tag:blogger.com,1999:blog-61458001934464767962024-02-08T07:21:27.496-08:00Islamic Law of FinanceUnknownnoreply@blogger.comBlogger29125tag:blogger.com,1999:blog-6145800193446476796.post-42152332705315874772020-05-04T03:10:00.000-07:002020-05-04T03:10:35.918-07:00MUDARABAH RISK MANAGEMENT<!--[if gte mso 9]><xml>
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<div align="center" class="MsoBodyText" style="text-align: center;">
<span lang="EN-US" style="font-family: "Tw Cen MT Condensed","sans-serif"; font-size: 20.0pt;">SHARIAH-BASED
RISK MANAGEMENT IN MUDARABAH SUKUK-PART 1</span></div>
<div class="MsoBodyText" style="text-align: justify;">
<span lang="EN-US" style="font-family: "Tw Cen MT Condensed","sans-serif"; font-size: 20.0pt;"><span style="mso-tab-count: 1;"> </span>Modern day sukuks are generally
structured based on conventional bond models where capital protection and
profit guarantee are normally provided with the provision of security or
collateral terms: as if the structures are based on debt transactions where
creditors are fully protected as part of the so called credit enhancement
process involving a lot of provisions under positive covenants and negative
pledges normally used in credit/loan/bond documentation. Mudarabah sukuk on the
contrary are not supposed to be debt-based instruments: rather they are based
on agency in the context of the management company being the investment or
business agent of the capital provider or investors. There is no creditor-debtor
relationship here that warrants the above-mentioned credit enhancements
normally employed in conventional lending contracts for debt securities. Since
Mudarabah sukuk do not involve any debt contract between the issuer and
investor, the kind of protection available to the investors here is not on the
basis that the capital provider is a creditor or lender but rather a principal
(muwakkil) in an agency contract. Hence different approaches are needed to
protect the interest of such a principal in the context of the mudarabah
investment contracts.</span></div>
<a name='more'></a><br />
<div class="MsoBodyText" style="text-align: justify;">
<span lang="EN-US" style="font-family: "Tw Cen MT Condensed","sans-serif"; font-size: 20.0pt;"><span style="mso-tab-count: 1;"> </span></span></div>
<div class="MsoBodyText" style="text-align: justify;">
<span lang="EN-US" style="font-family: "Tw Cen MT Condensed","sans-serif"; font-size: 20.0pt;"><span style="mso-tab-count: 1;"> </span>Popular writings have also been
describing things like “sukuk sale” or “sukuk in Islamic debt market” or any
other expressions that are nonetheless confusing. In the context of Mudarabah
specifically, it is normal to see inaccurate phrases like “One billion dollar
worth of Mudarabah sukuk have been to sold to international investors” or
“pricing for the Mudarabah sukuk” or “Mudarabah sukuk sold in Islamic capital
market” because all these imply that there are sale contracts (between the
issuer and the investors) involved in the issuance of the sukuk. The truth is
Mudarabah is neither loan nor a sale contract. It is by contrast a sort of
“partnership” arrangement founded upon agency (wakalah) as previously stated.
This happens when the Mudarib is in fact appointed as a trading agent/project
manager for the capital provider and he is to be compensated with a certain
percentage of profit if any, while capital loss if not due to the mudarib’s
fault or wrongdoings is to be incurred by the capital provider. However there
are views by some jurists that Mudarabah is a <u>special form</u> hiring
contract (<i style="mso-bidi-font-style: normal;">ijarah al-ashkhas</i>)
permitted by the Sunnah whereby the mudarib is hired by the capital provider
based on contingency fees in the form of profit sharing to run the mudarabah
business. Apart from not being a sale contract what is important to state is
that Mudarabah is not a lending contract either, hence the mudarib cannot be
considered indebted to the capital provider. However as we used to mention in
several of our previous postings, market players whether due to
misunderstanding or willful efforts by<span style="mso-spacerun: yes;">
</span>issuers<span style="mso-spacerun: yes;"> </span>in collaboration with
other connected parties involved in the issuance process, tend to project
Mudarabah sukuk as secured investment. Sukuk subscribers normally are enticed
or persuaded to invest if given strong assurance (false or otherwise) not only
as to prospect of guaranteed profit but most importantly of capital protection.
However, they can arguably be blamed for not making due Shariah diligence as to
the true nature of Mudarabah as a structure for the sukuk where neither capital
nor profit can be fully guaranteed or secured.</span></div>
<div class="MsoBodyText" style="text-align: justify;">
<br /></div>
<div align="center" class="MsoBodyText" style="text-align: center;">
<span lang="EN-US" style="font-family: "Tw Cen MT Condensed","sans-serif"; font-size: 20.0pt;">REGULATING
THE FUNCTIONS OR ROLES OF A MUDARIB IS THE KEY FOR RISK MANAGEMENT</span></div>
<div class="MsoBodyText" style="text-align: justify;">
<span lang="EN-US" style="font-family: "Tw Cen MT Condensed","sans-serif"; font-size: 20.0pt;"><span style="mso-tab-count: 1;"> </span>Given the nature of Mudarabah as
wakalah-based arrangement according to which the Mudarib acts as an agent for
the capital provider in running the business/project as entrusted, one key
element in risk management of this type of investment is related to the need for
the capital provider to be reasonably prudent in selecting the Mudarib as
investment agent. There needs to be sufficient degree of due diligence done to
ensure risks can be mitigated right before the Mudarib is appointed. In the
context of Mudarabah sukuk, relevant information must be sufficiently obtained
from various sources as to the status and track records of the prospective
issuer. It is not enough to rely just on information as contained in the
relevant prospectus. Although regulatory authorities may require certain
information be provided in the document, investors however must exercise
independent search of their own to be on the save side. </span></div>
<div class="MsoBodyText" style="text-align: justify;">
<span lang="EN-US" style="font-family: "Tw Cen MT Condensed","sans-serif"; font-size: 20.0pt;"><span style="mso-tab-count: 1;"> </span></span></div>
<div class="MsoBodyText" style="text-align: justify;">
<span lang="EN-US" style="font-family: "Tw Cen MT Condensed","sans-serif"; font-size: 20.0pt;"><span style="mso-tab-count: 1;"> </span>In order to protect the interest of
the capital provider, Muslim jurists have elaborated on certain fundamental
rules governing the conduct of a Mudarib as agent for the investor. As
principal, the capital provider apart from being prudent in selecting and
appointing the Mudarib can minimize his exposure or risk by exercising his
rights as a Muwakkil (principal) as per wakalah contract. In the context of
Mudarabah, there are several situations that may happen in a particular case.
Sometimes these aspects are discussed by the Muslim jurists in connection with
what are known as Mudarabah Mutalqah (unrestricted) and Mudarabah Muqayyadah
(restricted) where the actions of the Mudarib can be controlled.</span></div>
<div class="MsoBodyText" style="text-align: justify;">
<span lang="EN-US" style="font-family: "Tw Cen MT Condensed","sans-serif"; font-size: 20.0pt;"><span style="mso-tab-count: 1;"> </span></span></div>
<div class="MsoBodyText" style="text-align: justify;">
<span lang="EN-US" style="font-family: "Tw Cen MT Condensed","sans-serif"; font-size: 20.0pt;"><span style="mso-tab-count: 1;"> </span>Generally there are <u>actions that a
Mudarib can take by default</u> as a mudarbah contract is understood to come
with certain <u>basic implied terms</u> to be read into such a contract itself.
In this situation, even though not expressly provided for in the agreement, the
Mudarib can perform such actions as a matter of right as Mudarib. However there
are <u>actions that a Mudarib can only perform with expressed provision in the contracts</u>.
