Islamic Finance

An Introduction to Islamic Finance and Common Terminologies

Disclaimer

This enclosed information was prepared exclusively for the benefit and internal use of the recipient and does not carry any right of publication or disclosure to any other party. The content may not be used for any other purpose without prior written consent. The information herein reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. Preparing the same, we have relied upon and assumed, without independent verification, the accuracy and completeness of any information available from public sources. Except as required by law, we do not accept any responsibility for or liability whatsoever in respect of any loss, liability, claim, damage, cost or expense arising as a consequence (whether directly or indirectly) of reliance upon any information or any statement or opinion contained in this document, nor do they make any representation or warranty (whether expressed or implied) as to the accuracy completeness of this documents or its contents. This is not an offer documents and cannot give rise to any contract.

Ackowledgement CPA Australia wish to ackowledge the contribution of the AmInvestment Bank, Islamic Markets in the production of this information book. AmInvestment Bank AmInvestment Bank is a member of AmInvestment Bank Group, one of Malaysias leading investment banking groups with a track record of over 30 years and has won awards from the international financial press and major rating agencies. With its headquarters in Kuala Lumpur, Malaysia, AmInvestment Bank has an additional four branches in the other states of Johor, Pulau Pinang, Sabah and Sarawak as well as subsidiaries in Labuan, Jakarta, Singapore and Brunei Darussalam. As a leading financial services provider in the Islamic capital markets (ICM), AmInvestment Bank, through its Islamic Markets division, provides a full range of expertise in structuring customised Shariah-compliant products. The Islamic Markets department has a dedicated team of Islamic product specialists and Shariah technical experts committed to achieving excellence at the core of developing the ICM. AmInvestment Banks expertise in bringing innovative products and services to its clients is set to expand further in tandem with AmBank Groups strategic partnership with the Australia and New Zealand Banking Group (ANZ), one of Australias leading financial institutions. .

Table of Contents
The Fundamental Concepts of Islamic Finance ...................................................................................... 1 Introduction ............................................................................................................................................... 1 Common Concepts ................................................................................................................................... 2 Murabahah (Cost plus)........................................................................................................................ 2 Bai al-Inah (Sale and buy-back) ......................................................................................................... 3 Commodity Murabahah/Tawarruq (Tripartite Agreement Sale) .......................................................... 4 Mudharabah (Profit-sharing) ...............................................................................................................5 Musyarakah (Partnership) ................................................................................................................... 7 Ijarah (Leasing) ................................................................................................................................... 7 Supplementary Concepts and Principles .................................................................................................. 8 Qard Al-Hasan (Benevolent loan) ....................................................................................................... 8 Wadiah Yad Amanah (Safe-keeping Unprotected).......................................................................... 8 Wadiah Yad Dhamanah (Safe-keeping Protected).......................................................................... 8 Hibah (Gift) .......................................................................................................................................... 8 Wakalah (Agent or Delegate) .............................................................................................................. 9 Bai' Dayn (Debt Trading)..................................................................................................................... 9 Bai' Muzayadah (Open-Bidding Trading) ............................................................................................ 9 Kafalah (Guarantee)............................................................................................................................ 9 Hak Tamalluk (Ownership Right) ........................................................................................................ 9 Hiwalah (Debt assignment contract) ................................................................................................... 9 Ibra' (Rebate)....................................................................................................................................... 9 Ittifaq Dhimni (Pre-Agreed Contract)................................................................................................. 10 Rahn (Collateral) ............................................................................................................................... 10 Sukuk (Securities) ............................................................................................................................. 10 Ujrah (Fee) ........................................................................................................................................ 10 Urbun (Deposit) ................................................................................................................................. 10 Sukuk.......................................................................................................................................................... 11 Introduction ............................................................................................................................................. 11 Sukuk versus Conventional Bonds ......................................................................................................... 11 Sukuk Structures..................................................................................................................................... 12 Equity Based Structure...................................................................................................................... 12 Example of Basic Sukuk Musyarakah Structure ............................................................................... 12 Example of Basic Sukuk Mudharabah Structure............................................................................... 13 Lease Based Structure...................................................................................................................... 14

