MFA 3053

ISLAMIC CAPITAL MARKET

Shariah Compliance Stocks

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Objectives

01 Illustrate the various ways of

Shari’ah screening of stocks.
.

02
Identify the development of indices
in Islamic capital market.

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Modern Company and Capital Structure

Unincorporated
Incorporated vs joint stock companies

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Business Life Cycle

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SM – owned family 100% - 1m ---16.6%
IPO – open to the public – 5m
6m = total shares

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Shariah Discussion
‘al Ghorm bil Ghonm’
“NO REWARD WITHOUT RISK”

• Capital gains and dividend

• Musharakah – profit is not guaranteed
• 4 types
• Musharakah vs joint stock (shares)
Shareholders = getting profit at the end
Sukukholders / creditors = company debt _ profits

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Shariah Issues
1) Limited Liability and Legal Personality (shakhsiyyah I’tibariyyah) vs
musharakah
2) Joint Stock Company
3) Type of Company
That which is independently impermissible becomes permissible when done in
conjunction with the permissibility.
General need takes the ruling of specific necessity.
Majority has the ruling of the whole.
What is inescapable is tolerable.
4) Trading of Shares
 Permissible or not?
 Gambling and speculation
 Short selling

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Types of Shares
Ordinary share
Dividend paid after pref.s/holders & sukuk holders
Voting

Preference Shares
Cumulative and Non-Cumulative Preferred Shares
The OIC Islamic Fiqh Academy in its 7th session held in Jeddah in 1992 likewise declared:
• It is not permissible to issue preference shares with financial characteristics that
involve guaranteed payment of the capital or of a certain amount of profit or
ensure precedence over other shares at the time of liquidation or distribution of
dividends.
• It is however, permissible to give certain shares certain characteristics as related
to procedural or administrative matters

Rights Issues
Bonus right
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Issuance of Stocks and Initial Public Offering

• Issuance must be in accordance with Prospectus Guidelines –Public

Offering –provided by Securities Commission (SC)
• Requirement for necessary information in the prospectus, as follows;
i. Report by experts with date and return consents before issuance
of prospectus
ii. A prospectus must comply with SC Act 1993 (Act 498)

Private (no annual report) = Public (Prospectus)

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Issuance of Stocks and Initial Public Offering

• The company can sell new equity to investors to raise new

funds (primary offering)
or
• existing owners (i.e. a founder or venture capitalist) can sell
some or all of their share (secondary offering).

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IPO Methods

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STOCK SHARIAH
SCREENING
Criteria of Shariah Compliant Stock
Underlying instruments should not come from interest bearing elements
and free from other prohibited activities
Must be structured according to Shariah

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Shariah Screening Process
There is not an easy task to find company that we
can say as clean 100% most companies today
transact with interest, particularly with regard to their
financing.

 Additionally, companies may be involved in a mix of

Sharīʿah-compliant and Sharīʿah non-compliant
activities.

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Core Screening

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Scenario
• Are these companies Sharīʿah-compliant?
• Scenario 1
• A major supermarket chain sells a range of food, drinks and other products.
Some of these goods are alcoholic beverages, porcine products and car
insurance.
• Scenario 2
• An IT company produces software to be used by banks and financial
institutions in conducting their business transactions.
• The company distributes this software to both Islamic and conventional
financial institutions. When developing the software, it was tailored according
to the specifics of the respective financial transactions of these institutions.
The transactions conducted by conventional banks inevitably involve
charging or paying interest.
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Scenario
• Scenario 3
• A satellite corporation provides the platform for broadcast companies to have
a channel. A few of these broadcast companies offer pornographic media.
• Scenario 4
• A stationery company produces emblazoned pens, pencils, paper and other
items specifically for a company that offers gambling services.
• Scenario 5
• A beverage company has been successful in selling soda beverages since its
inception six years ago. It has recently decided to expand its service line to
sell high-end alcoholic beverages to selected clientele.
• Scenario 6
• A shopping mall developer rents out space to businesses. Along with tenants
involved in Sharīʿah-compliant businesses, it has also leased the property to
Sharīʿah non-compliant businesses.
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Malaysia: Two types of Screening
Business Screening – core screening
(nature of business)

