This article first appeared in Forum, The Edge Malaysia Weekly on September 19, 2022 - September 25, 2022
In my previous article, I argued that the time had come for a Third Way apart from the state versus market paradigm. This is a hybrid process whereby not-for-profit social enterprises actually undertake to solve both market and state failures.
Big business and banks have never been good at solving the needs of small businesses and borrowers. The bureaucracy’s welfare and business aid programmes are notoriously inefficient in helping small businesses and charities survive, let alone thrive. In the name of “the survival of the fittest” and “level playing fields”, small businesses and charities are often left on their own until the next crisis.
As social inequalities increase and climate warming/pandemic hurts the weak and poor unfairly, charities and corporate social responsibility (CSR) initiatives need to step up. Government budgets are strained by their huge sovereign debt overhang. Businesses and the rich often have the excuse that business uncertainties limit their ability to donate to charity or undertake more CSR projects. At the same time, the young feel that they must do their fair share on the environmental, social and governance (ESG) front.
The Third Way I recommended was the creation of a social equity exchange, in which non-profit social enterprises and charities would be able to raise capital and funding from the public (individual, corporate or foundation donors) who want to support the right social activities or charities that they trust. In my view, an Islamic stock market fulfils many of the social equity market objectives — because it rejects the debt dominated conventional financial market and adds social justice values (shariah) to the functions of finance.
As we all know, the distaste against usury has Judeo-Christian origins. But while Judaism and Christianity have turned a blind eye to usury, Islam remains strongly against the charging of interest on debt. Without getting into the religious interpretations, for which I am not qualified, the technical explanation of an interest-free market is an equity market in which risk is shared with all investors, instead of a debt- or bank-dominated market in which banks transfer their risks of default to the borrowers, via the need for collateral or guarantees. If you add the ethical elements to the equity market (no financing of activities that are harmful to society), plus the need for charity in the form of zakat, you have the basic framework of an Islamic finance market.
Most social enterprises, like all micro, small and medium enterprises (MSMEs), cannot compete in the free market arena because they often lack the essential combination of talent, funding and branding to succeed. As any private equity fund manager will tell you, just having good technology is necessary but insufficient to access public funding. You need the right combination of talent in the form of good marketing, fundraising skills, financial discipline, human resource management and project implementation and execution. Most tech start-ups need to be coached to even get to the start post of achieving unicorn status (US$1 billion valuation). Many do not make it.
Why is the branding necessary? Investors must have the trust that their funding will not be wasted through incompetence or fraud. Private equity/venture capital (PE/VC) funds are not just providers of funding — they fulfil an essential role of coaching — providing the know-how and organisational ability to take a concept (business idea) to actual fruition (delivery of profit and sustainability) in terms of an IPO (initial public offering).
PE/VC funds do this for profit, but there is no reason why the essential elements of their work cannot be applied to helping MSMEs in non-profit ventures. Banks provide funding, but have lost the art of coaching their borrowers to success. Investment bankers tend to stick to large firms.
Two months ago, the Securities and Exchange Board of India (SEBI) began consultations on the creation of a social stock exchange. This is an amazing pioneering effort that could start a Third Way market and a new path for emerging-market social enterprises.
Social stock exchanges and for-profit stock exchanges have common features, with the single exception of the latter being for profit-seeking enterprises. The infrastructure for both is theoretically almost identical. A stock market consists of an electronic bulletin board that discloses all the information about the companies, their shares under offer, prices traded and their history. Each transaction is matched, recorded, cleared and settled through a common share registration, clearing, settlement and payment system. The stock market is an ecosystem with buyers and sellers, intermediaries, regulators, standard-setters, service providers, infrastructure, and rules and regulations. A profit-oriented stock market works. There is no reason why its infrastructure cannot be shared for non-profit-making enterprises.
Indeed, other than the fact that social enterprises are not-for-profit, the buyers and sellers could be trading financial instruments just like common stocks or derivatives. Indeed, the instrument defined by SEBI is called Zero Coupon Zero Principal Instruments (ZCZPIs). Basically, you are buying or selling a product that gives no return and guarantees no principal.
Why would anyone want to hold such no-profit, no-return instruments?
Essentially, the social stock market (SSM) defines what a social enterprise (SE) is, and requires the SE to lodge an information document, like a prospectus, with the regulator and the stock exchange, that discloses the enterprise’s objectives, projects or programmes and how it intends to implement them. The SSM defines an eligible SE as one that has three years of revenue from eligible activities, with three years of record of delivery of its stated objectives. Such records would be verified by a “social auditor” or “social audit firm” that would include qualified self-regulatory organisations such as certified accounting firms.
In short, SEs listed on the SSM would show the world that they can deliver on their designated objectives, not in terms of profits, but in terms of impact. They will be rewarded for outcomes, which means they can raise more capital. If they don’t, they can be delisted, and those engaging in fraud punished as in normal stock markets.
This risk-taking seems fair to all concerned. But the proof of the pudding is in the eating. The concept of a social stock market fits the objectives of an Islamic finance/equity market. Throughout antiquity, Arab caravans were the first traders across deserts, facing huge risks. These were early venture capitalists in which trust and faith, as well as risk-sharing, formed the essential elements of Islamic finance.
Is it time for risk-taking in launching an Islamic social equity market in Malaysia?
Tan Sri Andrew Sheng writes on global issues that affect investors
Save by subscribing to us for your print and/or digital copy.
P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.