Shariah Principles and Consideration for Dealing in Shares and Also, the screening criteria of All Shares Islamic Index including Shariah Screening Criteria and Technical Screening Criteria.

1. SHARIAH PRINCIPLES AND
CONSIDERATION FOR
DEALING IN SHARES

2. 2
INTRODUCTION
Islamic Capital and Money Market 2
• Explores the basic Islamic principles of investment in stock market by
revisiting the norms laid down by shariah and current global practices of
Islamic stock market and indexes.
• The perspectives of devout Muslims, the current form of stock market
restricts a Muslim to make investments in the market due to unsatisfying
several provisions from the Islamic law.
• This presentation focuses on those rules and regulations of Islamic
shariah for the stock market that are ignored by the conventional market
efficiency theory

3. 3
CONT’D……
Islamic Capital and Money Market 3
• It is considered that the concept of stock market was first introduced in
France in the thirteenth century. The Islamic concept of mudrabah1,
which in some way resembles with the modern stock market concept, on
the other hand, can be dated back to the age of Prophet Muhammad
(PBUH) in the sixth century (Al-Barwari, 2002; cited by Osmani &
Abdullah, 2009).
• Tag El-Din (2002) further mentioned that most of the stock exchanges in
Muslim countries are basically western-style markets which tolerate
many practices that do not comply with Islamic principles.
• The conventional stock markets under the capitalistic system failed to
protect the interests of ordinary investors time and again due to
repeated stock market crashes across the globe, resulting chronic
financial crises and economic depressions.

4. 4
CONDITIONS FOR SHARIAH PERMISSIBILITY
Islamic Capital and Money Market 4
• Although making investments in the stock market is allowed in Islam in
principle, the shariah set out certain rules and regulations for it which
differentiates an Islamically compliant stock market from a conventional
stock market. These guidelines are:
A. Characteristics of the Company
B. Characteristics of the Investors
C. Characteristics of the Transaction

5. 5
A. CHARACTERISTICS OF THE COMPANY
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• Share or stock means ownership, and a shareholder or a stockholder
means an owner of the company.
• The long term investors are the long term shareholders who are mostly
responsible for the characteristics of the company through influencing
the operations, nature of the business and strategic decisions of the
company.
• The short term investors, who are not investor in nature but frequently
trade in the secondary market to gain short term price change, have very
little influence on the operations, nature of the business and strategic
decisions of the company.

6. 6
CONT’D……
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• Therefore, the long term investors are fully responsible for the
company's overall shariah provisions while the short term investors only
need to look at the following characteristics of the company to avoid any
violation of the shariah principles.
1. Nature of the Business of the Company
2. Nature of the Assets of the Company
3. Debt to Equity ratio

7. 7
1. NATURE OF THE BUSINESS OF COMPANY
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• According to Islamic principles, it is not permissible to acquire the stocks
of the companies which are directly or indirectly attributed to riba or
interest. Companies that provide financial services on interest, such as
interest based banks, insurance companies, finance and leasing
companies, etc. also fall under this category of prohibition.
• Muslim shareholders receive dividend, they must ascertain the
proportion of dividend coming from interest-bearing activities and give
them to charity. He also mentioned that shariah scholars have permitted
to invest in stocks of companies whose income from interest-related
activities is less than 5% of the company's total income. Butt (2014)
elaborates that the income of the company from non-shariah compliant
investment, which includes interest, should not exceed 5% of its gross
revenue.

8. 8
CONT’D……
Islamic Capital and Money Market 8
• Stocks of companies whose products are not permitted in shariah are
prohibited to own, purchase, sell etc. Examples: interest-based banks
and insurance companies, entertainment business, etc.
• Stocks of companies that abide by the rules of shariah, such as Islamic
banks and Islamic insurance companies are permissible.
• Stocks of companies whose products are permissible but the company
indulges in non-allowed transactions – such as getting interest based
financing, depositing in banks for interest, making contracts that include
prohibited conditions, e.g., selling gold and/or silver and/or currencies in
other than spot, or giving donations or selling arms to aggressors – and
companies that produce permissible products but also produce non
permissible products as a minor line of production are not permissible in
principle.

9. 9
CONT’D……
Islamic Capital and Money Market 9
• Shariah principles is not involved in any of the following businesses:
• Gambling
• Trading with non-deliverance of goods or service
• Trading with counterfeit offering/demand
• Conventional banks
• Conventional leasing companies
• Trading of risk that contain uncertainty (gharar) and/or gambling (maisir), e.g
conventional insurance
• Doing transactions that contain bribe substance

10. 10
2. NATURE OF THE ASSETS OF THE COMPANY
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• Trading above or below the par-value would be considered as riba under
Islamic principles. In reality, almost all of the companies have both liquid
and non-liquid assets. In that case, the jurists have different views
towards the ratio of liquid assets to total assets.
• The Shafi and Hanbali schools of thought have set this minimum at 51%, while
scholars from Hanafi school of thought have opined that the ratio must not be
more than 33% (Jakhura, 2010).
• Meezan Islamic Fund Criteria in Pakistan has set out the ratio of net illiquid assets
of the investee company as a percentage of the total asset should be up to 10%
• S&P Islamic Index allows this ratio up to 49%
• FTSE Islamic Index allows up to 45%
• Dow Jones Islamic Market Index (DJIMI) allows up to 33%.

