Creation of an Islamic stock index in West Africa

Accepted Manuscript Title: Creation of an Islamic stock index in West Africa Author: Mohamed Lamine Mbengue PII: DOI: Reference: S0275-5319(17)30183-6 http://dx.doi.org/doi:10.1016/j.ribaf.2017.04.017 RIBAF 633 To appear in: Research in International Business and Finance Received date: Revised date: Accepted date: 11-3-2017 6-4-2017 7-4-2017 Please cite this article as: Mbengue, M.L.,Creation of an Islamic stock index in West Africa, Research in International Business and Finance (2017), http://dx.doi.org/10.1016/j.ribaf.2017.04.017 This is a PDF file of an unedited manuscript that has been accepted for publication. As a service to our customers we are providing this early version of the manuscript. The manuscript will undergo copyediting, typesetting, and review of the resulting proof before it is published in its final form. Please note that during the production process errors may be discovered which could affect the content, and all legal disclaimers that apply to the journal pertain. t us cr ip Creation of an Islamic stock index in West Africa: Ac ce pt e d M an Mohamed Lamine Mbengue Professor Assistant Gaston Berger University Saint-Louis-Senegal Tel +221771870302 Page 1 of 9 Creation of an Islamic stock index in West Africa Introduction West Africa’s specificity in Islamic finance is mainly due to the big Muslim community. This Community represents more than 119 million believers, almost 51% us cr ip t of the population of the area (WAEMU1, Ghana, and Nigeria). This is a major element in the development of Islamic finance within the Economic Community of West African States (ECOWAS) 2 . Islam is a religion practiced in Africa since the 11th century and sub-Saharan Africa has now more than 250 million Muslims. Most of them live in West Africa and according to previsions in 2030, this region will have more than 257 million Muslims or 67% of its population. an By 2050, Nigeria will be the third most populous country in the world and eventually will surpass Indonesia as the first Muslim country in the world. The creation of an Islamic index in West Africa will attract international funds (British, American and M Emirati) which are specialized in the acquisition of Shariah compatible Islamic instruments. In order to take full advantage of this opportunity, the creation of a d compatible Shariah stock index would be an asset to enhance competitiveness and contribute to the integration process of ECOWAS capital markets. pt e The Islamic index in West Africa may encourage African fund managers to market "Shariah compatible" investment products. The main objective is to build an Islamic stock index in West Africa. ce The rest of the paper is structured as follows. First we will describe the methodology for constructing and calculating the Islamic index of West Africa. Finally, we will present Ac the results. I. Creation and composition of the Islamic Index To select the compatible Shariah stocks which compose the West African Islamic Index, we use companies which compose the following indices, WAEMU (BRVM10, BRVM composite,) Ghana (GSE Financial stock index) and Nigeria All Shares Index). 1 West African economic and monetary union (WAEMU) including eight countries: Benin, Burkina Faso, Côte d’Ivoire, Guinea Mali, Niger, Senegal, Togo. 2 ECOWAS includes 15 countries: Benin, Burkina Faso, Cap Vert, Côte d’Ivoire, the Gambia, Ghana, Guinea, Bissau Guinea, Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leone, Togo. Page 2 of 9 We use the S&P methodology guide which consists of selecting securities according to industry sector using the screening system. I.1. Creation of the Islamic Index The Shariah Board plays a very important role at this level. It is comprised by Shariah t scholars who are Ulemas (scholars) with very specific theological, legal and financial us cr ip knowledge, recognized internationally. - The various steps of Islamic screening It is up to the Shariah scholars to carry out screening of values in accordance with the Muslim law principles. There are two types of screening: sectoral (or extra-financial) screening and financial screening. an - Sectoral screening It consists of removing from the index companies which are in the following sectors: alcohol, tobacco, pig industry, non-Islamic banking and financial services, - Financial screening M entertainment (hotels, casinos / gambling, Cinema, pornography, music, etc.). d The financial screnning uses a series of ratios and the respect of criteria helps integrate pt e the Shariah compatible index. According to Derigs and Marzban (2008), El Kamilichi (2014) quantitative screens differ from one Islamic index to another and do not make the Shariah Board unanimity; they are only doors of tolerance. Screens are: the level of debts, receivables and interest-bearing securities. Violation of one of these levels results ce in the company exclusion from the index. The methodology adopted is that proposed by Standard & Poor's, which sets the tolerance thresholds. Ac R1 = Total Debts / Trailing 36 month average Market Capitalization <33%. R2 = Total cash and interest-bearing securities / Trailing 36 month average market capitalization <33%, R3 = Total receivables / Trailing 36 month average market capitalization average of 36 months <49%. However the index would gain credibility with 33% because the methodology is more restrictive. For Peillex and Rangau (2012), this less liquid index would be the price to get a Shariah credible index. 