Shariah Screening Methodology for Listed Securities

Introduction

In today's global economy, there is a growing demand for investment options that align with Shariah principles. As such, the classification of securities as Shariah-compliant has become a crucial consideration for investors seeking ethical and sustainable investment opportunities.

To determine whether a security meets the criteria of being Shariah-compliant, certain benchmarks are established. In Malaysia, the Shariah Advisory Council (“SAC”) of Securities Commission (“SC”) plays a crucial role in ensuring the compliance of securities with Shariah principles. The Shariah-compliant securities screening methodology is employed by the SC to determine whether a particular security adheres to Islamic principles. These benchmarks assess both the business activities and financial ratios of the company in question. By adhering to these benchmarks, investors can ensure that their investments are in line with Shariah principles.

Shariah Screening Methodology for Listed Securities by Securities Commission Malaysia

On an annual basis, the SC carefully review the Shariah status of these securities, using the most up-to-date audited financial statements from the respective companies. This diligent process ensures that all listed securities meet the necessary standards and adhere to Shariah principles.

The SAC adopts two screening approaches i.e. quantitative and qualitative.

For quantitative approach, they adopts a two-tier quantitative approach, which applies:

1.  business activity benchmarks; and
2.  financial ratio benchmarks.

Hence, the securities will be classified as Shariah-compliant if they are within the business activity and the financial ratio benchmarks.

As for the qualitative approach, the SAC takes into account the qualitative aspect which involves public perception or image of the company’s activities from the Islamic perspective.

Below are the details of the Shariah Screening Methodology for Listed Securities by SAC:

Level 1: Business Activity Screening

The contribution of Shariah non-compliant activities to the overall revenue and profit before taxation (PBT) of the company will be computed and compared against the relevant business activity benchmarks as follows:

(i)  The 5% benchmark

The 5% benchmark is applicable to the following businesses/ activities:

1. conventional banking;
2. conventional insurance;
3. gambling;
4. liquor and liquor-related activities;
5. pork and pork-related activities;
6. non-halal food and beverages;
7. Shariah non-compliant entertainment;
8. tobacco and tobacco-related activities;
9. interest income from conventional accounts and instruments (including interest income awarded arising from a court judgement or arbitrator and dividends from Shariah non-compliant investments); and
10. other activities deemed non-compliant according to Shariah principles.

For the above-mentioned businesses/ activities, the contribution of Shariah non-compliant businesses/ activities to the Group revenue or Group profit before taxation of the company must be less than 5%.

(ii)  The 20% benchmark

The 20% benchmark is applicable to the following businesses/ activities:

1. Share trading
2. Stockbroking business
3. Rental received from Shariah non-compliant activities
4. Other activities deemed non-compliant according to Shariah principles

For the above-mentioned businesses/ activities, the contribution of Shariah non-compliant businesses/ activities to the Group revenue or Group profit before taxation of the company must be less than 20%.

Level 2: Financial Ratio Benchmark Screening

For the financial ratio benchmarks, the SAC takes into account the following:

1. Cash over Total Assets
2. Cash only includes cash placed in conventional accounts and instruments, whereas cash placed in Islamic accounts and instruments are excluded from the calculation.
3. Debt over Total Assets
4. Debt only includes interest-bearing debt whereas Islamic financing or sukuk is excluded from the calculation.

Each ratio, which is intended to measure riba’ and riba’-based elements within a company’s statements of financial position, must be less than 33%.

Level 3: Qualitative Screening

In addition to the above two-tier quantitative criteria, the SAC also takes into account the qualitative aspect which involves public perception or the image of the company’s activities from the perspective of Islamic teaching.

Update on Hotel and Resort and Cinema based business

In recognition of the dynamic nature of the market, SAC of SC periodically revises this methodology to ensure its relevance and compatibility with current market needs. This proactive approach enables Islamic finance institutions to cater to the demands of a rapidly changing market while maintaining compliance with Shariah principles.

The recent resolutions of the Shariah Advisory Council of the Securities Commission Malaysia have brought about significant changes in the benchmarks for certain industries. One notable change is the removal of the 20% benchmark for hotel and resort operations.

Previously, a benchmark of 20% was applicable for hotel and resort operations. However, this benchmark is no longer applicable because the focus of hotel and resort operations nowadays is to provide accommodation.

SAC also revised the benchmark for cinema business from 5% to 20%. This change reflects a shift in perspective regarding the negative image previously associated with cinemas based on Sadd Zari'ah (closing the doors or ways which may lead to haram). The SAC has concluded that it is not appropriate to equate cinema business with other activities that are clearly prohibited by Shariah. This adjustment acknowledges the evolving understanding of the industry and strives to provide a more balanced approach in line with Islamic principles.

Conclusion

Ultimately, ensuring securities meet specific criteria based on business activities and financial ratios is vital in classifying them as Shariah-compliant investments. This classification provides peace of mind for investors who seek both financial growth and adherence to Islamic beliefs. With proper consideration and evaluation, investors can make informed decisions about where they allocate their funds while staying true to their values.