Equity

ISLAMIC EQUITY MARKET, SHARIAH STOCK
SCREENING & PREFERENCE SHARES

Prof Dato Dr. Mohd Azmi Omar
azmiomar@iium.edu.my
Level 4 Administration Building, International Islamic University Malaysia
53100 Gombak
Selangor Malaysia
2
Contents
Principles of Islamic equity investment
Islamic view on Ordinary share
Development in the Malaysian Islamic Capital Market
Islamic Equity Market
Shari'ah Compliant stocks in Bursa Malaysia
Screening Methodology for Shari'ah-Compliant Stocks
Securities Commission of Malaysia
Dow Jones Islamic Market Indexes
Dow Jones-RHB Islamic Malaysia Index
FTSE Global Islamic Index Series
S&P Shariah Indices
Guidelines on investment in Non-Shari'ah compliant securities
Preference shares
Convertible bonds
3
Principles of Islamic equity investment
Prohibition of riba (no guaranteed fixed return)
Prohibition of gharar (uncertainty withy deceit)
and maysir (gambling)
Primary business activity must be in line with
Shariah
Majority of assets must be illiquid
Non-permissible income must be below a
specified threshold
4
Speculation & Gambling
Stock Market provides the avenue for firms to
raise funds, for investor to invest their surplus
funds.
One needs to predict the future value of stock
prior to making any decision to buy or sell the
stocks
Is speculation gambling?
The Quran clearly prohibit us from gambling as
illustrated by the following verses relating to
games of chance or gambling, referred to in
Arabic as maysir; Allah SWT says;
5
They will ask thee about intoxicants and games of
chance. Say: In both there is great evil as well as some
benefit for man; but the evil which they cause is greater
than the benefit which they bring." Quran (2: 219)
The Messenger of Allah (SAW) also forbade us from
gambling as illustrated in the following Hadith;
From Abu Hurayrah (RA), that he said, "The Messenger
of God (S) forbade the 'sale of the pebble' [hasah] [sale
of an object chosen or determined by the throwing of a
pebble], and the sale of al-gharar. [Sahih Muslim]
6
Ibn Taymiyahs opinion on the above Hadith is that
gharar as the consequence of which is unknown and
goes further to claim that selling it involves maysir, which
is gambling. Maysir or gambling is prohibited in Islam
because it causes enmity and hatred and also involves
consuming property bi-al-batil, which is a type of
oppression. Being given the obvious prohibition of
gambling in both the Quran and the Hadith of the
Prophet (SAW), it is of utmost importance to determine
whether speculation in the stock market is similar to
gambling
7
Kamali (1996) defines speculation as consisting of "the
intelligent and rational forecasting of future price trends on the
basis of evidence and knowledge of past and present
conditions".
Based on the Quranic verses and the Hadith of the Prophet
(SAW), Ibn Taymiyah (ra) pointed out that if a sale contains
gharar and devours the property of others, it is the same as
gambling, which is clearly forbidden. Therefore, for a
transaction to be equated to gambling, it must involve the
devouring and unlawful appropriation of the property of others.
Speculative risk taking in commerce, which involves the
investment of assets, skills and labor is not similar to gambling.
This is because the buyer is engaged in a transaction aimed at
making profit through trading and not through dishonest
appropriation of the property of others.
8
El-Ashkar (1995) defined speculation as "the practice of
a) using available information to
b) anticipate future price movements of securities so that
c) an action of buying or selling securities may be taken with a
view to
d) buying or selling securities in order to
e) realize capital gains and/or maximize the capitalized value of
security-holdings.
It is a process that relies on the analysis of a lot of
economic and financial data, companies' financial reports,
political decisions, information about management skill and
aptitude and the personal profile of the decision makers.
That is to say, speculation is an activity that requires a great
deal of knowledge and skills. Therefore, speculation in
stock markets cannot be equated to gambling.
9
The sale of gharar is said to lead to maysir
(gambling) which leads to oppression and is
therefore prohibited in Islam. It is evident that
gharar is not present in speculation in stock
markets as each party is clear to the quantity,
specification, price, time and place of delivery of
the object. Moreover, the object of the transaction,
which is the purchased security, is available in the
market at the time of transaction and is, bound to
be available at the time of delivery. Therefore,
speculation has no element of gharar and, hence,
does not lead to maysir.
