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[TYPE THE COMPANY NAME]

Islamic Brokerage and

Trading HousesIslamic Banking and Finance Term Report1/18/2013


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Islamic Brokerage and Trading Houses

Contents

INTRODUCTION ....................................................................................................................... 3

CONVENTIONAL BROKERAGE HOUSE VERSUS ISLAMIC BROKERAGE HOUSE .............. 4

PROBLEM AREAS .................................................................................................................... 6

Short Selling: ...................................................................................................................... 6

Speculation ......................................................................................................................... 7

Margin Trading and intraday trading.................................................................................... 8

Derivatives: Options, Futures and Forwards trading: ........................................................... 9

Earnings of the Brokerage house ........................................................................................ 9

Trading of Non Shariah compliant stocks: ..........................................................................10

Karachi Stock Exchange Meezan Index: ............................................................................10

DIYANAH ISLAMIC FINANCIAL SERVICES (PVT.) LIMITED ..................................................13

How it was created? ...........................................................................................................13

Introduction of the Organization: ........................................................................................13

THE ISLAMIC MODES OF TRADE OFFERED BY DIYANAH ISLAMIC FINANCIAL SERVICES

ARE: .........................................................................................................................................15

Wakalah (A Regular Trading System) ................................................................................15

Modaraba (Profit Sharing) ..................................................................................................16

Shares Murabaha (Mode Of Islamic Financing In Equities) ................................................16

CONCLUSION ..........................................................................................................................18

RECOMMENDATIONS .............................................................................................................19

APPENDIX ................................................................................................................................22

Questionnaire ....................................................................................................................22

Bibliography ..............................................................................................................................23


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INTRODUCTION

In early 2000 in the US, a new method of mortgage lending was developed in the financial

system that allowed for excessive betting without immediate risk and incentives to sabotage

the system for personal profit. The system developed is named the Securitization Food Chain.

Simply stated, the Securitization Chain is a system whereby borrowers receive home loans from

lenders and the lenders pass these loans across a chain of investment banks, investors, and the

insurance companies. With each trade, one party earns a profit and the other party earns the

loan. The loans were mixed with other types of debt, such as car loans and credit card debt,

given a rating, and investors would include these mixes in their funds depending to their rating.

Since each party was removed from risk by selling the debt, lenders could extend absurd loans

that were highly unlikely to be repaid, rating agencies could grade the absurd debts highly

without consequence, and investors could sell the debts with confidence and bet on the debts

with insurance from big insurance companies. The result was the opportunity for virtually

anyone in the US to receive a home loan and purchase a home, which sent home prices

incredibly high (the bubble), and since the financial sector was profiting from this procedurethrough the Securitization Food Chain, they were becoming vastly wealthy and developing a

thirst for making extremely unwise bets and trades because of the immediate profit potential.

The bubble burst. As previously mentioned, the new mortgage lending system allowed the

financial sector to extend, trade, and bet on extravagant loans and pass on the risk of such

action to another party in exchange for a hefty commission. The system incentivized destructive

financial behavior. A significant percentage of the debts being traded could not be repaid.

Everyone was trading immediate profits for promises to pay debts with money they simply did

not have, and the crisis occurred when it came time for everyone to pay and no one could. The

result was that a financial base had been removed and the contagious crisis spread around the

globe.

These mortgage backed securities and derivatives were the reasons why the economy crashed

and poor people are still suffering. The recent financial crises as well as the growing awareness

of and demand for investing in accordance with Shariah principles on a global scale have

become the catalyst towards making the Islamic financial services industry a flourishing one.

Islamic finance products are developed by applying the appropriate Islamic financial contracts

to suit the financial needs of the users.

Globally, Islamic Capital Market Products and Services include

Sukuk Market Islamic Equity & Income funds

Islamic Equity Market

Islamic Stock Broking

Islamic Structured Products

Shariah Compliant Derivatives

In Pakistan, fewer products and services are offered which includes:


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Sukuk market

Islamic Funds

Shariah Compliant Stocks & Islamic Index

If we compare our Islamic capital market to the Global markets, we have seen that many

products and services are not available for our investors. Shariah compliant brokerage is one ofthem.In Pakistan, only few brokerage Houses have Islamic window and offers limited services.

Moreover a large number of investors are unaware about Shariah compliant shares and KMI30

index.

