Many people, including some ulama, are of the view that buying and selling shares of the companies through a stock exchange is not acceptable in Islam. One such view equates trading in shares on a stock exchange to gambling and prohibited speculation. Another equally naive view states that shares of the companies are no more than papers whose price goes up and down depending on how much the market players bet on them.
Given that now there is a thriving international market for shari’a compliant investing in stocks of listed companies, it is important to understand what makes it permissible to invest in such financial papers.
There is no disagreement amongst jurists that it is permissible to co-invest in businesses that carry out shari’a compliant activities. This can be done through a partnership – also called shirka in Arabic or musharaka in the literature on Islamic banking and finance. Shirka allows partners to forego their management rights. Thus, it is permissible for partners in a business to appoint one of them or even a third party to manage the business on their behalf.
In small partnerships, it is always problematic when some partners would like to quit or when new people would like to join. These so-called “exit” and “entry” related problems are taken care of by listing the business on a stock exchange. The investors in stocks of listed companies in fact buy equity in the listed business and can acquire controlling rights, if they buy certain percentage of the total equity, for example, one-third or majority shareholding. Most of the buyers of stocks, however, have no controlling rights, although they have voting rights through which they can raise their concerns at an Annual General Meetings (AGM) of the company they have invested in. This establishes the fact that investing in ordinary shares of listed companies is equivalent to buying equity in the business, which Islamic law permits.
However, it is important to consider some restrictions in this respect. Following are the important shari’a guidelines for investing in stocks of the listed companies:
n The business of the company whose stocks one wishes to buy must be shari’a compliant, ie, the companies that deal in the prohibited activities must be excluded from the universe of shari’a compliant stocks. The prohibited activities include (but are not limited to):
n Interest-based financial services (conventional banks, insurance companies, brokerage firms etc);
n Production, packaging, distribution and logistics, and sale of alcohol and other prohibited items like pork, pornographic materials, etc;
n Gambling and gaming; and
n Unethical activities and wasteful entertainment like music and movies.
In addition to the above, Islamic investment firms also follow the guidelines developed by western socially responsible investment firms, which include (among other things) exclusion of the companies that produce, distribute or sell tobacco and weapons.
The above requirements are known as business screens. As there are very few businesses that strictly fulfil all shari’a requirements, especially those related with their financial matters, contemporary shari’a scholars have developed and agreed on the following four financial screens:
n Total borrowings by the business should not be more than one-third of its market capitalisation (generally known as debt equity ratio screen);
n Total cash held by the firm and its investments in interest-bearing instruments (like interest-bearing bank deposits) must not exceed one-third of its market capitalisation;
n Funds receivables (invoices issued and other forms of debt owed to the firm by its clients and others) must not exceed one-third of its market capitalisation; and
n The company must not earn more than five per cent of its income from the prohibited activities
The above guidelines are adopted by the likes of Dow Jones for their Islamic indexes, which most of the Islamic investors use for selecting shari’a compliant stocks from the global universe of stocks and equities. In Pakistan, Meezan Bank uses slightly different screening criteria, which are given in the following:
n Total borrowing by the company must be less than 40 per cent of its total assets;
n The investment by the company in shari’a repugnant instruments should be less than 33 per cent of its assets;
n Income from the forbidden activities should be less than five per cent of the total gross revenue of the company;
n The ratio of illiquid assets to total assets should be at least 20 per cent; and
n The market price per share should be greater than the net liquid assets per share calculated as: (total assets – illiquid assets – total liabilities) divided by total number of shares
There are over 100 stocks on the Karachi Stock Exchange, which fulfil the above screening criteria, and hence are deemed shari’a compliant. It is important to understand that the actual process of selecting and investing in stocks of listed companies requires a lot of due diligence on such businesses. For example, Apple stock is deemed shari’a repugnant because it draws more than five per cent from the sale of iTunes (about nine per cent) and hence shari’a advisors would recommend not investing in the Apple stock. Similarly, Microsoft draws about 13 per cent from the sales of its division that produces and sells Xbox and music; hence it does not pass strict shari’a guidelines.
However, in the absence of further breakdown of revenue from this division, some shari’a advisors may take a relaxed view on Microsoft as the 13 per cent figure includes revenue from the sale of Xbox (hardware) and similar equipment (which in itself is not shari’a repugnant) and music (which is not fit for Islamic investing). In the absence of such a detailed breakdown, if someone wishes to invest in such a stock, the shari’a guidelines require that the dividends from such a stock must be purified by donating five per cent (as an approximation of the prohibited income) to independent charities. This process is known as dividend purification.
The writer is a Shari’a advisor to a number of banks and financial institutions and can be contacted at [email protected]
