Shariah RFP M3 common mistakes
Shariah RFP M3 · Understand the traps and how to avoid them.
Approving a structure because every step carries a recognised Arabic contract name - murabaha, ijarah, tawarruq - without tracing the order of events, who owns the asset at each point, and who bears destruction and credit risk.
Candidates learn contracts as vocabulary lists, so a scenario that uses familiar names feels correct even when the sequence is scrambled (asset sold before the institution owns it, a penalty retained as income, a guaranteed amount paid against a money advance). The item is testing sequencing, not naming.
What to do instead
Before answering, sketch the timeline: who owns the asset, from when, who bears risk of loss or destruction, and where money and asset actually move. Flag any step where the seller sells what it does not yet own, where a lender receives any increment, or where a 'profit' is contractually fixed against an advance of money regardless of the asset. Answer from the timeline, then attach contract names.
Treating one approval as portable: citing a local regulator's Shariah-compliant securities list for a foreign or unlisted instrument, or assuming a fund registered with a regulator has therefore been Shariah-certified.
Two separate gates look like one gate. The compliance list is a periodic snapshot with a defined scope (securities listed on that exchange, revised roughly semi-annually), and regulatory registration is a disclosure and governance test, not a fatwa. Candidates under time pressure grab the most familiar authority.
What to do instead
Always state the scope and date of the authority relied on. For locally listed equities, cite the Shariah advisory council list and its latest review date. For foreign, unlisted, private or structured instruments, require the product's own Shariah adviser approval or run your own screening under a named standard and document the conclusion.
Runs the screening arithmetic on headline figures - total reported revenue, total debt from the latest balance sheet - without decomposing revenue by segment and without checking which denominator the chosen standard actually specifies.
Standards differ: non-permissible revenue is commonly tested at 5% of revenue or income, while leverage is tested against market capitalisation in some methodologies and total assets in others, at thresholds around 30–33%. The arithmetic looks right, so nothing signals an error, and a conglomerate whose 'core' business is logistics but whose finance arm earns interest passes unchallenged.
What to do instead
Name the standard before computing, then apply its business-activity test, revenue purification ratio, leverage ratio and non-permissible investment test using that standard's own denominators end to end. Read the segment note, and where segment data is unavailable, say so and mark the stock for review rather than treating the headline number as clean.
Answers risk and return questions from the label 'sukuk' alone - describing every sukuk as profit-and-loss-sharing, or every sukuk as a bond equivalent - without identifying the underlying contract or whether the structure is asset-based or asset-backed.
'Sukuk = Islamic bond' is a convenient shortcut that survives basic study, but sukuk is a wrapper: the payoff comes from ijarah rentals, murabaha receivables, wakala or mudaraba, and a purchase undertaking can convert an apparently shared-risk structure into fixed, credit-like cash flows.
What to do instead
For each sukuk, state four things: the underlying contract, asset-based versus asset-backed, whether a purchase undertaking exists and at what price, and who bears loss if the asset is destroyed. Asset-based sukuk with a face-value undertaking at maturity behave like unsecured credit and should be described as such; note that undertaking-at-face-value is contested among scholars rather than settled.
Builds a Shariah portfolio by running a conventional model portfolio through a screen and deleting the failures, leaving weights that pile into two or three sectors and a single sukuk issuer, then presents it as diversified.
Screening is treated as a filter rather than a reconstruction. The exclusion set removes whole ballast sectors - conventional banks, insurers, alcohol, gambling, tobacco, interest-based media - so surviving names concentrate in technology, telecoms, healthcare and energy, and the residual weights drift upward without anyone deciding they should.
What to do instead
Re-weight after screening rather than before. Set explicit sector and single-issuer caps, add sukuk, gold or commodity-murabaha exposure for diversification, and state openly in the rationale that the constrained universe raises concentration. Measure and disclose the concentration (top-holding and sector shares) instead of letting it sit implicitly in the weights.
Places the client's cash buffer in a commodity murabaha or tawarruq deposit and then describes it in the liquidity plan as cash-equivalent and risk-free.
The instrument is marketed alongside cash and settles quickly, so the label carries over. The tawarruq mechanics (genuine commodity purchase and sale sequence, ownership before onward sale) and the fact that the return depends on the arranging institution's credit and willingness to roll are invisible in a one-line product description.
What to do instead
Classify it as an unsecured exposure to the arranging institution with rollover and commodity-sequence risk. Size it against the client's counterparty limits, stagger maturities to reduce rollover dependence, confirm the commodity trading documentation supports true ownership and sale, and never count it as risk-free in risk or return calculations.
Measures a Shariah portfolio against a conventional index and computes risk-adjusted return using a conventional interest rate as the risk-free rate, then reports the resulting shortfall as manager underperformance.
Default systems, data feeds and report templates are conventional, and the gap created by screening - excluded sectors, purification drag, timing of forced disposals after a compliance review - is never separated from genuine skill or market movement, so the comparison is unfair and unexplained.
What to do instead
Use a Shariah index or a custom screened composite as the primary benchmark, disclose the conventional index only as secondary context, and use a sukuk yield or an Islamic interbank rate as the risk-free proxy while stating that it is a proxy, not a true risk-free asset. Decompose the performance gap into sector exclusion, screening drift and purification drag.
Reports portfolio or fund return gross of purification and compares it directly with a conventional peer, or swings the other way and deducts zakat in the fund return line as though it were a manager expense.
Purification and zakat are treated as afterthoughts because they sit outside conventional performance reporting. Candidates also mix the bases: purification applied to the whole dividend rather than to the impure revenue share, purification applied to capital gains, or zakat assumed to be a fund-level cost.
What to do instead
Compute purification as the non-permissible revenue ratio multiplied by the dividend actually received, show it as a separate deduction beneath gross return, and do not purify capital gains under the majority view. Treat zakat as the client's own obligation (commonly 2.5% of zakatable assets held for a lunar year, subject to the nisab) and disclose it in the advice rather than embedding it in performance.
Completes the fact-find with risk tolerance, horizon, liquidity and return objective but never asks about zakat obligations, an existing conventional mortgage or insurance policy, tolerance for purification, or whether the client wants stricter screening than the minimum standard.
The template is inherited from conventional practice, where these fields do not exist, and candidates assume the Shariah constraint is a product-selection issue rather than a client-constraint issue. The result is a portfolio that is technically compliant but conflicts with the client's actual religious and financial position.
What to do instead
Add Shariah-specific fields: zakat liability and how the client handles it, existing conventional debt and takaful cover, appetite for purification, and the preferred screening standard or strictness (for example avoiding mixed-activity names entirely). Record the chosen standard and the purification and zakat arrangements in the investment policy statement as agreed constraints, and confirm the client has read them.
Issues the advice document with a generic past-performance disclaimer but no reference to the Shariah adviser's approval, fatwa or standard version used, no record of when the portfolio was last re-screened, and no client acknowledgement of purification and zakat responsibilities.
Compliance templates are copied from conventional advice packs and the Shariah trail is assumed to sit with the product provider. When a holding later fails a periodic review, there is nothing in the file showing what standard was applied, when it was checked, or what the client was told would happen on a forced disposal.
What to do instead
Use a Shariah documentation checklist for every file: the standard and version applied, the adviser or board approval and its date, the date of the latest screening or compliance review, the agreed treatment of impure income and forced disposals, the client's signed acknowledgement of purification and zakat duties, and the date the next review is due.