FINANCIAL SCREENING COMPARISON

Comparison between the users on the Financial Screening
Unlike conventional and socially responsible investment (SRI) portfolios, Islamic investment portfolios have to comply with certain financial screening criteria. The purpose of the financial screening criteria is to exclude companies with unacceptable levels of conventional debt, liquidity, and interest-based investment. Ideally, according to Islamic principles, companies must not borrow on the basis of interest rate, nor invest in debt-bearing instruments, as well as not generate income through any other Sharīʿah-impermissible activities. However, such restrictions would screen out the vast majority - if not all - of the stocks that are available on the market, even those listed in Islamic countries (Wilson, 2004). This is because contemporary companies tend to have exposure to interest-based finance ‘ribā’ for managing their working capital, as well as for financing the acquisition of fixed assets for expansion and diversification purposes (Khatkhatay and Nisar, 2006 Derigs and Marzban, 2008).

Some Islamic scholars, therefore, demonstrate their understanding of the difficulty by tolerating some financial ratios screening, if the basic business is Sharīʿah-permissible in nature and the exposure to ribā and other impermissible activities is not excessive. They argue that the judgment should be based on the majority since the majority deserves to be treated as the whole of a thing (AAOIFI, 2004). Also, the tolerance and relaxation of the Islamic norms aim to remove the hardship, acknowledging the general need for and widespread practice of interest-based activities which does not necessarily mean the acceptance of ribā or other Sharīʿah-impermissible activities (AAOIFI, 2004). In other words, the reason for such s relaxation is that an individual Muslim investor has no control over the whole business practices of companies that are managed in a non-Islamic manner, it also deals with the fact that fully Sharīʿah-compliant companies are rare (Khatkhatay and Nisar, 2006 and Derigs and Marzban, 2008).

The classification of quantitative criteria set by the users is summarized into three broad categories: 

(1) debt screen; 

(2) liquidity screen; and

(3) interest screen; 

Debt Screen

Debt and interest-bearing debt fall under the debt screen category, and because Islamic finance is based on the idea of risk and profit sharing, interest and principle borrowings and repayments are not Shari'ah-compliant. The degree of debt criterion is checked by all users polled in the study in accordance with Shari'ah standards, it is observed. There appears to be agreement among practitioners to use the benchmark of one-third as the tolerance threshold provided by Quranic understandings. On addition, total assets, market capitalization, and owner's equity are all divisors identified in debt screens used by all users.

Market capital is said to reflect the true value of a company, but because it is influenced by market sentiments, price volatility impacts the threshold value, causing inconsistency when the Shariah-compliant status of listed companies changes over time. As a result, some users feel that using average market capital is a better way to smooth out market price fluctuations,  To eliminate the seasonality effect in the Shariah-compliant status, some practitioners may elect to employ either total assets or market capitalization, In this study, for example, AAOIFI, DJIM, Russel Jadwa uses market capitalization as divisor, while SAC SC, MSCI and FTSE uses total asset as divisors. In summary, it is generally acceptable to have some debt in Shari’ah-compliant business.

Liquidity screen

From a Sharīʿah point of view, liquid assets such as cash and debt must be traded at par (Siddiqi, 2004). Therefore, according to Sharīʿah principles, a company with the majority of its assets comprising of cash or debt cannot be traded, either above or below its book value (Khatkhatay and Nisar, 2006). Thus, requiring a liquidity screening requirement is to avoid investing in companies whose liquid assets are traded at either premium or discount. The thresholds for liquidity screen ratios range from 33 to 70%, indicating that different Shari'ah jurisdictions use different criteria for determining the threshold level for liquidity screens. It can be noted that AAOIFI, MSCI, FTSE, and Russell Jadwa have a larger liquidity tolerance level (50 to 70%) than the others, which are typically set at one-third. In liquidity screens, users commonly utilise total asset, average, or total market capitalisation as the divisor, similar to debt screens. It's worth noting that only DJIM and Russell Jadwa employ total market capital as the liquidity screen divisor.

Interest screen

The purpose of this ratio is to ensure that the investment in interest-bearing securities is at an acceptable level. This is because an interest-based deposits, as well as interest-based securities, such as treasury bills, government and corporate bonds, certificates of deposit (CDs) and preferred stocks, are not Sharīʿah-compliant (Elfakhani et. al., 2005). Also, minimizing the investment in interest-based securities/deposit reduces the income that is generated from ribā (Khatkhatay and Nisar, 2006). Under the category of interest screen, two sets of ratios are classified: (1) interest income; and (2) cash plus interest-bearing securities. Interest income is only screened by SAC SC, and the general consensus is 5 per cent being the maximum threshold limit. Interest revenue or Riba cannot be more than 5 per cent of the total income. A standard benchmark of about 30 to 33 per cent is applied for cash plus interest-bearing securities. The difference between the users is again on the divisor, while cash plus interest-bearing securities use the total assets, average market capital or equity as the divisor, interest income ratio is divided by total income. This may be due to the existence of cash and interest-bearing securities in the balance sheet instead of interest income from the income statement. The nominator and denominator are matched depending on their extraction from the respective financial statements.

CONCLUSION
To conclude, shari'ah stock screening is the backbone of the Islamic capital market. The key to establishing a robust criterion for stocks is to have an efficient and practical Shari'ah screening process, because it is based on this criterion that stocks are classified as Shari'ah-compliant or non-compliant. The more theoretically robust and practically viable the Shari'ah screening criterion is, the more investors, corporations, regulators, and other actors in the Islamic capital market have faith in the market. The two sets of business and financial screens are profiled separately so that the similarities and differences between the two techniques may be easily seen. Some of these practitioners are more detailed in their list of Shari'ah-illegal activities, while others are more comprehensive in their inclusion of additional businesses as allowed.
Today, we can witness a big number of fund managers, banks, and industry participants from many nations relying on market intelligence providers to screen global assets at the macro level because they may not have their own Shari'ah boards and screening techniques.

Quoting Dr. Mohammed Obaidullah of Islamic Research and Training Institute (IRTI), “… screening is a subject matter of continuous change in the light of new insights and that these should not be taken as ‘divine’ rules of Shari’ah compliance…” (Malaysian ICM, 2011). As the legal maxim goes, judgements can alter over time in response to changing demands. In comparison to a regulator screener, whose major purpose is to promote the development of Islamic finance and champion its expansion, a worldwide screener-cum-market intelligence, who has clients with investment principles to fulfil, would have different considerations.

Next, comparison of the issuance process.