Monday, November 16, 2009

Management of Indonesian Private Foreign Borrowings: A Balanced Policy?

"If you owe your bank a hundred pounds, you have a problem. But if you owe a million it has."
(John Maynard Keynes - British Economist and founder of the Keynesian School)

Introduction

Keynes' brilliant statement above can accurately describes one of the most crucial problems of international financing activities, i.e., overconfidence in giving loans to companies from emerging markets, which is highly risked, tends to create problems rather than improvements. Problems not only to the financial institutions involving in such financing activities but also to the debtors, as in the end both of them are facing losses, not profits.

This overconfidence, combined with a lack of supervision from the Indonesian authorities can be considered as one of the main factors of the financial crisis in 1997. In that fateful tragedy, an already huge amount of foreign debts which were borrowed recklessly by Indonesian private companies suddenly turned into an endless pool of debt where Indonesian companies were drowning frantically due to the crisis in Rupiah's value.

Some people blame the speculators for creating that disaster, but those speculators are only a part of many factors that formed the crisis back in 1997. Another crucial factor which is also very important is the management of Indonesian private foreign borrowings. Without proper supervision and good risk management, foreign borrowings might be troublesome to the monetary policy of Indonesia and also the sustainability of business activities. Considering the fact that the amount of Indonesian global debt offering transactions are increasing significantly, it might be worthwhile to see the relevant issues that we may face and the policy that should be taken to prevent or solve them.

Why Choose Foreign Debts? 


There are many reasons for raising foreign debts, but I know one obvious reason and that is the lower interest rate. As you may be aware, there is a big discrepancy of interest rate between the US Fed and Bank Indonesia and therefore, to certain extent, obtaining foreign borrowings is more commercially acceptable to Indonesian companies since they can get a lower interest rate.

Of course, if there is no financial crisis, this formula might work. Unfortunately, when the Rupiah's value fell into the depth of hell in 1997, the disaster is inevitable. By having too many debts in foreign currencies and without having any hedging mechanism, the majority of Indonesian companies fall into bankruptcy when they realize that their debts have increased tremendously in correlation with the fall of Rupiah's rate.

Hiding Behind the Scene: Old Regulations on Foreign Borrowing
s

It is ironic that many Indonesian private companies were crushed in a crisis caused by unmanageable foreign borrowings while the Indonesian Government has already been dealing with foreign borrowings for a long time. It was in 1972, when the President of Indonesia issued Presidential Decree No. 59/1972 on Foreign Commercial Borrowings ("PD 59"), an archaic regulation which has been almost totally forgotten by everyone though it is still a full binding regulation.

Under PD 59, certain restrictions were imposed upon Indonesian companies, such as:

  • in case the borrowings involve the Government's guarantee, state owned companies are restricted to receive foreign borrowings without prior approval from the Minister of Finance (later on, the minister approval will be replaced by the approval of the Coordinating Minister of Economy, as the head of the Foreign Commercial Borrowing Team ("PKLN Team"), and the state owned companies are required to obtain prior approval from the PKLN Team before receiving any foreign debts, regardless of whether the Government acts as a guarantor or not to such foreign debts); and
  • private companies must report their foreign borrowings in a periodical basis to the Ministry of Finance and Bank Indonesia.
What was the main reason for issuing this PD 59? The reason, I believe, is quite simple, i.e. to manage the currency risk of those debts by supervising those Indonesian companies. Most Indonesian companies receive their income in Rupiah, but when Indonesian companies receive debts in foreign currencies, they have an obligation to pay those debts in foreign currencies. Due to such discrepancy, there is always a currency risk, a time bomb which eventually will explode, destroying everything.

To cut it short, while the nominal amount of the foreign debts will not change, the real amount may change in correlation with the progress of Rupiah's value. If the Rupiah's rate increase, the companies are lucky, but if not, they will face some serious problems. Imagine if a company has too many debts in foreign denomination and at the same time Rupiah's rate falls drastically. With an increase in the actual amount of the debts and without significant additional income, could the company still afford to pay its debts? I don't think so. And if there are too many companies having the same problem, what would be the result? A financial crisis!

Therefore, in my opinion, foreign borrowings must be supervised, so that the risk can be maintained. Of course there is a question on how such supervision can actually prevent the crisis? Further, how should the Government balances the policy to maintain the flexibility for those private companies in raising foreign debts.

Current Condition: Not Much Improvement

Interestingly, there isn't much improvement since the fateful 1997 crisis. As I've seen during my practice, Indonesian companies are still happy to pursue foreign debts, whether through bilateral or syndicated loan agreements arranged by foreign commercial banks or issuing notes to international investors arranged by investment bankers. Submitting reports to the PKLN Team, the Ministry of Finance and Bank Indonesia for Indonesian private companies or obtaining PKLN approval for state owned companies before getting their foreign debts have become administrative obligations which have no value other than to secure a clean legal opinion from lawyers.

This is indeed a sad news, yet inevitable. Due to the lack of implementing policy, the PKLN Team has forgotten their own task, and I have a solid evidence for this. In one transaction, we were asked to give a presentation to members of the PKLN team on the roles and authorities of the PKLN Team relating to PKLN approval. I must say that this is quite hilarious.

That's why, it does make sense when I heard a rumor that the Government intends to revoke the 1972 and 1991 regulations. Why preserving regulations which don't have any efficacy, regulations which only create administrative problems for private companies and state owned companies when they are trying to raise foreign debts?

True, we cannot maintain ineffective regulations, but in the case of foreign debts, I believe that the Government is missing the main point. Such administrative measures were created to protect the interest of those Indonesian companies! Rather than revoking those regulations, why not improving their implementation? But I guess, the Government may have their own thoughts, and I assume that this is related to the separation of tasks between the Government, as the guardian of Indonesian fiscal policy, and Bank Indonesia, as the guardian of Indonesian monetary policy.

Latest Regulations on Foreign Borrowings

After going through an enduring period, Bank Indonesia issued Bank Indonesia Regulation No. 10/7/PBI/2008 on Foreign Borrowings of Indonesian Non-Bank Companies on 19 February 2008 which was further followed up by an implementing regulation in the form of a circular letter on 22 December 2008. Basically, this regulation requires Indonesian non-bank companies to submit periodical reports (annually or semi annually) concerning their financial viability (this include the submission of a report on their financial ratio and their financial statement) and risk management analysis before they obtain foreign borrowings in any form whatsoever. The regulation also requires these Indonesian non-bank companies to obtain ratings from local or international rating agencies for each debt that they would obtain. Those who are interested to see the form of the report can see it here.

The purpose of this regulation is to ensure that Indonesian companies have sufficient consideration and a proper risk analysis in determining whether they should pursue loans from foreign parties, whether they are banks, other financial institutions, or bonds investors. Bank Indonesia states in this regulation that foreign borrowing is one of the major factors which may affect the Indonesian monetary stability and the sustainability of the Indonesian economic development, and therefore proper supervision is needed.

In my opinion, this regulation is quite balanced. I don't think that it can significantly affect the flexibility of Indonesian private companies in raising foreign debts. On the other hand, the regulation might provide various useful guidelines for the companies in conducting proper analysis before they get those foreign debts. In other words, this regulation is a further advancement to the old 1972 and 1991 regulations which only required submission of simple reports.

The regulation also imposes sanctions in the form of warning letters and announcements to the public (domestic or international). This is a good move from Bank Indonesia and the sanction should be more effective than any other penal sanctions, since reputation is very valuable in the market, and no companies dare to risk their good reputation for unclear benefits. It should be noted though that the sanctions will be effective on 1 January 2010.

I have high hopes on the further implementation of this regulation. Getting many global debt offering and other international financing deals are good for lawyer's business. However, it is also important to ensure that we are not advancing these companies toward doom because of reckless debt policy. Bank Indonesia should be strict when it deals with this reporting obligation to ensure the compliance of the Indonesian companies. After all, these regulations are made to protect their interest in the long term and the regulation can be a good nudge for them.

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Monday, November 09, 2009

Revisiting the Law on Mandatory Use of Indonesian Language: Updated Analysis

I have discussed Law No. 24/2009 on National Flag, Language, Emblem and Anthem ("Law 24/2009”) in my post dated 27 August 2009. However, I feel that my analysis on the issues related to this Law 24/2009 is not complete, I am not satisfied with the legal analysis in my previous post and in practice, the impact of this Law is greater than I've ever thought to be. Thus, I believe that I must revisit the issues on Law 24/2009 and provide a deeper analysis in this blog.

Our main issue revolves around Article 31 of Law 24/2009. The first paragraph of this Article requires the use of Indonesian language in agreements involving state institutions, Indonesian government authorities, Indonesian private institutions or Indonesian individuals. The elucidation of Article 31 paragraph 1 states that an agreement in this context includes international agreements made within the framework of public international law.

Article 31 paragraph 2 of Law 24/2009 further states that if the agreements involve foreign parties, the national language of those foreign parties and/or the English language can also be used. Furthermore, the elucidation of Article 31 paragraph 2 states that if agreements are executed in multiple languages, i.e.: Indonesian language, the national language of the foreign party and/or English language, each version is equally original.

