ISLAMIC SECURITIES MARKET

Some Controversial Issues

Presented to Professor Dr. Tariqullah Khan

Prepared by Samer Abou Zaghla 2013

CONTENTS

• Shari’ah Screening Criteria

• First Category – Islamic Bank Shares

• Third Category

• Products

• Options

• Index ETF Units

• Trading Practices

• Speculation

• Short selling

• Is Islamic Securities Market Possible

SHARI’AH SCREENINGCRITERIA –

TRADABILITY OF IB SHARES

Average Composition of Islamic Bank Assets*

* Source Professor Khan’s lectures

Receivable from Financing; 50%

Treasury;

30%

Investment; 20%

Receivable from Financing TreasuryInvestment

SHARI’AH SCREENINGCRITERIA – 3RD CATEGORY

Jurists – OIC Fiqh Academy

At one end some, including OIC Fiqh Academy, advocate that it is impermissible to invest in those stocks, based on a number of sources such as, the various Qura’n verses which prohibits Riba, Prophet’s PBUH Sayings (Ahadeeth) and some Fiqh maxims like the one which stipulates “If the lawful (Halal) mixed with the unlawful (Harram), then the unlawful dominates”.

Practitioners – Nizam Yaquby

At the other end of the spectrum, some advocate that it is permissible to own those companies but under some conditions. In fact, the promoters of permissibility have referred to a number of sources also, such as, the Fiqh maxim that says “That which is independently impermissible becomes permissible when done in conjunction with the permissible” and the other Maxim which says “What is Inescapable is Tolerable”.

OPTIONS

• Definition: Option is a contract between two parties whereby one party (writer/seller) has an obligation to fulfill the contract (deliver/receive the underlying asset) and the counterparty (holder/buyer) has the right (not the obligation) to exercise the option at a pre-agreed price over a certain period of time.

• Types: Call/Put

• Permissible/Impermissible

Gharar

Gambling/ZERO Sum Game

Remove expectations from financial assets

95%

5%

Exercise Vs Cash settlement

Exercise Cash settlement

INDEX ETF UNITS

• Index ETFs are open-ended mutual funds (basket of securities) that are listed and traded on stock markets like shares and replicate the constituents of certain index.

• Permissible/Impermissible

• Realism/Lack of Realism Attributes ETF Mutual Fund Share

Diversification Yes Yes No

Trading Yes No Yes

Tracking index Yes No No

Type Open Open/Close NA

More Flexible Yes No Yes

More Transparent Yes No Yes

Price MP NAV MP

ISLAMIC INDEX – QE ALRAYAN INDEX

SPECULATION

• Definition:

• Speculation is the investment activity whereby an investor is willing to tolerate a high risk with regard to high-frequency trading in the stock exchange.

• This type of investment involves a high level of risk and uncertainty about the profits or losses in the short term, but usually speculators have sufficient market experience as well as reasonable knowledge of how to read and analyze financial statements of listed companies, in addition to applying technical analysis and charting to shares prices and indexes.

SPECULATION PARADOX

Conservative

On one hand, some blame speculators for price manipulations, spreading rumors, increase prices volatility and ending up having price bubbles in stock markets. (Excessive Ghaban/deception)

Liberal

On the other hand, it is argued that speculative trading as an activity in itself does not constitute damage to the stock markets, but on the contrary, this activity provides the liquidity needed by those markets, since the speculator is always ready to buy or sell securities at any time during the trading session from the rest of the transacting parties in the market. (Slight Ghaban)

Opinion

‘Legitimate’ speculation helps, very often, to restore the balance between supply and demand, and reduces price fluctuations in the securities markets as well as playing an important role in determining the equilibrium price (fair price) of the listed securities. Also, speculation makes stock markets liquid and enable them to act as Exit windows to investors, consequently, this will encourage savings and investments through the primary and secondary segments of the capital market. (Slight Ghaban can be tolerated)

SHORT SELLING

• Definition:

• Short-selling is the sale of a security by a seller who (doesn’t own such security?) and borrows it on the anticipation that its price will decline and he/she will buy it after a period of time at the lower price to make profit.

• From definition, we can deduce that short-selling involves two issues i.e. (i) selling what is not owned (Gharar) and (ii) securities lending and borrowing (Riba).

SHORT SELLING

• From reviewing Fiqh literature we can deduce that selling an object by a seller who doesn’t own it is prohibited mainly due to “Gharar” and its implication of potential disputes that may arise between the buyer and seller in this case. But, since in today’s market this transaction is regulated by the market authorities and clearing houses (CCP) to always guarantee the delivery of securities from seller to buyer, regardless, then we can deduce that this issue has become irrelevant in present markets.

• The second issue of borrowing the securities is the real issue in short-selling transactions. Securities are considered as fungible and homogenous assets as money, thus, they are subject to Riba rulings, and since securities lending and borrowing contracts are executed based on a paid fee/interest to the lender, then it should be prohibited in Islamic securities market.

SHORT-SELLING – CCP ROLE

Seller

Buyer

CCP (Novation

)

IS ISLAMIC SECURITIES MARKET POSSIBLE

• Securities markets, in general, have genuine importance for countries’ economies. They facilitate funds mobilization from surplus units to deficit units. They help in spreading risks amongst a big number of risk takers. And, they provide a place and means for assets’ price discovery. Definitely, Islamic stock markets are no different and Muslim countries should encourage the establishment of such Sharia’h compliant markets for the benefit of their people.

• Islamic Securities markets should have built-in regulations to guarantee that listed securities and trading mechanisms are Sharia’h compliant.

• In principle, the investment in company’s common shares is permissible unless companies are dealing in non-sharia’h compliant businesses, or their screenings don’t comply with the well-known Sharia’h Indexes criteria.

• Bonds as a debt security cannot be listed in Islamic stock markets and can be replaced by Sukuk.

• Reasonable ‘legitimate’ speculations are accepted and needed for the success of Islamic Securities markets. (Slight Ghaban can be tolerated)

• Short-selling cannot be facilitated by Islamic Securities markets, not because Gharar but because the SBL mechanism which is based on interest/Riba

• Margin-trading cannot be facilitated by Islamic Securities markets as they involve interest-based loans.

THANK YOU

Q & A