Sequelae of the Dow Jones Fatwa and Evolution in Islamic Finance: The Real Estate Investment Example

Abstract

The Dow Jones fatwa of 1998 (one of the most monumental fatawa in the history of modern Islamic finance) sets forth tests for inclusion of equity securities in an Islamic index and, in conjunction, established a series of tests for testing the permissibility of investment under applicable Shari'ah principles. In so doing, it institutionalized certain principles pertaining to (a) permissible variance or permissible impurity in the Shari'ah context, (b) cleansing and purification of impure income (e.g., interest income), and (c) determinations regarding equity investments in entities that conduct some haram or impermissible business activities that do not constitute "core business activities" of the relevant entity and its affiliates.

While still one of the most widely applied tests in the equity investment context, some new indices and equity funds have more recently adopted modified versions of these tests. For example, the availability of operating statement information led to direct consideration of interest income and expense, rather than using the balance sheet tests, set forth in the Dow Jones fatwa, which estimate interest income and expense. As expected, the denominators of these newer tests changed to asset valuation measures or total revenue measures, rather than market capitalization measures. Some equity funds have built upon the permissible variance or impurity principles to further modify the tests to protect certain identifiable industries or circumstances (e.g., the hotel industry or hotels that serve alcohol to non-Muslims).

More broadly, the permissible variance or impurity, cleansing and core business activities principles have been applied in a wide range of different contexts since the Dow Jones fatwa. One such area is real estate investing. These principles have been applied so as to address the conflicts between the Shari'ah principles and various markets realities. For example, under the relevant Shari'ah principles and precepts, tenants in a building owned by Shari'ah-compliant investors must not be involved in impermissible (haram) business activities and leases with those tenants must be Shari'ah compliant. These principles place Islamic finance in a disadvantaged market position, particularly in non-Muslim jurisdictions, as they preclude purchases and ownership of buildings where tenants include ATMs, restaurants serving alcohol, supermarkets that sell pork or beer, financial institutions, non-mutual insurance and a wide range of others. In addition, much of the commercial leasing market involves triple net leases, which are also violative of the Shari'ah.

This paper is a an introductory consideration of the development of the three principles institutionalized in the Dow Jones fatwa as applied to this set of conflicts in Shari'ah-compliant real estate investments.

Keywords: Islamic Finance, fatwa, Shari'ah, Islamic capital markets, capital markets, equity investing, Dow Jones

JEL Classification: E44, F01, F21, F30, G15, G30, K10, K19, K22