Although the above provisions look simple, they have triggered significant legal problems, i.e.:

  • whether Indonesian companies are obliged to use Indonesian language in their commercial contracts since Article 31 paragraph 1 and its elucidation are not particularly clear on whether (i) the term “Indonesian private institutions” includes Indonesian companies or Indonesian branches of foreign companies; and (ii) the term “agreements” includes private commercial contracts;
  • suppose they are obliged to use Indonesian languages, what would be the legal impact for any failure to do so? Is this is a mandatory obligation or merely an administrative requirement?
  • with respect to dual languages contracts, whether “equally original” means that each contract must be executed as original (not merely translation) and if yes, whether the parties to such contract can choose non-Indonesian language as the governing language.
In practice, the impacts are disastrous, especially in relation to commercial contracts made between Indonesian and foreign parties. Most foreign parties fear that the failure of using Indonesian language in their contracts might cause the contracts to be annulled by operation of law due to breach of mandatory legal obligation. As a result, they act conservatively and request that the contracts must be executed in dual languages. Not only that this choice of action significantly delays the transactions completion and increases the parties’ costs, it also imposes unnecessary risks and liabilities, particularly because certain complicated contracts such as Indenture, Trust Deed and EPC Contracts are too technical to be perfectly translated into Indonesian language (which is a very young language compared to English). As a result of this and without any definitive meaning on the concept of “equally original,” parties are running the risk of executing a contract with misleading or incorrect terms and conditions.

While the fear is understandable, in my opinion, acting conservatively does not solve the problems and there are better ways to solve them rather than executing all contracts in dual languages format. First, we should refer to Article 40 of Law 24/2009 which stipulates that the use of Indonesian language will be further stipulated in Presidential Regulations. I appreciate the fact that the provisions of Law 24/2009 are still valid even without those Presidential Regulations. However, it also indicates that the provisions of this Law is not yet complete, which in fact is true. As a matter of Indonesian legal principle, when the text of the law is not clear, parties to a contract should not interpret the law for the detriment of any of the parties. If a party tries to annul a contract due to failure of using Indonesian language where each party to that contract is aware that having such Indonesian version would most probably cause adverse effect, it shows that such party has bad faiths and in my opinion the court should not grant the claim. After all, why forcing the parties to use Indonesian language if it does not give any clear benefit to them?

Second, Law 24/2009 does not provide for any sanction for failure to comply with the above requirements, and it is arguable under the general Indonesian legal principle that when a law provision does not have any sanction (or the sanctions are merely administrative), the failure of performing such provision cannot affect the validity of a legal act, i.e. the contract. This has been made clear in a famous landmark case where the Supreme Court decided that the failure of submitting a report on foreign loan (which is an administrative requirement under Bank Indonesia regulations) cannot be used as a valid reason to annul a credit agreement made between an Indonesian debtor and foreign creditors. While I understand that there is a previous case on the similar matter where the credit agreement was annulled, the latter precedent should prevail since it is in accordance with the correct interpretation of law and is closer to fairness, i.e. it is completely ridiculous and unfair to the creditors to invalidate a credit agreement due to the failure of the debtor to submit some administrative reports.

Therefore, I would suggest that in case a contract involves Indonesian and foreign parties, the parties should not execute a dual languages contract without first performing a complete analysis on the advantages and risks of having such format. Suppose they conclude that having a dual languages contract is not a viable option, I would suggest them to insert a clause stating that they have agreed to execute the contract in non-Indonesian language and that they will execute an Indonesian language version of the contract when the implementing regulations clearly oblige them to do so. This mechanic would be useful to prevent any party having bad faiths from trying to annul the contract.

On the "equally original" phrase, my suggestion is that the Parties involved must also insert a clause concerning governing language. It is indeed unclear on whether the equally original means that each language should be deemed as applicable. However, when in doubt, the Parties should not use an interpretation that harms them. In addition, why don't we refer to the freedom of contract principle? The Parties should be able to agree on the governing language of the contract, and therefore eliminating any risks to have misleading or incorrect terms. However, the main question would be: if the Parties execute the Indonesian language contract for the sake of complying with Law 24/2009 and the governing language of such Contract is non-Indonesian, what is the purpose of having an Indonesian version in the first place? Is not this a waste of time and money? The Government should answer this big question.

In the end, we can conclude that the existence of Law 24/2009 brings more problems than benefits in practice, particularly in relation to the use of Indonesian language. While, we can argue and use several solutions to solve the issues brought by Law 24/2009, it should be noted that there are no bullet proof mechanisms here. The courts could always have a different interpretation. So, let us hope that the Government can give us a better solution through the implementing regulations and the courts can decide based on the correct and fair interpretation of the law while we are waiting for the implementing regulations.

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Monday, November 02, 2009

Bringing Indonesian Islamic Finance to a New Level: A Review on the New VAT Law

At last, the long awaited draft amendment to the VAT law has been passed by the Indonesian legislative board (the "New VAT Law"). You can see the soft copy here. The law will be effective as of 1 April 2010. The most important thing here is the fact that the New VAT Law recognizes the existence of Islamic finance and exempts VAT for transactions that fall under the term of Islamic finance.

Article 1A Paragraph (1) h of the New VAT Law states that with respect to delivery of taxable goods by taxable entrepreneur in the context of Islamic financing activities, such delivery shall be only considered between the taxable entrepreneur and the party needing such taxable goods. While the elucidation of this Article does not provide specific explanation, it gives an example of a murabahah transaction for a vehicle financing, where an Islamic bank buys a car from a taxable entrepreneur based on an order from the Islamic bank customer. In this example, the New VAT Law acknowledges that under such Islamic financing structure, the Islamic bank would need to purchase the vehicle first and then resell it to its customer, however the New VAT Law further confirms that the delivery of such car is considered to be directly done from the taxable entrepreneur to the Shari'a bank customer. In other words, we can conclude that the New VAT Law acknowledges the role of the Islamic financial institutions as financial intermediaries.

In addition to the above, Article 4A Paragraph (3) d of the New VAT Law states that financial services are exempted from VAT. The elucidation of such Article further states that the definition of financial services include Shari'a based financing, whereas the financial services may be in the form of: (a) leasing, (b) factoring, (c) credit cards, and (d) consumer financing.

Although the above wordings are not clear enough to capture all kind of Islamic financing structure, I am still very happy with this new development as I believe that the New VAT Law might be the right trigger for bringing the Indonesian Islamic finance to a new level.

As you may be aware, before the enactment of this law, there is a huge confusion within Islamic finance players on whether their transactions are actually exempted from VAT or not. To add the confusion, in most of the time, the tax authorities were silent on the tax treatment. In short, it was like sitting on a deadly time bomb. In my opinion, there should not be any confusion in the first place, since from the accounting perspective, these Islamic financing transactions are recorded as ordinary financing transactions in the balance sheets of companies that receive such Islamic financing (substance over form) . In other words, there would be no record of sale and purchase or sale and lease back transactions in the financial statements since those structures are merely used to satisfy the Shari'a aspect and do not reflect actual transactions. However, a risk is a risk and without having any tax advisor who is brave enough to issue a clean tax opinion, most Islamic financial institutions were not eager to develop the business in Indonesia. Thus, there are no significant development of Indonesian Islamic finance until today. Hopefully, this should be no longer the case.

In addition to the above, further implementing regulations are still needed to resolve the remaining issues as provided below:
  • Will there be any criteria to determine the transactions that fall under Islamic finance transactions? I guess the Government will need to stipulate such criteria to avoid any moral hazard from business players who are trying to avoid paying VAT under the disguise of Islamic financing transactions.
  • It is unclear on how Ijarah transactions (lease structure) will be treated under the New VAT Law, since there is no transfer of beneficial ownership in an Ijarah transaction. Should the transaction be considered as an ordinary lease transaction? Surely not, but I would like to know how this will be solved from tax perspective.
  • While Ijarah Muntahia bit Tamlik financing structure (sale and lease back) should be accommodated under Article 4A Paragraph (3) d of the New VAT Law, it seems to me that this article only applies to leasing companies. What about IMBT financing provided by other kind of Islamic financial institutions, such as Islamic banks? Is there any requirement for securing a leasing company license before the exemption works?
  • What about Sukuk? From the original wordings, it seems that the New VAT Law only covers plain vanilla Islamic financing transactions conducted by Islamic banks.
I guess that would be the preliminary issues related to the New VAT Law. I will give more updates on this subject after the Government has issued further implementing regulations.

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Thursday, October 29, 2009

A Thank You Note

Please see here. This is the first time I am mentioned in a footnote. While there is nothing extraordinary with this, I am happy and appreciate the writer for using one of my articles (written with my partner) as a source of reference for his paper. There are still many things to come from the Capitalist Lawyer, and I'm planning to make all of those things happen.

