11.2 Shariah Equity Screening & Islamic Asset Management

Shariah Equity Screening & Islamic Asset Management

In the contemporary global economy, publicly traded corporations rarely operate with absolute theoretical purity. Large multinational conglomerates typically maintain operational bank accounts that earn minor interest, utilize revolving credit facilities with conventional financial institutions, or derive incidental revenue from ancillary commercial lines that contain questionable Shariah elements. If Islamic investors were restricted exclusively to companies with zero conventional exposure, capital market participation would be virtually impossible. To address this commercial reality, Islamic jurists formulated the science of Shariah Equity Screening, applying established legal maxims such as Umum al-Balwa (widespread unavoidable predicament), Raf' al-Haraj (removal of undue hardship), and Al-Akthar Yahkum li al-Kul (the majority/predominant determines the legal character of the whole).

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The Securities Commission Malaysia (SC) Screening Methodology

The Shariah Advisory Council of the Securities Commission Malaysia (SAC SC) began screening listed companies in the mid-1990s and published its first list of Shariah-compliant securities in 1997. The methodology has been revised several times:

• Before 2013: four business activity benchmarks (5%, 10%, 20% and 25%), with no financial ratio test.
• November 2013 revision: two business activity benchmarks (5% and 20%), plus new financial ratio benchmarks.
• Total-income approach: contributions are measured against group total income (revenue, other income and share of profit), and profit before tax was dropped. This was resolved in July 2024 and first applied to the May 2025 list.
• Single benchmark: at its 288th (24 February 2025) and 296th (13 November 2025) meetings, the SAC resolved to adopt a single 5% business activity benchmark and remove the 20% benchmark, for companies with financial years ending on or after 31 December 2025.

1. Tier 1: The Single 5% Business Activity Benchmark

The contribution of all Shariah non-compliant businesses or activities to the Group total income must be less than 5%. The listed activities are:

• conventional banking and lending; conventional insurance;
• gambling; liquor; pork; non-halal food and beverages, including food without halal certification;
• tobacco, cigarettes, electronic cigarettes and related products;
• interest income from conventional accounts and instruments (including interest awarded by a court or arbitrator, late payment charges and penalty charges); dividends from non-compliant investments;
• Shariah non-compliant entertainment; cinema;
• share trading; stockbroking business; rental received from non-compliant activities; and
• other activities the SAC deems non-compliant.

Activities that used to sit in the 20% band, such as share trading, stockbroking and non-compliant rental, are now counted against the same 5% threshold.

2. Tier 2: Financial Ratio Benchmarks

These ratios measure riba-based elements in the statement of financial position. Each must be less than 33%:

• Cash over Total Assets: only cash and cash equivalents placed in conventional accounts and instruments count; Islamic placements are excluded.
• Debt over Total Assets: only interest-bearing debt counts; Islamic financing and sukuk are excluded.

3. Qualitative Assessment

Passing the numbers is not enough. The SAC also considers the public perception or image of the company's activities from the perspective of Islamic teaching. A company can be excluded on qualitative grounds despite passing the ratios.

Practical Points

• The SC updates the list twice a year, on the last Friday of May and November.
• Since April 2024, the SAC reviews the Shariah status of companies seeking listing on Bursa Malaysia's Main, ACE and LEAP markets before listing, without a separate application.

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International Screening Comparison: SC Malaysia vs. AAOIFI vs. Global Index Providers

While the SC Malaysia framework serves as the national standard for Bursa Malaysia equities, international asset managers frequently operate under standards promulgated by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) or international index providers (such as Dow Jones Islamic Market (DJIM), FTSE Shariah, and MSCI Islamic).

The Denominator Divergence: Total Assets vs. Market Capitalization

The most critical methodological divide between Malaysia and international bodies lies in the financial ratio denominator:

• SC Malaysia uses Total Assets (Book Value): The SAC SC measures conventional cash and debt against Total Assets derived from the company's audited balance sheet. This approach reflects real economic assets, provides stability over time, and shields a company's Shariah status from external stock market volatility.
• AAOIFI and the Dow Jones Islamic Market Indices use Market Capitalization: AAOIFI Shariah Standard No. 21 tests interest-bearing borrowings and deposits against the company's market value (30% thresholds), and the Dow Jones Islamic Market indices use a 24-month average market capitalisation (33% thresholds). FTSE and MSCI Shariah index series, like the SC, use total assets. Proponents of market capitalisation argue it reflects current enterprise value. However, critics point out that during a severe market downturn or bear cycle, a company's market cap can collapse rapidly while its debt remains constant, causing the debt-to-market-cap ratio to breach 30% or 33% and triggering an arbitrary loss of Shariah compliance without any actual increase in borrowing.

