ROLE & REGULATION OF STOCK EXCHANGE IN

AN ISLAMIC ECONOMY

8th Distance Learning Course

An Intermediate Course in Islamic Economics

Presenter: Mohammed Obaidullah, Economist, IRTI

October 21, 2008
 PLAN OF PRESENTATION

Part I: Common Stock in Islamic Finance

Part II: Ethics & Efficiency in Islamic Stock Market

Part III: Issues & Trends in Regulation

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Part I: Common Stock in Islamic Finance

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Common Stock in Islamic Finance

• Common Stock and Mudaraba: Issue of Limited

Liability
• Common Stock and Musharaka: Issue of
Managerial Participation
• Common Stock and Sukuk

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Conditions for Permissibility and
Negotiability
• The main business of the company is not in violation of
Shariah.
• If the company invests/ lends/ deposits its surplus funds in
interest-bearing assets or borrows money on interest, it must
not be “significant”
• If some income from interest-bearing accounts is included in
the income of the company, the proportion of such income in
the dividend must be given in charity.
• Stocks of a company are negotiable only if the company owns
some non-liquid assets.

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Common Stock in Islamic Finance
Shariah Screens: Example: I (DJIM)
• Industry Type: Excluded are companies that represent the following
lines of business: alcohol, tobacco, pork-related products, financial
services, defense/weapons and entertainment.
• Financial Ratios: Excluded are companies whose:
• Total debt divided by trailing 12-month average market
capitalization is 33% or more; Cash plus interest-bearing securities
divided by trailing 12-month average market capitalization is 33%
or more; Accounts receivables divided by 12-month average market
capitalization is 33% or more.

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 FINANCIAL SCREEN

Subject to continuous change in the light of new insights ; Not to

be taken as “divine” rules of Shariah compliance.
Example: One-third rule:
•  The Prophet PBUH advised Abu Bakr RAA not to donate more
than One-Third of his wealth, and commented that "One Third
is too much (Al Thuluth Katheer)".
•  Critics of the one-third rule assert that it involves an out-of-
context use of the above hadith

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Common Stock in Islamic Finance
Shariah Screens: Example: II (S&P)

Sector-Based Screens
• Business activities related to the following are excluded:
Pork; Alcohol; Gambling; Financials; Advertising and
Media (newspapers are allowed, sub-industries are
analyzed individually); Pornography; Tobacco; Trading of
gold and silver as cash on deferred basis

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Common Stock in Islamic Finance
Shariah Screens: Example: II (S&P)
Accounting-Based Screens
•Debt / Market Value of Equity (12 Month average) < 33 %;
•Accounts Receivables / Market value of Equity (12 Month average) <
49 %;
•(Cash + Interest Bearing Securities) / Market value of Equity (12
Month average) <33%;
•Non-Permissible Income other than Interest Income / Revenue <
5%
•Dividend Purification Ratio: Dividends * (Non Permissible Revenue /
Total Revenue)

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Part II: Ethics & Efficiency in Islamic Stock
Market

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Ethics & Efficiency in Islamic Stock Market
Forms of Efficiency

• Allocational Efficiency
• Pricing Efficiency
• Informational Efficiency
• Operational Efficiency

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Ethics & Efficiency in Islamic Stock Market
Norms of Secular Ethics

•Freedom from Coercion

•Freedom from Misrepresentation
•Right to Equal Information
•Right to Equal Information Processing Power
•Freedom from Impulse
•Right to Trade at Efficient Prices
•Right to Equal Bargaining Power

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Ethics & Efficiency in Islamic Stock Market
Norms of Islamic Finance
•
Freedom to Contract
• Freedom from Al Riba
• Freedom from Al Gharar (Excessive Uncertainty)
• Freedom from Al-Qimar (Gambling) and Al-Maysir
(Unearned Income)
• Freedom from Price Control and Manipulation
• Entitlement to Transact at Fair Prices
• Entitlement to Equal, Adequate and Accurate Information
• Freedom from Darar (Detriment)
• Mutual Cooperation and Solidarity
• Maslahah Mursalah (Unrestricted Public Interest)

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Islamic Stock Market:
Nature and Regulation of Primary Market

• Merit Regulations Vs. Mandatory Disclosures

• Price Fixation Vs. Free Pricing
• Role of Intermediaries in Offer and Sale
• Tender Method (Bai Muzayadah)
Genuine Bids Only (Prohibition of saum `ala saum akhihi)
• Underwriting
Wholesale Purchase Followed by Retail
Best Efforts Underwriting
Risk Transfer

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Islamic Stock Market:
Nature and Regulation of Secondary Market

Speculation on Stock Markets:

Co-operative or Zero-sum Games
The Issue of Liquidity and Transaction Costs
Day Trading
Margin Trading: Riba-based Borrowing
Stock Lending and Short Selling
Settlement System
Insider Trading
Trading Halts
Allocational Vs. Operational Efficiency

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Part III: Issues & Trends in Regulation

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Issues & Trends in Regulation
International organization of securities commissions (IOSCO)

Objectives And Principles of Securities Regulation For Islamic

Securities Products
1.To ensure that markets are fair, efficient and transparent;
2.To protect investors; and
3.To reduce systemic risk
These objectives are supported by the 30 core principles

“There is no need to formulate separate regulatory principles

[as] IOSCO‟s objectives and principles of securities regulation
can be applied to Islamic capital markets.”
Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 IOSCO Recommendations
•Co-operation and information sharing between regulators
• Accounting disclosures based on internationally
acceptable standards (such as IFRS) in coordination with
AAOIFI
•Regulatory classification of Islamic securities products
and their treatment in a fair, transparent and consistent
manner
•individual regulators to consider defining their position on
Shariah compliance
•Subject of PSIAs – an ideal area of further research in IF

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Other Standard Setting Bodies
Islamic Financial Services Board (IFSB)
Covers banking, insurance and securities regulation
wide range of initiatives it has undertaken, for example
developing corporate governance standards for Islamic
collective investment schemes, and capital adequacy
requirements for Sukuk securitisations

Accounting and Auditing Organisation for Islamic

Financial Institutions (AAOIFI)
Standards on accounting, auditing, ethics, Shariah and
governance.

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Key Issues in Islamic Stock Market
Regulation

• How to maintain a linkage between financial

and real sectors of the economy
• How to balance between concerns about
allocational and operational efficiency

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008
 Thank You

Eighth Distance Learning Program on Intermediate Course in Islamic Economics, October 21, 2008