TOPIC THREE
ISLAMIC CAPITAL MARKETEQUITY MARKET
Shariah perspective on financial markets
“Although the original concept of financial markets is
sound and its application is very much needed in the
present-day context, yet their existing structure does
not present an example to carry out an objective of
investment and growth of capital within the Islamic
framework.
This situation requires serious academic effort to be
undertaken in collaboration between the jurists and the
economists, so that it may be possible to review the
existing system with it procedure and instruments and
to amend what needs amendment in the light of the
recognized principles of Shariah”
The Islamic Fiqh Council of the OIC
2
Role of Equity Market
Mobilize Fund.
• It facilitates the flow of fund directly from individuals and institutional
investors with surplus fund to corporation and investors who needs fund
for investments. This lead to efficient allocations of financial resources
in the economy - support economic growth through increase
investment in various industries, enhancing propspects of trade, finance
and commerce in a country.
An investment avenue.
• The market allows those investors with surplus fund to invest their
money in return for profits & enable firms to finance investments & new
business ventures.
Redistribute wealth.
• Equity financing allows circulation of fund & wealth in the economy
through investments & trade. Individual with small saving can invest in
equity market such buying mutual fund shares & earned dividend. This
increase wealth for low income investor & pensioners & thus
redistribute wealth.
Disadvantages of Equity financing
1. Shareholders’ interference
 large shareholders interfere with the management of the company &
managers must give up some control of the business to shareholders.
 if shareholders have different ideas about the company's strategic
direction or day-to-day operations, they can pose problems for the
company’s performance.
 smart business managers however know how to negotiate with differences
of opinions turning it into a positive contribution.
2. High registration cost
 marketing certain equities, such as Initial Public Offerings (IPOs), can be
very complex and expensive to maneuver successfully - such equity
financing may require complicated legal filings, documentations and a
great deal of paperwork to comply with various regulations.
3. Complexity of issuing stocks
 equity financing is more complex, and requires firms to use a third services
of party such as lawyers, accountants & investment banks.
Type of Equity Market
1) Primary Market
• Primary market is where firms raise fund by issuing new shares
(Initial Public Offering)
• Companies which are going public for the first time, need to
start with the IPO with the help of Islamic investment banks.
• Certificates of ownership (or stock) are issued by the company
in return for each financial contribution and shareholders can
either hold the shares indefinitely and earns dividend or they
can resell the shares they own in secondary markets for higher
prices and earn capital gain.
1) Secondary Market
• The secondary market provides opportunities for buyers and
sellers of listed stock to trade in shares and earn capital gain.
• Secondary market constitute the largest retail stock market
(deals are done by over the phone or counter) where investors &
institutions buy stocks at low prices and sell them later when
prices increase to earn profit in the form of capital gain.
• brokers are professionals who act as a middle man between the
buyers and sellers of stocks for fees.
• brokers must be associated with specific stockbroking companies
whose clients include inviduals and corporations
Islamic Capital Market
 The main purpose of ICM is to provide long term fund for government
agencies & corporations for investment and infrastructural
development.
 The transaction, operation and instruments used are based on the
principle of Shariah which are free from riba, gharar & maysir .
 The growth & development drivers of the Islamic capital market
include:
 greater awareness for Shariah-compliant investment and savings
products and services,
 rising income and wealth among the Muslim communities,
 increase demand for shariah compliant investment products &
services from governments, corporations & societies.
Islamic Capital Market Products
Islamic Equity Market
• Shariah compliant stocks
• Islamic equity funds
• Islamic REITs
• Islamic index
Islamic Sukuk Market
• Islamic fixed income securities
• Sukuk ijarah, musharakah &
mudharabah
• Islamic asset-backed securities
• Islamic bond funds
Shariah compliant derivatives
• Crude Palm Oil Futures
• Crude Palm Kernel Futures
• Single Stock Futures
Islamic structured products
• Dual currency structured investment
• Equity linked structured investment
Islamic stockbroking
• Shariah-compliant trading
• Shariah compliant margin financing
A) Islamic Equity Market
Definition: Islamic Equity Market is a financial market where company
shares, Islamic funds, Islamic real estate investment trust ( REIT) and other
securities are issued and traded under a stock exchange market, for e.g.
