Islamic Norms for Stocks Screening By Dr Shariq Nisar

 

Screening Criteria Of Securities And Exchnage Commission (SEC), Malaysia
Screening for shariah complaint stocks is done at central level by the Shariah Advisory Council (SAC) of the Securities and Exchange Commission (SEC). A list of permissible stocks is issued by the SAC twice a year. The screening criteria are mainly activity or income based. No debt or liquidity screens are used. Thus screening requires income statements but not the balance sheets of the companies. Individual funds or investment companies do not make their own shariah screening criteria. Following screening criteria are used:
Core Activities
The core activities of the companies should not be shariah incompatible. Therefore companies with following as their core business activities are excluded: Financial services based on riba (interest); gambling; 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 or related products; stock-broking or share trading in shariah non-approved securities; and other activities deemed non-permissible according to shariah.
Mixed Activities
For companies with activities comprising both permissible and non-permissible elements, the SAC considers two additional criteria:
a. The public perception or image of the company must be good; and
b. The core activities of the company are important and considered masalahah (in the public interest) to the Muslim ummah (nation) and the country, and the non- permissible element is very small and involves matters such as umum balwa (common plight and difficult to avoid), uruf (custom) and the rights of the non- Muslim community which are accepted by Islam.
Benchmarks of Tolerance
Applicable in case of mixed activities. If the contributions in turnover or profit before tax from non-permissible activities of a company exceed the benchmark, the securities of the company are classified as shariah non-approved. The benchmarks are:
The Five-Percent Benchmark
Applied to assess the level of mixed contributions from the activities that are clearly prohibited such as riba (interest-based companies like conventional banks), gambling, liquor and pork.
The Ten-Percent Benchmark
Applied to assess the level of mixed contributions from the activities that involve the element of ‘umum balwa” which is a prohibited element affecting most people and difficult to avoid. For example, interest income from fixed deposits in conventional banks.
The Twenty Five-Percent Benchmark
This benchmark is used to assess the level of mixed contributions from the activities that are generally permissible according to shariah and have an element of maslahah (public interest), but there are other elements that may affect the shariah status of these activities. For example, hotel and resort operations, share trading etc., as these activities may also involve other activities that are deemed non-permissible according to the shariah.
Meezan Islamic Fund Criteria, Pakistan
It undertakes investment in Equities, Mudarabahs, Islamic Sukuks, and other shariahcompliant fixed income securities. The shariah screening criteria for equities and other securities is given below:
Business of the Investee Company
The basic business of the Investee Company should be halal. Accordingly, investment in shares of conventional banks, insurance companies, leasing companies, companies dealing in alcohol, tobacco, pornography, etc. are not permissible.
Debt to Total Assets
The total interest-bearing debt of the Investee Company should not exceed 45% of the total assets.
Net Illiquid to Total Assets
The total illiquid assets of the Investee Company as a percentage of the total assets should be at least 10%.
Investment in Shariah Non-Compliant Activities and Income from Shariah
Non-Compliant Investments
The following two conditions are observed for screening purposes: The total investment of the Investee Company in shariah non-compliant business;
should not exceed 33% of the total assets and
the income from shariah non-compliant investment should not exceed 5% of the gross revenue. (Gross revenue means net sales plus other income).
Net Liquid Assets vs. Share Price
The net liquid assets (current assets minus current liabilities) per share should be less than the market price of the share.
Screening Norms Of National Commercial Bank, Saudi Arabia
Business Screen
Financial Screens
Interest-bearing Debt and Interest Income
I. Total Interest-bearing debts should not be more than 1/3rd or 33% of the total market cap.
II. Interest income should not be more than 5% of the total income.
Total Debt and Liquid Funds
The value of the debts and liquid funds should not be more than 50% of the market value of the company.
Dubai Islamic Bank Screening Criteria
Business Activities
The objective of the company should not be shariah-repugnant.
Financial Screens
1. Interest bearing Debts of the company must not exceed 30% of its total assets or current market cap.
2. Interest-bearing lending should not exceed 30% of its total assets or the current market cap.
3. Cash plus trade receivables plus investments and other debtors put together must not exceed 70% of the total assets or current market cap.
4. Total income from interest and other non-shariah compliant activities must not be higher than 5% of the operating income.
Islamic Norms For Stocks Screening Dow Jones Islamic Index Screening Criteria
Screens for Acceptable Business Activities
Activities of the companies should not be inconsistent with shariah precepts. Therefore, based on revenue allocation, if any company has business activities in the shariah inconsistent group or sub-group of industries it is excluded from the Islamic index universe. The DJIMI Shariah Supervisory Board established the following broad categories of industries as inconsistent with shariah precepts: alcohol, pork related products, conventional financial services (banking, insurance, etc.), hotels, entertainment (casinos/gambling, cinema, pornography, music, etc.), tobacco, and weapons and defense industries.
Screens for Acceptable Financial Ratios
After removing companies with unacceptable primary business activities, it removes companies with unacceptable levels of debt or impure (interest) income by applying the following screens:
Debt to Market Cap
Exclude companies for which Total Debt divided by Trailing Twelve Month Average Market Capitalization (TTMAMC) is greater than or equal to 33%. (Note: Total Debt = Short-Term Debt + Current Portion of Long-Term Debt + Long-Term Debt).
Liquid Assets to Market Cap
Exclude companies for which the sum of Cash and Interest-Bearing Securities divided by TTMAMC is greater than or equal to 33%.
Receivables to Market Cap
Exclude companies if Accounts Receivables divided by TTMAMC is greater than or equal to 33%. (Note: Accounts Receivables = Current Receivables + Long-Term Receivables).
S&P Shariah Indices Eligibility Criteria
Sector-Based Screens
Business activities related to the following are excluded:
Pork
Alcohol
Gambling
Financials
Advertising and Media (newspapers are allowed, sub-industries are analyzed
individually)
Pornography
Tobacco
Trading of gold and silver as cash on deferred basis
During the selection process, each company’s audited annual report is reviewed to ensure that the company is not involved in any non-Shariah compliant activities. Those that are found to be non-compliant are screened out. The above industries are not considered Islamic and would not be appropriate for investment for observant Muslims.
Accounting-Based Screens
After removing companies with non-compliant business activities, the rest of the companies are examined for compliance in financial ratios, as certain ratios may violate compliance measurements. Three areas of focus are leverage, cash, and the share of revenues derived from non-compliant activities. All of these are subject to evaluation on an ongoing basis.
Leverage Compliance. This compliance is measured as:
Debt / Market Value of Equity (12 Month average) < 33 %;
Cash Compliance. There are compliances with reference to cash holdings. These are:
Accounts Receivables / Market value of Equity (12 Month average) < 49 %;
(Cash + Interest Bearing Securities) / Market value of Equity (12 Month average) <33%;
Revenue Share from Non-Compliant Activities
In certain cases, revenues from noncompliant activities are permissible, if they comply with the following threshold:
(Non-Permissible Income other than Interest Income) / Revenue < 5%
Dividend Purification Ratio
This ratio is provided to investors for purification purposes, it is calculated as:
Dividend x (Non Permissible Revenue / Total Revenue)
The International Investor - Financial Times (Tii-Ftse) Index
Sector Screens
Financial Screen
Debt ratio:
Exclude company if interest-bearing Debt divided by its Total Assets is equal to or greater than 1/3 or 33.33%.
Dividend Cleansing:
"Tainted dividend" or receipts attributable to activities that are inconsistence with Islamic principles are donated in charity


 
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