July 24, 2024

Understanding Shariah Compliant Indexing

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Research and Insights

Maaqil Bhoyroo

Equity Index Product, Middle East & Africa

Islamic finance is a rapidly developing sector, servicing a global and growing Muslim population of over 2bn people.

With over US$4.5trn in assets, Islamic finance represents only one percent of the conventional financial system and is forecast to grow at double-digit rates over the coming years. This fast rate of expansion reflects the growing demand from an increasingly savings-rich client base and the increasing sophistication of Islamic financial and investment products.

In this paper, we introduce the central ideas of Islamic finance, before looking at recent market trends and noting the role of the UK and the London Stock Exchange Group (LSEG) in this important industry. We then explore the ways Islamic equity and bond indices are constructed, using the FTSE Russell benchmark range, including those we run in partnership with our Shariah screening partners.

A recent report by LSEG and the Islamic Corporation for the development of the private sector (ICD) showed how Islamic finance assets have grown steadily since 2015 across all the market segments. With the everchanging macro-economic environment, we also offer some insight into what the markets might hold for Islamic finance over the short/medium term, and whether the prevailing environment is one of growth or contraction.

Key takeaways:

Islamic finance is growing at a rapid pace and is forecast to reach $7trn in assets by 2027
The UK is a hub for Islamic finance and LSEG is heavily involved in this area
FTSE Russell offers Shariah-compliant equity and bond indices to a growing number of clients

Points of differentiation:

$90bn+ has been raised through over 110 Sukuk issuances since 2015 on the London Stock Exchange
LSEG is home to 8 Islamic ETPs with orderbook value traded of over £52m in 2023
FTSE Russell works with external Shariah screening specialists to develop solutions

What does our research mean for investors? 

By reading this paper, investors will gain a better understanding of the main principles of Islamic finance and how they are applied in equity and bond indices.

Islamic finance (also known as Shariah compliant finance) is finance that conforms to the moral precepts of Islam.

Islamic finance differs from conventional (Western) finance in its approach to money: it is based on the belief that money doesn’t have any intrinsic value. Instead, according to Islamic scholars, money should be seen just as a medium for exchanging products and services. Linked to this idea is a ban in Islamic finance on making money from money in the form of interest.

Islamic finance also prohibits investment in goods or services seen as harmful. This prohibition covers activities such as the production and sale of alcohol, tobacco and gambling.

Another principle in Islamic finance is that of partnership between the provider of finance and the entity receiving it. This means that the profits and risks of a business venture should be shared as far as possible, rather than one party claiming most or all of the upside or bearing the full risk of loss. In the Islamic finance partnership, losses and profits are often shared according to a pre-agreed ratio.

Activities seen as permissible and desirable within Islamic finance are called ‘halal’ and those seen as prohibited are called ‘haram’. These interpretations are made by Islamic scholars on the basis of three primary sources: the Qur’an, the Hadith (the sayings of the Prophet Muhammad) and the Sunnah (the practice and traditions of the Prophet Muhammad).
The UK’s financial markets play a prominent role in this industry. According to TheCityUK, the UK is one of the leading centres for Islamic finance outside the Muslim world.

This hub includes a vibrant Shariah-compliant banking sector, with four Islamic banks authorised to operate in the UK. The UK is also a key venue for the issuance of Sukuk, with more than $50bn raised through 68 Sukuk issues on the London Stock Exchange between 2015 and 2021.

The UK is a leading centre of Islamic finance education and training, with four internationally recognised professional institutions offering qualifications and certifications in the subject.

London is home to over 200 international law firms, and TheCityUK estimated in 2022 that at least 16 of these firms have dedicated Islamic finance sections. The majority of cross-border Islamic contracts are governed by English law.

The London Stock Exchange Group (LSEG) plays a prominent role in the Islamic finance sector through its dedicated Sukuk and Islamic funds platforms.

FTSE Russell, the LSEG subsidiary that produces, maintains, licenses and markets indices, has a rapidly growing range of Islamic equity and bond indices, which are described in further detail in this paper.