In this kind of situation, the capital provider can specifically authorize the
Mudarib to undertake certain actions that are outside the scope of the implied
terms of the Mudarbah. Furthermore there are <u>actions that a Mudarib can take
when full discretion </u>is given to him by the capital provider. A Mudarib can
also be <u>expressly prohibited</u> by the capital provider in performing
certain acts in which case <u>these need to be avoided at all costs.</u> Muslim
jurists nevertheless are not in agreement about the status of some of the
relevant <a href="https://www.blogger.com/null" name="_GoBack"></a>actions as to which category they should
belong.. to be continued in Part 2.</span></div>
Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-78968158024779671262020-04-03T00:02:00.000-07:002020-04-03T20:13:38.077-07:00<br />
<div align="center" class="MsoNormal" style="text-align: center;">
<b style="mso-bidi-font-weight: normal;"><span style="font-size: large;">MUDARABAH SUKUK CERTIFICATES: WHY DOES IT MATTER?</span><o:p></o:p></b><br />
<b style="mso-bidi-font-weight: normal;"><br /></b></div>
<div class="MsoNormal" style="text-align: justify; text-indent: .5in; text-justify: inter-ideograph;">
The topic may looks irrelevant when one recognises the fact
that sukuk are no longer novelties like what they used to be around 20 years
ago. Since then billion dollars of sukuk have been issued, both as public and
private securities not to mention also, in not small number of reading
materials, sukuk have been referred to as debt securities. In fact many
so-called Islamic finance writers generally put sukuk within the framework of
the so called Islamic debt market or sometimes Islamic fixed income
instruments. However from a number of court cases so far adjudicated, it is
clear that the true nature of sukuk certificates is still far from proper
understanding. This is so partly because sukuk have been issued using various
underlying contracts not similar to conventional bonds of various types where
the main contract used in the structures are no other than debt contracts i.e
lending/borrowing contracts. <o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify; text-indent: .5in; text-justify: inter-ideograph;">
The above issue leads us to answering the question posed in
the heading: why the nature of certificates issued in connection with sukuk
needs to be fully explained. As mentioned, this matter is closely related to
the contracts used in the relevant structures as there is no single character that
can be attributed to such certificates without full understanding of the
underlying contracts employed. For example in Dana Gas sukuk case, the issue
about whether the sukuk were truly of mudarabah type where profit could not be
fully guaranteed remains relevant as ever although the parties had come to
mutual<span style="mso-spacerun: yes;"> </span>settlement of their disputes.</div>
<a name='more'></a><o:p></o:p><br />
<div class="MsoNormal" style="text-align: justify; text-indent: .5in; text-justify: inter-ideograph;">
To put it simply: when one party hands over certain sum of
money to a sukuk issuer as a result of which process the later (sukuk issuer)
hands over to the former (money provider) the so-called sukuk certificates, the
question is these certificates would stand for what?. Let us refer to the very
first pronouncement by one Islamic authoritative/reputable body about sukuk.
The OIC Fiqh Academy (Islamic Law Academy of OIC) in 1988 issued a very useful
statement about the nature of sukuk certificates. Interestingly this
pronouncement was issued in relation to Muqaradah (another name for Mudarabah)
sukuk as the most important of all possible sukuk that could be offered, at
least during that very early period of sukuk development. <o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify; text-indent: .5in; text-justify: inter-ideograph;">
According to the OIC Fiqh Academy’s resolution: “<i style="mso-bidi-font-style: normal;">Muqaradah (Mudarabah) securities<span style="mso-spacerun: yes;"> </span>are investment instruments that are
structured on the basis of splitting Muqaradah capital by issuing sukuk <span style="mso-spacerun: yes;"> </span>testifying <span style="mso-spacerun: yes;"> </span>ownership over units (of the capital) of
equal value registered in the name of the owners thereof<span style="mso-spacerun: yes;"> </span>on the basis that they own undivided common
shares of the Muqaradah capital and whatever that may thereafter result from (employment
of ) such capital, proportionate to the ownership of every such owner as
mentioned”. <o:p></o:p></i></div>
<div class="MsoNormal" style="text-align: justify; text-indent: .5in; text-justify: inter-ideograph;">
From the above statement we know that in the first instance, the
sukuk certificates represent certain sums of money capital of the Mudarabah as
provided by the investors to the Mudarib on the basis of which the relevant
certificates are issued to them. But the resolution does not stop there in
explaining what may further happen to the said capital by adding the phase <i style="mso-bidi-font-style: normal;">“..and whatever that may thereafter result
from (employment of) such capital”</i>. By this we know that whatever the
mudarib may acquire in the form of other assets for the purpose of the Mudarabah
will come within the ambit of the definition of the sukuk in the sense that at
this later stage (if actually taken place) the certificates can no longer be
considered exclusively representing the money capital.<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify; text-indent: .5in; text-justify: inter-ideograph;">
Hence when one talks about asset-backed sukuk for instance,
one needs to be very particular about what types of asset that are owned by the
Mudarabah at the relevant time. This is important given the fact that Shariah
law recognizes several classes of assets with their specific governing rules.
After a subscription period is closed and money capital handed over to the
mudarib, at that moment the<span style="mso-spacerun: yes;"> </span>sukuk can be
described as asset-backed although they are entirely backed by such<span style="mso-spacerun: yes;"> </span>monetary sums as contributed since money is a
form of asset if not the most important of all assets. However when the mudarib
starts to acquire some other assets with the use of the money capital, the
sukuk are now considered to be backed by several categories of asset that are not
necessarily supposed to be governed by same rules governing money capital.
There may be assets in the form of real tangibles, debts, usufructs of
tangibles or even recognised rights. Under this scenario we may talk about
sukuk that are backed by a combination of assets rather than just by the monetary
ones.<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify; text-indent: .5in; text-justify: inter-ideograph;">
In connection to the above aspect, the OIC Fiqh Academy thus in
the context of using Mudarabah sukuk for project financing further require the
sukuk to be <i style="mso-bidi-font-style: normal;">“representing common undivided
ownership of the project for which establishment or financing such sukuk have
been issued and the need to consider such an ownership as continuing from the
beginning to the end of such project”.</i> Hence it is clear here that the
sukuk holders are in fact joint owners of the project funded by the issuance. As
such they are considered as partners in <i style="mso-bidi-font-style: normal;">Sharikat
al-milk</i> based on the project assets held by the Mudarabah considered to be
jointly owned by all of them.<o:p></o:p></div>
<br />Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-8804559571597129482020-01-25T06:26:00.000-08:002020-01-25T06:26:44.036-08:00MUDARABAH SUKUK: ARE THEY REALLY RISKY?<br />
<div align="center" class="Standard" style="text-align: center;">
<b style="mso-bidi-font-weight: normal;"><span style="font-size: 14.0pt;">MUDARABAH SUKUKS: ARE THEY REALLY RISKY?<o:p></o:p></span></b></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<span style="font-size: 14.0pt;">Mudarabah sukuk (<i>sukuk</i> is plural form of <i>sakk</i>-
commercial certificate/document, nevertheless here the term is used as a
singular word as generally treated) came to the forefront when Dana Gas case
was at its highest point in 2017/2018. Then everyone was discussing Dana Gas in
the context of the so-called impending default when the company declared that
its Mudarabah sukuk was no longer Shariah compliant and thus illegal and
unenforceable under UAE law. The issue then was about profit payment by Dana
Gas to holders of the sukuk: what are the rights of the sukuk holders when the
so-called profit was not going to be paid as expected and as to whether that
would trigger a default. Basically there are many questions that have been
raised in this Mudarabah sukuk, among others are the followings:<o:p></o:p></span></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="Standard" style="margin-left: .5in; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<!--[if !supportLists]--><span style="font-family: Symbol; font-size: 14.0pt; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="font-size: 14.0pt;">Whether
non-payment of profit by the Mudarib (Dana Gas) constitutes a default?<o:p></o:p></span></div>
<div class="Standard" style="margin-left: .5in; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<!--[if !supportLists]--><span style="font-family: Symbol; font-size: 14.0pt; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="font-size: 14.0pt;">What are actually
profits in the context of Mudarbah?<o:p></o:p></span></div>
<div class="Standard" style="margin-left: .5in; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<!--[if !supportLists]--><span style="font-family: Symbol; font-size: 14.0pt; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="font-size: 14.0pt;">Whether the
purchase undertaking provided in the agreement was valid and enforceable in
law?<o:p></o:p></span></div>
<div class="Standard" style="margin-left: .5in; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<!--[if !supportLists]--><span style="font-family: Symbol; font-size: 14.0pt; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="font-size: 14.0pt;">What are the
rights of Mudarabah sukuk holders when the sukuk was declared as not valid or
not Shariah compliant?<o:p></o:p></span></div>
<div class="Standard" style="margin-left: .5in; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<!--[if !supportLists]--><span style="font-family: Symbol; font-size: 14.0pt; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="font-size: 14.0pt;">What laws are to
be used the settling the dispute between the sukuk issuer and its sukuk
holders?<o:p></o:p></span></div>
<div class="Standard" style="margin-left: .5in; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<!--[if !supportLists]--><span style="font-family: Symbol; font-size: 14.0pt; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="font-size: 14.0pt;">What was actually
the nature of a Mudarabah contract entered into by the parties: whether it is
truly a Mudarabah of something else?<o:p></o:p></span></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<span style="font-size: 14.0pt;">As it turned out later, the parties to the debacle had
managed to resolved their dispute seemingly through an amicable settlement
toward the end of 2018, and that development was indeed something that was
commendable given the fact that settlement of disputes through compromise (<i style="mso-bidi-font-style: normal;">sulh</i>) leading to final resolution is in
fact the best Islamic option among several other options in dispute settlement.
Notwithstanding the positive development and the terms used by the parties in
their settlement agreements, many relevant questions about Mudarabah and Sukuk
Mudarabah are far from being clearly addressed in actual practices.</span></div>
<a name='more'></a> <o:p></o:p><br />
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<span style="font-size: 14.0pt;">One factor that may have given rise to this negative
state of affairs is related to the fact that market practitioners especially
investors are, for a very long period of time, used or accustomed to fixed
incomes securities structured more like conventional bonds underpinned by debt
contracts rather than investment ones. More specifically, in the context of
Islamic finance they are generally called asset-based Islamic securities/sukuk
where they are more or less (according so some) conventional bonds/securities
in disguise, the situation that led to the widely reported pronouncement in
2007 by Sheikh Taqi Usmani that 85% of sukuks issued up to that period were not
Shariah compliant. The crux of the matter is that asset-based structures negate
the very essence of sukuks as investment certificates/securities rather than
debt ones.<o:p></o:p></span></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<span style="font-size: 14.0pt;">It seems that the true contest taking place in the market
for quite sometime is actually between two forces. On the one hand, there are
sincere parties who are trying to bring back Islamic capital market practices
into its original form that is basically anchored on the spirit of fair
partnership between capital provider/investor and investment agents/companies
where their relationship is not one that is based on creditor-debtor positions.
