The document defines and describes the key characteristics and functions of stock exchanges. It notes that stock exchanges are markets where securities like shares, bonds, and derivatives are traded based on supply and demand. The document outlines several important functions of stock exchanges such as facilitating long-term financing for companies and governments, aiding price discovery, spreading risk, and providing liquidity. It also discusses various types of securities like shares and bonds, as well as trading mechanisms including speculation, short-selling, and margin trading, noting some issues from an Islamic perspective. The conclusion advocates for Islamic stock exchanges that comply with Shariah and prohibit interest-based activities like conventional bonds, short-selling, and margin trading.

1. December
2013
Stock
Exchange
–
Maqasidi
view

2. Contents
• First Part
• Definition & Characteristics of SE
• Functions of SE
• Importance of SE
• Second Part
• Main Types of Stocks:
– Shares
– Bonds
– Options
• Third Part
• Trading Mechanisms:
– Speculation
– Short Selling
– Margin Trading
• Conclusion

3. Definition and Characteristics
• Is the venue or the means in or through which
securities trading takes place. Securities are issued by
companies and governments and can take the form of
shares (equity), bonds (debt) and other investment
instruments such as, derivatives, ETFs…etc.
• Securities Markets are, in fact, free markets depend on
forces of supply/demand to determine prices, and are
operating under the supervision of official Regulators,
which are primarily responsible for investors protection
through ensuring fairness, transparency and integrity
of the markets, and that they are free of cheating,
fraud, ambiguity, rumors and gambling, and where the
price is determined transparently by the forces of
supply and demand.

4. Functions
• It is the venue where companies and governments can
constantly acquire long-term finance, in contrast to banks
which provide only short-term finance.
• It facilitates the price discovery process i.e. investors can
know the prices of financial assets through the market.
• It spreads risk amongst large number of investors, and
therefore, it adds to the stability of the financial system.
• It enhances corporate governance and financial disclosure
standards.
• It is a good source of liquidity, thus play an important role
in reducing liquidity risk.
• It represents an exit window, as it gives investors the
discretionary right to sell their securities at any time, which
helps to reduce liquidity risk.

5. Importance
• Encouragement of savings, investments and mobilization of funds.
A Securities market play an important role in mobilizing national
savings and direct them in the investment channels to support the
national economy, and increase the rates of growth and prosperity
which will eventually benefit the society as a whole.
• Source of Long-Term Funds. Securities markets (through both its
primary and secondary components) are considered to be one of
the most important source of funds for companies to obtain the
necessary funding for the establishment and expansion of
businesses.
• Price discovery. The stock exchange plays an important role in
determining the equilibrium prices (or fair prices) for securities
listed therein.
• Risk management. stock exchanges help to reduce the risk within
the economy by spreading the risk among a big number of risk
takers.

6. Stock Exchange – Public Interest
(Maslaha Mursala)
• Maslaha Mursala: Public interest that has no
textual authority on its validity or otherwise.
• Conditions:
– Not in conflict with Sharia’h
– Genuine
– General
– Doesn’t involve Hardships
Can we consider Stock Exchange
Maslaha Mursala?

7. Main Types of Securities
• Shares (Equity) The capital of a stock-company is
distributed into shares. Each share represents a part of
ownership and is offered for sale in order to raise capital
for the company.
• Shares can be classified according to Sharia’h
permissibility into 3 categories:
– Shares of companies which are involved in totally permissible
activities – In this case owning those shares is permissible from
Sharia’h standing. What about Shares of Islamic Banks where
receivables 75%?
– Shares of companies which are involved in totally impermissible
activities – In this case owning those shares is prohibited by
Sharia’h.
– Shares of companies for which their core business is permissible
but they have some impermissible activities such as financing
core business (which is permissible) through conventional debt.

8. 3rd Category
• The jurists’ opinions regarding the third category still
controversial, at one end some, including OIC Fiqh
Academy, advocate that it is impermissible to invest in
those stocks, based on a number of sources such as, the
various Qura’n verses which prohibits Riba, Prophet’s PBUH
Sayings (Ahadeeth) and some Fiqh maxims like the one
which stipulates “If the lawful (Halal) mixed with the
unlawful (Harram), then the unlawful dominates”.
• At the other end of the spectrum, some advocate that it is
permissible to own those companies but under some
conditions. In fact, the promoters of permissibility have
referred to a number of sources also, such as, the Fiqh
maxim that says “That which is independently
impermissible becomes permissible when done in
conjunction with the permissible” and the other Maxim
which says “What is Inescapable is Tolerable”.