Islamic brokerage house can serve as a medium of communication between investors and

Islamic Institutions, in order to help and create the awareness of Shariah compliant stocks to

the investors. In addition, these Shariah compliant brokerage houses create alternative

investment avenue and products, which is secure, return oriented, and Halal also by eliminating

unethical way of trading and discourage RIBA from capital market.

In the early 1990s, some initiatives were taken for Islamic capital development in Malaysia,

where the primary focus was to expand the concept of Sukuk and later of Islamic funds. For

Islamic equity funds, a Shariah screening criteria was developed by their respective board, to

filter Shariah compliance scripts. To analyze the performance of Shariah compliance stocks,

certain indexes were formed to analyze the performance of the shares. However, common

investors were not aware of these Islamic modes of investments. At that point, the presence of

Islamic brokerage houses became necessary in the Islamic financial sector. In Pakistan Islamic

financial institution is growing tremendously. Islamic Bank, Funds and Takaful provides their

services all over Pakistan, but the area of Islamic Brokerage Services is still underserved due to

personal interest of some strong brokers and market manipulators.

At present, investment can be made in many different ways like Bonds, Bank deposits, saving

certificates; all these investments are interest based. The Real Estate is comparatively non

liquid investments. Stocks, on the other hand, are highly liquid and provide interest (Riba) free

investment through Shariah Complaint Stocks. These scripts are identified with the guidance of

qualified and reputed Shariah Experts who select 100 scripts under strict Shariah Screening

Criteria.

CONVENTIONAL BROKERAGE HOUSE VERSUS ISLAMIC BROKERAGEHOUSE

Apart from the operational aspects and the technical differences, the core principles, purpose

and objective is what differentiate Islamic brokerage houses from conventional brokerage

houses.


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Islamic brokerage houses are created with the purpose of promoting equity based financing as

opposed to debt based financing. As Mufti Bilal Qazi pointed out that debt based financing has

the tendency to promote wealth concentration in the hands of few, and that the objectives of

Islamic finance will reap its benefits fully if our system embraces equity based financing more

than debt based financing.

Keeping this in mind, the objective of formation of an Islamic brokerage house is therefore to

develop a sovereign Islamic capital market. Islamic capital markets, once fully developed, are

supposed to do all the useful functions of conventional capital market and many more but with

justice and equitable distribution with Islamic orientation and growth objectives. Islamic capital

market will provide long term fund raising and investment by enhanced depth and liquidity of

Islamic financial system. Hence, the USP (Unique Selling Proposition) of an Islamic brokerage

house is their ideology.

An example of Malaysia is relevant in this context .which saw the future of Islamic finance more

than three decades ago, whereby the Malaysian Islamic financial system has transformed into acomprehensive Islamic financial landscape. As financial products structured based on Islamic

principles are, by nature, different from their conventional counterparts, that require a

dedicated framework, Malaysia has developed a world class legal, regulatory and Shariah

framework with strong government endorsement, the essential financial infrastructure, and an

environment which supports conducive product innovation and thought leadership in Islamic

finance.

Carrying such a mission, an Islamic brokerage house has values based on Shariah restrictions

and compliance that make them more committed and service oriented towards its clients. In

contrast, generally, a conventional stock brokerage house is inclined towards targeting for

large volumes to get more revenues. For this they often recommend or buy low priced stocksto their client causing huge depreciation in equity, rather than profit. On the other hand an

Islamic equity broker is bound to invest in Shariah Compliance scripts which are usually best

available stocks in market.


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PROBLEM AREAS

Through our primary research we have analyzed the following six major issues in the

conventional brokerage houses that are not in compliance with the Shariah. The realization of

these issues is the outcomes of the efforts made by DIFS to make their operations Shariah

Compliant. The issues are:

Short Selling

Speculation

Margin Trading and Intraday trading

Derivatives : Futures and Forwards trading

Earnings of the Brokerage house

Trading of Non Shariah compliant stocks

Short Selling:

Basically, short selling is the practice of selling securities which are borrowed from a third party,

typically a broker, with the promise of returning them later on. During the time the securities

between selling and repurchasing, the short seller hopes for a price decline, so that he can buy

cheap and make a profit.

Practically, the short seller sells the securities immediately after borrowing them. But if the

price of the securities increases against his expectation, he incurs the loss.

