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Chapter Five

Topic Outlines:
5.1 Overview of Islamic Capital
5.2 Islamic equity Market.
5.3 Shariah compliant stocks
5.4 Equity Market instruments, i.e.
Preferred stocks from Islamic
5,5 Equity related instruments
Islamic funds/unit trust, Islamic

Islamic Capital Market

Islamic Capital market is a long term financial market where
Islamic bonds, stocks and other securities are traded. The
transaction, operation and instruments used are based on
the principle of shariah; which are free from riba, gharar &
maysir .
The instruments used in ICM include: Islamic stocks, Islamic
funds, Islamic estate investment trust ( REIT), Islamic bonds
( Sukuk) & Islamic derivative instruments.
Over years, ICM has experienced rapid growth &
development. For instance, in 2012, the total global size of
sukuk market & equity market was USD $ 229.4 & USD $ 64.2
billion respectively.
Total assets of Islamic finance industry is USD 1.6 trillion,
Islamic banking assets constitute 80% of total assets of
Islamic financial industry, sukuk ( 15%), Islamic equity market
( 4%) & takaful ( 1%).
In 2012,the total global finance industry was USD $ 225

Islamic Capital Market

The growth & development drivers of the Islamic capital
market include:
Greater awareness for Shariah-compliant investment and
savings products and services,
Rising income and wealth among the Muslim communities,
Increase demand for shariah compliant investment products
& services from governments, corporations & societies.
The main purpose of ICM is to provide long term fund for
government agencies & corporations for investment and
infrastructural development.
There are two ways in which companies & government
agencies can raise fund from ICM:
One way by issuing debt ( Islamic bond) in Sukuk market.
Bondholders are entitle to their principle amount plus interest
or profit.
by issuing stocks in Equity market. Companies issue share
certificates as evidence of partial ownership of the company.
Shareholders receive profits in the form of dividends or
capital gains in case they sell the shares for higher prices

Components of Islamic
ICM is made
of three main

1. Islamic Equity Market

Islamic equity market include
Share/stock indexes
Investment funds/mutual funds/unit trusts
Islamic REITS
Islamic ETF
Islamic venture capital fund
Hedge fund
2. Sukuk Market ( Islamic bond)
Medium - & long term sukuk
3. Islamic Derivative Market
Islamic derivative instruments
Islamic structured products

Islamic Equity Market

Definition: Islamic Equity Market is a financial market where company

shares, Islamic funds, Islamic real estate investment trust ( REIT) and
other securities are traded under a stock exchange market, for e.g. Bursa
Like any other markets, the stock market has commodities, prices
mechanisms and a market place. The commodities are shares and
securities, in the form of paper representing rights to the holder which is
the buyer, and obligations on the issuer which is the original seller.
The price of stocks are determined by forces of demand and supply of the
stock of that particular company. The more successful the company is, the
stronger the demand for its share will be and the higher the price of the
stocks. Investors buy stocks at low prices and sell at higher prices in order
to earn returns. Investors can buy and sell stocks at any point in time.
The place of trading stocks is called stock exchange e.g. Bursa Malaysia.
Securities traded in Bursa Malaysia can be issued by both public
corporations or private corporations.
The trade in Islamic equity market are based on the contracts of
Mudarabah and Musharakah, i.e. profit & loss sharing.

Primary market of stock


- Equity market is divided into two, i.e. primary market & secondary
- Primary market is where firms raise fund by issuing new shares and
secondary market facilitate trading of existing stocks.
- For the companies which are going public for the first time, they need
to start with the Initial Public Offering or theIPO which can be
organised by the help of Islamic investment banks.
- Certificates of ownership ( or stock) are issued by the company in
return for each financial contribution and shareholders can either hold
the shares indefinitely and earns dividend or they can resell the shares
they own in secondary markets for higher prices and earn capital gain.
- Example of certificate of ownership of shares issued by company is
shown in the next slide.

