A renowned Shari’a-compliant equity fund that sits inside workplace pension schemes across the UK recently came under scrutiny for holdings most of its backers would never have expected.

Sitting inside the portfolio were companies with deep, well-documented ties to military and defense programmes: firms supplying components used in missile systems, data and surveillance platforms deployed in military operations.

These holdings had apparently cleared the fund’s Shari’a screening process. None of them had done anything wrong. At least, not on paper.

That’s the part worth pondering over. The investment itself did not constitute a compliance failure in the conventional sense. No step omitted, no rule misapplied. The fund did exactly what its screening methodology mandated it to. The problem, then, is not the fund. It is the screening methodology.

Most Shari’a equity screening today, including the methodology that traces back to AAOIFI standards, works by assessing a company’s business activities against a defined list of prohibited sectors (alcohol, gambling, pork, conventional banking and insurance, among others), alongside a set of financial ratios on debt and interest income.

Weapons and defence manufacturing has never made it that list, nor has the technology supporting “war-related missions”, as we saw in this particular case. The fund did not, in this instance, omit a step or misapply a rule. There was no injunction to exclude these investments in the first place.

What this tells us is that Shari’a compliance, in its current form, measures a company’s classification, not its conduct. The two may be mistaken for one and the same. They are not.

A company could be correctly classified and still engage in activities no reasonable interpretation of Islamic jurisprudence would permit. Yet the filtering process has no way of flagging it, since doing so was never part of its original remit.

I don’t consider it as a cause for alarm for the entire Islamic finance ecosystem. I don’t think the solution lies in jettisoning quantitative screening either, which to date, continues to operate as the only functional baseline.

But with a growing and mature Islamic finance audience, this scrutiny does offer a useful prompt to ask the right questions pertinent to the screening process, its original mandate and whether it continues to achieve what it was designed to.

Outstanding Sukuk exceeded $1 trillion last year, with an increasing share of capital flowing into Shari’a-compliant products and structures from investors seeking a conscious pledge conventional index funds do not provide.

More so and contrary to popular belief, there is a growing cohort of conscious investors outside the original Muslim pool, that have sought an ethical filter for years. One they can truly rely on.

The value of that ’ethical & compliant’ label is as good as its underlying screening process. Each incident chips away at that trust, regardless of the fund’s yield or the intent of those who run it. If Islamic finance is to grow the way it has been envisaged, the screening standard needs to keep up with the scrutiny that growth invites.

Classical Islamic jurisprudence has always distinguished a rule from a principle it exists to serve. The rule is the instrument. The principle is usually described through concepts like Maslaha, the public interest, and the broader Maqasid al-Shari’a, the objectives Islamic law exists to protect.

A quantitative screen is a rule and must not be misconstrued as a representation of the entire compliance architecture.

Sustainable solutions

It is not pragmatic for every Shari’a board to second-guess portfolio holdings on a granular level. What is possible though is to strengthen the existing quantitative screening process.

In simple terms, the screening process is the default gate-keeping exercise – fast, mechanical and auditable, as is required by global indexes to track funds effectively.

The screening process should be complimented by a qualitative review that serves as the final checkpoint and is integrated into the fund’s existing lifecycle. This layered approach will help identify cases where a company’s classification meets the criteria, but its conduct does not.

Take surveillance technology and military data contracts. If weapons and defence manufacturing were added to the prohibited list, a company supplying data and intelligence infrastructure behind military operations wouldn’t necessarily be filtered out, because it isn’t manufacturing anything. It’s selling software and AI models.

A purpose-driven reading of Islamic principles would struggle to let it pass. These are precisely the kinds of checks and balances that a qualitative review will serve to provide.

The wider investment world has already had a version of this conversation, from which we can draw useful parallels.

Sustainability thinking was built around three P’s: People, Planet and Profit. During a panel discussion at the Islamic Finance Conference held at the Harvard University last month, Rushdi Siddiqui, co-founder of the Capital Formation Institute in Islamic Markets, made a viable point that a fourth P – Purpose – deserves a seat at the table.

I think this accession is long overdue in the Islamic finance industry. A filtering process that examines a company’s business activities, without delving into its purpose, is doing only half its job.

Shari’a compliance was never meant to be a box-ticking exercise. It was meant to be a discipline that kept wealth generation aligned with a set of values.

Reintroducing purpose into the screening process is not a departure from the tradition that underpins it. It is a return to it.

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