How it happens? In a typical brokerage house, the process starts when the client does his

research of the market and analyses a particular companys financial performance. He

concludes that the share price will go down. Now the transaction will have the following steps:

He will set up a margin account

The he will order the broker by calling him where he will have options of either short

sale or buy to cover. He will order to go short for a number of shares.

On your behalf, the broker will then sell these shares on an open market, and the profits

are then put into the clients margin account.


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Why Islam opposes short selling? According to Shariah, short selling is impermissible in Islam.

The conceptual framework behind short selling violates the fundamental principles of a valid

sale.

Seller and owner are different:-In Islamic transactions, to sell something you must first have the

ownership of what is being sold or the subject of the sale. Therefore in order to sell a security,the security must be owned by the seller and not borrowed - which is the case in short selling.

The owner makes gains without owning the risks and rewards associated with the securities.

Riba:-Short selling is associated with the conventional borrowing and lending system of

securities which includes a series of interest-based charges for services, and interested

payments on borrowed securities. And as we all know, charging interest on services and

borrowed securities is considered as Riba.

Speculation: - Since short sellers are watching out for fluctuations in the markets, to sell the

share at a higher price and buy it back at a lower price and pocket the difference. Speculation

has been perceived negatively due to its resemblance with gambling.

Gharar: - There is uncertainty in the contract

Against the Islamic principles of Equity and Justice: In short selling the investor may gain while

the company loses value, which is a clear violation of the prohibition against unjust deeds

stated by the Quran in Sure Al Baqara, 2, 278 279: Deal not unjustly, and ye shall not be dealt

unjustly.

Moreover, by selling a short stock more people might be triggered towards to invest in short

selling. This leads the firm to expensive stock buy-back initiatives or in the worse bankruptcy. It

promotes the culture of insider trading among those who do short selling and cheating the

other party is not allowed in Islam.

Mr Owais further commented that there had been efforts to Islamize short selling and make it

permissible. Some scholars in countries like Malaysia advocated that short selling can be made

Shariah compliant if the client buys the stock rather than borrowing it by paying a portion of

the stock price and executing a simultaneous agreement to sell it back to the seller at a later

date. However, the underlying concept of short selling based on earning profits at the expense

of companys poor performance comes under the domain of exploitation, and is thus

impressible.

Speculation:

Excerpted from Present Financial Crisis Causes And Remedies From Islamic Perspective Post

Crisis Reforms By Justice Mufti Muhammad Taqi Usmani:

If speculation is used in a real trade transaction, it cannot pose a problem to the community.

When Adam Smith spoke about speculation, he contemplated it in real commercial activities.

He defined a speculator as a merchant who: exercises no one regular, established, or well-

known branch of business. He is a corn merchant this year or the tea merchant the year after.


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He enters into every trade when he foresees that it is likely to be more than commonly

profitable, and he quits when he foresees that its profits are likely to return to the level of other

traders.

This type of speculative merchant is not a risk for the economic system. Even Islam does not

prohibit such an activity so far as it does not amount to impermissible hoarding, termed inIslamic jurisprudence as Ihtikar, and so far as it does not violate any other rule of trade. Such a

trader can be harmful, at the most, to his own self, if he takes a wrong decision, unlike the

present financial speculators whose activities put the whole system at risk. The reason is that

they do not enter into real trade transactions. Most of their deals do not qualify to be termed

as real trade, and do not conform to the rules of valid sale.

In practice, speculators aggressively buy and sell stocks for capital gains which is not un-Islamic

because it is a form of business transaction involving in buying and selling of certain right over a

company. When trading in stocks, if one is neither dealing with interest-based transactions nor

a doubtful one, and the participant knows exactly what he or she buys and at what price, the

transaction is legitimate.

In this context, Mr Owais said: In the brokerage industry, we divide our clients into two

general groups: investors and speculators. The investors research the companies in which they

wish to invest, basing their decisions on their studies. Speculators often know nothing of the

companies whose stock they buy. Investors buy pieces of ownership in the underlying

companies. But speculators buy shares as commodities.

He further said that as a practicing broker, he personally witnessed many of the speculators not

only know nothing of the companies in which they invest. Even some of them do not know

the companies name. They just follow the ticker symbol used to report price movements.