10
Pro and Cons of Speculation
The above discussion has proved that although
speculation in the stock markets may look like gambling,
yet it is by no means similar to gambling.
Its positive side is that it can help stabilize prices and
activate a market where there is thin trading. It can also
provide signals to less-informed investors upon which to
act.
The negative effect of speculation is that excessive
amount of it may cause volatile price movements in the
market. It can thus be concluded that excessive
speculation should not be allowed, but a reasonable
degree of it be permitted. Quantitative limits on daily
trading volume and legislative guidelines may help
contain speculation within healthy bounds.
11
Fiqh View of Investing in Ordinary Shares
Permissible
if the main business of the company is in
compliant with Shariah rulings, then to
purchase, hold or sell its shares is permissible
even if the company was to undertake
prohibited activities such as borrowing money
and/or invest its money on the basis of interest,
the company can still be invested provided they
fulfil certain criteria. (Islamic Fiqh Academy,
1992)
12
Each and every action of the company cannot be
attributed to every shareholder in his/her individual
capacity
A shareholder may raise his objections to certain
company transactions that may run contrary to Shariah
during the annual general meeting but these objections
may be overruled by the majority of the shareholders
the responsibility of committing a non-halal activity such
as borrowing and investing money on the basis of
interest lies with those who commit such acts, it does not
render the whole company to be non-halal or non-
permissible
13
(source: Securities Commission Malaysia)
YEAR MILESTONES
1990 Shell MDS Sdn Bhd issued the first Islamic bond
1993 Arab-Malaysian Unit Trust Bhd issued the first
Islamic equity unit trust fund (Arab-Malaysian
Tabung Ittikal)
1994 BIMB Securities Sdn Bhd, the first full-fledged
Islamic stockbroking company, was established
14
1995 Securities Commission (SC) Malaysia established the Islamic
Capital Market Unit
1996 SC established the Shari'ah Advisory Council (SAC)
Rashid Hussain Bhd (RHB) launched Malaysias first Islamic
equity index, comprising Shari'ah compliant shares of Bursa
Malaysia main board companies
1997 Khazanah Nasional Bhd launched the Khazanah Murabahah
Bond, which is a zero coupon bond based on murabahah and
bai al-dayn concepts
SC launched an official SAC list of Shari'ah compliant
securities that are traded on Bursa Malaysia. The list is
updated every April and October
15
1999 Bursa Malaysia launched Malaysias second Islamic equity
index, the Kuala Lumpur Shari'ah Index (KLSI), comprising
all Shari'ah compliant shares of Main Board companies
2000 SC imposed the requirement for issuers of Islamic bonds to
engage independent Shari'ah advisers, as stipulated in the
Guidelines on the Offering of Private Debt Securities
RHB Unit Trust Management Bhd launched the first Islamic
bond fund
SC launched a dedicated Islamic Capital Market section on
its website
2001 The Capital Market Masterplan was launched. One of the
strategic initiatives was to establish Malaysia as an
international Islamic capital market centre
16
2002 Kumpulan Guthrie Bhd issued a US$150 million sukuk ijarah;
the first global corporate bond issue. It was listed on the
Labuan International Financial Exchange
Malaysian government issued a worlds first global sovereign
Islamic bond, sukuk ijarah, worth US600 million
SC imposed the requirement for the registration of Shari'ah
individuals/advisers for Islamic unit trust funds
MBf Unit Trust Management Bhd launched the first Shari'ah
index fund
SC published a book: Resolutions of the Securities
Commission Shari'ah Advisory Council
17
2002 Malaysian government, in its Federal Budget 2003, allowed
tax deduction for 5 years on expenses incurred in the
issuance of Islamic bonds, based on the Shari'ah principles of
ijarah, mudharabah and musharakah
2003 Malaysian government, in its Federal Budget 2004, allowed
tax deduction for 5 years on expenses incurred in the
issuance of Islamic bonds, based on the Shari'ah principle of
