Professor Dr. Aishath Muneeza

“The practice of dividend purification in Islamic finance is a complex concept that varies across different index providers and scholars. While there is consensus among scholars regarding the necessity of purification processes for investment funds, there are differing perspectives on which income elements require purification…”

In essence, the Shariah screening process serves as a vital mechanism to uphold Islamic principles within financial markets, ensuring that investments adhere to ethical and religious standards while also accommodating the dynamic nature of the industry through regular review and adaptation.

The disposal of Shariah non-compliant securities is imperative to uphold the principles of Islamic finance. Shariah-compliant investing prohibits involvement in activities deemed unethical or haram, such as alcohol, gambling, and interest-based transactions. Disposing of such securities ensures that investors' portfolios align with Shariah guidelines, safeguarding their wealth and adhering to ethical standards. Moreover, it fosters a sense of accountability and responsibility among investors, reinforcing their commitment to ethical investing practices.

The practice of dividend purification in Islamic finance is a complex concept that varies across different index providers and scholars. While there is consensus among scholars regarding the necessity of purification processes for investment funds, there are differing perspectives on which income elements require purification. These may encompass dividends, capital gains, or even a company's assets and liabilities. Purification, as per scholars, entails identifying and donating income derived from impermissible activities. It is deemed obligatory for shareholders at the end of a financial period, regardless of whether profits were distributed or the company incurred a gain or loss. While some advocate for dividend purification, others argue in favor of income purification, which addresses all impure income, not just distributed dividends.

AAOIFI Shariah Standard 21 on Financial Paper (shares and bonds), paragraph 3/4/6 mandates the elimination of prohibited income associated with shares that are commingled with the earnings of corporations. This obligation applies to the owner of the share, whether an investor or a trader, at the end of the financial period, irrespective of whether profits have been distributed or the corporation has declared a profit or suffered a loss. However, this obligation does not apply to those who sell the shares before the end of the financial period. The subject of elimination is the prohibited income specific to the share, regardless of profit distribution or the corporation's financial status. Intermediaries, agents, or managers are exempt from this obligation regarding part of their commission or wages, as it constitutes their rightful compensation for their work. To determine the amount to be eliminated, the total prohibited income of the corporation is divided by the number of shares, and the resulting figure is then multiplied by the number of shares owned by the individual, institution, fund, or other entity. It is impermissible to utilize the prohibited component in any manner, including through tax payments. The responsibility for eliminating the prohibited component of income lies with the institution if it is trading for itself or managing operations. In cases of intermediation, the institution must inform the investor of the mechanism for eliminating the prohibited component, and may offer these services, with or without charge, to interested parties. These rules apply regardless of whether the institution is trading directly or through another entity, and whether it is trading for itself, on behalf of another, or as an agent. It is essential to adhere to these rules throughout the trading period, and if compliance is not possible, it is obligatory to divest from such investments.

Investors have several methods to dispose of Shariah non-compliant securities. One approach involves selling these securities in the market, effectively removing them from the investor's portfolio. Alternatively, investors may choose to exchange these securities for Shariah-compliant alternatives, maintaining their investment exposure while upholding ethical principles. Each method provides investors with flexibility in portfolio management while ensuring adherence to Shariah guidelines. Additionally, conducting thorough research and due diligence is crucial to identifying Shariah-compliant investment opportunities and minimizing the risk of unintentionally investing in non-compliant securities.

After disposing of Shariah non-compliant securities, investors must purify their income to eliminate any acquired impurities during the investment period. Purification entails removing tainted income and reallocating it to charitable causes, primarily through zakat or sadaqah. This process guarantees that investors' earnings are devoid of haram elements, promoting financial purity and ethical integrity in their investment endeavors. Furthermore, purification serves as a mechanism for wealth redistribution, aiding marginalized communities and fostering social cohesion within society. The variances in Shariah screening approaches adopted by different bodies are summarized in the following table.

In examining various institutions and methodologies for income purification in Shariah-compliant investing, it is evident that each approach carries its unique characteristics and implications. From the SC Malaysia's advice on divesting from non-compliant securities to the OJK's emphasis on investor-driven purification, and CMDA's focus on company responsibility, each method underscores different aspects of compliance and transparency.

While MSCI integrates purification directly into the investment process, DJIM provides a clear framework for purification calculation. FTSE incorporates purification into its screening process, and AlMeezan sets specific benchmarks. Standardization across these approaches could enhance consistency and transparency, ultimately boosting investor confidence in Shariah-compliant investments.

Additionally, AAOIFI's standardized guidelines ensure consistency and transparency across investments, mandating the elimination of prohibited income at the end of the financial period for individual investors. AAOIFI's emphasis on clear delineation of responsibilities and consistent application of purification rules promotes fairness, accountability, and trust in Shariah-compliant investments globally.

Ethically, these practices demonstrate investors' dedication to Shariah principles and societal well-being, while financially, adherence to guidelines mitigates risks and fosters trust. Yet challenges remain, including identification of non-compliant securities and varying interpretations of Shariah guidelines.

To address these challenges and promote best practices, collaboration among stakeholders is essential. By upholding ethical standards and embracing transparency, the Islamic finance industry can continue to thrive while advancing its mission of ethical and inclusive economic development.