Secondary market of stock Exchange

Example Isabella has two options: hold the shares indefinitely and
earns dividend or she can sell the shares in secondary market for
high price and earn capital gain.
Therefore, secondary market of stock exchange provide
opportunities for buyers and sellers of listed stock to trade in shares
and earn capital gain.
Secondary market constitute the largest retail stock market where
there is short selling as investors & institutions buy stocks of
companies at low prices and sell them later when prices increases
in order to earn profit in the form of capital gain.
To invest in the stocks or to trade in the stock the investors have to
go through the brokers of the stock market.
The brokers are professionals basically act as a middle man
between the buyers and sellers of stocks for fees. Brokers must be
associated with specific stockbroking companies. Their clients
include inviduals and corporations and the deals are done by over
the phone or counter.

Role of Equity Market

Mobilize Fund. It facilitate the flow of fund directly from
individuals and institutional investors with surplus fund to
corporation and investors who needs fund for investments. This
lead to efficient allocations of financial resources in the economy.
An investment avenue. The market allows those investors with
surplus fund to invest their money based on Musharakah and
Mudarabah in return for profits & enable firms to finance
investments & new business ventures.
Redistribute wealth. Equity financing allows circulation of fund &
wealth in the economy through investments & trade. Individual
with small saving can invest in equity market such buying mutual
fund shares & earned dividend. This increase wealth for low
income investor & pensioners & thus redistribute wealth.
It provide fund that support economic growth through increase
investment in various industries, enhancing propspects of trade,
finance and commerce in a country.

Disadvantage of Equity financing

1. Interference of shareholders.
. large shareholders interfere with the management of the
company & managers must give up some control of the
business to shareholders.
. If shareholders have different ideas about the company's
strategic direction or day-to-day operations, they can pose
problems for the companys performance.
. Smart business managers however know how to negotiate with
differences of opinions turning it into a positive contribution.
2. High costs registering firm in stock market
. Marketing certain equities, such as Initial Public Offerings
(IPOs), can be very complex and expensive to maneuver
. Such equity financing may require complicated legal filings,
documentations and a great deal of paperwork to comply with
various regulations.
3. Complexity of issuing stocks
. Equity financing is more complex, and requires firms to use a

Shariah Principles on Equity investment

Prohibition of riba (no guaranteed fixed

Prohibition of gharar (unnecessary risk)
and maysir (gambling)
Primary business activity must be in line
with Shariah
Majority of assets of the company must
be physical assets not financial assets.
Non-permissible income must be below
a specified benchmark

Performance of Islamic Equity Market

Global Islamic equity market exhibited tremendous

Based on Global Islamic Asset Management report 2014,
there were 1,065 Islamic funds in the world, worth USD 56
About 80% of Islamic funds originate in the Gulf countries
& Malaysia.
In Malaysia, the number of Shariah compliant shares
increased significantly from 371 in 1997 to 826 in April
In terms of percentage of Shariah compliant stocks in
Bursa Malaysia, 1997 recorded only 57% while in April
2005 the percentage increased to 84% and in November
2012 it was 89%

Shari'ah Compliant Stocks in Bursa


As of November 2012

Securities Commission Shariah Benchmark for screening shares of listed


Line of business /


based on

Finances /
Financial Ratio



Stock Screening Benchmarks for Mixed listed


Through advise from Securities Commission

Shariah Council, Security Commission established
benchmark for screening Shariah compliant stocks.
SC used both Quantitative & Qualitative screening
The screening process begins by screening the
companies in terms of its activity, products and
all firms whose core businesses
activities are directly involved in interest-based,
entertainments and arms are prohibited to be
traded in Islamic stock markets.
Core businesses that are not shariah


All insurance companies are excluded


Conventional financial activities are excluded since

they are interest based


Producers, distributors and meat stores are

excluded. Special attention is focused on
companies that are involved in handling pork
products, such as supermarkets, hotels &


Producers/Distributers/Liquor stores are excluded.

