Shariah Justification of the Securities Commission Malaysia Benchmark

Shariah justification of the Securities Commission Malaysia benchmark

The Shariah benchmark primarily aims to ensure that investors avoid engaging in impermissible business activities. It was developed based on credible primary sources of Shariah, including the Quran, and the Sunnah, as well as secondary sources of Shariah, such as sadd dhariah (blocking the means to evil), istishab (original presumption), and ‘urf (customary practice). In Malaysia, the Shariah Advisory Council (SAC) of the Securities Commission (SC) convened a series of meetings to establish the Shariah screening methodology. This process took into account factors when referring to Shariah sources, including the current economic climate of the country, public interest (maslahah), the image of Islam, investors’ sentiments, social standing and public perception. 

The current Shariah screening methodology comprises business activity benchmarks and financial ratio benchmarks. The financial ratio benchmark sets a 33% limit on cash over total assets and debt over total assets to monitor cash in conventional accounts and interest-bearing debts, respectively. The business activity benchmark includes 5% and 20% thresholds, specifying that profits before taxation from the relevant activities must not exceed these limits.  

Several sources justify the Shariah screening methodology.  The Quran, in verse 29 of Surah An-Nisa’ (4), advises against consuming the wealth of others unjustly, except through mutual consent. This principle underpins the business sector benchmark, which excludes companies engaged in prohibited activities such as gambling and casinos. For businesses involved in mixed activities, a specific benchmark was developed based on substantial Shariah justifications. Among these justifications is the classical jurists’ view that permits a mufawadhah company between Muslims and non-Muslims, provided that Muslims refrain from participating in Shariah non-compliant activities. 

The modern reality of mixed companies differs from that of classical partnerships, where the line of separation between permissible and impermissible activities has blurred. On this premise, the mufawadhah partnership formed by Muslims and non-Muslims may involve mixed business activities.  In such cases, the company may still be considered Shariah- compliant.  The SAC of SC has also justified the Shariah-compliant status of a company whose core activity is permissible but includes a mix of permissible and prohibited elements, based on the principle of ‘umum balwa (common plight and difficult to avoid). 

Without such an allowance, the maslahah (public interest) would be affected, especially in economic fields involving control of certain sectors as well as social stability. The justification based on ‘umum balwa is also related to the impact an entity has on the economy.  The public interest would be compromised if companies with mixed activities in critical economic sectors were not considered Shariah-compliant. This situation aligns with the concept of úmum al-balwa as outlined by jurists. Therefore, companies that have a significantly positive influence on the economy might be granted Shariah-compliant status despite minimal non-compliant activities. This approach allows Muslim investors to participate in the growth of these important entities while complying with Shariah principles and preserving the maslahah (public interest) of the public and the country.

The income generated from impermissible activities is further deliberated, leading the SAC of SC to establish business sector benchmarks of 5% and 20%. These benchmarks are based on the upper limit of Ghabn Fahisy in the Hanafi Mazhab, as stated in Majallah Al-Ahkam Al-‘Adliyyah clause 165 (Majallah Al-Ahkam Al-’Adliyyah, 1884).  “Ghabn fahish: 5% for ordinary goods, 10% for animals and 20% for real estate or more.”

Ghabn refers to profit-making that is above the market price. Ghabn Fahish specifically denotes the act of gaining excessive profit through cheating, which is impermissible. However, if excessive profit-making occurs without any cheating involved, such an act is permissible. If the ghabn is small and not significant, it is excused and considered legally permissible.

The above Shariah justification aligns with the principle of fiqh al-awlawiyyat (priorities) which requires placing every matter according to its hierarchy of priority and importance based on Islamic principles. Furthermore, the SAC of SC justifies these benchmarks according to the principle of al-Dharuriyyat al-Khamsah (Five Necessities). Therefore, it is permissible to invest in a large company whose core business is permissible, even if its impermissible activities are minimal and fall within the established benchmarks.

