Product Innovation

In collaboration with prominent Shariah scholars, financial experts and legal professionals, Shariah Capital has developed a number of innovative solutions for its clients and partners. These include Shariah compliant risk management tools that replicate the economics of conventional short sales, options trading and leverage. Shariah Capital has also been successful in refining the screening criteria for equities, using data feeds and software that streamline the process for determining Shariah compliance for publicly-listed companies.

The Arboon Short Sale

Until the present stage of its development, modern Islamic Finance has been without the ability to profit from falling markets or even to protect stock market investments from downward trends. It is widely acknowledged in Shariah finance circles that the conventional methods for hedging, and the short sale in particular, are simply unacceptable owing to their use of elements that are contrary to Shariah principles and precepts. However, for the past several years scholars and experts have indicated a growing consensus that it may be possible, at least in theory, to use classical transactional models like salam and arboon to provide investment managers with effective tools for hedging and managing risk, including the ability to profit when the price of shares declines. Shariah Capital’s solution is outlined in a White Paper which explains the development of the Arboon Sale as a practical solution for the Al Safi Trust, providing investment managers with an effective way to benefit from stock market investments regardless of market trends. Most importantly, the Arboon Sale solution is completely Shariah compliant and has been certified as such by means of a fatwa signed by senior and experienced Shariah scholars, each of whom is a member of the Shariah Board of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the standard setting board for the modern Islamic financial industry. The White Paper is available here, in English or Arabic. See also the FAQs, also viewable here.

Refined Shariah Screens

Before a security can be labeled “Shariah Compliant” it must pass two levels of screening, each consisting of various methodologies and the associated tests for each. Building upon the original calculations and formulas for the development of the various well known Islamic indexes, Shariah Capital has successfully developed Shariah screens that, owing to their increased efficiency, yield a wider universe of investable securities while adhering to strict Shariah standards.

Level One Screening

Shariah Capital has established, and oversees the implementation of, guidelines to ensure that fund managers will not invest in securities of companies whose core businesses are contrary to Shariah principles and teachings. Such businesses include (a) alcohol production, use or sale for human consumption, (b) production, use or sale of pork products for human consumption, (c) conventional financial services (such as banking or insurance) where such activity involves interest (riba), (d) gambling and related activities, (e) pornography, (f) tobacco production and sale for human consumption, (g) manufacture and sale of weapons of mass destruction, and (h) other activities prohibited by the Shariah. (Click on the link to see Acceptable, Unacceptable and Possible Market Sectors based on FTSE Classifications.)

Level Two Screening

This level of screening deals with company financials, including capital structure, levels and types of debt, holdings of cash and cash equivalents (liquid instruments like certificates of deposit and money market funds) and receivables. There are many situations in which corporations will generate, through an activity or activities unrelated to the primary business of the company, revenue that is unacceptable under Shariah. All of these instances need to be subjected to screens. Shariah Capital has developed screening criteria, in collaboration with Shariah scholars, that accomplishes screening at this level in a more effective and efficient manner. Please follow this link for a more complete explanation of the Shariah screening process.

Refinements for Increased Efficiency

The refined screens developed by Shariah Capital focus directly on what is prohibited, whereas screen from other providers only focus indirectly on these elements. All of the well-known screens begin by considering a company's primary business, and then by scrutinizing its financials. Typically, the first of the financial items to be considered will be corporate debt. This is because, in the same way that smoke indicates fire, corporate debt indicates interest expense; and logic dictates that more debt equals more interest expense. Islamic indexes measure corporate debt in two different ways. One method is to divide total assets by total debt, and the other is to divide market capitalization by total debt. According to the Shariah Supervisory Boards of these indexes, if the ratio of debt/assets or the ratio of market capitalization/assets is less than 33%, then the stock will pass through the screens. If it is greater, the stock will be "screened out" and declared unacceptable for Shariah compliant investments. The refined screens employed by Shariah Capital, however, do not focus on debt. Instead, the refined screens focus directly on what is prohibited. They focus on interest expense. Debt, in and of itself, is not prohibited by Shariah rules. What is prohibited by Shariah rules, however, is the by-product of modern, conventional debt which is interest. So, when the truly offensive element in corporate debt is interest, the focus of Shariah screens also should be interest expense. Instead of measuring the smoke and estimating the size of the fire, it is more efficient and accurate to measure the fire itself.

Bottom Line: An Expanded Stock Universe

Using advanced software and data feeds, managers using Shariah Capital’s proprietary screens have access to over forty thousand stocks traded on exchanges around the world, of which more than two thirds have been determined to be Shariah compliant. Using the screens currently employed by the various Islamic indexes, however, considerably less than two fifths of the stocks screened will be Shariah compliant. Thus, Shariah Capital’s refined screens generate a significantly greater universe of acceptable companies than the universe that results from the popular Islamic indexes.

Consultation

In addition to the screening software, Shariah Capital employs a process involving its Chief Shariah Officer in the vetting of stocks for possible inclusion in the portfolios of fund managers. The Chief Shariah Officer may be queried at any time by fund managers in regard to stocks that they have targeted. While fund managers have access to the results of screening software, they also have the ability to seek the opinion of Shariah Capital whenever they encounter a stock about which there may be questions as to whether it is acceptable or unacceptable. For example, a manager may have direct access to information about a company’s plans to restructure debt within a certain period of time, or to liquidate a business that presently disqualifies it from inclusion, or to merge with a larger company and thus become compliant. This information could affect whether or not a company meets Shariah standards; and this is the reason Shariah Capital exclusively offers investment managers access to its in-house Shariah expertise.