2 Page 3 of 9 The use of market capitalization according to Pok (2012) by DJMI and S&P would reflect the true value of the company and erase the encountered seasonal effects when total asset are preferred. The results of Peillex and Rangau (2015) show that the choice of market capitalization to measure the company's value systematically contributes to ousting more companies than when total asset are preferred. t The Shariah scholars have established this ratio which must be less than 33% as a result us cr ip of a collective intellectual effort (Ijtihad). In order to select the "Shariah Compatible" stocks that could comprise the ECOWAS Islamic market Index (BRVM, Ghana, Nigeria), we use the following indices: NSE, BRVM 10 Composite BRVM, Ghana Stock exchange composite, in total the three stock exchanges Have a total of 273 companies, respectively (189) for Nigeria Stock Exchange, (37) for the BRVM and (40) for the Ghana Stock Exchange. an 1.2 Index calculation The three BRVM, GSE, NSE stock exchanges use the market capitalization weighting, M which is also used by most international indices. The weighting method used to calculate the Islamic index of West Africa is the weighting by floating capitalizations with a cap of the securities’ weight. The floating is the fraction of the capital available d to the public allowing to take only the part of the capital that can be effectively pt e exchanged. This passage to free float which is adopted by the three stock exchanges allows to ensure a better coherence between the stock market reality of a security and its weight in the index, but also to limit the volatility caused by the imbalance between the ce weight of a value in the Index and the share of floating capital. A 20% capping factor is used to avoid overweighting a value and to ensure a good representativeness of the Ac sample. The formula for calculating the index is as follows: with 1000. ∑ ∶ free float factor of the value i in t ; float shares of the value i in t ; total shares of the value i in t ; free float , / ; number of free ∶ capping factor of the value i in t; : the value of i in t; : number of ∶ basic capitalization; : adjustment coefficient in t. For the various screening steps as part of our study, we need to know the financial statements for the three financial years (2012, 2013, 2014), the 36- 3 Page 4 of 9 month average stock price and the number of shares composing the various BRVM Composite indices , Gse composite and Nse all shares grouped together in Ecowas all shares. The number of shares is multiplied by the average monthly rate to calculate the market capitalization. Rate data are extracted from the Datastream and Bloomberg databases. t 2. Results us cr ip 2.1 Sectoral screening results The least restrictive sectoral screening is the first step. Among the 266 eligible stocks’ values, 90 companies belong in part to an illegal sector. The sectoral result shows that finance and insurance sector is the most prohibitive haram sector, confirming the results of Peillex and Rangau (2012). The three BRVM, GSE, and NSE stock exchanges are 23.68%, 26.8% and 30.21% respectively. The total of the three stock exchanges an (ECOWAS all Shares) is 28%. The share of other illicit sectors, according to Islamic law, remains very low between 0.38% and 1.14% (alcohol, tobacco, hotels, advertising). M For the first stage of the screening, 66% represent the share of selected companies which still remain to compose the Ecowas Shariah index. 2.2 Financial screening results d We come up to a list of 27 compatible values according to the screening rules used by pt e the S&P Shariah board. Our results show, with the second screening, that the Nigeria Stock Exchange comprises 15 Halal companies, BRVM 6 and Ghana Stock Exchange also 6. It appears that 27 companies have been accepted in the Islamic index. With a ce 90% exclusion rate confirming most studies on Islamic indices. With 26% of the values, the materials and building sector is overrepresented in the Islamic index confirming one Ac of the basic principles of Islamic finance which is the backing to a tangible asset. It is followed by the health sector, 11% of the companies. In terms of capitalization, two companies (Dangote Cement, Nestlé Nigeria) represent more than 75% of the total capitalization of the Ecowas Shariah index. 