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ISLAMIC INVESTMENT

Mahyuddin Khalidemkay@

salam.uitm

.edu.my

The Principles of Islamic Investment

Topic Outline

Islamic Investment Concept Principle of Islamic Investment Shariah Supervisory Board Shariah Screening Principle of Zakat on Investment Speculation, Gharar and Gambling Time Value of Money Purification of Income

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Islamic Worldview and Investment

Transcendental accountability to Allah SWTHablumminallah

Social accountability to the societyHablumminan-

nass

Individuals as trustees or vicegerentsKhalifah

Success in this world and in the hereafterFalah

Economic goals beyond purely wealth maximizationTazkiyah

Personal accountabilityTaklif

Justice in relationships, contracts, and activitiesAdalah

Public interest is more important than personal interestMaslahah

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Definitions of Islamic Investment

Islamic Investment is an investment in financial services and investment products that

adhere to Islamic principles

Islamic Investment can be defined as:• A joint pool in which

the investors contribute their money for the purpose of its investment to earn permissible (halal) profits in strict conformity with the Islamic law

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Islamic Investment

The Islamic financial system broadly refers to financial market transactions, operations and services that comply with Islamic rules, principles and codes of practices

The Islamic financial services industry comprise Islamic banking, Islamic insurance and Islamic capital market.

In other words working to earn a halal living is itself a religious obligation second in importance after the primary religious obligations like prayers, fasting and hajj.

Narrated by Abdullah ibn Masud r.a., the Prophet Muhammad (PBUH) said: ‘Seeking halal earning is a

duty after the duty.’

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Islamic Investment

Modern Islamic

financial products and services are developed

using 2 different

approaches.

By identifying the existing conventional products and

services that are generally acceptable to Islam, and modifying, removing any

prohibited elements that are able to comply with Shariah

principles

By involving the application of various Shariah principles to facilitate the origination and

innovation of new products and services

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The Principles of Islamic Investment

Shariah compliant investment activities

Prohibition of riba, gharar

and maysir

Sanctity of

contracts

Money as capital

Risk sharing

Prohibition of

speculative

activities

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Sources of Islamic Investment

PRIMARY SOURCES• Al-Quran• Sunnah• Ijma’• QiyasSECONDARY SOURCES• Istihsan (juristic preference of the stronger

principles)• Istishab(Presumption of continuity)• Maslahah Mursalah (extended analogy/

consideration of public interest)• Sadd al-Zarai’ (blocking unlawful means to an

unlawful end)

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Criteria of Islamic Investment

Investment must be in ethical sectors (profits are not from prohibited activities, and non-Islamic financial institutions

Investment of property and wealth must be result from a partnership between the investor and the user of capital in which rewards and risks are share

Investment must be considered the philosophy of Islamic business (e.g: social justice, equitability, and fairness as well as practicality of transaction

The major prohibited elements are riba (interest), gharar (uncertainty), maisir (gambling), non-halal (prohibited) food and drinks and immoral activities

When a transaction have a prohibited elements, it’s must first be removed for it to be Shariah-compliant

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Benefits for Muslim to involve in investment activities

Children education

Insurance protection

Shelter

Provision for retirement

Source of income

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Challenges of Islamic Investment

Competition with the conventional systemEfficient and active Islamic financial marketAvailability of a wide range of instruments Human resource requirementUniformity of scholarly views

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Differences between Islamic and conventional investment

Activities Contractual Relation

ProfitRisk

The Determination of Permissible Activities

In Islamic perspectives, all activities must be acceptable and not related to prohibited by Islamic law.