Bursa Malaysia.
The commodities are shares and securities, in the form of paper
representing rights to the holder which is the buyer, and obligations on the
issuer which is the original seller.
- price of stocks are determined by forces of demand and supply of the
stock of that particular company. The more successful the company is,
the stronger the demand for its share will be and the higher the price of
the stocks. Investors buy stocks at low prices and sell at higher prices in
order to earn returns. Investors can buy and sell stocks at any point in
time.
- issuance and trading in the Islamic equity market are based on the
contracts of mudarabah and musharakah, i.e. profit & loss sharing.
Securities traded in Bursa Malaysia can be issued by both public and
private corporations.
Shari’ah Principles on Equity investment
• prohibition of riba (no guaranteed fixed return)
• prohibition of gharar (unnecessary risk) and maysir
(gambling)
• primary business activity must be in line with Shariah
• majority of assets of the company must be physical
assets not financial assets.
• non-permissible income must be below a specified
benchmark
• Shariah screening of common shares
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New screening methodology by SC’s SAC
Quantitative
Assessment
Revised Shariah
Screening
Methodology
Current Shariah
Screening
Methodology
Business activity
benchmarks
• 5%
• 20%
• 5%
• 10%
• 20%
• 25%
Financial ratio
benchmarks
• 33%
• Not Applicable
New screening methodology - Business Activity Benchmarks
1. The 5% benchmark would be applicable to the following business
activities:
• conventional banking;
• conventional insurance;
• gambling;
• liquor and liquor-related activities;
• pork and pork-related activities;
• non-halal food and beverages;
• Shariah non-compliant entertainment;
• interest income from conventional accounts and instruments;
• tobacco and tobacco-related activities; and
• other activities deemed non-compliant according to Shariah.
New screening methodology - Business Activity Benchmarks
2. The 20% benchmark would be applicable to the following
activities:
• hotel and resort operations;
• share trading;
• stockbroking business;
• rental received from Shariah non-compliant activities; and
• other activities deemed non-compliant according to
Shariah.
New screening methodology : Financial ratios Benchmarks
i) Cash over Total Assets
Cash will only include cash placed in conventional accounts
and instruments, whereas cash placed in Islamic accounts
and instruments will be excluded from the calculation.
ii) Debt over Total Assets
Debt will only include interest-bearing debt whereas Islamic
debt/financing or sukuk will be excluded from the
calculation.
Both ratios, which are intended to measure riba and riba-based
elements within a company's balance sheet, must be lower than 33%.
Mixed Company Criteria [ applied to revenue & profit
before tax ]
5% Benchmark
• If any of the company subsidiary involve indirectly in
prohibited activities such as conventional banking,
gambling, liquor, pork, non-halal food & beverage, nonhalal entertainment, etc. then income & profit from the
subsidiary should be less than 5% of total Group income &
profit.
20% Benchmark
• Due to maslahah to the public, e.g. hotel and resort, stockbroking, rental income received from non-shariah
compliant, & other non-shariah activities should be less
than 20% of total Group income & profit.
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Illustration
• ABC Berhad has a small division which is a conventional finance
company. The revenue and profit before tax contribution of this
division does not exceed 5% of the entire company’s total revenue and
profit before tax – ABC Berhad can be described as Shari’ah tolerated.
• DEF Berhad is a conglomerate that has a wholly-owned subsidiary
involved in the hotel business that may involve illegitimate business
practice such as dealing with alcohol or client indulged prostitution.
Revenue and profit before tax from that subsidiary comprises
approximately 20% of the group’s revenue and profit before tax - The
proceeds may be described as Shari’ah compliant.
