Tuesday, July 14, 2009


There is a near consensus about derivatives (structured products included)being one of the culprits to blame for causing the financial meltdown that no one know for sure how the world can get out. Bailouts, tightening regulations, rescue plans, extra deposit guarantee schemes: all have being pursued but still there has been no clear sign that things are actually better. The last we heard was about a number of banks and brokerage firms thathad been banned by the Singaporean authority from further marketing structured financial products that have caused investors there millions in losses due to the toxic investment schemes. Luckily some have been partly compensated. But still we are not able to understand why there are many proponents of derivatives among the growing number of Islamic finance practitioners as if they have turned a blind eye on the devastating effects of such products that even the conventional players and regulators themselves have admitted. The main reason given in support of the so-called Islamic derivative products is that they are needed for risk management purpose i.e for hedging. Everyone knows that in the world of modern financial markets the distinction between hedging and speculation is not easy to be made. After all, once a door is opened, there is no assurance that only good guys will come in. The truth is that risk management is embedded in the Islamic law of contract and financial transactions such that if they are truly implemented as provided, there is actually no real need to address the issue of risk the way it is pursued in the conventional sense. Hence the biggest question to answer here is whether all that need to be followed in term of Shariah rules are actually implemented. Some concerned observers have expressed their serious dismay at the ways and manners Islamic finance has been practiced of late... Coming back to Islamic view on derivative: for those who want to read more on this please get a copy of a very well-researched book (in Arabic) on Islamic view on derivatives written originally based on a request of OIC Fiqh Academy. ( Al-Mushtaqqat al- Maliyyah: dirasah muqaranah bayna al-nuzum al-wadi'yyah wa ahkam al-shariah al-islamiyyah,-by Dr. Samir Abdel Hamid Radwan, 2005, Dar al-Nashr li'l Jamiaat, Cairo.). Notes: The author at the end of the book swear in God's name that to the best of his knowledge, based on the research conducted to prepare for the book, his finding is that derivatives, as they are, are far from being shariah compliant. It is worth-noting also that the OIC Fiqh Academy had issued similar resolution several years ago.

Friday, July 3, 2009


International commodity murabahah and tawarruq are the two topics that have being raised quite prominently these days especially after the Islamic Fiqh Academy of OIC issued its resolution on tawarruq in April. The use of murabahah concept in transactions involving sales of goods and assets, when used in its correct form is not a controversial topic in itself because murabahah in its classical form is recognised as valid by the majority of Muslim jurists right from the earliest days of Islamic law.
Conceptually in order to have a valid Murabahah there must be two sales involved: the first being between a supplier of goods and a seller in murabahah while the second leg is between the murabahah seller ( who is himself a buyer in the transaction with the supplier) and the murabahah buyer. In order for the second contract of sale to be valid, the murabahah seller must have obtained full title and ownership of the goods sold in the first contract with the supplier in a full Shariah compliant manner: meaning that the goods and its economic/ ownership risk has been fully transferred to the murabahah seller. This will only happens when the goods has been actually or constructively delivered to the possession of the murabahah seller such that if anything should happen to the goods after that possession, loss is to be borne by the murabahan seller as a new owner. When this requirement is fulfilled, there is no question as to the right of the murabahah seller to sell the same goods to the murabahah buyer in the subsequent sale. This is obvious due to the Shariah rule that provides only an owner or his agent can affect a valid sale contract.
The issue as far as the current confusion as to the validity or otherwise of transactions involving either commodity murabahah or tawarruq is not so much of the conceptual aspect of the sales but more of whether the current practices adhere or not to rule as explained. In practice, most financial institutions that utilises both of the above concepts have been dealing with international commodity exchanges that are in fact, more often than not, parties involved in future commodity markets rather than normal physical markets. One such metal exchange that the present writer has access to some published information, states clearly that in practice as far as this metal exchange is concerned, only 1 % of their commodity (future) contracts ends up with physical delivery of the relevant metals. This is not surprising given the fact that such an exchange is known to be one of the many similar exchanges that are involved in commodity future market. So the big issues here is how come the Islamic financial institutions did not realise this fact as many of them are likely to be aware of several earlier resolutions by the OIC Fiqh Council that had disallowed involvement in future markets which was declared as non-shariah compliant in its current format.
The recent resolution by IFA does not mention this point directly but the concern can be understood by implication when the resolution mentions about the absence of genuine sales in tawarruq as currently practiced. Buy right the resolution should have reiterated its earlier resolutions concerning future market to support its present resolution on tawarruq. Perhap it is worth noting also that in the past few years or so there have been calls by concerned parties including Shariah scholars for Islamic financial institutions to use local commodities in their murabahah or tawarruq transactions. The reason given was that in the case of local commodity markets, there should be no difficulty in ensuring the existence of the relevant commodities and the truthfulness of the sales. So in short the major concern that underlines the Fiqh Academy resolution is so directly tied up to the way the relevant transactions are carried out, and not their conceptual acceptance from Shariah perspective. This is understandable considering what the Shariah says about sales as allowed in Islam where they must mean true sales and not money lending in disguise: hence when sale are intended it must be clear that transfer of ownership together with economic risk has taken place as between the parties in the first transaction before the second sale can take place. After all, in Shariah it is sale and only true sale that can be taken as justification for profit. So when the existence of true sale is doubtful, then there is no reason for the relevant transaction to be considered valid or Shariah compliant. Hence the biggest question posed indirectly by the resolution is how many of those so-called Islamic finance practitioners are sincerely willing to wear the title of genuine traders in their activities, and not as money-lenders in disguise.