Example of Basic Sukuk Ijarah Structure.......................................................................................... 14 Sales Based Structure....................................................................................................................... 15 Example of Basic Sukuk Istisna ....................................................................................................... 15 Example of Basic Sukuk Murabahah Structure................................................................................. 16 Example of Basic Sukuk Tawarruq Structure.................................................................................... 17 Shariah Compliant Investments on Equities.......................................................................................... 18 Review Process ...................................................................................................................................... 18 Benchmarks....................................................................................................................................... 19 Glossary ..................................................................................................................................................... 20 References................................................................................................................................................. 21 Acknowledgements .................................................................................................................................. 22 Contact Details .......................................................................................................................................... 23

Islamic Finance:
An introduction to Islamic Finance and common terminologies

The Fundamental Concepts of Islamic Finance

Introduction
Islamic finance has been established as an alternative to the conventional banking system which is made up of components not permitted by the Shariah (Islamic rules and jurisprudence). Shariah is essentially a code of ethics and conduct that is derived from the Al-Quran and teachings of the Prophet Muhammad. In the context of Shariah, there are permissible and non-permissible attributes as to how Muslims conduct their activities and this includes economic participation, which must be free of forbidden elements among others as Riba, Gharar and Maisir. Riba refers to the consumption of usury or interest, as the Shariah forbids Muslims to earn profits out of money without participating among others in trade, risk-taking and putting in a fair amount of effort. In Islam, trade is, but sees Riba as wrong, while permitting profits generated from trade. Gharar is broadly defined as uncertainty. It is exemplified by a particular sale of item whose existence or characteristics are not certain (i.e. birds in the sky or fish in the ocean), due to the vague and precarious nature which makes the trade similar to gambling. This practice is prevalent in conventional financial activities such as conventional insurance and some derivative contracts. There are alternatives, for instance Takaful as the Shariah compliant practice of insurance which is significantly different from conventional insurance as it drafts contracts void of Gharar and Riba. Maisir or commonly known as gambling is strongly prohibited due to the harms it may bring to those practicing it. The game of chance, although beneficial should chance be in your favor, is best avoided as it also poses an extreme risk. A person may enjoy large winnings but could similarly suffer from crippling losses.

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Islamic Finance:
An introduction to Islamic Finance and common terminologies Common Concepts
Murabahah (Cost plus) This refers to the sale of goods at a price which includes a profit margin as agreed by both parties. Such sales contracts are valid on the condition that the price, other costs and the profit margin of the seller are stated at the time of the agreement of sale. Appended below in a simple diagrammatical illustration of using Murabahah in a financing structure:

2. Financier sells to buyer for $(x + y) with y being the agreed profit element

1.

Financier buys asset from seller for $x

3. Buyer pays for the assets on a deferred basis

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Bai al-Inah (Sale and buy-back) It is almost similar in concept to Murabahah. As with Murabahah, the customer purchases the particular item of interest from the financier and the transaction concludes with the customer obtaining the item while making settlements in the form of continuous deferred payments to the bank. With Bai al-Inah however, the customer who has purchased the item of commodity then sells it back to the financier for cash at spot price. The customer receives the desired amount of cash (from sale) and makes deferred payments (from initial purchase) with the aim of settling the transaction. For this example, the asset would be a piece of land of similar value that is needed by the customer. Customer purchases land from financier on deferred payment basis with a mark-up in price to reflect the deferred payment. Land asset is then immediately resold to the financier for cash at discount (spot), usually the price reflecting the value of the land. Appended below is a simple diagrammatical illustration of using Bai al-Inah in a financing structure:

1. A commodity owned by the financier i.e. a piece of land, is sold on deferred payments to the borrowing customer at agreed price

4. Financier pays the customer the spot price for the land asset and the customer is now in possession of cash

2. Customer pays for the land asset with cost plus mark-up on deferred payments terms

3. Customer resells the land asset to the financier

$(x + y<profit>) = $P

$(P - y) = $x

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Commodity Murabahah/Tawarruq (Tripartite Agreement Sale) Tawarruq is a tripartite agreement in which the financier agrees to purchase a commodity on behalf of the customer. The 3 parties involved are the financier, customer and a commodities trader which represents the free market institution. For instance, the financier firstly purchases the commodity from the trader on spot basis for $900. The financier now sells the commodity to the customer on deferred payment basis i.e. $1000. Customer now owns commodity and owes the financier $1000 on deferred payment. To obtain cash, the customer sells the commodity to the third party buyer or commodities trader. The cash obtained here acts as monetary financing element of the transaction. Appended below is a simple diagrammatical illustration of using Tawarruq in a financing structure:

2. The commodity is sold to the customer on deferred basis at a premium representing the financiers profit

3. The customer then sells the commodity to another commodity trader (Trader B) in the commodity market on spot for cash i.e. bought for $1000 (deferred) but sold for $800 (cash). The customer now has the cash on hand while owing the financier its $1000 in installments

1.

