Islamic Equity Market in Malaysia

By:
Prof. Dr. Mohd. Ma’sum Billah
masum@applied-islamicfinance.com
masum2001@yahoo.com
+6019-3699542

Equity market is a wide market that involves many sellers and buyers around the world . According to surah Al-Baqarah ayah 265 Allah has stated that,

“…..God hath permitted trade and forbidden usury….”

Islam allows trade and prohibits riba’. The problem is elements and instruments exist in equity market abstain Muslim to participate and be active in the equity market. As a Muslim we must engage in halal business and Muslim shouldn’t cooperate in haram business, as Allah says,

“…Help you another in righteousness and piety but help, ye not one another in sin and rancour….” (5:2)

Equity is an ordinary share issued by a company. A share is one unit of ownership. As we know equity shares of companies are traded in equity market that are further classified as primary and secondary market. This paper is going to clarify thoughts and suggestions provided by Muslim scholars on equity market. And we are going to look in brief on the equity market in Malaysia. New issues market or primary market deals with the new securities, which were not previously available to the investing public. Stock exchange or secondary market is organized market that is used to facilitate trading in securities. This paper will further discuss on Islamic equity market in Malaysia relating to its practical scenario and its recommendation.

An Islamic Equity Fund is a corporation based on the investor’s surplus of liquidity and the professional skills of the fund manager. The liquidity is to be invested in stock of companies that operate according to the Islamic law. Stock exchange is a market where securities and shares are bought and sold. The stock exchange is a natural corollary of the principle of limited liability. The limited liability theory restricts the ability of each holder of shares to his own holdings and does not extend to his personal fortunes.

The Islamic economy would have the institution of stock exchange, which would fit in its overall framework and suit its socio-economic goals. For example, the Islamic economy would attempt to eliminate speculation by non-genuine investors, without abolishing a free-market for shares and certificates. The Islamic stock exchange would deal in equity capital available in the form of mudarabah or shirkah certificates. Interest bearing loans and securities do not exist in the Islamic economy. Similarly there would be no preferences shares in the Islamic economy as it involves fixed pre-determined guaranteed rate of return which is akin to riba and thus un-Islamic.

How to integrate equity investment those held by institutional investor that could be managed in a manner acceptable from an Islamic perspective. Some scholar agreed that to screen equity investment in stock market through out the world, which is potentially acceptable to Islamic investors by identifying principles compliance with Shariah law. Shariah law in Islam means that rules and regulation of permissibility and prohibitions made by Allah as in Quran and Sunnah, rules that had been agreed by Muslim scholars. Allah allows any business transaction as long as it on the Islamic path. As Allah says in the Quran,

“… that is because they say, “Trade like usury, “But Allah permitted trade and forbidden usury….” (Surah Al-Baqarah: 275).

In this case Islamic justification is that it enables Muslim capital to be harnessed within the Islamic world, increasing growth and performance and reducing reliance on riba’. To ensure that the companies involve for the investment are acceptable from the perspective of the Shariah law, the fund management group can screen the prospective company to be include in the portfolio. No haram equity criteria and elements should involve in the investment. Allah hates those who doing mischief and commit crime on earth. As in Quran says,

“When he turns his back, his aim everywhere is to spread mischief through the earth and destroy crops and cattle. But God loveth not mischief” (2:205).

“….if ye do (such Harm), it would be wickedness in you. So fear God; for it is God that teaches you. And God is well acquainted with all things…” (2:282)

Islamic equity in Malaysia is an Islamic financing institution, which would fit in its overall framework and suit its socio-economic mission and goals. In Islamic financing contract, Islamic equity is based on the concept of Musyarakah and Mudharabah. Interest bearing loans and securities do not exist in the Islamic economy as it involves pre-determined guaranteed rate of return which is related to riba’ and thus un-Islamic. Allah prohibit interest involvement in business as in Quran says,

“Those who devour usury will not stand except as stand one whomm the evil one by his touch hath driven to madness……” (2:275)

Al-Musyarakah is a general partnership whereby two or more persons agree to exploit their labor and capital jointly and to share the profit and losses of the partnership. This concept utilized for working capital or project financing purposes where as a reward to the financiers, the financed party would allocate to the financiers a pre-agreed portion of the profit derived. These profits can either be paid on a periodical basis or on a provisional basis, but subject to regular adjustment (semi-annually or annually).

On termination of Musyarakah financing contract, a final profit and loss account is prepared and final adjustment is made. In al- Musyarakah equity based financing the financier together with the initiator will provide the financing in agreed proportions. All parties including the financier have the right to participate in the management of the project, but all parties have the option to waive such right. All parties agree through negotiation on the ratio of distribution of the profit generated from the project, however in the event of loss, the parties bear loss in proportion to their shares in financing.

The second instrument in Islamic equity based contract is al-Mudharabah. Al-Mudharabah involves a profit sharing contract, which has a semi-equity and semi- debt characteristics. Whereas Rabb Al-mal or the capital provider entrust his funds to another parties, a mudharib or entrepreneur who contribute his skills and effort. Funds are to be utilized in an agreed manner by the mudharib. As in the Quran says,

“….And if one of you deposits a thing on trust with another, let the trustee (faithfully) discharge his trust, and let him fear his lord. Conceal not evidence; for whoever conceals it, his heart is tainted with sin, and Allah knoweth all that ye do.”

