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What is Shariah Compliance?

Shariah-compliant funds are investment funds that follow the requirements of Shariah law and the principles of Islam. They are often recognized as a type of socially responsible investing.

Ethical and responsible investing is a topic that is becoming increasingly popular among investors, as they consider their values and beliefs when making investment decisions. Globally, many investors are choosing to support companies that take the environmental, social, and ethical factors into account, as well as those that promote corporate governance and shareholder advocacy.  In recent years, a growing number of investors have sought out Shariah-compliant investments. According to Refinitiv’s Islamic Finance Development Report 2021, Islamic financial assets were valued at $3.374 billion at the end of 2020, up from $2.964 billion in 2019 and $2.2 billion in 2015. Moreover, Islamic exchange-traded funds (ETFs) overall had a record year in 2021 with more than 900 new launches worldwide and over $1 trillion in global net inflows, taking assets under management to $9.9 trillion at the end of November (Dr. Chris Mellor, head of EMEA ETF Equity and Commodity Product Management).  Sharia-compliant investing not only appeals to Muslims but also provides socially responsible opportunities for people of other faiths. The main objective of Shariah-compliant investments is to provide an avenue for investors who wish to invest in a way that complies with Islamic law, governed in accordance with Shariah principles under the guidelines of the Shariah supervisory board – Accounting and Auditing Organization for Islamic financial institutions (AAOIFI).  But what does that mean, exactly? Keep reading as we break down what Shariah compliant investing is all about.

What is Shariah Compliance?

Shariah-compliant funds are investment funds that follow Islamic law. A Shariah-compliant investment should not involve any of the activities prohibited by Islam, such as usury (riba), gambling (maisir) and ambiguity (gharar). This includes investments in companies or sectors that are engaged in Shariah non-compliant activities such as:

  • Institutions that deal with interest and excess debt
  • Alcohol
  • Pork-related products and non-halal food production, packaging and processing or connected activity
  • Gambling
  • Adult entertainment
  • Tobacco
  • Marijuana
  • Cloning
  • Firearms and defense

What makes a stock Shariah compliant? 

Islamic scholars have established a screening process similar to ‘negatively screened’ ethical funds using ESG criteria to determine whether a business activity abides by Shariah principles. Along with the screening process, a Shariah-compliant fund will include an advisory board made up of Islamic scholars who decide or check which companies meet the rules set out by AAOIFI. Each fund’s policies may differ as it is run in accordance with the Shariah boards beliefs and interpretations. Investors should consult the fund’s prospectus before investing. The screening process involves the following stages:

1. Business activity screening

A businesses activity must be in accordance with Shariah principles, therefore any companies involved in the below activities are screened out:

  • Institutions that deal with interest and excess debtConventional finance (non-Islamic banking, finance, and insurance, etc.)
  • Alcohol
  • Pork-related products and non-halal food production, packaging and processing or connected activity
  • Gambling
  • Adult entertainment
  • Tobacco
  • Marijuana
  • Cloning
  • FirearmsWeapons and defense

The rule of thumb is that the revenue from these investments cannot exceed 5% of the gross revenue of the company. Investors should check income for non-sharia compliant investments and gross revenue from annual reports to verify this.

2. Financial Ratio Screening 

Once the companies with non-compliant business activities have been screened out, they are further reviewed with accounting ratios.  A company would be acceptable for Shariah–compliant investments if it meets the following criteria:

  • Interest-bearing securities and assets must be less than 30% of trailing 36-month average market capitalization
  • Interest-bearing debt must be less than 30% of trailing 36 month average market capitalization

If it exceeds the percentage allowed, the company or investment will be considered Shariah non-compliant.

Are ETFs Shariah compliant?

Yes, there are Shariah-compliant exchange-traded funds (ETFs) that track an Islamic benchmark index. The index is composed of companies that are compliant with Shariah law. Furthermore, Islamic ETFs follow the Shariah principle and guidelines and are managed by an appointed committee, which regularly reviews the ETF to ensure strict adherence to Islamic principles. At baraka, we provide Shariah-compliant investment funds such as the S&P 500 Shariah, which includes Shariah-compliant securities tracked by the S&P 500 index.

How to buy Shariah compliant stocks with baraka?

At baraka, we offer users the chance to Halalify their portfolio through our Shariah filter allowing them to invest in stocks and ETFs without compromising their personal beliefs. When users turn the Shariah filter they will only view stocks that adhere to the Shariah compliant principles. Baraka provides access to traditional securities and does not intend to engage a Shariah advisor or obtain a fatwa regarding Shariah screened securities listed on the app. Baraka does not have an Islamic Window endorsement from the DFSA. Clients should be aware that Shariah screened stocks may involve additional risks and costs. There can be no assurance as to the Shariah compliance of the securities listed by Baraka Financial Limited. Clients are reminded that views on Shariah compliance may also differ. If you do not understand such risks or costs or are unsure whether the securities offered by Baraka Financial Limited are in compliance with the principles of Shariah, you should consult a Shariah advisor.