By definition, a capital instrument is any contract or contractual agreement that gives rise to a financial asset (cash, an equity instrument issued by another entity, or contractual rights) belonging to one entity and a financial liability or equity instrument belonging to another entity. Broadly, it includes all components of equity capital: ordinary equity, both voting and non-voting, and preference shares. However, under Shari’ah, preference shares are characteristically associated with a degree of gharar and inequality in terms of the financial rights extended to its holders. Therefore, preference shares carrying certain financial rights are impermissible from a Shari’ah standpoint.

This also applies to other types such as convertible or hybrid financial instruments which are debt-based in character and which may be converted into equity. Certain Islamic capital instruments such as sukuk or senior debt instruments would not normally be treated as “capital instruments” unless these instruments are embedded with specific convertibility features.

Equity-type contracts, such as participatory ventures (joint venture musharaka contracts) (a investments but not financing) meet the criteria of Islamic capital instruments. The musharaka stake is classified as a capital instrument at inception. Other investment vehicles, such as shari’a compliant investment notes, would be classified as capital instruments if embedded with a convertibility option/ clause.

In general, and for different types of institutions, any other financial instruments which are eligible as regulatory capital are also regarded as capital instruments.