• GHI Berhad has investment in an associated company that operates a
brewery, which contributes about 8% of the company’s total profit
before tax – The company is Sharia’h non-compliant
• JKL Berhad has a subsidiary that is a licensed distributor of tobacco
products. While this subsidiary make up about 7 % of JKL’s profit before
tax – Sharia’h non-compliant.
Kaya Raya Holdings Berhad stock is shariah compliant using Stock
Screening Benchmark
Principal activity – Construction and civil engineering
Kaya Raya
Holdings Berhad
Subsidiary
KRH Cons.
Sdn. Bhd
Lai Kuay
Sdn. Bhd
Strong Heart
Sdn. Bhd
Group info :
Group Revenue : RM10 million
Group Profit
: RM 5 million
Non-permissible activities
info :
Revenue tobacco : RM 900,000
Profit tobacco
: RM 400,000
Associated Kapur Barus Kejuruteraan
Sdn. Bhd
Siaga Sdn. Bhd
Tobacco business
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Related information
(Source: Nik Ruslin, SC)
Qualitative Screening Benchmark
Used for screening companies involved in mixed activities, i.e. both
Shari'ah permissible and non-permissible elements.
The criteria include:
1. Core activities of the company are halal but Haram element is
small compared to core activities.
2. Public image/perception of company is good.
3. Core activities of the company are important, have element of
urf (custom) and of public interest (maslahah) to the Muslim
ummah and the country.
• Note: If a subsidiary or holding company meets all these criteria,
then the stock of the parent company is shariah compliant.
Reclassification of Shariah Compliant Investment
 Announcement date of Shariah compliant stock - May &
November.
 Shariah provide the following options in case of reclassification
from permissible to non-permissible status:
1. Price increase above market rate
 Investor should, sell immediately and take the gain before it
increases.
 Or If you cannot sell immediately, then whatever gain beyond the gain
on the announcement date has to be given to charity.
2. Price fall below the market price
 If there is a loss, investor should wait until the price reaches the
break-even level.
Islamic Equity Market Instruments
1. Shares or Stocks
There are four types of shares or stocks, i.e. common stocks,
preferred stocks, bonus shares & rights issues.
1. Ordinary shares
 An ordinary share represents undivided ownership by a
shareholder in the business of the company.
 Ordinary shares (Common stock) give the holder the right to
vote on matters of corporate policy, & appointment of board
of directors.
 The holder of ordinary shares are the owners of the company
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Features of Ordinary shares Shares or Stocks
Directly issued, paid-up & perpetual.
In the event of liquidation, they are paid last
based on the proportion of capital contributed.
Dividends to ordinary shareholders are not
obligatory.
In case of losses, ordinary shareholders bear the
losses first.
The participated capital is not secured or
guaranteed by the company.
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Types of shares or stocks
2. Preferred shares or stocks.
Preference share is a hybrid instrument that gives the holder a
fixed dividend, priority in the event of liquidation but no
voting rights in the company annual general meeting.
Rationale for issuing preference shares include:
 issuer firm want to reduce risk of debt financing & thus by
issuing preference share the debt – equity-ratio will be low.
 firms also want to restrict foreign shareholders from holding
voting rights.
 fnvestor want more secure income as investing in preference
shares gives them fixed & secured income.
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Features of Preference Shares or Stocks
1. Cumulative & non-cumulative Preferred Stock
 In cumulative preferred stocks, dividend are cumulative that is if the
dividend is not paid in a given year, it will accumulate for future payments in
subsequent years.
 In non-cumulative preferred stock, if the company is unable to make the
dividend payment, the obligation is not carried forward.
2. Claim on Assets and Income
 Company must pay fixed dividends to preferred stockholders before it pays
dividend to common stockholders.
3. Protective Provisions
 Generally preferred shareholders are allowed to vote in the general meeting
in the event of non payment of dividends.
4. Convertibility
 Preferred stock can be converted into a predetermined number of shares of
common stock.