The element of Dharuriyyat lies in the economic strength of the country, which is crucial for its continuous progress. Therefore, it is not acceptable to dismiss large companies solely because they engage in a few activities that do not align with Shariah principles. By investing in these companies, investors, especially Muslims, can direct their capital towards permissible activities that outweigh the prohibited ones, thereby significantly contributing to economic growth. This approach not only enables Muslim investors to actively participate in the economy but also supports their involvement in strategic companies.

The 33% benchmark in the financial ratio is based on the hadith concerning Sa’ad ibn Abi Waqqas's intention to donate his entire estate to charity (narrated by Ahmad, Abu Daud, Nasa’i and Ibn Majah). According to this hadith, the Prophet Muhammad (S.A.W) approved Sa’ad’s intention to donate 1/3 or 33.33%, of his assets to charity.  This percentage can serve as a standard benchmark to establish the maximum limit of a mixture, as any amount exceeding this percentage would be considered excessive and should not be tolerated.

The debt ratio aims to minimise the company’s involvement in riba’ (usury or interest). Ideally, this ratio should be zero percent. However, due to the difficulty in achieving a zero percent ratio, it is permissible for the ratio to remain at 33%, as indicated in the hadith.

Regarding the asset ratio, the SAC of SC employs the cash over total assets ratio.  This approach differs from other indices such as DJIMI, AAOIFI, S&P, Thomson Reuters Ideal Ratings Islamic Indices and ISRA Bloomberg which use market capitalisation. A study indicates that total assets are chosen for their stability compared to market capitalisation, as they better reflect a company's true financial condition. 

Moreover, the principle of Ghalabah (predominance) is used as justification, supported by the legal maxim: “Consideration is given to the predominant and widespread, not to the rare.” Predominance is a qualitative and abstract concept, and therefore subjective. In this case, the principle of Akthariyyah (majority) which states that “the ruling of the majority applies to the whole,” is applicable for determining predominance. In this regard, classical jurists have deliberated on the issue of funding from both permissible and prohibited sources. The majority agree that transactions involving both types of funds are allowable, provided that the proportion of permissible funds is greater. However, there is no unanimous agreement on what constitutes a 'majority.' One perspective suggests that it is more than 50%, while another considers it to be more than one-third. Additionally, some define 'minority' as anything up to one-third.  

From a non-quantitative perspective, a company’s image is used to assess Shariah-compliance. Image refers to the public perception people of a matter, and in this context, it involves how the public views the relationship between Islam and specific business activities. Therefore, in addition to the two-tier quantitative criteria, the SAC of SC also considers the qualitative aspect involving the image of the company’s activities from an Islamic perspective. This image aspect includes evaluating public perception, which is assessed based on the principles of maslahah (public interest) and sadd al-dharia’ah (blocking the means). Business activities that benefit Muslim society at large but also have elements that may tarnish the image of the Muslim community, such as a broadcast company airing a variety of TV programmes, the sale of liquor in public transport, or condom related businesses may be considered Shariah non-compliant. The Shariah status of such image-related activities is determined at the discretion of the SAC of SC. 

However, it is important to note that the discretion of the SAC of SC is based on substantive Shariah justification and argumentation. Shariah principles are flexible and adaptable according to the needs of the people and other factors. For example, the condom business and its related activities were previously considered unacceptable due to image factors based on the principle of sadd al-dhariah (blocking the means to evil). However, this Shariah resolution has evolved over time, with the SAC of SC now considering the principle of original presumption (istishab) as a basis for excluding condom businesses and related activities from the Shariah screening methodology for listed securities. The principle of original presumption rules that condoms are regarded as neutral and treated as medical devices for health purposes.  Therefore, their original permissibility takes precedence over other external factors, such as image, that might otherwise render them impermissible. 

In summary, various Shariah benchmarks are used across various jurisdictions, with some being specific to individual countries and others to particular regions. These benchmarks exhibit variations, each supported by its own justifications based on credible sources. Currently, the benchmarking used in the Shariah screening methodology adopted by the SAC of SC is considered a matter of ijtihad, justified by the fiqh reasonings and arguments mentioned above. Although benchmarks may have changed in the past and may change in the future, any modifications will always be based on substantive Shariah justifications.