Financial Screening –financial obligations

activities

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Previous screening method

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(I) Business Screening
■ Sale and manufacturing of alcohol
■ Gambling, gaming, casino operations
■ Conventional interest-based finance including insurance
■ Pornography
■ Sale and production of pork-related products and non-ḥalāl
meat
■ Other non-permissible activities (including Sharīʿah non-
compliant entertainment)

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 SCREENING APPROACH :
SECURITIES COMMISSION, MALAYSIA 1995 VS 2013

https://www.sc.com.my/regulation/regulatory-faqs/frequently-asked-questions-on-
revised-shariah-screening-methodology
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(II) Financial Screening
Indebtedness
Total conventional debt/total assets
33%> = non-compliant

Cash and receivables

Cash and receivable / total assets

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Approach

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Issues
Information

Change of Business Focus

Customer exclusivity

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 DIFFERENT SCREENING APPROACH :
SECURITIES COMMISSION
• Business Screening
• Income from the following impure sources cannot exceed 5% of revenue:
• ■ Alcohol
• ■ Pork-related products
• ■ Conventional financial services
• ■ Entertainment (hotels, casinos/gambling, cinema, pornography, music)
• ■ Tobacco
• ■ Weapons and defence
• Financial Screening
• ■ Total debt divided by trailing average market capitalisation should be less than 33%.
• Total debt includes: Short-term debt plus current portion of long-term debt plus long-term debt.
• ■ Cash and interest-bearing securities divided by average market capitalisation should be less than 33%.
• ■ Accounts receivables divided by trailing average market capitalisation should be less than 33%.
• Receivables include current receivables plus long-term receivables.
• Note: Average market capitalisation could be based on 12, 24 or 36 months trailing average market
capitalisation depending on the volatility of the market. The more volatile the market is, the longer
duration is used for calculating the average. This ensures stability of the indices.

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 SCREENING APPROACH :
SECURITIES COMMISSION VS DJIM

https://www.sc.com.my/development/islamic-capital-market/list-of-shariah-compliant-securities-by-scs-shariah-advi
sory-council

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 DIFFERENT SCREENING APPROACH :
AAOIFI
Participation in the shares of a corporation whose primary activities are Sharīʿah-
compliant is allowed based on the following conditions.
• Business Screening
 That the company does not state in its memorandum of association that its
objective is to deal in interest, or in prohibited goods or materials like pork and
others.
 That the total amount of income generated from such prohibited activities should
not exceed 5% of the total Income of the corporation.
• Financial Screening
 Total long- and short-term debt divided by market capitalisation is less than 30%
 Total interest-bearing securities divided by market capitalisation is less than 30%
 Interest income divided by total income or total revenue is less than 5%
 Cash and receivables divided by total assets is less than 70%

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PURIFICATION=PURGING
AAOIFI advocates the following method for purification:
1. Identify the total number of common shares of the company.
2. Divide the total prohibited income by the total number of shares
issued to get non-compliant
Non compliant income/ total numbers of shares = non-
compliant for 1 unit dividend per share.
3. Multiply these by the total number of shares owned by the
investor.
Your holding* non-compliant for 1 unit= final amount
4. This final amount should be reduced from the dividends.

