Discover our complete guide to Shariah Compliant Investment, it’s key principles and how it works in practice within the social investment sector.
What is Shariah Compliant Investing?
Shariah Compliant Investing is a type of investment that must follow Islamic Law. It is known as socially responsible investing due to the specific requirement to access the fund that complies with Islamic principles. As charging interest is prohibited, Islamic banks agree to a certain amount of profit or loss from the business.
Like most social investments, a shariah compliant social investment fund will care about both financial return and social impact created for beneficiaries. They will also need to adhere to Sharia Law (Islamic law), which means this type of fund needs to be managed within the core principles of Islamic Faith.
In this blog, we’ll go into the key principles and benefits of Sharia Compliant Investing as well as some examples of how this works in practice within social investment.
Key Principles of Shariah Compliant Investing
1. Prohibition of Riba (interest or cost of capital)
Riba is the Islamic term for interest which is prohibited in Shariah Compliant Investing. This is a fundamental principle of the investment practice and in basic terms means that Muslims are encouraged to avoid any kind of investment deals that involve paying or receiving interest as part of the financial terms.
2. Avoidance of Haram
Haram is an Arabic term in Islam that describes anything that is ‘forbidden, inviolable or sacred’ according to Shariah Law. In relation to social investment, this specifically refers to interest-bearing financial agreements, but could also cover any loans/investments into sectors that cover forbidden activities, including gambling, alcohol, weaponry and some meat-based trading.
3. Socially Responsible Investments
Shariah Complaint Investing lends itself to social investment because of the emphasis placed on the social impact delivered to beneficiaries by the investment, alongside any kind of financial return. Any kind of repayable finance will need to be able to plan, measure and communicate the impact they deliver to attract individuals looking to invest in accordance to these principles.
4. Transparency and Fairness
For repayable finance to be Halal (permissible) for investors and beneficiaries, transparency and fairness must be evident throughout every stage of the investment process. We would expect this already from social investors, but in some cases, organisations may need to make fundamental changes to their operation so as to remain compliant, particularly around sharing cost of capital rates.
As with many things, there’s no one-size-fits-all when it comes to Shariah Compliant Investing, and some of the above will be open to interpretation. It is important to remember that people will have different approaches and relationship regards to their faith, so investors should not assume and rather have conversations on a case-to-case basis.
Benefits of Shariah Compliant Investment
By its very nature, social investment adopts Mudarabah, which means that profits, losses and risk is split across stakeholders. Risk sharing also promotes the Islamic value of ‘togetherness’ as both parties carry risk, this protects them both from one of the parties gaining at the cost of someone else.
Shariah compliant investing is designed for the prevention of social harm and the protection of the individual, for example lending money at high rates of interest is impermissible due to the risks of debt, inflation and monopolising investment in the benefit of high-end investors.
Challenges of Shariah Compliant Investment
Whilst Shariah investing grows in popularity, it is still not considered a mainstream form of investment, and it’s lacking in public exposure and specific regulation in some areas.
Shariah investing still presents challenges, and some of the requirements could translate to fewer investment choices.
Despite these limitations, Shariah compliant investment is constantly growing with more organisations considering it by the day. the rapid growth it has experienced is undeniable within the UK, especially London, which is recognised as the hub for Islamic Finance in the West.
Common Misconceptions
Misconception #1 - Shariah Compliant investing is for only muslims
Shariah compliant investing is exclusive to Muslims. In reality, its ethical focus attracts both Muslims and non-Muslims
Misconception #2 - Islamic finance is not concerned about profit
Some have this misconception that islamic investors are only 'charitably led' and are not concerend about returns. However, much like social investors the truth is that islamic finance takes both the profit aspect and social return into account.
Decoding Shariah Compliant Investing Jargon
It's no secret that jargon, buzzwords and acronyms aplenty can be found within the wonderful world of social investment. Here's some of the key terms related to shariah compliant investing defined in easy-understand, jargon-free language to help you to better understand this space.
Riba
The islamic term for interest which is prohibited in Islamic/Shariah compliant financing.
Husna
Simply defined, this is a godly loan. You borrow and reutnr the same amount of money, meaning no one is increasing their wealth through interest earned on the investment
Mudharabah
Widely known as a profit-sharing contract where one party provides funds to another party that provides management expertise in return. The profits are then shared between two parties.
Ujrah
Fee paid to an agent or third party for their services within the creation of a financial investment arrangement
Wakalah
Is a contract between an agent and principal. This contract enables the agent to render services and be paid a fee (Ujrah). This type of agreement enables the pooling off investors into a yield sharing structure.
Sukuk
Is a certifcate of investment that represents a portion of ownership, in a portfolio of eligble existing or future assets. This is also commonly referred to as "sharia compliant" bonds.
To read through more complex social investment terms click here to visit our jargon buster.
Hungry for more?
For you podcast listeners out there, tune in as Richard Thickepenny discusses an ethical and innovative shariah- compliant financing model, which is being used to purchase propertise to house refugees. An interesting and unique approach to the way social investment can help improve lives across the UK.
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