Special attention is focused on businesses that
derive significant income from this area, such as
supermarkets, hotels & restaurants


Casinos, hotels and bookmakers are excluded


Companies involved in adult entertainment are



Companies involved in tobacco production are



Companies that derive significant income from

defence and armaments are excluded

Mixed Company Criteria [ applied to revenue

& profit before tax ]
- 5% Benchmark
If any of the company subsidiary involve
indirectly in prohibited activities such as
conventional banking, gambling, liquor,
pork, non-halal food & beverage, non-halal
entertainment, etc. then income & profit
from the subsidiary should be less than 5%
of total Group income & profit.
20% Benchmark
Due to maslahah to the public, e.g. hotel
and resort, stock-broking, rental income
received from non-shariah compliant, &
other non-shariah activities should be less
than 20% of total Group income18& profit.

ABC Berhad has a small division which is a conventional finance
company. The revenue and profit before tax contribution of this
division does not exceed 5% of the entire companys total revenue
and profit before tax ABC Berhad can be described as Shariah
DEF Berhad is a conglomerate that has a wholly-owned subsidiary
involved in the hotel business that may involve illegitimate
business practice such as dealing with alcohol or client indulged
prostitution. Revenue and profit before tax from that subsidiary
comprises approximately 20% of the groups revenue and profit
before tax - The proceeds may be described as Shariah compliant.
GHI Berhad has investment in an associated company that
operates a brewery, which contributes about 8% of the companys
total profit before tax The company is Shariah non-compliant
JKL Berhad has a subsidiary that is a licensed distributor of tobacco
products. While this subsidiary make up about 7 % of JKLs profit
before tax Shariah non-compliant.

Kaya Raya Holdings Berhad stock is shariah

compliant using Stock Screening Benchmark
Principal activity Construction and civil engineering
Kaya Raya
Holdings Berhad


KRH Cons.
Sdn. Bhd

Lai Kuay
Sdn. Bhd

Strong Heart
Sdn. Bhd

info: :
Revenue: :RM10
Group Profit
: RM 5 million
info: :
tobacco: :RM
Profit tobacco
: RM 400,000

Associated Kapur Barus Kejuruteraan

Sdn. Bhd
Siaga Sdn. Bhd

Tobacco business


(Source: Nik Ruslin, SC)

Financial Ratio
Liquid ratio = Cash over Total asset
Conventional analysts regard a company that hold
large part of its assets in form of cash or cash
equivalent & earned interest as financially sound
company. Why?
It means the company can be able to meet meet its
short-term debts.
However, in Shariah perspective, a company cash to
asset ratio should be low, reflecting that most of the
assets are invested in real production of goods &
Therefore, Islam discourage firms from holding large
part of its assets in the form of cash & cash

Financial Ratio: Interest Paid

Leverage = debt-to-equity ratio
Companys capital constitute both debt & equity.
Low leverage means low debt-to-equity ratio, which
reflects sound financial position of the company as it
has less commitment in paying debt & vice versa.
In conventional financial analysis low debt levels are
considered to be a positive sign for investment.
Since Shariah prohibits paying interest, leverage
levels of a company should be within the acceptable
thresholds in order to be Shariah compliant.
Typically, acceptable levels of leverage are 33% or
less, meaning large part of the firm capital should be
derived from equity not debt.

2. Qualitative Screening
Securities Commission of Malaysia

used also
Qualitative benchmark to screen companies which
are involved in multiple industries, i.e., companies
whose business activities comprise both Shari'ah
permissible and non-permissible elements.
The analysis is done at the holding company,
subsidiary company and associate company levels.
The criteria include:
1. Core activities of the company are halal but Haram
element is small compared to core activities.
2. Public image/perception of company is good.
3. Core activities of the company are important, have
element of urf (custom) and of public interest
(maslahah) to the Muslim ummah and the country.
. Note: If a subsidiary or holding company meets all

Shariah Compliance of Stock

transferrable subscription rights (TSRs).
The warrants and TSRs are considered
Shariah-compliant only if the underlying
shares are also shariah- compliants.
When asset status change from Shariahcompliant to Shariah-non compliant,
Shariah gives two possibilities to investors
on the announcement date:
1. The price is above purchase price

Reclassification of Shariah Compliance Investment

Announcement date in stock market normally is in May &
If investors invest in company stocks & the status of the
stock change from shariah compliant to non-shariah
Shariah provide the following options. On announcement
date, If:
1. Price increase above market rate
. Investor should, sell immediately and take the gain before
it increases.
.Or If you cannot sell immediately, then whatever gain
beyond the gain on the announcement date has to be
given to charity.
2. Price fall below the market price
.If there is a loss, investor should wait until the price
reaches the break-even level.

