UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for December 20, 2010

Islamic Real Estate Investment Trusts (REITs)

 

 

 

According to AMANIE, Islamic REIT is a form of mutual fund/unit trust which is used to own and operate income-producing real estate.  An REIT is essentially a collective investment scheme where investors pool money together to purchase property for rental purposes and capital gain.  The Islamic REIT must meet certain requirements pertaining to the nature of the assets and the financing of the REIT.  The  invested assets must be approved assets such as residential properties, hospitals, etc. and the tenants should have activities which are Sharia’h compliant.  Furthermore, all the financing for an Islamic REIT must be done through Sharia’h compliant products and services.  (AMANIE)

Guidelines for Islamic REITs

http://www.scribd.com/doc/8158885/guidelines-for-islamic-reits

http://www.sc.com.my/eng/html/resources/guidelines/UTs/Islamic%20REIT%20FAQ.pdf

Islamic REITs: A Sharia’h Compliant Investment Option

www.assaif.org/content/download/3596/…/Islamic%20REITs.pdf

Practice and Prospect of Islamic Real Estate Investment Trusts (I-REITs) in Malaysian Islamic Capital Market

http://www.asyrafwajdi.com/download.php?f=0008(downloaded-from-asyrafwajdi.com).pdf

Islamic REITs Explained by the Central Bank of Bahrain

http://www.islamicfinanceevents.com/bahrain07/documents/islamic_reits.pdf

Islamic Exchange Traded Fund (ETF)

 

 

 

According to AMANIE, an Islamic ETF is an open-ended mutual fund/unit trust which is structured to mirror the return of an index in a particular market or sector such as Dow Jones Islamic Market Titans 100.  Unlike other mutual funds/unit trusts, investors in the Islamic ETF are investing in a basket of shares which are exactly the shares that constitute a particular index.   In an Islamic ETF, all of the shares must be Sharia’h compliant.  Islamic ETF can be traded almost on a daily basis and the NAV of the fund is exactly the same as the index performance. (AMANIE)

According to Bank Negara Malaysia, “ETFs are essentially unit trust funds that are listed and traded on a stock exchange. They are open-ended with a unique in-kind creation and redemption mechanism supported by a system of participating dealers and liquidity providers. The difference between ETFs and unit trust funds is in the manner their units are bought and sold.

ETFs are listed and therefore their units can be bought and sold anytime during stock exchange trading hours. Investors buy and sell ETF units through their stockbroker rather than through unit trust agents. ETFs are index tracking fund. Most ETFs are passively managed index funds although there is ongoing work being done to create enhanced and actively managed ETFs. In the managing of index funds passively, managers do not pick stocks based on fundamental analysis. Instead, managers aim to track the performance of a benchmark index.

Islamic ETFs and conventional ETFs share common characteristics. The main difference between a conventional ETF and Islamic ETF is the benchmark index that the Islamic ETF tracks. An Islamic ETF only tracks an Islamic benchmark index where the index constituents comprise of companies which are Shariah-compliant. The provision for the establishment of Islamic ETF is embedded in the Guidelines on Exchange-Traded Funds.” http://www.mifc.com/index.php?ch=seg_inv_etf&pg=seg_inv_etf_info

Exchange Traded Funds (ETF’s) GUIDELINES

http://www.sc.com.my/eng/html/resources/guidelines/ETF/ETF_Guidelines_090611.pdf

Private Equity Funds in Islamic Finance

 

 

 

In private equity, investment in private companies is motivated by the desire to control the company.  This can be done through acquiring a majority shareholding  for example with the purpose of controlling management of the company.  Since investment through a private equity fund is for the purpose of acquiring control of a company, the Islamic stock selection criteria  (stock screening levels 1,2, and 3)  does not apply here.  However, if the investor seeks to control the management of a company through a private equity fund, they are only allowed to invest in companies which are totally Sharia’h compliant in both core-activities and balance sheet screening.  Some Sharia’h scholars allow them to invest in companies which pass the stock screening criteria (levels 1,2,3) provided that they have committed to convert the company into a totally Sharia’h compliant company within an accepted period of time.  Alternatively, an Islamic private equity fund may co-invest with other conventional private equity funds as a minority shareholder in order to allow the Islamic private equity fund to invest in companies which meet all the stipulated criteria without the need for conversion to a totally Sharia’h compliant company.  (AMANIE)

Growth of Private Equity Funds in Islamic Finance

www.assaif.org/content/download/…/Private%20Equity%20Fund.pdf

The Origins of Islamic Private Equity in the Gulf

http://www.ameinfo.com/206370.html

Middle East Private Equity

http://www.dubaibeat.com/investors/middle_east_private_equity/

Islamic Public Equity Funds: Mutual Funds/Unit Trusts

 

 

A mutual fund/unit trust operates as a company that pools money from a group of investors for the purpose of purchasing securities.  The mutual fund/unit trust then issue shares or units to the investors, which represents the investor’s holding in the portfolio and the proportion of income entitlement of the investor that results from the holding.    

