1. ALHUDAmnajeebkhan@hotmail.com1

2. ALHUDAmnajeebkhan@hotmail.com2 Shariah Guidelines For ISLAMIC FUNDS April 24, 2012 Alhuda-CIBE Trainings Avari Towers, Karachi By Muhammad Najeeb Khan Sharia Advisor Habib Mertropolatin Bank Sharia Board Member UBL Islamic Fund

3. Islamic Investment The term 'Islamic Investment Fund" in this chapter means a joint pool wherein the investors contribute their surplus money for the purpose of its investment to earn halal profits in strict conformity with the precepts of Islamic Shari‘ah The term 'Islamic Investment Fund" in this chapter means a joint pool wherein the investors contribute their surplus money for the purpose of its investment to earn halal profits in strict conformity with the precepts of Islamic Shari‘ah ALHUDAmnajeebkhan@hotmail.com3

4. Islamic Investment Firstly, instead of a fixed return tied up with their face value, they must carry a pro-rata profit actually earned by the Fund. Therefore, neither the principal nor a rate of profit (tied up with the principal) can be guaranteed. Firstly, instead of a fixed return tied up with their face value, they must carry a pro-rata profit actually earned by the Fund. Therefore, neither the principal nor a rate of profit (tied up with the principal) can be guaranteed. ALHUDAmnajeebkhan@hotmail.com4

5. Islamic Investment Secondly, the amounts so pooled together must be invested in a business acceptable to Shari‘ah. It means that not only the channels of investment, but also the terms agreed with them must conform to the Islamic principles. Secondly, the amounts so pooled together must be invested in a business acceptable to Shari‘ah. It means that not only the channels of investment, but also the terms agreed with them must conform to the Islamic principles. ALHUDAmnajeebkhan@hotmail.com5

6. Equity Fund In an equity fund the amounts are invested in the shares of joint stock companies. The profits are mainly derived through the capital gains by purchasing the shares and selling them when their prices are increased. Profits are also earned through dividends distributed by the relevant companies. In an equity fund the amounts are invested in the shares of joint stock companies. The profits are mainly derived through the capital gains by purchasing the shares and selling them when their prices are increased. Profits are also earned through dividends distributed by the relevant companies. ALHUDAmnajeebkhan@hotmail.com6

7. Equity Fund It is obvious that if the main business of a company is not lawful in terms of Shari‘ah, it is not allowed for an Islamic Fund to purchase, hold or sell its shares, because it will entail the direct involvement of the share holder in that prohibited business. It is obvious that if the main business of a company is not lawful in terms of Shari‘ah, it is not allowed for an Islamic Fund to purchase, hold or sell its shares, because it will entail the direct involvement of the share holder in that prohibited business. ALHUDAmnajeebkhan@hotmail.com7

8. Conditions Conditions for investment in Shares In the light of the foregoing discussion, dealing in equity shares can be acceptable in Shari‘ah subject to the following conditions: Conditions for investment in Shares In the light of the foregoing discussion, dealing in equity shares can be acceptable in Shari‘ah subject to the following conditions: ALHUDAmnajeebkhan@hotmail.com8

9. Conditions 1. The main business of the company is not violative of Shari‘ah. Therefore, it is not permissible to acquire the shares of the companies providing financial services on interest, like conventional banks, insurance companies, or the companies involved in some other business not approved by the Shari‘ah. 1. The main business of the company is not violative of Shari‘ah. Therefore, it is not permissible to acquire the shares of the companies providing financial services on interest, like conventional banks, insurance companies, or the companies involved in some other business not approved by the Shari‘ah. ALHUDAmnajeebkhan@hotmail.com9

10. Conditions 2. If the main business of the companies is halâl, like automobiles, textile, etc. but they deposit their surplus amounts in an interest-bearing account or borrow money on interest, the share holder must express his disapproval against such dealings, preferably by raising his voice against such activities in the annual general meeting of the company. 2. If the main business of the companies is halâl, like automobiles, textile, etc. but they deposit their surplus amounts in an interest-bearing account or borrow money on interest, the share holder must express his disapproval against such dealings, preferably by raising his voice against such activities in the annual general meeting of the company. ALHUDAmnajeebkhan@hotmail.com10

11. Conditions 3. If some income from interest-bearing accounts is included in the income of the company, the proportion of such income in the dividend paid to the share-holder must be given in charity, and must not be retained by him. For example, if 5% of the whole income of a company has come out of interest-bearing deposits, 5% of the dividend must be given in charity. 3. If some income from interest-bearing accounts is included in the income of the company, the proportion of such income in the dividend paid to the share-holder must be given in charity, and must not be retained by him. For example, if 5% of the whole income of a company has come out of interest-bearing deposits, 5% of the dividend must be given in charity. ALHUDAmnajeebkhan@hotmail.com11

