As per world bank rankings on financial inclusion, Pakistan ranks poorly at 136 out of 158 countries. According to data from the Securities and Exchange Commission of Pakistan, from the Capital Market Development Plan Report, only 210,000 retail investors have a trading account on the Pakistan Stock Exchange (PSX). The number of active investors in PSX is around 100,000. This accounts for less than 0.1 per cent of the population.

In comparison, other regional markets have far higher participant levels. Bangladesh stock market has 2.7 million retail investors participating, Malaysia Stock Market has 2.5m retail investors, Thailand has 1.46m and India has a much larger retail investor base of 32m. Even Sri Lanka which only has a population of 21m has 630,000 retail investors.

One of the reasons for this low investor participation is the lack of information regarding stock market investment avenues and apprehension amongst the general public regarding the Sharia-permissibility of stock market investments. Due to the general perception that stock market investments are often based on speculation, the apprehensions regarding market manipulation, and market features like short-sell and margin borrowing raise doubt regarding the Sharia compliance status of the trading process. Often the lack of clarity amongst the investors regarding the business model and Sharia-compliance level of the listed scrips induces many Sharia scholars to advise the general public to stay away from stock market investments.

One of the ways in which this can be solved is via the development of a Sharia-compliant trade counter at the Pakistan Stock Exchange which would streamline the trade process in an approved Sharia-compliant manner, resulting in increased investor confidence and investor information, while providing ease of mind and confidence regarding the soundness of stock market investments in the light of Sharia principles.

Sharia-compliant stocks represent 56pc of the market capitalisation and average trade volume of the PSX’s business, which represents a significant chunk of overall listed equity investments in the country

To date, many steps have been taken by the PSX to address this perception issue by incorporating measures that help sharia-compliant investments via the stock market.

KMI-all share index and KMI-30 index, are the two indices that provide a universe of sharia-compliant stocks for investment, screened as per the KMI sharia-compliance screening criteria. Moreover, the first Sharia-compliant exchange-traded fund (ETF), Meezan Pakistan ETF, was launched in 2020, which tracks Sharia-compliant securities with higher market capitalisation.

The PSX has also issued notices to listed companies to ensure that they make all relevant disclosures required for Sharia screening and those disclosures have also been mandated under the Companies Act,2017. All these steps have helped provide a platform for investors to undertake investments in Sharia-compliant securities with ease. In light of these, the PSX bagged the Best Islamic Stock Exchange Award 2021 by Global Islamic Finance Awards, since more than 50pc of the listed securities on PSX are shariah-compliant.

However, other than security selection the trading process apprehension remains unaddressed and many investors remain unaware of the possibility and ways to undertake Sharia-compliant stock market investments in Pakistan. Therefore, to further facilitate investors in Sharia-compliant securities, a Sharia-compliant trade mechanism is the next needed step.

As per our analysis of the last three years’ data of the PSX, the all-share index and the KMI-all-share index (illustrated in the table), the Sharia-compliant stocks represent 56pc of the market capitalisation and average trade volume of the PSX’s business, which represents a significant chunk of overall listed equity investments in the country.

Moreover, Sharia-compliant stocks’ annualised three-year-growth rate has been significantly higher than the overall listed equity universe of PSX, while as compared to the growth differential between the two indices, the trade volume has been comparatively lower for KMI-All.

One reason is the lack of an Islamic trading counter on PSX, due to which the general public who wishes to directly invest in Sharia-compliant stocks, in a Sharia-compliant manner, is unable to do so.

At a total of Rs17.6 billion, 2021 has been a year of record-sized initial public offerings (IPO). Of the five IPOs last year, four of them (worth Rs11.2bn) were Sharia-compliant scrips as Islamic banks were amongst their bankers-to-the-issue. This also signals high public demand for Sharia-compliant investments.

With recent government efforts to channel foreign investments towards Pakistani capital markets, funds have been flowing into PSX via Roshan Digital Account (RDA) holders. A sizeable number of RDA holders of Meezan bank, requested a Sharia-compliant trading facility, because of which Meezan Bank had to ask specific brokers to maintain a system adhering to Sharia-trade rules, particularly for their customers.

Moreover, since 40pc of mutual fund assets in Pakistan are managed by Sharia-compliant mutual funds, the proposed Islamic counter can help improve their liquidity and returns by facilitating immediate trade, controlling volatility and helping to reduce trade costs.

Ahmed Ali Siddiqui, Director, Centre for Excellence in Islamic Finance, IBA.
Maryam Tariq, research associate

Published in Dawn, The Business and Finance Weekly, April 18th, 2022