The revised screening methodology for shariah-compliant securities, to come into force in November 2013, could not only make for a more "stable" shariah-compliant securities list but also a shorter one, as it looks to screen companies not only based on income from activities but also on debt and cash in its balance sheet.
As at November 2012, 817 or 89% of the total 923 companies on Bursa Malaysia are shariah-compliant.
While not many, there have been cases of companies going in and out of the shariah list, as it exceeds existing revenue and pre-tax profit contribution thresholds accepted under the screening methodology.
Examples are companies such as Tan Chong Motor Holdings Bhd, Hap Seng Consolidated Bhd and Borneo Oil Bhd. Hap Seng is currently non-compliant, Tan Chong shariah-compliant, while Borneo Oil Bhd is non-compliant.
One analyst who declined to be named said the lack of certainty has made it difficult for investors to lock in their investments for the long term.
This however is not a sentiment shared by Gerald Ambrose, managing director of Aberdeen Asset Management Sdn Bhd. He said as fund managers, they review their portfolio of stocks on a quarterly basis and it is up to them to manage their portfolio.
"Its never been a problem before (and) I don't see it becoming one," he told SunBiz via phone recently.
A fund manager with another fund management company said the Securities Commission's (SC) guidelines are "very clear" on the action to be taken in the case of a shariah-compliant stock becoming non-compliant.
"If we are "in the money" (book price recovered) we are to sell immediately. If the price is below book price then we wait until such a time when we are "in the money" again, at which point we are duty bound to sell.
"There is no question of losses due to the change (in shariah status)," he said.
The current screening methodology sets the threshold for income derived from non-permissible activities at 5%, 10%, 20% and 25%.
Revenue contribution from activities such as trading of alcohol and pork have a lower threshold of less than 5% of contribution to total revenue, while others like stockbroking firms and resorts are given more leeway with contribution from non-permissible activities not allowed to exceed 25% of contribution to total revenue to remain as a shariah-compliant stock.
In June 2012, however, the SC's Shariah Advisory Council (SAC) had decided to include a financial ratio benchmark which looks at cash over total asset and debt over total asset screenings to come up with a more comprehensive assessment of shariah compliance.
"This revision is in line with the SC's initiatives to further build scale in the shariah-compliant equity and investment management segments as well as expand the Islamic capital market's (ICM) international reach, as outlined in the Capital Market Masterplan 2," the SC said in its frequently-asked-questions on the revised screening methodology.
The revised screening methodology will also see companies complying with either the 5% threshold or the other 20% one to be considered shariah-compliant.
The change in screening basically means that companies initially allowed higher thresholds, will have to contend with lower ones, from 10% to 5% and 25% to 20%. The revision proves to be a challenge for companies with high level of conventional debt, which will be caught as currently there is no screening for the total conventional debt of the company.
Cash placed in conventional instruments over total asset and conventional debt over total assets must be less than 33% under the financial ratio benchmark adopted by the SAC.
The SC is set to have a briefing on the revised screening methodology later this month.
The FTSE Shariah Global Equity Index Series and Dow Jones Islamic Market Index are two examples of indices that also incorporate the financial ratio benchmark into its screens.
The FTSE Global Equity Index Series, for example, classifies companies involved with activities in conventional finance, alcohol and non-halal food as non-shariah compliant and later screens remaining companies further through a financial ratio methodology which looks at not only cash and debt over total asset but also account receivables and cash.
Cash and debt over total assets must be less than 33%, while account receivables and cash must be less than 50% of total assets.
Further to that, total interest and non-compliant activities income should also not exceed 5% of total revenue.
source: The Sun Daily