A VERY ENJOYABLE (AND INFORMATIVE ARTICLE)...PLEASE READ

As I was doing some work, I came across an article written by Dr. Husain Shahata (a professor in Al-Azhar University) on “The International Financial System Crisis in the Perspective of the Islamic Economy”. I read the articles 3 times because the paper was presented in a simple and easy-to-understand way with no big financial jargons that could confuse a normal layman – this is good because economic crisis is the “in thing” now where even the man on the street is all ears when it comes to talking about “ECONOMY”…

His introduction to the article is very catchy and it could just grasp the attention of anyone (yours truly, included) and it’s the painful truth…"The economists of the man-made economy have predicted the collapse signs of the socialist economic system because of its concepts & principles which contradict the human nature and conflict with the Islamic rules & regulations. Similarly, the economists of the capitalist economic system have predicted the collapse signs thereof because of its concepts & principles which contradict the orders of Allah The Almighty and undermines the values & morals. It is relies upon the monopoly and the usury interests (Credit and loans against interest) which are the most vicious evil in the Earth and the motive behind worshipping money, controlling the borrowers by the lenders, restricting their freedom, stealing their business & homes and causing dangerous social & economic effects.”

He further explained the aspects of the international financial system crisis and derived a statement – “The right diagnosis of the crisis is the master key for finding the right remedy”.

So, what is the right diagnosis? Have all the economists in the world been so wrong?

Well, according to the author, famous economists worldwide, including winners of Nobel Prize like Maurice Allias said: The capitalist economy system is depending on certain concepts and rules which are the main cause of its collapse if not amended immediately.

A real shocker, huh? Or maybe, not.

The authors stated 7 reasons for the current crisis :

First: The economic morals corruption such as: monopoly, deception, the fabricated rumors, lies, fraud, exploitation and the delusive transactions which all caused injustice treatment by the wealthy people and creditors against the poor and debtors. This injustice will make the wronged people complain from injustice and the creditors will complain from debtors and the result will be social revolutions when they refrain from repaying their debts and loans.

Second: Money became the substance of tyranny and the weapon of the tyrants for controlling policies and taking the sovereign decisions in the world to the degree that the materialists became worshippers of money.

Third: The usury banking system relies on the interest rate system and operates within the frame of dealing, trading, purchasing and selling of debts. Whenever the interest rate of the deposit increases, the interest rate of the loans given to individuals and companies will increase similarly and all of this will benefit the banks and financial brokers while the borrowers will suffer injustice in paying the loans taken by them for the purpose of consumption or production. Some economists, like Adam Smith, the father of economists, said: "The real development and the rational use of the production factors will not be achieved unless the interest rate became nil" and they considered the alternative method is the system of sharing profits and losses because it enhance stability and security. They further said: "The interest rate system will make the money goes to the hands of small group of people who will control the wealth totally".

Fourth: The traditional financial and banking system relies on the method of scheduling the debts against a higher interest rate or replacing the due loans with new ones of higher interest rate, exactly like what the Arab before Islam was saying: (Pay now or increase the interest rate). This process will cause additional liabilities on the borrowers who were unable to repay the first loan due to the higher rate of interest.

Fifth: The international financial system and the financial markets system are mainly depending on the financial derivates system which, in turn, depends on delusive transactions which, in turn, depend on probabilities & possibilities i.e. there are no true exchange of goods and services, it is just gambling and betting. Not only this, some of these transactions are depending on credits taken from the banks in the form of loans which can lead to a financial crisis in case of loss.

Sixth: The bad manners of the financial brokerage institutions which induce people to take loans, deceive them and exploit their ignorance to take loans from the financial institutions. They request high commissions if the risks were high and the borrower alone will bear the adverse consequences thereof and this ultimately will lead to the financial crisis.

Seventh: The expansions in applying the credit cards system (Overdraft) which caused high financial liabilities on the users who will bear higher interest rates if he could not repay the debt until he is put to jail, mortgage his car or house. This is exactly what happened to many holders of such cards, caused them confusions in the budget of their homes, and led finally to a crisis in certain usury banks.

There’s more of the article than what have been reproduced above. I highly recommend the article – it is one of the most enjoyable read I’ve had this week. The author really save the best piece of the article for last, i.e., in his conclusion :

To the people who are confused in their life, straying in darkness of the nights, hurry up to Islam again.

To those who wish to reform society and get rid of its problems, difficulties and rescue it, hurry up to Islam.

To those who are standing at the door of reform and hesitant about the right way to be taken, hurry up to Islam.

To those who were confused with means and lost their aims, hurry up to Islam, it is the right way.

To those who spent their life in fruitless experiments under the instructions of hesitant minds and confused thinking, hurry up to Islam.

To those sincere & faithful people, hurry up to Islam.

"ALLAHU AKBAR"

CONVENTIONAL VERSUS ISLAMIC ETF

Exchange Traded Funds (ETFs) have emerged in 1993 in the US originally to provide a more efficient way for investors to track equity markets. In view of the increasing complexity of financial markets, investors resort to look for dynamic and innovative investment instruments that could be used to diversify their portfolio and ETF becomes an immediate attraction due to its feature that combines many of the best characteristics of stocks and mutual funds.