Islamic Equity

1. Shares or Stocks
Basically there are four types of shares or
stocks, i.e. common stocks, preferred stocks,
bonus shares & rights issues.
1. Ordinary shares
.An ordinary share represents undivided
ownership by a shareholder in the business of
the company.
.Ordinary shares (Common stock) give the
holder the right to vote on matters of corporate
policy, & appointment of board of directors.
.The holder of ordinary shares are the owners of
the company

Features of Ordinary shares Shares or Stocks

Directly issued, paid-up & perpetual.

In the event of liquidation, they are
paid last based on the proportion of
capital contributed.
Dividends to ordinary shareholders are
not obligatory.
In case of losses, ordinary shareholders
bear the losses first.
The participated capital is not secured
or guaranteed by the company.

ContShares or Stocks
2. Preferred shares or stocks.
Preference share is a hybrid instrument that gives
the holder a fixed dividend, priority in the event of
liquidation but no voting rights in the company
annual general meeting.
Rationale for issuing preference shares include:
Issuer firm want to reduce risk of debt financing &
thus by issuing preference share the debt equityratio will be low.
Firms also want to restrict foreign shareholders
from holding voting rights.
Investor want more secure income as investing in
preference shares
gives them fixed & secured

Features of Preference Shares or Stocks

1. Cumulative & non-cumulative Preferred Stock
. In cumulative preferred stocks, dividend are cumulative that is
if the dividend is not paid in a given year, it will accumulate for
future payments in subsequent years.
. In non- cumulative preferred stock, if the company is unable
to make the dividend payment, the obligation is not carried
2. Claim on Assets and Income
. Company must pay fixed dividends to preferred stockholders
before it pays dividend to common stockholders.
3. Protective Provisions
. Generally preferred shareholders are allowed to vote in the
general meeting in the event of non payment of dividends.
4. Convertibility
. Preferred stock can be converted into a predetermined number of
shares of common stock.
5. In case of liquidation, preference shareholders are given priority
&30paid first.

Cont. Shares or Stocks

3. Bonus shares
A bonus share is a free share of stock given to current
shareholders in a company.
This is based on the number of shares that is owned by
shareholders, i.e. shareholders who owns large number of
shares receive more bonus shares.
Company issues bonus shares when it expect positive growth
in order to boost performance of its stock.
4. Rights issues
Rights issues are shares offered on discount to existing
shareholders in proportion to their current shareholding.
Company can issues Transferable Subscription Rights ( TSR) to
ordinary shareholders or warrant to preference shareholders.
However, rights issues could indicates that the company is
having financial problems & that can leads to fall in its share

2. Islamic Real Estate Investment Trust

( REITs)
A REIT is a management company that gather a pool of funds from
investors, which is then used to buy, manage and sell assets in the
real estate sector.
A REIT must invest at least 50% of its total assets in real estate.
REIT must be run & administered by management company that are
subsidiary of banks or property development company, or property
investment holding companies that are approved by Security
Example of Islamic REIT listed on Bursa Malaysia is Al-Hadharah
Boustead involved in palm oil plantations assets.
REIT provide investors chance to diversified their investment in an
income generating real estate sector such as residential,
commercial, retail properties, plantation land, storage facilities,
warehouses etc.
Investors earn return from either dividends or capital gains and REIT
is obligatory to protect fund of the investors.

