8th August 2016 was the date the Employee Provident Funds (EPF) in Malaysia announced the opening of its registration counters to move t he existing funds into Shariah-compliant Employee Provident funds.

The response was monumental where people came to line up to register since 7 am and lines can be seen snaking out of the offices. People had to come personally to sign the conversion form (which includes Agency appointments as part of the Aqad) and agree to the terms. There’s great relief that finally there is a Shariah compliant fund for contributors, although it will not happen immediately. Conversion starts 1 January 2017.

As to date, about 45,000 people have signed the conversion.

But many questions still arise from whether EPF will really pull it off. As usual, the suspicions and sarcasms arise on the whole process of “complying with Shariah” and what is required. The common questions are whether they have the infrastructure to manage such a big fund in an Islamic market which is perceived to be not that huge. Can it support the whole fund, or will any excess funds not invested in Islamic instruments “flow” back to the mixed market?

I am sure EPF have able fund managers. But I am surprised to hear questions whether EPF is really going “Islamic” or just another ploy to hoodwink the public. Questions such as, do they really know which company is Shariah compliant, are the Shariah Advisors reliable, do they just advice or do they have any authority or power to influence the investment strategies of EPF to comply. Can we trust them?

Before I write further, I have to say that the Shariah Advisory Committee of EPF consist of 5 heavyweights in the industry. Dr Aznan, Dr Akram, Dr Zahar, Dr Engku and Dr Kamaruzaman. Someone implied that they will eventually cave in to organisational pressure when “tough investment decisions” have to be made, but this comment do not fully appreciate the role of SAC in any Islamic Financial institutions. The SAC has a huge responsibility to ensure the operations of the funds are Shariah compliant, the income is Shariah compliant, and the distribution of dividends are Shariah compliant. Consistently. Continuously. Automatically.

So what is the process that usually happens in an Islamic Financial Institution (IFI)? How influential are the SAC to the operations of an IFI? I cannot fully vouch for EPF but the governance framework should be consistent throughout the industry. The following is what usually happens in the process of determining Shariah compliance investments for EPF to enter into, and the control processes to ensure it remains Shairah compliant.

Shariah Compliant Investment Selection, Deployment, and Dividend Distribution.

In general, the SAC and IFI must start to build a framework that meets the Shariah rules to invest and deploy these Islamic funds. The following steps usually applies:

1. The IFI first start identifying Shariah compliant counters, companies and investments that meets the criteria set by the SAC. There are several benchmark in the market that guides these criteria such as the Securities Commission criteria for Shariah Compliant Companies, BNM listing of Shariah Prohibited Activities, or even using the Accepted Bills-i which lists non-Shariah compliant goods (if a company trades in these goods). Based on the above, the benchmark of what is acceptable is decided by SAC. Deliberated and discussed. SAC will also decide whether to follow market benchmark or adopt a more stricter stance than the market.
2. For mixed counters or companies, SAC will also decide on an acceptable benchmarks. For example, companies which has more than 5% clearly non-Shariah compliant activities are excluded from the “approved” listing. If the activities are not clearly identifiable, the “unidentifiable” activities should not be more than 20% of all the company’s activities. Different IFI adopts different benchmarks. Looking at EPF SAC, it is likely the benchmarks are stricter.
3. An Investment Mandate, based on the rules defined by SAC above is then formulated to outline the type of acceptable counters/companies/investment, the deployment strategy, the monitoring and reporting requirements, escalation processes, calculation and declaration of income, distribution of dividends and finally the financial disclosures.
4. The Investment Mandate should be guiding instructions for Treasury to follow in managing the funds. Based on the mandate, Treasury finds the companies/counters/investments that meet the criteria and manage the funds accordingly.
5. The list of the investments / companies are reviewed regularly to ensure they still remain as Shariah compliant throughout the investment period. Any companies that fall out of the criteria will be removed from the lists. Any non-compliant incidences will be escalated to the SAC.
6. On an interim basis, Internal Audit (reporting to Board of Directors) and Shariah Review (reporting to SAC) will do their periodic audits to ensure that the Shariah parameters are always met and adhered to. Any incidences of non-Shariah compliant investments will be tabled to SAC for a decision. The decision will be whether to exit the investment, make rectification, or worse case scenario, deem the investment non-Compliant and remove the dividends received from the pool and pay them out to charity.
7. At the end of the investment period (declaration dates), the SAC will look at the financial results, the investments made, the exclusion of non-Shariah compliant income/dividend, and overall operations of the funds. Once satisfied, the SAC signs off and income/dividend may then be distributed.

In short, the SAC not only outline the mandate for Shariah compliant investments, they are also responsible in the various aspects of the management of the funds to ensure what is paid out are “clean” dividends not tarnished by non-Shariah compliant components. There is a huge responsibility for the SAC towards the general public who rely on them to formulate the right investment mandate for them. I don’t envy such position; the burden is great but I have to say EPF had it right by appointing such heavyweights to their SAC.

May Islamic EPF continue to be a choice that is taken by the public. Wallahualam

For a full collection of the videos on Shariah Compliant EPF, click on this link: EPF-I http://www.kwsp.gov.my/shariah/videos.html