While on the other side of the fence, there are those who relentlessly pushing
the market players to maintain such debtor-creditor mentality thanks to their
conventional upbringing and outlooks. For this last group, debt-based
securities or sukuks are supposed to be the way mainly because for them these instruments
are more efficient and less risky not to mention their attachment to debt-based
finance underpinned by interest charges described sometimes in different
terminologies.<o:p></o:p></span></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<span style="font-size: 14.0pt;">The above situation is not something new: this writer
can vividly recall far back around 2007, when he presented in an international
Islamic finance conference held in Singapore on the topic related to Sukuk for
global acceptance. (Before that in 2001 the writer used to present about
similar topic but appropriate for that early date of Islamic securities
development, the topic reads something like “Muqarada (Mudaraba) bonds as
alternatives for debt-based bonds”). During that morning session of 2007
conference, the writer stressed the need to be mindful of the fact that sukuks
should be for all intent and purposes be considered as investment certificates
or securities where returns could not be fully guaranteed like the conventional
bonds. Came the afternoon session when a fellow presenter representing an Islamic
financial institution took his turn when he with full force told participants
that Sukuks were no different from other kinds of fixed income securities where
investors could be assured of the outcome of their so-called investment in
sukuks. The result was, many participants were confused with such conflicting
descriptions of sukuks and as a result they seemed to end that day’s session
with more questions than answers. This experience is no less different from
when the writer participated in an Islamic finance round-table session in Dubai
in the same year. The topic of Mudarabah was discussed and it turned out that
many so called Islamic finance important players who participated voiced their
negative views about Mudarabah. The writer later discovered that many of those
who were holding such views were no other than conventional bankers involved in
Islamic banking windows in that part of the world. Not long after the end of discussion
about Mudarabah, came the topic of personal financing and these same group of
players seemed to be very adamant in proving that their versions of <i style="mso-bidi-font-style: normal;">tawarruq </i>as employed in the their
Islamic credit cards are more Shariah compliant than their competitors!. <span style="mso-spacerun: yes;"> </span>Although we are now in the beginning of the
year 2020, don’t be surprise to experience the same kind of encounter with many
practitioners with the same kind of mentality as narrated above: for them nothing
but debts.<o:p></o:p></span></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<span style="font-size: 14.0pt;">So much we want to make it clear to these fellows
about the correct understanding about sukuks as investment<span style="mso-spacerun: yes;"> </span>certificates <span style="mso-spacerun: yes;"> </span>rather than debt ones, just because of their views
that debt financing is better that non-debt based one, they always try to pull
sukuks into the domain of the so called debt market. The problem is that once
this is the adopted framework, it is not surprising to find that sukuk
structures are adjusted to achieve their suspect motive even at the expense of
real Shariah compliance objective. The evidence for this is not difficult to
find: read properly many of the sukuk issuance prospectuses, it is not
difficult to discover how terms and conditions governing the sukuks were laid
down in such a way that at the end of the day the objective of protecting the
principal and profit were to be attained through “clever/smart” documentation contrary
to the Shariah dictate about investment in its true sense. This so called risk
management strategy employed in the legal documentation of many sukuks issued
so far is the clearest testimony of the intended framework within which sukuks
have been practiced all these while. <o:p></o:p></span></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<span style="font-size: 14.0pt;">The reason for this development to happen are numerous
but in this posting the writer only would like to highlight one possible factor
that has lead to this situation. It is the lack of deep understanding about the
nature of Shariah contracts used in structuring many sukuks. Take for example Mudarbah
sukuk; a big issue raised revolves around Mudarabah as being more risky from
risk management perspective and the claim of investors not being fully
protected if this contract is used especially after the AAOFII declaration of
2007 where it was widely reported that there was obvious decline in the number
of Mudarabah sukuks issued after the statement. The market is said to view the
prohibition by AAOIFII of the often used capital and profit protection
mechanisms widely employed before that time as making Mudarabah sukuks to be
more risky to investors. This understanding basically shows to the fact that
the market participants are very lacking in terms of proper understanding about
the nature of Mudarabah especially in the context of protecting the interest of
both the investor and the mudarib involved. For sure risk management is
important in any type of investment decision to be made by any investor, but to
adopt risk mitigation strategy commonly employed for debt-based contracts to
Mudarabah (which is not debt contract) is indeed very unfortunate and shows
among others lack of proper understanding about Mudarabah itself. In the next
posting the writer will discuss further what should be known about risk
management in the context of Mudarabah investment as elaborated by Muslim
jurists to show how, if the guidance is followed, Mudarabah<span style="mso-spacerun: yes;"> </span>can hopefully be given fair treatment it truly
deserves.<o:p></o:p></span></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="Standard" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<br />Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-35660845614493546502017-07-13T08:39:00.002-07:002019-09-13T00:33:30.002-07:00DANA GAS: WHERE CREDITORS ARE HIDING IN THE SUKUK?<!--[if gte mso 9]><xml>
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<div align="center" class="MsoNormal" style="text-align: center; text-indent: 0.5in;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">DANA GAS: WHERE CREDITORS ARE HIDING IN
THE SUKUK?</span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">The latest issue surrounding Dana <span style="font-family: "verdana" , sans-serif;">G</span>as Sukuk clearly shows that
the market is still struggling to understand the true nature of sukuk. In
reports published of late, many still talk about creditors taking steps to
protect their interest related to payment of the so called dividend or profit as
mentioned or provided for in the sukuk documents. </span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">If the word “creditors” is to be understood conventionally referring
to someone who has lent a certain sum of money, who for sure is entitled for a
repayment at a certain future agreed date, then obviously the use of such word
in the context of sukuk is totally unacceptable. The reason being true Shariah
compliant sukuk are basically not debt instruments like conventional bonds
where sums of money are borrowed or lent.</span></span></span><br />
<a name='more'></a><span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;"> </span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">Sukuk if it is to be understood correctly have nothing to do
with money lending (by sukuk holders) as they are basically investment
securities and not debt ones. In the case of Dana Gas Sukuk which was structured
on the basis of Mudarabah contract the investors/sukuk holders must have known
from the outset that profit/dividend is not guaranteed as it will depend
basically on actual performance of the underlying assets/projects that backed
up the sukuk. </span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">Although sukuk holders have no right to guaranteed profit
they however enjoy a certain degree of protection in a different sense. If
wrongdoing or negligence or breach of terms and conditions of mudarabah contract
can be proven, they have the right to be fully indemnified by the issuer or Mudarabah Management Company. Notwithstanding, profit shall always be paid out
of actual profit generated by the activities carried out by the issuer as agent
for the sukuk holders in running the business. </span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">In the above context sukuk documents and prospectus must make
sure that the true nature of mudarabah investment is clearly stated, and sukuk
holders owe to themselves to appreciate this fact properly. In the same
connection, the issuer should be properly advised not to state anything that
may mislead the potential sukuk holders about to the true nature of the investment
in sukuk where returns are actually based on actual performance and not as per
guaranteed fixed rate of return. </span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">UAE is fortunate because it had enacted legislation governing
commercial transactions including Islamic/Shariah based ones. The Civil Transaction
Code of 1985 which is of general application in all the emirates provides for rules
that need to be followed by all relevant parties lest their transactions can be
declared null and void as per the law. </span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">In this context, legal arguments can be put forward by all
the involved parties in accordance with such established provisions of the relevant laws. In a broader context, with the presence of such provisions a
certain degree of uncertainty related to legal status of transaction can be
properly addressed within the ambit of the law. </span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">What however remains to be answered in the case of Dana Gas
Sukuk is this: if truly the sukuk is against the law, how come the legal
advisors involved in the issuance of the sukuk several years ago were not aware
of the so-called point of law related to the nature of Mudarabah Sukuk. This
issue is as important as the question of shariah compliance of the sukuk since
legal compliance is of no less important than the Shariah one. Although the
issuer’s latest action was premised on the legal opinion it obtained from their
legal advisor, it seems that such opinion if actually given was actually a
belated one. It is unthinkable that the basic nature of mudarabah contract was
overlooked when they structured and documented the sukuk in the first place
given the fact Mudarabah as a contract/structure is not something of novelty in
nature. </span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">What ever that may happen to the parties involved, if Islamic
law is to be used in settling the dispute, surely there is enough guidance from
Shariah perspective to solve the problem. However the big question is: to what
extent the parties are willing to resort to Shariah dispute settlement mechanisms? The indications are, as it was obvious in several other previous
cases involving Islamic finance, that not everyone is giving due importance to
Islamic ways of settling disputes via Islamic competent courts or arbitrators.
