chapter 2 the principles of islamic investment
TRANSCRIPT
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ISLAMIC INVESTMENT
Mahyuddin Khalidemkay@
salam.uitm
.edu.my
The Principles of Islamic Investment
Topic Outline
Islamic Investment Concept Principle of Islamic Investment Shariah Supervisory Board Shariah Screening Principle of Zakat on Investment Speculation, Gharar and Gambling Time Value of Money Purification of Income
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Islamic Worldview and Investment
Transcendental accountability to Allah SWTHablumminallah
Social accountability to the societyHablumminan-
nass
Individuals as trustees or vicegerentsKhalifah
Success in this world and in the hereafterFalah
Economic goals beyond purely wealth maximizationTazkiyah
Personal accountabilityTaklif
Justice in relationships, contracts, and activitiesAdalah
Public interest is more important than personal interestMaslahah
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Definitions of Islamic Investment
Islamic Investment is an investment in financial services and investment products that
adhere to Islamic principles
Islamic Investment can be defined as:• A joint pool in which
the investors contribute their money for the purpose of its investment to earn permissible (halal) profits in strict conformity with the Islamic law
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Islamic Investment
The Islamic financial system broadly refers to financial market transactions, operations and services that comply with Islamic rules, principles and codes of practices
The Islamic financial services industry comprise Islamic banking, Islamic insurance and Islamic capital market.
In other words working to earn a halal living is itself a religious obligation second in importance after the primary religious obligations like prayers, fasting and hajj.
Narrated by Abdullah ibn Masud r.a., the Prophet Muhammad (PBUH) said: ‘Seeking halal earning is a
duty after the duty.’
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Islamic Investment
Modern Islamic
financial products and services are developed
using 2 different
approaches.
By identifying the existing conventional products and
services that are generally acceptable to Islam, and modifying, removing any
prohibited elements that are able to comply with Shariah
principles
By involving the application of various Shariah principles to facilitate the origination and
innovation of new products and services
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The Principles of Islamic Investment
Shariah compliant investment activities
Prohibition of riba, gharar
and maysir
Sanctity of
contracts
Money as capital
Risk sharing
Prohibition of
speculative
activities
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Sources of Islamic Investment
PRIMARY SOURCES• Al-Quran• Sunnah• Ijma’• QiyasSECONDARY SOURCES• Istihsan (juristic preference of the stronger
principles)• Istishab(Presumption of continuity)• Maslahah Mursalah (extended analogy/
consideration of public interest)• Sadd al-Zarai’ (blocking unlawful means to an
unlawful end)
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Criteria of Islamic Investment
Investment must be in ethical sectors (profits are not from prohibited activities, and non-Islamic financial institutions
Investment of property and wealth must be result from a partnership between the investor and the user of capital in which rewards and risks are share
Investment must be considered the philosophy of Islamic business (e.g: social justice, equitability, and fairness as well as practicality of transaction
The major prohibited elements are riba (interest), gharar (uncertainty), maisir (gambling), non-halal (prohibited) food and drinks and immoral activities
When a transaction have a prohibited elements, it’s must first be removed for it to be Shariah-compliant
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Benefits for Muslim to involve in investment activities
Children education
Insurance protection
Shelter
Provision for retirement
Source of income
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Challenges of Islamic Investment
Competition with the conventional systemEfficient and active Islamic financial marketAvailability of a wide range of instruments Human resource requirementUniformity of scholarly views
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Differences between Islamic and conventional investment
Activities Contractual Relation
ProfitRisk
The Determination of Permissible Activities
In Islamic perspectives, all activities must be acceptable and not related to prohibited by Islamic law.