As a result, speculation leads to volatility in prices and this is very de-stabilizing and it wreaks

havoc for the value investor. Commenting on particularly the local stock market, Mr Owais said

that KSE has very high volatility because there are few very big giants and number of very small

market players. Given these conditions, speculators take advantage of this hyper sensitive

market.

Margin Trading and intraday trading

In the case of margin trading, an investor purchases stocks by paying part of it in cash and

borrowing the remainder from the brokerage firm at the margin interest rate. This practice is

clearly not legitimate from an Islamic point of view because of the interest element in it.Moreover this is a very risky practice, as one can lose more than what he has borrowed.

However, if the interest element can be eliminated, then such a practice can be made allowed.

Mr Owais shared with us the example of Malaysia wherein, Bank Islam Malaysia Berhad tried to

overcome this issue through the introduction of share financing, by adopting Mudaraba profit

sharing principles. Similarly the brokerage companies can also make margin trading legal by

replacing the interest element with the principles of Mudaraba.


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Intraday day trading means that when an investor orders a broker to buy shares, he or she has

a few days to settle the payment. In Pakistan, it is T+2. Within this period, the investor might

choose to sell the shares, before settling the payment due for the purchase of the stocks. If

selling of the stocks produces profit (selling prices higher than purchasing prices), then the

brokerage firm will pay the investor but if losses arise (selling prices lower than purchasing

prices), then the investor will have to settle the differences. Typically, the trader does this onthe basis margin trading (borrowing money from broker to buy the stock). Since margin Day

traders sometimes borrow money to trade. This is called margin trading. Since margin interests

are typically only charged on overnight balances, the trader does not hold his position

overnight.

Thus rather than investing, intraday trading leads to speculation as trader buys and sells lots of

stocks that same day and therefore such trading is prohibited because it involves the element

ofgharar(uncertainty), gambling and sale of the stock the payment of which is not yet settled.

Derivatives: Options, Futures and Forwards trading:

When viewed solely as a promise to buy or sell an asset at a predetermined price within a

stipulated period, Shariah scholars find nothing objectionable with derivatives. However, it is in

the trading of this promises and the charging of premiums that objections are raised.

In the case of futures contracts for example, some scholars have objected stating that sale and

purchase cannot be affected for a future date. Secondly, in most of the futures transactions,

delivery of the commodities or their possession is not intended. In most cases, the transactions

end up with the settlement of difference of prices only, which is not allowed in the Shariah.1

Thus, trading of derivatives involves gharar and traders primarily seek speculative gains from

trading in derivatives.

To close a point on derivatives trading, Mr Owais spelled out these features that should be

considered if Shariah compliant derivatives are made: riba, maysir (gambling), gharar

(uncertainty), jahl(ignorance) and deception.

Earnings of the Brokerage house

Prior 2008, the brokerage houses used to be 90% leveraged. This implies that a huge proportion

of their income was spent in paying interest on debt. This renders the whole business as non

Shariah. But now the limits have been imposed and upto 30% leveraged market is allowed.

Typically, brokers earn commission per share. To fully explain the exploitation that happens in

conventional brokerage houses, Mr Owais explained the psyche of an average investor: In

Pakistan, the investors are mostly risk averse. Since the companies which are well established

have high share prices, the fluctuations in their prices does not bring about the same results as

1(What Shariah Experts Say. Option Futures and Swap., Volume1, April-June 1999)


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those of unstable companies having low share prices. Therefore, investors go for low price

shares rather than high priced shares either because he does not have enough money to buy

the expensive share of a stable company, or he looks for making gains by buying a number of

low priced shares.

Here the broker faces a moral dilemma, where he either earns money by advising the clients tobuy more number of shares of unstable company or forego his high income prospects by

advising the clients to buy fewer shares of stable companies. In conventional trading system,

broker target volume instead of clients profitability by exploiting his greed and involve

investors in speculation rather than investment and they suffer losses due to the uncertainty in

stock market. Thus, in conventional brokerage houses, such moral considerations are

superseded by profit motive, and thus investors suffer, and lose his trust on the market.

In addition, these two issues prevalent in the conventional brokerage houses are also against

the principles of Shariah:

Trading of Right Allotment Letter is prohibited because right allotment is evidence andan agreement letter given to the shareholder by the company. It does not imply share or

ownership, and hence cannot be traded.

