Professor Dr. Aishath Muneeza

“….The SAC of SC Malaysia provides guidance on the timing for the disposal of Shariah non-compliant securities. It distinguishes between securities initially classified as Shariah-compliant but later reclassified as non-compliant and those already identified as non-compliant. For the former, investors are advised to dispose of securities if their market price exceeds or equals the investment cost on the effective date of reclassification. Dividends received and capital gains up to this date can be retained, while subsequent dividends and excess capital gains must be donated to charity….”

These sectors are carefully evaluated to ensure that companies included in the DJIMI meet the ethical and religious criteria outlined by Shariah principles. By excluding businesses involved in non-compliant activities, the DJIMI aims to provide investors with a portfolio of stocks that align with Islamic ethical standards.

ii) Financial Ratio Screening

Based on the Shariah screening criteria provided, the financial screening process for companies included in DJIMI involves evaluating compliance with specific accounting ratios. These ratios focus on leverage, cash holdings, and the share of revenues derived from non-compliant activities. Below a breakdown of the financial screening criteria:

Cash Compliance:

Accounts Receivables / Market value of Equity (36-month average) < 49%

Includes total accounts receivables, other non-business/non-trade related receivables, other debit balances, and Murabaha receivables.

(Cash + Interest Bearing Securities) / Market value of Equity (36-month average) < 33%

Includes cash in hand, cash in current accounts, cash deposits, term deposits, short-term interest-based securities, marketable securities, and short-term investments held for sale/trading.

Excludes Islamic investments.

Leverage Compliance:

Debt / Market Value of Equity (36-month average) < 33%

Includes long-term interest-bearing debt, short-term interest-bearing debt, current portion of long-term interest-bearing debt, and interest-bearing short-term liabilities such as overdrafts and bridge loans.

Excludes short-term non-interest-bearing operational payables/liabilities, long-/short-term Islamic debt, long-/short-term non-interest-bearing debt, and loans from sovereign bodies that are non-interest-based.

Average Market Capitalization of Stocks:

Calculated by multiplying the moving average daily closing price of the stock over a specified period by the total number of shares outstanding.

For stocks with multiple share classes, adjustments are made using the last closing price of the main share class.

For companies with insufficient price history, the moving average is calculated over the available trading days.

These financial screening criteria help ensure that companies included in the DJIMI meet the required financial standards while also complying with Shariah principles. Companies failing to meet these criteria may be excluded from the index to maintain its Shariah-compliant status.

Shariah-compliant investing, companies generating a minimal percentage of their revenue from non-compliant activities may still be considered for inclusion in investment portfolios. However, any dividends earned from these activities, along with interest income, must undergo a purification process. This process involves segregating and donating a portion of the income received from non-compliant sources to charity, thereby purifying the overall income.

The Dividend Purification (DP) ratio is calculated by dividing the total non-permissible revenue, including interest income, by the total revenue generated by the company. The DP ratio is determined based on various sources of non-compliant income, such as interest income, revenue from alcohol, gambling, pornography, and other prohibited activities. This ratio serves as a guideline for determining the proportion of dividends that require purification.

The dividends subject to purification include income received from interest-bearing sources like bank deposits, bonds, and money market instruments. Additionally, revenue generated from non-compliant activities, such as alcohol sales, financial services, gambling, and others, contribute to the purification requirement. The sum of all non-permissible income is divided by the total revenue to ascertain the purification ratio.

The purification process relies on data extracted from the company's latest financial reports, including annual and quarterly filings. In the absence of annual reports, detailed quarterly reports or prospectuses are utilized for accurate calculations. The purification ratio dictates the percentage of dividends that must be allocated to charity, with higher ratios necessitating a larger portion of dividends to be purified. This process ensures adherence to Shariah principles in investment practices, maintaining the integrity of Shariah-compliant portfolios.

Different methodologies are employed by institutions like DJIM, MSCI and CMDA Maldives, each with its unique approach to dividend purification.

DJIM and MSCI both incorporate dividend purification measures to maintain compliance with Shariah principles. DJIM calculates DP ratio, dividing total non-permissible revenue, including interest income and revenue from prohibited activities, by the company's total revenue. Dividends subject to purification are determined based on this ratio and are donated to charity to ensure adherence to Shariah principles. Similarly, MSCI applies a "dividend adjustment factor" to reinvested dividends, deducting income from prohibited activities and interest income before reinvestment, thus aligning with Shariah guidelines.

In contrast, CMDA Maldives emphasizes the responsibility of companies to purify tainted income, rather than investors. The Authority mandates companies to maintain records of non-compliant income, allocating it solely for social responsibility purposes. This approach differs from others where investors are directly involved in the purification process.

The SAC of SC Malaysia provides guidance on the timing for the disposal of Shariah non-compliant securities. It distinguishes between securities initially classified as Shariah-compliant but later reclassified as non-compliant and those already identified as non-compliant. For the former, investors are advised to dispose of securities if their market price exceeds or equals the investment cost on the effective date of reclassification. Dividends received and capital gains up to this date can be retained, while subsequent dividends and excess capital gains must be donated to charity. For the latter, investors are advised to dispose of non-compliant securities within a month of learning their status, with any gains to be channeled to charity, retaining only the investment cost.

Overall, while dividend purification remains a common practice in Islamic finance, the approach varies across institutions and jurisdictions, reflecting diverse interpretations of Shariah principles and regulatory frameworks.