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Islamic Finance

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SECTION A: LIST OF SYARIAH COMPLIANCE COMPANY In Malaysia, Kuala Lumpur Stock Exchange Shari’ah Index (KLSESI) was introduced in 1997 by Securities Commission (SC). KLSESI was introducing to provide an avenue for Muslims investors to participate in equity investment in accordance to Shari’ah principle. This index comprised of firms listed on both the Main and the Second Board, and Masdeq at KLSE (Bursa Malaysia). KLSESI is the tool in Islamic capital market (ICM) plan where the activities carried out in that market are not conflict with the conscience of Muslims and religion of Muslim. Besides, the ICM represents an assertion of religious law in capital market transactions where the market should be freed from the involvement of prohibited activities by Islam. Under this index, it focuses on the core activity and level of interest income of company to determine whether a particular company is permissible or not in the index.

Before companies listed on KLSE, they should make sure that their investments are permissible under Shari’ah law. The activities are considered impermissible if the operations are based on the interest; involve gambling, manufacture or sale haram products or contains elements of gharar. Furthermore, for companies that compromised both permissible and non-permissible elements, there are several additional criteria. The criteria are:
a) The core activities of the companies must not contravene the principles of Shari’ah as outlined in the four criteria before. Furthermore, the proportion of unlawful (haram) elements must be very small compared with the core activities.
b) The public perception or image of the company must be good
c) The core activities of the company are important and considered maslahah (benefit in general) to the Muslim Ummah and the country, while the haram (unlawful) element is very small and involves matters such as ummu balwa (common plight), uruf (custom) and the rights of the non-Muslim community which are accepted by Islam.
d) The level of interest income received from fixed deposits in conventional financial institutions and other investments in interest-bearing accounts complies with the levels set up by the SAC

Furthermore, Bursa Malaysia also launched two indices to track the performance of Shari’ah compliant securities which are the FTSE Bursa Malaysia EMAS Shari’ah Index (FBM EMAS Shari’ah) and FTSE Bursa Malaysia Hijrah Shari’ah Index (FBM Hijrah Shari’ah). Those two are designed for the creation of structured products, index tracking funds and ETFs or as a performance benchmark.

The FBM EMAS Shari’ah is a benchmark index that applies the principles set out by the SAC. These Shari’ah compliant companies are further filtered for FBM Hijrah Shari’ah. Besides, the screening methodology used is the one set up by Yasaar Ltd, a leading global Shari’ah consultancy, to meet the requirements of international Islamic investors.

The numbers of shariah compliant stocks are increasing from year to years. Figure 1 shows about the analysis of total shariah compliant stock listed in Bursa Malaysia. From the figure, it shows that the highest listed shariah compliant stocks are 89% which are in year 2011 and 2012.

Figure 1: Statistic of Shariah Compliant Stock
(% of Shariah compliant stock from total listed stock in Bursa Malaysia)

Table 1 shows the number of listed companies based on the industries. The statistics is taken for 30 November 2012. In year 2012, the total securities are 923 and shariah compliant stocks are about 817 or 88.52%. The industry of trading/services has the highest amount of shariah compliant securities.

Table 1: List of Shariah Compliance Companies

MAIN MARKET
SHARIAH-COMPLIANT SECURITIES
NON SHARIAH-COMPLIANT SECURITIES
TOTAL SECURITIES
Consumer products 125 10 135
Industrial products 253 10 263
Mining 1 0 1
Construction 43 2 45
Trading/Services 178 28 206
Properties 74 13 87
Plantation 39 3 42
Technology 95 2 97
Infrastructure (IPC) 7 0 7
Finance 2 33 35
Hotels Nil 4 4
Closed-end Nil 1 1
Total 817 106 923