istisna
2004 The International Organization of Securities Commission
(IOSCO)s Islamic Capital Market Task Force, chaired by SC
Malaysia, released the Islamic Capital Market Fact Finding
Report as an IOSCO public document in July 2004
SC released the Guidelines on the Offering of Islamic
Securities
18
2004 Ingress Corp Bhd issued the first domestic corporate Islamic
bond, which was modelled on the Malaysian Global Sukuk
Sarawak Corporate Sukuk Inc, a special purpose vehicle
established by the Sarawak Economic Development
Corporation launched a maiden 5-year US$350 million global
Sukuk Ijarah in the form of floating rate trust certificates that will
mature in 2009. The sukuk is listed and traded on LFX
International finance Corp (IFC), the private arm of the World
Bank issued RM500 million Islamic bonds, which was the first
issuance of ringgit-denominated Islamic bonds by a
supranational body
19
2004 Additional tax measures were announced in the Budget 2005
to remove any tax or duty on Islamic capital market products,
provided such products were approved by the SAC of the SC
2005 The World Bank issued RM760 million Islamic bonds that will
mature in 2010. This ringgit-denominated issue is the largest
supranational deal in the ringgit bond market
20
Islamic Equity Market
Islamic equity market in Malaysia showed
tremendous progress
The number of Shariah compliant shares
has increased significantly from 371 in
1997 to 826 in April 2005
In terms of percentage of Shariah
compliant stocks in Bursa Malaysia, 1997
recorded only 57% whilst in April 2005 the
percentage has increased to 84%
21
Shariah compliant stocks in Bursa Malaysia
Number of Shari'ah Compliant Stocks in Bursa
Malaysia
371
476
531 542 543 541 544
585
636
677
699
778
826
280
204
197
188 193 198
213
210
176
188
207
185
159
0
200
400
600
800
1000
1200
J un-
97
Dec-
97
May-
98
Sep-
98
J an-
99
May-
99
Sep-
99
Sep-
00
Sep-
01
Sep-
02
Sep-
03
Sep-
04
Apr-
05
Year
N
u
m
b
e
r

o
f

S
t
o
c
k
s
No of Shariah Compliant Stocks No of Non Shariah Compliant Stocks
22
Shari'ah Compliant Stocks in Bursa Malaysia
Percentage
of Non
Syariah-
Compliant
Stocks
16%
Percentage
of Syariah-
Compliant
Stocks
84%
As of April 2005
23
(As of April 2005)
Main Board / Second Board /
MESDAQ
Approved
Securities
Total
Securities
Percentage of
Approved
Securities
Consumer Products 126 137 92
Industrial Products 279 301 93
Mining Nil 1 Nil
Construction 62 63 98
Trading/Services 157 196 80
Properties 83 102 81
Plantation 41 44 93
Technology 64 68 94
Infrastructure (IPC) 7 9 98
Finance 5 55 9
Hotel Nil 5 Nil
Trusts 2 3 67
Close End Fund Nil 1 Nil
TOTAL 826 985 84
24
(As of 25 May 2007)
Main Board / Second Board /
MESDAQ
Approved
Securities
Total
Securities
Percentage of
Approved
Securities
Consumer Products 126 135 93
Industrial Products 287 308 93
Mining 1 1 100
Construction 57 59 97
Trading/Services 166 204 81
Properties 80 100 80
Plantation 41 47 87
Technology 104 106 98
Infrastructure (IPC) 8 9 89
Finance 5 47 11
Hotel Nil 5 Nil
Close End Fund Nil 2 Nil
TOTAL 875 1,023 86
25
Currently there is no international Shari'ah standard for
stock screening
Different funds or fund managers utilise different
standards based on their Shari'ah council
In Malaysia we have the list issued by Securities
Commission, Dow Jones-RHB Islamic Malaysia Index
and FBM Shariah Index
At the international level we have the Dow Jones Islamic
Market Indexes, FTSE Global Islamic Index Series and
S&P Islamic Index Series
26
Rules to ensure that ordinary shares are Shari'ah
compliant
The stock screening process is divided into two stages:
Evaluation in terms of company activities, products and industry
Computation of a set of financial ratios & compare them against
specified benchmarks
The screening process begins by screening the
company in terms of its activity, products and industry
alcohol, tobacco, pork-related products, conventional
financial services, weapon and defense, entertainment
(hotels, casinos/gambling, cinema, pornography, music,
etc.) are excluded
27
Next, a set of measures called financial filters is also used to
refine the selection.
