclasses: those that are linked to an asset, for example right of crossing over a land ( aq al-Murur); and those that are not linked to the asset. Forexample, the right to be nurtured ( haq al-Hadanah). From Islamic Jurisprudence it can be gauged that Preliminary Arguments to Explain the Nature of Shares The scholars have no problem with the first two classes. But, regarding the third class, differences of opinion prevail. It is argued that a person cannot sell the right to be nurtured or a woman cannot sell her right of khula’ (i.e. To claim her divorce from the husband by offering him compensation). The main advocates that this type of rights is not mal proper are the Ahnaf. They claim that this is mal almujarradah, hence they are not subject to sale. In the Maliki school of law it would seem that from the subsidiary rulings (furui’ masail) there can be a chance that they are saleable. Regarding the Shawafi and Hanabila there is no restriction on the sale such rights. Preliminary Arguments to Explain the Nature of Shares This classification of mal, became important because of the concept of bay (sale) in Islam. So, this is the second issue that the Jurists have discussed before pronouncing on shares. The definition of sale is given as the exchange of mal for a l (tabadal al-mal bi al-mal) in Islamic law. Therefore for something to be a mal it must have three essentials. First it must be permissible in shari’ah, secondly there is benefit out of its use. Third is that the customs accept it as mal for their dealings. Preliminary Arguments to Explain the Nature of Shares The third issue raised is what consists of milkiyyah (ownership). Some scholars in the past have stipulated that there should be qabdhah (take possession for the article sold) for the transfer ownership in the goods to take place. Others have argued that urf plays a role here as well. All these questions were answered in the light that shares are special types of mal (property) and that the bay (sale) of it can be compared to intangible commodity and that milkiyyah (ownership) will pass over according to the rule and procedure of the stock exchange. However, they did not discuss the issue of personal rights involved in it and whether it is really asset backed. The pertinent question is whether a shareholder can sell this personal right vested in the bundle of rights he is entitled to, on an open market. Here again there are differences of opinion among Muslim scholars. Some say it is permissible while others negate the permissibility on the basis that it is huquq al-mujarradah. Preliminary Arguments to Explain the Nature of Shares This discussion should be analysed in the light of British law because it is the pioneer in this modern world. In law, sale of personal rights falls within the ambit of voluntary assignment of contractual rights and liabilities (Furmston, 2001:156). In other words its owner can expressly assign the right created by a contract to a third party. In our case the contractual relation between a company and a shareholder gives Preliminary Arguments to Explain the Nature of Shares Can one sell this right on the Stock Exchange market; put differently can an assignee bring an action on his own initiative against a recalcitrant debtor? Does an assignment bind the debtor as well as the assignors? This topic is generally described as the assignment of “chose in action.” “Chose in action” is a known legal expression used to describe all personal rights of property which can only be claimed or enforced by action, and not taking physical possession (Furmston, 2001:521). It is a term that comprises a large number of proprietary rights, such as debt, negotiable instruments and includes shares! Many of these have been made assignable by statute. Shares are one of them. It is sold online as an intangible asset. Preliminary Arguments to Explain the Nature of Shares Though in law one can assign this right, but in shari’ah there is difference of opinion. Uthmani (1999b:160) has attempted to do a classification of the concept of rights in Islamic commercial law and has elaborated on this issue by trying to develop some fatawa on the question of personal rights in assets. It is here that the Ahnaf have difference of opinion. According to them this will tantamount to huquq almujarradah and most unlikely can be subjected to sale. However, Uthmani has argued this differently. He tried to prove that there are exceptions regarding huquq almujarradah in the ahnaf fiqh. But other great scholars such as Mufti Mehmood Hassan Gangohi, have rejected the sale of shares on this basis that one cannot sell the huquq al-mujarradah. Preliminary Arguments to Explain the Nature of Shares The problem is, if one says that he can sell his personal right on the stock exchange, then can one sell his other benefits as well? On the basis of the chose “ in action” and voluntary assignment one should be able to do so as discussed earlier. Then, logically this will imply that an employee, as a stakeholder in the company, can also develop a secondary market for selling his right for a bonus pay! Yet, this analogical deduction will not meet approval of scholars! This is a debatable issue that will lead to gharar and riba. This is important to consider because the employees also are stakeholders in the company. In fact their claim is above that of the shareholders in the case of insolvency! Therefore practically, the issue of huquq almujarradah does hold some weight, at least from aahnaf point of view. Preliminary Arguments to Explain the Nature of Shares Another point to consider regarding bay ’ of huquq