Exchange-traded funds (ETFs) were launched in the early 1990s, combining the features of mutual funds and shares. In their 25-year history, ETFs have become one of the fastest-growing segments of the investment management business. ETFs are a listed index-tracking fund whose primary objective is to achieve the returns that correspond to the performance of a particular index. Conventional ETFs are subject to a number of non-Shariah compliant issues. The equities held in an ETF are not screened for Shariah compliance. Therefore, the core business activity as well as the financial ratios are at high risk of non-Shariah compliance. Conventional ETFs regularly practice securities lending, which accrue interest. Synthetic ETFs use conventional swap agreements which contravene Shariah principles from various dimensions. Thus, a Shariah compliant ETF must undergo Shariah screening of its business activity as well as its financial ratios. In terms of tracking, a Shariah compliant ETF should only track an Islamic index. In addition, the constituents making up the Islamic ETF must be lawful assets. Lastly, a Shariah Supervisory Board will also need to be established to ensure Shariah compliance.
The full paper along with other research papers of Mufti Faraz Adam can be downloaded from the following link:
https://shariyah.com/insights-research/