Provisional Trading for IPO companies which are not yet established is prohibited

because the subject matter does not exist or cannot be identified. And therefore, there

is an element ofgharar(uncertainty)

Trading of Non Shariah compliant stocks:

In conventional brokerage houses, all kinds of stocks are traded, and the capital gains and

dividends of non Shariah compliant stocks may constitute income as haram.

Karachi Stock Exchange Meezan Index:

The objective of KSE Meezan Index (KMI-30) is to serve as a gauge for measuring the

performance of Shariah Complaint Equity Investment, and it also provides investors with a

suitable benchmark for comparing returns on their Shariah Complaint Investments. The index

tracks 30 companies that qualify the Shariah and Technical screening Criteria which is as

follows.

For stocks / scripts to be Shariah Compliant, it must meet all the seven key tests of the

Technical Screening Criteria2, as given below:

2(Technical Screening Criteria)


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The Company which is on the Defaulters Counter and / or its trading is suspended,

declared non-tradable (NT) in preceding 6 months from the date of re-composition shall

not be considered for inclusion in the KMI-30 Index.

The Company will be eligible for KMI-30 Index if its securities are available in the Central

Depository System (CDC).

The Company should have a formal listing history of at least two months on the KarachiStock Exchange (KSE).

The Company must have an operational track record of at least one financial year and it

should be in default(s) of the Listing Regulations.

The Company should have minimum free-float shares of 5% of total outstanding shares.

The Company will be eligible for the KMI-30 Index if its securities are traded for 75% of

the total trading days.

Mutual Funds (both Open-Ended and Closed-Ended) are eligible for inclusion in the KMI-

30 Index.

Shariah Compliance Scripts are those which have been filtered by Shariah Screening criteria

3

,prepared by renowned Shariah Scholars from all over the world. The criteria are described as:

Business of the Investee Company

The core business of the company should not violate any principle of Shariah.

Therefore, it is not permissible to acquire the shares of the companies providing financial

services on interest like conventional banks, insurance companies, leasing companies or the

companies involved in some other business not approved by the Shariah e.g. Companies

making or selling liquor, pork, haram meat, or involved in gambling, operating night clubs,

disseminating pornographic content, prostitution etc.

Interest Bearing Debt to Total Assets

Debt/Asset ratio should be less than or equal to 40%, which mean company should have 60% or

more from equity financing.

Non-Compliant Investments to Total Assets

Companies by law are restricted to invest in insurance or banking sector to secure their funds,

now companies have two options either to invest totally in Takaful (newly launched) or stuck up

with conventional arenas, if they are invested in conventional arena, they need to manage it

equal to or less than 33%.

Non-complaint Income to Total revenue

The ratio of Non Compliant Income to Total Revenue should be less than 5%. Total Non

Compliant Income includes income from gambling, income from interest based transactions,

income from Gharar (Islamic word) based transactions i.e. derivatives, insurance claim

3(Khalid Waheed, June 2011)Islamic Stock Broking & Trading


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reimbursement from a conventional insurance company, any penalty charged on late payment

in credit sale, income from casinos, addictive drugs, alcohol, dividend income from above

mentioned businesses or companies which have been declared Shariah Non-Compliant due to

non-compliance to any of the mentioned criteria for Shariah Compliance etc.

Illiquid Assets to Total Assets

The ratio of Illiquid Assets to Total Assets should be at least 20%. Illiquid Assets include

inventory of raw materials, work-in-process, all fixed assets such as property, plant &

equipment, stores and spares, stock in trade etc.

Net Liquid Assets/Share Vs Market Price/Share

Market Price per share should be at least equal to or greater than net liquid assets per share.


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DIYANAH ISLAMIC FINANCIAL SERVICES (PVT.) LIMITED

How it was created?

Mr Owais Anees shared with us the efforts that were made to establish a brokerage house

dedicated for only Shariah compliant investments. In 2007, he along his colleagues shared this

ideology with Mufti Asim Zaki and Mufti Zubair Usmani. Both assured their support, and

together they started working on the mechanism and structured the product in line with

Shariah principles under the aegis of eminent scholars of Darul Uloom. Initially, they looked for

the models established in other countries, but they found only 2 brokerage houses that were

completely Shariah compliant in India and Srilanka. The issue was that these models could not

be adopted as they were based in non-Islamic countries. So they had to come up with their own

model. After attaining the required Fatwas, they opened Islamic window in Hum Securities

Limited in 2010 under the head of Hum Islamic Brokerage Services. Later on, as per the

recommendation of Shariah advisors and scholars, they formed a separate Shariah compliant

company Diyanah Islamic Financial Services (Pvt.) Limited as Pakistans Premier IslamicBrokerage Company.

