1        Introduction

Malaysia’s
exports for halal-certified products have increased over the last few years; it
increased from RM15.2 billion in 2010 to RM32.8 billion in 2013, approximately 4.6%
of total exports. It should be noted that in 2013, the number of halal-certified
companies by the Department of Islamic Development Malaysia (known as JAKIM)
reached 34% to 4,443 companies as compared to 3,316 in 2012. A large percentage
(75%) of the firm is Small and Medium Enterprises (SMEs), and 25% are
Multi-National Companies (MNCs).

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Since Malaysia
has potential to become a halal hub globally, it is important for halal
companies to be resilient and sustainable. It is therefore important to provide
an alternative to halal firms, mostly SME-sized to engage in Islamic
crowdfunding activities to gain access to Shariah-compliant funding but
dominated by financial technology (fintech). Fintech is a new technology and
innovation aimed to compete with traditional financial methods in the delivery
of financial services.

 

Realizing that
Malaysia aims to become a global halal hub, it is important that halal
compliance is comprehensive and integrate every aspect of the industry’s value
chain. Comprehensiveness refers to the compliance of all sectors to Shariah
principles and objectives, aims, visions and missions are driven by Islamic
values to achieve profit for the well-being of the community, families and
individuals.

 

While the halal
industry is growing rapidly, with continuous increasing demand of Muslim
populations worldwide, not all halal institutions or firms are financed
Islamically or in a proper Shariah compliant. Therefore, it is crucial for the
halal industry to certified halal not only from the production process and the
preparation of the products, but also by the means of financing. According to
Kavilash Chawla, the halal industry expert and managing director of Nur Global
Strategies, states: “Trying to provide halal
certified products without financing them through Islamic facilities
demonstrates a fundamental disconnect from a belief perspective.” He
continued to say, “If your products are produced using halal methodologies, processes and
resources, but your company is financed in a haram way, then technically one would assume that your output is haram”.

 

Since the halal
industry financing requirements are not being properly met, the industry may be
deemed not to function fully in Shariah compliance principles. Hence, there is
growing awareness that the long-term growth of the halal industry depends
largely on the development of complete Shariah-compliant principles through
Islamic financing.

In recent years, the concept
of crowdfunding has emerged as one of the alternative financing. Crowdfunding
became popular among start-ups or small-medium enterprises (SME) to enable them
to raise funds to start business operations. The advancement of technology in Internet
has successfully establish a of a crowdfunding platform. Crowdfunding is seen
to have potential to growth and will be able to provide more options for
business capital access.

 

2        Understanding the Concept of
Crowdfunding and Equity Crowdfunding

Crowdfunding is not a
new concept but is a new term used in financing to determine the type of
financing activity that gather funds consisting of small and medium-sized
contributions from the crowd of people (public) from different backgrounds, age
group, religions and races to participate in economic efforts which aims to
mutually finance each other based on specific needs by referring to certain criteria.
It is defined as a type of online activity involving individuals, institutions,
non-profit organizations, or companies proposing to groups of individuals of
varying knowledge, heterogeneity, and numbers, through flexible open calls to
the worldwide market through the Internet seeking for financial fund or
resources in the form of monetary contributions, sometimes in exchange for
future products, services, or rewards. The definition denote three important
elements in crowdfunding, which are technology, capital funding, and the power
of the crowd. These three crucial elements enable many small efforts to
accumulate into a huge financial outcome.

Technology is not only
a core element in crowdfunding exercises but also the backbone of it that
provides a platform for founders to expose their projects to a large number of
potential backers. This platform also facilitates communication between
founders and backers (both potential and actual) through its features such as
comment section, project update capabilities, and email exchanges. Founder is
an individual or a group of people with different knowledge and experience
seeking financial assistance to envision a product or project and then present
their ideas clearly and firmly to would-be backers, or to test market ideas, to
gain exposure for future financing, and to build relationships by fostering
open communication and collaboration with backers. In the meantime, backer’s
roles range from contributing money to market testing and giving judgment on
the ideas proposed by the founders and to consider whether a project is worth
pursuing.