The filters use a number of financial ratios and compare
them against their respective benchmarks to weed out non-
Shariah compliant stocks
The data for ratios are taken from Balance Sheet and
Income Statement. In the case of Dow Jones Indexes they
use stock market data as well
In general these ratios can be categorised as liquid assets,
interest income and leverage
The ratio benchmark ranges from:
Liquid asset: 17% to 49%
Interest income: 5% to 15%
Leverage: 30% to 33%
28
Screening Methodology for Shari'ah-Compliant Stocks :
Securities Commission of Malaysia applied additional
criteria to companies which are involved in multiple
business, i.e., companies whose business activities
comprise both Shari'ah permissible and non-permissible
elements. The analysis is done at the holding company,
subsidiary company and associate company levels. The
additional criteria include:
Core activities of the company are activities not against the
Shari'ah principles as mentioned earlier
Haram element is small compared to core activities, i.e.,
compared against benchmark
Public image/perception of company is good
Core activities of the company are important and of public
interest (maslahah) to the muslim ummah and the country
Proportion of haram element is small and in matters such as
umum balwa (common plight), uruf (customs) and the rights of
the non-Muslim community which are accepted by Islam
29
It maybe possible that a companys main business is
Shariah compliant but the revenue from the subsidiary
whose activities are not Shariah compliant may lead to
that company being considered as non-Shariah
compliant
30
Screening Process of SAC, Securities Commission, Malaysia
Activity, Industry
& Product
Financial services
based on riba (interest)
Gambling/gaming
Manufacture and / or
sale of non-halal
products
Manufacture or sale of
tobacco-based products
or related products
Conventional
insurance (gharar)
Entertainment
Stockbroking or share
trading in Shariah non-
compliant securities
Other activities
deemed non-
permissible
Quantitative Analysis
TO and PBT of non-
approved activities
SOP of non-approved
securities
Interest Income
Dividend received
from investment in
non-approved
securities
All of the above must
be below certain
threshold
Image public
perception or image of
the company,
importance of the
companies to ummah,
uruf (custom), umum
balwa (common
plight), rights of non-
muslims etc.
P
e
r
m
i
s
s
i
b
l
e
Stage 1 Stage2 Stage 3
No Yes
Yes
Drop
Drop
Drop
Yes
No
No
Qualitative Analysis
* List is updated every April and October
31
1. Group TO
2. Group PBT
1. TO and PBT of non approved activities
2. SOP of non approved activities
3. Interest income
4. Dividend received from investment in non approved securities
Consolidate information on :
1. TO and PBT of non permissible activities vs group TO and PBT
2. SOP of non permissible activities vs group PBT
3. Interest income vs group TO
4. Dividend received from investment in non approved securities vs group PBT
Compute percentage of contribution :
Non-approved if exceeds financial benchmark
Compare the percentages against financial benchmark
SC Stage 2 : Quantitative Analysis
(Source: Nik Ruslin, SC)
32
SC - Financial benchmarks
The 5-percent benchmark
to assess the level of mixed contributions from the
activities that are clearly prohibited such as riba
(interest-based companies like conventional banks),
gambling, liquor and pork
activities that involve the element of umum balwa which
is prohibited element affecting most people and difficult
to avoid e.g interest income from fixed deposits in
conventional banks and tobacco-related activities
33
This benchmark is used to asses the level of
contribution of mixed rental payment from Shariah non-
compliant activities, such as rental payments from
premises used in gambling, sale of liquor, etc.
activities that are generally permissible according to
Shariah and have an element of maslahah to the public,
but there are other elements that may effect the Shariah
compliance status of these activities for e.g hotel and
resort operations, share trading, stockbroking, as these
activities may also involve other activities that are
deemed non-permissible to the Shariah
34
Fiqh Justification for Sharih benchmarks
(source: SC Malaysia)
Status of mixed business companies
No historical precedent
Cited Ibnu Subki in Al-Ashbah wa al-Nazair to rule as
prohibited something that is a mix of the permissible and
the prohibited is ihtiyat (precautionary measure) and it is
not necessarily prohibited.
SC Malaysia took into accounts other Fiqh principles to
support their case
These include maslahah, umum balwa, urf khas min
asalib iqtisodiyah, fasaduz zaman and huquq ghair
muslimin
35
Fiqh Justification for Sharih benchmarks
(source: SC Malaysia) (cont)
In addition they also cited Ibnu Qayyim who
wrote in his book Badaie al-Fawaid about the
nature of prohibited property which is of 2 kinds:
Prohibited because of its zat (nature), for, e.g., pork,
liquor. Hence mixing of meat slaughtered by Muslim and
Non Ahli Kitab is prohibited.
