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Shariah Guidelines For
ISLAMIC FUNDS
April 24, 2012
Alhuda-CIBE Trainings
Avari Towers, Karachi
By
Muhammad Najeeb Khan
Sharia Advisor
Habib Mertropolatin Bank
Sharia Board Member
UBL Islamic Fund
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Islamic Investment
• The term 'Islamic Investment Fund" in this
chapter means a joint pool wherein the
investors contribute their surplus money
for the purpose of its investment to earn
halal profits in strict conformity with the
precepts of Islamic Shari‘ah
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Islamic Investment
• Firstly, instead of a fixed return tied up
with their face value, they must carry a
pro-rata profit actually earned by the
Fund. Therefore, neither the principal nor
a rate of profit (tied up with the principal)
can be guaranteed.
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Islamic Investment
• Secondly, the amounts so pooled
together must be invested in a business
acceptable to Shari‘ah. It means that not
only the channels of investment, but also
the terms agreed with them must conform
to the Islamic principles.
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Equity Fund
•
In an equity fund the amounts are
invested in the shares of joint stock
companies. The profits are mainly derived
through the capital gains by purchasing
the shares and selling them when their
prices are increased. Profits are also
earned through dividends distributed by
the relevant companies.
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Equity Fund
•
It is obvious that if the main business of a
company is not lawful in terms of Shari‘ah,
it is not allowed for an Islamic Fund to
purchase, hold or sell its shares, because
it will entail the direct involvement of the
share holder in that prohibited business.
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Conditions
• Conditions for investment in Shares
In the light of the foregoing discussion,
dealing in equity shares can be acceptable
in Shari‘ah subject to the following
conditions:
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Conditions
• 1. The main business of the company is
not violative of Shari‘ah. Therefore, it is
not permissible to acquire the shares of
the companies providing financial services
on interest, like conventional banks,
insurance companies, or the companies
involved in some other business not
approved by the Shari‘ah.
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Conditions
• 2. If the main business of the companies
is halâl, like automobiles, textile, etc. but
they deposit their surplus amounts in an
interest-bearing account or borrow money
on interest, the share holder must express
his disapproval against such dealings,
preferably by raising his voice against
such activities in the annual general
meeting of the company.
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Conditions
• 3. If some income from interest-bearing
accounts is included in the income of the
company, the proportion of such income
in the dividend paid to the share-holder
must be given in charity, and must not be
retained by him. For example, if 5% of the
whole income of a company has come out
of interest-bearing deposits, 5% of the
dividend must be given in charity.
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Conditions
• 4. The shares of a company are
negotiable only if the company owns some
illiquid assets. If all the assets of a
company are in liquid form, i.e. in the
form of money they cannot be purchased
or sold except at par value, because in
this case the share represents money only
and the money cannot be traded in except
at par.
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Conditions
• What should be the exact proportion of illquid
assets of a company for warranting the
negotiability of its shares? The contemporary
scholars have different views about this
question. Some scholars are of the view that the
ratio of illiquid assets must be 51% in the least.
They argue that if such assets are less than
50%, then most of the assets are in liquid form,
and therefore, all its assets should be treated as
liquid on the basis of the juristic principle:
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Conditions
• Some other scholars have opined that even if
the illiquid asset of a company are 33%, its
shares can be treated as negotiable.
The third view is based on the Hanafi
jurisprudence. The principle of the hanafi school
is that whenever an asset is a combination of
liquid and illiquid assets, it can be negotiable
irrespective of the proportion of its liquid part.
However, this principle is subject to two
conditions:
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According to Shariah Standards of Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI) a
Stock Company has been defined as:
“A stock company is a company of which the capital is
partitioned into equal units of tradable shares and each
shareholder’s liability is limited to his shares in the
capital. It is a form of financing partnership. The rules of
Sharikat al-Inan apply to this company except on the
issue of the limited liability of the shareholders and the
fact that this type of company cannot be unilaterally
terminated by one party or a minority of its
shareholders”
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Scope
Transactions in an Islamic Capital Market should be free
from the involvement of prohibited activities by Islam as
well as free from the elements such as usury (riba),
gambling (maisir) and ambiguity (gharar)
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Shariah Compliant Stocks
• Shariah Guide lines:
• Shariah based principle of equity
participation is Shirkah
• Stocks are classified as Shariah compliant
if their business activities do not fall in the
prohibited list prescribed by Shariah
Scholars
• Certain financial ratios are also applied for
screening.
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Shariah Compliant Stocks
Prohibited activities:
• Alcohol
• Gambling
• Pork related products
• Pornography
• Conventional financial
services
• Conventional insurance
• Tobacco,
• Indecent Entertainment
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Financial Ratios:
• Main ratios applied are
– Debt to equity ratio
– Cash and interest bearing
securities to equity ratio
– Cash to asset ratio
• In Malaysia, the screening of
listed stocks is undertaken by
a centralised body- Shariah
Advisory Council of SEC
• In other jurisdictions,
screening services are
performed by individual
institutions
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Stock Market Business
• The stock exchange provides a market place
•
where investors can buy and sell shares. The
exchange’s role is to monitor the market to
ensure that it is working efficiently, fairly and
transparently.
The trading system comprises four distinct
segments:
• T+ (2) settlement
• Spot transactions
• Provisionally listed counter
• Futures contract
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Key components of Islamic Capital Markets
Shariah Compliant Stocks
Islamic Capital Market
Islamic Funds
Islamic Bonds
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Shariah Related Issues in Stocks Trading
• Not permitted to purchase shares by raising
interest bearing loans through a broker or
someone else.
• Not permitted to pledge the shares for the
interest bearing loan.
• It is not permitted to sell the shares that the
seller does not own which is called short
sale. The promise by the broker to lend
these shares at the time of delivery is of no
consequence.
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Issues in Stocks Trading (Contd)
• Not permitted to conclude futures contract
•
•
for shares because according to Shariah
only one thing either payment or delivery
can be deferred.
Not permitted to conclude the contracts of
options for shares or to conclude swap
contracts with respect to shares and their
returns.
The contract of Salam is not permissible in
shares – identified items.
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Stock Screening Criteria
Various Criterion have been developed by the
Scholars to screen any scrip’s eligibility for
investment. The major stock screening
criterion followed are:
• Dow Jones Islamic Market Indices Criteria
(DJIMI)
• Meezan Islamic Market Index Criteria (KMI
30 Index Criteria)
Dow Jones Islamic Market
Index Criteria

