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The Securities and Exchange Commission of Sri Lanka has adopted a unique two-tier screening methodology for Shari’ah-compliant securities to standardize whitelist publishing across the local capital market. The framework mandates qualitative business activity assessments alongside quantitative financial ratio benchmarks, including limits on impermissible income, interest-bearing borrowings, and illiquid assets. Additionally, the directive requires bi-annual whitelist publications and dividend purification advice endorsed by SEC-accredited scholars, with the methodology subject to revision every three years.
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Shari’ah Compliant Securities Screening Methodology Introduction The Colombo Stock Exchange (CSE) has 284 companies representing 20 GICS industry groups as of 28th June 2024, with a Market Capitalization of Rs. 4,760.00Bn. Investors who are based on Islamic faith, can invest in such companies provided that it meets Shari’ah requirements. There are several Shari’ah screening standards such as AAOIFI, FTSE- Global Shari’ah, S&P 500 Shariah Index, and Dow Jones, which are globally accepted. However, considering that Sri Lanka is a relatively small market and adaptable to external factors, it is felt that a unique Shari’ah screening standard that suits the Sri Lankan capital market would be developed. This may help to standardize the process and make it uniform methodology among all the whitelist publishers in the country. Thus, Securities and Exchange Commission (SEC) of Sri Lanka, has accredited Six (6) scholars to oversee Shari’ah-related matters related to the Capital market in Sri Lanka. The following method is reviewed and recommended to the SEC by the six accredited scholars as the most suitable technique to execute the screening for the Sri Lankan market. Proposed Methodology The accredited scholars by the SEC adopt that Each security (Ordinary Share) shall undergo a two-tier screening of qualitative and quantitative approach, which applies the business activity benchmarks and the financial ratio benchmarks, in determining the Shari’ah status of the listed securities. Hence, the securities will be classified as Shari’ah-compliant if their business activities and financial ratios are below these benchmarks. A. Qualitative Screening (Business Activity Benchmarks) Any company that is mainly involved in the following core business activities is considered impermissible and therefore would not qualify under the whitelist.
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B. Quantitative Screening (Financial Ratio Benchmarks) For the financial ratio benchmarks, the six accredited scholars by the SEC considers the following:
i. Impermissible Income
Impermissible Income/ Total Income < 5%
Impermissible Income includes income from gambling, income from interest based transactions, income from Gharar (Uncertainty) based transactions i.e. derivatives, insurance claim 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 Shari’ah Non-Compliant due to non-compliance to any of the mentioned criteria for Shari’ah Compliance etc. Elimination of Impermissible Income of < 5% It is important for the investors to ensure the Elimination of impermissible income (Purification). It has two elements. Impermissible income in a) Dividend Distributed and b) Capital Gain. The following formula/ ratio shall be adhered to compute the purification amount for Dividend Distributed. Purification Amount = (Total Dividend Received / Number of Shares Owned * Percentage of Impermissible Income)
ii. Interest Bearing Borrowings
Interest Bearing Borrowings/ Total Assets or Market Capitalization < 33% (whichever is higher) Debt only includes interest-bearing debt whereas Islamic financing or sukuk is excluded from the calculation. Interest-bearing borrowings, in this case, is classified as any interest-bearing debt including Bonds, TFCs, Commercial Paper, Conventional Bank Loans, Finance Lease, Hire Purchase, issuing preference shares etc.
iii. Impermissible Investment
Impermissible Investment or deposit / Total Asset < 33% Impermissible Investments, include investments in conventional mutual funds, conventional money market instruments, Commercial Paper, interest bearing bank deposits, Bonds, PIBs, FIB, T-Bills, CoIs, CoDs, TFCs, DSCs, NSS, derivatives etc.
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iv. Liquidity Ratio
Illiquid Asset/Total Asset < 70%
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Source: Securities and Exchange Commission of Sri Lanka — original document · Summary generated with machine assistance and reviewed before publication; the authoritative text is the regulator's original document. How RegAlert works
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