5. In case of liquidation, preference shareholders are given priority & paid first.
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Types of shares or stocks
3. Bonus shares
 A bonus share is a free share of stock given to current shareholders in
a company.
 This is based on the number of shares that is owned by shareholders,
i.e. shareholders who owns large number of shares receive more
bonus shares.
 Company issues bonus shares when it expect positive growth in order
to boost performance of its stock.
4. Rights issues
 Rights issues are shares offered on discount to existing shareholders in
proportion to their current shareholding.
 Company can issue Transferable Subscription Rights ( TSR) to ordinary
shareholders or warrant to preference shareholders.
 However, rights issues could indicate that the company is having
financial problems & that can leads to fall in its share prices.
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Global Shariah Indices
• Dow Jones Islamic Market Index – first Islamic
equity index launched in February 1999
– First benchmark to represent Islamic compliant
portfolio
• Financial Times Stock Exchange launched
Islamic Global Index family in Nov 1999
• FTSE SGX Shariah Index Series
• S & P Shariah Indices (2006)
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
Dow Jones-RHB Islamic Malaysia Index

Kuala Lumpur Shariah Index

FTSE Bursa Malaysia EMAS Shariah Index

FTSE Bursa Malaysia Hijrah Shariah Index
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2. Islamic Real Estate Investment Trust ( REITs)
• A REIT is a management company that gather a pool of funds from investors,
which is then used to buy, manage and sell assets in the real estate sector.
• A REIT must invest at least 50% of its total assets in real estate.
• REIT must be run & administered by management company that are
subsidiary of banks or property development company, or property
investment holding companies that are approved by Security Commission
• Example of Islamic REIT listed on Bursa Malaysia is Al-Hadharah Boustead
involved in palm oil plantations assets.
• REIT provide investors chance to diversify their investment in an income
generating real estate sector such as residential, commercial, retail
properties, plantation land, storage facilities, warehouses etc.
• Investors earn return from either dividends or capital gains and REIT is
obligatory to protect fund of the investors.
Types of Real Estate Investment Trust ( REITs)
There are four types of REITS
1. Equity REITS
 Equity REITS own & operate income-producing real estate.
 Their activities involve developing, leasing, & providing management & tenants
services.
2. Mortgage REITS
 Mortgage REITS lend money to real estate owners & operators in conventional
using interest but Islamic mortgage REITS used ijarah contract.
3. Hybrid REITS
 Hybrid REITS are combination of equity & mortgage REITS
 They own & operate real estate but at the same time provide loans to real estate
owners & operators.
4. Stapled REITS
 They are investment vehicles that combined together two or more separate REITS
business entities into single new financial instrument which is traded in bursa
Malaysia.
 Example, KLCC REITS merged together shares of KLCC property Holding Bhd, units
of KLCC REITS that consist of Petronas twin towers, menara petronas 3 & menara
ExxonMobil.
 It is the first world Islamic staple REITS with market capitalization of USD 3.53
billion.
Islamic Real Estate Investment Trust ( REITs)
Guidelines for Islamic Real Estate Investment Trust (REIT) issued by
Security Commission.
–
–
–
–
–
Rental from non-permissible activities capped at 20%
Islamic REIT not allowed to own real estate in which
all tenants operate non-permissible activities, even if
percentage of rental from that property to the total
turnover of the Islamic REIT is still below 20%
Islamic REIT fund manager should not accept new
tenants whose activities are fully non-permissible.
All forms of investment, deposits and financing
instruments must be Shari’ah compliant
Real estate property must be insured using takaful
schemes, where available
Islamic VS Conventional REIT
Conventional REIT
• Shari’ah
Committee/Advisor
• There is no need for
any Sharia advisor
• Permissibility of activities • No restrictions
performed by tenants
Islamic REIT
• Islamic REIT must
appoint shariah advisor to
endorse their activities
• only halal activities are
allowed e.g. no club
• Insurance of Property
• Conventional insurance • the manager must use
with insurance companies takaful for protection.
as permitted by trustee
• Financing
• no limitations
• Financing should be
shariah compliants.
