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Shariah Guidelines For


ISLAMIC FUNDS
By

Muhammad Najeeb Khan


Sharia Advisor
Habib Mertropolatin Bank
Sharia Board Member
UBL Islamic Fund
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According to Shariah Standards of Accounting and


Auditing Organization for Islamic Financial
Institutions (AAOIFI) a Stock Company has been
defined as:
A stock company is a company of which the capital is
partitioned into equal units of tradable shares and
each shareholders liability is limited to his shares in
the capital. It is a form of financing partnership. The
rules of Sharikat al-Inan apply to this company
except on the issue of the limited liability of the
shareholders and the fact that this type of company
cannot be unilaterally terminated by one party or a
minority of its shareholders
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Scope
Transactions in an Islamic Capital Market should be
free from the involvement of prohibited activities
by Islam as well as free from the elements such
as usury (riba), gambling (maisir) and ambiguity
(gharar)

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Shariah Compliant Stocks


Shariah Guide lines:
Shariah based principle of equity

participation is Shirkah
Stocks are classified as Shariah
compliant if their business activities do
not fall in the prohibited list prescribed
by Shariah Scholars
Certain financial ratios are also applied
for screening.
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Shariah Compliant Stocks


Prohibited activities:
Alcohol
Gambling

Pork related products


Pornography
Conventional financial

services
Conventional insurance

Tobacco,
Indecent Entertainment
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Financial Ratios:
Main ratios applied are

Debt to equity ratio


Cash and interest bearing
securities to equity ratio
Cash to asset ratio

In Malaysia, the screening of

listed stocks is undertaken by


a centralised body- Shariah
Advisory Council of SEC

In other jurisdictions, screening


services are performed by
individual institutions

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Stock Market Business


The stock exchange provides a market place

where investors can buy and sell shares. The


exchanges role is to monitor the market to
ensure that it is working efficiently, fairly and
transparently.
The trading system comprises four distinct
segments:
T+ (2) settlement
Spot transactions
Provisionally listed counter
Futures contract
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Key components of Islamic Capital Markets

Shariah Compliant Stocks

Islamic Capital Market

Islamic Funds

Islamic Bonds

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Shariah Related Issues in Stocks


Trading
Not permitted to purchase shares by
raising interest bearing loans through a
broker or someone else.

Not permitted to pledge the shares for


the interest bearing loan.

It is not permitted to sell the shares

that the seller does not own which is


called short sale. The promise by the
broker to lend these shares at the time
of delivery is of no consequence.

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Issues in Stocks Trading (Contd)

Not permitted to conclude futures

contract for shares because according


to Shariah only one thing either
payment or delivery can be deferred.
Not permitted to conclude the
contracts of options for shares or to
conclude swap contracts with respect
to shares and their returns.
The contract of Salam is not
permissible in shares identified
items.
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Stock Screening Criteria

Various Criterion have been developed by


the Scholars to screen any scrips
eligibility for investment. The major
stock screening criterion followed are:
Dow Jones Islamic Market Indices
Criteria (DJIMI)
Meezan Islamic Market Index Criteria
(KMI 30 Index Criteria)

Dow Jones Islamic Market


Index Criteria

Business of the Investee Company: The basic business


of the investee company should be Halal.

Debt to Market Capitalization: Total debt divided by


12-month average market capitalization should be less
than 33%.

Cash and Interest Bearing Securities: The sum of


companys cash and interest-bearing securities divided by
trailing 12-month average market capitalization should be
less than 33%.

Accounts Receivables: Accounts receivables divided


trailing 12-month average market capitalization should be

Meezan Islamic Market Index Criteria

Business of the Investee Company: The basic business of the


investee company should be Halal.

Debt to Total Assets: The interest bearing debt of the investee


company should not exceed 37% of total assets.

Illiquid Assets to Total Assets: Total illiquid assets of the Investee


company as a percentage of total assets should be at least 25%.

Investment in Shariah Non-Compliant Activities: Total investment


of the investee company in Shariah non-compliant business should
not exceed 33% of total assets.

Income from Shariah Non-Compliant Investments: The income


from Shariah non-compliant investments should not exceed 5% of
gross revenues of the investee company.

Net Liquid Assets vs. Share Price: The net liquid assets per share
should be less than the market price of the share.

Purification Requirement
It is necessary to purify the earnings by deducting
from the returns on the investments those
earnings emanating from an unacceptable source
from a Shariah point of view.
In context of equity investment according to
Shariah standards it is obligatory to eliminate
prohibited income that is mixed up with the
earnings of the company and this obligation is on
the one who is the owner of the shares.

Purification Requirement
Elimination is not obligatory for the intermediary,
agent or manager out of part of their commission
or wages because this is their right in lieu of the
work they have undertaken.
In case of Fund Management it is responsibility
of the Management Company to eliminate the
prohibited income.
According to Shariah Standards for the
determination of the percentage of prohibited
income the recourse should be the last verified
financials position.

Purification Requirement

we calculate the percentage of non-compliant


income to the gross revenue (sales + other
income) for each investee company and this
percentage is called as charity rate.

Charity rate for each investee company is


multiplied with the dividend income from
respective companies to get the charitable
amount. This charitable amount is then
transferred to a separate account.

Shariah advisor verifies the whole process of


elimination of prohibited income and issues a
certificate to be included in the annual

Quantitative Screening
Criteria
The basic business of the investee company

should not be non-Shariah compliant like


conventional banks and insurance companies
Total non-Shriah compliant debt of the
Investee Company should not exceed 40% of
the total assets.
Total illiquid assets (which are not cash or cash
equivalent) of the Investee Company as a
percentage of the total assets should be at
least 20%
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Quantitative Screening
Criteria
Total investment of the investee company

in Shariah non-compliant business (as a


secondary source of income) should not
exceed 33% of the total assets
Investee Companys interest income or any
other non- Shariah compliant income
should not exceed 5% of its gross revenues
All the essential Shariah trading rules
would be applied in case of trading; hence
short sale or sale before settlement date
would not be allowed
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JAZAKALLAH

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