9. Islamic Index – QE Alrayan Index

10. Types of Securities – Cont’d
• Bonds (RIBA) Bonds are the second major security
listed in Stock Exchanges. A bond can be defined as
certificates of equal value issued by companies and/or
countries, and represents a short or long term
loan/financial claim on the issuing entity to repay its
face value as well as fixed accrued interest in specific
dates.
• Options (Gharar/Gambling) Option is a contract
between two parties whereby one party (writer/seller)
has an obligation to fulfill the contract and the
counterparty (holder/buyer) has the right (not the
obligation) to exercise the option at a pre-agreed price
over a certain period of time. ZERO Sum Game

11. Trading Mechanisms - Speculation
• Speculation is the investment activity whereby an
investor is willing to tolerate a high risk with regard to
high-frequency trading in the stock exchange.
• The speculator is the investor who owns a relatively
large capital outlay and has a diverse portfolio of
securities and trades securities on a high frequency
basis over the short term, which does not exceed hours
or few days maximum.
• This type of investment involves a high level of risk and
uncertainty about the profits or losses in the short
term, but usually speculators have sufficient market
experience as well as reasonable knowledge of how to
read and analyze financial statements of listed
companies, in addition to applying technical analysis
and charting to shares prices and indexes.

12. Speculation Paradox
• On one hand, some blame speculators for price manipulations,
spreading rumors, increase prices volatility and ending up having
price bubbles in stock markets. (Excessive Ghaban)
• On the other hand, it is argued that speculative trading as an
activity in itself does not constitute damage to the stock markets,
but on the contrary, this activity provides the liquidity needed by
those markets, since the speculator is always ready to buy or sell
securities at any time during the trading session from the rest of
the transacting parties in the market. (Slight Ghaban)
• Opinion: Legitimate speculation helps, very often, to restore the
balance between supply and demand, and reduces price
fluctuations in the securities markets as well as playing an
important role in determining the equilibrium price (fair price) of
the listed securities. Also, speculation makes stock markets liquid
and enable them to act as Exit windows to investors, consequently,
this will encourage savings and investments through the primary
and secondary segments of the capital market. (Slight Ghaban can
be tolerated)

13. Trading Mechanisms – Short Selling
• Short-selling is the sale of a security by a seller
who doesn’t own such security and borrows it
on the anticipation that its price will decline
and he/she will buy it after a period of time at
the lower price to make profit.
• From definition, we can deduce that short-
selling involves two issues i.e. (i) selling what
is not owned (Gharar) and (ii) securities
lending and borrowing (Riba).

14. Trading Mechanisms – Short Selling
• From reviewing Fiqh literature we can deduce that selling
an object by a seller who doesn’t own it is prohibited
mainly due to “Gharar” and its implication of potential
disputes that may arise between the buyer and seller in this
case. But, since in today’s market this transaction is
regulated by the market authorities and clearing houses
(CCP) to always guarantee the delivery of securities from
seller to buyer, regardless, then we can deduce that this
issue has become irrelevant in present markets.
• The second issue of borrowing the securities is the real
issue in short-selling transactions. Securities are considered
as fungible and homogenous assets as money, thus, they
are subject to Riba rulings, and since securities lending and
borrowing contracts are executed based on a paid
fee/interest to the lender, then it should be prohibited in
Islamic securities market.

15. Trading Mechanisms – Margin Trading
• Securities can be bought on credit offered by brokerage
companies to their clients. In this case, the buyer
contributes part of the purchase amount, let’s say 40%
(initial margin) .The Brokerage Company finances the
other 60% for an interest and takes the bought
securities as a collateral.
• If prices of the bought securities decline the brokerage
company asks the buyer to replenish their account, this
is referred to as a margin call, if the buyer doesn’t pay
the required amount the broker has the right to sell the
collateralized securities to cover the unpaid part of the
account.
• Obviously, this transaction is impermissible from
Sharia’h perspective as it involves interest (Riba).

16. Conclusion
• Stock markets, in general, have genuine importance for countries’
economies. They facilitate funds mobilization from surplus units to deficit
units. They help in spreading risks amongst a big number of risk takers.
And, they provide a place and means for assets’ price discovery. Definitely,
Islamic stock markets are no different and Muslim countries should
encourage the establishment of such Sharia’h compliant markets for the
benefit of their people.
• Islamic stock markets should have built-in regulations to guarantee that
listed securities and trading mechanisms are Sharia’h compliant.
• In principle, the investment in company’s common shares is permissible
unless companies are dealing in non-sharia’h compliant businesses, or
their screenings don’t comply with the well-known Sharia’h Indexes
criteria.
• Bonds as a debt security cannot be listed in Islamic stock markets and can
be replaced by Sukuk.
• Reasonable ‘legitimate’ speculations are accepted and needed for the
success of Islamic stock markets. (Slight Ghaban can be tolerated)
• Short-selling cannot be facilitated by Islamic stock markets, not because
Gharar but because the SBL mechanism which is based on interest/Riba
• Margin-trading cannot be facilitated by Islamic stock markets as they
involve interest-based loans.

17. Thank You
Q & A