An examples of the prohibited activities are follow: Alcohol Gambling Pork or a related products Pornography Conventional financial, banking & insurance services

Also, an activities such as tobacco, hotels or entertainment are prohibited

The decision are depends on the methodology or interpretation used by Islamic scholars in different jurisdictions

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Investment and Financing of Halal Activities

Impermissible to invest and give financing to

related activities

Financial serviced based on Riba

Gambling and gaming

Manufacture or sale of non-halal products

Manufacture or sale of tobacco-based or related product

Stockbroking or share trading in Shariah non-compliant securities

Other activities that conflicts with Shariah

Entertainment activities that conflicts with Shariah

Conventional insurance that containing of gharar

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Profit and Loss Sharing vs. Lender-borrower Relationship

PROFIT LOSS SHARING• First Tier

• Between bank and depositor• The depositor are considered to be

provider of the capital (Rabb al mal)• The bank functions as a working

partner or manager of funds (mudarib or amil)

• Second Tier• Between bank and entrepreneur• The entrepreneur is the manager of

fund• The bank functions as provider of

capital

LENDER-BORROWER RELATIONSHIP• The relationship between a lender and

a borrower is governed by a loan contract between them.

• Such a contract would specify all the obligations of the two parties in every possible future contingency.

• With respect to:• The amount of repayment• The interest rate on the remaining

debt.• A possible adjustment in the collateral

required by the lender.• The actions (in particular investment

decisions) to be undertaken by the borrower.

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Prohibition of Riba

• Unlawful gain derived from the quantitative inequality of the counter-values in any transaction purporting to effect the exchange of 2 or more species which belong to the same genus(category) and are governed by the same efficient cause(illah)

Definition of Riba on Trade transaction

• A predetermined excess or surplus over and above the loan received by the creditor conditionally in relation to a specified period

Definition of Riba on Loan transaction

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Elements of Riba

Excess or surplus over and above the loan

capital

Bargain to be conditional

on the payment of a predetermine

d surplus

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Prohibition of Gharar

Gharar literally means reduction. In Fiqh it is ambiguity that carries the risk of reduction. It is divided into minor and major Gharar. Major Gharar renders a

contract invalid or impermissible (Haram). Gharar is defined by Wahbah al-Zuhayli as a sale of

(i) that which is not known to exist or not, (ii) whose measure is not known to be large or small, or (iii) that is undeliverable.

Professor Zarqa considers gharar as a sale “of probable items whose existence or characteristics are not certain, due to the risky nature that makes it similar to gambling.”

The prohibition of Gharar gets into stronger relevance in regard to derivatives, which are sometimes referred to belong to the categories of a Gharar sales and sometimes simply compared to straight gambling.

Gharar, however, influences largely the way the insurance business needs to be done as it renders a conventional contract as not permissible for Muslims.

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Prohibition of Maysir

Gambling (Maysir, maisir;الَْميِْسر ) or Qimar, قمار) ) as a game to spend money and expect larger outcomes was widespread practiced in the pre-Islamic time of the Arabs.

The Quran prohibited gambling alongside alcoholics: “They ask you concerning wine and gambling. Say: ‘In them is great sin, and

some benefit for men, but the sin is greater than the benefit. […]” (Al-Baqarah: 219)

Gambling differs from trade as what one receives is the other’s loss, it is a zero sum while trade exchange generates typically a win-win situation.

There is some concerns among Muslims whether investing in stock market resembles gambling by nature; while the majority of scholars accepts trading of company shares as long as the companies are not involved in forbidden areas or involved in Riba.

The reservation of some Muslims may remain, especially if they feel uncomfortable regarding the proper intentions of themselves.

In stock trading is a grey zone where investing ends and gambling starts which cannot be drawn precisely, but it is related clearly to the individuals intention, which is not be judged by legal analysis but by self control.

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Shariah Supervisory Board

Definition: A group of Shariah experts whose responsibility is to monitor

and supervise the operations of Islamic financial institutions in order to ensure that it does not contravene Shariah principles.

In theory, the role of SSB involves six areas: Provide fatwas that certify permissible financial products; Undertake Shariah audit to ensure products comply with

guidelines; Dispose of non-Shariah compliant income or earnings; Provide advice to the bank on the distribution of income to

shareholders or depositors/investment account holders. Provide guidance to the bank on its wider social role.

