Taint of controversy

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An embarrassing and potentially damaging controversy is emerging in Islamic equity funds. Because of the way the vast majority have been handled by mainstream brokers, many may not be as Shariah-compliant as investing customers would expect.
Many Islamic equity funds are managed by conventional asset managers that may operate a large number of funds, of which only a few are marketed as Shariah-compliant. There will be overlap between the stocks held in the Shariah-compliant funds and the other funds.
If the fund manager trades through an omnibus account with a broker, there may be little or no security that non-compliant stocks don't end up in the Islamic account. If it does happen and is spotted, the stock would have to be sold but the revenue would be unclean.
Also, margin financing is likely to be done conventionally for all stocks traded by the broker for the manager. Because of related interest charges this would not be Shariah-compliant.

The source of the funding, from a conventional broker that makes a high proportion of its income from interest would also be unclean. And if the fund manager fails to pay the broker on time it will incur interest charges.
Nothing is more damaging for an Islamic finance product than to be deemed not in accordance with religious law.
This June, RHB Securities, a leading Malaysian brokerage, launched the first dedicated Islamic institutional brokerage after deciding that it was otherwise unable to guarantee that none of these potential problems were materializing.
"Two parallel blood streams are needed," says Chrisanne Chin, head of dealing at RHB Securities. "It's the only way to guarantee that everything remains separate."
RHB's move alerted Securities Commission Malaysia to the problem and other Malaysian institutions have followed suit. CIMB will soon launch its own separately capitalized Islamic brokerage, which will provide Shariah-compliant margin financing. In the UK, Fyshe-Creststar has also launched an Islamic brokerage product.
This is not a problem unique to Malaysia. "It's absolutely unfathomable to think that they wouldn't try to cut corners," says a leading expert on Islamic equity funds of conventional asset managers that are marketing Islamic funds. "In Malaysia the fund sponsors and the fund managers tend to be the same institutions but in the Gulf the banks act only as gatherers of assets because they're not competent enough to manage them themselves," he says. "It may be difficult to monitor the separation and almost impossible to check. This is a problem that has to be addressed."

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Abigail Hofman:

Taint of controversy

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