In short, any profit on sale of shares would also be shared by the outgoing sahib al-mal with the mudharibs of the business in the proportion agreed to in the original agreement of the business. On the termination of financing contract, refund of the capital investment together with a share profits generated based on a pre-agreed ratio by the rabb al-mal, however the mudharib does not share the losses except for loss of time and effort.

However there are several points of differences between equity investment and traditional Musyarakah and Mudharabah. Normally equities can be disposed of at any time without the permission of the company being financed, unlike mudharabah and Musyarakah investment which are for a fixed time period agreed between the financier as Rabb al-mal and the manager or entrepreneur as mudharib.

The potential liquidity is one of the most attractive features of equities, whereas Mudharabah and Musyarakah investment are inherently liquid. Furthermore the equity investor can sell some of his shares in a particular company. Most investors in equity based funds hope to capital gains, which in contrast with Mudharabah and Musyarakah contracts enjoys the possibility of a share in the profit of the business but not the capital gains. Although all these reason of equity investment regarded as occupying a different place in a portfolio to Mudharabah and Musyarakah investment. However they are a place that Islamic investors have the right to occupy according to the fiqh Academy ruling of 1996.

Like so many other Asian countries, Malaysia equity market activity has grown significantly in the past several years. In 1980, 182 Malaysian companies were listed on the Kuala Lumpur Stock Exchange compared to 321 at the end of 1991. Market capitalization grew from M$43.1 billions in 1980 to M$ 161.4 billion at the end of 1991, despite the delisting of 53 Singaporean companies in1990.

Table Kuala Lumpur Stock Exchange Statistics

The market has become a more important source to fund raising over the years. New equity offerings totaled only M$137 Million in1980 and peaked at M$ 8.5 Billion in1990 before falling back to M$2.7 billion in1991. At secondary market level, annual trading value for 1991 totaled M$30.1 billion (12.3 billion shares), compared to M$5.6 billion (1.5 billion shares) in 1980, again despite the Singapore company to delisting.

The Islamic financial markets in Malaysia comprise the Islamic money market and the Islamic capital market. The Islamic money market, introduced in 1994 comprises the trading of Islamic papers, the Mudharabah inter-bank investment, and the Islamic clearing and settlement system. The Islamic capital market in Malaysia comprises a primary securities market, in which new issues of Islamic Government papers and Islamic corporate securities are offered to the public as well as institutions; a secondary market, in which existing Islamic Government papers and Islamic corporate securities are transacted; and the equity market and unit trusts.

The Islamic equity market is reflected by the stock-broking activities, Islamic unit trusts, Islamic index and the list of the Syariah-approved counters. In terms of the stock-broking activities, the country now has a full-fledged Islamic stock-broking firm and three conventional stock-broking firms offering Islamic stock-broking services. In April 1999, the Kuala Lumpur Stock Exchange (KLSE) introduced an Islamic equity benchmark index for those who wish to invest according to Syariah. The KLSE Islamic Index tracks Syariah-compliant stocks in the KLSE, constructed from the list of Syariah-approved counters issued by the Securities Commission (SC).

The unit trusts are a group of specialized financial intermediaries in the capital market which offer small investors the opportunity to pool their resources in a diversified portfolio of securities which are managed and selected by professional portfolio managers. The inception of Islamic unit trust began in 1993 when Tabung Ittikal was introduced by Arab-Malaysian Unit Trust. The success of the fund paved the way for the introduction of more Islamic unit trusts and as at end-May 1999, there were 13 Islamic unit trusts in the country with total fund size of RM3.55 billion.

In Malaysia, Islamic equity-related products include Syariah-compliant stocks listed on the Main and Second Board of the KLSE, two Syariah indices and equity derivatives Equity derivatives such as warrants are approved provided that the underlying shares are Syariah-compliant. Apart from warrants, the Syariah Advisory Council has approved the structural concept of index futures to facilitate the development of risk management products.

As of mid March 2000, 544 out of 745 or 73% of equity stocks traded on the KLSE are syariah compliant. Malaysia has a very liquid secondary equity market with listed companies from a wide range of sectors of the economy. The vibrant Islamic equity market has been instrumental in spearheading the growth of the Islamic fund management industry in Malaysia especially in the 1990s. As of 31 December 1999, there were 13 unit trust funds administered according to Islamic principles with an NAV of RM 1.4 billion or approximately US$368 million, compare to 10 funds in 1997.

ISLAMIC EQUITY CAPITAL MARKET

Prior to the availability of any form of infrastructures and clear guidelines pertaining to the permissibility i.e. halal of any equity securities, the Muslims in Malaysia have no alternatives to invest their hard earns monies.

Therefore, their participation in development of the Islamic Capital Market in general and the Islamic Equity Capital Market in particular were restricted.