In terms of its
operations, each crowdfunding campaign is set for a goal of a certain amount of
money and the fixed number of days, and often the most successful projects
receive about 25-40% of their revenue from first, second and third-degree
connections, which may consist of friends, family or acquaintances, while unrelated
investors start supporting campaigns they believe in when the project has
gained some traction.

 

Based on the above, the
essence and substance of crowdfunding could be summarized as follows:

1.     Purpose:
Funding a project or venture or capitalize enterprise;

2.     Small
contributions of money,

3.     Large
number of people or large number of individuals; and

4.     Through
Internet or web based platform or online.

 

In Islamic crowdfunding
there are four parties, namely:

1. Entrepreneurs
(issuer) who can seek funding through the ECF platform.

2. Investors (donors) who
provide capital either in terms of debt or debt.

3. Electronic platform
(operator) that marketing the project.

4. Board of Sharia (BS)

 

There are four
categories of crowdfunding platform (CFP):

i.       Equity-based
crowdfunding

Allow funders to receive compensation in the form of
equity-based or revenue or profit-sharing arrangements. This structure
triggered regulatory issues as it could potentially offer complexity in its
exercise. Basically, it is a avenue for investors to participate in equity.
Investors will enjoy return on investment made based on the terms specified in
the campaign.

ii.      Crowdfunding
based on lending

The funders receive fixed periodic income and expect the
original principal repayment.

iii.    Crowdfunding
based on donations

When the funders make a donation without any expectation to
gain anything.

iv.    Crowdfunding
based on rewards

Where
the funders fund a project for non-financial rewards.

Therefore, crowdfunding
can be a veritable tool for halal financing when Islamic financial principles
are used appropriately in structuring crowdsourcing ecosystems. However, for
discussion purposes of this assignment, only equity based crowdfunding (ECF) is
relevant.

 

3        Financing Challenges of Small and Medium
Sized Halal Firms

It is important to
examine the current financing challenges of SME halal firms in Malaysia. One of
the most challenging situations faced by start-ups or potential and current
SMEs is financing. In general, SMEs in Malaysia have the diversity of financial
landscapes where they receive financial assistance. The primary source of
funding for SMEs is financial institutions, and generally include both
financial institutions established under the Financial Services Act 2013 (Act
758) and the Islamic Financial Services Act 2013 (Act 759), and development
financial institutions (DFIs) established under the Development Financial
Institutions Act 2002 (Act 618). The Government and Bank Negara Malaysia also
provide a number of funds and schemes in which SMEs can access required
financing. Figure 1 below
illustrates an overview financial landscape for SMEs in Malaysia.

 

               Figure 1: Financial Landscape
for SMEs in Malaysia

          Source: National SME Development Council, 2014,
p. 84.

While
the above resources show a robust landscape for SMEs financing,
Shariah-compliant SMEs that are the main drivers for the halal industry face
financing challenges as they are excluded from the most common financing
opportunities which are polluted with elements of interest prohibited in
Islamic commercial law. In fact, an additional factor that exacerbates this
situation is the fact that Islamic banks operating in most jurisdictions around
the world are not lending institutions compared to their conventional
counterparts. Hence, they are not primarily established to provide financing
facilities through lending to customers but they are involved in structured
Shariah-compliant transactions that facilitate financial intermediation. Hence,
Halal SMEs are left with scanty funds raised from family and friends, as they
are not considered as a priority in the business of modern Islamic banks.

 

Challenges
of Halal SME Firms

From
the perspective of Halal SMEs surveyed, it is clear that financing is a major
challenge still facing by SMEs in improving their productivity and
competitiveness in local and regional halal markets. Procedures for obtaining
financing from banks are complicated and it is difficult to meet the
requirements of procedures set by banks. This contributes to other sources of
financing or reliance on scanty sources that will affect its performance,
productivity and expansion plans. In addition, irregular business flows and
decrease in sales are also considered as the challenges faced by some of the
Halal SMEs. This might be due to lack of diversity and product differentiation.
There are various Halal products and services that can be offered by any of the
SME firms instead of duplicating or replicating what other established firms
offered.

Apart
from competition from other Halal firms, it is difficult for Islamic SME to compete
with non-Muslim SME firms operating in the country, mostly owned by Chinese who
are more expert in marketing and productivity. Despite the halal product
production, it appears that Chinese firms dominate the market and Muslim-owned
SME firms cannot meet the level of sophistication of marketing strategies
adopted by their counterparts. This scenario significantly affected their
productivity and profits, and has negatively affected their ability to redeem
their loans.