As with this Dana Gas Sukuk, English court was given non-exclusive jurisdiction
as per the sukuk documents besides Emirate’s court in certain matters as also
provided in the same documents. </span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">So the big question here is; will the English court be willing
to consider the specificity of Shariah rules in their forthcoming judgment
given that the sukuk holders had taken action in the English court. To answer this,
one has to read about what had been decided in Shamil bank, the Blom bank and
Symphony Gems cases. In all of these cases, the English judges had issued their
judgements based on English law. </span></span></span></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;">
</span></span><br />
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: small;"><span style="font-family: "verdana" , sans-serif;"><span style="line-height: 115%;">With the development such as the above is it worthy to talk
about Shariah compliance in its honest sense. By right what is started with the
so-called Shariah compliant investment needs to be ended or resolved with
similar pronouncement. It remains to be seen whether the parties are serious about
the Shariah compliance aspect or they are just like any other players in the bond
market.</span></span></span></div>
<span style="font-size: small;">
</span><br />
<div class="MsoNormal">
<br /></div>
Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-64602002335864982362015-06-26T03:58:00.000-07:002015-06-26T04:07:28.078-07:00"WAAD" AND ISLAMIC CONTRACTUAL FRAMEWORK?<!--[if gte mso 9]><xml>
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<div align="center" class="MsoNormal" style="mso-pagination: none; text-align: center;">
<b style="mso-bidi-font-weight: normal;"><span style="font-size: 14.0pt;">‘WAAD’ OR
PROMISE: WHY IT IS INCONSISTENT WITH ISLAMIC CONTRACTUAL FRAMEWORK</span></b></div>
<div align="center" class="MsoNormal" style="mso-pagination: none; text-align: center;">
<br /></div>
<div class="MsoNormal" style="mso-pagination: none; text-align: justify;">
<span style="font-size: 14.0pt;">In one of the previous posts, we raised up an issue
pertaining to the use “waad” or promise in Islamic finance and how it seems
that this concept has been widely employed to achieve some objectives aimed at
helping one party but denying justice to the other side in a transaction. For a
start, Islamic law right from the outset has recognized a distinction between a
promise and a contract (‘aqd) where a contract has been viewed more important
than a promise at least in the context of external binding effect. However even
in the case of contracts, Islamic law does look at the nature of the contracts
concerned when it comes to the question of their external binding effect<span style="mso-spacerun: yes;"> </span>that will define whether the court will
enforce the ensuing obligations or not. </span></div>
<a name='more'></a><br />
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<br /></div>
<div class="MsoNormal" style="mso-pagination: none; text-align: justify;">
<span style="font-size: 14.0pt;">In this connection there are at least three major categories
of contract to talk about in terms of the binding effect of a contract. Firstly
there are contracts held to be binding on both contracting parties upon their
formation where none of the parties are allowed to unilaterally terminate the
relevant contract, and among others this includes sale and purchase and leasing
or contract of/for service known as ijarah. The second type comprises contracts
that are held to be not binding on both of the parties such that at any time
any one of them can unilaterally put an end to the relationship without any
need to get approval from the other side like in the case of the contract of
wakalah (agency), mudarabah, sharikah (partnership) and the likes. And lastly
there are contracts that are viewed to be of special category when one of the
party is allowed to terminate while the other is to stick to them with no right
to terminate unless with the consent of the first party. One example is the
contract of surety or guaranty, where the creditor can always free the guarantor
from the contract at any time, but the guarantor has no such a right as he is
to stick to it as per the term agreed.</span></div>
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<br /></div>
<div class="MsoNormal" style="mso-pagination: none; text-align: justify;">
<span style="font-size: 14.0pt;">It is interesting to note, even in the case of the
contracts that are supposed to be binding on both of the parties like sale and
ijarah, both parties if they wish, can insert the right to terminate the
contract in their agreement based on a concept known<span style="mso-spacerun: yes;"> </span>as <i style="mso-bidi-font-style: normal;">khiyar
al-shart </i>as<i style="mso-bidi-font-style: normal;"> </i>they may have provided
in the contract according to which the party who asks for it will have the
right to terminate such a contract within a specific time period.<span style="mso-spacerun: yes;"> </span>This concept is very similar to the modern
notion of right of cooling off (cooling off period) where the parties can
provide for it as part of the contractual terms, in which case they have right
to set aside the duly formed contract within specific period of time. </span></div>
<div class="MsoNormal" style="mso-pagination: none; text-align: justify;">
<br /></div>
<div class="MsoNormal" style="mso-pagination: none; text-align: justify;">
<span style="font-size: 14.0pt;">Coming back to the issue of binding promise as
previously discussed (refer to previous post), now it has become clear that if
the concept is relied upon, it<span style="mso-spacerun: yes;"> </span>(binding
promise) will take away the flexibility of the law of contracts<span style="mso-spacerun: yes;"> </span>itself by not allowing the relevant parties
to have equal bargaining power in their dealings. The binding effect of a
contract of exchange like sale and purchase derives its sanctity from the fact
that if one of the parties unilaterally backs off from his contractual duty
without agreement from the other side (who is ever willing to provide his part
of the bargain), then the one who is ready to continue can pursue the first
party in the court of law for enforcement (for specific performance). Therefore,
in the case of a contract that is binding on both of the parties, there is an
element of consideration where there are bargains on both sides which is not
the case in a one-sided promise. One basic question to ask here is how can a
party (promisee) who himself has not made any commitment to provide any
bargain/return/consideration to the other side is allowed to pursue the first
party (promisor) for an enforcement of a promise. Promise itself is said to be
not more than a statement by a person that he intends to carry out some good deeds
in future, such that it is up to the promisor to fulfill it or not even though
in a religious/moral term he is commanded to fulfill it unless there is any
justified reason not to fulfill it. Given that the promisee has not made similar
commitment, he cannot enforce the unilateral declaration of promise made by the
promisor, as there is no equal bargaining/fairness in the equation. Apart from
that, there is always a general Shariah prohibition on taking away anything
from an owner except based on the owner’s consent either premised on a sale or
gift contract. In short, if the notion of binding promise is to be widely
applied, it will defeat the purpose of the law of contract in accordance to
which people generally bargain their positions on a level playing field.
Although the approach that allows for a promise to be made binding seems to
address the issue of a customer not wanting to conclude a promised sale
contract like in Murabahah for instance, the danger of putting aside the
general<span style="mso-spacerun: yes;"> </span>theory/rule of Islamic<span style="mso-spacerun: yes;"> </span>contract is far more serious than the
anticipated benefit as it will defeat the very contractual framework that has
been laid down for the general benefit/protection<span style="mso-spacerun: yes;"> </span>of all, not to mention the flexibility of the
law of<span style="mso-spacerun: yes;"> </span>contract itself when it
recognizes the different categories of contracts from their binding effect
perspective. </span></div>
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<br /></div>
<div class="MsoNormal" style="mso-pagination: none; text-align: justify;">
<span style="font-size: 14.0pt;">It is interesting to note in this connection that in
May this year (2015), Islamic Fiqh Academy of Muslim World League (Rabitah
al-Aalam al-Islami) based in Mecca, issued a fatwa prohibiting the use of “waad”
in forward currency exchange as employed in Islamic finance. It emphasized that
Islamic rule prohibiting sale of currency not on cash/spot basis is far more
important to be observed as compared to the need to hedge against currency
exposure/risk based on doubtful method that clearly goes against Shariah
ruling. As known, Islamic finance practitioners have been using “waad” to
structure the so-called Islamic version of currency swap that has raised
serious concern among many Shariah scholars.</span></div>
Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-26858600748642212692014-06-21T08:04:00.000-07:002015-06-26T02:10:18.272-07:00CHARGING FEES FOR FINANCIAL GUARANTEE: THE BASIC ISSUE<div style="margin-bottom: 0in;">
<span style="font-size: medium;"><b>GUARANTEE FEES AND
ISLAMIC FINANCE: WHAT IS THE BASIC ISSUE??</b></span></div>
<div style="margin-bottom: 0in;">
<br /></div>
<div align="JUSTIFY" style="margin-bottom: 0in;">
<span style="font-size: medium;">Islam
prohibits charging of interest for money lending if such is
contractually made compulsory on a borrower and as such has made it
very clear that payment and receipt of interest made compulsory based
on contracts between the two parties is prohibited. However the
borrower is allowed out of his own accord without compulsion to pay
more than what he had borrowed from the lender as a token of
gratitude for the kindness rendered. Money lending must always be
treated as a benevolent contract in Islam that its shall carry no
interest charges.</span><br />
<a name='more'></a><span style="font-size: medium;"> Having said that one may ask: will it be possible
or allowable to charge fees for provision of a financial guarantee
which is itself a form of standby credit/lending to cover for a
possible default by a guaranteed borrower/debtor??. It is known
that it is a matter of contingency whether the guarantee is ever
utili<span style="font-size: medium;">z</span>ed or not; depending upon whether there is any actual default
by the borrower in which case the guarantor will be called or tasked
to pay the debt in question. Assuming there is such a default and the
guarantor had duly paid the debt to the creditor to discharge the
debtor's debt, provided such a guarantee was given as a result of a
request by the debtor, then the guarantor who had paid the amount to
the creditor will undoubtedly have a right of full recourse against
the debtor. It is like the debtor had actually borrowed the amount
