Financial Accounting- Theories Of Corporate Governance -Islamic Financial Products - Report Writing Assessment Answer

Financial Accounting Assignment

Case Scenario

The global Islamic finance market is expected to reach USD 2.6 trillion by 2017 (PwC, 2013) and financial centres around the world want this business. Although Australia has a relatively small Muslim population (around 2%), we are seen as having high potential to expand into the area of Islamic finance (Maierbrugger, 2016). Islamic finance requires corporate governance that is grounded in the ethical and moral framework described by Sharia, and illegal or socially detrimental acts are prohibited (Abu-Tapanjeh, 2009). Following graduation, you have obtained work as an analyst for an Australian bank. The directors of the bank are considering expanding into Islamic financial products, and listened with interest as the chief economist of Citigroup recently suggested Australian banks could utilise principles of Islamic finance for the benefit of all Australians (Shapiro, 2016). To support their decision-making, the directors of the bank wish to understand the governance issues associated with issuing Islamic financial products, first at a theoretical level, and then in the Australian context. You have been asked to research and report as follows:

Assignment Task

In your report you will use academic literature, first to describe and explain the models and underlying theories of Corporate Governance; then to discuss and identify the place of Islamic corporate governance within these models, including the role of the Sharia committee. You will then critically evaluate whether financial services companies (including banks) operating under an Islamic corporate governance framework fit within the existing Australian corporate governance framework; and consider more specifically, whether Islamic financial products are compatible with the Australian business environment. Finally, based upon your analysis, you will advise the directors of the bank whether the principles of Islamic corporate governance and/or the issuance of Islamic financial products seem incompatible with the Australian business environment, or may be accommodated with minor legislative changes.

Introduction

The Purpose of the report is to highlight the importance of Islamic corporate governance and the role of the Sharia committee in the Australian context and critically evaluate and analyse the Islamic corporate governance and financial products in Australia so as to recommend their compatibility with the conventional business environment or otherwise. The report follows a theoretical review of the governance models and attempts to find the place of Islamic governance within this framework.

The significance of the research is to provide a valuable insight into the working of the Islamic governance in Australia as it is believed that no research has been carried out so far in this context. The research will be academic in nature relying on available literature in this regard; obtained through primary and secondary research and the findings will be limited to Australia.

2. Literature review

2.1. Corporate governance models

As the corporate environment and structure is varying with the complex globalization trends, three important models of corporate governance have found place. These are: The Anglo-Saxon model, the continental model and the Japanese model.

While the Anglo-Saxon model is bent towards the stock market, the other two models model the banking and credit markets. To be noted that the Japanese model is identified as inflexible and concentrated, while the Anglo-Saxon model is regarded comparatively flexible.

The Anglo-Saxon Model

The Anglo-Saxon model finds origin in the independent business societies of Great Britain and the United States. It regards the board of directorsand shareholders as ultimate controllers and places the other officers in the next lower level hierarchy ranking. Shareholders authorize the board which in turn issues instructions to the managers. Companies adopting this model tend to exercise legal controls over their shareholders' authority regarding the routine matters. The Capital structure is dispersed and the regulatory authorities like the Securities Exchange Commission tend to favour shareholders over the company management in case of conflicts(Ross, 2015)

The Continental Model

The "continental” model originated in Europe and is regarded as a blend of the fascist and Catholic philosophies. The model finds favour with companies in Germany and Italy. The company is regarded as a coordinating devise among various national interest groups. Banks play a very important role in terms of financing and decision making while creditors find utmost priority under the model. The structure of the company includes a board taking care of management and a supervisory council controlling the board. Government exercises a strong influence on the company under this model.

The Japanese Model

The Japanese model originates as an outlier of the above. The model recognizes two important legal relationships i.e. shareholders, customers, creditors and trade unions on one hand; and between the managers and shareholders on the other hand. The model symbolizes balanced joint responsibility and is based on the principle of "keiretsu," denoting loyalty between suppliers and customers. By implication, the model favours old business relationships over the newer ones. Regulators exercise a strong influence on the company under this model as they are normally the major stakeholders. The Central Banks and Ministry of Finance tend to control negotiations and Corporate relationships resulting in total lack of transparency. Shareholders do not find much preference under the system. (emerging markets, 2016)

2.2. Islamic corporate governance and the role of the Sharia committee

Islamic corporate governance is based on accountability, transparency and trustworthiness. These practices are linked to God as per the concept of ‘tawhid’ implying full submission to god’s will and no harm to others. The business is run with a spiritual backing.(Abu Karky, n.d.)The corporate governance is the prerogative of selected financial institutions abiding the Islamic law or Sharia. The Sharia rules govern the bank’s working as well as serve as a point of reference for the control and monitoring of all players in the system. So Sharia can be compared to a blueprint of laws to be followed, like elimination of riba or interest in all its forms, to ensure justice to all shareholders.

To ensure that proper compliance with these rulings, a Sharia committee or religious committee consisting of Sharia scholars and religious scholars is entrusted the responsibility. The committee discharges the role of supervision and consultation.(Kasri, n.d.)These Islamic banks ought to ensure abidance of the rules of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Service Board (IFSB). For risk mitigation, banks need to ensure sound corporate governance and risk management. The Sharia committee plays a crucial role in the circulation of finance and investment by applying Islamic law principles to finance and investment.