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Shariah Screening

Definition: The process of identifying Shariah-compliant investments.

Shariah clearly defines activities in which Muslims are not to be involved, such as riba and the consumption of alcohol and pork.

Consequently, Muslims cannot invest in assets of businesses earning primarily from such activities.

2 tier benchmark for screening: Business Activity Ratio Financial Ratio

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Non-Shariah Compliant Investment Activities

Ruling on Non-Shariah compliant investment products which are advertently/inadvertently bought: Must be disposed within a month of knowing the status of the

securities Any capital gain or dividend received during or

after the disposal of the securities has to bechannelled to charitable bodies

Investor has a right to only obtain the originalinvestment cost

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Principle of Zakat on Investment

• Wealth belongs to government, community or Waqf isnot subjected to Zakat

Individual Right of Ownership

• Show the most accurate and relevant value of the assets

• Measure the net worth of the individual / company

The valuation of assets should be based on current or market value.

• Assets should be owned for one full year (haul).• Zakat charged only once a year (except for

agricultureproduce)

Yearly principle

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Principle of Zakat on Investment

• The aim of Nisab (minimum requirement) is to ensure zakatable wealth is in excess of normal requirements.

Ability to Pay

• Zakat computation must be true and fair• Zakat payers need to truthfully disclosed all his/her

financial facts.

Full Disclosure

• Measurement must be objective and quantifiable• Justice to both Zakat payers (who hold the financial

obligation) and Zakat beneficiaries (who are the rightful recipients of Zakat).

Objectivity (True and Fair View)

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Calculation of Zakat on Investment

• Based on zakat on agriculture product.• The shares are considered as fixed assets if shareholders or

investors acquired the shares:• for long-term investment• as a way to gain control over the company's capital (Held

to Maturity)• as a participation (stake) in the company's capital

• Thus, only its income generated (i.e. dividend) will besubjected to Zakat at 10% (as for agriculture produce).

Long-term Investment on Stock

• If shareholders acquired the shares for trading activity, it is considered current assets, and its value and income is subject to Zakat.

• Thus, Zakat on Shares = (Market Value of Shares x Quantity) x 2.5%.

Short-term Investment on Stock

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Calculation of Zakat on Investment

• Zakat on Sukuk has been argued should be charged as aform of valuable trading commodity.• Thus, Zakat for Sukuk = (Current Market Value x

Quantity) x 2.5%

Investment on sukuk

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Speculation & Gambling

Stock Market provides the avenue for firms to raise funds, for investor to invest their

surplus funds.

One needs to predict the future value of stock prior to making any decision to buy or

sell thestocks

The Messenger of Allah (SAW) also forbade us from gambling as illustrated in the following Hadith From Abu Hurayrah (RA), that he said, ”The Messenger of God (S) forbade the 'sale of the

pebble' [hasah] [sale of an object chosen or determined by the throwing of a pebble], and the sale of al-gharar. [Sahih Muslim]

The Quran clearly prohibit us from gambling as illustrated by the following verses relating to games of chance or gambling. Allah SWT

says:“They will ask thee about intoxicants and games of chance. Say: In both there is great evil as well as some benefit for man; but the evil which they cause is greater than the benefit

which they bring.” Quran (2: 219)

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Speculation & Gambling

Being given the obvious prohibition of gambling in both the Quran and the Hadith of the Prophet (SAW), it is of utmost importance to determine whether speculation in the stock market is similar to gambling.

Maysir or gambling is prohibited in Islam because it causes enmity and hatred and also involves consuming property bi-al-batil, which is a type of oppression.

Ibn Taymiyah’s opinion on the above Hadith is that gharar as the consequence of which is unknown and goes further to claim that selling it involves maysir, which is gambling.

