How to Become an Islamic Index Constituent

If your company is a purveyor of pork products, sells alcohol or runs a casino, you can forget about raising money from the world’s 1.6 billion Muslims, right?

In fact, this is not always the case, says Mohamad Safri Shahul Hamid, Deputy CEO at Malaysian financial institution MIDF Amanah Investment Bank Berhad. If these activities account for 5% or less of revenues and adre “cleansed” through charitable donations, for example, then you can participate in Islamic finance.
Mohamad Safri spoke to CFO Innovation’s Cesar Bacani about the ins and outs of non-Islamic companies joining the world indexes and other ways they can gain the attention of Muslim investors, who are among the least affected by the global financial crisis. Excerpts:
A listed company looking to tap Islamic money would do well to be included in the Dow Jones Islamic Index family and the FTSE Shariah Global Islamic Index Series. How can non-Muslim companies be included in these benchmarks? I know those in tobacco, pork-related products, conventional financial services, weapons and defence and hotels, casinos, pornography and so on are screened out. Are there other criteria?
Dow Jones is based in the United States, but they are advised by their own set of Shariah scholars – they are named on their website. There are qualitative criteria [the business activities] and quantitative criteria [financial ratios]. 
For example, total debt over trailing 24-month average market capitalization must not exceed 33%. Accounts receivable divided by trailing24-month average market cap must not exceed 33% as well. The last test is cash equivalents over market capitalization trailing average over the last 24 months, which should not exceed 33%.
FTSE has its own Islamic index and its own criteria as well, which are similar but not the same as the Dow Jones Islamic index criteria. FTSE criteria are similar in the sense that the numerators [are the same] – they also look at debt, cash and interest-bearing items and accounts receivable. But the denominator is different – it’s total assets [rather than market capitalization as in Dow Jones].
These financials ratios seem more like prudential measures to me, rather than Islamic strictures.
Yes, you are right, these are prudential or commercial considerations. But at the same time, they have a bearing on Islamic consideration. For example, from an Islamic finance perspective, a company should not be over-leveraged. Hence, you have [the debt and cash equivalents] tests. They cannot exceed the one-third cap or threshold set up by the scholars.
So the 33% threshold was decided by Islamic scholars, not Dow Jones or FTSE?
The thresholds were set out by the scholars many years ago when the Dow Jones Islamic Index was launched [in 2003] and the FTSE index was started [in 2007]. The index makers have to get certifications from Islamic scholars.
Everyone that buys into Islamic products [must have] their own Shariah scholars. Islamic banks and Islamic insurance companies are guided by their own Shariah committee. Before the treasury or the investing department within a particular bank or takaful [Islamic insurance] company invests in a product, they need to get the green light from their own Shariah body.
I know Islam as a religion is decentralized, unlike Roman Catholicism, for example, where you have the Pope as central authority. So if every entity has its own set of Shariah scholars, does that mean the criteria for what is Shariah-compliant and what is not will differ and a company judged Shariah-compliant in one market will not be accepted as such in another market?
It’s difficult to achieve 100%. Nobody’s perfect and to achieve perfection in this world is not going to be easy. This is also true of conventional products. If you try to sell in Hong Kong, for example, maybe your product may not be so hot, but in other parts of the world it would do well.
One thing that struck me was the ruling by Malaysian Islamic scholars that if 5% of your revenues come from non-Islamic business activities, you can still be deemed Shariah-compliant. Does this apply only to Malaysia, or is it accepted globally as well?
I was involved in [the structuring] of an exchangeable bond for Khazanah [Malaysian government’s investment arm]. One of the three assets it could be exchanged for was [Asian retailer] Parkson. When we went to the Middle East, to Iran, Saudi, Dubai, we told them that when you go into Parkson today, there are certain sections where you can find non Shariah-compliant goods [such as alcohol]. They were aware and they still accepted our structure. They still deemed the company as a Shariah-compliant company. So it [5% or less of revenues from non-Islamic activities] is a globally acceptable criterion.
But I imagine you would need to cleanse the company of those non-Shariah sales?
Yes, you will need to have a mechanism [accepted by your Shariah scholars] to purify those earnings. Usually the company will donate the money to charity.
Is there one global body that you can go to get a definitive ruling that all Islamic markets will accept?
At the moment, we do not have [such] a body. We do have the AAOIFI [Auditing and Accounting Organisation for Islamic Financial Institutions], which is the closest thing to a world governing body.
Will the AAOIFI endorse a particular financial instrument, for example, the exchangeable bond that you helped Khazanah float?
No. It will be each entity’s Shariah scholars. The Khazanah bond was endorsed by the Shariah body of the lead arrangers, the banks. And because it was a global issue, a dollar issue, we needed to make sure that the Shariah scholars endorsing it came from all over the world. One bank is from Malaysia, one bank has operations in Saudi, one bank has got operations in Bahrain. These banks have their own Shariah committee, and the Shariah committee consists of individuals from the respective institutions.
So if I’m issuing an Islamic bond, it’s a good idea for me to include a bank in Malaysia, a bank in Bahrain, in Saudi Arabia and other Islamic financial centres?
That is the message that we’ve been telling the client, especially those clients that are not from the active markets. 
Is this a good strategy as well for an initial public offering that is targeted at both conventional investors and Islamic investors?
An IPO is a bit more different. For a fixed income instrument via sukuk [Islamic bond], we need to explain the structure to investors and scholars. The challenge in doing an IPO lies in trying to educate the potential investors on the status/background of the company [in terms of its being a Shariah-compliant company].
Basically, the tests that we discussed earlier regarding the Dow Jones and FTSE ratios will come into play. Those tests are globally acceptable. If the IPO meets those tests, there’s no issue about whether it is deemed Shariah-compliant in Asia and non-Shariah-compliant in the Middle East.
It’s actually simpler to do an IPO that’s Shariah-compliant compared with structuring a Shariah-compliant fixed income instrument?
In a way, yes, that’s the case. But unlike sukuk, we’ve not seen cross-border IPOs, for example, [a Malaysian IPO] that is marketed aggressively to Middle Eastern investors.
We’ve seen Malaysian and Indonesian sukuk being marketed in the Middle East, and likewise some of the Middle Eastern names coming over to market their sukuk in Hong Kong or Singapore. Maybe it’s not so much [the issue] of being a Shariah-compliant play, but more the price-earnings multiple. Maybe they [companies in the Middle East] think that stocks in Asia or in Malaysia are very expensive.
It’s possible for an IPO that happens to meet all the criteria set by Dow Jones and FTSE to for Shariah-compliance to obtain the usual regulatory approvals and also obtain the endorsement of its lead arrangers’ Shariah scholars?
You don’t have to split [the IPO] into conventional and Islamic tranches. When we do an IPO, like doing a sukuk, we just have one Shariah-compliant tranche[but] focus [the marketing] on both sets of investors.
We do a book-building or roadshow. We will basically bring together all the investors, Islamic and non-Islamic, into one room and we will tell [everyone] that this is a Shariah-compliant counter. Conventional investors don’t really care; they will come in irrespective of whether it’s Shariah-compliant or not. They come in because of the commercial aspects and the earning forecast, the expected gains or income to be derived from this particular counter.
But for the Islamic investor, yes, the fatwa, the ruling endorsement would be required before a takaful company, for example, can invest.

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