3. Islamic Fund/ Unit Trust/Mutual fund
 Definition: Unit trust is a fund management firm, which pools investors’ capital
into a fund then managed by professional managers
 The fund will be invested in a diversified portfolio of
–
stocks, Islamic bond, money market and/or
–
fixed income securities and/or
–
other assets as permitted by the deed as well as the Security
Commission guidelines on Unit Trust
 Returns to investors are usually in the form of income distribution (dividends)
and/or capital appreciation derived from the pool of assets
 What makes Unit trust Islamic?
–
Stock Selection : Unit trust invest only on Shari’ah-approved companies
–
Non-use of interest-bearing securities.
–
Example of Islamic Unit trust manager include RHB unit trust, Public
bank mutual fund, CIMB wealth advisor etc.
Advantages of Islamic Fund/Unit trust
1. Diversification
 It gives opportunities to small investors to diversify their portfolio, which
would otherwise be impossible for them to invest in diversified securities such
as stock, bonds, money market instruments, etc.
2. Lower risks
 Fund manager invest the fund in diversified portfolio & this minimize risks.
3. Liquidity investment
 Investors can sell back or redeem some or all of their units on any business
day & get back their money within short period of times.
4. Lower cost
 Since the fund manager takes care of large number of investors, the fund
management fee is spread across the shareholders. Thus, fee paid per
investor is low.
5. Economies of scale
 By pooling the fund together small investors can become partly owner of
properties or businesses which would not have been possible for small
investors.
Securities Commission Malaysia guidelines for
Islamic fund management
1. An Islamic fund manager must ensure that its investment
activities are limited to Sharia’h-compliant investments.
2. Islamic fund manager should invest only in securities listed as
Shariah-compliant securities.
3. However, if the securities are not listed, an Islamic fund
manager is encouraged to follow the Security Commission
methodology in screening Shariah compliant of unlisted
securities.
4. To invest in international stock exchange outside, an Islamic
fund manager should only invest in securities endorsed by the
Shariah advise of the recognized stock exchanged or by an
international Shariah standard setting body.
Islamic Venture Capital and Private Equity
• SC issued Guidelines & Best Practices on Islamic
Venture Capital May 2008
– to serve as guidance for venture capital corporations
and management in carrying out Islamic venture
capital businesses or activities
• Must comply to the following fundamental
requirements:
1. The appointment of Shariah Adviser
2. The core activities of the investee company must be
Shariah compliant
Requirements for Islamic venture capital
Shariah Adviser
i.
To provide expertise and guidance on all
Shariah matters including:
• Portfolio management, trading practices
• Documentation, structuring & investment
• Maintenance of accounts
• Scrutinising any compliance report
prepared by Shariah compliance officer
• Prepare a written disclosure and declaration
to the Board of Directors
• Administrative and other operational matter
Shariah-compliant Activities
Non-permitted ctivities
i. Financial services based on riba (interest)
ii. Gambling/gaming
iii. Manufacture or sale of non-halal products
or related products
iv. Conventional insurance
v. Entertainment activities that are nonpermissible according to Syariah
vi. Manufacture or sale of tobacco-based
products or related product
vii. Stockbroking or share trading in Syariah
noncompliant securities
viii. Hotels and resorts; and
ix. Other activities deemed non-permissible
according to Shariah.
Shariah Issues in Equity Market
1. Issue of limited liability & legal personality
 Public limited companies are registered as legal entity & thus
have limited liability.
 In case of liquidation or insolvency, creditors can only claim on
company’s asset not the owners’ asset. This is unfair for
creditors.
2. Issue of joint stock company
 The idea of corporation with many shareholders was alien to
Islamic laws, jurists are yet to determine in its legality.
3. Issue of trading shares
 Although shariah permits trading of shares, but in conventioinal
equity markets trading of shares in both primary & secondary
markets involves element of gharar & maysir.
 These two elements are completely prohibited in Islam.