Thursday, July 2, 2009

Before answering the question, it is best to consider the concept of modern corporations or companies in the light of the major rules and regulations as practised today. Although these corporation have some similarities with Islamic sharikah by virtue of the fact that they all can come into being when at least two individuals "form" the company or sharikah, and have them registered with the Registrar of Companies, yet once established and registered with the relevant authority these modern companies are recognized by the law as separate legal entities distinct from their shareholders.
In the context of Islamic sharikah however, the shariah envisages the role of the partners as individuals who are to carry out their business activities jointly with a view of making profit. This furthermore boils down to whether what is formed is a mufawadah or inan structure: in the case of the former the partners are agents and guarantors among themselves, whereas in the later case, they are only agents. Hence in the context of Inan, a partner is considered to be acting personally with regard to his portion of the equity of the sharikah, and at the same acting as an agent with regard to his partner’s portion. It is a requirement in Islamic law however that all partners need to put their capitals in an indistinguishable form in a common fund or account separated from their other assets. Nevertheless the liability of the parties in the context of their business dealings with third parties is not necessarily limited to their shares in the sharikah as any act carried out properly in accordance with the agency will bind the respective partners, although loss is to be shared in proportion to their capital contribution.
But if we look closer at modern corporations it will become clear that the purpose or objective of the separate legal entity is to allow for a separate account be created for the entities so that it will be made possible to identify their assets and liabilities because those need to be treated independently from the assets or liabilities of their shareholders. These entities can sue and be sued in the course of their business dealings with outsiders. In a company limited by shares however the liability of the shareholders are limited to the number of shares of certain value subscribed by them precisely because the law consider these corporation as different from their shareholders. Given this position one may think of a mudarabah structure in Islamic law, where the manager is supposed to be different from the capital provider meaning that this mudarib is a different or separate legal entity distinct from the entity of the capital provider. Hence can we consider modern corporations as individual managers/mudaribs in the context of their dealing with the shareholders?
In the case of Islamic mudarabah, it is provided that the rabulmal is going to be held liable up to the amount of the capital he actually contributed and duly handed over to the mudarib. He will not be made answerable for any liability of the mudarabah in excess of the capital so contributed. However in modern company structure, it is the requirement that a shareholder must pay up all shares that he owns but he is not duty bound to pay up for the share until a call is made by the company, and he will be imposed with interest charge in favour of the company if he fails to do just that after the call. This effectively means that he is considered indebted to the company by not obliging to the demand of the call, hence a debt is thus created for which interest is charged.
From an Islamic perspective in the context of mudarabah and musharkah all capitals must be passed on to the account of the mudarabah or partnership otherwise the contract is compromised in term of effectiveness and validity. Because a party in mudarabah if he a capital provider, is free to withdraw from the mudarabah, non payment of the capital to the account of the mudarabah will practically end the agreement as this contract is in the nature of non-binding contract, or at least the mudarabahis to be valid only up to the amount of capital actually contributed. Similarly in the context of sharikah it is part of the requirement of the Islamic scheme that the capital is to be pooled together to create common ownership available for all partners to utilize in the name of the musharakah in line with the concept of mutual agency as between all the partners. However if one party refuses to provide the capital in such a manner, he can be considered as to withdraw from the sharikah since to effectively establish the partnership all capitals contributions must be actually made and not just promised. Like in the case of the parties in mudarabah, partners also can withdraw from the sharikah as a matter of general rule if they so wish.
From a different perspective, practically the operation of modern companies and corporations is not necessarily in line with the rules and conditions of the Islamic sharikah . Modern companies issue shares and loan capitals of various kinds, some of which are subject to interest. Debentures, for instance, are resorted to by modern companies when they want to raise additional money through debt instruments, which are, in essence, interest-based and thus not approved by Islam. They may also issue securities (loan stocks) that pay a fixed rate of return to holders - a process which is also contrary to Islamic law. Then there are the issues of preference share that gives more priority to a certain class of shareholders in relation to profits or returns and the right to repayment of capital upon dissolution of the companies. Therefore, there are many issues that need to handled if the companies and modern corporations are to achieve Shariah compliant status. Not only that they must avoid dealing in haram goods and services, they also need to ensure that their setup and structure are Shariah compliant.