from the guarantor in order for the debt to be repaid. </span>
</div>
<div align="JUSTIFY" style="margin-bottom: 0in;">
<br /></div>
<div align="JUSTIFY" style="margin-bottom: 0in;">
<span style="font-size: medium;">Now if fees
are collected by the guarantor for providing such a guarantee as
explained what it means is that he would receive at the end of the
day more than what he had lent to the original debtor (full recourse
amount plus guarantee fees) which in itself will constitute
riba/interest arising from lending. When Islam prohibit charging of
interest for money <u>actually</u> lent as in the case of straight
lending with interest, or as in the above case where the guarantee is
utilised then is there any doubt about the unlawfulness of charging
fees for money <u>not actually lent</u> as is in the case where the
guarantee is not utili<span style="font-size: medium;">z</span>ed. If charging interest for money actually
lent is riba, then charging fees for guarantee not utili<span style="font-size: medium;">z</span>ed can be
argued to be more serious than in the first case. This is the
operation of a principle known in Islamic law as a form of rule
based on <i>qiyas awla</i> (<i>min bab al-awla</i>) meaning a
fortiori in English which means a more serious case as compared to
the other one (i.e. charging interest for money actually lent.); if
charging fees for provision of guarantee as explained is allowed then
what is so big about charging interest/fees for money actually lent
as charging fees for no borrowing is far more serious than charging
interest for money actually lent.</span></div>
<div align="JUSTIFY" style="margin-bottom: 0in;">
<br /></div>
<div align="JUSTIFY" style="margin-bottom: 0in;">
<span style="font-size: medium;">The fact is
that the Muslim jurists of the past were very aware of this situation
when they decided that charging fees for guarantee is not permissible
in Shariah as it leads to riba coming through a back-door (when the
guarantee is utili<span style="font-size: medium;">z</span>ed), and the problem seems to be more serious when
the fees are collected while the guarantee is not utili<span style="font-size: medium;">z</span>ed. In the
case of actual lending with riba, even though the borrower receives
benefit from the lending/borrowing, still the creditor is not allowed
to charge interest. What more to say if there is no actual lending
taking place (i.e. guarantee not utili<span style="font-size: medium;">z</span>ed), can the lender/guarantor
be allowed to charge fees?</span></div>
<div align="JUSTIFY" style="margin-bottom: 0in;">
<br /></div>
<div align="JUSTIFY" style="margin-bottom: 0in;">
<span style="font-size: medium;">It is to be
pointed out however, as known, conventional banks charge interest for
their lending activities as a matter of routine because profit for
them come in the form of interest charged; the bigger the amount the
better. Since lending is done in a big scale and on a consistent
basis the issue of credit risk posed by such activities arise. In
order to ensure smooth running and growth of lending and credit
activities it is of no surprise that issuance of guarantee with fees
is common place as well to support the lending activities as stated.
In this context borrowing is encouraged all the times and to the
fullest extent as it is the life blood of the banking business, hence
guarantee with fees and with it credit guarantee schemes are offered
everywhere to support such lending. This is of no surprise in the
context of conventional banking/finance as everything revolves around
lending with interest. Hence charging fees for financial guarantee
has been treated as another form of financial business/product with
ease.</span></div>
<div align="JUSTIFY" style="margin-bottom: 0in;">
<br /></div>
<div align="JUSTIFY" style="margin-bottom: 0in;">
<span style="font-size: medium;">But the sad
thing is about the practice of charging fees for issuance of
guarantee by Islamic financial institutions that has been quite
normal a practice for years conducted based on some doubtful
justifications. The paradox in this case is that these same
institutions are projecting themselves as riba-free financiers who
are supposed to to do away with charging interest but when they
collect fees for contingency lending activities ( giving financial
guarantee) as described above then something must be very alarming,
and in fact such fees are to form part of the incomes/profit
generated from the so called Islamic financial service business. When
riba is of no concern to conventional banking/finance we fully
understand; there is nothing much to say about collecting or charging
fees for the provision of financial guarantee as it is a form of
lending as well although on contingency basis. But when the fees are
charged by the so-called Islamic banks which are supposed to avoid
riba (coming from money <u>actually</u> lent), then a serious
question will arise as to whether riba is truly avoided in their
operation as far as charging fees for guarantee is concerned. </span>
</div>
Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-59850026173123149052013-10-05T07:42:00.000-07:002015-06-26T02:11:43.091-07:00CRISIS IN ISLAMIC FINANCE EDUCATIONIslamic finance as practiced today is a new phenomenon that is very interesting to look at not because it is related to the so-called growth rate that is so impressive according to many reports of late. True that to a certain extent, the figure normally quoted to support this claim of impressive growth is there to be appreciated but the basic question to ask is whether such an achievement is truly an achievement worthy of celebration. <br />
<a name='more'></a><br />
<br />
The reason for this matter to be raised is simple; the growth as mentioned is not free from critics who pointed to claims that many Islamic financial products that have so far been introduced and practiced in the market mimic their conventional counterparts such that they have lost their original Islamic identity. The issue has become more prominent with the debate surrounding whether what is needed are Shariah compliant products or Shariah based ones. Proponents on both sides of the argument have to accept the fact that in Islam what is required is that all what need to be done need to be done according to the Islamic ways of doing things. Hence the key to the whole issue is closely related to the level of knowledge prevailing in the market about what is the Islamic ways of conducting financial and commercial activities. Everything is related to the level of knowledge needed to ensure consistency with the Islamic dictates as properly understood. <br />
<br />
But the sad thing is that there seems to be a crisis in the area of education in Islamic finance where it has been said that a minimum standard has not been applied both in terms of student and lecturer intakes at various level of education in Islamic finance. Issues have been raised as to the presence of not so qualified teaching staff at various centers offering Islamic finance education, and there seem to be no control as far as the necessary qualification is concerned that have led some observers to conclude that given the existing mode of education, there will be no hope for the field to be improved in terms of quality education when both of the aspects as mentioned are not given adequate attention. There are many centers that have been established recently or in the past couple of years to offer related courses at various levels of Islamic finance education but the sad thing is that many a time it is found out that such education lack substantive coverage on basic Islamic concepts just because many individuals who are tasked to teach are not suitable or qualified enough to present Islamic view on financial and business matters given their background, as they are mostly trained in western economic or financial system and thus lacking in substantive Islamic knowledge. With these background can it be expected that they can present to the students Islamic information they way it should be when they themselves are still struggling with some basic understanding about finance from Islamic perspective. The outcome of all of these phenomena is an education which is slanted more toward imparting conventional financial knowledge rather than the Islamic one. This problem is further aggravated by the fact that, the majority of players in Islamic finance sectors come from conventional background with little proper education or training in Islamic finance the correct way. It has been noted in some situations, people with little credential in terms of Islamic knowledge have been appointed to set direction to what is supposed to be Islamic finance education. If this is the situation what hope is there that the future direction of Islamic finance is leading to a correct destiny as those who are mandated to set the future are themselves confused about what the direction would be. To make matter worse there are instances where people moved to this field just because they saw more opportunities lie in this field not being truthful to themselves whether they have the minimum standard to be there or not. It is surprising to see or even mind boggling to ponder about the fact that in certain circumstances people are busy talking about the need to regulate Shariah advisors but not other players in the markets who are themselves devoid of minimum necessary qualification to talk about things Islamic but have full freedom to practice with little scrutiny as to their suitability and qualification. Unless minimum standard is put in place to regulate the basic qualification needed to teach Islamic finance related subjects at various centers of education offering courses in Islamic finance, there is little hope that the level of knowledge can be improved in the correct manner; truthful to a saying which says that “one who has not in possession cannot give.. .”.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-37411872858566644842013-01-19T09:07:00.000-08:002015-06-26T02:12:18.537-07:00THE EGYPTIAN DEBATE ON SUKUK LAW<!--[if gte mso 9]><xml>
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<br />
<div class="MsoNormal">
<span style="font-size: 14pt; line-height: 115%;">THE EGYPTIAN
DEBATE ON SUKUK LAW</span></div>
<div class="MsoNormal">
<span style="font-size: 14pt; line-height: 115%;">The current
Egyptian debate about the sukuk draft law that had been proposed by the
government and tabled in the People Assembly and passed but rejected by some shows
clearly that sukuk is such a topical topic in a country where Islamic finance
was tested many decades ago even before many other countries started their Islamic
finance movement. During the eighties of the last century, many would remember
the controversy surrounding the so-called Islamic investment schemes that were
mushrooming in the country including the famous case of al-Rayyan Investment Scheme. The difference is that the government of
the day at that time had a very different attitude toward Islamic finance and
about anything Islamic generally. </span><br />
<a name='more'></a><span style="font-size: 14pt; line-height: 115%;">Today the atmosphere has changed where the
Muslim Brotherhood inspired parties are part of the establishment.