Prohibited due to other reasons such as the means or
way it is earned or acquired. For e.g. money in itself is
okay but the manner it is acquired such as by robbery is
not acceptable. Shares of companies are by nature
acceptable but shares of mixed business companies
may not be acceptable
36
Shariah Benchmark
50% rule
Utilize the fatwa concerning silk mixed with
common thread. This is based on the hadith of
the Prophet saw:
The Prophet saw took a piece of silk and placed it
on his right. He took some gold and placed it on his
left. Then he said: Both these things are prohibited
unto men among my followers, but permissible for
the women
If it is pure silk then it is prohibited for men to
wear the silk cloth but if the cloth is mixed with
50% or less silk and the remaining common
thread then it is permissible
37
Shariah Benchmark (cont..)
One Third rule
Utilize the analogy of hibah (gift) where a
person can bequeath a maximum of one third of
his property as gift to an unrelated person
Benchmark based on Ghabn Fahish
(extraordinary margin or profit or gain)
Describes gain through cheating and
manipulation (tanajush)
38
Shariah Benchmark (cont..)
Ghabn fahish accompanied with tanajush is not
permissible
Hanafi mazhab ruled that the upper limits for
ghabn fahish are as follows:
5% for ordinary goods
10% for animals used for riding and
20% for fixed assets
39
Case Study 1 : Kaya Raya Holdings Berhad
Principal activity Construction and civil engineering
Associated
Kaya Raya
Holdings Berhad
KRH Cons.
Sdn. Bhd
Subsidiary
Lai Kuay
Sdn. Bhd
Strong Heart
Sdn. Bhd
Kapur Barus
Sdn. Bhd
Kejuruteraan
Siaga Sdn. Bhd
Tobacco business
Related information
Group info :
Group TO : RM10 million
Group PBT : RM 5 million
Non-permissible activities
info :
TO tobacco : RM 900,000
PBT tobacco : RM 400,000
40
Case study 1 : Pre-compliance result
Benchmark for tobacco : 10% of Group TO or Group PBT
Pre-compliance result :
Approved (contribution from tobacco below the benchmark)
Non-permissibles Calculation
Quantitative
result
Percentage of tobacco
to Group TO
RM900,000 / RM10.0 mil 9%
Percentage of tobacco
to Group PBT
RM400,000 / RM5.0 mil 8%
41
Case Study 2 : Teguh Tegap Holdings Berhad
Principal activity Manufacturing of furniture and other related industry
Associated
Teguh Tegap
Holdings Berhad
Cengal Biru
Sdn. Bhd
Subsidiary
Nyatoh Tua
Sdn. Bhd
Merbau Siam
Sdn. Bhd
Plywood
Sdn. Bhd
Nasib Baik
Sdn. Bhd
Gaming business
Related information
Group info :
Group TO : RM 2 million
Group PBT : RM 500,000
info :
Interest income : RM 220,000
SOP gaming : RM 24,000
Interest income
42
Benchmark for interest income : 10% of Group TO
Benchmark for gaming : 5% of Group TO / Group PBT
Non-approved (contribution from interest income exceeds the
benchmark)
Quantitative
result
Percentage of interest
income to Group TO
RM220,000 / RM2.0 mil 11%
Percentage of gaming
to Group PBT (SOP)
RM24,000 / RM500,000 4.8%
43
Case Study 3 : Blind Spot Berhad
Principal activity Construction
Associated
Blind Spot
Berhad
Go Ahead
Sdn. Bhd
Subsidiary
Ho Hap
Sdn. Bhd
Gantang Besar
Sdn. Bhd
Hud Hud
Sdn. Bhd
Garuda
Sdn. Bhd
Gaming business
Related information
Group info :
Group TO : RM 10 million
Group PBT : RM 5 million
info :
TO liquor : RM 400,000
PBT liquor : RM 120,000
TO gaming : RM 200,000