almujarradah is that it involves the sale of something unidentifiable. Hence, there is an element of speculation involved because as it stands there is a lack of information on shares certificates. The share is supposed to disseminate information on the company. The urf on the market is that people do not know what really is happening in the company. It is just a reliance on the share indices. Therefore due to this lack of information there is an element of gharar that should be taken into account. This information asymmetry can also implicate ghaban. Preliminary Arguments to Explain the Nature of Shares The next issue that needs to be elaborated upon is whether sale of shares is asset-backed? British law however, does consider share as a property of a sui generis nature. But the sale of such property is still ambiguous when one ponders on its asset backed aspect. There is no solid proof that it is asset backed in the light of section 182 of the Companies Act 1985 as mentioned previously. However, it can be argued that section 107 of the Insolvency Act 1986 provides: Subject “ to the provisions of this Act as to preferential payments, the company’s ’ property in a voluntary winding up shall on the winding up be applied in satisfaction of the companys ’ liability pari-passu and subject to that application, shall (unless the articles otherwise provide) be distributed among the members according to their rights and interests in the company.” Prima facie this provision seems to make a share asset-backed. But one has to look at reality and not only at the words of the law. This is because law is a dynamic subject prone to changes according to the demand of the market forces. In reality only about 1% of companies in England and Wales go in compulsory liquidation due to insolvency and not voluntary insolvency. Preliminary Arguments to Explain the Nature of Shares Thus, there is nothing left for the shareholders as residual assets! Also in the winding up process the ordinary shareholders are entitled to the entire surplus of assets remaining only after payment of the liabilities of the company including any payment to employees who is a stakeholder in the company just as a shareholder, under the Insolvency Act 1986, s.187 and after the return of the capital of all classes of shares, unless preference shares are given the right to participate in the distribution of those surplus assets (Morse, 2002: 6.02). Therefore it is just an expectation in realty. The Islamic view on the issue of liquidation can be ramified in two legal maxims: AlNadir Mulhiqun bi al-Adam, ‘ something remote is equated to non-existence. The second one is Al-Ibrah ‘ li al-Ghalib al-Shai la li al-Nadir, consideration is taken of the well spread majority and not of the rare (elements) (Zarqa, 2001: 236). Hence when one considers the reality of liquidation of listed companies there is not strong proof for claiming that sale of shares is asset-backed from an Islamic point of view. It can be argued still that in case of voluntary liquidation there may be an asset. But as the statistics are proving it, this too is very little in percentage to give a fatawa. Also most listed companies do not go for voluntary liquidation. Preliminary Arguments to Explain the Nature of Shares Another issue that needs further discussion is that in the process of liquidation of companies; assets are usually sold and if anything is left in the form of cash, then it is the cash that is handed over to the insolvent and not the assets per se. It can be argued that from the shareholders’ ’ point of view that this is similar to doing transaction with a bank that works your capital by investing it and give you money at the end. Preliminary Arguments to Explain the Nature of Shares From the above facts the question is, can one advocate the permissibility of sale of shares on the basis that it is asset-backed, and which is mere expectation of shareholders should there be a liquidation? It is submitted that this matter should be reconsidered as there may be an element of riba involved in that! Another point to consider regarding the sale of shares is that if a company is sold as a going “ concern,” however, then the shareholders are not entitled to this residual value, nor to control of its disposition, even after all other legal obligations have been met (Warthington, 2001:313). This raises the issue of milkiyyah over the issue of the assets. This is another area that the Muslim Jurists have not touched upon. It can be argued that the shareholders have a hope that the sale will be to their benefit. But this is not a concrete argument to prove that a share is asset backed. Then employees as well can have the same expectation as discussed earlier! Preliminary Arguments to Explain the Nature of Shares In fact in the case of Short v Treasury (1948, 1 KB 116 LA), the court refused to value the share of Short Bros as “ between a willing buyer and a willing seller.” They were valued on the basis of the quoted share price, but the shareholders argued that, since all the shares were being whole undertaking should be valued and the price thus determined apportioned among the shareholders, or the value should be the price which one buyer would give for the whole block, which should then be similarly apportioned. This case proves that a shareholders expectation is not in his hands (Davies, 2003:617). Preliminary Arguments to Explain the Nature of Shares From the above discussions one can gauge that the sale of shares is approved by all school of laws. Each one can have their own proofs. However, it can be seen that the shari’ah