In light of this, the various regulatory authorities and market players responded by providing the necessary infrastructures and guidelines to ensure that the Muslims have a permissible alternative avenue for their investments which will eventually contribute to the development of the Islamic financial system in Malaysia as a whole.

During the early days, Bank Islam Malaysia Berhad, being the first Islamic Bank in Malaysia, had taken the initiative to review and identify companies listed on the Kuala Lumpur Stock Exchange considered permissible for Muslims to invest in. Their efforts were a significant event as it provided the much-needed break through for Muslims to participate in the stock market.

The break through was further boosted by the introduction of the Syariah Approved Securities list in June 1997 by the Securities Commissions Syariah Advisory Council.

The Syariah Approved Securities list contains a list of stock that is listed on the KLSE of which Muslims can invest in. Currently, there are 606 stocks on the list. Besides the equity securities, the Securities Commissions Syariah Advisory Council had also approved other conventional market instruments such as call warrants and Transferable Subscription Rights for investment by Muslims.

In order to accommodate the possibility to participate in the stock market, various Islamic stock-broking services began to emerge with the first being BIMB Securities Sdn Bhd, which was established in1994. In addition, there are also other conventional stockbrokers that had seized the opportunity to operate Islamic windows side-by-side with their conventional stock-broking services since then.

Presently, the Islamic Equity Capital Market has grown to a point where Muslims investors could allow professionals to manage their funds via the various Islamic Unit Trust Funds and Asset Management Companies.

As for benchmarking the performances of the Islamic Equity Capital Market, various indices were created. There are currently two main Islamic indices used by the various market participants namely, the RHB Islamic Index introduced in1996 and the KLSE Syariah Index introduced in1999.

In general, the availability of the Syariah Approved List, the stock-broking services as well as the indices enables more participants, either individuals or corporate, to be involved in the Islamic Equity Capital Market.

This will eventually lead to a more dynamic and mature market, which are prerequisites for the development of the Islamic financial system.

An equity unit trust is the most common type of unit trust. Equity unit trusts funds are popular in Malaysia as they provide investors with exposure to the Malaysian equity market, which is the largest equity market in South East Asia. The performance of the units is therefore linked to the performance of the equity market. A rising market will normally give rise to an increase in the value of the unit and vice-verse.

There is wide array of equity unit trusts available in the market, ranging from funds with higher risk, higher return characteristics to funds with lower risk, lower returns. Funds labeled “aggressive growth funds” generally invest in stocks with higher growth potential, but with possibly higher risk characteristics. Over the longer term, it would be anticipated that funds of this sort would produce higher returns, but with higher volatility.

Another type of unit trust is Index tracker funds. They invest in a range of securities whose performance will most closely match that of the KLSE composite index. Investors onto these types of units will normally generate returns, which closely resemble the performance of the stock market index, both in term of risk and return.

Equity unit trusts can also take the form of income funds i.e. unit trusts, which emphasize income as priority or a combination of both income and growth. This means that the funds will invest primarily in stocks which earn significant dividend income, as opposed to stocks which pay a little or no dividends, but might focus on capital growth potential.

These trusts invest mainly in corporate bonds, government securities and liquid securities like bills and cash. The objective of a feed income unit trust is generally to provide regular income with less emphasis on capital growth. It is possible however, during period of volatile interest rates for these funds to generate both capital gains and losses.

Generally, the volatility or risk element of fled income funds is lower than that of equity funds. Capital is more secure, especially if the bonds are held to maturity. Because of this risk characteristic, it is normal to expect that the returns offered by these funds are lower than that offered by equity unit trusts. However, this is not always the case and there have been instances in the history of Malaysia financial markets, where fixed interest unit trust products have delivered higher returns, at significantly less risk.

Often, fled interest units are held by an investor as part of their overall investment portfolio. They provide a useful diversification to insulate an investor’s unit trust portfolios from the risk of negative returns in any one period. In some markets, fixed interest investments have a high negative correlation with equities, which means that when equity markets are down, the returns in fixed interest are up. This is very useful concept employed in the management of less risky portfolios. Examples of such fixed income unit trusts include Maybank Income Trust, KL Bond Fund and Arab Malaysian Gilts.

Islamic Equity Market in Malaysia is still in their infancy stage of growth and development. There are several recommendations to improve the performance of Islamic Equity Market:

CONCLUSION

Islamic equity market in Malaysia shows a good improvement each day. As in the year 2000, 73 percent equity stocks traded on the KLSE are Shariah compliant Malaysia’s Islamic equity market contains various regulatory authorities and market players responded by providing the necessary infrastructures and guidelines to ensure that the Muslims have a permissible alternative avenue for their investment. Islamic equity market in Malaysia has grown and developed where as many professionals could manage their funds through various Islamic units trust funds and assets management companies. In Malaysia, Islamic equity related-product must compliant with Shariah law. Negative criteria must be avoided from the equity investment. Shariah Advisory Council plays a major role in the development of Islamic equity market in Malaysia. As long as, the concept of Mudharabah and Musyarakah are practiced in equity financing, investors may enjoy permissible benefit.