The members or Ulamas also ensure compliance with Sharia rulings by periodic review of the operations of the banks and financial institution and by query resolution for new products and processes introduced in the system. Where required the committee also plays an advisory role. The committee is forward looking in its approach and does not use religion to curb business. Regular dialogues with eminent economists are held to ensure conformity to market demand and outlook.(jstor, 2016)

The business is run on the concept of Amana (trust) implying discharge of duties by concerned responsibly and with trust on behalf of the shareholders so as to ensure good governance and ethical conduct. Where Agency problems arise due to conflict of interests between the agent i.e. management and the principal i.e. investor; reference to Sharia is made to foster investors’ confidence and establish a sound banking and financial system.("Governance Issues and Islamic Banking", 2016)

3. Discussion and analysis

3.1. Islamic corporate governance in Australia

Muslim population in Australia is about 2%, though Islamic finance shows promising future in the country. Islamic finance is strictly grounded on the Sharia. Banks in the country could use these principles for national benefit.

Islamic corporate governance has a broad outlook and cannot be used to segment roles and actions under the divine religion.("Corporate governance from the Islamic perspective: A comparative analysis with OECD principles", 2016)In the last decade, Islamic banking has grown globally at 10 to 20 %, and has moved into the conventional banking and financial systems of over 51 countries(Sole, 2007)

The model is based on Hisbah and stresses book keeping, proper disclosure, transparency of operations based on Sharia ethics which are very much a part of the conventional Australian banking already("Development in legal Issues of Corporate Governance in Islamic Finance: Journal of Economic and Administrative Sciences: Vol 25, No 1", 2016)

In order to reconcile the Sharia way of working with the with the Australian corporate governance model emphasis will have to be made to deal suitably with the variations between the two especially in regard to the treatment of interest, property and financial contractual rights so as to foster capital formation and strong markets. While the Conventional Corporate governance is expected to have a broad corporate responsibility, it is more or less confined to relationships between the suppliers and company or shareholders and management. Islamic corporate governance defines rules for conduct with suppliers, customers, competitor’s, employees based on spiritual and practical needs of the times which are ethical. However, one cannot rule out the challenges (Bhatti & Bhatti, 2010)

It was found in a study conducted in Saudi Arabia that companies committing to Islamic governance score higher on the voluntary disclosure index compared to conventional disclosure companies. (Grassa, 2015) Australia's constitution and a singular legal system make the adoption of Islamic governance challenging. In cases of conflict between the verdict of the Shariya and Australian governance, the Shariya law may cause unnecessary difficulty in running business and business may prefer law of the land. It will be important to preserve public order.(Abdala, 2012)

In particular issues like return on deposits, treatment of reserves and sovereign investments, a crystal clear understanding by the financial world of the Shariya Committee and Islamic governance, amendments to the legal system and tax systems may have to be dealt with. Most importantly, the establishment of Shariya Committee consisting of highly qualified scholars in Australia for the working of the system in legal, regulatory and supervisory regime poses a challenge. A strong framework and a judiciary system will take care of the compatibility issues.

3.2. Islamic financial products in Australia

Islamic banks sell products like Musharakah (partnership) and Mudarabah (profit-sharing) where risk is shared with the client and the bank is allowed monitoring, supervision and access rights to books and records. This gives rise to an ethical dilemma when faced with a conflict of interest between shareholders and partners. To be noted that the company affairs are conducted by the management in this setup. These are equity based financing products highly successful alternatives to venture capital and private equity financing with the added advantage to bind the partners in profit and risk sharing. In the Musharakah set-up, losses are shared in propotion to the investment while profits are shared in agreed proportions. Management of the enterprise by the parties is optional.

The Musharakah Mutaniqisa is a diminishing partnership shared equity rental used for housing finance which entitles the ownership on a unit basis; the customer and the financer being co- owners though the property is normally occupied by the owner. The monthly payments are divided into rent and acquisition cost. Conflict arises in case of third party sales as Islam believes that one transaction cannot form a basis for another. Separate transaction in this regard are held to be legally enforceable. However, the product is often criticized on these grounds.

Among the non-equity based products Murabaha (here profit on sale is known both to the buyer and the seller justifying the sale from the conventional sale, Ijara , Ijara Muntahia Bitamleek , Tayseer ijara or home finance and hire purchase or Ijara wa Iqtina are popular . Financing for unjustified purposes and overheads is banned. Justified purposes include purchase of motor vehicle and consumer goods.(Ahmad, 2010)

4. Conclusion and recommendation

The principles of Islamic corporate governance and Islamic financial products could be accommodated with minor legislative changes such that these changes are typical to the Australian business. This would not only increase the product and revenue base for the banks but would also inculcate ethical business in the country.

Islamic corporate governance is based on accountability, transparency and trustworthiness. It defines rules for conduct with suppliers, customers, competitor’s, employees based on spiritual and practical needs of the times which are ethical. A strong framework and a judiciary system will take care of the compatibility issues.