PBT gaming : RM100,000
Liquor business
44
Benchmark for liquor and gaming : 5% of Group TO / Group PBT
Contribution from non-approved activities :
Group TO : (4% + 2%) = 6%
Group PBT : (2.4% + 2) = 4.4
Non-approved (contributions from non-approved activities [liquor & gaming] exceed the benchmark)
Quantitative
result
Percentage of liquor to
Group TO
RM400,000 / RM10.0 mil 4%
Percentage of liquor to
Group PBT
RM120,000 / RM5.0 mil 2.4%
Percentage of gaming to
Group TO
RM200,000 / RM10.0 mil 2%
Percentage of gaming to
Group PBT
RM100,000 / RM5.0 mil 2%
45
Screening Process of Dow Jones Islamic Index
(before 2001)
Activity, Industry
and Product
Non-Permissible
Activities:
Pork Production
Non-Halal Food
Products
Alcohol Beverages
Gaming
Interest based
Financial Institution
Entertainment
Arms, Defense
Tobacco
Activities Contrary
to Islam
Stage 1
Stage 2
Financial Ratio Filters
Total Debt to Total
Asset Ratio 33%
Account Receivables
to Total Asset Ratio
47%
Non-Operating
Interest Income to
Operating Income
9%
Drop
Drop
No
Yes
No Yes
Permissible
* List is updated every quarter
46
Screening Process of Dow Jones Islamic Index
(2001)
Activity, Industry
and Product
Non-Permissible
Activities:
Pork Production
Non-Halal Food
Products
Alcohol Beverages
Gaming
Interest based
Entertainment
Arms, Defense
Tobacco
Activities Contrary
to Islam
Stage 1
Stage 2
Total Debt to Trailing 12-Month
Moving Average Market
Capitalization 33%
Account Receivables to Total
Asset Ratio 45%
Cash +Interest Bearing
Securities to Trailing 12-Month
Capitalization 33%
Drop
Drop
No
No
Permissible
Yes
Yes
47
Screening Process of Dow Jones Islamic Index (2003)
Activity, Industry
and Product
Non-Permissible
Activities:
Pork Production
Non-Halal Food
Products
Alcohol Beverages
Gaming
Interest based
Entertainment
Arms, Defense
Tobacco
Activities Contrary
to Islam
Stage 1
Stage 2
Total Debt to Trailing 12-Month
Capitalization 33%
Account Receivables to Trailing
12-Month Moving Average Market
Capitalization 33%
Cash +Interest Bearing Securities
to Trailing 12-Month Moving
Average Market Capitalization
33%
Drop
Drop
No
No
Permissible
Yes
Yes
48
Introduced in 1999.
Subset of DowJ ones Global Indexes.
40%of DJ Global Indexs market cap.
60 indexes.
6 Islamic scholars.
49
The DJ IMI family includes global, regional, country,
industry, and market-cap-based indexes.
Global Indexes
DJ IMI
DJ IM Large-Cap Index
DJ IM Mid-Cap Index
DJ IM Small-Cap Index
DJ IM - Ex. U.S. Index
DJ IM Developed Index
DJ IM Developed - Ex. U.S. Index
DJ IM Emerging Markets Index
Global Industry Indexes
DJ IM Basic Materials Index
DJ IM Consumer Goods Index
DJ IM Consumer Services Index
DJ IM Oil & Gas Index
DJ IM Financials Index
DJ IM Health Care Index
DJ IM Industrials Index
DJ IM Technology Index
DJ IM Telecommunications Index
DJ IM Utilities Index
Titans (Blue-Chip) Indexes
DJ IM Titans 100 Index
DJ IM Europe Titans 25 Index
DJ IM Asia/Pacific Titans25Index
DJ IM U.S. Titans 50 Index
50
U.S. Indexes
DJ IM U.S. Index
DJ IM U.S. Large-Cap Index
DJ IM U.S. Mid-Cap Index
DJ IM U.S. Small-Cap Index
Europe and Eurozone Indexes
DJ IM Europe Index
DJ IM Europe Large-Cap Index
DJ IM Europe Mid-Cap Index
DJ IM Europe Small-Cap Index
DJ IM Euro Index
DJ IM Euro Large-Cap Index
DJ IM Euro Mid-Cap Index
DJ IM Euro Small-Cap Index