In Islamic Finance, mutual fund/unit trusts may be open-ended or close-ended funds.  Under the open-ended fund structure, the fund is obliged to re-purchase shares/units from the investors at any time when redeemed by the investor.  The re-purchase price is based on the current value of the fund’s net assets where the NAV is equal to the fund’s asset-fund’s liabilities divided by the number of shares/units issued.  The fund can also offer new shares or units to the public on an ongoing basis if demand exists.  Redemption or issuance of new shares /units may affect the NAV.  

In close-ended funds, the number of shares or units made available to the public is limited at the time of the inception of the fund.  In contrast to the open-ended fund structure, the investors may only redeem their shares/units by selling their shares/units on the open market based on the market value. 

For a mutual fund/unit trust to be Sharia’h Compliant, it must meet the following criteria:

  1. All underlying stocks must be Sharia’h compliant.
  2. Cleansing of the dividends must be undertaken.
  3. A Sharia’h board must be established to oversee the fund investment.
  4. All relevant businesses such as cash management, accounting, etc must be Sharia’h compliant.  (AMANIE)

 

Islamic Equity Mutual Fund Performance in Malaysia: Risk and Return Analysis

http://www.nikmaheran.com/v1/attachments/030_IslamicEquityMutualFundinMalaysia.pdf

The Performance Analysis of Islamic Mutual Funds – A Comparative Study between Indonesia and Malaysia

 http://staff.ui.ac.id/internal/060603200/publikasi/200708ThePerformanceAnalysisofIslamicMutualFunds.pdf

 

Stock Screening in Islamic Finance

 

 

According to Amanie, there are two main methods for Islamic stock screening including the Malaysian and the Global approach.  In the Malaysian approach, one examines the core-activities and non-halal income while in the Global approach, one examines the core activities, non-halal income as well as the interest expense and the ratio of liquid assets to illiquid assets. 

Stock Screening (Level 1) Core-Prohibited Activities

The following activities are generally considered core-prohibited activities:

  • Conventional financial institutions based on interest (riba) or contractual uncertainty (gharar) – insurance/reinsurance.
  • Alcoholic beverages.
  • Gaming/gambling/games of chance.
  • Pork production.
  • Non-halal food products.
  • Entertainment and leisure related to pornography or with an adult content.
  • Arms, defence, and military equipment manufacturers. (Hallelujah!)
  • Tobacco-related products.
  • Other activities deemed to be repugnant to Sharia’h principles.

 

According to Amanie, all of the core-prohibited activities listed above are clearly prohibited in the sources of Islamic law except the arms and tobacco related products.  ‘While arms and weapons could be destructive to the society, the tobacco related products are harmful to one’s life and others.’

 

Stock Screening (Level 2) Financial Ratios

After passing the first level of stock screening, the screening moves to level two, which is basically financial ratio screening.  In order to be approved as Sharia’h compliant stock, the company issuing the stock shall not be in one of the following categories:

  1. A company whose interest-bearing debt, divided by the immediately preceding 12 month average market capitalization (or total assets) exceeds 33%;
  2. A company whose cash and interest-bearing securities, divided by the immediately preceding 12 month average market capitalization (or total assets) exceeds 33%;
  3. A company whose cash and receivables, divided by the immediate preceding 12 month average market capitalization (or total assets) exceeds 33%/49%. *This ratio is relevant in making the share tradable on the secondary market  – (to avoid exchanging money for money).  The AAOIFI Sharia’h Standard on Shares allows shares to be traded even if the liquid assets are more than 49% provided they do not exceed 70%.

 

*(Non-halal interest income and interest expense is tolerated up to 33% of the total market capitalization or total assets.  The Scholars have relied indirectly on one Tradition of the Prophet (PBUH) in giving a will to an outsider which was limited to one third of one’s property.)

Stock Screening (Level 3) Non-Halal Income

Non-halal income is generally tolerated up to 5%, which is subject to cleansing out of dividends paid by the company.  Non-halal income is generated from non-halal activities such as listed in the core-prohibited activities above.  (AMANIE)

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance