Impact of shariah-compliant status on firms’ decision to practice forex hedging

Abstract

Purpose The purpose of this paper is to investigate whether the shariah-compliant status of the firms negatively influences their use of foreign exchange hedging instruments. Design/methodology/approach This paper uses a logit panel regression on 350 firm-year observations from 70 nonfinancial listed firms over the period from 2010 to 2014. Shariah-compliant companies account for about 84 per cent of the sample firms. Findings Preliminarily, the results show that none of the samples of the shariah-compliant firms report any use of Islamic hedging instrument, either in the form of wa’d or tawarruq. The results of the study’s logit panel regression contradict the authors’ prediction that the shariah-compliant status negatively influences firms’ decision to hedge. In contrast, shariah-compliant companies are twice as likely as their conventional counterparts in adopting forex hedging. Research limitations/implications This study is limited to information disclosed in the items 31, 36 and 37 of financial management policies in the annual report. However, given that shariah-compliant firms must abide by the limit of 5 per cent profits before tax from clearly prohibited activities (including riba’), the need for exclusive disclosure on the adoption of Islamic or conventional hedging appears to be imperative for the viability of the Malaysian Islamic capital market. Practical implications In evaluating the shariah compliance of a company, investors (individual or institutional) must look further than just interest-based riba’ in mixed-business companies to ensure that they comply with the 5 per cent maximum requirement on the non-halal business contribution to profit. This is because the finding of this study indicates that shariah-compliant companies are twice as likely to adopt forex hedging, when none of them reports the use of Islamic hedging tools. Investors must therefore give ample allowance to riba’ that can be induced through the use of conventional forex hedging instruments. This is until the security market regulator imposes a requirement on shariah-compliant companies an explicit disclosure of the use of Islamic versus conventional hedging tools, as they had done in the case of Islamic versus conventional debt instruments. Social implications Muslim and socially responsible investors rely on the Shariah-compliant status of the company in ensuring that their wealth grows according to the Shariah principles. To sustain and develop the Islamic capital market which the firms have been relying on for external capital, Shariah-compliant firms and the authority awarding the status are equally responsible for honoring the trust that these investors by ensuring the permissibility (halal) of the business and the conduct of their business. Originality/value Conventional forex hedging instruments are criticized for violating as-sarf, a shariah principle, which requires the exchanges of particular assets (gold, silver and currency) to be delivered on the spot, and thereby infusing riba’ al-fadhl. Although Islamic (wa’d- or tawarruq-based) hedging instruments are widely available by Islamic banks in this country since they were introduced by Bank Negara Malaysia in 2010, paradoxically, the authors’ observation indicates that none of the studied firms reports the adoption of these instruments in their annual reports.

Shariah Compliance in Islamic Economics: A Bibliometric Analysis

“…The authors offered an evaluation instrument as a measuring tool for companies to evaluate the consistency of the values. Based on this, the status of shariah compliance in a company is a framework for its behaviour (Abdul-Rahim et al, 2019). This framework is a prerequisite for the formation of an image or benchmarking as a company that is consistent with shariah values, and (iv) a set of shariah compliance status and functions on firms.…”

Non-linear relationship between foreign currency derivatives and firm value: evidence on Sharīʿah compliant firms

“…Abdul-Rahim et al (2019) documented that SCFs are found twice as likely as conventional firms to adopt hedging instruments and the Sharīʿah compliant status does not hinder the respecting firms from using the contractual hedging instrument to mitigate risk exposure. Meanwhile Mohamad et al (2014) found that financial firms used hedging instruments to reduce risk exposure such as Islamic forex, cross-currency swap and commodity hedging instrument.…”

“…This is due to no requirement or accounting standard imposed on firms in Malaysia to disclose whether the hedging instruments are Sharīʿah compliant. Abdul-Rahim et al (2019) acknowledged the fact that most of Malaysian firms still adopt conventional hedging instruments mainly because of more documentation needed in dealing with Islamic hedging instruments. They added further that documentation related to Islamic hedging instruments are also cumbersome and need to be prepared before and after the transactions are completed.…”

“…Mohamad et al (2014) stated that empirical studies on Islamic hedging are still limited due to the lack of awareness on Islamic hedging and poor documentation of Islamic hedging in annual reports of firms. Abdul-Rahim et al (2019) in their studies using linear regression found that none of the samples of the Sharīʿah compliant firms (SCFs) in Malaysia report any use of Islamic hedging instrument, either in the form of wa ' d or tawarruq . They further recorded that SCFs are twice as likely as their conventional counterparts in adopting foreign exchange hedging.…”

Impact of Foreign Currency Derivatives on Firm Performance: Evidence on Shari’ah and non-Shari’ah Compliant Firms

“…Similarly, Ismail et al (2013) stated that non-Shari'ah compliant firms widely practiced risk management unlike the Shari'ah compliant firms. Abdul Rahim et al (2019) on the other hand, documented that Shari'ah compliant firms are found twice as likely as conventional firms to adopt hedging instruments implying that being Shari'ah compliant does not hinder the respective firms to hedge to mitigate risk exposure. It is worth noting that Islamic risk management instruments has increased based on the average volume of foreign exchange forward transactions (BNM 2017) and Malaysia is the leading country in Islamic finance with the most advanced Islamic capital market (Ledhem & Mekidiche 2020).…”