The financier purchases commodity from a trader (Trader A) in the commodity market

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Mudharabah (Profit-sharing) Refers to an agreement made between a capital provider and another party who acts as the entrepreneur. This arrangement will enable the entrepreneur to carry out business projects and profits are distributed based on a pre-agreed profit-sharing ratio. In the case of losses, the losses are borne by the provider of the funds with the exception of authentic cases of negligence by the entrepreneur, whereby the entrepreneur will then have to bear the losses. The financier's maximum loss is limited to his share of the financing and the mudharib (entrepreneur) must not bear any of loss attributable to invested capital. Appended below in a simple diagrammatical illustration of using Mudharabah in a financing structure:

1. F in an c ie r c on t r ib ut es m on e t a r i l y t o t he pa r tne rs h i p w i t h a n a g ree d pro fit ratio.

2 . E n t re p ren e u r b ri ng s h i s id ea s , h u man c a pi t a l , ne twork, e ffort et c. t o t he partnership

3 . Mudharabah partnership is formed

with agreed profit ratios. Loss to capital is borne by the financier whereas the entrepreneur incurs losses in the form of time, effort and other intangible forms

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
In Malaysia, the concept is also commonly used in the retail banking practice of fixed deposit taking. In utilizing the Mudharabah concept for this use, the customer (depositor) becomes the capital provider whereas the bank assumes the role of both business manager and entrepreneur. Appended below is a simple diagrammatical illustration of using Mudharabah as a fixed deposit instrument:

Customer/Depositor
1

1 . Depo sitor and Bank agree on the te rms of M ud hara ba h an d th e pro fit - s h ari ng rati os . The D e po sit o r t h e n p ro vi d e s funds to t he Bank

Bank
2

2 . T h e B an k i n v e s t s t he f u n d s a n d m an age s i t s ope ra t i on .

Investment/Asset
3

Profit$$

3 . T h e p r o fi t g e n e r a t e d b y t he i nve stm ent w il l b e s h a re d b etw een t he tw o p a r tie s b ase d on t he pre agre ed ratio. In the even t of a l oss, the De positor as a n i n v e sto r b e a rs al l t h e l o sse s and t he Ban k wi ll l o se t he res o u rc e s s pe n t .

Source: Extracted from Understanding Islamic Finance by MIFC*

*Malaysia International Islamic Finance Centre An initiative comprising a community network of financial and market regulatory bodies, Government ministries and agencies, financial institutions, human capital development institutions and professional services companies that are participating in the field of Islamic finance

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Musyarakah (Partnership) Refers to a partnership or joint venture for a specific shariah-compliant business, whereby the distribution of profits will be apportioned according to an agreed ratio. In the event of losses, both parties will share the losses on the basis of their equity participation.

1.

Customer injects a portion of funds i.e. $100 (10% of total)

2. 3. The financier injects a portion of the funds i.e. $900 (90% of total)

2. The combination of funds 3. forms the partnership with 90% and 10% belonging to the financier and customer respectively

Ijarah (Leasing) Refers to an arrangement under which the lessor leases equipment, building or other facilities to a customer at an agreed rental fee(s) or charge(s), as agreed by both parties.

1.

An item such as a property is identified and purchased by the financier

2. The financier owns all rights (including liabilities) to the property and leases it out to the customer

3. Customer gains usage rights and makes rental payments for the benefits (usufruct)

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Islamic Finance:
An introduction to Islamic Finance and common terminologies Supplementary Concepts and Principles
Qard Al-Hasan (Benevolent loan) Consists of a loan given to a borrower on a goodwill basis, i.e. no interest or fees are charged. In the early stages of development in Malaysia, the concept was used in Government investment certificates. Today, it has expanded to include other products such as credit cards and in the structure of liquidity management instruments. Borrower may, at their discretion, repay more than they borrowed. This would be deemed as a gift and is not predetermined, as any pre-agreed return over the principal constitutes interest or Riba. Seen as being the only pure form of Islamic financing loan as, unlike all the other financing structures, it makes no attempt to charge Riba (interest), which is prohibited under Islam. Instead, it is done on good intention to ensure that the party receiving of the loan is able to keep afloat.

