Proposed Shariah Compliant (Islamic) Counter or Trading Platform at Pakistan Stock Exchange
Writter by: Junaid Khanani & Hafiz Arsalan Ahmed (Students of MS – IBF at Center of Excellence in Islamic Finance, Institute of Business Administration, Karachi. Under Supervision by: Professor Ahmed Ali Siddiqui (SEVP, Meezan Bank Limited)
In an Islamic economy where interest bearing loans are prohibited and where direct participation in business enterprise, with its attendant risks and profit sharing is encouraged, the existence of a well-functioning Shariah Compliant Stock Exchange is very important. It would allow for the mobilization of savings for investment and provide means for liquidity to individual shareholders.
However, existing Stock Exchanges generate practices such as speculation and fluctuations in share prices which are not consistent with the teachings of Islam. As a consequence, Muslims who are considered as pioneers of profit and loss sharing investments in businesses through contractual agreements cannot engage wholeheartedly in the trading of conventional stock markets because most stock exchanges in Muslim countries are basically Western style markets which tolerate many practices that do not comply with Shariah principles.
Moreover, stock markets that follow the Islamic principles are still in the early stages of development. As a first step towards Islamic Stock Exchange in Pakistan, KMI 30 and KMI all shares Islamic indices are already introduced, which provide investors a list of Shariah compliant companies listed in Pakistan Stock Exchange. As a next step, this article attempts to document the guidelines under which conditions Shariah permits Muslims to participate in trading in the stock market. This article will be beneficial for the regulatory authorities to establish separate Shariah Compliant (Islamic) counter / platform to conduct Shariah compliant trading in Pakistan Stock Exchange, which may lead to a fully-fledged Islamic Stock Exchange in Pakistan.
Speculation is one of the most important issues to be dealt with when planning an Islamic stock exchange. Trade involves some degree of speculation. Merchants speculate on prices for their commodities. Several scholars defined speculation as consisting of the intelligent and rational forecasting of future price trends on the basis of evidence and knowledge. It is evident that Muslims are increasingly interested in investing in Halal securities traded in stock markets all around the world in order to earn the economic benefits. However, one needs to predict the future value of a stock prior to making any decision either to buy or to sell the securities. Hence there is a great deal of speculation involved in stock markets.
Speculation involves risk taking. Speculation is the practice of using available information to anticipate future price movements of securities so that an action of buying or selling securities may be taken with a view to realize capital gains and/or maximize the capitalized value of security holdings. From this point of view, some scholars argued that the decision taken in speculation is not result of casting dice. However, it is a process that relies on the analysis of a lot of economic and financial data, companies’ financial reports, political decisions, information about management skill and aptitude, and the personal profile of the decision markers. That is to say, speculation is an activity that requires a great deal of knowledge and skills. Therefore speculation in stock markets cannot be equated to gambling.
The sale of gharar is said to lead to maysir (gambling). It is evident that gharar is not present in speculation in stock markets, as each party is clear to quantity, specification, price and time of delivery of the object. Moreover, the object of the transaction, which is the purchased security, is available in the market at the time of transaction and is bound to be available at the time of
delivery. Therefore, speculation has no element of gharar and hence, does not lead to maysir (gambling).
The conclusion of the above discussion is that although speculation in the stock markets may look like gambling, it is by no means akin to gambling. Speculation has both pros and cons. Its positive side is that it can stabilize prices and activate a market where there is thin trading. It can also provide signals to less informed investors upon which to act. The negative effect of speculation is that excessive amount of it may cause volatile price movements in the market and is prohibited by Shariah. It can thus be concluded that excessive speculation should not be allowed, but a reasonable degree of it be permitted. The speculation can be controlled to a
limited extent by the prohibition of the following items on an Shariah compliant (Islamic) trading counter / platform:
1. Carry Over Trade (COT) / Continuous Funding System (CFS)
2. Margin Financing
3. Short Selling
4. Cash Settled or Deliverable Future Trading
5. Cash Settled Trading in Indices
6. Prohibition of Sale before Delivery
At Pakistan Stock Exchange, trades are settled on the second working day (T + 2), following the day of trade. As per Shariah principles, shares cannot be sold before the shares are delivered into the CDC account of the buyer. Shariah compliant investors are therefore exposed to price risk for 2 days in an excessive volatile market.
This process restricts the activities of Shariah compliant investors because they are not willing to take price risk for two days. In order to bring increased efficiency and transparency to the clearing and settlement process of Customers’ trade and to provide maximum protection to their cash and securities, CDC and NCCPL have launched National Custodial Services (NCS) and Direct Settlement Services (DSS) respectively for the stock market investors.
Under these services, the PSX Brokers are only involved for trade execution while NCCPL or CDC provides clearing, settlement, and custodial services for such trades. For this purpose, the investors open web-based NCS account with NCCPL or IAS account with CDC. These direct settlement facilities enable the investors to maintain their cash and securities balances directly with NCCPL and/or CDC. These services can be used for a Shariah compliant (Islamic) counter / platform with the following rules:
1. It will be mandatory for Shariah compliant investors to open NCS account with NCCPL or IAS account with CDC for direct settlement facility.
2. The investor can open trading account with any broker (TREC holder) of Pakistan Stock Exchange.
3. The investor will enter into Master Murabaha Financing agreement with any Islamic bank or Islamic Window of any conventional bank in case of Murabaha Financing is required.
4. All Shariah compliant eligible shares as per the screening criteria of KMI All Shares Islamic Index shall be eligible for trading on Shariah complaint counter.
Buying of Shares
5. CDC or NCCPL shall provide information of cash balance and the amount of Murabah facility available to the investor to stock exchange in pre-opening session of the market.
6. On the basis of information, stock exchange will provide exposure for buying of shares to the investor up to the amount of cash plus Murabaha financing.
7. In case of execution of buy order CDC and NCCPL will immediately settle the trade by reducing the cash balance from the investor account and transferring the shares to the investor account.
Selling of Shares
8. CDC or NCCPL shall provide information of securities available in the IAS account of the investor to stock exchange in pre-opening session of the market.
9. On the basis of information, stock exchange will provide exposure for selling of shares to the investor up to the number of shares available into the IAS account of the investor.
10. In case of execution of sell order CDC and NCCPL will immediately settle the trade by increase the cash balance from the investor account and transferring the shares from the investor account to the buyer.
The proposed Shariah compliant (Islamic) counter / platform shall provide following benefits to the Islamic Banks:
1. New avenue of Shariah compliant investment.
2. Tawarruq based interbank borrowing and placement of funds.
3. Tawarruq based corporate and retail financing.
4. Murabaha Financing Product
5. Avenue for development of Short term and long term Sukuks Market
The proposed Shariah compliant (Islamic) counter / platform shall provide following benefits to the Pakistan Stock Exchange: :
1. Inclusion of Shariah compliant investors.
2. Opportunities for small investors.
3. Better liquidity through immediate settlement.