11. 11
3. DEBT TO EQUITY RATIO
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• Shariah principles do not allow interest bearing debt. However, based on
Islamic principles, shariah scholars have allowed investment into a
company if its debt-financing is not more than 33%.
• The Dow Jones Islamic Market Index and FTSE Islamic Index exclude the
companies in which debt to asset ratio is greater than or equal to 33%.
• Shariah Advisory Council (SAC) of Securities & Exchange Commission in
Malaysia also follows this 33% standard.
• Meezan Islamic Fund Criteria in Pakistan, on the other hand, allows up to
45% debt to asset ratio.

12. 12
B. CHARACTERISTICS OF THE INVESTOR
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• Characteristics of the investors defined in two categories:
1. Nature of the Ownership
2. Nature of the Intention

13. 13
1. NATURE OF THE OWNERSHIP
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• Dividends of preferred stocks are generally greater than those of
common stocks and are paid at regular intervals. Since preferred
shareholders do not have the right to vote, and they are not considered
as actual partners of the company, therefore, the extra money they get is
like riba as they take it without sharing the risk of profit and loss.
• Shariah allows only common stocks to be traded. There seems to be a
consensus of opinion among contemporary jurists on the permissibility
of exchanging common stocks through buying and selling transactions.
• Islamic Fiqh Academy declared that investing in ordinary shares is
permissible if the main business of the company is in compliance with
shariah ruling.

14. 14
2. NATURE OF THE INTENTION
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• The argument here is that in stock market, the buying or selling is done
with the intention of making a profit anticipating that price will change
and gain will come from natural or artificial price differences.
• The issue of speculation has been addressed by shariah scholars and
they have provided their views on the issue that investors in stock
market buy securities on the hope that their prices will go up in the
future and they will be able to realize capital gains.
• The Shariah Advisory Council (SAC) resolved that speculation is
permissible under Islamic jurisprudence.

15. 15
CONT’D……
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• According to SAC, speculation and gambling appear to be similar in
practice. As such, we do hear, for example, the exhortation not to treat
the share market as a casino. This perception arises because speculators
enter the market depending solely on luck, similar to gambling. But the
share market is not a place for gambling. It is a place that allows
shareholders to dispose ownership of shares to other investors in order
to gain liquidity. Whether it is gambling or not depends on the conduct
of the investors who enter and leave the market, and their motives.
• Therefore, it can be concluded that under the shariah provision, the
baseline of speculation is founded on the intention or behavior of the
investors. The decisions must not be based on uncertainty and
generating excessive risk, but based on the fundamental analysis and
intention to get normal profit from the market.

16. 16
C. CHARACTERISTICS OF THE TRANSACTION
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• Characteristics of the transactions defined in two categories:
1. Nature of the Transaction
2. Nature of the Zakat (compulsory tax) Provision

17. 17
1. NATURE OF THE TRANSACTION
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• Many Islamic jurists disagree on the validity of forwards, future and
options as the sold commodity and payment of the price are made in a
future date resulting in the elements of gharar (uncertainty) and
gambling. The shariah forbids gharar (selling something that is not
owned or that cannot be described in accurate detail in terms of type,
size, and amount).
• Similarly, the short-selling violates the shariah principle for the same
reason. Shariah strongly opposed the existence of short-selling in an
Islamic market, arguing that such sales are speculative involving riba and
gharar in the whole transaction and fails to perform any useful economic
function.

18. 18
2. NATURE OF THE ZAKAT PROVISION
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• The zakat (compulsory tax) on stocks is obligatory upon the owners of
the shares. The zakat may be paid by the company on behalf of the
Muslim shareholders or by the shareholders themselves.
• If zakat is not paid by the company, Muslim shareholders needs to pay it
individually
• The entire exercise of following shariah principles meticulously becomes
a paradox if the investors ignore the payment of zakat.

19. 19
CONT’D……
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• There are two ways to calculate zakat at individual level, depending on
the nature of the investors. If the shareholder is a short term investor, ,
who has the intention for price gain and is ready to sell the share
anytime when price increases, then zakat will be calculated on the full
market value of the share every year. If the shareholder is a long term
investor, who has no intention to take any short price gain but invests for
dividend gain, then zakat will be calculated only on the dividend amount
every year, and onetime zakat on the full selling price at the time of
selling the share.

