Islamic Market Indexes
Islamic funds must appoint a Shari’ah board to provide guidance to the managers of the fund on matters of Shari’ah law and, in particular, whether the proposed investments of the fund are Shari’ah-compliant. The Shari’ah Board should be independent from trustee and portfolio manager. Its role includes portfolio purification, selection and monitoring, working with fund management, and monitoring of fund fees and fund documentation.
Portfolio purification consists on deducting the income from interest-bearing investments from total earnings and ensuring that the portfolio doesn’t include prohibited investment transactions. The supervisory board also oversees the choice of investments by screening stocks that could allow the fund to subscribe to an Islamic index. The selected stocks need to be continually monitored by Shari’ah boards to check any context change and to remove stocks that fail to comply with the criteria from the fund portfolio. In addition, fund managers may not always be clear on the application of Shari’ah principles in certain situations or complex financial instruments and there is likely to be lapses and mistakes with regard to non-compliance; especially when the fund manager is a non-Muslim. Shari’ah Board should ensure that investors are made aware of the fund’s fees and how these are structured. It is also involved in the preparation and review of all pertinent legal and business documentation as all documentation of the fund requires making references to the Shari’ah and its interpretations.
Portfolio purification consists on deducting the income from interest-bearing investments from total earnings and ensuring that the portfolio doesn’t include prohibited investment transactions. The supervisory board also oversees the choice of investments by screening stocks that could allow the fund to subscribe to an Islamic index. The selected stocks need to be continually monitored by Shari’ah boards to check any context change and to remove stocks that fail to comply with the criteria from the fund portfolio. In addition, fund managers may not always be clear on the application of Shari’ah principles in certain situations or complex financial instruments and there is likely to be lapses and mistakes with regard to non-compliance; especially when the fund manager is a non-Muslim. Shari’ah Board should ensure that investors are made aware of the fund’s fees and how these are structured. It is also involved in the preparation and review of all pertinent legal and business documentation as all documentation of the fund requires making references to the Shari’ah and its interpretations.
Dow Jones Islamic Indexes
The Dow Jones Islamic Markets (DJIM) Index Shari'ah Supervisory Board was established to advise on the methodology for screening securities for inclusion in the Dow Jones Islamic Market Indexes and related matters relating to the Shari'ah compliance of the indexes' eligible components. The independent Shari'ah Board consists of five eminent Shari'ah scholars from around the world. The geographic diversity of the scholars ensures that diverse interpretations of Shari'ah law are represented (djindexes.com; 09.2009). The DJIM approach is a good example of Islamic screening; it takes place at three levels: prohibited industries, acceptable financial ratios and monitoring, removal and replacement. The companies in the DJIM are reviewed on a quarterly basis for continued compliance. The first level of DJIM financial screens examines the leverage ratios of the company in question. The debt/market capitalisation ratio requirement was set by the DJIM Shari’ah supervisory board to at less than 33 per cent. The DJIM financial screens then try to establish the level of non-operating interest income that should be kept to a minimum; the Haram income must be purified by way of giving to charity. The board does any purification methodology or formula to all Islamic. In term of liquidity screens, Muslim scholars consider that it is permissible for an Islamic investor to purchase shares of a company which accounts receivables do not exceed 45 per cent of total assets. DJIM screening also stipulate that an Islamic investor may not purchase securities, with a predetermined rate of return and a guaranteed principal, and he may not purchase the shares of companies whose primary or basic business is unlawful. Instead he is encouraged to seek out and examine the merits of special companies with pro-environmental policies, or that provide humanitarian services.
LIBOR Indexes
As more and more Islamic banks begin to operate globally, a benchmark for the Islamic banking industry is needed to evaluate the performance of Islamic products. The LIBOR index has been approved by Shari’ah boards for use as a benchmark for Islamic returns. LIBOR is the London Interbank Offered Rate, a financial benchmark based on interbank lending rates. in short, an interest rate-based measurement. And, since Islamic banks cannot charge interest on financing and leasing operations in pricing their profit mark-up and rental income, some scholars will continue to be divergent about the pricing of Islamic products linked to conventional interest rate benchmarks until the Islamic financial system can establish its own benchmark.
Yet, LIBOR benchmark is widely used to determine the pricing of Islamic financing as well as Islamic investment products. In fact, profit based on a rate of interest should not be as prohibited as interest itself even though the use of the rate of interest for determining permissible profit cannot be considered desirable and the appearance of Islamic valid transactions to an interest-based financing should be avoided as far as possible.
Therefore, many institutions financing by way of Murabahah and Ijarah determine their profit on the basis of current LIBOR rate, the mark-up on Murabahah can be equal to LIBOR or some percentage above LIBOR. Similarly, rental income in an Ijarah agreement can be based on LIBOR. Still, that the essential condition for the validity of Murabahah or Ijarah is that all ingredients and consequences of a genuine sale are respected. And since as a mere benchmark and that there is no participation by Muslim investors in LIBOR, it has nothing to do with the transaction. Therefore, if a Murabahah or Ijarah transactions fulfil all the conditions, the use of the interest rate as a benchmark for determining the mark-up does not render the transaction as invalid because the deal itself does not contain interest. In fact, the rate of interest is used only as an indicator or as a benchmark.
As a consequence, until a standard Islamic alternative that satisfies Shari’ah ban on interest would be available, the use of LIBOR will still be a permissible option to evaluate the rate of return on financing by Islamic banks.
Yet, LIBOR benchmark is widely used to determine the pricing of Islamic financing as well as Islamic investment products. In fact, profit based on a rate of interest should not be as prohibited as interest itself even though the use of the rate of interest for determining permissible profit cannot be considered desirable and the appearance of Islamic valid transactions to an interest-based financing should be avoided as far as possible.
Therefore, many institutions financing by way of Murabahah and Ijarah determine their profit on the basis of current LIBOR rate, the mark-up on Murabahah can be equal to LIBOR or some percentage above LIBOR. Similarly, rental income in an Ijarah agreement can be based on LIBOR. Still, that the essential condition for the validity of Murabahah or Ijarah is that all ingredients and consequences of a genuine sale are respected. And since as a mere benchmark and that there is no participation by Muslim investors in LIBOR, it has nothing to do with the transaction. Therefore, if a Murabahah or Ijarah transactions fulfil all the conditions, the use of the interest rate as a benchmark for determining the mark-up does not render the transaction as invalid because the deal itself does not contain interest. In fact, the rate of interest is used only as an indicator or as a benchmark.
As a consequence, until a standard Islamic alternative that satisfies Shari’ah ban on interest would be available, the use of LIBOR will still be a permissible option to evaluate the rate of return on financing by Islamic banks.