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AAOFI: How to Calculate Amount of Purification?
(Interest Income/Total Outstanding Shares)*(No. of Shares Held at Year-end)
Example:
Let us assume a company, XYZ Private Limited, has Total Income of USD 500,000 million, Total
Expenses of USD 470,000 million, Profit before Tax (PBT) of USD 36,500 million, Tax of USD8,500
million and Profit after Tax (PAT) of USD 28,000 million. The Total Interest Income of the company is
USD 2,000 million and the Total Outstanding Shares are 300 million. Assume an investor purchases
10 million shares of XYZ Private Limited and holds the same for six months. Let us assume a
company, XYZ Private Limited, has Total Income of USD 500,000 million, Total Expenses of USD
470,000 million, Profit before Tax (PBT) of USD 36,500 million, Tax of USD8,500 million and Profit
after Tax (PAT) of USD 28,000 million. The Total Interest Income of the company is USD 2,000 million
and the Total Outstanding Shares are 300 million. Assume an investor purchases 10 million shares of
XYZ Private Limited and holds the same for six months. Let us assume a company, XYZ Private
Limited, has Total Income of USD 500,000 million, Total Expenses of USD 470,000 million, Profit
before Tax (PBT) of USD 36,500 million, Tax of USD8,500 million and Profit after Tax (PAT) of USD
28,000 million. The Total Interest Income of the company is USD 2,000 million and the Total
Outstanding Shares are 300 million. Assume an investor purchases 10 million shares of XYZ Private
Limited and holds the same for six months.
(Mufti Abdul Kadir Barkatullah*S. M. Wasiullah, 2016)

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Amount = (2,000/300)*(10)
= (6.67)*(10)
= USD 66.7 million

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Disposal (SC Malaysia)
How to Dispose Of Shariah Non-Compliant Securities?
1) “Shariah-compliant securities” which are subsequently re-classified as “Shariah non-
compliant”
• These refer to securities which were earlier classified as Shariah compliant but due to certain
factors such as changes in the companies’ business operations and financial positions, are
subsequently reclassified as Shariah non-compliant.
• If on the date the updated list takes effect (28 November 2014), the respective market price of
Shariah non-compliant securities exceeds or is equal to the investment cost, investors who hold
such securities must dispose them off. Any dividends received up to the date of the
announcement and capital gains arising from the disposal of Shariah non-compliant securities on
the date of the announcement can be kept by the investors.
• However, any dividends received and excess capital gain from the disposal of Shariah non-
compliant securities after the date of the announcement should be channelled to baitulmal and/or
charitable bodies.
• Market price of the said securities is below the investment cost. It is also permissible for the
investors to keep the dividends received during the holding period until such time when the total
amount of dividends received and the market value of the Shariah non-compliant securities held
equal the investment cost. At this stage, they are advised to dispose of their holding.
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Disposal (SC Malaysia)
In addition, during the holding period, investors are allowed to subscribe to:
a) any issue of new securities by a company whose Shariah non-compliant securities are held
by the investors, for example rights issues, bonus issues, special issues and warrants (excluding
securities whose nature is Shariah non-compliant e.g. loan stocks); and
b) Shariah-compliant securities of other companies offered by the company whose Shariah non-
compliant securities are held by the investors, on condition that they expedite the disposal of the
Shariah non-compliant securities.

2) Shariah non-compliant securities

The SAC advises investors who invest based on Shariah principles to dispose of any Shariah non-
compliant securities which they presently hold, within a month of knowing the status of the
securities. Any gain made in the form of capital gain or dividend received before or after the
disposal of the securities has to be channelled to baitulmal and / or charitable bodies. The investor
has a right to retain only the investment cost.

Taken from the document; “List of Shariah-compliant Securities” as at 28 November 2014

by the Shariah Advisory Council of the Securities Commission Malaysia
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CASE STUDY 1

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CASE STUDY 2 : SUMMARY

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STOCK INDEX
An index is a single measure that uses this
information and reflects the performance of the
entire market providing instant assessment for the
investor, and saves much time and effort.

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SHARIAH ISSUES
• Tanazul
• Non-cumulative dividend vs cumulative (Preferred
stock)
• Mix income – purification approaches?

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Tutorial
Lecture Ques:

List five Shariah compliant companies using the current SC listing, and identify
their business activities.

Pls do in group, and respond through tele group.

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