Islamic Capital Markets

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2 Chapter 1. Muslim beliefs 19 Five pillars of faith Profession of Faith Five Daily Prayers lakat or almsgiving.: Sawm or fasting Pilgrimage to Mecca 22 Six Islamic Creeds 24 Definition of Iman 24 Iman as basis of righteous deeds Belief in Allah and his attributes Belief in Destiny (Qada'ar) Belief in angels Belief in apostles Belief in the Revealed Books Belief in the Hereafter...29 Chapter 2. Sharia'a law and Sharia'a Boards: roles, responsibility and membership 33 Objectives of the Sharia 'a 34 Sharia'a: the framework of Islamic banking 34 Compliance with the'scheme of Sharia'a laws 37 Sharia'a Islamic investment principles 37 Conditions for investment in shares : 38 Sharia'a Supervisory Board (SSB) 39 Function and responsibilities 39 Sharia'a Boards: roles and scope of responsibilities 40 Dubai Islamic Bank (DIB) 42 Sharia'a Board scholar qualifications...42 Dr Hussain Hamid Hassan 44 DrAliAlQaradaghi 44 Dr Mohamed Elgari 44 DrMohd. DaudBakar 45 Sheikh Nizam M.S. Yaquby 45 Sheikh Muhammed Taqi Usmani 45 Sheikh Abdullah Bin Suleiman Al-Maniya 46 Sheikh Dr Abdullah bin Abdulaziz Al Musleh 46 Sheikh Dr Muhammad Al-AliAlQari bin Eid 47 11

3 Islamic Capital Markets State Bank of Pakistan (SBP): proper criteria for appointment of Sharia'a advisors 47 Solvency and financial integrity 47 Integrity, honesty and reputation 48 Chapter 3- Conventional and Islamic financial intermediation 49 Functions of afinancialsystem 50 Surplus saving and deficit spending units 51 Budget positions create the need for a financial system 51 Financial claims 52 Transferring funds from SSUs to DSUs ; 52 Direct financing 53 Indirect financing 53 Benefits offinancialintermediation 55 Intermediation services 55 Direct credit markets, efficient capital markets and Islamic capital markets 57 Weak-form efficiency 57 Semi-strong-form efficiency: 58 Strong-form efficiency 58 Informational efficiency matter and constrained portfolios 58 Capital markets and the economy 59 Principal-agent problem 59 Stockholders versus creditors: agency conflicts 61 Principal-agent problems as applied to banking Costly verification Moral hazard Adverse selection.63 Collateral and screening 64 The optimality of debt and the Islamic banking implications 64 Characteristics of Mudaraba 64 Incentive issues with Mudaraba 65 Islamic banks and corporate governance 67 Stakeholders in an Islamic bank 67 Mudaraba and corporate governance 68 Governance structures 70 References 71 Chapter 4. Islamic capital markets and Islamic securitisation 73 What are Islamic capital markets? 75 Functions of an Islamic capital market 78 Objectives of an Islamic capital market 78 Islamic capital market portfolio choices 79 Conditions for investment in shares 79 12

4 Islamic framework offinancialregulation 80 Ukhuwah 80 Adi 81 Ihsan 81 Evolution of Islamic capital markets 81 Current market environment 83 Development of Islamic capital market products 84 Islamic securitisation and Islamic capital markets 85 Islamic framework for securitisation: the basics 86 Islamic securitisation - building on the basic principles 87 Pass-through structure 89 Pay-through structure 90 True sale structure 90 Subordination and Islamic finance 90 Challenges for the Islamic capital markets 91 References 93 Chapter 5. Islamic investment principles 95 Why Islamic investing? 96 What is Islamic investing? 96 Hadith on eating interest 97 Is investing in the stock market allowed under the Sharia'a} 97 Are these Islamically acceptable alternatives? 98 What is rite? 99 What is the rationale for the Islamic prohibition of riba? 100 Micro-economic rationale for the ban on riba 100 Macro-economic rationale for the ban on riba 102 Whatisgtorar? 104 Islamic investing and purification 104 What is purification? 104 Major prohibitions in Islam 104 Zakat and Islamic prohibitions 107 Who can receive zakat? 107 What has zakat got to do with' Islamic prohibitions? 107 Appendix 5.1. Islamic investment prohibitions: a case study 108 Case study questions 110 Chapter 6. Sharia'a compliant wholesale markets 113 What is commodity Murabaha? : 114 Why is commodity Murabaha Sharia'a compliant? 115 Indicative money-market profit rates 116 EIIB amanah commodity Murabaha 117 Commodity Murabaha - what are the principles? 117 Singapore Central Provider Fund: commodity Murabaha scheme

5 Islamic Capital Markets IIFM and the standardised commodity Murabaha programme 121 What is Tawarruq? 123 Chapter 7. Islamic funds, equities, indices and ETFs 125 Sharia'a Islamic investment principles 126 What is an Islamic fund? 126 Islamic mutual fund versus conventional mutual fund 127 Closed and open-ended funds 127 Sharia'a compliant fund market: historical overview 128 Geographic focus : 130 Islamic indices, 131 What is Sharia 'a compliance? 131 Islamic fund statistics 133 Types of Islamic funds Equity fund Ijara fund Commodity fund Murabaha fand Mixed Islamic fund 138 Recent innovations with Islamic funds 139 Real estate funds 139 Capital protected funds 139 Innovative product development 140 Islamic private equity 141 Exchange tradable funds (ETFs) 142 What are Islamic ETFs? 145 Appendix 7.1. Dow Jones Islamic Market Indices 146 Benchmarking criteria 147 Sharia'a compliant industries, 148 Dodging falling boulders : But sitting out some opportunities, too 150 ROI compared with secular indexes 151 Constituent indexes 151 References 152 Chapter 8. Derivatives and hedge funds in Islamic finance 153 Introduction 154 What are conventional derivatives? 154 Forward contracts 154 Futures and options contracts 156 Derivative contracts - the Islamic story 157 Issues involved in the creation of Islamic derivatives 157 Riba 158 Gharar