Business of the Investee Company: The basic business
of the investee company should be Halal.

Debt to Market Capitalization: Total debt divided by
12-month average market capitalization should be less
than 33%.

Cash and Interest Bearing Securities: The sum of
company’s cash and interest-bearing securities divided by
trailing 12-month average market capitalization should be
less than 33%.

Accounts Receivables: Accounts receivables divided
trailing 12-month average market capitalization should be
less than 33%.
Meezan Islamic Market Index Criteria

Business of the Investee Company: The basic business of the
investee company should be Halal.

Debt to Total Assets: The interest bearing debt of the investee
company should not exceed 37% of total assets.

Illiquid Assets to Total Assets: Total illiquid assets of the Investee
company as a percentage of total assets should be at least 25%.

Investment in Shariah Non-Compliant Activities: Total investment
of the investee company in Shariah non-compliant business should
not exceed 33% of total assets.

Income from Shariah Non-Compliant Investments: The income
from Shariah non-compliant investments should not exceed 5% of
gross revenues of the investee company.

Net Liquid Assets vs. Share Price: The net liquid assets per share
should be less than the market price of the share.
Purification Requirement
 It is necessary to purify the earnings by deducting
from the returns on the investments those
earnings emanating from an unacceptable source
from a Shariah point of view.
 In context of equity investment according to
Shariah standards it is obligatory to eliminate
prohibited income that is mixed up with the
earnings of the company and this obligation is on
the one who is the owner of the shares.
Purification Requirement
 Elimination is not obligatory for the intermediary,
agent or manager out of part of their commission
or wages because this is their right in lieu of the
work they have undertaken.
 In case of Fund Management it is responsibility
of the Management Company to eliminate the
prohibited income.
 According to Shariah Standards for the
determination of the percentage of prohibited
income the recourse should be the last verified
financials position.
Purification Requirement

we calculate the percentage of non-compliant
income to the gross revenue (sales + other income)
for each investee company and this percentage is
called as charity rate.

Charity rate for each investee company is multiplied
with the dividend income from respective companies
to get the charitable amount. This charitable amount
is then transferred to a separate account.

Shariah advisor verifies the whole process of
elimination of prohibited income and issues a
certificate to be included in the annual accounts of
the fund.
Quantitative Screening Criteria
• The basic business of the investee company
•
•
should not be non-Shariah compliant like
conventional banks and insurance companies
Total non-Shriah compliant debt of the Investee
Company should not exceed 40% of the total
assets.
Total illiquid assets (which are not cash or cash
equivalent) of the Investee Company as a
percentage of the total assets should be at least
20%
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Quantitative Screening Criteria
• Total investment of the investee company in
•
•
Shariah non-compliant business (as a secondary
source of income) should not exceed 33% of the
total assets
Investee Company’s interest income or any
other non- Shariah compliant income should not
exceed 5% of its gross revenues
All the essential Shariah trading rules would be
applied in case of trading; hence short sale or
sale before settlement date would not be
allowed
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JAZAKALLAH
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