NEWHORIZON

NEWHORIZON April to June 2013
POINT OF VIEW
various ‘cleansing’ or ‘purification’
mechanisms that are operative
upon and after the occurrence
of the equity investment and are
designed to address subsequent
impure consequences (e.g., interest
income, which is cleansed through
donation to charity).
The DJIMI Fatwa established
two sets of tests to determine
the permissibility of the equity
investment (see Figure 1). The
first test had two branches: (a)
whether the subject security is
itself impermissible because, say,
it is a fixed income instrument
(such as preferred stock) with
an impermissibly stipulated or
guaranteed return; and (b) whether
the ‘core’ business of the subject
entity (as opposed to ‘any’ business)
is halal and impermissible (because
it entails dealings in alcohol,
tobacco, pork products, interestbased
financial services, non-takaful
insurance, defence and weapons,
casinos/gambling, pornography,
or other inappropriate elements).
If those threshold tests do not
preclude investment, the inquiry
turns to whether the entity has
an impermissible degree of riba
or haram income as determined
pursuant to a series of financial
tests that are summarised in Figure
1.
The DJIMI Fatwa institutionalised
the principle that some degree
of impermissibility or impurity is
permitted in defined circumstances:
an entity may have a degree of
interest income or expense, for
example. However, that impurity
must be ‘cleansed’ or ‘purified’
where possible.
The basis for evolution and
development of the variance,
purification and core business
concepts was laid down in the
DJIMI Fatwa itself. The DJIMI
Fatwa mandated a periodic and
continuous review process to
ensure ongoing compliance and,
in connection with each financial
test, emphasised that more precise
tests must be adopted if they
become available and that Shari’ah
compliance must be measured
using the most accurate tests
available from time to time.
Evolutionary Application in
Real Estate Investing
To set the stage for examining
the evolution of the DJIMI
Fatwa concepts, the basic
principles are that (a) tenants in
a building owned or controlled
by a Shari’ah-compliant company
cannot conduct business activities
that are not compliant with the
Shari’ah and (b) the occupational
tenant leases for that building
must be Shari’ah compliant.
The tenant business activities
requirement profoundly influenced
the development of Shari’ahcompliant
real estate investments
in the early years. Thus, for
example, from 1998 to 2002
the focus was on investments
in residential properties, in part
because this eliminated the need to
test tenant business activities (and
in part because of the growth in
the residential property markets at
the time). The business activities
requirement was also a strong
influence in shaping the first
Shari’ah-compliant commercial real
estate funds around 2000-2002. In
the early years, those funds focused
on single tenant properties so as
to minimise business activities
concerns and associated due
diligence costs.
As the Shari’ah-compliant real
estate sector began to grow (and it
grew rapidly), and began to focus
on multi-tenant and mixed use
properties, there was progressive
implementation, and evolution, of
the permissible variance, cleansing
and core business concepts in two
areas: tenant business activities
analysis; and tenant lease analysis.
This occurred in three situations:
(a) a compliant business activity
conducted by the tenant at the
leased property where that tenant,
as a larger entity, also conducted
non-compliant business activities at
other locations; (b) a non-compliant
activity conducted at the leased
property; and (c) non-compliant
tenant leases for the leased property.
In this context, it is important to
note that the DJIMI Fatwa and
subsequent fatwa have focused on
the ‘core’ business activities tests
rather than each and every business
activity of a prospective tenant: the
business activities at the property
must be Shari’ah compliant, at least
to the extent of the permissible
variance parameters, and the
‘core’ business of the tenant and
its corporate group must be in
compliant activities. Purification
and cleansing tests have been utilised
to address allowable impermissible
non-interest business activity income
derived from real estate investments,
with an outside tolerance collar (of,
say, 5%).
An early example of non-compliant
activity involved the acquisition of
a large commercial property that
had only one non-compliant tenant,
an automatic teller machine (ATM)
owned and operated by an interestbased
bank. The relevant Shari’ah
Board undertook a careful factual
inquiry and determined that, among
other factors, the square footage
and proportionate rent of the ATM
space was minimal relative to the
entirety, there were no Islamic banks
as alternatives, and the business
conducted at the ATM was primarily
non-commercial. The acquisition of
the building and the presence of the
ATM, were permitted. The number
and variety of scenarios involving
non-compliant tenants expanded
quickly and commensurately with
the expansion of Shari’ah-compliant
real estate investments. Consider, as
examples, supermarkets selling pork
and/or alcohol products, restaurants
serving alcohol, the check clearing
operations of an interest-based bank,
and the back-office operations of
insurance companies as but a few of
the myriad of factual scenarios that
have been considered.
www.islamic-banking.com IIBI 13