12. Conditions 4. The shares of a company are negotiable only if the company owns some illiquid assets. If all the assets of a company are in liquid form, i.e. in the form of money they cannot be purchased or sold except at par value, because in this case the share represents money only and the money cannot be traded in except at par. 4. The shares of a company are negotiable only if the company owns some illiquid assets. If all the assets of a company are in liquid form, i.e. in the form of money they cannot be purchased or sold except at par value, because in this case the share represents money only and the money cannot be traded in except at par. ALHUDAmnajeebkhan@hotmail.com12

13. Conditions What should be the exact proportion of illquid assets of a company for warranting the negotiability of its shares? The contemporary scholars have different views about this question. Some scholars are of the view that the ratio of illiquid assets must be 51% in the least. They argue that if such assets are less than 50%, then most of the assets are in liquid form, and therefore, all its assets should be treated as liquid on the basis of the juristic principle: What should be the exact proportion of illquid assets of a company for warranting the negotiability of its shares? The contemporary scholars have different views about this question. Some scholars are of the view that the ratio of illiquid assets must be 51% in the least. They argue that if such assets are less than 50%, then most of the assets are in liquid form, and therefore, all its assets should be treated as liquid on the basis of the juristic principle: ALHUDAmnajeebkhan@hotmail.com13

14. Conditions Some other scholars have opined that even if the illiquid asset of a company are 33%, its shares can be treated as negotiable. The third view is based on the Hanafi jurisprudence. The principle of the hanafi school is that whenever an asset is a combination of liquid and illiquid assets, it can be negotiable irrespective of the proportion of its liquid part. However, this principle is subject to two conditions: Some other scholars have opined that even if the illiquid asset of a company are 33%, its shares can be treated as negotiable. The third view is based on the Hanafi jurisprudence. The principle of the hanafi school is that whenever an asset is a combination of liquid and illiquid assets, it can be negotiable irrespective of the proportion of its liquid part. However, this principle is subject to two conditions: ALHUDAmnajeebkhan@hotmail.com14

15. ALHUDAmnajeebkhan@hotmail.com15 According to Shariah Standards of Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) a Stock Company has been defined as: “A stock company is a company of which the capital is partitioned into equal units of tradable shares and each shareholder’s liability is limited to his shares in the capital. It is a form of financing partnership. The rules of Sharikat al-Inan apply to this company except on the issue of the limited liability of the shareholders and the fact that this type of company cannot be unilaterally terminated by one party or a minority of its shareholders”

16. ALHUDAmnajeebkhan@hotmail.com16 Scope Transactions in an Islamic Capital Market should be free from the involvement of prohibited activities by Islam as well as free from the elements such as usury (riba), gambling (maisir) and ambiguity (gharar)

17. ALHUDAmnajeebkhan@hotmail.com17 Shariah Compliant Stocks Shariah Guide lines: Shariah Guide lines: Shariah based principle of equity participation is Shirkah Shariah based principle of equity participation is Shirkah Stocks are classified as Shariah compliant if their business activities do not fall in the prohibited list prescribed by Shariah Scholars Stocks are classified as Shariah compliant if their business activities do not fall in the prohibited list prescribed by Shariah Scholars Certain financial ratios are also applied for screening. Certain financial ratios are also applied for screening.

18. ALHUDAmnajeebkhan@hotmail.com18 Shariah Compliant Stocks Prohibited activities: Alcohol Alcohol Gambling Gambling Pork related products Pork related products Pornography Pornography Conventional financial services Conventional financial services Conventional insurance Conventional insurance Tobacco, Tobacco, Indecent Entertainment Indecent Entertainment Financial Ratios: Main ratios applied are Main ratios applied are –Debt to equity ratio –Cash and interest bearing securities to equity ratio –Cash to asset ratio In Malaysia, the screening of listed stocks is undertaken by a centralised body- Shariah Advisory Council of SEC In Malaysia, the screening of listed stocks is undertaken by a centralised body- Shariah Advisory Council of SEC In other jurisdictions, screening services are performed by individual institutions In other jurisdictions, screening services are performed by individual institutions

19. ALHUDAmnajeebkhan@hotmail.com19 Stock Market Business The stock exchange provides a market place where investors can buy and sell shares. The exchange’s role is to monitor the market to ensure that it is working efficiently, fairly and transparently. The stock exchange provides a market place where investors can buy and sell shares. The exchange’s role is to monitor the market to ensure that it is working efficiently, fairly and transparently. The trading system comprises four distinct segments: The trading system comprises four distinct segments: T+ (2) settlement T+ (2) settlement Spot transactions Spot transactions Provisionally listed counter Provisionally listed counter Futures contract Futures contract

