How Islamic equity is walking the screening tightrope

Islamic equity screening is at heart of halal investing - it demystifies a permissible stock, shapes how Shariah-compliant funds and indices are constructed, and underpins investor confidence across a global equity market worth around $6 trillion in assets.

At its core, screening occurs at the intersection of Islamic jurisprudence, accounting practices, and market mechanics. While most frameworks share the same foundational principles, differences in interpretation and implementation remain, raising critical questions pertinent to consistency, transparency and the overarching purpose of the underlying investment.

Common ground, diverging interpretation
Globally, Islamic equity screening is governed by a handful of key frameworks including the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in Bahrain and Malaysia’s Securities Commission (SC), as well as rules devised by major stock index providers like S&P Dow Jones, MSCI or FTSE.

Each framework adopts a similar two-pronged approach, which includes business activity filters that exclude impermissible sectors such as gambling, conventional finance, alcohol and pork. It also consists of financial ratio filters that assess a company’s leverage - or the amount of interest-bearing debt versus its equity structure - as well as determinants such as cash in the firm’s conventional accounts, or any accrued impure income. 

“The majority of Shariah screening methodologies, as far as business activity filters are concerned, are largely in conformity,” says Faraz Adam, a Shariah scholar and founder of Amanah Advisors, a UK-headquartered Shariah advisory firm. 

“They are consistent and cover almost all the same sectors and activities.”

However, subtle differences emerge, he notes, in financial filters. “Most standards overlap on key areas such as interest-bearing debt, receivables, and impure income. The main points of divergence tend to appear in the liquidity filter and ratio thresholds.”

For example, MSCI’s Islamic Index Series uses total assets as the denominator for its financial ratios, whereas S&P Dow Jones applies a 24-month average market capitalisation, capping both debt and interest-bearing items at 33% of that base.

Malaysia’s SC adds a 20% benchmark for mixed activities. For example, a hotel is Shariah-compliant but derives minor revenue from non-halal products.

“Most discrepancies come down to methodology and interpretation,” says Saad Malik, co-founder of Zoya, a Shariah-compliant stock-screening app. “The results can vary based on which ratios are used, how they’re calculated, and how certain revenue streams are categorised.”

While the differences may appear to be minor, they can alter a stock’s Shariah-compliance classification - an investable security certified halal by one platform may be shunned by its peer as impermissible, often creating confusion for investors scuttling between platforms. 

According to the London Stock Exchange Group, more than 9,000 stocks have been certified as Shariah-compliant globally after screening over 30,000 listed companies. 

Pragmatism over perfection
One common criticism of Shariah screening that has remained consistent over time is the inclusion of companies that may have indirect exposure or links to impermissible activities or products.

Dr Mohammad Akram Laldin, a Shariah scholar and professor at INCEIF University in Malaysia, argues that such concerns misconstrue the pragmatic spirit of Islamic finance.

“It’s almost impossible to find a company that is 100% halal,” he says. “That’s why scholars have set thresholds for non-permissible income and activities. These parameters reflect a pragmatic, gradual approach. If we restricted ourselves to companies that were perfectly pure, the investable universe would be extremely limited.”

These thresholds should evolve with markets, he adds.

“Ideally, they should remain dynamic, reviewed as the market evolves, so that one day, as more companies align with Shariah [principles], the standards can become even stricter.”

This flexibility is what keeps Islamic investing viable in global capital markets allowing for ijtihad or independent reasoning, while maintaining allegiance to Shariah principles.

Ambiguity, institutional complexity erode sheen 
A key element of Shariah compliance is purification, the cleansing of impure income (such as interest) through charitable donation. But the question of who bears responsibility for purification remains contested.

In practice, some funds purify at the institutional level and disclose the amount per share; others leave it to investors to calculate and donate themselves. Major index providers, like MSCI, incorporate purification into their total-return methodology, while firms like HSBC Asset Management conduct an annual Shariah audit to identify and donate prohibited income to charity.

The challenge is ensuring transparency. As retail participation grows through digital platforms, so does the appetite for information, from Shariah-compliant securities to the management of purification.

For global asset managers, balancing credibility, consistency, and cost is another challenge.

Sefian Kassem, global head of ETF & indexing investment specialists at HSBC Asset Management, says the firm’s suite of Shariah-compliant exchange-traded funds (ETFs) and index funds rely on third-party benchmark indices. And while it is beneficial to have standards, they must be legally and commercially viable, too.

“Global standards are helpful as baselines,” he says. “But the flexibility to apply local standards is important because Shariah boards in different jurisdictions can apply different standards according to local preferences.”

Furthermore, rules for managing a company’s transition from Shariah complaint to non-compliant and vice versa exist, too. “These are embedded within the index methodology and are ratified by both the relevant index providers’ Shariah board and HSBC's Shariah board,” he says. 

Active managers also face their own hurdles. Monem Salam of Saturna Capital says data gaps often make Shariah screening more art than science. “Often companies don’t report interest income or other metrics required for screening.”

“As active managers, we can usually work backwards from public accounts, but this is more difficult for passive managers,” adds Salam. 

Active asset management focuses on outperforming a benchmark such as the S&P 500 Index, with managers actively choosing investments. Conversely, passive management aims to match the market’s returns by replicating it. 

Restoring investor confidence
For all its progress, one of the greatest Shariah screening challenges remains that of trust and comprehension.

“Better understanding of portfolio construction by fund managers and investors would help the industry move forward,” Rizwan Malik, head of Islamic Finance Centre at Bahrain Institute of Banking and Finance tells Salaam Gateway. 

“More importantly engagement between fund managers and underlying companies should increase thereby making the data more accessible.”

Others see the diversity of approaches as a reflection of Islam’s intellectual richness and tradition. 

“Differences are not a weakness,” adds Zoya’s Malik. “They show that Shariah finance is living and adaptive.”