Wadiah Yad Amanah (Safe-keeping Unprotected) An agreement for safekeeping of funds made between a holder of funds and a party entrusted with the safekeeping of the funds. In this principle, the party entrusted shall not have any responsibilities concerning the damages or losses happened to the funds and/or goods kept by the party entrusted unless as the consequences of his own negligence. The party entrusted is not allowed to use the funds for investment purposes. The most possible transaction pursuant to this principle is safe deposit box. Wadiah can be simply defined safe-keeping deposit. The standard Islamic financial transaction in which X entrusts property to Y for safe-keeping. Wadiah refers to the deposited property.

Wadiah Yad Dhamanah (Safe-keeping Protected) Goods or deposits kept for safekeeping with another person, who is not the owner. As wadiah is a trust, the depository becomes the guarantor and guarantees repayment of the whole amount of the deposits, or any part thereof outstanding in the accounts of the depositors, when demanded. The depository is entrusted with safekeeping of the funds, while allowing it to be reinvested. This entitles the owner of funds to be protected from loss of funds. The depositors are not entitled to any share of the profits but the depository may provide returns to the depositors as a token of appreciation.

Hibah (Gift) Hibah literally means a gift. It is an act of transferring of ownership of an asset or usufruct without an exchange of counter value during the lifetime of the transferor. It can also be used by borrowers who have been granted Qard Al-Hasan loan mention above. No agreement to provide Hibah can be made its an arbitrary payment made at the discretion of the person making it.

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Wakalah (Agent or Delegate) In Islamic Finance terms, Wakalah refers to a contract in which one person or party appoints another person or party to act on their behalf in a disclosed transaction. The party acting as agent is bound to the limitations that the appointer has set out as the agent has a duty to protect the interests of its appointer. The practice is found to be common within Sukuk, Takaful (Islamic Insurance) and Islamic Trade Financing contracts as local and overseas agents are appointed to assist in conducting transactions and exchanges between these borders. The fee can be a fixed amount or based on an agreed ratio of investment profit.

Bai' Dayn (Debt Trading) A transaction that involves the sale and purchase of securities or debt certificates that conforms with Shariah. Securities or debt certificates will be issued by a debtor to a creditor as an evidence of indebtedness.

Bai' Muzayadah (Open-Bidding Trading) An action by a person to sell his asset in the open market through a bidding process amongst potential buyers. The asset for sale will be awarded to the person who has offered the highest bid/price. This is also known as the sale and purchase transaction based on tender.

Kafalah (Guarantee) A contract of guarantee whereby a guarantor underwrites any claim and obligation that should be fulfilled by an owner of the asset. This concept is also applicable to a guarantee provided on a debt transaction in the event a debtor fails to fulfill his debt obligation. The same definition can be applied for Dhaman.

Hak Tamalluk (Ownership Right) An asset in the form of ownership rights as classified by Shariah which are tradable.

Hiwalah (Debt assignment contract) A contract that allows a debtor to transfer his debt obligation to a third party.

Ibra' (Rebate) Waiving partially or totally a right to claim a debt. An act by a person to withdraw his rights to collect payment from a person who has the obligation to repay the amount borrowed from him.

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Ittifaq Dhimni (Pre-Agreed Contract) A sale and re-purchase of the underlying asset of which the prices are agreed by the parties prior to the completion of the contract. This is an external agreement which must be reached before the contract can be concluded to allow for the bidding process (Bai al-Muzayadah) to take place.

Rahn (Collateral) An act whereby a valuable asset is made as collateral for a debt. The collateral will be utilized to settle the debt when a debtor is in default.

Sukuk (Securities) A document or certificate which represents the value of an asset.

Ujrah (Fee) A financial charge for the utilization of services or manfaat (benefit). In the context of today's economy, it can be in the form of salary, wage, allowance, commission and alike.