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Monday, October 26, 2009

The Birthday of the Capitalist Lawyer: Some Wishes and Thoughts on Law and Lawyers

Today is my 26th birthday, so in this special day, instead of writing and analyzing things, let me tell you some of my wishes and random thoughts on my most beloved subjects, law and lawyers. Enjoy!
  1. I believe that laws should be made by professionals not some common people, i.e. the parliament, and I wish that we could achieve that as soon as possible. Of course, the process of recruiting those professionals should be made as democratic and transparent as possible. If not, then we would only have another despotic government.
  2. I wish to have a virtual data base that has complete legal references and sources which have been systematically organized and all I need to do to find them is by one click. That would be glorious.
  3. I wish that I could have more time in learning all the new things about law. Law is a never ending process, continuously evolving in order to achieve perfection. It is really frustrating that I can't follow all of those new developments.
  4. Being a lawyer requires great intelligence, perseverance, persistence, and diligence, but none of them would be helpful if you don't have the passion.
  5. Good lawyers love to be challenged, great lawyers surpass those challenges. However, always remember the golden rule of lawyers: Do not take responsibilities more than you are being paid for.
  6. Never underestimate the usefulness of inputting your time sheets daily.
  7. Commercial pragmatists are the next generation of lawyers, those who can smoothly combine superb legal knowledge with deep commercial understanding of the client's business.
  8. Lawyers are consultants and therefore our job is to help our clients in making decisions not to make decisions by ourselves. See the golden rule above.
  9. If you're only looking for the money, you should not work as a lawyer, since there are other jobs that will give you better income with less working time. But, if you're looking for a respectable profession that can satisfy your pride, you have come to the right place.
  10. If you have worked as a lawyer for years and you still can't gain the trust of your clients, you should stop and pick another career. Without client's trust there would be no business development, no business development means no advance in career, so why bother working as a lawyer?
  11. Doing you best is not enough to reach the top. Always try to surpass your own standard and never be satisfied with your performance even when you think that you have reached the top, there is always a room to grow, a room for improvement. Like my partner once said: "I could never be fully satisfied with my associates since I fear that once I tell them how satisfied I am, they would cease to improve their qualities."

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Monday, October 19, 2009

Why Forcing Listed Companies to Waive Their Dividends Restrictions?

If I could only complain one thing on the process of doing an initial public offering of shares in Indonesia, that must be the requirement for a proposed listed company to obtain from its creditors a waiver of any restriction on such company's capacity to pay dividends to its shareholders or any restriction of dividends payment on the subsidiaries level, provided that the proposed listed company income depends on the payment of dividends from its subsidiaries.

You will be amazed to know that this is not based on a strict regulation, rather it came from an unwritten policy of the Indonesian Capital Market and Financial Institution Supervisory Agency ("Bapepam-LK"). According to Bapepam-LK officials, when a company is trying to raise funds from the public, such company should be able to pay dividends to its shareholders since such dividends will become the main source of income for its shareholders. Therefore, any restrictions for dividend payment should be eliminated as well.

Okay, to certain extent the argument makes sense, but such argument is too simple to be used as a reason for forcing those proposed listed companies to obtain a waiver of their dividend payment restrictions. As far as I know, from the investors perspective, there are two main ways to obtain income from the capital market: (i) payment of dividends, or (ii) capital gain, i.e. buy low, sell high. In other words, dividend is not the only source of income, and in practice, not all investors focus on getting the dividends.

Furthermore, waiving the restriction of such dividend payment may significantly affect the possibility of securing a financing from financial institutions. As you may be aware, for companies, there are three ways of raising funds, i.e. (i) debt financing, (ii) equity financing, and (iii) hybrid financing (the combination of debt and equity financing). Some financial institutions would require its debtors to limit their payment of dividends to ensure that the debtors could have sufficient funds to repay their debts to these financial institutions. From my experience, there were some cases where the proposed listed company had to repay its debts because its creditors did not agree to waive the dividend restriction. If the debt is not huge, than that wouldn't be a problem, but if the amount is huge, the company will face a serious problem as getting the creditors approval might not be easy and the financial condition of the company may also be compromised.

I always believe that capital market regulations should focus on transparency, on how disclosures about the condition of publicly listed companies should be made, not on how they should perform or doing its business activities, that is the role of the management and that is why they are being paid. Forcing proposed listed companies to waive their dividend restrictions is essentially the same with limiting their choices between debt and equity financing, and I am sure that this is not efficient!

In my opinion, the most important thing is that the proposed listed companies have disclosed in their prospectuses that they have several debts and in those debts, they are being limited to pay dividends (fully or partly). If proper disclosures have been made, it is up to the investors decision on whether to invest in such companies or not. That would be the ideal things to have in Indonesia.

Unfortunately, this Bapepam-LK unwritten policy has not been revoked until today. The only thing that we could do now is to lobby Bapepam-LK and make them understand on this issue. Protecting Indonesian investors is very important, but we should also do that in a proper way, not by limiting the options of publicly listed companies, which in some cases, is actually counterproductive.

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Monday, October 12, 2009

Why the Pure Theory of Law Matters: Understanding the Misunderstood Kelsen (Part 3)

In the third and also the last part of my article, we will discuss the actual implementation of Kelsen's theory of law and why such theory matters. If you have read all of my previous related posts and you are still reading this post, I must first congratulate you for your persistence and patience. I hope this article would be useful to help you in understanding the basic characteristics of the law.

The Validity of Law and the Problem of Bad Laws

In my opinion, the most important contribution of Kelsen's theory is the theory that the validity of the laws does not depend on their contents or the values represented by those contents but on: (i) how they were established (i.e. whether they were made based on a correct mechanism set out by higher norms), and (ii) the validity of the higher level's norms which enable those laws to be created.

What are the implications? No matter how bad a law is drafted or no matter how ridiculous a law is, as long as the above requirements have been satisfied, a valid law is always a law and people should obey such law. Now, before you claim that I am a supporter of despotic governments who issue laws without any check and balance mechanism, please hold your tongue.

If we know and understand that a valid law is still valid even though it is a very, very bad law, we must do our best to prevent such thing from occurring. Kelsen's theory is very useful here because it brings us to the cold reality, i.e., there is always a chance that a law is a bad law, and when such bad law is validly issued, it will become a valid bad law. Then, whether people like it or not, they would need to obey such bad law. Of course people can always disobey that law, but then they would live under the mercy of the officials who implement such law. While there are also mechanisms to review those bad laws in some countries, until a final and binding verdict is issued, those bad laws are still deemed to be valid, and there is no guarantee that the results would be in favor of those who oppose the enactment of such laws.

Have you ever counted the amount of bad laws in Indonesia? One good example would be Law No. 24/2009 on the Flag, the Language, the National Emblem, and the National Anthem. You could see my discussion on this law here. This law has caused tremendous problems and uproars among the businessmen and lawyers due to its ambiguity and ridiculous requirements in drafting private agreements. But can we say that this is not a valid law, simply because it is stupid? No, we can't! We have to live with it until the law is amended or it has been judicially reviewed by the Constitutional Court.

That's why we should always be mindful to the fact that laws are made by politicians where many interests were intertwined. It is true that the first drafts might be made by professionals legal drafters, but as soon as those drafts go to the parliament's commissions, we can only hope that they make the right judgment and decision (though we clearly know that they fail to do so in many instances).

If you ask me, I'm not a supporter of the principle that laws should be made by ordinary common people through the parliament. The fact that these laws were made through democratic process (if we can call this absurd process as democratic) does not necessarily means that the end results would be good. Laws should be made by professionals based on a thorough research among the people. So that the Government can find or at least assess the true needs of the society and stipulate laws that can accommodate such needs. Specific values should be diminished and the Government should focus on stipulating laws that bring the greater good to the society, that could be easily understood by the people and that could be implemented effectively. Looks like an utopia, eh?

Law as a Product of Men

The next important contribution from Kelsen's theory of law is the theory that essentially, law is the product of men, it is not created by divine powers or supreme intellects. While this concept has been already recognized under the positive theory of laws, Kelsen brings the concept to the next level. Again, this has a deep relationship with his concept about the validity of the law.

By rejecting the theory that law is derived from specific values created by divine powers or morality, Kelsen established the concept that the validity of the law is not related to its content. I couldn't less agree. The reason is simple, we can easily assess whether a law is made through the correct mechanism but we can't asses the correctness of a moral or religious value that becomes the underlying principle of the law. Determining the validity of the law based on its values would be horrendous because we do not have a universally acceptable standard and people could always challenge the validity of the laws by too many reasons.

There are also other consequences of Kelsen's theory. I know that some prominent legal scholars believe that laws should reflect the values of the society where the laws were enacted. To certain degree, that might be correct, but not always. Imagine the new Qanun in Aceh that permits stoning for adultery. You can see my related post here. The Qanun makers stated that the Qanun is issued in accordance with the cultural believe of the Aceh's society. Assuming that this is true, can we accept this kind of law as the right one? I would say no! And I believe that most people would say the same. According to Kelsen's theory, the Qanun is a valid law. But how about those who believe in the relationship between law and society. Would they have the same view about the validity of this absurd Qanun?

Kelsen's theory enables us to have a scientific method in assessing the validity of the law and we should be grateful for that.

The Hierarchy of Laws

Last, but not least, Kelsen's theory of law helps us to understand the nature of the hierarchy of laws which is very useful when we need to analyze different ranks of law and determine the validity of a law's provision. In Indonesia, Kelsen's concept has been implemented in Law No. 10/2004 on the Stipulation of Regulations where it states the basic hierarchy of Indonesian regulations and stipulates that the power of a regulation corresponds with its level in such hierarchy.

There are a huge number of laws out there and there is always a possibility that some laws contravene other laws. This is especially right when we are dealing with the laws of a developing country where the laws are not well harmonized. Without a clear concept of the hierarchy of law, we would be confused in determining which law should be applied where there were two or more contradicting laws.

By using the hierarchy of laws and the fact that this concept has been implemented in Indonesian regulations, we would have a solid basis in determining the applicability of valid laws in accordance with its level in the hierarchy, i.e. lower level laws cannot have provisions that contravene the provisions of the higher level laws. If such contravening provisions exist, the provisions of the lower level laws should be deemed as inapplicable.