Discussing the core objective of DIFS, Mr Owais said that he wanted to create excellent human

resource to develop basic Islamic products for the investors to create awareness program for

the masses regarding Islamic Finance specifically Shariah compliant investment in stock market,

and to change the perception of general public regarding Islamic Finance and riba.

Introduction of the Organization:

Diyanah Islamic Financial Services (Pvt.) Limited has the unique distinction of being the

Pakistan's first Islamic stock brokerage house, a pioneering institution that has combined thebest of traditional Islamic values with the technology and innovation that characterize the

modern way of trading. Their core emphasis to promote riba free trading in Stock Exchange

which not only HALAH but also give a handsome amount of profits to the clients.

Diyanah Islamic Financial Services (DIFS) are the pioneers of Shariah Compliant Equity Market

Services in Pakistan and offer comprehensive products for the national Equity Markets. Core

activity of DIFS is equity trading and Investment. DIFS has its main office in Karachi near Karachi

Stock Exchange and sub office in Islamabad.

Diyanah Islamic Financial Services is also a Corporate Broker of Islamabad Stock Exchange, and

has advance technological setups for its corporate and individual clients both. DIFS is fullycommitted excellent and customized professional services to its all clients. It completely

believes that the transparency of mechanism is an integral part of financial services.

The products not only fulfills the aspect of modern market but also fulfill the Shariah approved

rules & regulations. DIFS offer professional Shariah Compliant brokerage services, both financial

and technical, to all investors looking for value added brokerage services to invest in the Stock

Exchange according to the principles of Shariah.


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The research team provides awareness programs on regular basis to the clients including

Shariah rules & regulation about the Stock Exchange, Shariah approved list of companies

(Shariah compliant shares), Shariah rules about the investments and shariah guidelines about

the trading and leverage transactions.

Vision

It is our aspiration to be the leading Shariah Investment House with regional and global reach

by creating innovative Shariah Complaint products for investors.

Mission

To help people find the correct investment by following the principles of Islamic / Shariah

Law.To develop a Shariah Compliant Capital Market, where people can invest according to the

principles of Shariah.

Islamic Investment Ideology:

Islam provides us comprehensive and straight path of life, which covers all of its aspects, and

guides us accordingly, through this we handle individual and social, material and moral,

economic and political, legal and cultural, national and international aspects of our life. In fact

earning, saving and investment can become acts of Ibadah if done according to Shariah.

Objectives:

- DIFS brings a wide range of investment options which are profitable and at the same

time compliant to Islamic standards.

- DIFS provides personalized service so that the investment plan suits every single

individual style etc- DIFS provides the best financial services which are strictly Shariah compliant and follows

best international standard practices.

The management team of DIFS includes:

Khalid Waheed - Chairman

Khaleel M Rehman Chief Executive Officer

Owais Anis Chief Operating Officer

Tanveer Bakhsh - Manager Settlement & Business Development

Ali Muhammad Usmani - Investment Advisor

The Shariah board consists of Mufti Asad Gul and Mufti Asfar Iqbal

Services provided at DIFS:

The dilemma of the Stock Market is that, most people are unaware of its Investment Strategies,

and get manipulated by various sources. DIFS ensures that clients understand their worth and

facilitate the investor(s) in making decisions regarding investments and portfolio designing, to

name a few. The services that are offered to the clients include:


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Investment Advisory in Shariah Compliant Stocks

Islamic Investment Products

Online Trading

Research based Advisory

Assistance in Portfolio Designing

Dedicated Support by Calls, SMS , Web updates and E-Mails

Commission Structure:

8 paisa for less than 50 shares

10 paisa for more than 50 but less than 75 shares

Maximum rate is 40 paisa per share.