Several definitions of an ETF are as follows :

a) ETFs are index funds that trade on a stock exchange. Like a mutual fund, they represent a collection of stocks, but unlike a mutual fund, they trade throughout the day like a stock. This is similar to a closed-end fund, but unlike a closed-end fund, ETFs do not have a limited number of shares and they trade very close to their underlying net asset value

b) ETFs invest in a group of stocks or bonds or other instruments which track the performance of an index. ETFs are listed and traded on a stock exchange

c) An ETF is a pooled investment whose value is linked to an index which itself is based on a basket of assets. The index may be based on equity markets, specific sectors, bonds, commodities or even currencies, allowing a great diversity of investment opportunities

Most ETFs are passively managed index funds although there is ongoing work being done to create enhanced and actively managed ETFs. In the managing of index funds passively, managers do not pick stocks based on fundamental analysis. Instead, managers aim to track the performance of a benchmark index.

At the end of May 2009, the Global ETF industry had 1,660 ETFs with 3,008 listings, assets of US$775.20 billion, from 90 providers on 42 exchanges around the world (Barclays Global Investors, May 2009).

So what about Islamic ETF? Well, let us see….

The methodologies used by index providers to create appropriate Shariah compliant indices have shown all the main indices have broadly similar methodologies regarding business activity screening, financial ratio screening and dividend purification. Thus, these new indices have allowed investors to follow equity markets in a way that is consistent with their underlying Shariah principles and rigorous in its structure and methodology. Shariah complaint indexes give investors exposure to an index based on a screening and selection process, which combines the index design with Islamic principles. Investors are able to access a market segment that is in line with Islamic rules and way of life.

The Dow Jones Islamic Market (DJIM) Index was introduced in 1999 as the first index intended to measure the global universe of investable equities that pass screens for Shariah compliance and most importantly, the Dow Jones financial ratios have been accepted by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). The DJIM’s Shariah Advisory Committee comprised of the following scholars :

a) Shaykh Abdul Sattar Abu Ghuddah (Syria)

Dr. Abu Ghuddah is a senior Shar’ah Advisor to Albaraka Investment Co. of Saudi Arabia. He holds a PhD in Islamic Law. Dr. Abu Ghuddah has published many books on Islamic Financial transactions. He was an advisor for Islamic Law Encyclopeadia (Kuwait Awqaf Ministry). Dr. Abu Ghuddah is a member and chairman of several reputed Islamic Shariah Boards.

b) Shaykh Nizam Yaquby (Bahrain)

Mr. Yaquby is a member of the Islamic supervisory boards for several Islamic institutions, including the Arab Islamic Bank and the Abu Dhabi Islamic Bank. His work has appeared in the following publications: Risalah Fi al–Tawbah, Qurrat al–’Ainayn fi Fada il Birr al–Walidayn, Irshad al–’Uqala’ila Hukun al–Qira’h min al–Mushaf fi al–Salah, Tahqia al–Amal fi Ikhraj Zakat al–Fitr bi al–Mal.

c) Shaykh Dr. Mohamed A. Elgari (Saudi Arabia)

Dr. Elgari is an associate professor of Islamic Economics and the director of the Center for Research in Islamic Economics at King Abdulaziz University in Saudi Arabia. He is an expert at the Islamic Jurisprudence Academy (OIC), Economics. He is also an advisor to several Islamic financial institutions worldwide and the author of many books on Islamic banking.

d) Shaykh Yusuf Talal DeLorenzo (United States)

Mr. DeLorenzo is considered a leading Islamic scholar in the United States. He has translated over twenty books from Arabic, Persian, and Urdu for publication in English and has been commissioned to prepare a new translation of the Quran. Mr. DeLorenzo compiled the first English translation of legal rulings issued by Shariah supervisory boards on the operations of Islamic banks. since 1989, Mr. DeLorenzo has served as secretary of the Fiqh Council of North America. He is also a Shariah consultant to several Islamic financial institutions and was an advisor on Islamic education to the government of Pakistan.

e) Shaykh Dr. Mohd Daud Bakar (Malaysia)

Dr. Bakar is currently a member of the Shariah Advisory Council of many financial institutions in Malaysia and around the world, including the Central Bank of Malaysia, Securities Commission of Malaysia, International Islamic Financial Market in Bahrain, Accounting and Auditing Organization for Islamic Financial Institutions in Bahrain and HSBC (Malaysia).

The prospects for Islamic ETFs are bright as there is a shortage of good Islamic investment instruments to cater for the rising global demand for such products. An Islamic ETF only tracks an Islamic benchmark index where the index constituents comprise of companies which are Shariah compliant. On 22 January 2008, Malaysia launched the region’s first Shariah compliant ETF.

A LITTLE INTRODUCTION ON STRUCTURED INVESTMENT PRODUCTS

The range of structured investment products available on the market has increased enormously in recent years. The market growth has been mainly investor-driven.