scholars have not revisited their fatawa. The law is clear that shareholders are not owners of assets, it is mere expectation that they will have something upon liquidation if the articles of association stipulates it and that there is some gharar involved in the sale of shares (Hassan, 2000). The objective of this discourse analysis is to show that the matter of sale of shares is not final and that the shari’ah scholars will have to give a second thought as to what a share really is? Preliminary Arguments to Explain the Nature of Shares If it is not asset-backed from a legal and practical point of view then there may be riba involved in such a transaction. However, in the light of the Shawafi, Hambali and Maliki School of jurisprudence there seem to be a leeway for the sale of shares if the necessary conditions to prove assetbacked transaction are met and developed. But from the Ahnaf point of view, there seems to be some cloud over this issue. But again ‘ urf as a source of law should be considered, given the importance of the stock exchange markets. Another point to consider is that on an accounting point of view shares are considered as an asset for shareholders. Hence, this also should be used when reconsidering the nature of share and its sale on the stock exchange. Preliminary Arguments to Explain the Nature of Shares Based on the assumption that sale of shares is asset-backed and that share is a mal, the shari’ah scholars have developed specific criteria to allow the sale of shares on the stock exchange. An analysis of those criteria will be made and some suggestions will be made to improve upon these criteria. Criteria for Creating an Islamic Share Index As discussed above one of the main features of Islamic finance is to develop asset-backed financial products. This golden thread should be reflected in the sale of shares as well. To this end shari’ah scholars have established some criteria that pave the way for such a transaction to be shari’ah compliant. However, these criteria need to be assessed as the earliest ones have undergone changes already; and scholars are still discussing as to how to improve this grey area due to its embryonic stages. One of the earliest criteria formulated were done for the Dow Jones Islamic Market Index in 1999.which is fairly recent. The FTSE Islamic Index followed thereafter in 2000. The purpose of Islamising the indexes is to enable the 1.2 billion Muslims to explore other avenues of halal income. Hence one would expect the FTSE Islamic Index (used on the London Stock Exchange) to be a low-debt, non-financial social ethical index in the broad sense. Criteria for Creating an Islamic Share Index ( Halal Business Area) To become eligible for inclusion in the FTSE a company should undergo three screening filters: The Qur’ nic rationale for this criterion is that one should not help towards sinning. However, it has been argued that Imam Abu Hanifas ’ view is that if the deal is with non-Muslim, e.g. In a state where most companies are owned by nonMuslim, then with a strong abomination it would be permissible to invest in such companies. However, in Sahibains ’ view this is not right and the fatawa is on their opinion. (Mujahidul Islam, 2000:102). Criteria for Creating an Islamic Share Index ( Halal Business Area) It is stated in fatawa Hindiyyah (vol. 4, p. 333) that if a Muslim enters a contract of murabah with a Christian and the latter makes some profits by means of alcohol or swine, then Abu Hanifas ’ view is that, it is appropriate for the Muslims to give that ratio of profit in sadaqah. However, this is in the case when he did not know of the transaction beforehand. From this discussion it can be argued that in modern context where the western world is leading the investment market, one has to consider the extent of investment to be done with them. Islam has not really forbid partnership or joint ventures with non-Muslims except under certain circumstances which are mainly ethical. Criteria for Creating an Islamic Share Index (A Company Must Meet Specific Financial Constraint) Once a company with acceptable primary business activities has been eliminated from the universe, the remaining stocks are tested according to three filters: First, exclude companies if Total Debt divided by Trailing 12-month Average Market Capitalisation is greater than or equal to 33%. (Note that Total Debt= Short term debt + Current portion of long term debt + Long term debt.). In simpler language the debt equity ratio must not exceed 33% (Yaqubi, 2000). The rationale behind this criterion is that many joint stock companies sometimes resort to leverage at a certain interest for expanding their business activities or to meet their emergency cash requirements and this means paying interest to lending parties. Although the dividend of these companies do not include explicit interest payments (because in this case they are paying interest), nevertheless, this does not mean that they are not dealing in unlawful activities, i.e. In this case usury-based loans. Criteria for Creating an Islamic Share Index (A Company Must Meet Specific Financial Constraint) Hence, the debt ratio to the shareholders equity should be as low as possible. However from an accounting point of view this criterion is wrongly formulated because debt does not necessary mean loans, it includes other liabilities such as creditors’ items in the balance sheet. This does not always involve interest and most manufacturing companies will have a high percentage of purchase on credit reflected in the balance sheet. This is not reflected in this ratio. May be in