I encourage all lawyers to learn and to fully understand this concept as this is one of the basic skills in doing their job analyzing the regulations.

Conclusions

We have discussed some important implementations of the Pure Theory of Law and I hope that the discussion can enlighten us with respect to the nature and function of law. In the end, law is the product and tool of men, and therefore, it is up to us to make a law that can bring the greater goods to the society.

We also know the danger of having a valid bad laws and we must do our best to prevent such thing from ever happening. Therefore, in the future, I hope, that the drafting of laws could be done by professional legal drafters supported by greater participation of the society.

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Saturday, October 10, 2009

A First Year Grad Student Wins the Nobel Prize in Economics

I can't stop laughing with this great piece of article from Greg Mankiw. Sigh, if only the Nobel Committee also gives Nobel Prize in laws, I should also be able to make this parody, hahaha. Anyway, it's a very good parody which questions why Obama is named as the winner of the Nobel Peace Prize. Enjoy, and don't forget to see the link in his post.

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Thursday, October 08, 2009

The Know-It-All Government vs The Down-to-Earth Government

Here is a very concise article about the role of the Government. A must read for those who would like to understand policies differences between the "big" and "small" government. I can understand why most people will be in favor of the "big" government" during the term of crisis. We love saviors aren't we? For most of us, those smart looking officials seem to have all what it takes to save the country (and ahem, I'm not referring to the officials of my country).

Well, you better think again. I agree that the government must have a role in the development of a country, or else why we need to have a government in the first place? But we must also acknowledge the limitations of the government. They are, after all, made from the people and they definitely could not know and understand everything, including the entire risks and benefits of their policies. A good government should know when to stop making policies to avoid over regulation which could turn into a mess in the long term, or even in the short term.

By the way, hat off to Mr. David Brooks for his intelligent and easy to understand analogy.

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Monday, October 05, 2009

Why the Pure Theory of Law Matters: Understanding the Misunderstood Kelsen (Part 2)

In the first part of my article, we have discussed the basic concepts of Hans Kelsen's Pure Theory of Law. In this second part, we will discuss the concept of Norms, and the relationship between efficacy and validity of the law.

Norms, the Hierarchy of Norms, and the Basic Norm

A discussion on Kelsen's theory of law wouldn't be complete without discussing the Norms. As I've said previously, according to Kelsen, the law can be viewed as a specific social technique and as a norm. What is a norm? Kelsen describes norm as a rule expressing the fact that somebody ought to act in a certain way, without implying that "anybody" really wants the person to act that way. Further, Kelsen also defines norm as an impersonal and anonymous command (this is made by Kelsen to counter argue John Austin's definition of law, i.e. law as a command from a sovereign).

From his definition, we can conclude three important concepts: (i) a norm is a rule that provide certain "guidelines" to its intended subject whereas such intended subject is ought to follow such "guidelines", (ii) a norm is neutral, it is not representing the will and interest of certain people or entity, and the most important thing is (iii) the validity of the norm is not related to the entity which stipulate such norm (that's why it is considered as an impersonal and anonymous command) but on the validity of the norm which gives authority to such entity.

Following Kelsen's way of thinking, the validity of a norm (let us call it as Norm No. 1) shall be determined by the validity of the norm having the authority to create/establish Norm No. 1 (let us call this second norm as Norm No. 2) in accordance with the procedures stipulated by Norm No. 2. Logically, Norm No. 2 should have a higher level than Norm No. 1 and both should exist in the same order/system. If not, how can Norm No. 2 create and determine that Norm No. 1 is valid? Thus we've seen the birth of the Hierarchy of Norms. Pretty simple, eh?

The process shall be repeated until we reach the highest level of the Hierarchy of Norms, where we will find the Basic Norm. What are the characteristics of the Basic Norm? According to Kelsen, the Basic Norm, unlike any other Norms, is not created in a legal procedure by a law creating organ. It is not -as a positive legal norm is- valid because it is created in a certain way by a legal act, but it is valid because it is presupposed to be valid because without this presupposition, no human act could be interpreted as a legal, especially as a norm-creating act.

Among all other concepts that were introduced in the Pure Theory of Law, the Basic Norm is the most controversial one, especially with respect to the presupposition of the existence and validity of the Basic Norm. For some scholars, such presupposition defeats the entire purpose of the Pure Theory of Law to create a scientific legal theory. How could a scientific legal theory explain that the validity of the Basic Norm, which is basically the ultimate source of validity of all other Norms, thus acting as the core of the Pure Theory of Law, depends on a presupposition?

I can understand their critics, but in this case, the presupposition should be correct. Citing Kelsen's own words: "The whole function of this Basic Norm is to confer law-creating power on the act of the first legislator and on all the other acts based on the first act. To interpret these acts of human beings as legal acts and their products as binding Norms, and that means to interpret the empirical material which presents itself as law as such, is possible only on the condition that the Basic Norm is presupposed as a valid Norm." Okay, the words might be confusing, but what are the truly meaning of these words?

As mentioned in Part 1, apart from characterizing the law as a norm, the Pure Theory of Law also characterizes the law as a specific technique for social organization. The Pure Theory of Law also rejects any attempt to establish a relationship between the validity of the law and any value which may be reflected within such law. A law might be unjust or just, but being an unjust law doesn't necessarily means that such law is invalid. As a logical consequence, when we reach the Basic Norm level, the only way for us to conclude that the entire legal system is valid is by presupposing the validity of the Basic Norm. We need to remember that the Pure Theory of Law is always about the positive laws, laws made by men. Basic Norm as the ultimate Norm which enable all derivative Norms to be considered valid is derived from social facts and such Basic Norm becomes valid, because we assume it as a valid Norm.

Let me give you an example: Why we stick with the 1945 Constitution and consider it as the basis of all laws stipulated in Indonesia? It is not a sacred document created by God, in fact it is a document made by a bunch of people that we call as the Indonesian founding fathers, which was later amended by the Indonesian parliament. It was once replaced by another constitutions and then we returned to use it using a decree of a president which is obviously has a lower status than the constitution. Yet, we're still using the 1945 Constitution and we still believe that all regulations in Indonesia should not contravene the 1945 Constitution and that all regulations in Indonesia obtain their validity since the 1945 Constitution allows the stipulation of laws and regulations.

Yes, 1945 Constitution can be considered as a Basic Norm, but is it valid because it corresponds with justice or the interest of all Indonesian people? Not necessarily. It was not even drafted by the entire Indonesian people, rather it was made by a committee whose most members were appointed by Japanese government. It is without doubt that some Indonesian people might have different views with the idea of such committee and the content of the 1945 Constitution. Even the drafters of the 1945 Constitution and its amendments could have different views among themselves when they draft the 1945 Constitution. So why? Why we still use the 1945 Constitution? The answer lies in Kelsen's theory, the 1945 Constitution is valid and becomes the source of all Indonesian laws because we assume that the 1945 Constitution is valid. That is the only logical explanation, the principle of legitimacy.

That's why Kelsen acknowledged in his "General Theory of Law and State" that the Basic Norm of a legal order can be replaced by a revolution which include the so-called coup d'etat.

Validity and Efficacy of the Law

Before we move on, let me explain first the meaning of efficacy. Efficacy of the law means the effectiveness of such law with respect to its effect to the society, i.e. the degree to which the law is being actually complied by the society. It is common for us to see laws which are so ineffective that the existence of those laws mean nothing to the society, and other type of laws which are very effective and have a high rate of compliance. The main question is, can we consider a law that is not efficacious as a valid law?

In Kelsen's opinion, consistent with his theory, the efficacy of the total legal order is a condition for the validity of the relevant Norms, but not the reason for their validity, because the validity of a Norm depends on whether it is created in a constitutional way or not (please refer to above discussion on the Hierarchy of Norms). Therefore, the degree of compliance of law does not affect the validity of such law. In other words, it is possible for us to have a valid law which has a low degree of compliance or no compliance at law. One example that I could think of would be the regulation that obliges companies that have trade business licenses (SIUP) to submit periodical reports to the Department of Trade. Based on my experience, the percentage of non compliance for this particular obligation reaches 99.9999%. Pretty amazing!

There is more to it. Kelsen also acknowledged that a law/norm wouldn't be valid anymore if the total legal system has lost its efficacy. Theoretically, this is correct. Suppose the current Indonesian legal system loses its efficacy, say because of a revolution, where the 1945 Constitution is entirely dismissed and replaced, and the government has been toppled up. Unless there is a new constitution having a transitional provision which says that the remaining laws remain to be valid, we would lose the legal basis to consider that such remaining laws are still valid.

However, since the possibility of having such worst case scenario is very rare, we could stick to the basic principle of the Pure Theory of Law, i.e. the efficacy of the law does not affect the validity of such law. I believe that this is a very important concept having significant practical implications, and we shall further discuss such implementation in the last part of my post, where we shall also discuss the implementation of other parts of Kelsen's Pure Theory of Law.

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Sunday, October 04, 2009

Is There any Relationship Between God's Wrath and Natural Disaster?

Natural disasters are without a doubt a powerful force in this world. They destroy many lives and cause great losses not only to a particular area but also a nation as a whole. However, the fact that most people do not learn from the various occurrence of these disasters truly enrages me. Well, saying that people haven't learned anything might be exaggerating, they did learned something, but not in the right thing as we shall see further below.

