By Maria Trombly | Securities Industry News | June 6, 2005

What exactly is a shari'a-compliant security and how does it differ from the usual kind?

At the Forum for Developing Markets held by the World Federation of Exchanges last week in Beijing, Securities Industry News posed this question to the heads of exchanges in several Muslim countries.

One main principle, they agreed, was that the underlying company must not engage in un-Islamic businesses--such as owning a chain of bars where alcohol is served. But there's more to it than that.

Zaha Rina Zahari, CEO of RHB Securities in Kuala Lumpur and a former regulator in Malaysia, explained some of the details.

Riba: Interest

A shari'a-compliant security must not pay exorbitant interest. How much is exorbitant? That depends on the country. But it's possible to structure loans so that no interest at all is involved. For example, in the case of a home mortgage, the bank would retain ownership of the property. That way, the risk that the price will go down is shared by the bank and the borrower. In the U.S., by comparison, the homebuyer bears the valuation risk and the bank gets paid regardless.

It's not just a matter of semantics, Zahari said. A shari'a-compliant security has to be structured so that interest isn't collected on low-risk investments.

"The risk allocation is different," she said. "In Islamic finance, risk is more of a level playing field."

Gharar: Uncertainty

Under the prohibition against uncertainty, most derivatives products are not allowed, said Zahari. "Al Gharar is defined as speculative risk on instruments that could not be quantitatively defined," she said. "However, there is some flexibility in the interpretation of this."

Maisir: Gambling

The prohibition against gambling requires complete transparency in the financial product, Zahari said.

Alternative Financing Strategies

Alternative investments that do not violate shari'a rules include partnerships, profit-sharing agreements, deferred payments, and leasing agreements, Zaharia said.