Every stock in the stock exchanges across the world goes through certain screening process so as to qualify it as Shariah Compliant. And even after it is being awarded Shariah Compliant status, it is being monitored through out the day so as to ensure it is Shariah Compliant. This is done various agencies across the world. These agencies varies from country to country.
Even if we think, a company may not be Shariah Compliant due to its operations, it may be due to our lack of knowledge regarding the operations and their financial performance. The scholars in the Shariah Screening Agencies analyses the company's finance and operations before awarding them with the Shariah Compliance Certification.
The shares of companies are declared Shariah Compliant only after it has cleared certain criteria which is often known as Sharia Screening.
There are mainly 3 screening methodology used in the Islamic Finance Market nowadays. It includes
- Dow Jones Islamic Indices Stock Screening
- The FTSE Shariah Stock Screening
- Securities Commission of Malaysia Shariah Stock Screening
Dow Jones Islamic Indices Stock Screening.
This stock screening comprises mainly of two screening process:
- Industry Screen: This screening process verifies whether the company are in the specific industry which has been permitted in Islam.
The prohibited industries include Alcohol, Pork-related products, Conventional financial services, Entertainment, Tobacco, Weapons and defense.
- Financial Ratio Screening: This process analyses the financial performance of the company. All of the following must be less than 33%:
- Total debt divided by trailing 24-month average market capitalization.
- The sum of a company’s cash and interest-bearing securities divided by trailing 24-month average market capitalization.
- Accounts receivables divided by trailing 24-month average market capitalization.
Only if the company passes these two screening process, Dow Jones gives the stock Shariah Compliant status.
The FTSE Shariah Stock Screening
This stock screening process is also similar to the Dow Jones Stock Screening, but has small difference in the Financial Screening process. The screening process are as follows:
Based on core activities: The company should be engaged in the following industries
- Conventional finance (non Islamic banking, finance and insurance, etc)
- Alcohol pork related products
- Entertainment (casinos/gambling, pornography, cinemas, music, hotels, etc)
- Tobacco weapons and defense
Based on Financial Ratios
- Debt divided by total assets <33%
- Cash and interest bearing items < 33%
- Account receivables and cash < 50%
- Non compliant income other than interest < 5%
- Total interest income < 5%
- Purification ratio 5% of dividend
Only when a company complies to the requirement, it will be awarded the Shariah Compliant status.
Securities Commission of Malaysia Shariah Stock Screening
The Securities Commission of Malaysia declares a stock as Shariah Compliant only after going through the following processes.
Based on its Industry
- Financial services based on riba/interest.
- Manufacture or sale of non-Halal products or related products.
- Conventional Insurance.
- Entertainment activities that are non permissible according to shariah.
- Manufacture or sale of tobacco based products.
- Stock broking or share trading in non-shariah approved securities.
- Other activities deemed non permissible by shariah.
Financial Ratio Filtering
- 5% benchmark – when the non-permissible are clearly prohibited (riba; gambling; liquor; pork) *Must not be included as part of dividend.
- 10% benchmark – involve element of umum balwah prohibited element affecting most people and difficult to avoid e.g. interest income and tobacco related activities.
- 20% benchmark – mixed rental payment from Shariah non-compliant activities such as rental from premises used for gambling; sale of liquor etc.
- 25% benchmark – activities that are generally permissible and beneficial (maslahah) but contains elements that may affect the Shariah status of these activities. Among these activities are hotel and resort; share trading; stock broking and others.