THE ISLAMIC MODES OF TRADE OFFERED BY DIYANAH ISLAMIC

FINANCIAL SERVICES ARE:

Wakalah (A Regular Trading System)

Traditionally there are few options available for investing in stock market:

Delivery Based Investment

Margin Finance

Future Derivatives

In conventional brokerage system, the main focus of the broker is to earn commission. They

mostly advise margin financing and/or future derivative options to their clients which involve

more risk and uncertainty. In delivery based investments, the broker also usually chooses third

tier stocks whose prices are low to get maximum volumes. But Shariah compliant brokerage

house can provide the mode of Wakalah in which the company act as a Wakeel for the client

and thus try to restrict the risk of the investor to minimum. The primary focus is kept on the

security and profit of the client rather than the commission of the broker. After signing the

Wakala agreement, investors must follow the following Shariah restrictions, which itself is a

complete risk management mechanism.

- Only Shariah Compliant shares are allowed for trading by avoiding practices such asshort selling, Intraday, leverage and future trading.

- Provisional trading for IPOs will also not be allowed except those IPO companies which

physically exist and are already established. Furthermore, right allotment letter is also

prohibited for trade.

Shariah compliant scripts which filtered by Shariah screening criteria are fundamentally the

best available stocks in which investors can get not only the annual return, but also achieve


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attractive capital gains. If the price of these Shariah compliant scripts decreases due to any

market forces and economical circumstances, it recovers more quickly at the correction of the

market which we witnessed in the recovery session of 2008-2009 in Karachi Stock Exchange.

Simultaneously by avoiding leverage and future options investor can avoid unnecessary trading

which causes undesirable losses.

Modaraba (Profit Sharing)

Modaraba is one of the prime modes of Islamic Financial System. Modaraba is a kind of

partnership, wherein one party provides finance to other party for the purpose of carrying on

business. The party who provides the finance is called the Rab-ul-Maal, whereas the other party

who puts its management skills for the Modaraba is called the Modarib (working partner).

However the concept of Modaraba is first time introduced in equity market in which client will

be Rab-al-Maal and Islamic Brokerage House (IBH) will act as a Modarib.Moreover,

Modaraba investment account is the group of IBH individual account holders where their funds

will be managed by IBH investment committee in their respective accounts. Thus Modaraba willbe in between client and IBH on profit sharing basis.

Furthermore in Modaraba mode no commission will be charged from the client on their trades

except Government taxes and KSE charges. The proposed profit sharing will be calculated at the

ratio of 25:75 (or any mutually agreed sharing ratio) from the realized net profit. If any payout

is announced by the company, it will be distributed in the same ratio. In case of loss, all the

losses will be bared by the client (Rab-ul-Maal) and Company (Modarib) will only lost his profit.

Working Procedure:

Below is the working procedure which will be followed by the company:

1. The investor will authorize IBH representative for his/her investment.

2. All the decisions regarding investment will be taken by IBH investment committee selected

on the basis of their expertise and experience. Approval of at least 3 committee members will

be required for execution.

3. The real time information about all the trades done by the investment committee will be

provided to the participant account holders by SMS/Email and through our website.

Shares Murabaha (Mode Of Islamic Financing In Equities)

Shares Murabaha is the Shariah way of providing financial assistance to the clients for buying of

Shariah Compliant scripts for a defined time period. The product also provides

individual/corporate investor with a Halal and consistence stream of periodic income with focus

on relative stability of principle amount in Shariah Compliant manner. Therefore in this

agreement investor can participate both as financier or financee depend on his/her

requirement. For instance, any client of IBH will get finance for buying of Shariah Compliant

Shares as a financee in a Shariah way. Similarly any financier can get better rate of return as


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compare to the others Islamic financial institutions by investing his amount in Murabaha

account.

Working procedure:

1. Both client and financier should have signed Master Murabaha Agreement with the

company (IBH).

2. Minimum Murabaha contract will be of three months for Financier and Minimum Murabaha

maturity date for the client will be of 7 days with the IBH.

3. For the client minimum 50% margin will be required to get the Murabaha financing.

4. A Wakeel will be appointed by the buyer on his own or by IBH (other than IBH or its

employee) recommendation and notify him accordingly in writing or verbally to fulfill the

compulsion of Murabaha transactions. Whereas IBH will act as a Mudarib of the financier.

5. As per request of Wakeel of the client, shares will be purchased by the Mudarib (IBH) via

merchandiser (Karachi Stock Exchange trading terminal) in the Financier account at required

quantity and buying rate.

