The potential of attracting Shariah-compliant investors to the Pakistan Stock Exchange (PSX) was witnessed once again with massive participation in Pakistan’s first listed government Ijarah Sukuk issuance.
Against the auction target of Rs30 billion set by the Ministry of Finance, the bids received from retail and institutional investors were over Rs396.2 billion and the maiden auction was 13 times oversubscribed.
It is interesting to note that the government was able to attract one-year investors at 2.5% below the policy rate of 22% and even 1% below the minimum deposit rate prescribed by the State Bank of Pakistan (SBP) for conventional banks on saving accounts.
This massive participation even at lower rates reflects the preference of the market for Shariah-compliant instruments combined with the assurance of halal returns. Moreover, it will further help the government to benefit from Sukuk issuance at lower rates as compared to conventional options.
The keen interest in the listed Sukuk reflects the opportunities available for the development of Shariah-compliant instruments. If this demand is tapped with the right solutions, the liquidity available with investors looking for interest-free and halal returns can be used for the benefit of the economy and lowering the government’s financial burden.
The landmark Sukuk transaction and increased coordination among capital market infrastructure institutions, including the PSX, National Clearing Company of Pakistan Limited and Central Depository Company (CDC) with the active support of SECP are very positive signs for further development of Islamic capital markets in the country.
With the recent federal government and central bank decisions to convert to an Islamic financial system by December 2027 and with the strategy to gradually phase out conventional banking, many corporate entities are now exploring conversion to Islamic financing and looking at capital markets for their financial needs.
Against the backdrop of recent market developments, a golden opportunity knocks at our doors to develop Islamic capital markets and target Shariah-compliant retail investors to come at the PSX. This step will not only increase the investor base but will also be helpful for companies looking to raise capital.
According to data from the SECP Capital Market Development Plan Report, only 210,000 retail investors have a trading account at the PSX while the number of active investors is estimated at around 100,000. One of the reasons for this low investor enthusiasm is apprehension amongst the general public regarding the Shariah permissibility of stock market investment.
Due to the current market practices, the perception that stock market investments are based on speculation, market features like short selling and interest-based borrowing, Shariah non-compliance status of the trading process like day trade and futures trade, and lack of clarity about the Shariah-compliance level of the listed scrips, many Shariah scholars tend to advise the general public to stay away from the stock market.
It is now time that focused efforts are made to develop and launch a dedicated Islamic trading counter at the PSX so it can attract genuine investors that are not interested in speculation but want to trade and invest in a Shariah-compliant manner and want to stay away from the legacy practices that are in conflict with the religious guidelines.
At present, the PSX features two Shariah-compliant indices namely the KMI-30 Index and the All Share KMI Index that are recomposed every six months and include companies that qualify for the Shariah-compliant screening criteria.
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As per the latest available re-composition data for June 2023 at the PSX website, 251 listed companies are declared compliant and investors looking to invest in Shariah-compliant shares can invest in these scrips.
Proposed Islamic counter
An Islamic trading counter at a stock exchange can be developed where investment in shares and their sale/purchase is undertaken under Shariah guidelines. This entails that all the mechanisms, rules and settlement methods would be designed as per the Islamic commercial law.
Such a counter has several salient features that are lacking in the current trade counter of the exchange. The Shariah-compliant counter will allow investors to deal only in the shares that are Shariah-compliant and are listed in Islamic indices. These shares are required to pass the screening criteria as defined by the PSX and recently notified by the SECP.
It means that shares of companies where the nature of business is non-compliant cannot be traded including conventional banks, insurance firms, wine manufacturers, etc and similarly the companies that have a high conventional leverage or have significant non-compliant earnings will be screened out.
Settlement and delivery mechanism
At the PSX, at present if an investor buys a share today, it is normally settled and delivered in the investor’s CDC account on a T+2 basis ie, the share is delivered on the third day of trade. Hence, at present, the Shariah-compliant investor has to wait for two days to get the delivery and then he is entitled to sell it further.
This restriction is based on a well-known rule of the Islamic law that it is impermissible to sell anything before the possession of the subject matter. Shariah-compliant investors are, therefore, exposed to price risk for two days in an excessively volatile market and some investors due to the lack of understanding enter into same-day trade as well.
For the Islamic counter, it is suggested to have real-time settlement and immediate transfer to the investor’s CDC account. From a technology point of view, this is an achievable task, however, it would require a buyer to have a pre-funded account before entering a purchase deal.
This step will also enable an investor to execute same-day sales while following Shariah guidelines related to possession.
Restriction on speculation
Another important feature of the Islamic trading counter is that it would not allow speculation (short selling) as selling anything that is not under the possession of the seller is prohibited in Islam.
Furthermore, future sales, sale of letters of rights, and pre-IPO trade would also be restricted for the investors. These prohibitions will help to control speculation and unwarranted volatility, once these stocks are traded under an Islamic trade counter.
For share financing, the investors trading on the Islamic counter will be allowed to avail of Murabaha-based financing options, however, interest-based margin financing or lending will not be allowed.
The proposed Islamic trading counter can bring great benefits to the PSX and the economy at large, with the inclusion of more retail investors and an increase in market liquidity. This could also provide investment opportunities to global investors who are looking for ethical and Shariah-compliant options.
The writer is the Director, IBA Centre for Excellence in Islamic Finance
Published in The Express Tribune, December 18th, 2023.
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