In Indonesia, whenever a disaster occurs, what would be the first thing to expect by us to see? Yes, statements that the disaster came because of God's wrath. The fact that some of the biggest disasters occurred in areas inhabited mostly by moslems also supports the claim that the disasters are actually a form of punishment from God because Indonesian moslems have not lived in accordance with God's laws or the Shari'a (maybe these people forget that moslems are indeed the majority of Indonesian citizens and therefore they are also the majority in the most parts of Indonesian territories).

With respect to the recent West Sumatra's earthquake, some people even connect the occurrence time of such earthquake (and the subsequent earthquakes) with some verses in the Koran which coincidentally talk about God's punishment for the sin of men. To what extent can people make this kind of scary correlation? This is not funny anymore, this is dangerous.

I have three simple arguments why there shouldn't be any relationship between the wrath of God and natural disasters:
  • If the disasters came because of men's sins, then using such logic, non moslem countries such as the United States of America and Israel must have been wiped off from the map a long, long time ago as most of them are unbelievers and their policies have hurted many moslems. But, apparently, they are not and in fact they are two of the most powerful countries in the Earth.
  • If the disasters came as a warning for Indonesian's moslem wrongdoings, then we are in a danger of having a very cruel and childish god (note that I'm not using the capital "G") who love to crush its beings for simple reasons. I simply don't buy this crazy idea.
  • No one could ever know what is in God's mind, so why even bother to make any relationship between God's wrath and natural disaster? Aren't we having a bad prejudice to our God?
Further, have you ever imagined that this fatalistic kind of thought is not efficient at all? By thinking that natural disaster is a part of God's punishment, people will believe that disasters cannot be avoided by any means whatsoever, it will then create pessimistic people who would surrender themselves to the oblivion without doing anything much. There would be no incentives to make better technologies to prevent disasters, minimize the damages, and save lives if people are thinking that they are facing with God's wrath and its inevitable destruction. For these pessimistic guys, all efforts would be useless.

My God, is this the path that we will take? Will we let some irresponsible people use religion to scare the society? Religion should provide comfort to the people, to help them believe on the future, not to let them down and feel sorry about themselves.

I guess this is the right time for us to really consider the fact that we live in a country which has a huge risk for earthquakes. Natural scientists have warned us and it is quite easy to find the data on this matter. Why don't we learn? I see history is repeating itself. We experience disasters, then we try to help the victims and discuss the ways to prevent these disasters to happen or at least minimize the damages, but after some times, we eventually forget them and you know what, before we can make a decent preparation, disasters have knocked ours door again. Absurd, simply absurd.

If I'm the Government, apart from conducting any necessary real actions to help the victims, I would quickly release a statement saying that there is no relationship between natural disaster and God's wrath. I will not go to the mosque to pray and ask God why these disasters occur in my term and not others. What I will say are: the victims shall be taken care of, preventing actions shall be considered and conducted, and the reconstruction shall be done by paying attention to the potential risks of disasters in Indonesia. We need to ensure that the victims are still sane and that they can move on with their lives! My deepest sympathy to the victims and I hope that they can move on with their life. Disasters might crush our assets and some of our beloved ones. But as long we still alive, we will show that humans' determination will crush any limitation.

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Tuesday, September 29, 2009

Financial Crisis Manual: A Prestigious Work Product or a Desperate Attempt for Finding Clients?

American law firms never cease to amuse me. After working together with other firms in producing a 40 pages comment to an SEC regulation, now Davis Polk & Wardwell LLP, a very respectable US law firm provides an impressive 279 pages of financial crisis manual. You can read the manual here and its quick summary here. In general, it discusses the current regulatory issues related to the US financial crisis and the effect of such regulations to US financial institutions. I haven't read the manual, but the table of contents shows a very promising product.

Nevertheless, the most interesting part of this manual is not about the content or the quality of such manual as I am quite sure that the manual has been prepared in a professional manner, but the fact that 21 partners and counsels of Davis Polk are the ones that have prepared this manual. Given the latest news on how US law firms are trying to survive in the crisis, I have no doubt now that the crisis has really affected such law firms.

While it is true that from time to time law firms publish certain materials for the purpose of marketing and promotion, in normal circumstances, it is hard to believe that a law firm can produce a manual that is very huge and comprehensive, how in the world that they can find a spare time to write the manual? I'm afraid this time I might need to assume that such opportunity exists because of the crisis, i.e. less work, less billable hours, more promotional time.

Well, I hope that I'm wrong though. Maybe in the United States, it is usual for law firms to issue this kind of manual. After all, they have many resources for doing that.

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Monday, September 28, 2009

Why the Pure Theory of Law Matters: Understanding the Misunderstood Kelsen (Part 1)

Okay, I know that this blog is made for common readers, but I guess that writing a subject on legal theory and legal philosophy once in a while wouldn't do much harm. Besides, I cannot resist the temptation of writing this post. While Hans Kelsen is known as a prominent jurist and a worldwide respected legal scholar, he could also hold the first rank of the most misunderstood legal scholars of all time. There are so many critics to his legal theory (known as the "General Theory of Law" and the "Pure Theory of Law") that in some cases, his name and theory are recorded in law text books only for the sake of being criticized. Of course, this doesn't mean that his theory is less regarded than other legal theories since debating and criticizing are very usual in a well educated community. However, I feel that those critics are not the result of a correct understanding of Kelsen's theory. Instead, such critics were made on a false ground, a misunderstanding of Kelsen's real intention when he first declared his theory of law to the public.

Personally, after reading Kelsen's book, "The General Theory of Law and State," it is very hard for me to understand the basis of the critics and attacks made toward his theory. In my opinion, Kelsen provides a solid basis for lawyers in understanding the law and its basic characteristics, i.e. law as a norm and as a specific technique for social organization. We'll take a look on these issues further (some will be discussed in Part 2). But, for the appetizer, let us discuss first some basic concepts of the General Theory of Law and the Pure Theory of Law.

What is the General Theory of Law and the Pure Theory of Law?

In my opinion, nothing can better describe Kelsen's theory of law than Kelsen's own words. Therefore, to ensure that my description of this theory could reflect Kelsen's original thought in the highest manner, I will stay as close as possible with the description made by Kelsen in "The General Theory of Law and State." Expect a little bit of copy and paste here. But don't worry, my personal comments will be made separately below.

According to Kelsen, the General Theory of Law is a general theory of positive law and positive law is always the law of a define community (such as the law of Indonesia, the law of the United States, etc). Kelsen claims that his general theory is made as a result of a comparative analysis of the different positive legal orders, furnishing the fundamental concepts by which the positive law of a definite legal community can be described.

Further, the subject matters of a general theory of law is the legal norms, their elements, their interrelation, the legal order as a whole, its structure, the relationship between different legal orders and finally the unity of the law in the plurality of positive legal orders. This kind of theory must derive its concepts exclusively from the contents of positive legal norms and therefore must not be influenced by the motives or intentions of regulators or the interests of the individuals to which they are the subject of such law, unless these motives and interests are manifested in the material produced by the lawmaking process. In other words, the general theory of law is directed at a structural analysis of positive law rather than a psychological or economic explanation of its conditions, or a moral or political evaluation of its ends.

Next, what is the Pure Theory of Law? According to Kelsen, the Pure Theory of Law means that such theory is being kept free from all the elements foreign to the specific method of a science whose only purpose is the cognition of law. Further, Kelsen argues that a science has to describe its object as it actually is, not to prescribe how it should be or should not be from the point of view of some specific value judgments. The latter is a problem of politics, and as such, concerns the art of government, an activity directed at values, not an object of science, which is directed at reality.

The Pure Theory of Law considers its subject (law) not as a more or less imperfect copy of a transcendental idea. It does not try to comprehend the law as an offspring of justice. It sees the law not as the manifestation of a super human authority, but a specific social technique based on human experiences. Consequently, it seeks the basic of law, i.e. the reason of its validity, not in a meta-juristic principle, but in a juristic hypothesis, i.e. a Basic Norm, to be established by a logical analysis of actual juristic thinking.

My Notes on Kelsen's Theory of Law

Referring to Kelsen's thought above, I can conclude that a general theory of law focuses only on the structure and content of the law. It analyzes the law as it is and it is neutral, i.e. it does not question and judge the values or ideas contained within a law which is not the concern of a general theory of law. I find this as enlightening, though I understand that some people may find this idea as distasteful, i.e. how can someone claims that a theory of law should be separated from value judgment, the idea of justice, the idea of good? Wouldn't this provide a theoretical support for a despotic ruler to establish laws in accordance with his own wish and interest, without any accountability and any check and balance mechanism?

To tell you the truth, the answers are quite easy. First, a theory of law which depends on value judgment to analyze the law's validity will not work simply because it is impossible to determine a value than can be universally accepted by each and every men. As an example, who can perfectly define the term "Justice"? Even the great John Rawls with his magnum opus "A Theory of Justice," a book that has been prepared by him for more than 20 years, can't provide the perfected idea of justice to which every scholars would agree. The question of justice has been asked even by Socrates and Plato more than 2,400 years ago, and yet we have not resolved such question until today.