6 Forward contracts and Islamic finance 159 Futures contracts and Islamic finance 159 Swap contracts and Islamic finance 159 Option contracts and Islamic finance 160 What are Islamic derivatives? 160 Salam contract 160 Istisna'a contract 160 Arboun contract 161 Murabaha contract 161 Islamic swaps 161 Derivatives and the role of promises in the Sharia'a - Wa'd 161 The Islamic scholars and derivatives 163 AreSharia'a Scholars' objections consistent? 164 Futures 164 Options and Arboun 164 What are conventional hedge funds? 166 Characteristics of hedge funds 167 What is short selling? 168 What are Islamic hedge funds? 169 Islamic hedge funds: Sharia tissues 170 How does Salam-based shorting work? 171 Arboun - some additional issues 173 More issues with hedge funds 174 The Islamic navigator 175 References 176 Appendix 8.1. Why are derivatives forbidden (haram) under Sbaria'alm? 177 Definition of maisir, 178 The Qur'an on the prohibition of gambling 178 Ahadith on the prohibition of gambling 179 Stone altars, gambling and Jahiliya 179 A brief history of the prohibition of gambling in Islam 180 Nature of gambling and the Arabs 180 Divining arrows for seeking fortune 181 Appendix 8.2. Total returns swap and the 'Sharia'a conversion technology' stratagem: a case study 183 Summary 184 Introduction 185 A few explanations 186 'Sharia'a Conversion Technology' Stratagem 187 LIBOR and how returns are determined 188 The purpose of the transaction

7 Islamic Capital Markets The movement of the cash 190 Ramifications for the Industry 193 Sadd al-dhara'i: blocking ostensibly legitimate means to illegitimate ends 194 Conclusion 196 Appendix 8.3. Capital protection and Islamic finance: a case study 198 What is the Meezan Capital Protected Fund-I? 199 What are the salient features of MCPF-I? 199 Investment objective, investment policy and investment restrictions 200 Investment objective : Capital protection 200 General investment policy 201 Investment policy for capital protection segment 201 Investment policy of investment segment 202 Investment restrictions 203 % Exemptions to investment restrictions 204 Borrowing restrictions 204 Duration 205 Open-end fund 205 Units : 205 Risks 206 Performance risk 206 Equity risk 207 Credit risk 207 Capital protection risk 207 Events risk : Interest rate risk 207 Other risks.'. _ 207 Sharia'a governance and Sharia'a advisory services 208 Sharia'a governance 208 Sharia'a Advisor 208 Case study questions 209 Chapter 9. Sukuk (Islamic bonds) 211 What are sukuk? 212 Some linguistics 212 Some history 212 What do sukuk represent? 212 What is the underlying principle behind sukuk? 214 Sukuk secondary market 214 Some controversies 215 Characteristics of sukuk 215 Islamic legitimacy of sukuk

8 Why have Islamic bonds? 216 Sukuk: a survey 217 Varieties of sukuk 217 Ijara sukuk 218 Istisna'a sukuk 218 Salam sukuk 218 Mudaraba sukuk 219 Musharaka sukuk 219 Murabaha sukuk AAOIFI sukuk classifications 219 Are sukuk Islamic? The controversy 224 Issue 1 :'. 224 Issue Issue Appendix 9.1. The Central Bank of Bahrain (CBB) Salam sukuk programme 227 CBB: al salam sukuk (Islamic short-term securities) 228 The concept of al salam 228 An example of al salam contract 229 The CBB sukuk - structure 229 Sukuk al-salam 230. Sukuk al-salam in practice 231 Salam sukuk 232 Appendix 9.2. Salam sukuk: Term Sheet 233 Government of Bahrain non-negotiable Government salam securities 234 Regulations and terms of issue 234 Chapter 10. Islamic real estate investment trusts 237 WhatisaREIT? 238 Combining real estate and unit trust funds 238 Real estate investment trusts (REITs) 238 Features of REITs 239 REITs versus alternative real estate investments 240 WtefareSteria'acompliantREITs? 241 Sharia'a compliant REITs under the DFSA regulatory regime 242 Malaysian REITs (M-REITs) 242 Saudi Arabian REITs 244 Appendix Guidelines for Malaysian Islamic real estate investment trusts Rental of real estate by an Islamic REIT for business purposes Investment, deposit and financing for an Islamic REIT Insurance Forward sales or purchase of currency for risk management

9 Islamic Capital Markets Rental activities that are classified as non-permissible 247 Appendix Frequently asked questions about Malaysian Islamic real estate investment trusts 249 World's 100 largest Islamic banks 253 Top 500 Islamic Financial Institutions 263 Glossary of Islamic capital market terminology 279 References and bibliography 284 AAOIFI publications 288 Articles