An examples of the prohibited activities are follow: Alcohol Gambling Pork or a related products Pornography Conventional financial, banking & insurance services
Also, an activities such as tobacco, hotels or entertainment are prohibited
The decision are depends on the methodology or interpretation used by Islamic scholars in different jurisdictions
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Investment and Financing of Halal Activities
Impermissible to invest and give financing to
related activities
Financial serviced based on Riba
Gambling and gaming
Manufacture or sale of non-halal products
Manufacture or sale of tobacco-based or related product
Stockbroking or share trading in Shariah non-compliant securities
Other activities that conflicts with Shariah
Entertainment activities that conflicts with Shariah
Conventional insurance that containing of gharar
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Profit and Loss Sharing vs. Lender-borrower Relationship
PROFIT LOSS SHARING• First Tier
• Between bank and depositor• The depositor are considered to be
provider of the capital (Rabb al mal)• The bank functions as a working
partner or manager of funds (mudarib or amil)
• Second Tier• Between bank and entrepreneur• The entrepreneur is the manager of
fund• The bank functions as provider of
capital
LENDER-BORROWER RELATIONSHIP• The relationship between a lender and
a borrower is governed by a loan contract between them.
• Such a contract would specify all the obligations of the two parties in every possible future contingency.
• With respect to:• The amount of repayment• The interest rate on the remaining
debt.• A possible adjustment in the collateral
required by the lender.• The actions (in particular investment
decisions) to be undertaken by the borrower.
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Prohibition of Riba
• Unlawful gain derived from the quantitative inequality of the counter-values in any transaction purporting to effect the exchange of 2 or more species which belong to the same genus(category) and are governed by the same efficient cause(illah)
Definition of Riba on Trade transaction
• A predetermined excess or surplus over and above the loan received by the creditor conditionally in relation to a specified period
Definition of Riba on Loan transaction
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Elements of Riba
Excess or surplus over and above the loan
capital
Bargain to be conditional
on the payment of a predetermine
d surplus
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Prohibition of Gharar
Gharar literally means reduction. In Fiqh it is ambiguity that carries the risk of reduction. It is divided into minor and major Gharar. Major Gharar renders a
contract invalid or impermissible (Haram). Gharar is defined by Wahbah al-Zuhayli as a sale of
(i) that which is not known to exist or not, (ii) whose measure is not known to be large or small, or (iii) that is undeliverable.
Professor Zarqa considers gharar as a sale “of probable items whose existence or characteristics are not certain, due to the risky nature that makes it similar to gambling.”
The prohibition of Gharar gets into stronger relevance in regard to derivatives, which are sometimes referred to belong to the categories of a Gharar sales and sometimes simply compared to straight gambling.
Gharar, however, influences largely the way the insurance business needs to be done as it renders a conventional contract as not permissible for Muslims.
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Prohibition of Maysir
Gambling (Maysir, maisir;الَْميِْسر ) or Qimar, قمار) ) as a game to spend money and expect larger outcomes was widespread practiced in the pre-Islamic time of the Arabs.
The Quran prohibited gambling alongside alcoholics: “They ask you concerning wine and gambling. Say: ‘In them is great sin, and
some benefit for men, but the sin is greater than the benefit. […]” (Al-Baqarah: 219)
Gambling differs from trade as what one receives is the other’s loss, it is a zero sum while trade exchange generates typically a win-win situation.
There is some concerns among Muslims whether investing in stock market resembles gambling by nature; while the majority of scholars accepts trading of company shares as long as the companies are not involved in forbidden areas or involved in Riba.
The reservation of some Muslims may remain, especially if they feel uncomfortable regarding the proper intentions of themselves.
In stock trading is a grey zone where investing ends and gambling starts which cannot be drawn precisely, but it is related clearly to the individuals intention, which is not be judged by legal analysis but by self control.
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Shariah Supervisory Board
Definition: A group of Shariah experts whose responsibility is to monitor
and supervise the operations of Islamic financial institutions in order to ensure that it does not contravene Shariah principles.
In theory, the role of SSB involves six areas: Provide fatwas that certify permissible financial products; Undertake Shariah audit to ensure products comply with
guidelines; Dispose of non-Shariah compliant income or earnings; Provide advice to the bank on the distribution of income to
shareholders or depositors/investment account holders. Provide guidance to the bank on its wider social role.