Urbun (Deposit) May also be referred to as urban or arabun. It is a deposit given by the buyer to the seller in a contract between the two parties. Should the sale proceed successfully, the deposit will be part of the price of goods. Otherwise, it will be considered as Hibah (gift) from the buyer to the seller.

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Islamic Finance:
An introduction to Islamic Finance and common terminologies

Sukuk
Introduction
The Arabic term for Islamic securities is Sukuk. Sukuk is the plural of Sak which literally means certificates. Other similar terms can be used to defined Islamic certificates are Taskik means process of dividing assets into papers (Sukuk) and Tawriq is to render something into cash. Technically, Sukuk refer to securities, notes, paper or certificates, with the features of liquidity and tradability. The Securities Commission of Malaysia (SC) defines Sukuk as a document or certificate which represents the value of asset. Asset may include financial asset such as receivables and debts, as well as non financial assets like tangible asset, usufructs and services. According to Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Sukuk can be defined as certificates of equal value representing undivided shares in ownership of tangible asset, usufructs and services (in the ownership of) the assets of particular projects or special investment activity.

Sukuk versus Conventional Bonds

The diagram below gives the comparison between conventional bonds and Sukuk. nd

Conventional Bonds 1. Loan contract to create indebtedness 2. Return to Investors is the extra amount charged on the loan amount (interest charges) 3. Trading of the bonds amount to trading of debts, normally with discounting 4. The holder owns cash flow only 5. Proceeds are invested in any business without restrictions

Sukuk 1. Use a variety of contracts to create financial obligations between Issuer and Investor. For example; sale, lease, equity partnership, joint venture partnership. 2. Return to Investors comes from the in-built profit elements in the sale, lease or partnership contracts. 3. Tradability of the Sukuk depends on the nature of the asset underlying the Islamic securities 4. Holder owns assets as well as the right on the cash flow 5. Investment in Shariahcompliant activities

VS

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Islamic Finance:
An introduction to Islamic Finance and common terminologies Sukuk Structures
Equity Based Structure Profit and Loss-sharing (Musyarakah) n Defined as a partnership arrangement between two parties or more to finance a business venture whereby all parties contribute capital either in the form of cash or in kind for the purpose of financing the business venture. Any profit derived from the venture is distributed based on a preagreed profit sharing ratio, but a loss is shared on the basis of equity participation. Example of Basic Sukuk Musyarakah Structure
7

Descriptions:
1. 2. 3. Issuer provides 1% of capital (x) Investors provides 99% of capital (y) Issuer issues Sukuk Musyarakah to evidence the participations in the Musyarakah Venture Issuer issues Purchase Undertaking to buy back the asset upon maturity of the Sukuk Return from Musyarakah Venture channeled to Issuer Profit payment to Investors Upon maturity, Issuer purchases Musyarakah assets (Purchase Undertaking) Proceeds from the sale of the asset will be used to repay the investors, in terms of the principal amount of the Sukuk

4.
3 3

Musyarik 1 (Issuer)

Musharakah Sukuk

Musyarik 2 (Investors)

5. 6. 7.

Capital X 1%

Capital Y 99%

8.

Musyarakah Agreement: Issuer & Investors agreed on profit & loss distribution.

Musyarakah Venture
8

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Profit-sharing (Mudharabah) A contract made between two parties to finance a business venture. The parties are a Rabb alMal or an investor who solely provides the capital; and a mudharib or entrepreneur who solely manages the project. If the venture is profitable, the profit is distributed based on a pre-agreed ratio. If there is loss, it will be borne solely by the provider of the capital. Example of Basic Sukuk Mudharabah Structure

Descriptions:
6

Mudharib (Issuer)

Mudharabah Sukuk

Rabb Al-Mal (Investors)

Entrepreneurship
Mudharabah Agreement: Issuer & Investors agreed on profit & loss distribution.

