Islamic Equity Market

Islamic capital market’s (ICM’s) have been growing at a significant pace, with an annual growth rate of 12%-15%, although world ICM assets comprise of only a small percentage of the global capital market (less than 2%). ICMs operate in most major economies, including those with Muslim minorities, in different levels of sophistication: some markets offer only Shariah-compliant stocks, whilst others provide opportunities to invest in Sukuk (Islamic bonds), Shariah compliant unit trusts or mutual funds, Islamic Real Estate Investment Trusts (iREITS), and even Islamic Exchange Traded Funds (iETFS). Malaysia for instance, provides a comprehensive suite of Islamic capital market products and offers a broad range of options for investors across varying investment horizons and risk appetites. 

Shariah-compliant capital market products are traded on leading world exchanges, including the Dubai NASDAQ, Malaysia stock exchange, London stock exchange, Luxembourg stock exchange, and the Saudi Arabia stock exchange. Even South Africa, with an estimated 2% Muslim population, has an Islamic stock index called the FTSE/JSE Shariah All Share Index. 

The ICM is an integral part of the Islamic Financial System, consisting of Shariah-compliant financial assets and securities that may be listed, traded or invested in via a variety of platforms. As a parallel offering to the conventional capital market, the ICM offers investment opportunities for investors and funding solutions for those raising capital, all within the parameters of Islamic law. The most basic of these parameters requires that such investments avoid riba (interest), gharar (excessive uncertainty), maysir (gambling) and are not involved in immoral activities. 

A primary component of the ICM is the Islamic equities market. Equities are shares in companies, and if these shares are listed on a publicly accessible share or stock exchange, anyone has access to buying and owning a share of the company of their choice.  Investors seeking to invest in companies that are Shariah compliant or ethical can purchase listed shares in companies that have passed a Shariah screening process. The screening process is based on globally accepted filtering principles established by Shariah Scholars and financial experts through the Islamic Fiqh Academy Rulings of 1990 and 1992 (IFA Resolution No 63/1/7, 1992). The Dow Jones Islamic Index (DJIM) rules developed by the Shariah Advisory Board of the DJIM in 1998 launched a list of stocks that passed the screening, leading to several indices applying a Shariah screening process. These include the FTSE Islamic index in London, Standard & Poor’s and the Morgan Stanley Capital International (MSCI) in the US, amongst many others. 

Malaysia

The Malaysian Islamic equity market has seen significant growth and innovation over the past two decades. The KLSI was launched on 17 April 1999. The subsequent development of the Securities Screening Methodology by an appointed Islamic Juristic Council known as the Shariah Advisory Council (SAC) of Securities Commission Malaysia (SC) has played a crucial role in determining the Shariah compliance of securities listed and traded on Bursa Malaysia. This has facilitated the expansion of the Islamic mutual funds industry, making it an important emerging component of the Islamic finance industry. By determining the Shariah compliance of listed companies, equity market offer choice and access to discerning investors who would otherwise be left out of a key component in wealth generation. The screening process is viewed as a beneficial innovation that provides maslahah or benefit to the broader community, benefitting both companies and investors.

Although the Shariah screening process varies slightly across different jurisdictions, the primary aspects are generally the same: a business screen (also known as the qualitative screen) is applied first, to determine the legitimacy of the main business, followed by a financial assessment of the company (also known as a quantitative screen). Ratios and thresholds may differ, but the principles of assessment are generally the same. In Malaysia, the SAC of SC screens listed shares based on qualitative and quantitative methodology. In accordance with Shariah screening protocols, the initial step mandates the exclusion of firms engaged in primary operations deemed non-compliant with Shariah tenets. This encompasses sectors such as pork, alcohol, usury (riba), and their related industries. Occasionally, a company’s principal business aligns with Shariah standards, yet its ancillary activities may not. In these scenarios, the scrutiny pivots to whether these secondary undertakings fall within permissible thresholds. 

A method to assess these subsidiary activities involves the analysis of revenue percentages they contribute. This facet of the screening is crucial, as it also prescribes the proportion of dividends requiring purification through philanthropic disbursements. The threshold of income from impermissible activities is limited to less than 5% of total income. This means that dividends earned from companies that qualify with a threshold of 4% impermissible income for example, will need to be purified by deducting the impermissible portion of the dividend and disbursing it to charity). The SAC-SC also adds a list of activities such as stockbroking, share trading and rental from impermissible activities to be less than 20% of total income as well. 

For companies with activities comprising both permissible and non-permissible activities, the SAC of SC measures the level of mixed contributions from permissible and non-permissible activities towards turnover and profit before tax of a company. The SAC of SC uses benchmarks based on Ijtihad (Shariah-based reasoning). Where the contributions of non-permissible activities exceed the benchmark, the securities are classified as Shariah non-compliant.

The SAC of SC subsequently assesses the financial management of the company by applying financial ratio benchmarks. The financial ratio benchmarks are intended to measure riba and riba-based elements within a company’s statements of financial position. According to the SAC, each of the following two financial ratios must be less than 33%:

• The ratio of total debt to total assets
• The ratio of cash and interest-bearing securities to total assets.

Finally, the SAC of SC takes into account public perception or image of the company’s activities from the perspective of Islamic teachings. A company must have a good reputation and integrity that has not been marred by illicit or harmful activities to society or communities, even though these activities may not have been illegal. The core activities of the company must also be considered as important and beneficial to society, providing positive utility thereby contributing to economic growth in a responsible manner.

In summary, the Islamic equities market is a formidable component of the broader ICM, providing investors seeking Shariah-compliant options in preserving and generating wealth. Several international markets provide Islamically screened stocks, using criteria agreed and accepted by Islamic juristic authorities in the field. The Malaysian SAC of SC provides such guidance through screening that applies both qualitative and quantitative criteria in asserting the permissibility of stock purchases. Further enhancements to the screening include compliance with sustainability criteria that integrate environmental, social and governance (ESG), merging Shariah screened stocks with ESG stocks, another class of investment in the global equities market.