SECTION B: BACKGROUND OF COMPANY
The company that we are chosen from Shariah compliant security is Oriental Food Industry Sdn Bhd. Oriental Food Industries Sdn Bhd was established and incorporated in 1978. The company divided their product into four categories which are snack food, wafer, potato snacks and bakery products. In Malaysia, the product brand names like Rota, Super Ring, Jacker and Oriental are well-known household brand names where its commercially strong and generating the required sales and profit.
In addition, the company is mark in the food manufacturing industry as the leading position in the snack food and confectionery industry in Malaysia. They are more focus on needs and interests of the customers by manufacturing the products that focuses on the quality. This company believes that the business depends on the product quality, product range, research and development, effect on sales and advertising policies, competitive pricing and good domestic and international distribution network in order to give best practice to the customer.
Oriental Food Industry Sdn Bhd was listed by Security Comission (SC) as Shariah Compliant starting from 27 October 2000. In term of quality control and certifications, the company had obtained several certificates in order to achieve optimum control procedure which are MS ISO 9001:2008 and Hazard Analysis and Critical Control Point (HACCP). Besides, they are also received a certificate by the Malacca State Islamic Departments as a manufacturer of ‘halal’ products in order to improve its product quality and remain the demanding international health standards. Through the quality also, they are also focus more on hygiene of food where they have effective and efficient quality assurance system to cover production process, testing line and others. The ingredients that used by company also must be measured by trained staff in order to provide the quality of product is remained and ensure no error incur in process of production.

SECTION C: SREENING METHOD FOR SYARIAH COMPLIANCE METHOD
• Existing Shariah Screening Methodology
The list of Shariah compliant securities are announced twice a year. The securities will be categorized into Shariah compliant securities and Shariah non-compliant. Shariah compliant securities are for companies in which its activities are complying with Shariah principles. Besides, companies that involve in the activities like financial services based on riba (interest), gambling, conventional insurance, entertainment activities that are not permissible in Shariah and other is classified as Shariah non-compliant.

The Shariah screening methodology consists of quantitative and qualitative approach. For the quantitative approach, SAC has recognized a benchmark based on source of Shariah where if contribution from non-permissible activities exceeds the benchmark, it will be classified as Shariah non-compliant. The benchmark must be compare with group profit before tax including 5%, 10%, 20% and 25% benchmark. In term of 5%, it represents level of contribution from the activities that prohibited including riba, gambling, liquor and pork. Next, 10% benchmark is used for tobacco related activities and interest income from conventional account and instrument. Besides, 20% benchmark is used to analyze the contribution from rental payment from Shariah non-compliant activities while 25% benchmark is used to assess the activities like hotel and resort operation, share trading and stock broking.

For the qualitative approach, SAC focus on two criteria for those companies with activities include permissible and non-permissible aspect. Firstly, SAC focus on the public perception or image of the company which must be good performance and it must incur maslaha (benefit) to the Muslim and country. In addition, non-permissible activities that include umum balwa (plight and hard to avoid), uruf (custom) and right of Muslim society is accepted by Islam.

• Revised Shariah Screening Methodology In June 2012, SAC has announced the adoption of a revised screening methodology to determine the Shariah-compliant status of listed companies and will be effective from November 2013. The differences between existing and revised Shariah screening method is in term of qualitative approach. Under the new approach, the benchmark must be compare with group profit before tax including 5% and 20% benchmark. The new 5% benchmark includes the previous benchmark of 5% and 10%.For new 20%, it include the previous benchmark of 20% and 25%. Besides, financial ratio will be compute and it should not be less than 33%. The ratio involve are debt/total assets (Debt Ratio) and cash and cash equivalent/total assets (Cash Ratio). For quantitative approach, they still use the same approach. Through the newly introduced financial ratio, they are intended to measure riba and riba-based element within companies’ balance sheet and should be lower than 33%. For cash ratio, the Cash will only include cash placed in conventional accounts and instruments, whereas cash placed in Islamic accounts and instruments will be excluded from the calculation. On the other hand, for debt ratio, the debt will only include interest-bearing debt whereas Islamic debt/financing or sukuk will be excluded from the calculation. The revised methodology will affect the Shariah-compliant status of the company. For example:

a) Companies with mixed activities which are currently assessed under the 10% or 25% benchmarks may be affected because their activities are now assessed under the 5% or 20% benchmarks
Company A Shariah non-compliant activity Current methodology
[ 10% benchmark] Revised methodology
[ 5% benchmark]
Business activity : Property development, trading of building materials and manufacture and distribution of cigarettes (tobacco) Total conventional debt / group total assets = 39% n.a Not applicable
Status : Shariah-compliant Status : Shariah non-compliant
b) Companies with high level of conventional debt may be affected as currently there is no screening based on the total conventional debt of the company
Company A Level of conventional debt Current methodology Revised methodology
[ 33% benchmark]
Business activity :
Property development, trading of building materials and construction works Total conventional debt / group total assets = 39% n.a Not applicable
Status : Shariah-compliant Status : Shariah non-compliant

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