1. Quantitative Screening of Business Activity

5% Tolerance Threshold

• To assess the level of mixed contributions from clearly prohibited activities, such as interest-based activities, gambling, liquor and pork, interest income from conventional accounts and instruments, and tobacco-related activities.
• Where the company is involved in any of the above business activities, the stock screening process calculates the percentage of the revenue of the activity over the group revenue or the profit before tax of the activity over the group profit before tax (whichever is higher).
• Calculation:

  The result of the above calculation must be less than 5% to pass the Shariah stock screening process.

  • Step 1. Determine the total income and profit before tax from the company’s financial statements.
  • Step 2. Determine the income and profit before tax from the non-permissible activities.
  • Step 3. Calculate the percentage as follows:
    • [Income from non-permissible activity / Total income] x 100
    • [Profit before tax from non-permissible activity / Profit before tax from all activity] x 100
  • Step 4: Determine which is higher and check whether it is less than 5%

20% Tolerance Threshold

a) To assess the level of mixed contributions from activities generally permissible according to Shariah and also have an element of maslahah (public interest) but might involve other elements that affect the Shariah status of these activities e.g. hotel and resort operations.

b) Where the company is involved in any of the above business activities, the stock screening process calculates the percentage of the revenue of the activity over the group revenue or the profit before tax of the activity over the group profit before tax (whichever is higher).

c) Calculation:

• Step 1: Determine the total income and profit before tax from the company’s financial statements.
• Step 2: Determine the income and profit before tax from the non-permissible activities.
• Step 3: Calculate the percentage as follows:
  • 1. [Income from non-permissible activity / Total income] x 100
  • 2. [Profit before tax from non-permissible activity / Profit before tax from all activity] x 100
• Step 4: Determine whichever is higher and check whether it is less than 20%

The result of the above calculation must be less than 20% to pass the Shariah stock screening process.

2. Quantitative Screening of Financial Ratio

33% Tolerance Threshold

a) To assess the level of a company’s cash and cash equivalent instruments as well as the interest-bearing debt over its total assets.

b) Calculation for the cash and cash equivalent over total assets:

• Step 1: Determine the total cash and cash equivalent from the balance sheet.
• Step 2: Determine the total assets from the balance sheet.
• Step 3: Calculate the percentage as follows:

  [Cash + Cash equivalent / Total asset] x 100

• Step 4: Check whether it is less than 33%

  The result of the above calculation must be less than 33% to pass the Shariah stock screening process.

c) Calculation for the interest-bearing debt over total assets:

• Step 1: Determine the total interest-bearing debt, debt instruments and Shariah-compliant financing (if any) from the balance sheet.
• Step 2: Determine the total assets from the balance sheet.
• Step 3: Calculate the percentage as follows:

  [Interest bearing debt + debt instruments — Shariah-compliant financing / Total assets] x 100

• Step 4: Check whether it is less than 33%

The result of the above calculation must be less than 33% to pass the Shariah stock screening process.

3. Qualitative Screening of Public Perception and Image of the Company

To assess the policies or activities of the company that might breach Shariah rules and tarnish the image of Islam.

This process is conducted on a case-by-case basis by the Shariah Advisory Council of the Securities Commission of Malaysia on two criteria, as follows:

a) The public perception or image of the company must be good, and

b) The core activities of the company are important and considered maslahah (in public interest) for the Muslim ummah (community) and the country, and the non-permissible element is minor and involves matters such as `umum balwa (common plight and difficult to avoid), `uruf (custom) and the rights of the non-Muslim community accepted by Islam.

 

*DOW JONES SCREENING PROCESS*

In many ways the stock screening procedure used by Dow Jones for its Islamic Index is more elaborate and tighter than those of Malaysia’s SAC. As is the case with the Malaysia criteria, there are two broad categories, the nature business and financial aspect. The Dow Jones’ criteria are much more stringent where a company’s financial aspects are concerned. In fact, while the Malaysia evaluation does not look at a company’s balance sheet, only its income statement, the Dow Jones criteria involves both financial statements, especially the balance sheet

Dow Jones begins with an initial step that involves eliminating stocks of all companies involved in an exhaustive list of activities. These are industries related to alcohol, liquor, pork, conventional financial service (banking, insurance, merchant banking, etc.), hotels, entertainment (including cinema, music), tobacco, defense, weapons manufacturing, and so on. Although this steps qualitative, the second step involves the quantitative analysis of the firm’s financial ratios. This numerical analysis is really aimed at two things: (1) identifying firms with “exercise” leverage in the capital structure, and (2) identifying firms with unacceptable levels of interest income. This is generally done by applying the following three key ratios:

1. Debt to trailing 12-month average, market capitalization (debt to TTMAMC).

Computed as:

(Total interst -Bearing debt) / (12 month average market cap) x 100

Thus, any firm with a debt to TTMAMC ratio exceeding 33 percent will be excluded. The rationale is that such a firm is paying a substantial portion of its earnings as interest on its debts.

 

i) BASED ON THE ABOVE SITUATION (MALAYSIA SAC vs DOW JONES), WHAT ARE THE DIFFERENCES IN STEPS INVOLVED? (20 MARKS)

ii) WHICH IS MORE STRINGENT IN TERMS OF SCREENING PROCESS AND RULES? (10 MARKS)

Transcribed Image Text:

2.Liquid assets [ Cash deposit + Marketable Securities + Interest Bearing Instruments / TTMAMC] × 100 3. Receivables to TTMAMC Accounts Receivable + Trade Notes and Other Receivables / TTMAMC] × 100| 2.Liquid assets [ Cash deposit + Marketable Securities + Interest Bearing Instruments / TTMAMC] × 100 3. Receivables to TTMAMC Accounts Receivable + Trade Notes and Other Receivables / TTMAMC] × 100|

Answer rating: 100% (QA)

i The differences in steps involved between Malaysias SAC Securities Commission of Malaysia and Dow Jones for Islamic stock screening are as follows M... View the full answer