Interestingly they were the ones who spearheaded the finance movement in Egypt
during the last few decades of the last century, such that many initiatives
involving Islamic investment were popularized by them.</span></div>
<div class="MsoNormal">
<span style="font-size: 14pt; line-height: 115%;">On the other
hand, the concern as expressed by the members of Al-Azhar Research Academy who
rejected the draft has its own merit given the current economic problems
experienced by Egypt right now. Having rejected the IMF offer of financial
assistance based on sovereignty argument, it is of no surprise to see that the
same argument (together with Shariah compliance issue) was put forward by the
Al-Azhar scholars in rejecting the draft law. One thing significant in this
context is the fact that those al-Azhar scholars seem to have properly
understood what sukuk should mean when it come to the issue of the underlying
assets to be used to back up any future issuance of sukuk: that to be Shariah
compliant, investors or sukuk purchasers must be accorded with the true right
of ownership of the assets/project on the basis of which sukuk are to be issued.
If no such conveyance of ownership in its true sense, then purely from Shariah perspective
the sukuk are not Shariah compliant, therefore the outcome, as feared by those
scholars, is no other than the prospect of foreigners holding ownership over
Egyptian assets/project; the source of concern when it comes to the issue of
national interest or sovereignty. Although the argumentation put forward by the
government officials involved in drafting the law centered around the positive
role that can be played by sukuk in financing government public utility or
development projects, some officials even tried to play down the fear as raised
by the opposing side by saying that there would never be the sell out of the
national assets due to sukuk issuance because they said that sukuk were just financing
tools. This last argument seems to be more or less conventional in nature where
in essence sukuk are viewed more or less similar to conventional bonds where
tangible assets have very little role to play in the securitization as bonds
are debt based. But when it come to sukuk, the equation is totally different
since sukuk issuance must be backed up by real assets although at the initial
stage (after collection of the investment sum from investors as per their
subscription), sukuk represent ownership of the capital/sum collected/contributed,
but once the same is used to purchase the real assets/project such ownership
will thus extended to the acquired assets or project. (This is in line with the
relevant Resolution by Islamic Fiqh Academy on Sukuk al-Muqaradah). To say that
sukuk do not implicate ownership of the underlying assets or projects is a clear misstatement of the whole concept. </span></div>
<div class="MsoNormal">
<span style="font-size: 14pt; line-height: 115%;">Therefore
what seems to be happening in Egypt right now as far as sukuk are concerned is
that everyone is in favor of the prospect of sukuk issuance but some have wanted
the process to take into account the issue of national interest or sovereignty.
This attitude is understandable given the current political situations in the
country that is still not stable, and as such any prospect of too much foreign influence
in the economic sector is really something that needs to be well considered
before any big move is taken to reform the economy.</span></div>
Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-44421731441866815892012-10-26T08:16:00.001-07:002015-06-26T02:13:02.688-07:00SUKUK BACKED BY MIXED ASSETSUKUK BACKED BY MIXED ASSET<br />
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Sukuk literally means “pieces of paper” or “documents that acknowledge something.” In a commercial sense it refers to instruments used in Islamic finance to allow one party to raise capital or funds in the capital market with the issuance of sukuk papers that list the rights and obligations of all parties involved in a transaction. Even though sukuk are sometimes referred to as Islamic bonds, they are not bonds in the conventional sense as holders of the former are not supposed to expect a fixed rate of returns from their purchase of these securities, as is the case with conventional bond holders. In the case of sukuk, what is important is that holders of the certificates must own the underlying assets to justify returns which are not fixed but are tied to actual returns/incomes generated by the assets owned. Hence, in the case of sukuk musharakah, for example, investors are sold portions of assets to be used in business. Returns to holders are in fact income or profit earned from the use of the assets in a manner specified in the sukuk contracts. <br />
<a name='more'></a><br />
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The class of assets that has been used for the purpose of issuing sukuk is fast developing, ranging from mere tangible properties to include rights and claims or receivables. However, the latter classifications have been the subject of discussion by Shariah scholars in terms of their status with regard to securitization or sukuk issuance.<br />
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The emergence of sukuk in the market and their wide approval by international Islamic investors stems initially from the fact that they are supposed to be asset-backed. The underlying assets are normally in the form of real tangible assets, a portion of which are sold to investors as previously stated. But in the beginning what the investors own are basically proportionate interest or ownership of the capital provided/money price when they purchase the sukuk as a result of which they are given the necessary certificates/sukuk.<br />
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Therefore, sukuk are different from Islamic debt securities which have been widely used in Malaysia for quite sometimes even though they have been described as sukuk as well of late. Islamic debt securities consider outstanding debts to be the subject matters of the transactions that lead to the issuance of securities and as such these certificates may be properly known in fact as debt certificates rather than sukuk that are basically investment certificates whose returns are tied up to the real performance of the relevant assets that back up these papers.<br />
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The debts in Islamic debt securities (IDS) are normally debts that have originated from the sale and purchase of tangible assets by way of installments or deferred price the process of which ends up with the debtor/purchaser in the BBA/credit sale issuing certificates of indebtedness in favor of the seller the same to be made tradable in the financial or capital market. What happen in the case of Islamic debt securities is that in order for the certificates to be made tradable the concept used is what is known as sale of debt or bai al-dayn as understood in Islamic law whose permissibility has been debated by Muslim jurist since ancient time<br />
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On the other hand, in the case of sukuk, the subject matters represented by the certificates are tangible assets that have been purchased with the use of the fund contributed by the investors when they purchase the sukuk. Given that these assets are held in common by all the relevant investors, each of them is considered to have owned a proportionate interest in the asset commensurate with their respective amount of investment the ownership of which will allow him to get the anticipated return if any and at the same time to assume ownership risk as well throughout the duration.<br />
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For those who do not approve a sale of debt in the form of certain sum of money owed (the majority), their concern arises from the act of selling the debt to a third party for more or less than its value that will according to them result in riba'. Apart from this, they also insist that other conditions need to be fulfilled first before debts can be sold particularly to third parties. This is done to safeguard the interests of all parties involved and to avoid triggering Shariah restrictions related to riba' and gharar.<br />
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However, when the issued securities represent mixed assets comprising real tangible assets and debts, the trading of these securities can be allowed according to some opinions provided that the value or proportion of real tangible assets surpasses that of the debts or at least 51% or more of the combination of the two. <br />
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<br />Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-63270472738077818102012-07-13T08:04:00.000-07:002015-06-26T02:14:35.981-07:00ISLAMIC BANKS AND HOUSES UNDER CONSTRUCTIONISLAMIC BANKS AND THE SALE OF HOUSES UNDER CONSTRUCTION: WHERE IS THE FAULT?<br />
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Issues have been recently raised about the predicament faced by consumers who have to suffer due to houses they purchased using Islamic banking facilities provided by Islamic banks in Malaysia. According to one report by Islamic Consumer Association of Malaysia (PPIM) complaints received by the association from consumers about house financing in the past couples of years run into thousands mostly related to non-delivery of the purchased houses due to abandoned housing projects. Many parties have voiced their displeasure at the way the relevant financing is done and called for an immediate review by competent Shariah authority to address injustice to the consumers. What is more damaging, it has been said, the good name of Islam has been compromised by such a banking practice resorted to by the so-called Islamic banks.<br />
<a name='more'></a><br />
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What happened was that normally it involved many customers who had purchased houses under construction from developers where the same houses were subsequently sold to Islamic banks at the original buying cost minus deposit paid to the developers and the same were repurchased back from the bank by the customers/purchasers at a higher price normally to be paid in deffered payment term or installment as a form of facility granted by the banks. In the Malaysian practice such facilities are structured using the concept of BBA (bai bi thaman ajil-sale with price differed). <br />
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However given the fact that there are two immediate transactions (one after the other) entered into by the bank and the customers concerned, such a facility is in fact a form of what is known as Inah transaction i.e it is a form of BBA where there is an embedded element of Inah sale (sale and repurchase back) in it where the house is sold to the bank and repurchased back by the customer at much higher prices. <br />
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Notwithstanding this Inah issue, what is problematic here relates to the fact that the subject-matter of the sale is a house under construction or one that is to be constructed. This is the first mistake done by the parties to this form of financing which they name as BBA (deffered payment sale), since according to Shariah law in BBA/deffered payment sale, only the price is allowed to be paid in future ( deffered) and not the asset (subject-matter of the sale) also be deffered as well like what happen in the context of the housing finance as described above where the house is yet to be in existence. The true Shariah concept of BBA dictates that in a Shariah compliant BBA ( setting aside the issue of Inah for a while), once agreed, the BBA must end up with the purchaser being delivered with the asset purchased (together with conveyance of full title to depict true ownership transfer from the seller) right after the sale contract.<br />