practice, only the interest bearing loans are taken into account. However, it is suggested that a new formula be devised for the purpose of these criteria, or else many companies can be excluded from the listing in FTSE Islamic Index (or other Islamic indices for that purpose). Criteria for Creating an Islamic Share Index (A Company Must Meet Specific Financial Constraint) A possible solution could be to devise loan equity ratio because the purpose is to limit interest in the dealings while the equity ratio is a leverage ratio to calculate the extent to which a firm relies on debt. Other things being equal, a higher leverage ratio indicates a riskier firm, because the debt payments are fixed even if the earnings of the firm fluctuate. As a result, should the cash flow diminish excessively, the firm might miss its debt payments deadline, putting it in technical default, and at times interest is charged. However, this is of a less concern to us as compared to the interest on loans per se. Criteria for Creating an Islamic Share Index (A Company Must Meet Specific Financial Constraint) Another important point to keep in mind is that the percentage of 33% is arbitrary, some scholars have used 30%, and others have used 33%. This is deduced from a shari’ah principle a third is much. This principle is used to determine the minimum and maximum limits. Scholars have been accustomed to rule in many issues, that what is less that one third is the criteria of a small percentage. This inference is analogous to what is reported from the Prophet (s) as saying one “ third and one third is too much.” However this dictum was an advice given to Sahabi who wanted to bequeath his whole estate and leaving nothing for his children. The Prophet (s) wanted to bring him from the maximum to the minimum level in the process. On the other hand, in the case of the debt equity ratio, the objective is to find a maximum that can be allowed. Hence, from a qiyas point of view it can be argued that the criteria of 33% can still be debated. Criteria for Creating an Islamic Share Index (A Company Must Meet Specific Financial Constraint) Another issue that needs our attention is that the valuation and definition of shareholders’ equities is multifaceted. Different companies have different ways to computerise these equities, e.g. some look at the market value of stocks or paid up capital or the net asset values on total assets. Each company has its own criteria. And different countries may have different standard accounting principles or nomenclatures for tax or legal reasons. Hence, it is submitted that the shari’ah scholars must try to standardize this issue to bring in more certainty. The second financial constraint is to exclude companies if the sum of cash and interest bearing securities divided by trailing 12month Average Market Capitalisation is greater than or equal to 33%. Other scholars have expressed exclusion on the basis of debt and cash money forming 50% of the existing assets. This criterion is not mentioned for the FTSE Global Islamic Index. Criteria for Creating an Islamic Share Index (A Company Must Meet Specific Financial Constraint Islamically a debt cannot be sold to a third party, neither sale of cash for cash (of same denomination) (Uthmani, 1999a:38). Therefore contemporary scholars stipulate that equities of companies, the business activities of which are lawful may be traded if total cash and debts in their balance sheets do not exceed the total value of other assets, that is, real assets, and not debts and cash, should constitute the majority of their assets. In other words there must be some illiquid assets so that the sale of shares is asset-backed in order to avoid rib (Hakim,2002:4). Or else sale of assets should be at par value, which is virtually impossible to calculate exactly. However, due to the globalisation (Chorafas,1992:22) effect on the stock exchange these need to be revisited. The multi listing of companies raise the issue of currency and also it has been argued that sale of debt can be allowed by some academics (Kamali, 2002:348). Seeing the importance of the stock exchange it is submitted that this criteria demands a revisit. Criteria for Creating an Islamic Share Index (A Company Must Meet Specific Financial Constraint The rationale for this criterion is the legal maxim the “ majority deserves to be treated as the whole of things.” Besides the 33% or 50% ratio, there is also a third view based on the ahnaf school is that whenever assets are combinations of liquid and illiquid assets, dealings can be negotiable irrespective of the proportion of the liquid ratio. However, this principle is subject to two conditions: Firstly the illiquid part of the combination must not be in an ignorable quantity. It means that it should be in a considerable proportion. The proportion needs to be determined, and above than 50% has been stipulated, due to the maxim elaborated earlier. Secondly, the price of the combination should be more than the value of the liquid amount contained therein. Or else this type of transaction falls within the purview of riba and it is disallowed. This is in line with what was discussed above, that is Islamic finance is asset-backed. This aspect seems to be more elaborate, but according to the shawafi this cannot be done (Uthmani, 2003:209) Criteria for Creating an Islamic Share Index (A Company Must Meet Specific Financial Constraint The third financial constraints is that interest (or unlawful gains), should represent less than 5% of total revenue. This criterion has been and is still a bone of contention among Muslim scholars. This