Comparative Table: SC Malaysia vs. International Screening Frameworks

Index providers such as FTSE, MSCI and DJIM also apply their own receivables or liquidity tests, and their exact thresholds differ. For the AQIF exam, focus on the SC's 5% and 33% benchmarks and on the total-assets versus market-capitalisation contrast.

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Islamic Asset Management & Fund Vehicles

The Islamic asset management industry structures collective investment schemes (CIS) that channel institutional and retail capital into screened assets:

1. Islamic Unit Trusts (Mutual Funds): Open-ended collective investment schemes governed by a trust deed between the fund manager and an independent trustee. All underlying holdings must be approved Shariah-compliant equities, Sukuk, and Islamic money market placements. An independent Shariah Committee or Shariah Adviser is legally mandated to oversee product operations, investment compliance, and periodic audit reviews.
2. Islamic Real Estate Investment Trusts (i-REITs): Specialized investment vehicles that acquire and manage income-generating real estate portfolios (office towers, industrial warehouses, retail shopping malls, and healthcare facilities). Malaysia issued the world's first guidelines for Islamic REITs in 2005. Under the SC's rules, rental from non-permissible activities must be less than 20% of the Islamic REIT's total turnover, and an Islamic REIT must not acquire real estate whose tenants all carry out fully non-compliant activities. The manager must monitor tenants and keep non-compliant rental below the threshold.
3. Islamic Exchange-Traded Funds (i-ETFs) & Private Equity: i-ETFs are open-ended funds traded continuously on stock exchanges (such as Bursa Malaysia), tracking benchmark Shariah indices (e.g., FTSE Bursa Malaysia EMAS Shariah Index). Islamic Private Equity and Venture Capital funds invest directly in privately held unlisted companies, operating strictly under partnership contracts (Musharakah and Mudarabah) and prohibiting high financial leverage via conventional debt.

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Dividend Purification Mechanics & Reclassification Protocol

The Imperative of Dividend Purification

Because Shariah screening permits investment in companies with up to 5% non-permissible revenue and up to 33% conventional cash/debt, companies frequently distribute dividends that contain minor non-halal elements (principally conventional interest earned on operational bank accounts). Under the rules of Islamic wealth management, an investor or fund manager cannot lawfully consume or reinvest the tainted portion of a dividend distribution. It must be cleansed through Dividend Purification (Tathir al-Arbah).

Purification Calculation Methodology

The fund manager calculates the non-permissible percentage from the company's latest published annual financial statements:

$\text{Purification Ratio} = \frac{\text{Non-Permissible Income}}{\text{Total Gross Revenue}}$

$\text{Purification Amount} = \text{Total Dividend Received} \times \text{Purification Ratio}$

For example, if an Islamic fund receives a dividend of $100,000 from a manufacturing corporation, and the company's financial report discloses that conventional interest income accounted for 2.4% of total revenue, the fund manager must purify $2,400 ($100,000 × 0.024). The $2,400 must be channeled directly to registered charitable organizations or social welfare causes (e.g., disaster relief, poverty alleviation, healthcare equipment for public hospitals). The fund cannot use purified funds to pay taxes, management fees, or corporate operational expenses.

When a Security Is Reclassified as Non-Compliant

The SC publishes the updated list every May and November. If a security an investor holds is reclassified as Shariah non-compliant, the SAC's guidance is:

• Market price at or above the investment cost: dispose of the holding. The investor may keep dividends received and capital gains up to the date the reclassification is announced. Any further gains after that date must be channelled to charity.
• Market price below the investment cost: the investor may keep holding, and may keep dividends received while holding, until the dividends received plus the market value of the holding equal the original investment cost. At that point the investor should dispose of it.
• The investor is always entitled to recover the original investment cost. Returns beyond what the rules allow are purified through charity.