Types of Real Estate Investment Trust

( REITs)
There are four types of REITS
1. Equity REITS
. Equity REITS own & operate income-producing real estate.
. Their activities involve developing, leasing, & providing management & tenants
2. Mortgage REITS
. Mortgage REITS lend money to real estate owners & operators in conventional
using interest but Islamic mortgage REITS used ijarah contract.
3. Hybrid REITS
. Hybrid REITS are combination of equity & mortgage REITS
. They own & operate real estate but at the same time provide loans to real
estate owners & operators.
4. Stapled REITS
. They are investment vehicles that combined together two or more separate
REITS business entities into single new financial instrument which is traded in
bursa Malaysia.
. Example, KLCC REITS merged together shares of KLCC property Holding Bhd,
units of KLCC REITS that consist of Petronas twin towers, menara petronas 3 &
menara ExxonMobil.
. It is the first world Islamic staple REITS with market capitalization of USD 3.53

Islamic Real Estate Investment Trust ( REITs)

Guidelines for Islamic Real Estate Investment

Trust (REIT) issued by Security Commission.
Rental from non-permissible activities capped
at 20%
Islamic REIT not allowed to own real estate in
which all tenants operate non-permissible
activities, even if percentage of rental from
that property to the total turnover of the
Islamic REIT is still below 20%
Islamic REIT fund manager should not accept
new tenants whose activities are fully nonpermissible
All forms of investment, deposits and financing
instruments must be Shariah compliant

Differences between Islamic REIT &

Conventional REIT
Conventional REIT

There is no need for

any Sharia advisor

Permissibility of activities No restrictions

performed by tenants

Islamic REIT
Islamic REIT must
appoint shariah advisor to
endorse their activities
only halal activities are
allowed e.g. no club

Insurance of Property

Conventional insurance the manager must use

with insurance companies takaful for protection.
as permitted by trustee


no limitations

Financing should be
shariah compliants.

3. Islamic Fund/ Unit Trust/Mutual fund

Definition: Unit trust is a fund management firm, which pools
investors capital into a fund then managed by professional managers
The fund will be invested in a diversified portfolio of

stocks, Islamic bond, money market and/or

fixed income securities and/or

other assets as permitted by the deed as well as the Security

Commission guidelines on Unit Trust
Returns to investors are usually in the form of income distribution
(dividends) and/or capital appreciation derived from the pool of assets
What makes Unit trust Islamic?
Stock Selection : Unit trust invest only on Shariah-approved
Non-use of interest-bearing securities.
Example of Islamic Unit trust manager include RHB unit trust,
Public bank mutual fund, CIMB wealth advisor etc.

Advantages of Islamic Fund/Unit trust

1. Diversification
. It give opportunities to small investors to diversified their portfolio,
which would otherwise be impossible for them to invest in diversified
securities such as stock, bonds, money market instruments, etc.
2. Lower risks
. Fund manager invest the fund in diversified portfolio & this minimize
3. Liquidity investment
. Investors can sell back or redeem some or all of their units on any
business day & get back their money within short period of times.
4. Lower cost
. Since the fund manager take care of large number of investors, the
fund management fee is spread across the shareholders. Thus, fee
paid per investor is low.
5. Economies of scale
. By pooling the fund together small investors can become partly owner
of properties or businesses which would not have been possible for
small investors.

Securities Commission Malaysia

guidelines for
Islamic fund management

According to the guidelines set by securities

1. An Islamic fund manager must ensure that its
investment activities are limited to Shariahcompliant investments.
Islamic fund manager should invest only in
securities listed as Shariah-compliant securities.
3. However, if the securities are not listed, an Islamic
fund manager is encouraged to follow the Security
Commission methodology in screening shariah
compliant of unlisted securities.
4. To invest in international stock exchange outside, an
Islamic fund manager should only invest in securities
endorsed by the Shariah advise of the recognized

Shariah Issues in Equity Market

1. Issue of limited liability & legal personality
. Public limited companies are registered as legal entity &
thus have limited liability.
.In case of liquidation or insolvency, creditors can only
claim on companys asset not the owners asset. This is
unfair for creditors.
2. Issue of joint stock company
.The idea of corporation with many shareholders was alien
to Islamic laws, jurists are yet to determine in its legality.
3. Issue of trading shares
.Although shariah permits trading of shares, but in
conventioinal equity markets trading of shares in both
primary & secondary markets involves element of gharar
& maysir.
.These two elements are completely prohibited in Islam.

Questions, Suggestions and/or

Thank you