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But what happen in the financing done by the banks is that the bank purchases the so-called house from the customer (do not forget at that time the house is yet to be constructed by the developer) and immediately sells it back to the same customer for a deffered price to paid in installment the first of which is to be paid right after the contract is signed and after the bank had paid the proceed of the first sale ( sale by customer to the bank) to the developer (who had in the first instance sold the same “house under construction” to the customer in the first place) thereby releasing the customer from the debt owed to the developer and at the same time assuming new debt toward the bank (the amount of which is higher) as a result of the BBA purchase from the bank in the second transaction.<br />
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As seen, such a procedure as described can be aptly termed as a form of conventional financing rather that an Islamic one given the absence of one of the most important element of validity from Shariah perspective where the BBA was affected for a non existent subject matter whereas a valid BBA sale requires the subject matter to be in existence and actually delivered to the relevant purchaser right after the conclusion of the contract.<br />
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What is more astonishing is that (as reported by consumers) irrespective of whether the house is completed and delivered or not they have to pay the installments to the bank for houses that have never seen the day light. Worst still at the same time the same customer in some cases is forced to pay rent for a substitute housing during the relevant period such that it is more like he has been penalized twice for such an event of non- completion/delivery for which he also has to blame himself for entering into such an arrangement in the first place. But for the banks who hold out to be running their business as per the Shariah requirement, such an issue cannot be taken lightly and the society at large surely has an interest at stake when issues are raised about such a practice that seems to be a blatant disregard of Shariah requirement.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-35034995601133337552012-03-26T07:42:00.002-07:002015-06-26T02:15:34.535-07:00STANDARDIZATION OF SHARIAH OPINIONS<!--[if gte mso 9]><xml> <w:worddocument> <w:view>Normal</w:View> <w:zoom>0</w:Zoom> <w:trackmoves/> <w:trackformatting/> <w:punctuationkerning/> <w:validateagainstschemas/> <w:saveifxmlinvalid>false</w:SaveIfXMLInvalid> <w:ignoremixedcontent>false</w:IgnoreMixedContent> <w:alwaysshowplaceholdertext>false</w:AlwaysShowPlaceholderText> <w:donotpromoteqf/> <w:lidthemeother>EN-US</w:LidThemeOther> <w:lidthemeasian>X-NONE</w:LidThemeAsian> <w:lidthemecomplexscript>X-NONE</w:LidThemeComplexScript> <w:compatibility> 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<span style="font-size: 78%;"><b><span style="font-size: 18pt; line-height: 115%;">STANDARDISATION OF SHARIAH OPINIONS/LAW IN ISLAMIC FINANCE: WHAT ARE THE ISSUES?</span></b></span></div>
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<span style="font-size: 78%;"><span style="font-size: 18pt; line-height: 115%;">We often hear people involved in Islamic finance talk (in seminars and conferences) about the need to standardize shariah laws/opinions related to the practice as they claim that without such a move the sector cannot grow. They say that the impediment to the so called growth lies with the conflicting views coming from jurists of Islamic law. But the same persons when confronted with facts about the conflicting and multiplicity of the legal systems of the world and the various judicial decisions made in various jurisdictions that are also appealable at various stages of trials in civil or conventional courts, they don’t dare to say even a word about it. </span></span></div>
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<span style="font-size: 78%;"><span style="font-size: 18pt; line-height: 115%;">As for the Shariah, sometimes their statements in this context seem to be a form of mockery of the Shariah itself. Ironically these same people are there out in the open to take advantage of the Shariah but they do even seem to give a little respect to the same system. Observers may tend to describe them giving more respect to the other systems of law, when they readily accept the relevant pronouncement from that side without a word being said about its wisdom and appropriateness. For them what are decided are the truth and the whole truth beyond any question whatsoever. But when it comes to Shariah, due to their lack of understanding or even less respect of the system, they do not have any reservation to spare.</span></span></div>
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<span style="font-size: 78%;"><span style="font-size: 18pt; line-height: 115%;"> Are they not mindful of the fact that in today’s world there are many legal systems in operation in different parts of the globe with salient feature. Even within the boundary of a legal system based on English Common Law itself there are many variations; British law and American law originated from the same source i.e. the English common law, but the two are different in some respects. What about socialist legal systems of China and Russia? Are they not different from the so called Western law?. Even in Europe itself, everyone knows the distinctive features of the Continental legal system of mainland Europe as opposed to the system followed in England.</span></span></div>
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<span style="font-size: 78%;"><span style="font-size: 18pt; line-height: 115%;">So when it comes to the different mazhabs in Islamic law (operating in different parts of Muslim lands with varying degree of application) like the Hanbali, Shafie, Maliki and Hanafi for instance, why do these people feel sometimes that they are at liberty to say negative words about the Islamic Shariah system without proper comprehension? Do they know that the mazhab system is a form of standardization effort tested over long period of time in Islamic history just like the multiplicity of the world legal system we have today?.</span></span></div>
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<span style="font-size: 78%;"><span style="font-size: 18pt; line-height: 115%;">Partly the answer for the above lack of understanding comes from the fact that the Shariah system is not implemented in many parts of the world in a comprehensive manner for too long where people can see its beauty. In fact what happens is that in many cases even though the transactions may have been structured based on Shariah principles and rules but they lack proper supports from the legal system within which they are being practiced as in many cases, Islamic finance has been pursued within and subject to conventional legal framework. The second possible reason could be that in conventional finance the anchor contract employed is one of lending and borrowing (with interest); the central concept in conventional finance. But when it comes to Islamic transactions, there are a lot of other contracts to apply given the essence of Islamic transactions that is based on sale with its various structures. Practitioners/players (many join from conventional experience/practice) are normally at lost to appreciate the underlying distinction between Islamic and conventional transactions, so the easiest thing to say if you are in these circumstances is the phrase like “Shariah law is very confusing; it has so many views and opinions”. </span></span></div>
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<span style="font-size: 78%;"><span style="font-size: 18pt; line-height: 115%;">Paradoxically why they did not say the same thing about the various legal systems and rules or decisions coming out the conventional legal system?. Perhaps some may have apprehension of the law of contempt in conventional courts to say so. Since there is no Shariah judge with a full power in sight, (the one that may even send them to jail for contempt), we have a free ride, they may say…</span></span></div>
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<span style="font-size: 78%;"><span style="font-size: 18pt; line-height: 115%;"> </span></span></div>
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<span lang="EN-US" style="font-size: 100%; line-height: 115%;">CREDIT RISK IN ISLAMIC DEPOSIT</span></div>
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<span lang="EN-US" style="font-size: 100%; line-height: 115%;">Islamic financial institutions mostly Islamic banks take in deposit in various forms, and employ such deposits in ways they deem fit as part of their so called Islamic banking business. In some jurisdictions the term Wadi’ah is normally used to refer to such deposits for convenience sake and for a purpose seemingly to impress upon the fact it is more of safekeeping arrangement undertaken by depositors with the banks concerned, as the term wadiah in its original sense connotes safe-keeping contract between owners of assets and safe-keepers or trustees-custodians. </span></div>
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<span lang="EN-US" style="font-size: 100%; line-height: 115%;">But then when it come to banking business as commonly understood, such concept of custodianship is a misplaced term in the real application since in most cases the banks that accept the fund would as a matter of practical application use or employ the fund for their business operation. On this score alone it may be safely said that the use of such term as wadiah in the above context is not accurate to describe truthfully what actually happened in the context of the banking practice as described. </span></div>
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<span lang="EN-US" style="font-size: 100%; line-height: 115%;">In Shariah parlance, when wadiah is created the basic objective is for safe-custody and not for usage by the custodian; if usage is intended it will depend on whether the deposited item or object is durable or perishable by usage or consumable in nature in which case the transaction is known as qard. If however the item is durable such that any intended usage will not diminish it, (meaning it may be returned safely after usage) then the arrangement is known as I’arah or borrowing or lending of durable item. From the foregoing discussion it has become clear that to be considered wadiah the purpose must be for safe-keeping rather than usage or borrowing as is in the case of either qard or iarah as explained. </span></div>
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<span lang="EN-US" style="font-size: 100%; line-height: 115%;">The problem started to emerge when Islamic banking deposit was referred to as wadiah when it was clear right from the very beginning that the banks’ intention was to make use of such deposit as it deemed fit for their business purpose. If classical Shariah framework is to be applied such an arrangement with that purpose needs to be viewed as a form of qard considering the fact that the money collected and used/spent is not returnable as it moves from one hand to another in transactions. However when the term wadiah is used to refer to such deposit, misunderstanding is bound to arise just because wadiah from its very concept only connotes safe-keeping. To address this issue some banks added another term to the original wadiah thus the concept was said or described as <i>wadiah yadd damanah</i> ( wadiah/safe-keeping with guarantee); such combined term is in itself more confusing given that by conceptual definition wadiah is not supposed to be guaranteed in all circumstances the way qard/loan is. </span></div>
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<span lang="EN-US" style="font-size: 100%; line-height: 115%;">According to Shariah, a custodian in the contact of wadiah is only liable in case of negligence or fault and not like a borrower who is under a duty to repay back what is borrowed in whatever circumstances. Wadiah custodian however will not be held liable if the reason for such inability to return back the deposit when demanded has nothing to do with any element of negligence or fault on the part of the custodian.</span></div>