20. ALL SHARES ISLAMIC INDEX
SCREENING CRITERIAS

21. 21
SHARIAH SCREENING CRITERIA
Islamic Capital and Money Market 21
• Screening Criteria # 1: Business of the Investee Company
• The core business of the company should not violate any principle of Shariah.
Therefore, it is not permissible to acquire the shares of the companies providing
financial services on interest like conventional banks, insurance companies,
leasing companies or the companies involved in some other business not
approved by the Shariah e.g. Companies making or selling liquor, pork, haram
meat, or involved in gambling, or any other impermissible activities as per
Shariah. Further, companies carrying out Tobacco and Explosive business will be
excluded on ethical grounds.

22. 22
CONT’D……
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• Screening Criteria # 2: Interest Bearing Debt to Total Assets, 37%
• The Interest Bearing Debt to Assets ratio should be less than 37%. To understand
the rationale behind this condition, it should be kept in mind that such
companies are mostly based on interest. Here again, the aforementioned
principle applies i.e. if the shareholder is not personally agreeable to such
borrowings, but has been overruled by the majority, these borrowing
transactions cannot be attributed to him/her. Debt, in this case, is classified as
any interest bearing debt including Bonds, TF

23. 23
CONT’D……
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• Screening Criteria # 3: Non-Compliant Investments to Total Assets, <37%
• The ratio of Non-Compliant Investments to Total Assets should be less than 33%.
Non-Shariah Compliant Investments include investments in conventional mutual
funds, conventional money market instruments, Commercial Paper, interest
bearing bank deposits, Bonds, PIBs, FIB, T-Bills, CoIs, CoDs, TFCs, DSCs, NSS,
derivatives etc. Non-Compliant investments also include investments in
companies which are declared Shariah non-Compliant due to non-compliance to
any of the mentioned criteria for Shariah Compliance.

24. 24
CONT’D……
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• Screening Criteria # 4: Non-complaint Income to Total revenue, <5%
• The ratio of Non-Compliant Income to Total Revenue should be less than 5%.
Total Revenue includes Gross Revenue plus any other income earned by the
company. Non-Compliant Income includes income from gambling, income from
interest based transactions, income from Gharar based transactions i.e.
derivatives, insurance claim reimbursement from a conventional insurance
company, any penalty charged on late payment in credit sale, income from
casinos, addictive drugs, alcohol, dividend income from above mentioned
businesses or companies which have been declared Shariah Non-Compliant due
to non-compliance to any of the mentioned criteria for Shariah Compliance etc.

25. 25
CONT’D……
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• Screening Criteria # 5: Illiquid Assets to Total Assets, >25%
• The ratio of Illiquid Assets to Total Assets should be at least 25%. The Sum of all
those assets whose trade price can deviate from par value, according to the rules
of Shariah, is considered the aggregate value of illiquid assets. Illiquid Assets
include inventory of raw materials, work-in-process, all fixed assets such as
property, plant & equipment, stores and spares, stock in trade etc.

26. 26
CONT’D……
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• Screening Criteria # 6: Net Liquid Assets/Share Vs Market Price/Share
• Market Price per share should be at least equal to or greater than net liquid
assets per share. Net liquid assets per share is calculated by using the following
formula:
Net Liquid Assets Per share =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑙𝑙𝑖𝑞𝑢𝑖𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑁𝑜. 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

27. 27
TECHNICAL SCREENING CRITERIA
Islamic Capital and Money Market 27
• Screening Criteria #1: The Company which is on the Defaulters’ Counter
and/or its trading is suspended, declared Non-Tradable (i.e. NT) as on
the re-composition date shall NOT be considered for inclusion in All
Shares Islamic Index.
• Screening Criteria #2: The Company will be eligible for All Shares Islamic
Index of Pakistan of Pakistan if its securities are available in the Central
Depository System.
• Screening Criteria #3: Newly listed company shall be included in index re
composition list which full fills the other eligible criteria.

28. 28
CONT’D……
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• Screening Criteria #4: The company must have an operational track
record of at least one financial year.
• Screening Criteria #5: The Company which have less than 5% free-float
and / or of its shares are traded for less than 75% of the total trading
days of the review period shall be included in Index however disclosed
separately in the index.
• Screening Criteria #6: Mutual Funds (both Open-Ended and Closed-
Ended) are ineligible for inclusion in the All shares Islamic Index,
however a separate list of all Shariah complaints investments will be
developed including mutual fund and Sukkuk to provide investment with
comprehensive list of Shariah complaints investment avenues in the
capital market.

29. 29
EXPLANATION
Islamic Capital and Money Market 29
• The principal objective of the All Shares Islamic Index is to gauge the
performance of the Shariah compliant segment of the equity market.
Accordingly, it is important that all those shares which meet the Shariah
screening criteria should be included in the All Shares Islamic Index in
order to ensure completeness of the index and adherence to the core
objective of the proposed All Shares Islamic Index. However, it is also
worth noting that many of the listed companies in Pakistan are closely
held by sponsors, resulting in very small free floats. Such shares can be
illiquid and carry a high risk of price distortion. In order to achieve the
objective of the index, companies which do not meet the requirements
of “minimum free float of 5%” and “at least 75% days trading”, should be
disclosed as a separate category to inform the investors about the
illiquid nature of these shares.

30. THANK YOU
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