I had explained the Shariah permissibility of modern joint stock companies in the last article. Today, I will discuss the do’s and don’ts for trading in the shares of a public joint stock company (PJSC) which is classified as a compliant entity based on certain screening parameters defined in AAOIFI Shariah Standard No 21 ‘Financial Paper (Shares and Bonds)’.
A detailed explanation of the Shariah screening criteria, justification and benefits shall be discussed separately down the line under the subject of Islamic funds after I have completed the cycle of explaining the Islamic finance and investment contracts.
A particular share or stock of a PJSC signifies the undivided part of the overall capital of the company. The more shares an investor holds, the higher the ratio of its ownership in the entity, ie the ownership in the assets of PJSC and the rights associated with them.
Assume the owners of a privately held entity called Solid Trading dealing in steel bars decide to strongly participate in the IPO of a new steel manufacturing company called Steelex, the founding shareholders of which have opted to function on a Shariah compliant basis. Solid Trading is allotted a considerable number of shares based on its subscription application, thereby acquiring the ownership of Steelex — the new PJSC — to the extent of the shares it has been able to purchase in the IPO.
Being the start-up, Steelex shall convert the cash it received through IPO in purchasing the plant, machinery, equipment, vehicle, etc, besides erecting the infrastructure (factory and office premises). By virtue of such conversion, Steelex shall have developed a set of assets with an aggregated monetary value which shall be owned by all shareholders pro-rata and all shareholders will have the right over the financial benefits emanating from these assets to the extent of their respective ownership of the company.
If Solid Trading wants to increase its shareholding in Steelex owing to the synergy in the activity, and with an aim to carry out major purchases of its steel bar inventory from Steelex (thereby also having the possibility to earn profit in the shape of Steelex dividends), it will have to turn to the stock exchange where Steelex shares are listed. It is possible that Solid Trading would find that the Steelex share price has gone up compared to when it bought it at par value in the IPO. What is the Shariah position in this situation?
Well, the share price depends upon the old established supply and demand equilibrium to which Islamic principles are accommodative of. Hence, there is no prohibition in the trading of shares at higher or lower than the par value.
In another scenario, Solid Trading would like to purchase a certain number of Steelex shares but unfortunately its current cash flow does not allow it to do so until it realizes the trade receivables in the next three months. Can Solid Trading buy Steelex shares on a deferred basis from the seller? This is an interesting point.
As stated previously, each share of Steelex represents an undivided ownership in its assets, which makes it a commodity and readers would know that Islam permits trading in commodities provided they are not Shariah repugnant. Moreover, a commodity can be freely bought and sold on a spot or deferred basis through Murabahah or Musawwamah contracts.
Therefore, it will be in order from a Shariah perspective for Solid Trading to purchase the additional shares of Steelex on a deferred payment basis either directly from the seller or through a financial institution. In fact, a number of Islamic banks do offer the purchase of listed stocks through Murabahah contracts where the bank purchases the shares on a spot basis from the seller and immediately disposes off to the client who pays on an agreed deferred basis, similar to a car Murabahah transaction explained earlier in this space.
Can Solid Trading get its trade receivables discounted from a financial institution to be able to get cash for the purchase of Steelex shares? Well, if the memorandum and articles of association of Solid Trading are neutral, ie are not drawn on Shariah compliance lines, it may utilize the conventional banking facilities including discounting of trade receivables. Nonetheless, if the owners of Solid Trading care for the Shariah way of operation, they will not be able to get the receivables discounted since no Islamic bank is permitted by its Shariah board to buy the debt from clients at a discounted price since it involves interest.
How about Solid Trading entering into a transaction with a seller (normally a broker) who promises to deliver the Steelex shares on a future date at an agreed price? This way, Solid Trading shall achieve the purpose of acquiring the desired number of Steelex shares and also will not need to pay upfront since its current cash flow is tight. Such transactions are called short-selling and are strictly prohibited by Shariah principles since they violate the golden Shariah principle of “you don’t sell something which you do not own and possess”.
This noble principle alone saved the Islamic financial institutions from collapse during the global financial crisis of 2008–09 when their conventional counterparts were falling like a house of cards.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the senior advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected]
Next Week: Discussion on joint stock companies shall continue.