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Shariah Screening
Definition: The process of identifying Shariah-compliant investments.
Shariah clearly defines activities in which Muslims are not to be involved, such as riba and the consumption of alcohol and pork.
Consequently, Muslims cannot invest in assets of businesses earning primarily from such activities.
2 tier benchmark for screening: Business Activity Ratio Financial Ratio
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Non-Shariah Compliant Investment Activities
Ruling on Non-Shariah compliant investment products which are advertently/inadvertently bought: Must be disposed within a month of knowing the status of the
securities Any capital gain or dividend received during or
after the disposal of the securities has to bechannelled to charitable bodies
Investor has a right to only obtain the originalinvestment cost
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Principle of Zakat on Investment
• Wealth belongs to government, community or Waqf isnot subjected to Zakat
Individual Right of Ownership
• Show the most accurate and relevant value of the assets
• Measure the net worth of the individual / company
The valuation of assets should be based on current or market value.
• Assets should be owned for one full year (haul).• Zakat charged only once a year (except for
agricultureproduce)
Yearly principle
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Principle of Zakat on Investment
• The aim of Nisab (minimum requirement) is to ensure zakatable wealth is in excess of normal requirements.
Ability to Pay
• Zakat computation must be true and fair• Zakat payers need to truthfully disclosed all his/her
financial facts.
Full Disclosure
• Measurement must be objective and quantifiable• Justice to both Zakat payers (who hold the financial
obligation) and Zakat beneficiaries (who are the rightful recipients of Zakat).
Objectivity (True and Fair View)
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Calculation of Zakat on Investment
• Based on zakat on agriculture product.• The shares are considered as fixed assets if shareholders or
investors acquired the shares:• for long-term investment• as a way to gain control over the company's capital (Held
to Maturity)• as a participation (stake) in the company's capital
• Thus, only its income generated (i.e. dividend) will besubjected to Zakat at 10% (as for agriculture produce).
Long-term Investment on Stock
• If shareholders acquired the shares for trading activity, it is considered current assets, and its value and income is subject to Zakat.
• Thus, Zakat on Shares = (Market Value of Shares x Quantity) x 2.5%.
Short-term Investment on Stock
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Calculation of Zakat on Investment
• Zakat on Sukuk has been argued should be charged as aform of valuable trading commodity.• Thus, Zakat for Sukuk = (Current Market Value x
Quantity) x 2.5%
Investment on sukuk
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Speculation & Gambling
Stock Market provides the avenue for firms to raise funds, for investor to invest their
surplus funds.
One needs to predict the future value of stock prior to making any decision to buy or
sell thestocks
The Messenger of Allah (SAW) also forbade us from gambling as illustrated in the following Hadith From Abu Hurayrah (RA), that he said, ”The Messenger of God (S) forbade the 'sale of the
pebble' [hasah] [sale of an object chosen or determined by the throwing of a pebble], and the sale of al-gharar. [Sahih Muslim]
The Quran clearly prohibit us from gambling as illustrated by the following verses relating to games of chance or gambling. Allah SWT
says:“They will ask thee about intoxicants and games of chance. Say: In both there is great evil as well as some benefit for man; but the evil which they cause is greater than the benefit
which they bring.” Quran (2: 219)
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Speculation & Gambling
Being given the obvious prohibition of gambling in both the Quran and the Hadith of the Prophet (SAW), it is of utmost importance to determine whether speculation in the stock market is similar to gambling.
Maysir or gambling is prohibited in Islam because it causes enmity and hatred and also involves consuming property bi-al-batil, which is a type of oppression.
Ibn Taymiyah’s opinion on the above Hadith is that gharar as the consequence of which is unknown and goes further to claim that selling it involves maysir, which is gambling.
Based on the Quranic verses and the Hadith of the Prophet (SAW), Ibn Taymiyah pointed out that if a sale contains gharar and devours the property of others, it is the same as gambling, which is clearly forbidden. Therefore, for a transaction to be equated to gambling, it must involve
the devouring and unlawful appropriation of the property of others.
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Speculation & Gambling
Kamali (1996) defines speculation as consisting of "the intelligent and rational forecasting of future price trends on the basis of evidence and knowledge of past and present conditions".
Speculative risk taking in commerce, which involves theinvestment of assets, skills and labor is not similar to gambling. This is because the buyer is engaged in a transaction aimed
atmaking profit through trading and not through dishonestappropriation of the property of others.
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Speculation & Gambling
El-Ashkar (1995) defined speculation as: "the practice of:
using available information to anticipate future price movements of securities so that an action of buying or selling securities may be taken with a
view to buying or selling securities in order to realize capital gains and/or maximize the capitalized value of
security-holdings. It is a process that relies on the analysis of a lot of
economic and financial data, companies' financial reports,political decisions, information about management skill and aptitude and the personal profile of the decision makers. That is to say, speculation is an activity that requires a great
deal of knowledge and skills. Therefore, speculation in stock markets cannot be equated to
gambling.
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Speculation & Gharar
The sale of gharar is said to lead to maysir (gambling) which leads to oppression and is therefore prohibited in Islam.
It is evident that gharar is not present in speculation in stock markets as each party is clear to the quantity, specification, price, time and place of delivery of the object.
Moreover, the object of the transaction, which is the purchased security, is available in the market at the time of transaction and is, bound to be available at the time of delivery.
Therefore, speculation has no element of gharar and, hence, does not lead to maysir.
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Pro and Cons of Speculation
The above discussion has proved that although speculation in the stock markets may look like gambling, yet it is by no means similar to gambling.
Its positive side is that it can help stabilize prices andactivate a market where there is thin trading. It can also provide signals to less-informed investors upon
which to act. The negative effect of speculation is that excessive
amount of it may cause volatile price movements in themarket. It can thus be concluded that excessive speculation should
not be allowed, but a reasonable degree of it be permitted. Quantitative limits on daily trading volume and legislative
guidelines may help contain speculation within healthy bounds.
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Time Value of Money from Islamic Perspective
The Time Value of Money (TVM)• The idea that money available at the present time
is worth more than the same amount in the future due to its potential earning capacity.
This core principle of finance holds thatProvided money can earn interest, any amount
of money is worth more the sooner it is received. TVM is also referred to as present
discounted value.
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Time Value of Money from Islamic Perspective
Islam recognizes the legitimacy of the TVM emanating from deferral (ajal) and acceleration (‘ajal) in Islamic financial transactions such as deferred sale and bilateralrebate (da‘ wa ta‘ajjal).
However its application must be in conformity with specific shariah guidelines to avert unfair economic effects of financial transactions such as interest (riba).
The application of TVM in accordance with its fundamental rules can actually remove riba from the economy and prevent frommaking of money out of money.
Benefits of the knowledge of the time value of money: For investment analysis To compare investment alternatives To analyse how time impacts business activities To minimize a risk
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Purification of Income
Investor/Unit trust fund receives income from invested companies in the form of dividend and capital gain.
Not all income are considered “clean”. Some are derived from non halal sources such as interest income
Purification of income requires identifying the non halal portion of income received from invested companies and deducting it from the total income prior to distribution
The income net of purification is then distributed to the investors
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Purification of Income
The “tainted” income cannot be distributed to investors but instead donated to charities
It is also possible for the fund to allow discretion to the investor in deciding the recipient charitable organization
No consensus among Shariah scholars in implementing purification
No standard available from AAOFFI
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Summary
In this chapter
you have learned about:
Islamic Investment Concept
Shariah Screening and Supervisory
BoardPrinciple of Zakat on
Investment
Speculation, Gharar and Gambling
Time Value of Money
Purification of Income
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38 Thank you