126 Islamic Finance in Practice
The basic methodology of ensuring business and financial compliance may
seem simple at first glance. However, on closer examination, several critical
issues crop up. The first issue is of business classification. The broad category
of prohibited categories is clear. However, corporations are complex entities
and engage in a diverse variety of activities. For this purpose there are two
classification systems that can be used. One is the standard industry
classification (SIC) codes, the other one is the international business
classification(IBC) code.
SIC codes are much more detailed and delve into several layers of
corporations’ activities. Thus, an individual company may have up to eight
SIC codes associated with its activities. IBC codes are much more general
and focus on the core businesses of corporations.
With the help of some examples it is possible to outline the complex
process that needs to be in place to keep the screens current and up-to-date.
For the purposes of determining whether the proportion of unacceptable
activities is under 5 per cent, SIC codes seem to provide greater robustness.
However, aggregation of activities by their associated SIC codes are not free
of issues. As an example, a SIC code could beassignedtolivestockproduction,
but it would be difficult to determine whether this includes pig farming or
other disallowed activity. This would have to be determined byactual contact
with the corporation concerned. Similarly, production of beverages presents
a host of issues, including the possible production or otherwise of alcoholic
drinks.
At another level, business compliance also involves some decisions to be
made by principles. Thus, a company specializing inconventional financial
industry publications is a case in point. Does this activity constitute a part
of the conventional finance category or the more neutral category of
publishing? If we adopt the latter option, then what classification would we
give to a company manufacturing gaming machines? As one ploughs through
the possible investable stock universe, a multitude of such issues needs to
be addressed. In many cases, detailed discussions with Shari’a scholars are
needed to come to a decision.
Even after these deliberations, it may not be possible to verify if over 95
per cent of any corporations’ revenue comes from compliant activities. In
many cases, data is simply not available. In others, data may be available,
but not from published sources. In either case, a direct engagement with the
corporation is called for. For a large universe, this activity can be quite
expensive. However, principle companies are excluded from screened
universes if satisfactory data is not available. They are only screened back
in once satisfactorydata becomes available.Financial compliance
For financial ratios, gearing levels, receivables and interest income are
material. Typically, gearing would have to be les than 33 per cent; cash and