Capital Y

1. Investors provides capital 2. Issuers provides entrepreneurship 3. Issuer issues Sukuk Mudharabah to evidence the participations of Rab al-Mal in the Mudharabah Venture 4. Issuer issues Purchase Undertaking to buy back the asset upon maturity of the Sukuk 5. Return from Mudharabah Venture channeled to Issuer 6. Profit payment to Investors 7. Upon maturity, Issuer repurchases Mudharabah assets (Purchase Undertaking) 8. Proceeds from the sale of the asset will be used to repay the investors, in terms of the principal amount of the Sukuk

Mudharabah Venture
8

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Lease Based Structure Ijarah (Leasing) A manfaah (usufruct) type of contract whereby a lessor (owner) leases out an asset or equipment to its client at an agreed rental fee and pre-determined lease period upon the aqad (contract). The ownership of the leased equipment remains in the hands of the lessor. Example of Basic Sukuk Ijarah Structure Sukuk Ijarah Descriptions: 1. Sells assets to SPV at Purchase Price on cash basis 2. SPV issues Sukuk to investors that represent beneficial ownership of the assets 3. Proceeds from issuance of Sukuk 4. Lease the asset to Customer 5. Rental payment 6. Distribution of rental payment (Profit to Sukuk holders/investors) 7. At maturity, SPV sells the asset back to the Customer 8. Proceeds from the sale of the asset will be used to repay the investors, in term of the principal amount of the Sukuk

Customer

SPV
6

Investors

5 7

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Sales Based Structure Istisna (Purchase Order) A purchase contract of an asset whereby a buyer places an order with the seller to purchase the asset to be constructed or delivered in the future according to the specifications given in the contract. Both parties of the contract decide on the sale and purchase prices and the settlement can be delayed or arranged based on the schedule of the work completed Example of Basic Sukuk Istisna Descriptions:
5

Customer

Sukuk Istisna

Investors

Contractor
4

1. Customer requests investors to deliver with full completion a certain project valued at RM (x + y) million Istisna Sale Price in installment basis (over deferred period) 2. Customer issues Istisna Sukuk to evidence obligations to pay Sale Price in several installments 3. Investors requests contractor to develop project as requested under (1) at RM x million i.e. Istisna Purchase Price. Payment term: Preagreed terms or on spot basis 4. Upon full completion, project handed over by contractor to investors 5. Investors delivers ordered project to client

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Murabahah (Cost Plus Sale) A contract referring to the sale and purchase transaction for the financing of an asset whereby the cost and profit margin (mark-up) are made known and agreed upon by all parties involved. The settlement for the purchase can either be on a deferred lump sum basis or installment basis, which is specified in the agreement. Example of Basic Sukuk Murabahah Structure

Descriptions:
4

Issuer

Sukuk Murabahah

Investors

1. Investors purchase from Issuer the indentified asset at Purchase Price which is equivalent to the amount to be disbursed. 2. Subsequently, Investors will sell the asset at Selling Price (Cost + Mark-up price). 3. Issuer issues Sukuk Murabahah to evidence the Selling Price payable by Issuer. 4. Issuer pays the Sale Price on deferred payment basis.

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
Tawarruq (Commodity Murabahah) Tawarruq refers to a tripartite arrangement where investors (Investor(s)) through an agent will purchase a specified commodity from a supplier in the market on spot basis. The commodity is subsequently sold by the Investor(s) to the Issuer at cost plus profit on a deferred payment basis. The Issuer will then sell the commodity, on spot basis, to another party in the market for cash. Example of Basic Sukuk Tawarruq Structure

Descriptions: 1. Investors appoint Facility Agent agent to buy and sell Shariah compliant commodities.

Investor

Facility Agent

Commodity Purchaser /Issuer

2. The Issuer issue Sukuk to evidence the Investors interests and rights on ownership of the commodities when commodities are acquired and rights to receive the Selling Price when commodities are being sold. 3. Investors subscribe for the Sukuk which were issued by Issuer and pay the Purchase Price of commodities which is equivalent to the amount to be disbursed. 4. On the purchase date, the Investors via Facility Agent shall purchase the commodities from commodity market.

5. The titles of the commodities are transferred from Trader A to Facility Agent (act on behalf of Investors). 6. Facility agent will sell the commodities to Issuer at Selling Price (cost + mark-up) on deferred payment basis. 7. Issuer sells the commodities to Trader B at Purchase Price on spot for cash. 8. Trader B pays proceeds 9. Issuer shall pay the Selling Price on deferred payment basis to Investors

Trader

Commodity Market

Trader

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Islamic Finance:
An introduction to Islamic Finance and common terminologies

Shariah Compliant Investments on Equities

In Malaysia, the Shariah Advisory Council (SAC) of Securities Commission Malaysia (SC) has outlined the parameters of Shariah compliant investments. These parameters provide headroom in the form of thresholds or benchmarks that a specific investment must stay within in order for it to be shariah-compliant. The SAC has approved an updated list of securities, which have been classified as Shariah-compliant securities. This list is updated and published periodically to keep the public informed of the standings of these listed entities.