There is also a greater reason why Kelsen made such separation. As noted above, Kelsen defines law as a specific social technique made by men, and that definition, in my opinion, becomes the core of the structure of Kelsen's theory. To cut it short, Kelsen's theory is methodological (which is in accordance with Kelsen's ambition to establish a scientific theory of law). As such, Kelsen's theory deals with the method of establishing and operating the law, not the background of why such law was made on the first place.

As a logical consequence of this theory, the existence and validity of the law are no longer attached to morality, justice, religion, history, etc. Rather, a law would be deemed valid if it is created in accordance with the mechanism set out within a legal order/system (Kelsen believes that a law should be established in a coherent legal order/system, i.e. a positive legal order) and derived from a systematic hierarchy of norms, i.e. a law/norm's validity is determined by the validity of the law/norm having a higher level than such norm (this goes on until we reach the hypothetical Basic Norm (Grundnorm) which will be discussed further below).

It is also worth to note that while Kelsen makes such separation in his theory, it doesn't mean that he doesn't care about the value judgment of law. He understand that whether you like it or not, every law in this world must be based on certain value and thus such law can be good or bad, just or unjust. We can't deny that fact. However, Kelsen views this value judgment issues as not an issue of legal theory, but more a philosophical question or political science issue and should be answered by philosophers and political scientists. I would add that economists and sociologists would also be helpful in answering these value judgment questions.

For clarification purpose, while I do make a differentiation between the General Theory of Law and the Pure Theory of Law, they are actually inseparable, i.e. Kelsen's theory of law is a general legal theory purified from any non legal elements. This concludes Part 1 from my planned 3 Parts of Post. In the second part, we will discuss the concept of Norms and the relationship between the efficacy and validity of the law.

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Monday, September 21, 2009

Questioning the Claim of an Eternally Just Law: An Overview of the Aceh Qanun

All right, it has been a while since my last post. I guess I can blame my excessive office workload (made a whopping 64 billable hours last week or more than 12 billable hours a business day) and the Id Mubarak holidays for this blogging non-productive period, eh?

In today's post, we will discuss a very interesting issue that has been debated for centuries without ever being finally resolved, even until today. Yes, we are talking about the validity of the claim that there is an eternally just law in this world that can be applied in whatever situation and condition, an everlasting law that will prevail over any other laws.

Now, is this claim valid, i.e. do we, humans, have this kind of law? Sorry to say, but my quick reply would be no. In my opinion, there is no such thing as an eternally just law, because those that are being called just as of now could turn into unjust the next minute. As long as we don't have a single, complete, and universally acceptable definition of the term "justice," we should say goodbye to the concept of an eternally just law.

However, I am not surprised if many people would disagree with my opinion. We could easily spotted these guys when we are dealing with those who believe in the existence of a perfect God's law that holds supremacy over all kind of man-made laws. Usually, such people also believe that the implementation of the God's law would solve any problem in the society because such law is made by the wisdom and grace of the God that surpass humans' limited capabilities.

There are many variations of laws that could fall under the category of God-made laws, however it is safe to assume that all religious laws could be considered as God laws (of course in this case, the deity to which we call it God will depend on the respective religions). Among these religious laws, I have no doubt that the Islamic law holds the foremost position due to: (i) its huge coverage (almost all aspects of life, private and public, are being governed by the Islamic laws), (ii) its well-established legal system (though the Islamic legal system does not have a single and united codification of laws which is applicable in each part of this world, it has established a generally acceptable legal sources and methods of legal reasoning), and the most important thing (iii) its wide use in various parts of the world (with modifications here and there).

Islamic law is indeed interesting. The fact that there are so many ways in implementing this law and the controversies that surround such implementation amuses me. How could this happen? Similar with other types of religious laws, the implementation of Islamic law often falls under the same trap of too much regulating the citizen's private life. Something that I believe is no longer acceptable in this modern world. In addition, as most devoted believers take as granted that the entire body of the Islamic law is derived from God itself, whether through the Koran or through the Sunnah (words, acts, and silent approvals from the Prophet), the Islamic law faces the chronic problem of inflexibility as these people claim that the provisions of the Islamic law cannot be changed in any condition whatsoever (subject to any waiver that is specifically provided under the Islamic law (rukshah)).

I could agree with the unchanging part if we're talking about the Ibadah aspect of Islamic law, i.e. any acts made as an implementation of the relationship between men and God, such as prayer, (shalat), fasting, and hajj. You can't change the basic rules that there are 5 obligatory shalat times in one day, or that mandatory fasting should be conducted in the Ramadan months. But, it is difficult for me to comprehend if we are also saying that any rules of Islamic law related to the Muamalah aspect, i.e. any private acts of men or any acts made between men, including trading, business, marriage, inheritance, etc, should also be fixed for eternity. The implementation of this kind of law should be made in accordance with the situation and condition of the respective era.

For me, rather than trying to made up the benefit or secret wisdom of this Muamalah related laws, it would be better to deeply analyze whether such laws are still viable for use. That would be more effective. You would be surprised to see how many books and articles were made to support the rule that daughters can only receive half of the sons' share in receiving inheritance, or why women is better staying at home and don't work. And that is not including the various ridiculous reasons contained within those books and articles. To add the problem, those who are trying to make a proper review of these rules will be most likely deemed as unfaithful, unbelievers whose faith in God should be questioned.

This brings us to the issue of the Aceh's Qanun. It is truly unfortunate that the Aceh's Qanun, as a part of Islamic law implementation in Indonesia, cannot outshine its counterparts by creating new development that can show some good quality of creativity. Instead, it stays with the mainstream and therefore brings unnecessary problems.

The Aceh's Qanun is basically a new regulation issued by the Regional Government of Aceh which deals with the penalization of certain acts that are being considered as a crime under the Islamic laws (the one which is specifically adopted by the Regional Government of Aceh since there is no single codification of Islamic laws in this world. See above). For ease of reference, let us call this new regulation as Qanun.

As stated above, the stipulation of this Qanun is very unfortunate and it really saddens me. Here we are in the 21st century, and yet, we are still clinging to the past, again and again trying to bring personal life choices into the public room. As you will see further below, except for rape, sexual harassment, and gambling, this Qanun mainly deals with humans' private actions. The Qanun makers also show a liking to the use of Arabic terms as all of the criminalized actions are named in Arabic (which is quite odd since the Qanun is intended for Indonesians).

These are the criminalized actions in the Qanun: (i) drinking alcoholic beverages, (ii) gambling, (iii) male and female being in a closed/hidden room without any marriage relationship and they are not prohibited from marrying each other (khalwat) (please note that these people don't have to do anything to be punished. Simply being together in a closed room would be sufficient to punish them); (iv) male and female making out (including holding hands together, kissing and hugging) without having a marriage relationship (ikhtilath); (v) male and female having sex outside of a marriage relationship (adultery/zina); (vi) performing male-to-male sex, a.k.a gay sex (liwath); (vii) performing female-to-female sex, a.k.a lesbian sex (musahaqah), (viii) harassing sexually, (ix) raping, and (x) accusing other people of performing adultery without having the minimum 4 witnesses as a valid evidence (qadzaf).

The sanctions for these criminal actions include among others caning, prison, fines in the form of gold and stoning/death penalty for a married person that conduct adultery. Now, I wouldn't discuss why this Qanun can exist under the Indonesian legal system. If you're interested with that subject, I suggest that you should see this nice post here. Instead, I would like to focus on the backgrounds used by the Aceh Regional Government to issue this Qanun including all of its provisions.

In the elucidation of the Qanun, the Qanun makers claim that the Qanun was made as a response to the need of the Aceh's people to implement the Islamic law in their society since Islamic law has been considered as an inseparable part of the Aceh's culture. Further, they also claim that the Qanun was established on four basic principles which include: (i) the rules shall be derived from the Koran and the Sunnah; (ii) the interpretation of such rules shall be made in accordance with the local needs of Aceh people and in the context of Indonesian legal system; (iii) the implementation of such rules shall be made by taking into consideration the future progress and the needs of the 21st century's Indonesian people who are still in the process of development (which cover modern issues such as protection of human rights, gender equality, and technology development); and (iv) the implementation of such rules shall also be guided by the Islamic legal principles of using the best opinions from various schools (mazhab) and finding and developing better provisions.

Comparing to the reality of this Qanun, I must admit that the above principles sound very bombastic, if not misleading (especially for the third principle). I don't see any aspect, even the slightest one, that can be used to say that this Qanun has been made in accordance with the above principles. Well, maybe the Qanun corresponds with the first principle, but surely the makers are not paying any attention to the other three principles.

And to complete the irony, the Qanun makers were also hoping in the Qanun's elucidation that the implementation of this Qanun (in accordance with the above principles) can reflect a law that could bring justice and prosperity to the entire society (rahmatan lil alamin). Nice try and keep dreaming sirs.

Come on, how can we say that a law that permits a married person to be killed by stoning due to adultery can be considered as a law that brings prosperity? I can agree if the state would like to punish this kind of person (and by the way, we do have this kind of provision in our Penal Code), but killing the person? That's outrageous.

What make it worse is the fact that the Qanun does not provide any clear mechanism for evidencing the adultery, whereas in the classic Islamic law, an adultery case can only be validly proofed if there are 4 witness who clearly see such act, i.e. a penis is being inserted into a vagina. In fact, it is so hard to implement this rule, that the only known case where a person is being stoned for conducting adultery is a case where a pregnant woman came to the prophet and acknowledged that she has conducted an adultery. The prophet himself has ordered this woman to go home since there is no clear evidence that she has indeed conducted an adultery (even though she is pregnant). But the woman insisted and after more than 2 years of begging to be stoned, she actually got what she wanted, which only happen after she gave birth and taken care her child for some time.