6. On behalf of financier IBH will offer to sell these shares with the same quantity and rate tothe client by adding profits, all taxes and commission after the settlement date. The client

will provide written promise to buy these shares from IB at the Murabaha price with the

same quantity of Shares. In this case buyer must be aware of the original price and profit

charged by the Financier, commission charged by the IBH, government taxes, CDC and other

charges.

7. Murabaha Price = Buying Price + Commission + Govt. Taxes + CDC + Other charges+ X

where, X = Profit amount charged

8. Client and his/her Wakeel is bound to pay the Murabaha amount within due time. (In case

of his/her expiry/absence, his/her nominee is bound to accept the contract)

9.

Mark to market losses due to decline in the market rate of scripts will call from the buyer, if

his/her worth of margin custody decrease by more than 10% till the maturity date.

10. In case of early payment rebate will not be the right of financier

11. In case of absence / expiry of the client; his/her nominee is liable to except all his/her

contracts.


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CONCLUSION


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RECOMMENDATIONS

During our interview, Mr Owais Anees shared with us the problem related to the dearth of

required human capital in the country for Islamic brokerage house. He said that human

capital development is crucial, as the current lack of qualified young Islamic graduatesshould it not be addressed. , can hamper the development of the sector. Therefore it is

recommended that on a national and international level, global bodies should be developed

to oversee standardization of continuous education and training. Some examples of training

institutes include Kuwait Finance House (KFH), International Shariah Research Academy

(ISRA), Bank Negara Malaysia, and International Centre for Education in Islamic Finance

(INCEIF) but the rapid growth in global financial industry requires more such institutions.

The objective of developing Islamic capital market can only be achieved if the rest of the

brokerage houses either open a window or a separate Islamic Brokerage company. DIFS is a

proof that Islamic brokerage houses are commercially viable.

Formation of Islamic Regulatory body that forms rules and regulations & ensure

compliances keeping in mind that country specific financial and economic issues faced by

Pakistan. Currently, the Shariah compliance is based on the regulations of international

Islamic financial institutions.

Islamic banks, financial institutions and scholars should work together to identify the best

practices that should be followed by stock brokers in Islamic stock brokerage houses, or

working in a window in conventional brokerage houses. These may include:

o Adequate human resources with the necessary qualification, expertise and

experience to manage and administer the provision of Islamic stock broking services.

o Independent Shariah Member or Shariah Adviser

o Operations, systems andprocedures comply with Shariahprinciples, and regulations,

and standards

Developing KMI-30 is encouraging. But in order to develop and make a greater impact on

the whole financial system, Islamic brokerage houses require Islamic Exchange which will be

a place where like-minded investors will generate Halal earnings, and the project financers

can generate the equity financing without any doubt and hassle.

Governments should encourage formation of more Islamic Brokerage houses in Pakistan to

ensure that the capital markets of Pakistan are not played with by major Non Shariah

compliant players.


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The existing brokerage house should continuously work hand in hand with scholars to come

up with new ways to facilitate trading for investors and provide health Islamic alternatives

to conventional brokerage houses.


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APPENDIX

Questionnaire

1. What are the differences between conventional brokerage house and Islamic brokerage

house?

2. How did Diyanah come into existence?

3. How is Diyanah different?

4. What services does Diyanah offer to the investors?

5. What is KMI 30 index?

6. What are the implications and feasibilities of having an Islamic window at Karachi Stock

Exchange?

7. What are possible recommendations to improve brokerage services in Pakistan and all

over?


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Bibliography

http://www.difs.com.pk/Knowledge-Center. (n.d.).

Khalid Waheed, C. H. (June 2011). Islamic Stock Broking and Trading. Retrieved from

http://www.islamicfinancenews.com/listing_article_ID.asp?nm_id=22424

Technical Screening Criteria. (n.d.). Retrieved from Dyanah Islamic Financial Services Limited:

http://www.difs.com.pk/Knowledge-Center

What Shariah Experts Say. Option Futures and Swap. (Volume1, April-June 1999). Retrieved

from http://islamic-finance.net/journals/journal1/art4.pdf

http://www.difs.com.pk
http://www.difs.com.pk/http://www.difs.com.pk/http://www.difs.com.pk/

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