Asia/Pacific Indexes
DJ IM Amana Sri Lanka Index
DJ IM Asia/Pacific Index
DJ IM Asia/Pacific Large-Cap Index
DJ IM Asia/Pacific Mid-Cap Index
DJ IM Asia/Pacific Small-Cap Index
DJ -J S Pakistan Islamic Index
Other Country/Regional Indexes
DJ IM Canada Index
DJ IM U.K. Index
DJ IM J apan Index
DJ IM BRIC Index
DJ IM China Offshore Index
DJ IM Turkey Index
Specialty Indexes
DJ IM Sustainability Index
DJ DFM Index
DJ DFM Titans 10 Index
51
Screening Process of FTSE Global Islamic Index Series
(In collobration with TII prior to 2006)
Activity, Industry
and Product
Non-Permissible
Activities:
Pork Production
Non-Halal Food
Products
Alcohol Beverages
Gaming
Interest based
Entertainment
Arms, Defense
Tobacco
Activities Contrary
to Islam
Stage 1
Stage 2
Total Interest
Bearing Debt to
Total Asset Ratio
33.33%
Drop
Drop
No
Yes
No Yes
Permissible
Cleanse
tainted
dividend
52
Screening Process of FTSE Global Islamic Index Series
(In collobration with Yasaar, 2006 onwards )
Activity, Industry
and Product
Non-Permissible
Activities:
Pork Production
Non-Halal Food
Products
Alcohol Beverages
Gaming
Interest based
Entertainment
Arms, Defense
Tobacco
Activities Contrary
to Islam
Stage 1
Stage 2
5 ratios are
computed
Drop
Drop
No
Yes
No Yes
Permissible
Cleanse
tainted
dividend
5%
53
Introduced in 2000.
Subset of FTSE All-World Index universe.
5 indexes.
Shariah Board withYasaar Research Inc.
54
FTSE Global Islamic Index
FTSE Americas Islamic Index
FTSE Europe Islamic Index
FTSE Pacific Basin Islamic Index
FTSE South Africa Islamic Index
55
Screening Process of S&P Shariah Indices
Activity, Industry
and Product
Excludes:
Pork Production
Non-Halal Food
Products
Alcohol Beverages
Gaming
Interest based
Entertainment
Arms, Defense
Tobacco
Gold & silver
trading as cash on
deferred basis
Activities Contrary
to Islam
Stage 1
Stage 2
4 ratios
Drop
Drop
No
Yes
No Yes
Permissible
Cleanse
tainted
dividend
56
S&P Shariah Indices
Introduced in 2006.
Subset of S&P 500, S&P Europe 350, and
S&P J apan 500 universes.
60%of parent indexs market cap.
3 indexes.
Shariah Board with Ratings Intelligence
Partners.
57
Screening Process Of Islamiq.com
Activity, Industry
& Product
Non-Permissible
Activities:
- Pork Production
- Non-Halal food
Products
- Alcoholic Beverages
- Gaming
- Interest-based
Financial Institutions
- Entertainment
- Arms, Defense
- Tobacco
- Activities contrary
to Islam
Interest Income
Total Interest
Income 5% of
company Gross
Total Revenues
Note: Interest
expense should
not be deducted
from this amount
Leverage & Asset
Liquidity
Total conventional
Debt to Equity
ratio 30%
Cash and short term
investments to Total
Assets Ratio 45%
P
e
r
m
i
s
s
i
b
l
e
Stage 1 Stage2 Stage 3
No Yes
Yes
Drop
Drop
Drop
Yes
No
No
58
Financial Filters
59
Islamic Stock Indices Comparison
Dow Jones
Index Market
FTSE SI S&P SI
Index Review Annual review in June Annual review in
September
Semi-annual review in
March and September
Composition Review Quarterly review
Changes implemented
on the 3
rd
Friday in
March, June,
September and
December
Quarterly review
Changes implemented
on the 3
rd
or the 2
nd
Friday in March, June,
September, December
(2
nd
Friday only
applicable for S&P
Japan 500 Shariah)
Semi-annually review
Changes implemented
on the 3
rd
Friday in
March and
September.