Why do we still insist of using this rule? On a bigger scale, why do we even consider to use the rules that were established a long time ago and might not be relevant anymore in this era. Maybe, it would be effective in the past to control the society by fear. It is not a secret that 1,400 years ago the arab people were living in a barbaric era. Of course they would need to have a law that can impose fear to them and make them obey such law. But now?

I would even dare to say that this law is inefficient! Why bother to find people who are being together in a closed room or are making out somewhere and then punish them? Are we trying to deplete our resources to finance these useless acts? Or assuming that an adultery case is validly evidenced, should we stone the convicted to death? Who will bear responsibility for the family left behind? The state by using the money of the tax payer??? This is utterly ridiculous and the Qanun simply doesn't meet the test of a law that can bring global prosperity to the society, well, unless the Qanun makers believe that the prosperity will come since God will bless Aceh and Indonesia for implementing the Qanun. Again, keep dreaming sirs. The real fact is clear, this Qanun brings unnecessary costs and fear to the society.

I believe that this is the right time for us to bring an end to the claim of an eternally just law. In this modern era, a law or a policy should be made in accordance with the people needs and should be implemented in the most effective and efficient way. A good law shall prevail without much hesitation, but a bad law can only prevail by using force which would be costly. For Islamic law, it would be useful if we start to review the current rules and determine whether such rules would still be applicable. We need to remember that since Koran or Sunnah cannot be changed forever, the law contained within should be flexible and it is our task to make a better interpretation. When man-made laws are wrong, we can always amend them, but we can't amend the content of the Koran and/or Sunnah. The content will always be the same but the implementation should depend on the actual condition. Only by making it flexible that we can ensure the survivability of the Islamic law, or else, I fear that in the future, the Islamic law shall only be regarded as a part of the forgotten history.

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Monday, September 14, 2009

A Phony Market Oriented Law: Some Critiques on the New Electricity Law

I have grown tired with the absurdity of some of the laws that have been passed recently by the Indonesian House of Representatives ("DPR"), particularly the laws on film and electricity (thanks to Mova for the link on Electricity Law). I won't make a review on the new Film Law as Rob Baiton has made an excellent summary and review on such law in his post here. So, I'll go with the new Electricity Law instead.

The Current Nature of Indonesian Electricity Business

Now, before we go forward with the review, we need to understand the nature of electricity business in Indonesia. First of all, in Indonesia, and probably in the majority parts of the world, electricity has been considered as a public utility, which means that it is also a political commodity. I'll discuss further below on the implication of electricity status as a political commodity.

As you might be aware, there is only one electricity provider in Indonesia, PT PLN (Persero) ("PLN"), an Indonesian state owned company, that has been deemed by the Government to provide public service obligation in the electricity sector. As a public service company, PLN has the first priority to establish electricity business in Indonesia and may receive Government supports in order to run its business, including to receive subsidies to replace any costs of PLN for performing such public task.

Under the old Electricity Law (Law No. 15/1985) and its implementing regulations, the electricity business is actually opened to private enterprises, and to certain extent these companies can also directly sell and distribute their electricity to end consumers. However in practice, most private enterprises sell their electricity to PLN and then PLN shall sell and distribute such electricity power to the people. Arguably, this is not efficient for business purposes, but as will be discussed further, I tend to believe that this is the best option in Indonesia, at least until we have a better solution.

Issues on Electricity Price

Historically, the electricity price is always determined by the Government, which makes sense when we considering the nature of electricity as a political commodity. Since politicians need to maintain their votes, most of them would try to make the electricity price as low as possible by all necessary means, even if such means are not economically viable. What is the easiest option for the Government then? Subsidizing the electricity price. It causes a considerable amount of pressures to our Stated Budget, but hey, who cares as long as the people is happy, right?

Who is the main victim of this policy? PLN. For years PLN has been operating in loss, not because they are not efficient but because they cannot sell their electricity in accordance with the market price or at least a price that can cover their basic costs. Though I understand that now some type of industries must purchase electricity from PLN on a market based price, the majority of ordinary citizen like us pay the subsidized price of electricity.

The other victims of this policy are of course private enterprises. As long as there is a subsidy, market price wouldn't work, and thus there are not many incentives for private enterprises to enter into this business. Even worse, there is also a price control for selling electricity to the end consumers. So, the least thing that they could do is to sell electricity to PLN and hoping for a better price which is of course still higher than the subsidized price.

Review on the New Electricity Law: The Government Misunderstanding of The Market



At a first glance, it seems that the new Electricity Law is a market oriented law. The law unbundles the electricity industry by separating electricity business into electricity generation, transmission, distribution, and sale businesses, and opens the opportunities for regional companies and private enterprises to enter directly into the electricity business in certain territories of Indonesia (provided that PLN doesn't have the capacity to establish and run an electricity business in such territories). So, under the new Electricity Law, private enterprises can now sell their electricity to end consumers. Seems a very market oriented law to me, but is it true? Now, before people go to the Constitutional Court and wasting their time asking the Court to deem this Law as unconstitutional due to its market oriented policy, I suggest that those people should look further into this new Law and compare it with the old one, so that they can realize that this Law is indeed one of the greatest blunders of all time.


Yes, all of the concepts provided in the new Electricity Law has been already regulated in the old Electricity Law and its implementing regulations. If there is an actual change, that must be the fact that the new Eletricity Law combines the concepts in the old Electricity Law and its implementing regulations into one Law, and yeah now the new Electricity Law opens the possibility of local governments to join the mess. Good job, DPR, good job.


Further, apart from the introduction of regional government in determining the price of electricity, there is no change to provisions on electricity price control. Articles 33, 34 and 35 of the new Electricity Law clearly state that any electricity generating business license holders cannot sell their electricity to the consumers without having secured approvals from the Government or local government. The law does state that the price of electricity should be based on healthy market practice, but what the use of having this provision if in the end the price should be approved first by the Government or local governments?


In my opinion, the above articles render this new Electricity Law to become useless if not bring unnecessary problem. The reason why we open a business to the market force is to let business players compete and create competitive prices that benefit the consumers. But that wouldn't happen if the prices are still being controlled! As long as the politicians care about their votes in the next election, who would willingly let the electricity price goes to the market? They all know already that the current price of electricity is lower than the actual market price.


In other words, there would be no incentives for business players to enter into electricity business and start directly selling their electricity to consumers if they cannot enforce market price. The only way that this policy will work is if the Government/local governments subsidize the price of electricity generated by private enterprises in order to cover their costs. However, this will create additional paper work and in overall would not be efficient.


I bet that the private enterprises would rather stick to the old ways, i.e. they sell their electricity on a market price basis to PLN (theoretically it's not a truly market price, but it is still the best option) and then PLN will sell such electricity to the people in subsidized price. Everyone would be happy and the Government will not have to be bothered by dealing with entities other than PLN with respect of subsidy.


Some Thoughts on Indonesian Electricity Business
I think this is the time for the Government to be consistent in issuing its policies. The Government can't expect that private enterprises would be amused by this mumbo jumbo government-market synchronized regulation. It doesn't create harmony, it creates discord! If we want to stick with market oriented policy, we would need to let it work based on market principles, the price should not be fixed anymore and the most efficient company will emerge as the winner from the competition.


But come on, can we do that? I'm not sure that we can quickly change our policy after having so many years running the electricity business as we have it today. That would be suicidal. In my mind, rather than creating a fake opening of business opportunities, the Government should focus on helping PLN to become a more efficient company, which means that PLN can reduce the costs of its electricity generating, cutting its actual price and therefore would enable the Government to reduce the subsidy in the long run. How can the Government help? Well, some have been done such as the Fast Track program where the Government acts as a guarantor for PLN's financial obligations for establishing coal fired power plants. The Government can also provide tax incentives to PLN or build new infrastructures to be injected to PLN's equity as a payment in kind. Of course this will cause the Government to bear additional costs in the short run (since they will also need to pay the subsidy), but in the long run, if PLN can improve its efficiency, all of us, including the Government, would receive the benefit. I would love to see the implementation of market principles in the electricity sector, but now is not the right time.

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Thursday, September 10, 2009

The Indonesian Cigarettes Chronicles: A Quick Review on the Latest Constitutional Court's Decision

Today, the Constitutional Court issues its decision on the Judicial Review of Article 46 Paragraph 3 (c) of Law No. 32/2002 on Broadcasting ("Broadcasting Law") which basically deals on the constitutionality of the provision of a Law that allow cigarettes advertisement in broadcasting media. You can see the complete 306 pages decision here. The constitutional claim was made by among others the National Committee of Child Protection and the Child Protection Agency of West Java.

From my quick reading of the decision, I can conclude that the main target of this claim is to banish all type of cigarettes advertisement in Indonesian broadcasting media by claiming that the above provision of the Broadcasting Law is contravening with Article 28B paragraph (2) (the right of each child to live, grow, and develop, and to earn protection from violence and discrimination), Article 28A (the right of each person to live and maintain its life), Article 28C paragraph (1) (the right of each person to develop himself through satisfaction of basic needs) and Article 28F (the right of each person to communicate and obtain information to develop himself and his society) of the 1945 Constitution.

