[TYPE THE COMPANY NAME]

Islamic Brokerage and Trading Houses

Islamic Banking and Finance Term Report
1/18/2013

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

Islamic Brokerage and Trading Houses

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 procedure through 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:

Islamic Brokerage and Trading Houses

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 of them.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 BROKERAGE HOUSE

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.

Islamic Brokerage and Trading Houses

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 a comprehensive 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 stocks to 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.

Islamic Brokerage and Trading Houses

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.

Islamic Brokerage and Trading Houses

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

Islamic Brokerage and Trading Houses

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 in Islamic 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.

Islamic Brokerage and Trading Houses

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 on the 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 of gharar (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)

Islamic Brokerage and Trading Houses

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 to buy 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 and an 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 of gharar(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:

(Technical Screening Criteria)

Islamic Brokerage and Trading Houses

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 Karachi Stock 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 KMI30 Index.

Shariah Compliance Scripts are those which have been filtered by Shariah Screening criteria3, 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

Islamic Brokerage and Trading Houses

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.

Islamic Brokerage and Trading Houses

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 Islamic Brokerage 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 the best 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 fully committed 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.

Islamic Brokerage and Trading Houses

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:

Islamic Brokerage and Trading Houses

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 as short 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

Islamic Brokerage and Trading Houses

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 will be 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

Islamic Brokerage and Trading Houses

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 to the 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.

Islamic Brokerage and Trading Houses

CONCLUSION

Islamic Brokerage and Trading Houses

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 graduates should 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.

Islamic Brokerage and Trading Houses

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.

Islamic Brokerage and Trading Houses

Islamic Brokerage and Trading Houses

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?

Islamic Brokerage and Trading Houses

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