Having just completed an elaborate discussion on the Islamic capital market instrument called Sukuk spanning over 30 articles, I would now like to explore the other capital market instruments permissible in terms of the Shariah principles.
First, it is important to understand what the capital market is all about! It is not a brick and mortar place, such as a vegetable and fruit market or a meat and fish market where capital can be traded. A capital market is a platform or notional market where the transfer of money (capital) takes place from those who have a surplus of it to those who are in deficit or in need of it to invest or finance a project.
I provide below the conventional capital market tools and to what extent they are permissible in Shariah:
Listed stocks, also known as equity securities: These are publicly traded shares of companies where the holders of shares are pro-rata undivided joint partners of the company by virtue of which they remain exposed to the ownership risks. They receive a dividend if the company is doing well and get nothing if it does not.
The shareholders reap the benefit by exiting through the bourse and receive a considerable capital gain if the share price is trading at multiples of its par value. Conversely, they also get a hit upon quitting if the share price is reflective of the company’s weak financial condition. At times, the stockholders get nothing if the company is wound up due to unfavorable circumstances or mismanagement.
Shariah permissibility: Shariah scholars allow purchasing the equity securities for the purpose of getting a dividend, and also to benefit from its trading, if the stock has passed the screening hurdles. These are the company’s activity not being in the non-permissible items or services, besides the company’s financials meeting with certain parameters set by AAOIFI, which I will explain when I start writing on asset management. These are known as the compliant stocks.
Investors can either buy the compliant stocks in the primary market, directly from the company through the IPO or from the existing shareholders in the secondary market through the bourse.
Though the brick and mortar stock exchanges were traditionally used for trading in shares in person, and they do still exist, technological advancement has made it possible to do live trading from the comfort of your desk. Blockchain-based virtual bourses have also emerged where 24/7 trading can be carried out as against a fixed timing at the traditional stock exchanges.
Debt securities: In simple terms, these represent interest-bearing loans lent by the buyers of the security to its seller. Treasury bonds or bills or notes issued by the governments all over the world mostly through apex banks fall under this category. Also, the corporate bonds issued by the private sector are regarded as debt securities.
I have just concluded the long write-up on Sukuk, which are known by the market as the ‘Islamic bond’ and is categorized as a debt capital market instrument to which I strongly differ and have given my arguments in past articles as to why.
In my opinion, Sukuk need to be reclassified as an equity capital market instrument since the buyers of Sukuk do not receive interest, like the bondholders do. The Sukukholders are paid a share from the revenue generated by the underlying Sukuk asset.
Moreover, if the asset is destroyed due to no fault of the obligor (originator of the Sukuk), the Sukukholders stop getting the profit forthwith and rely on the extent of the insurance amount paid by the insurer for redemption. This is in contrast to conventional bonds where you do not find any link between the money lent and its utilization by the bond originator and a predetermined interest is periodically paid to bondholders. Some people regard the purchase undertaking given by the Sukuk originator to the trustee shell company (representing the Sukukholders) as the guarantee but it is not true since the purchase undertaking will only be effective if the underlying asset is intact and is not destroyed. Please refer to my Sukuk articles to understand it better.
Shariah permissibility: The Sukuk can be purchased in the primary market, ie directly from the trustee shell company, or in the secondary market from the existing Sukukholders through the bourse, or over the counter which is predominantly the practice. The investors must ensure that they have reviewed the Fatwa signed by the Shariah scholars before subscribing or purchasing the Sukuk.
Foreign exchange (FX trading): In FX trading, a currency is exchanged for another at spot if there is a need to use it immediately or forward if the purpose is to hedge against future payments or simply for speculative purposes. In a forward transaction, the contract between the buyer and the seller is entered into on the current date but the actual transaction takes place on an agreed future date.
Shariah permissibility: It is impermissible in Shariah to enter into a forward contract where both considerations viz. the delivery and payment of the currency are deferred. The principle equally applies on commodities or any other asset.
As for fiat currency (be it physical or in a ledger entry form), it is a Shariah condition that both values must be exchanged hand-to-hand, ie on a spot basis. However, other than currency (commodity or asset), it is permissible that one consideration is delivered on spot and the other one is handed at a later date. I have explained the principle clearly in the earlier articles and have also discussed it in the write-ups on Murabahah and Salam.
The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.
Next week: Wrap-up discussion on capital market shall continue.