The capital markets in most of the emerging financial markets are undertaking regulatory reforms with a view to making capital markets more attractive for domestic and foreign investments. Islamic financial institutions are taking serious initiatives to, among others; ensure higher transparency and accountability within the financial markets, particularly regarding publicly traded companies. For that reason, good corporate governance is essential ingredients for the development of a vibrant and sound Islamic finance industry.
The concept of corporate governance was proposed as a result of increasing awareness on the importance of the need to protect the rights of all stakeholders, including minority
shareholders. Whilst the term corporate governance is relatively new, the concept is essentially not strange to Islam.
The term ‘corporate governance’ has gained importance only in the last two decades. Although there are a large number of documents and works about this subject, its effects have not yet been fully spelled out.
Corporate governance has been defined in many ways;
The Organization for Economic Cooperation and Development (OECD) defines corporate governance as “set of relationships between a company’s management, its board, its shareholders and other stakeholders”.
The UK Combined Code‘s definition is “Corporate governance is the system by which
Companies are directed and controlled. ”.
Regardless of the various definitions, corporate governance has mainly to do with “transparency”, “accountability” and “fairness”.
Good Corporate Governance:
Good corporate governance is more than a good idea. It encourages flow of investments, lowers the cost of capital, and supports strong capital markets. Corporate governance represents structures and processes that entail individuals carrying out business whilst exercising professional discretion in a way that exhibits integrity, judgment, and transparency. These principles are essential to Shari’a and Islamic finance.
The OECD Principles of Corporate Governance focus on:
Accountability: Ensure that management is accountable to the Board and the Board is accountable to shareholders;
Fairness: Protect shareholders’ rights; treat all shareholders - including minorities – equitably and provide for effective redress for violations;
Transparency: Ensure timely and accurate disclosure on all material matters, i. e. the financial situation, performance and ownership;
Responsibility: Recognize the legal rights of stakeholders.
Teachings of Shari’a bind fairness and honesty to the main principles of any conduct including transactions. We may strongly argue that good corporate governance is consistent with Shari’a-compliant financial conduct which prohibits fraud, embezzlement, misstatement and other patterns of dealings that cause abuse, injustice and gharar (risk, uncertainty, and hazard).
Is Islamic Corporate Governance Model Different?
The question remains: How corporate governance of an Islamic financial institution is different from a conventional counterpart? The Islamic model of corporate governance would first look at the transactional structure to see whether the transaction involves elements that invalidate the gains or profits. The conventional governance practices do not perform a similar function (except for the related party, self-dealing etc. transactions). On the other hand, it ensures that the transactions do not contravene the corporate code of business ethics and cross the line that the law has drawn.
Since Shari’a represents a major source of legislation in most of the Muslim countries, it plays an important role in the legislative and regulatory development in such countries. It is not unlikely that some Muslim countries would rely on Shari’a for possible future implementation of corporate governance, whether in the form of any code or regulations. For example, Shari’a provides the proper platform for codifying the fiduciary duties and related ethical practices. These practices are the foundation of principles of good corporate governance as outlined in OECD Principles of Corporate Governance. Basically we strongly may conclude that modern corporate governance practices are consistent with Shari’a.
The OECD Corporate Governance Principles emphasize more disclosures and rights to shareholders. Capital markets ensure strong enforcement of such rights. Hence, protection of minority interest is considered crucial for stronger capital markets. For that reason legal protections to the minority shareholders and their strong enforcement promote the local and international investors to invest in the emerging markets.
Shari’a has mandated similar or higher importance to such issues for doing business. Like modern governance practices, the Islamic corporate governance modle requires application of modern and higher standards of minority protection against expropriation, more disclosures and transparency and effective accountability.
With this outlook and as Shari’a does not indicate any upper limit for better regulation, the contemporary drive for achieving higher standards in corporate governance do not appear to be conflicting with Shari’a. Consequently, the Islamic financial institutions would have no problem in meeting the modern corporate governance practices.
Who Are the Major Stakeholders In Islamic Financial Institutions?
There are a number of key players and stakeholders in Islamic Financial Institutions:
Shareholders: they would be interested in protecting the value of their equity in the financial institution and obtain a good rate of return.
Demand Depositors: they would be interested in guaranteeing the valued of their deposits and have ready access to their funds whenever they would like to do so.
Investment Depositors: Murabaha contract holders with Islamic banks through which they supply funds while banks would invest them properly. They would be interested in protection of principal and obtain a good rate of return.
Regulators: Having legal power to monitor the daily activities of Islamic financial institution, they would be interested in preventing systemic problems and crises, protection of quality of financial products and efficiency of the financial system.
Financial Market Authorities: They set minimum standards for transparency and disclosure and would be interested in having efficient financial market.
Islamic Finance Community: Would benefit from standardizing financial Islamic products, contracts and practices.
The public: would be interested in obtaining quality financial services at competitive prices.
In view of the above, in order to have a good corporate governance mode, the board of directors, management as well as the auditors of an Islamic financial institution should perform their professional duties with the objectives of satisfying the needs of the shareholders and Allah as well. Corporate governance aims to enhance accountability, transparency and trustworthy. These values are crucial in Islam.
The Shari’a Supervisory Board Role in Corporate Governance
Part of the internal governance structure of the Islamic financial institution and appointed by shareholders of the institution. Its main function is to review and ensure that all transactions, contracts, products and applications relating to the Islamic financial institution comply to Shari’a rules and principles with the specific fatwa, rulings and guidelines that have been issued
In order to establish a good corporate governance framework, the Shari’a Supervisory Board may have to extend their jurisdiction to cover governance issues of this nature.
According to The Islamic Financial Services Board (IFSB) “there is no “single model” of corporate governance that can work well in every country; each country or even each organization should develop its own model that can cater for its specific needs and objectives”.
From the standpoint of Islam, deeds are more significant than sheer words, slogans, rhetoric or lectures, as highlighted in one verse of the Quran: "Why do you say that which you do not do?”. Corporate governance should be practiced in the form of deeds and actions. Only when actions speak louder than words, can a good corporate culture come forward and protect the welfare of all stakeholders in today's corporate
About The Author
Hany Abou-El-Fotouh is Director Head of Policy & Corporate Affairs / Board Secretary, CI Capital Holding - the investment banking arm of Commercial International Bank which is the largest private bank in Egypt . He provides advice and direction to the Board and management with respect to corporate governance practices and formulates corporate policies.
Hany is a leading expert on money laundering and terrorist financing controls in the MENA region. Founder of the Middle East Compliance Officers’ Forum (MECOF), he has been honored for his work in promoting compliance culture and awareness in the MENA region
Hany writes articles to different newspapers and journals on a variety of subjects. He is a public speaker and professional trainer. Previously, he worked in various senior positions in leading banks in Egypt and GCC countries like HSBC, Oman International Bank, Banque Saudi Fransi among others
Hany is a certified member of the Association of Certified Anti-Money Laundering Specialists (ACAMS) and Certified Director by Egyptian Institute of Directors