In its decision (by 5 to 4 vote, which means that it is a very close decision), the Constitutional Court rejects such claim entirely based on the following reasons: (i) cigarettes industry is still a legal and valid industry in Indonesia and therefore has the same right with other industries to promote and make advertisement on its business activities; (ii) there is already a strict regulation on cigarettes advertisement in Indonesia and therefore, if there is a violation to such regulation, such violation must be handled through the mechanism stated by the relevant regulation, i.e. it is not an issue on the constitutionality of the disputed provision, rather an issue on the implementation of a regulation; (iii) it is not clearly evidenced that there is a causality between cigarettes advertisement and the inability of a person to develop himself and his life; and (iv) even if cigarettes advertisement in broadcasting media is deemed unconstitutional and therefore must be banned, it won't affect the ability of the cigarettes company to use other media and mechanism to promote cigarettes and therefore it would not be effective to deemed such provision as unconstitutional and it wouldn't be fair to the cigarettes industry, i.e. why are they being prohibited to advertise in the broadcasting media only?

How about the dissenting opinion? It's quite simple, they discuss the danger of cigarettes and their bad effect to the youth and also the fact that while the advertisement of any other addictive substance is prohibited in the broadcasting media, the advertisement of cigarettes (which could definitely be considered as an addictive substance) is not prohibited as long as the advertisement does not involve any visualization of cigarettes. Therefore, in their opinion, advertisement of the cigarettes in the broadcasting media should be deemed unconstitutional and should be prohibited.

I tend to support the Constitutional Court official decision. However, before I discuss my reasons to support the decision, let me tell you that I'm not a fan of cigarettes, in fact, I hate them. I can't breath normally when cigarettes are all around, they cause bad odors and will definitely ruin your health. I guess everyone knows that, after all each cigarettes advertisement contains a warning on the danger of smoking and its negative effect to human's health.

So why do I support the Constitutional Court decision? Simply because from legal point of view their analysis is correct. If the Government declares that an industry is legal to be established and operated in Indonesia, why prohibit such Industry to develop its business here, including making advertisements through various broadcasting medias? Such advertisement prohibition would be nonsense and it would be better if from the first place the Government banned the entire cigarettes industry in entirety. Further, it is also correct that rather than arguing the constitutionality of the advertisement of cigarettes in broadcasting media, it would be better to focus on enforcing the regulation on cigarettes advertising. You know, there are already many regulations in Indonesia which deal with the danger of cigarettes and the proper advertising mechanism for cigarettes. Why don't we improve these regulations instead?

Though I would love to see the banning of cigarettes in Indonesia, we need to look at a bigger picture here, as long as the benefit of having cigarettes industry in Indonesia is higher than the costs of having such industry, there would never be an end to the Indonesian cigarettes industry. The case becomes more difficult since the benefit of having the industry is easier to calculate, i.e. the amount of Government income from cigarettes duty and levies, the huge income of most of the cigarettes companies, and the amount of worker which are involved in this industry, compared to the costs of having such industry, i.e. bad development for the youth and public health which is very hard to calculate.

If we really want to prevent people from smoking in Indonesia, I would suggest that rather than prohibiting the development of the business which may also negatively affect the whole economy, we should build an industry which can provide the substitution of cigarettes in a more efficient way and can be easily accessed by all people, such as chewing gum or therapic medicines. If the Government really cares with the quality of life of its citizens, it can encourage the development of this cigarettes substitution industry by providing some incentives such as tax cut, subsidy, easier licensing, etc. Of course continuing education for the people on the danger of smoking would be always needed.

We can also use one of the most famous legal principle, i.e. people must be responsible for the externalities of their acts, or in a less complicated way, if you cause loss to other people, you need to be responsible to such loss and pay the damages. To certain extent, this has been reflected in our current regulation on cigarettes, i.e. this industry pays a huge amount of money to the Government in the form of tax and duties in order to run their business. Further discussion can be made on what kind of policy that need to be established in order to implement this principle.

In the end, our goal here is to replace the cigarettes industry through several stages in order to ensure that the transition would be smooth and would not adversely affect our economy. Remember, there are many stakeholders in this industry, and there is no easy answer when dealing with cigarettes industry. Let us hope that we can find a better solution in the future.

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Monday, September 07, 2009

On Why the Negative List Should Stay Away from Publicly Listed Companies

Let me start this article by explaining the basic concept of the Negative List. It is a regulation issued by the President of the Republic of Indonesia stipulating the area of business which are opened (with certain requirements) or closed to foreign investment in Indonesia. The main reason for Indonesia in having this Negative List is to close or limit any foreign investments in industries which: (i) are being prohibited in Indonesia, such as gambling; (ii) are being considered as strategic for the interest of Indonesia; and (iii) are being reserved for small to mid scale business players.

In short, except for point (i), the Negative List can be considered as a protection mechanism imposed by the Government of Indonesia. Is it good? I must admit that I'm not a huge supporter of the Negative List, as I don't believe that restriction of ownership would be effective to protect the what so called interest of the people of Indonesia.

Up until today, it is generally assumed that the Negative List is not applicable for publicly listed companies. The Negative List is not quite clear on this issue, but at least Law No. 25/2007 on Capital Investment ("Investment Law") states that the provisions of the Investment Law are not applicable for any indirect or portfolio investments, whereas the majority of Indonesian legal scholars interpret that indirect or portfolio investments refer to investment in the capital market, i.e. in publicly listed companies. Therefore, as a logical consequence of this interpretation, the Negative List (in its capacity as one of the implementing regulations of the Investment Law) should not be applicable to publicly listed companies.

However, recently I've heard a shocking news, i.e. there are some discussions within Government officials that the Negative List will be revised in order to cover publicly listed companies. If such plan is executed, foreign investment limitations will also be applied to publicly listed companies. Clearly, I oppose this plan and my reasons shall be further discussed below.


First of all, how can the Government limits foreign ownership in the shares of publicly listed companies? Those shares are listed on the Indonesia Stock Exchange and are effectively being traded (at least most of them). Some of the most active shares are even being traded by each second. While it is possible to control the sale of shares in an Initial Public Offering, it is almost impossible, if not entirely impossible, for someone to control or limit parties in purchasing the shares of a publicly listed company in the secondary market, unless such purchase is considered as a change of control, i.e. takeover.

Even if it is somehow possible to limit the foreign ownership in the secondary market, any attempt to maintain such limitation would be mostly inefficient since it will require a great monitoring mechanism. Under the current technology, such mechanism would be very costly. You want to supervise all transactions and then impose a system which will limit the purchase of shares by foreigners if certain thresholds have been satisfied? And then you want the monitoring system to operate on per second basis? I say, tough luck.

A possible restriction mechanism that can be applied is by limiting the amount of shares that can be offered to the public. However, this is not recommended because such restriction may negatively affect the liquidity of the shares of such company and as a result of which, the public may suffer unnecessary losses.

Second, an attempt to limit foreign investments in the capital market might cause a turbulence within the capital market. I understand that some people might regard this risk as a theoretical risk rather than an actual risk, but I wouldn't be too confident if I were them. Like or not, in most of the time, capital market is driven by fear and greed. Announcing to the public that foreign investment limitations will be applied to publicly listed companies is a very good way to cause unnecessary fear within market players. And believe me, the imaginations are unlimited, foreign investors may think that the market condition is not conducive anymore, some of them will think that their investments will be reduced or they will be forced to divest their shares, etc. In any case, it wouldn't be good for most of the time!

Third, with respect to foreign investments, most Indonesian regulations do not differentiate the ultimate ownership of foreign entities who made investment in Indonesia, i.e. whether the ultimate owners of such foreign entities are truly foreigners or Indonesians. You may be aware that many Indonesian business entities use foreign companies as their investment vehicle in the capital market, which is mainly done for tax purposes.

As a result of the above policy, any investment made by foreign entities in Indonesia will be considered as foreign investments regardless of the ultimate ownership of such entities. Applying this limitation to publicly listed companies would be counterproductive because it may also jeopardize the interest of Indonesians who made their investments through foreign entities.

In addition, as stated above, is having an ownership restriction would be an effective way to protect the interest of the Indonesian people? By all means, capital investment, whether made by foreign or domestic entities should be good for the development. If we want to have the full benefit of such investment, forget about the ownership, or at least put it as the last issue to be considered. The most important issue that we need to achieve through foreign investments is how we can actually "force" those foreign investors to transfer their knowledge to their Indonesian counterparts and how these foreign investments will contribute to the greater good of the society, i.e. creating job opportunities and establishing infrastructure for stronger industry in Indonesia. Shares ownership would be useless if the Indonesian counterparts are not capable to conduct the business as they will end up as puppets of the foreign investors. Surely, this is not something that we want.

Now, if the Government insists that this new regulation will be applied, I will suggest that: (i) the limitation will only be applied to publicly listed companies established after the enactment of such regulation, so all publicly listed companies prior to the enactment will be exempted and their shares are free from any foreign ownership limitations; (ii) the limitation (if any) should only be applied to foreign investors who clearly control the relevant publicly listed companies (under the current Bapepam-LK regulation, a party will be deemed as a controller of a publicly listed company if it owns at least 50% of the shares of such company).

My advice to the Government, stop trying to make politically correct acts, you won the election with a considerable support from the voters, so please focus on making the best policy available rather than trying to look like a populist government which is a shame.

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