20. ALHUDAmnajeebkhan@hotmail.com20 Key components of Islamic Capital Markets Shariah Compliant Stocks Islamic Funds Islamic Bonds Islamic Capital Market

21. ALHUDAmnajeebkhan@hotmail.com21 Shariah Related Issues in Stocks Trading Not permitted to purchase shares by raising interest bearing loans through a broker or someone else. Not permitted to purchase shares by raising interest bearing loans through a broker or someone else. Not permitted to pledge the shares for the interest bearing loan. Not permitted to pledge the shares for the interest bearing loan. It is not permitted to sell the shares that the seller does not own which is called short sale. The promise by the broker to lend these shares at the time of delivery is of no consequence. It is not permitted to sell the shares that the seller does not own which is called short sale. The promise by the broker to lend these shares at the time of delivery is of no consequence.

22. ALHUDAmnajeebkhan@hotmail.com22 Issues in Stocks Trading (Contd) Not permitted to conclude futures contract for shares because according to Shariah only one thing either payment or delivery can be deferred. Not permitted to conclude futures contract for shares because according to Shariah only one thing either payment or delivery can be deferred. Not permitted to conclude the contracts of options for shares or to conclude swap contracts with respect to shares and their returns. Not permitted to conclude the contracts of options for shares or to conclude swap contracts with respect to shares and their returns. The contract of Salam is not permissible in shares – identified items. The contract of Salam is not permissible in shares – identified items.

23. Stock Screening Criteria Various Criterion have been developed by the Scholars to screen any scrip’s eligibility for investment. The major stock screening criterion followed are: Dow Jones Islamic Market Indices Criteria (DJIMI) Meezan Islamic Market Index Criteria (KMI 30 Index Criteria)

24.  Business of the Investee Company: The basic business of the investee company should be Halal.  Debt to Market Capitalization: Total debt divided by 12-month average market capitalization should be less than 33%.  Cash and Interest Bearing Securities: The sum of company’s cash and interest-bearing securities divided by trailing 12-month average market capitalization should be less than 33%.  Accounts Receivables: Accounts receivables divided trailing 12-month average market capitalization should be less than 33%. Dow Jones Islamic Market Index Criteria

25.  Business of the Investee Company: The basic business of the investee company should be Halal.  Debt to Total Assets: The interest bearing debt of the investee company should not exceed 37% of total assets.  Illiquid Assets to Total Assets: Total illiquid assets of the Investee company as a percentage of total assets should be at least 25%.  Investment in Shariah Non-Compliant Activities: Total investment of the investee company in Shariah non-compliant business should not exceed 33% of total assets.  Income from Shariah Non-Compliant Investments: The income from Shariah non-compliant investments should not exceed 5% of gross revenues of the investee company.  Net Liquid Assets vs. Share Price: The net liquid assets per share should be less than the market price of the share. Meezan Islamic Market Index Criteria

26.  It is necessary to purify the earnings by deducting from the returns on the investments those earnings emanating from an unacceptable source from a Shariah point of view.  In context of equity investment according to Shariah standards it is obligatory to eliminate prohibited income that is mixed up with the earnings of the company and this obligation is on the one who is the owner of the shares. Purification Requirement

27.  Elimination is not obligatory for the intermediary, agent or manager out of part of their commission or wages because this is their right in lieu of the work they have undertaken.  In case of Fund Management it is responsibility of the Management Company to eliminate the prohibited income.  According to Shariah Standards for the determination of the percentage of prohibited income the recourse should be the last verified financials position. Purification Requirement

28.  we calculate the percentage of non-compliant income to the gross revenue (sales + other income) for each investee company and this percentage is called as charity rate.  Charity rate for each investee company is multiplied with the dividend income from respective companies to get the charitable amount. This charitable amount is then transferred to a separate account.  Shariah advisor verifies the whole process of elimination of prohibited income and issues a certificate to be included in the annual accounts of the fund. Purification Requirement

29. ALHUDAmnajeebkhan@hotmail.com29 Quantitative Screening Criteria The basic business of the investee company should not be non-Shariah compliant like conventional banks and insurance companies Total non-Shriah compliant debt of the Investee Company should not exceed 40% of the total assets. Total illiquid assets (which are not cash or cash equivalent) of the Investee Company as a percentage of the total assets should be at least 20%

30. ALHUDAmnajeebkhan@hotmail.com30 Quantitative Screening Criteria Total investment of the investee company in Shariah non-compliant business (as a secondary source of income) should not exceed 33% of the total assets Investee Company’s interest income or any other non- Shariah compliant income should not exceed 5% of its gross revenues All the essential Shariah trading rules would be applied in case of trading; hence short sale or sale before settlement date would not be allowed

31. ALHUDAmnajeebkhan@hotmail.com31 JAZAKALLAH