Shariah ScreeningEmpowering investors in disciplining markets

A proposed modified criteria

Tariqullah Khan

This is an academic handout and not a business proposal.

Important!

First, some Q&A on

Shariah Screening

---Second, the

modified criteria

Does the Shariah allow buying and selling company shares? Can I invest in Google, Facebook or Twitter Shares? Can I invest in a hotel, that may occasionally be selling alcohol? Can I buy and sell shares of a company which owes a lot to others?

Q

A These questions have become very relevant in modern times where technology has facilitated globalization and investors’ concerns with Shariah- compliance has also grown – estimated size US$ 2 trillions. Shariah Screening is a computer aided response of the market to address to similar questions to facilitate wealth management in compliance with the Shariah.

1

1Q

Investment decisions have important implications for human and economic development, environmental balance, use of resources and for the future generations.Hence these shall not merely be determined by expected financial returns but shall also be based on the non-financial benefits and overall impact on society & its future.Thus investment decisions shall be simultaneously guided by the compliance with certain ethical and moral norms in addition to the expectations for a rate of return.So what is the exact concern addressed?

A

QWhat is the background of Shariah Screening?

2AIn recent years there has been a growing interest in ethical & socially responsible investments. In 1994 the Fiqh Academy of the OIC ruled that it is not permissible to buy and sell shares of companies which don’t 100% confirm to the Shariah even if the business itself may be permissible like a hotel that sells alcohol.Indeed, this is very restrictive as almost all companies somehow violate certain Shariah conditions. This meant that Shariah compliant investment in stock markets is not possible. This imposes restrictions under which capital markets cannot be flourished.As a response of the market, the pioneering Dow Jones Islamic Market Index (DJIMI), developed by Mr. Rushdi Siddiqi of the Dow Jones & his team was launched in 1999 in Bahrain and subsequently replicated in a number of different ways.A research paper "Trading In Equities - A Shariah Perspective" by Nizam Yaquby was submitted to the Fourth Harvard University Forum on Islamic Finance in 2000.

What is the Dow Jones Islamic Market Index (DJIMI)?

Q3A

The Dow Jones Islamic Market Index was launched in Bahrain during 1999. Official and latest information about the Dow Jones Islamic Market Index (DJIMI) is available at http://www.djindexes.com/islamicmarket/

Step ❶ Exclude businesses:Alcohol, Pork-related products, Conventional financial services, Entertainment, TobaccoWeapons and defense

DJIMI Screening Criteria

Step ❷ Confirm to following Tolerable Financial Ratios:I. Debt to Market Cap

<33%II. Receivables <33%III. Cash and interest

bearing securities <33%

Step ❸ purify through charity by limiting impurity to 5% of income

So what does the DJIMI mean simply?Q3

A DJIMI Screening Criteria simply means that:

In the first place, the computer will delete Alcoholic products, Pork-related products, Conventional financial services, Entertainment, Tobacco, Weapons and defense industry products.

In the second place, the computer will delete companies whose a) Debt/ Market Capitalization ratio, b) Receivables/Market Capitalization ratio and c) Cash and interest bearing securities/Market capitalization ratio will exceed 33%.

After screening on the 2 levels, the remaining companies will be considered Shariah compliant. This screening is done under supervision of Shariah scholars.

Are there any samples of the DJIMIs?

4A

Q

Yes there are, e.g., the following is a December 21st 2013 screen shot from the DJIMI dynamic Website

In addition to DJIMI are there any other Shariah

Screening Indices?

5Q

A Indeed, there are several others and the number is growing rapidly. Few examples are:I. FTSE Shariah Index - http://

www.ftse.com/Indices/FTSE_Shariah_Global_Equity_Index_Series/index.jsp

II. S & P 500 Shariah Index - http://us.spindices.com/indices/equity/sp-500-shariah-index

III. MSCI Global Islamic Indices - http://www.mscibarra.com/products/indices/international_equity_indices/islamic/

IV. IdealRatings - http://www.idealratings.com/V. BSE Shariah 50 Index - http://

www.tasis.in/BSE-TASIS.pdfVI. Thomson Reuters Islamic Indices - http

://thomsonreuters.com/islamic-indices/

Do they use same methodology?