Islamic investment emerged as a response to rising investor demand in the Middle East in the 1970s and is now growing at an estimated annual rate of 15%. Over the years, liberalization of state policies in most Middle East and South East Asian countries have benefited the institutions; Islamic investment has also allegedly further developed in the wake of socially responsible investment and a revival of Islamic ideology as applied to investment ethics.

A structured investment product has no particular definition and generally, it involves the combination of various legal structures to achieve a certain solution or products matching investors’ requirements. Structured investment products are designed to facilitate highly customized risk-return objectives and used most often to protect principal, enhance returns and more closely align the investment with the investor's market and economic views. The ultimate goal is to develop an investment with a better risk-return outcome than its original underlying market exposure.

Structured investment products help investors pursue diversified portfolios without the complex credit, legal and operational issues that surround the execution of derivative strategies; address various market conditions and risk management objectives, e.g., protection, optimization, enhancing returns and leverage.

The range of structured investment products available is extensive. Most structured investment products fall into one of the four basic categories, ranging from relatively conservative investments to those that offer greater potential returns while taking on more risk, which are :

1) Principal protection

Principal protected structured products may be more appropriate for conservative investors seeking market exposure with principal preservation. A principal protected investment may be appropriate for investors unwilling to risk their principal or who have long-term financial obligations. These investors are willing to forgo some upside potential or yield in exchange for principal protection at maturity. These investments generally offer a return at maturity linked to an underlying such as a broad-based equity index or a qualified basket of stocks. Investors typically give up a portion of the equity appreciation in exchange for principal protection. Maturities often range from five to seven years, and clients should intend to hold the investments to maturity.

2) Enhanced yield

Enhanced yield structures may be appropriate for more risk tolerant investors seeking higher returns than comparable debt instruments. Payment at maturity on investments is determined by the performance of an underlying asset or group of assets and principal may be at risk. Here, investors generally forfeit partial or full principal protection at maturity in exchange for the potential to earn a higher participation. In exchange for accepting full downside exposure in the underlying, an enhanced yield investment offers double or triple the equity returns up to pre-specified maximum. Therefore, investors can be exposed to downside risk and may lose part or all of their original investment. Additionally, investors may receive shares of stock at a value below the original principal amount at maturity. Coupon payments and payment at maturity is subject to the credit risk of the issuer.

3) Access

Structured investment products can provide investors with access to an asset or group of assets not readily available to private investors. These products can offer exposure to markets or strategies that may be inefficient or difficult for investors to obtain, such as foreign exchange rates or commodities. Since these products may not provide for full repayment of principal at maturity and are typically linked to sophisticated underlying assets, they may be more appropriate for moderate to aggressive investors.

4) Leverage

Structured products that utilize leverage may be generally more appropriate for aggressive investors wanting to capitalize on a particular market view. These short term products provide partial or no principal protection but do offer the potential to receive leveraged returns on the value of the underlying asset. Some structures may offer additional leverage in exchange for capped or limited upside potential. Investors are exposed to downside risk of the underlying investment and may lose part or all of their original investment.

Islam encourages people to take business risks in return of reward and also encourages the earning of income rather than leaving funds inactive (which is the foundation of the legal maxim, al-ghorm bil ghonm). Since structured investment product, by its nature, is something that can deliver diverse risky cash flows to investors, it is a huge business. Thus, the Islamic structurers are also looking for ways to deliver the same cash flows, by using Islamic investment structured products to the Shariah-conscious Muslim investors. The main challenge for banks lies in structuring products in a Shariah compliant way, that requires strong innovation capabilities as well as a robust infrastructure to satisfy risk management and booking requirements of such investments.

In Malaysia, the first Shariah compliant structure was approved by the Securities Commission in 2006 and to-date, more than RM23 billion has been approved, where majority of the Islamic structured investment products are linked to performance of equities, profit rates, foreign exchange rates and fixed income instruments.

Usually, structured investment products need to be “wrapped” so that it could be used to create securities, making it legal and tax efficient. The same applies to Islamic structured investment products, where “wrapping” is necessary to make the product Shariah compliant.

Another pertinent fact to consider when structuring Islamic financial products is that not only must the desired payout profiles with their risk-return features be optimised, but strict care must be taken to ensure that the tripartite harmony with Shariah is observed, which means that the following three elements must all conform with Shariah, i.e.:

a) underlying

b) trading mechanism or investment strategy

c) packaging structure

In Malaysia, the regulatory requirements for issuance of Islamic investment structured products are clearly spelt out in the Bank Negara Malaysia and Securities Commission of Malaysia. Islamic products need to comply with the general regulatory requirements which include requirement for disclosures, suitability and fair dealing requirements and rating requirements; and most importantly, to adhere to the Shariah specific requirements.

The future looks bright for Islamic structured investment products. Financial institutions in countries such as Bahrain, the United Arab Emirates and Malaysia have been gearing up for more Shariah compliant financial instruments and structured finance, both on the asset and liability sides.

Shariah compliant products have long been treated as “Muslim only,” however, such perceptions no longer carry any weight as leading financial centres located in “non-Muslim” soils, e.g., Hong Kong, London, New York and Singapore, are making significant progress in establishing the legal and prudential foundations to accommodate Islamic finance side by side with the conventional financial system.