Based on the Quranic verses and the Hadith of the Prophet (SAW), Ibn Taymiyah pointed out that if a sale contains gharar and devours the property of others, it is the same as gambling, which is clearly forbidden. Therefore, for a transaction to be equated to gambling, it must involve

the devouring and unlawful appropriation of the property of others.

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Speculation & Gambling

Kamali (1996) defines speculation as consisting of "the intelligent and rational forecasting of future price trends on the basis of evidence and knowledge of past and present conditions".

Speculative risk taking in commerce, which involves theinvestment of assets, skills and labor is not similar to gambling. This is because the buyer is engaged in a transaction aimed

atmaking profit through trading and not through dishonestappropriation of the property of others.

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Speculation & Gambling

El-Ashkar (1995) defined speculation as: "the practice of:

using available information to anticipate future price movements of securities so that an action of buying or selling securities may be taken with a

view to buying or selling securities in order to realize capital gains and/or maximize the capitalized value of

security-holdings. It is a process that relies on the analysis of a lot of

economic and financial data, companies' financial reports,political decisions, information about management skill and aptitude and the personal profile of the decision makers. That is to say, speculation is an activity that requires a great

deal of knowledge and skills. Therefore, speculation in stock markets cannot be equated to

gambling.

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Speculation & Gharar

The sale of gharar is said to lead to maysir (gambling) which leads to oppression and is therefore prohibited in Islam.

It is evident that gharar is not present in speculation in stock markets as each party is clear to the quantity, specification, price, time and place of delivery of the object.

Moreover, the object of the transaction, which is the purchased security, is available in the market at the time of transaction and is, bound to be available at the time of delivery.

Therefore, speculation has no element of gharar and, hence, does not lead to maysir.

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Pro and Cons of Speculation

The above discussion has proved that although speculation in the stock markets may look like gambling, yet it is by no means similar to gambling.

Its positive side is that it can help stabilize prices andactivate a market where there is thin trading. It can also provide signals to less-informed investors upon

which to act. The negative effect of speculation is that excessive

amount of it may cause volatile price movements in themarket. It can thus be concluded that excessive speculation should

not be allowed, but a reasonable degree of it be permitted. Quantitative limits on daily trading volume and legislative

guidelines may help contain speculation within healthy bounds.

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Time Value of Money from Islamic Perspective

The Time Value of Money (TVM)• The idea that money available at the present time

is worth more than the same amount in the future due to its potential earning capacity.

This core principle of finance holds thatProvided money can earn interest, any amount

of money is worth more the sooner it is received. TVM is also referred to as present

discounted value.

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Time Value of Money from Islamic Perspective

Islam recognizes the legitimacy of the TVM emanating from deferral (ajal) and acceleration (‘ajal) in Islamic financial transactions such as deferred sale and bilateralrebate (da‘ wa ta‘ajjal).

However its application must be in conformity with specific shariah guidelines to avert unfair economic effects of financial transactions such as interest (riba).

The application of TVM in accordance with its fundamental rules can actually remove riba from the economy and prevent frommaking of money out of money.

Benefits of the knowledge of the time value of money: For investment analysis To compare investment alternatives To analyse how time impacts business activities To minimize a risk

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Purification of Income

Investor/Unit trust fund receives income from invested companies in the form of dividend and capital gain.

Not all income are considered “clean”. Some are derived from non halal sources such as interest income

Purification of income requires identifying the non halal portion of income received from invested companies and deducting it from the total income prior to distribution

The income net of purification is then distributed to the investors

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Purification of Income

The “tainted” income cannot be distributed to investors but instead donated to charities

It is also possible for the fund to allow discretion to the investor in deciding the recipient charitable organization

No consensus among Shariah scholars in implementing purification

No standard available from AAOFFI

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Summary

In this chapter

you have learned about:

Islamic Investment Concept

Shariah Screening and Supervisory

BoardPrinciple of Zakat on

Investment

Speculation, Gharar and Gambling

Time Value of Money

Purification of Income

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38 Thank you