Some Halal SMEs are
facing the challenge of expanding their business. They unable to extend their
tentacles to new business boundaries or even compete with other Halal entities
within the ASEAN region due to lack of funds. There are some SME firms also
facing difficulties in buying raw materials and packaging. This is where the
information and communication technology (ICT) may play an important role in
transforming the Halal industry. Introducing automated processes will enhance
SME businesses and provide them with competitive edge in the increasingly
competitive globalize Halal market.

 

 

 

6        Advantages of Equity-based Crowdfunding

There are several
advantages of equity-based crowdfunding from an Islamic financial perspective
that includes promoting the original financing form based on profit and loss
sharing basis (known as musharakah); reducing the funding gaps as access to
capital is provided to a wide range of entrepreneurs; introducing new asset
class for small and medium-sized investors; minimizing risks through splitting
limited capital across multiple start-ups; promote innovation and retain local
talent; create and increase job opportunity with the establishment of
starts-ups; providing support to the growth of ventures to enterprises and
possible future initial public offers (IPOs) in new sectors that are virtually
non-existent in the public equity markets in Muslim countries; and increase
diversity for fund managers.

7        Recommendation

As Malaysia is one of
the most important Islamic financial hubs in the world, the demand from the
market for Shariah-compliant equities crowdfunding is expected. The equity
crowdfunding framework usually involves cross-border transactions, dispute
settlement mechanisms should also be looked into, especially when the structure
is based on Islamic principles. This is because Islamic law is inapplicable in
many jurisdictions. Based on this expectation, it is recommended as follows:

a.     The
requirement for the appointment and of the Islamic capital market products vide
Part E of Guideline is insufficient to ensure a proper and holistic Shariah
governance framework for crowdfunding activities. The provisions of the
Guidelines on Recognized Markets need to be reviewed and additional adjustments
should be incorporated to strengthen the Shariah governance aspect of Islamic
equity crowdfunding in the country. This is important because Shariah-compliant
transactions are conducted based on the nature of Shariah contract involved.

b.     The
Shariah contract parameter shall be issued by the regulator to allow
crowdfunding activities to be conducted on the basis of Shariah principles.

c.     This
guideline should define specifically the criteria for qualifying parties in the
practice of Shariah equity crowdfunding.

d.     The
current position on the requirement of the appointment of an approved Shariah
adviser may cause the market to become uncertain and may dispute the approved
transaction if there is no solid Syariah parameter relating to such
crowdfunding activities.

e.     It is
recommended that an alternative dispute resolution (ADR) should be used as a
transaction term to control disputes between parties involved in order to
prevent jurisdiction issues arising from any court proceedings. The award of
arbitration, for instance, can be enforced in various jurisdictions.

 

8        Conclusion

It is
inappropriate to just conclude that equity crowdfunding in Malaysia is Shariah
compliant. There is more to the models in terms of Shariah governance, the
nature of the business, and the type of products and services offered. Even the
way the contract is executed, profit and risk are shared and allocated must
have some Shariah bearing.

Therefore,
scaling up start-ups may require innovative ways to raise funds even through a
Shariah-compliant mechanism. For a sustainable halal industry, there is a need
for a Shariah-compliant model that will increase the funds injected into the
industry.

In
fact, crowdfunding is an infant industry that grow fast in parallel with the
technological advancement that are currently experiencing by the world and is
expected to be a bigger portfolio in the future in Malaysia. Therefore,
necessary adjustments should be done promptly to ensure that their operations
are well supervised and the parties involved are well protected. The Securities
Commission may make new guidelines for Shariah equity crowdfunding in order to
guide the industry. Out of the six ECF platforms verified recently, only Ata
Plus seems to be rooted in Shariah-compliant business. Others are successful
conventional ECFs which may need to provide the principles of Syariah compliant
for issuers and investors who are influenced by Shariah compliance sentiments.
Major stakeholders in the Islamic financial services industry must place all
decrees to ensure the use of Shariah principles in a more prominent manner of
crowdfunding.

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