Review Process
The process is divided into two separate portions which are each carried out by the SC and the SAC. The steps are of both quantitative and qualitative measures which is aimed to allow for a more wholesome and equally transparent view of these companies. A standard criterion has been applied by the SAC in focusing on the activities of the companies listed on Bursa Malaysia. Subject to certain conditions, companies whose activities are not contrary to the Shariah principles will be classified as Shariah-compliant securities. This is subject to the companies having satisfied the criterion and do not engage in the following core activities: a) Financial services based on Riba b) Gambling and gaming c) Manufacture or sale of non-halal products or related products d) Conventional insurance e) Entertainment activities that are non-permissible according to Shariah f) Manufacture of sale of tobacco-based products or related products g) Stockbroking or share trading in Shariah non-compliant securities h) Other activities deemed non-permissible according to Shariah. A company must satisfy that at least 95% of its gross revenue is generated by activities other than those mentioned above. The SAC also considers the level of contribution of interest income received by the company from conventional fixed deposits or other interest bearing financial instruments. In addition, dividends received from investment in non-compliant securities are also considered in the analysis carried out by the SAC.

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Islamic Finance:
An introduction to Islamic Finance and common terminologies
For companies that comprise both permissible and non-permissible elements, the SAC considers two additional criteria: a) Public perception or image of the company must be of good standing. b) The core activities of the company are important and considered maslahah (benefit in general) to the Muslim ummah (nation) and the country, and the non-permissible element is very small and involves matters such as umum balwa (common plight and difficult to avoid, uruf (custom) and the rights of the non-Muslim community which are accepted by Islam. Benchmarks The SAC has established several benchmarks based on reasoning from the source of Shariah by qualified Shariah scholars). If the contributions from non-permissible activities exceed the benchmark, the securities will not qualify. 5 Percent Benchmark This is used to assess the level of mixed contributions from activities that are clearly prohibited such as Riba (interest-based companies like conventional banks), gambling, liquor and pork. 10 Percent Benchmark Used to assess the level of mixed contributions from the activities that involve the element of umum balwa which is a prohibited element affecting most people and difficult to avoid. An example of such a contribution is the interest income from fixed deposits in conventional banks. This benchmark is also used for tobacco-related activities. 20 Percent Benchmark Used to assess the level of contribution from mixed rental payment from Shariah non-compliant activities, such as rental payment from the premise that is involved in gambling, sale of liquor etc. 25 Percent Benchmark Used to assess the level of mixed contributions from activities that is generally permissible according to Shariah and has an element of maslahah to the public, but there are other elements that may affect the Shariah status of these activities. Among the activities that belong to this benchmark hotel and resort operations, share trading, stockbroking and other, as these activities may also involve other activities that are deemed non-permissible according to the Shariah.

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Islamic Finance:
An introduction to Islamic Finance and common terminologies

Glossary

Aqad

A central term in Islamic law, which essentially means, contract. Not necessarily financial or business specific Sale; an agreement between two parties (the seller and the buyer) to the effect that the ownership of the sale item is transferred from the seller to the buyer in exchange for a price Teachings and quotes from the Prophet Muhammad (p.b.u.h)). A report of the sayings or actions of Muhammad or his companions, together with the tradition of its chain of transmission Arabic word that denotes the meaning of lawful, referring to actions, items that are permitted within shariah rules/ Permissible, lawful; said of a deed which is not prohibited by Allah, opposite of haram Impermissible, unlawful, opposite of halal General benefit(s) When referred after the name of the Muslim Prophet Muhammad, it means peace be upon him Nation or people of the nation of Islam Common plight and difficult to avoid Customary practices of the community in terms of verbal usage or conduct that is not contrary to principles of Shariah The legal right of using and enjoying the fruits or profits of something belonging to another; or the right to use or enjoy something The lending of money with an interest charge for its use; especially: the lending of money at exorbitant interest rates

Bai

Hadith

Halal

Haram Maslahah p.b.u.h.

