What is a Shariah Compliant Investment?

Financial markets are witnessing the growing success story of Islamic finance, a unique form of investment that corresponds with the values of socially responsible investing which is also Shariah Compliant.

Islamic finance is an equitable mode of finance that derives its principles from Shariah, the Islamic law. The most distinctive element of Islamic finance is the prohibition of interest, whether nominal or excessive, simple or compound, fixed or floating.

Shariah Compliant financial transactions are based on the essential maxim of sharing risk and reward. The customer and the financier share the risk of any investment on agreed terms and divide any profits between them.

Islamic finance does not allow creating new financial risks in order to gain profit; it is about protecting society from trickery, fraud, and social tensions.

Shariah products also stress accountability, fairness, and transparency. In addition to risk-sharing and the prohibition of interest, under the principles of Shariah, investment is also disallowed in businesses that deal with alcohol, pork, gambling, weapons, tobacco, media, ‘conventional’ financial institutions, pornography, and anything else which it deems ‘Haraam’ (unlawful).

It is also ensured that not only the underlying investments but also the contractual terms agreed between the investors and the investment manager conform to Islamic principles. Islam also disallows certain contracts due to inherent elements which render them ‘Haraam’ (unlawful).

This concept covers particular types of uncertainty or contingency in contracts such as options trading, short selling, futures, derivatives, and conventional insurance.

Shariah-compliant investments by the Shariah board comprised of respected Shariah scholars who are highly qualified to issue “Fatwas” (religious rulings) on financial transactions. This panel of Shariah experts ensures full compliance of the investments and transactions with Islamic principles.

All Islamic investment fund companies have appointed Shariah boards that not only provide approvals on individual investments on a regular basis but also conduct a Shariah audit annually to ensure all activities of the investment funds are fully compliant.

All dividends and profits are screened by the Shariah Audit Committee to ensure full Shariah Compliance of the final declared dividend or profit.

Shariah Compliance Screening

There are certain criteria that must be fulfilled when investing in a company in order for such an investment to be Shariah Compliant. There are essentially two stages involved in the Shariah screening process. It is important that the holding company including the subsidiary company fulfills the industry screen.

For example, a vehicle asset manufacturing company may have a vehicle asset financing subsidiary that generates impermissible income via conventional and interest-bearing lending practices, therefore investing in the holding company would be impermissible.

1. Sharia Industry Screen

The following business activities are impermissible:

1.1) Conventional Banking and Insurance

1.2) Alcohol

1.3) Pork and all non-Halal food items

1.4) Gambling

1.5) Tobacco

1.6) Adult Entertainment and all other impermissible actions as decided by the Shariah Supervisory Board

1.7) Conventional derivatives

1.8) Weapons

2. Shariah Financial Screen

The Shariah Financial Screen monitors the impact of non-Shariah Compliant practices of a company and its potential impact on corporate performance. The investment companies must be compliant with the Shariah Financial Ratios as decided by the Shariah Supervisory Board.

Screen:

2.1) Conventional Debt/Total Market Capitalization – 33%

2.2) (Cash +Interest Bearing Deposits)/Total Market Capitalization – 33%

2.3) Total Interest/Revenue -2%

Shariah Governance and Shariah Board

Shariah Governance refers to the structured policies and procedures of the Islamic Investment Fund to ensure full Shariah Compliance.

All Shariah-compliant investments must be certified by experts in Shariah, generally through a panel or board comprised of respected Shariah scholars who are qualified to issue “Fatwas” (religious rulings) on financial transactions.

This panel of Shariah experts ensures full compliance of all Shariah-compliant investment funds. The Shariah Supervisory Board not only provides initial approvals on investment objectives and investment strategy of all funds but also reviews the investments periodically to ensure the continuous compliance of the investments of the funds to Islamic principles.

Moreover, the Shariah Audit Committee conducts annual Shariah audits of all funds to ensure adherence to their rulings during the year.

Common Shariah Investment Funds

The most common forms of Shariah-compliant investment funds are equity funds, private equity funds, trade finance funds, real estate