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DEVELOPMENTS IN ISLAMIC FINANCE – Book Sample

Towards a Robust Shariah Screening Criterion for Stocks

Abstract

 If it was not for the indices for Shariah compliant equities, the global Islamic capital market (ICM) would not have proliferated with an astounding pace. Those indices have played an extremely crucial role in assisting the investors seeking Shariah compliant stocks to invest their capital. This conjecture is equally true for Pakistan. In this regard, a remarkable initiative recently taken by the country is the launch of All Shares Islamic Index of Pakistan (ASIIP).

The index has been established to develop Pakistan’s ICM and to cater the needs of the investors pursuing Shariah compliant investment in stocks. The selection criterion of ASIIP comprises of mainly two categories: (1) Shariah screening criterion and (2) technical filters.

Although a general understanding has been established regarding the Shariah screening criterion and its conceptual basis, there seems to always linger a muddle about how those Shariah rulings are unswervingly related to it. Part of this confusion is attributable to the presence of rather an incongruity between the criterion and its Shariah underpinnings. In view of that, this paper gives an insightful discussion on the criterion from Shariah perspective.

 It critically analyses the criterion and its underlying Shariah basis by con-ducting a comprehensive and conscientious research through qualitative method. In doing so, it also juxtaposes the criterion directly to the classical sources of Islamic jurisprudence.

On the basis of analysis, it pro-poses major modifications, on the one hand, to introduce a new ratio or filter within the criterion and, on the other hand, to exclude unnecessary ones from it. It also recommends re-examining the benchmarks for the prevalent ratios.

These propositions would not only improve the robustness of the prevailing criterion, but also help abridging the gap between practical aspect of the criterion and its conceptual Shariah basis. Ultimately, it would vitally contribute to critical success factors and future progression of ICM in Pakistan.

Islamic capital market (ICM) is an integral part of Islamic financial system without which Islamic finance would have faced great difficulty in delivering its value proposition of profit and loss sharing, circulation of wealth, promoting business partnerships, and stimulating real economic activities.

In fact, the concept of “risk sharing” which has gained popularity lately as the essence of Islamic finance inculcates asset-backed equity financing and participation in mobilising economic resources in order to utilise them in the most efficient way for the sake of realizing social justice and economic development.

One of the most significant means for boosting the idea of risk-sharing is through strengthening the ICM which would subsequently facilitate participation of a vast group of investors towards economic growth and prosperity (Maghrebi and Mirakhor 2015).

Due to the crucial importance of ICMs, many countries, like Malaysia, Indonesia, Bahrain, UAE and Saudi Arabia, have already established their own markets, while they are keenly putting their efforts to further develop them into more resilient, deeper and global ones. On the contrary, Pakistan is yet to develop its ICM as equities and sukuk issuances are still comparatively few in the country. Nevertheless, the country has shown sincere interest, braced by huge domestic demand, to grow in the area (IFSB 2016).

One of the critical success factors of the ICM in Pakistan is the launch of KSE-Meezan Index 30 (KMI-30) in September 2008. More recently, All Shares Islamic Index of Pakistan (ASIIP) has also been introduced in November 2015, which is a milestone in the development of ICM at the domestic level. Both the indices measure performance of equities listed at the Pakistan Stock Exchange (PSX), except with a difference that KMI-30 only tracks thirty most liquid Shariah compli-ant companies listed on PSX, while ASIIP tracks all Shariah compliant companies that are listed at the same stock exchange. Nevertheless, the Shariah screening criterion for both the indices is exactly the same (PSX 2015a, b).

The criterion of both indices comprises mainly of two categories of filters: (1) Shariah screening criterion and (2) technical filters.

It is the former category which is the focus of this paper. Although a gen-eral understanding has been established regarding the screening criterion and its Shariah basis, due to lack of any quality research, it remains ambiguous that how such screening criterion is directly related to its Fiqhi basis and Shariah rulings.

Moreover, there is a need to critically analyse the criterion itself against its Shariah underpinnings in order to eliminate any potential incongruity. In view of that, this paper gives an insightful discussion on the criterion from Shariah perspective.

Furthermore, it critically analyses the criterion and its underly-ing Shariah basis by conducting a comprehensive and conscientious research through the utilisation of the method of qualitative documen-tary analysis.

In order to achieve this objective, this paper is organised in the fol-lowing manner. It starts with an introduction, followed by a description of the Shariah screening criterion of ASIIP. It then delves into a methodical discussion and critical analysis of Fiqhi and logical basis of the filters in the screening criterion of ASIIP one by one. After that, it presents a proposal for introducing a new and unique filter in