2.3 The results of Index calculation To avoid the dominance of certain stocks in the index, we opted for a 20% capping factor in order to take into account the small cap. The table1 below shows companies which are accepted in the Ecowas Shariah index and data relating to the free float of the companies composing the Ecowas Shariah index. 4 Page 5 of 9 an us cr Table1 : Data relating to the free float of the companies composing the Ecowas Shariah Index calculated close on December 31, 2012 Weighted Free float market capitaliza capitaization tion Weighted free float market capitalization Capping factor weight retained 129 609 278 0,005 1 0,01 0,08 6 002 036 554 0,21 1 0,23 12 720 626 632 0,1 12 631 582 245 0,45 1 0,49 1 107 711 716 031 0,83 107 711 716 031 3,84 1 4,2 0,94 3 391 775 457 0,03 3 191 660 705 0,11 1 0,12 1 139 033 942 559 1,08 139 033 942 559 4,96 1 5,42 0,48 3 354 016 896 0,03 1 593 158 026 0,06 1 0,06 Price Free float factor Capitalization African Champion Limited 36 500 260 26 0,14 953 009 399 0,01 Ayrton Drugs Manufacturing 215 000 000 47 0,59 10 104 438 642 Benso Oil Palm 34 800 000 366 0,99 Fan Milk limited 116 207 288 927 Starwin Products 259 810 000 13 Unilever Ghana 62 500 000 2225 Aluminium Extrusion Austin Laz & Company Cap 9 17 040 507 405 408 0,09 6 947 671 786 437 53,8 619 037 556 171 22,09 0,83 20 219 956 000 34 0,99 7 420 775 964 0,06 7 346 568 204 0,26 1 0,29 1 079 860 000 6 0,2 6 873 929 788 0,05 1 374 785 958 0,05 1 0,05 700 000 000 71 0,99 49 906 107 769 0,39 49 407 046 691 1,76 1 1,93 1 878 202 040 144 0,25 270 082 332 879 2,09 66 170 171 555 2,36 1 2,58 E-Tranzact International 4 200 000 000 12 0,99 51 331 996 563 0,4 50 839 209 396 1,81 1 1,98 Glaxo Smithkline Consumer 1 195 876 488 115 0,54 137 328 443 576 1,06 73 608 045 757 2,63 1 2,87 Lafarge Africa 4 554 901 810 186 0,3 848 526 060 471 6,57 251 163 713 899 8,96 1 9,79 297 000 000 2 0,2 699 513 034 0,01 139 902 607 0 1 0,01 Nestlé Nigeria 792 656 252 2228 0,37 1 765 999 479 296 13,68 644 589 809 943 23 0,796 20 Nigeria Ropes 263 668 295 25 0,14 6 587 721 174 0,05 919 645 876 0,03 1 0,04 Okumu Oil Palm 953 910 000 68 1 64 516 972 214 0,5 64 516 972 214 2,3 1 2,52 Unilever Nigeria 3 783 296 250 148 0,5 559 926 400 029 4,34 278 843 347 214 9,95 1 10,87 250 019 781 159 0,62 39 787 991 502 0,31 24 469 614 774 0,87 1 0,95 CFAO Motors CI 1 813 719 46000 0,04 83 431 074 000 0,65 3 437 360 249 0,12 1 0,13 Saph 5 111 601 39000 0,21 199 352 439 000 1,54 41 644 724 507 1,49 1 1,62 Servair Abidjan 545 600 9500 0,14 5 183 200 000 0,04 743 270 880 0,03 1 0,03 Setao 134 400 8400 0,21 1 128 960 000 0,01 241 484 544 0,01 1 0,01 Sogh 2 160 184 65000 0,2 140 411 960 000 1,09 27 675 197 316 0,99 1 1,08 Sonatel 100 000 000 14500 0,22 1 450 000 000 000 11,23 325 815 000 000 11,63 1 12,71 TOTAL 38 412 898 411 1,29E+13 100 2,80E+12 100 0,915118725 100 Ac Mcnichols Plc ce Cadbury Nigeria ed Dangote Cement 368 461 038 pt African Paints M Number of Shares Name of Company Union Home Ream Estate Nb: The prices of listed companies in Nigeria and Ghana are converted into FCFA, the BRVM's prices are already in FCFA Page 6 of 9 Conclusion The objective of this paper was to propose the creation of an Islamic stock exchange index in West Africa, taking into account a stock pool regrouping stock exchanges of t the Ghana, Nigeria and the Regional Stock Exchanges (BRVM). It also contributes to us cr ip the integration project of the three African stock exchanges in order to promote Shariahcompliant investment. The results reveal, thanks to the extra-financial Islamic screening system, that the financial sector is particularly representative of the three exchanges, significantly reducing the number of securities. The two types of screening show that 90% of the companies comprising the three exchanges are excluded from the "Ecowas Shariah" Islamic index. The choice of market capitalization as a denominator for an financial screnning seems to influence the results confirming the academics works on the various Islamic index. We opted for a 20% capping factor in order to take into M account the small capitalizations, with a wider pool of shares, this factor could be reduced. The interest of the creation of an Islamic stock index in West Africa is not a symbolic d dimension aimed at issuing a positive signal for muslim investors with the performance pt e of West African stock exchanges it seems that this index also has its own financial Ac ce arguments and can be the subject of future research. Page 7 of 9 References AFRICAN SECURITIES EXCHANGES ASSOCIATION(ASEA)., 2014 "Annual report & Statistics", Westlands Roads, Nairobi. us cr ip t DERIGS U. AND MARZBAN S., 2008, "Review and Analysis of Current ShariahCompliant Equity Screening Practices", International Journal of Islamic and Middle Eastern Finance and Management, 1, N° 4, pp. 285-303. EL KHAMLICHI A.," A. SANNAJUST AND H.K. SARKAR., 2014, "Islamic equity indices: insight and comparison with conventional counterparts", Bankers, Markets and Investors N° 130 pp.69-80. an KHATKHATAY, M. H ET S. 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