Revisiting the AAOIFI Shari’ah Standard’s Stock Screening Criteria (Part 1)
Farrukh Habib,International Shari’ah Research Academy for Islamic Finance, Abu Umar Faruq Ahmad, University Brunei Darussalam
A vigorous and vibrant equity market being an integral part of a resilient and sustainable Islamic financial system, plays a vital role in the overall economic developments of a country. However, the contribution of Muslim investors to the equity market requires the availability of Shari`ah compliant stocks for them to invest, which must pass a certain set of Shari`ah screening criteria prior to any investment.
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) offers a criterion for screening stocks to include them in the Shari`ah compliant list, which consists of total five filters.
The objectives of this study are three-fold: 1) critically analyse AAOIFI’s criterion and providing the Shari`ah justification behind these filters; 2) develop and introduce a unique filter to be included in the criterion as a replacement of one of the current filters; and 3) suggest to re-examine one of the existing filters, and proposes the removal of two filters from the criterion.
To sum up, this paper advocates major changes in AAOIFI’s criterion based on stronger Shari`ah justifications a. It is expected that the findings of this study would not only provide an efficient and practically sustainable solution, it would also enable more companies to become Shari`ah compliant, and provide Muslim investors a wider universe of Shari`ah compliant stocks to choose from for their investment.
Keywords: Corporation; Company; Islamic Capital Markets; Shari`ah Compliant Shares; Screening Methodology.
Shari`ah compliant financial markets are considered part and parcel of the Islamic financial system and of the real economy in many jurisdictions. Above all, the propagation of the Islamic Capital Market (ICM) tremendously contributed to the much-applauded overall growth of Islamic finance.
On the one hand, the ICM has facilitated the investors who were previously searching for Shari`ah compliant projects in finding viable and potentially profitable investment venues for their capital; and it has ensured, on the other hand, that their capital goes into the projects or instruments which are directly related to the real economy, i.e., stocks, Sukuk, etc. This in turn has been translated into playing a pivotal role in overall economic development.
Nevertheless, the establishment of the ICM is a recent phenomenon. The Shari`ah did not allow Muslim investors for sometimes to take part in the equity market. It was considered permissible only after the International Islamic Fiqh Academy of the Organization of Islamic Cooperation (IIFA-OIC) had issued a resolution in 1992.
The IIFA-OIC allowed participation in joint stock companies whose business activities are completely Shari`ah compliant. Accordingly, it did not allow involvement in the companies whose business activities are either impermissible or a mixture of permissible and impermissible elements (IIFA-OIC, 2000, Resolution # 63/1/7).
The Islamic Fiqh Council (IFC) of the Muslim World League (MWL), also seconded the IIFA-OIC’s view in its own resolution issued in 1995 (IFC, 2006, Session # 14, Resolution # 4).
These Shari`ah resolutions were perceived as a good step towards establishing the ICM; however, what has been proposed in such resolutions may not be congruent with the reality. As a matter of fact, majority of the companies in stock markets, one way or the other, are involved to a certain extent in prohibited activities. It is very hard to find a listed company which is completely Shari`ah compliant.
Meaning to say that although one may find companies in the stock markets whose main business activities are Shari`ah compliant, they are usually also involved in some prohibited activities.
For example, a supermarket offers many permissible household products, but it also sells liquor and pork. A hotel is another good example which mainly provides accommodation but also serves alcohol to its customers, or operates a casino as a side business.
Furthermore, a company that manufactures permissible electronic items may also borrow on interest or place its surplus cash in interest-earning deposits or financial instruments.
As per the above resolutions, it is not allowed to participate in or trade shares of such companies. Therefore, those resolutions did not completely remove the hurdle faced by the investors wishing to be compliant with the Shari`ah in the arena of capital markets.
Many Shari`ah scholars recognized this challenging situation and tried to propose practically viable solutions to it. They did not out-rightly reject the mixed activity companies; rather suggested criteria to decide whether a company or stock is Shari`ah compliant. Therefore, the focus was diverted to the companies with a mixture of permissible and impermissible activities.
The main objective of the suggested AAOIFI criteria was to include a company with a permissible main business activity and with a minimum level of impermissible elements into the list of Shari`ah compliant companies.
(To be continued ….)