criterion as well has not been used by the FTSE Global Islamic Index. It is still a rod in the wheel because as expressed in a hadith that a time will come when interest will be so rife that nobody will be left but as eater so interest even one does eat interest its dust will reach his nostrils. Thus, under modern commercial norms virtually all listed companies are directly involved in interest either by way of deposits or loans. Thus Muslim scholars have struggled with this condition. Nizam Yaqubi has dealt with the differences of opinion of Muslim Scholars of the Arab world. In summary his research reveals that their discussion rotates around four legal maxims: a. What is independently impermissible is permissible when done together with the permissible acts. b. The general need takes the rule of the specific necessity. c. Mixture of negligible unlawful part with major lawful part is allowed. d. What is inescapable is tolerable. In the light of the above juristic principles, which have been used by different scholars to derive contradictory results, it would seem that there is still room to debate the issue of interest involved in dealings of shares. However, the main stream scholars and the fiqh academies have moved in the direction of allowing sale of shares subject to the criteria under discussion. Submission of Accounts Another criterion developed is the submission of accounts. Hence, the shari’ ah scholars sitting on the shari’ah board of firms developing Islamic index have made a condition that the audit report and accounts of the listed companies should be submitted to them at regular interval. It is submitted that even the accounts recording of subsidiary companies of the listed companies as well should be reviewed by the scholars because often the accounting system does not reveal all transactions of the subsidiaries which may be in line with the ratios. The holding company does have more than 50% in these companies thus they are liable. They cannot claim their irresponsibility at the AGM as shareholders do have a responsibility to voice out anything un-Islamic in the AGM. The Articles of Association Should Provide for the Shareholders to Have Residual Assets The Insolvency Act 1986 does provide that the share holders will be entitled to residual assets only if the articles of association provide for it. It is submitted that this should be a criterion, as well as a safety valve, despite most listed companies will have this provision in their articles of association. Hence, this should be a condition in accepting companies on Islamic index to consolidate the asset-backed aspect. Disclosure of Nature of Share Transactions by Shari’ah Audit Generally speaking people accept assumption made in the 1960s ’ or 1970s ’ in many disciplines without taking into account the changes that may have taken place. In other words they depend on accepted ‘ urf. But this is acceptable Islamically when ‘ urf is strong; but if ‘ urf is not strong as is the case with legal dynamism, when the law of court applies, then, it is imperative to convert the ‘ urf into a shari’ah (condition). This must be made explicit in the dealing of shares. People must be informed of the contract they are entering into. Therefore to improve on the filtering criteria, the shari’ah audits of international equity fund should inform the buyers of shares that their ownership is confined to a bundle of rights and not necessarily to the assets of the company. This will make the deal more efficient at the level of gharar due to a decrease in the information asymmetry. This was a brief analysis to show that there is still improvement warranted in the filtering “ ” criteria Conclusion This lecture is an attempt to demonstrate that shares are just entitlements to a bundle of rights, which means that they represent only personal rights and not real rights. Consequently dealings with shares of listed companies are not asset-backed. This may lead to problems of rib and gharar. Even the filtering criteria to purchase shares demand further improvement as suggested. Given the volatility of the stock exchange market, it would be more appropriate to establish Islamic Securities House to monitor and advise investment on such a market. Islamic indexes are not enough, there are many other issues that need to be taken into account besides shares – regulations, fiqh issues, investment appraisal, monitoring of indexes. Conclusion Islamic finance is still in its infancy as compared to conventional finance. However, the stock exchange market is a magnet that pulls all types financial institutions either to invest their liquidity or to raise funds. Hence, extra care should be taken when dealing with such markets. Law can change any time but some Islamic principles are immutable. This dichotomy of secular and Islamic legal system needs further debate as there is more dependence of Islamic finance over secular law. This is an arena that needs further attention. If secular law is accepted as ‘ urf (customs), then there must be a shar (condition), to make it a strong ‘ urf due to the dynamism in the commercial world. In concluding, it should be pointed out that the filters “ ” used in Islamic finance for shares are designed to remove companies with high debt, therefore, by definition there should be lower risk inability to pay in a wind up. It is vital that statistics compare like-with-like to establish a sensible analysis. Hence, this is an area which the shari’ah scholars can consolidate if they want to rely on the liquidation aspect to substantiate the asset-backed position of shares. Thank you THE END