Q6A

Yes, except for Securities Commission Malaysia, like the DJIMI all Shariah screening services are offered by commercial companies using almost same methodology - based on a negative screening of industries followed by a financial ratios based screening of companies.

The Securities Commission Malaysia (SCM) -http://www.sc.com.my/frequently-asked-questions-on-revised-shariah-screening-methodology/ also undertakes Shariah screening of shares based on its own methodology. The SCM uses three considerations in its screening1. Negative screening of industry2. Financial ratio-based screening of companies

based on social responsibility of businesses3. The level of Shariah-compliant component in

the financial ratios

What is new in the proposed modified criteria?

Q

A7 Objectives of the Shariah are adopted as an anchor for the social responsibility

Considerations for environment and issues of human rights like child labor are included

Businesses consistent with the above two considerations are given preference

The proposed criteria is similar to the SCM criteria with the

following differences:

modified criteria in7 steps

Make a list of all companies that are potentially available for investment1 Ask if the companies

comply with Maqasid Al

Shariah or do not comply

Maqasid Al Shariah – In harmony, promotion/enhancement and safeguard of 1. Mind & Intellect, 2. Human dignity, 3. Future generations, 4. Wealth, 5. Religious Faith

Delete from list, companies that do not comply with

Maqasid Al Shariah2Companies engaged in:1) Child labor2) Environmental degradation3) Commercialization of sex4) Alcohol, tobacco, illicit drugs5) Commercialization of lending as

interest-based financial services6) Gambling and zero sum games

including financial derivatives7) Supporting aggression and

violation of human rights

Classify selected companies in terms of contribution to social

responsibility3 ① Food, shelter, water, sanitation, primary & secondary education, basic health

② Utilities, infrastructure, general health care and higher and professional education

③ Requirements of meeting middle class living standards in a society

④ Comforts, refinements and entertainment

⑤ Luxuries

4From list selected in step 3 delete if:

① Food, shelter, water, sanitation, primary & secondary education, basic health

② Utilities, infrastructure, health and higher and professional education

③ Requirements of meeting middle class living standards in a society

④ Comforts, refinements and entertainment

⑤ Luxuries

60%

50%

40%

30%10%

Debts to be paid to others are greater than % of total market capitalization or market value of total assets

5From list selected in step 3 delete if:

① Food, shelter, water, sanitation, primary & secondary education, basic health

② Utilities, infrastructure, health and higher and professional education

③ Requirements of meeting middle class living standards in a society

④ Comforts, refinements and entertainment

⑤ Luxuries

60%

60%

40%

30%30%

Debts to be received from others are greater than % of total market capitalization or market value of total assets

6From list selected in step 3 delete if:

① Food, shelter, water, sanitation, primary & secondary education, basic health

② Utilities, infrastructure, health and higher and professional education

③ Requirements of meeting middle class living standards in a society

④ Comforts, refinements and entertainment

⑤ Luxuries

30%

30%

30%

20%

10%

Cash & interesting bearing assets are greater than % of total market capitalization or market value of total assets

7From list selected in step 3 delete if:

① Food, shelter, water, sanitation, primary & secondary education, basic health

② Utilities, infrastructure, health and higher and professional education

③ Requirements of meeting middle class living standards in a society

④ Comforts, refinements and entertainment

⑤ Luxuries

10%

10%

10%

5%5%

Impure income is greater than % of total income

Summary of the Proposed Modified Shariah Screening

Criteria

Sectors1. Food, shelter, water, sanitation, primary & secondary education, basic health2. Utilities, infrastructure, health and higher and professional education3. Requirements of meeting middle class living standards in a society4. Comforts, refinements and entertainment5. Luxuries

Tolerability limits Leverag

e

60%

50%

40%

30%

10%

Liquid assets30%

30%

30%

20%

10%

Receivables

60%

60%

40%

30%

30%

Income impurity10%

10%

10%

5%

5%