Islamic Fund Management
44
Once this initial screen is passed, the
financial screen
is then used to determine the extent of a
company's Shariah non-compliant financial behaviour. This presents a significant challenge, as
very few companies are completely Shariah-compliant in the current global market. As a result,
many Islamic scholars agree to use certain financial ratios to determine whether a company is
financially Shariah-compliant. While these ratios vary based on a specific Shariah board's
discretion, a commonly used standard developed by the AAOIFI (2015) can be employed, as
follows:
Total conventional loans (long-term and short-term debts) must be less than 30% of the
total market capitalisation of the company.
Total interest-bearing deposits must be less than 30% of the total market capitalisation
of the company.
Total interest and Shariah non-compliant income must be less than 5% of the total
revenue of the company.
By utilising its total market capitalisation, the entire value of the company (including
intangible assets) can be considered, thus enabling more companies to be Shariah-compliant.
Any of the company's income derived from Shariah non-compliant activities should be purified
by the investor, by donating the
haram
portion of the income to charity.
Table 3.2provides a list of different Shariah screening methodologies adopted by a regulator
(i.e. the SAC of the SC) and various index providers.
Figure 3.2 presents an example of the
Islamic equity fund screening process in Malaysia.
Table 3.2: Comparison of Different Shariah Screening Methodologies
SAC of SC
(Malaysia)
S&P Dow
Jones Shariah
Indices
MSCI Islamic Index
FTSE
Shariah
Global
Equity Index
Series
Series
M-Series
Scope
Malaysian stocks
Global stocks
Global stocks
Global stocks
Screener
Regulator
Index provider
Index provider
Index provider
Focus
Business activity
and financial
ratio
benchmarks
Sector-based
and accounting-
based screens
Business activity and financial
screening
Business sector
and financial
screening
Financial
Ratio
Total debts/
Total assets
= < 33%
Cash/Total
assets
= < 33%
Total debts/
Market
capitalisation
= < 33%
Accounts
receivables/
Market
capitalisation
= < 49%
Cash +
Interest-
bearing
securities/
Market
Total debts/
Total assets
= < 33.33%
Cash +
Interest-
bearing
securities/
Total assets
= < 33.33%
Accounts
receivables +
Cash/Total
assets
= < 33.33%
Total debts/
Average
market
capitalisation
= < 33.33%
Cash +
Interest-
bearing
securities/
Average
market
capitalisation
= < 33.33%
Accounts
Total
debts/Total
assets
= < 33.333%
Accounts
receivables +
Cash/Total
assets
= < 50%
Cash +
Interest-
bearing
securities/
Total assets