Ummah Umum balwa Uruf

Usufruct

Usury

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Islamic Finance:
An introduction to Islamic Finance and common terminologies

References
Ali, Mohammad Imad, 2005, Finance in Islam, Islamic Finance Glossary Available online: http://www.financeinislam.com/article/10/1/549

HilalPlaza: Author, HilalPlaza.com,Basic Concepts of Islamic Finance, undated Available online: http://www.hilalplaza.com/Islamic-Finance.html Bank Negara Malaysia (BNM): Author, 2007, Shariah Resolutions in Islamic Finance, 1st Edition, Malaysia, Published by Bank Negara Malaysia

Islamic Banking and Finance Institute Malaysia (IBFIM): Author, 2010, Glossary Available online: http://www.ibfim.com/

Islamic Finance Information Service (IFIS): Author, 2003, Glossary Available online: http://www.securities.com

Malaysian International Islamic Financial Center (MIFC): Author, Understanding Islamic Finance, p.10, Applications in Islamic Finance, 2006, 1st Edition, Malaysia, Published by MIFC

Muqthi: Author, Current Progress on Wadiah Certificate, Its Me, 2006 Available online: http://muqs.multiply.com/journal

Screening: Unknown Author, Islamic Finance Wiki, 2010 Available online: http://wiki.islamicfinance.de/index.php/Screening

Securities Commission Malaysia: Author, Glossary of Islamic Capital Market Terms, 2010 Available online: http://www.sc.com.my/

Securities Commission Malaysia: Author, Islamic Equity Market, p.14 The Criteria and Rationale of Islamic Equity Investment, 2009, 1st Edition, Published by LexisNexis

Securities Commission Malaysia: Author, List of Syariah-Compliant Securities by the Syariah Advisory Council of the Securities Commission Malaysia, 2010, Published by Securities Commission Malaysia

Securities Commission Malaysia: Author, Resolutions of the Securities Commission Syariah Advisory Council, 2009, Revised 2nd Edition, Published by Securities Commission Malaysia, Malaysia

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Islamic Finance:
An introduction to Islamic Finance and common terminologies

Acknowledgements
Producing Islamic Finance Fact Sheet: An Introduction to Islamic Finance and Common Terminologies has been made possible through a combination of collaborative endeavors, cooperation and invaluable experience. AmInvestment Bank, Islamic Markets would like to thank each individual who has contributed either directly or indirectly. We are grateful to the following for contributing and reviewing the contents of this booklet: Mohd Effendi Abdullah (Director/Head, AmInvestment Bank, Islamic Markets); Zairulnizad Shahrim (Associate Director, AmInvestment Bank, Islamic Markets); Nur Syafiqah Md Saad (Executive, AmInvestment Bank, Islamic Markets); Arif Zikri Azizi (Trainee, AmInvestment Bank, Islamic Markets).

The collaborative efforts will go a long way to fill the gap in capacity development, build and compile knowledge and information, and in addition, enrich intellectual capital of Islamic Finance and Islamic Capital Markets.

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Islamic Finance:
An introduction to Islamic Finance and common terminologies

Contact Details
AmInvestment Bank Bhd Islamic Markets 21st Floor, Bangunan AmBank Group, No. 55 Jalan Raja Chulan, 50200 Kuala Lumpur, Malaysia. www.ambankgroup.com CPA Australia Professional Standards Lvl 20, 28 Freshwater Place, Southbank Melbourne, Vic 3006 Australia Tel +61 3 9606 9606 www.cpaaustralia.com.au E-mail ProfessionalStandards@cpaaustralia.com.au

Mohd Effendi Abdullah Director/Head Islamic Markets Tel +603 2072 7748 E-mail effendi@ambankgroup.com

CPA Australia Malaysia Suite 10.01 level 10,The Gardens South Tower Mid Valley City Lingkaran Syed Putra 59200, Kuala Lumpur Tel: +603 2267 3388 E: my@cpaaustralia.com.au

Zairulnizad Shahrim Associate Director Islamic Markets Tel +603 2036 1645 E-mail zairul@ambankgroup.com

CPA Australia Singapore 10 06 StarHub Centre 51 Cuppage Road Singapore 229469 P: +65 6836 1233 E: sg@cpaaustralia.com.au

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