Component
Weightings Review
Quarterly update
Changes > 10% in
number of shares,
updated Immediately
Quarterly update
Changes > 5% in
number of shares,
updated immediately
Semi-annually update
Computation Float-adjusted value-
weighted
Float-adjusted Value-weighted
60
Comparison between Shariah compliant securities of SC Malaysia and
Dow Jones-RHB Islamic Malaysia as of May 2005
Number of
Shariah
Compliant
Stocks
Number of
Stocks in Bursa
Malaysia
Percentage of
Shariah
Compliant
Stocks
SC 826 985 84%
DJ-RHB 45 985 4.6%
61
Shariah compliant securities which are subsequently
considered as Non-Shariah compliant
Action to be taken by the investor/fund manager :
On the announcement date
Price of share > original investment cost
Action: liquidate immediately. Any capital gain can be kept by the
investor
Price of share < original investment cost
May hold the share until price of share equals to original investment
cost
Liquidate when total dividends received (if any) together with the market
price of the non-approved share equal the original investment cost
62
Shariah compliant securities which are subsequently
considered as Non-Shariah compliant
After the announcement date (due to inadvertant
mistake)
Price of share > original investment cost
Liquidate immediately. Any profit (the difference between original
investment cost and closing price of announcement date) can be kept
Residual Profit (the difference between disposal price and closing price
of announcement date) to be channelled to charitable bodies
Price of share < original investment cost
May hold the share until price of share equals to original investment
cost
Liquidate when total dividends received (if any) together with the
market price of the non-approved share equal the original
investment cost
63
Example Assuming investor holds the share and
dispose on 20
th
May 2005
Investment cost = RM2.50/share
Closing price on the announcement date = RM4.00/share
Disposal Price = RM5.00/share
Dividend received on 15 May 05 = RM0.50/share
Capital gain at announcement date =RM1.50/share (kept by investor)
Difference between disposal price and and closing price on announcement date = RM
1.00/share (channelled to charitable bodies)
Dividend received can be kept by the investor
Question: What is the right approach if the disposal price on 20
th
May 2005 is RM2.00?
Kept by investor
(RM1.50)
Investment Cost
(20 January 05)
Announcement date
(29 April 05)
Disposal price
(20 May 05)
2.50 4.00 5.00
Channelled to charitable bodies
(RM1.00)
64
Non-Shariah compliant securities which are
advertently/inadvertently bought by Shariah fund
Must be disposed within a month of knowing the
status of the securities
Any capital gain or dividend received during or
after the disposal of the securities has to be
channeled to charitable bodies
Investor has a right to only obtain the original
investment cost
65
Purification of Income
Investor/Unit trust fund receives income from
invested companies in the form of dividend and
capital gain. Not all income are considered clean.
Some are derived from non halal sources such as
interest income
Purification of income requires identifying the non
halal portion of income received from invested
companies and deducting it from the total income
prior to distribution
The income net of purification is then distributed to
the investors
66
Purification of Income
The tainted income cannot be distributed to
investors but instead donated to charities
It is also possible for the fund to allow discretion
to the investor in deciding the recipient
charitable organization
No consensus among Shariah scholars in
implementing purification
No standard available from AAOFFI
FTSE GII recommends 5% of the dividend
received is taken out and given to charities
S&P SI provides the following formula to
estimate tainted dividend
67
Div*(Non-permissible Revenue/Revenue)
68
Preference Shares (saham Preferen)
Malaysian Companies Act 1965 has
defined preference share as a share that
does not give a right to the shareholders to
vote at its general meeting or any right to
participate in any distribution of the
company that has stated the amount,
whether through dividends, redemption,
dissolution or otherwise
69
Preference Shares (saham Preferen)
The characteristics of a preference shares
are as follows:
Predetermined dividend
Higher entitlement to assets if business is
liquidated
No voting rights
70
Preference Shares (cont.)
OIC Fiqh academy ruled that preference
shares are not permissible
Syariah Advisory Council of Malaysian
Securities Commission ruled that non-
cumulative preference shares are
permissible based on tanazul where the
right to profit of the ordinary shareholder is
given willingly to a preference shareholder.
71
Convertible Stocks/Bonds
Preference shares or bonds that will be
converted into ordinary shares after a
predetermined period
Value of future conversion is uncertain although
the conversion ratio, i.e., the number of ordinary
shares that will be given upon conversion, is
fixed
No formal fatwa given although most Shariah
scholars are concerned about element of gharar
72
Shareholder Rewards
Cash dividends
No objections from Shariah
Bonus issue or stock dividend
Shares in lieu of cash
No objections from Shariah
Rights issues
Current shareholders given special right to
purchase new shares at below market price
Acceptable to Shariah
73
Shareholder benefits or perks
Rewards given to shareholder in kind rather
than cash, for e.g., free food or food coupon,
hotel stays etc
Acceptable to Shariah
Wallahuwaalam
Thank You
azmiomar@iiu.edu.my

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