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<span style="font-size: 100%;"><u><span lang="EN-US" style="line-height: 115%;">Deposit Guarantee and Mudarabah</span></u></span></div>
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<span lang="EN-US" style="font-size: 100%; line-height: 115%;">Islamic banks also collect funds in the form of mudarabah investment deposits which are either general or specific investment account where the idea is to differentiate these deposits from those collected as wadiah as previously described. Up to this level such deposits that are said to be for investment on the basis of mudarabah pose no big problem, but if we move a layer below, it will become clear that in practice not all basic rules governing mudarabah are followed. This is apparent when we take into consideration that the bulk of the monies so collected by the banks (as mudarabah deposit or placement) is later employed mostly in either murabahah credit sales or BBA (deferred payment sale) in providing financing to their so-called customers. The issue is, when the banks collect such deposit, they thus become a mudarib/enterprenuer and as such are to be bound by the rule of mudarabah. </span></div>
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<span lang="EN-US" style="font-size: 100%; line-height: 115%;">In the law of mudarabah, it is a settled principle that the mudarib shall have no right to be involved in granting facility in the form of deferred payment sale as a matter of right as a mudarib because such an act is viewed to expose the mudarabah fund to risk of non- payment by buyers i.e credit risk. which will eventually create a loss at the detriment of the investor/rabbulmal. The generally accepted opinion in Shariah jurisprudence is that if a mudarib performs such an act, he will be held strictly liable for any non-payment arising there from since such an action is considered not to be part of a role of a mudarib by default. Additionally it is also a generally accepted rule in Shariah that it is not permissible for a mudarabah contract to be made embedded with a capital protection clause as this is not in line with the very nature of mudarabah concept and application. There are however two general opinions regarding the mudarabah contract that is embedded with such a clause; one opinion goes on to state that the whole contract will become invalid by such a provision while the other one only regards the clause as not valid and of no practical implication due to such impermissibility. Thus the mudarabah contract as per this second opinion can still be operative but without such a clause.</span></div>
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<span lang="EN-US" style="font-size: 100%; line-height: 115%;">From the above discussion it has become clear that had banks truthfully followed the correct rule of mudarabah by not involving in credit sales as widely practiced, there would have been no need to talk about credit risk from Islamic perspective the way it is understood in the conventional contact. Conventional banking institutions lend money to their customers so they have no alternative but to address the issue of credit risk as understood. Islamic mudarib banks, not only that they are not supposed to lend money to do business, but also they have to refrain from any involvement in deferred/credit sale as a matter of requirement of mudarabah rule. But when such a rule is not followed, whether they like it or not the issue of credit risk is there to be addressed as a matter of self-induced problem that should not emerge in the first place had the true concept and rule of mudarabah were correctly followed. Sadly as is always the case, it is much easier to replicate the conventional practice than sticking truthfully to the original concept; as originality has a price not everyone is willing to pay.</span></div>
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Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-82216650421582681742011-11-15T08:32:00.000-08:002011-11-15T08:36:22.818-08:00SUKUK DEFAULTSUKUK DEFAULT: IS IT TRULY A DEFAULT?<br />As indicated in a previous posting, sukuk if properly understood means certificates proving ownership of underlying assets that back up the issuance of such certificates which are for all intent and purpose issued to testify that a certain sum of money has been invested and handed over to the issuer/manager. Sukuk as per the generally accepted global definition means investment certificates of equal value issued to investors as documentary proofs of their investment. They are not debt certificates as wrongfully described by some uninformed writers unless they talk about certificates as issued in Malaysia as part of what is known as IPDS (Islamic Private Debt Securities) backed by BBA debts in which case such certificates are truly debt certificates. This IPDS cannot be considered as sukuk according to the global definition especially in the context of a relevant resolution on Sukuk Muqaradah (Mudarabah) passed by the OIC Fiqh Academy in 1988 .<br /><br />True sukuks must confer true right of ownership to sukuk holders in the manner recognized by the Shariah, the same to be made available to them as true owners of the underlying assets that back up the sukuk which initially means the money capital handed over to the issuer as part of the investment. The issuer then is expected to utilize the fund to purchase productive or trade assets to be dealt with accordingly in the ensuing business to be carried out to garner profit for the investment. In this context the issuer cum manager is to act as an agent for the sukuk holders or investors in conducting the trading business or in managing the project for which purpose the sukuk have been issued.<br /><br />Provided the agent/issuer/manager has conducted himself as expected ( on best effort basis) and without negligence or be in breach of the terms of the investment contract/sukuk deeds, if loss should occur then as a general rule he is not to be held liable precisely because he has been acting as an agent whose liability is fault-based. If ever he is to be held liable for the loss, the sukuk holders must come with acceptable evidence to prove it. Juristic opinion however differ in terms of how the manager’s statement as to the cause of the loss is to be relied upon: whether it is to be taken at its face value or he needs to be asked to take an oath of assertion that such loss is not due to his negligence or wrong doing.<br /><br />Given this Shariah position, hardly that one can compare this position with that of a default in the context of debt securitization (bond) as understood in the conventional sense where default there would means inability of the issuer to pay coupon as agreed or to be unable to redeem the principle at its face value upon maturity. In the case of the sukuks however, there will be no default if non-payment of profit is not caused by any negligence or wrongful act on the part of the issuer/manager as profit is only payable if there has been actual profit realized by the investment. Even if the issuer is unable to redeem the sukuk at the end of the period as agreed, if such inability/loss is occasioned by no fault on his part, such loss is to be borne by the investors or sukuk holders who are in fact entitled to get back the remaining portion of any assets that belong to the fund at the material time meaning; that they must have a right of recourse to the remaining asset of the sukuk. This is only possible if the sukuk are aseet-backed sukuk and not the asset-based ones. In order for sukuk to be valid from Shariah perspective, the issuance must be in the form of asset-backed that should confer true right of ownership to the sukuk holders of all the underlying assets that backed up the issuance.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-64272272512105388312011-08-25T08:56:00.000-07:002011-08-25T08:58:38.937-07:00RULE OF LAW AND ISLAMIC FINANCESTANDARDISATION, JUSTICE AND THE RULE OF LAW: WHERE IS DISPUTE SETTLEMENT IN ISLAMIC FINANCE?
<br />As Ibn Khaldun, the outstanding Muslim social scientist put it many centuries ago, a man cannot live except in a civil society because he cannot survive in isolation. Demands of life could not be fulfilled unless he co-operates with others, and the others need him to fulfill their basic needs too. The gathering of people in a particular place or locality leads to urbanization which is the essence of hadharah or civilization. Civilized people need systems to conduct their daily activities and to settle disputes arising as between them. Life without dispute settlement mechanisms is a form of anarchy by definition.
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<br />In the contemporary world however, multiplicity in legal systems is a fact of life that no informed observers and students of law can ignore. The numerous systems and rules applied and followed worldwide testify to the fact that everywhere justice is sought after at whatever price. Nevertheless, the biggest question to answer is not related to what particular system that is followed but what justice it brings to real lives of the people. In the end, it is justice in itself that is sought after by nearly all irrespective of race, colour or place of abode. The quest for justice is a never-ending endeavor of the human race of all ages. Islam as a religion is very vocal about the need to uphold justice. In the Quran Allah Almighty says:
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<br /> “ O ye who believe! Stand out firmly for justice, as witness to God, even against yourselves, or your parents, or your kin, and whether it is (against) rich or poor: for God best protects both. Follow not the lusts ( of your hearts), lest ye swerve, and if ye distort (justice) or decline to do justice, verily God is well-acquainted with all that ye do.”
<br />(Al-Quran 4: 135)
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<br />It is of interest to compare the above Islamic notion of justice with the so-called distributive and remedial justice of Aristotle, the natural justice of Anglo-American Common Law and the formal justice of the Roman Law. Whatever description that may be attributed to all of the above notions, one certain thing is that each system seeks to define justice and provide solutions to human problems which involve rights and obligations and the associated phenomena related therein.
<br />One of the most important elements needed for justice to be done is the existence of an independent judiciary that seeks to settle disputes arising in the society. No law can be effective in rendering justice unless the means through which it is delivered and made applicable is supported by just process and procedure. Granted all of that, the rule of law is thus established where law reigns supreme; nothing is done or rendered except in accordance with clear provisions of law as interpreted and explained by competent and independent judges.
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<br />In the context of judicial independence the most pertinent aspect is to see whether the establishment of the judiciary itself reflects sincere regard for principles of justice. One legitimate question to ask is: to what extent, the established court system or judiciary is subject to constraint and limitations that would seek to influence its task in administering and upholding justice or whether there are constitutional provisions that guarantee its independence?. If there are in fact such constraint and limitations, whether they are justified in the context of an overall effort to establish harmony in society founded upon the noble concept of justice that is supposed to maintain workable balance with regard to competing interests and rights?.
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<br />It has been said time and again that, the judiciary is the true guardian of justice in any society such that any weakness in its roles and functions vis-a-vis other organs of the state will adversely affect the whole system of value and justice. Likewise, any deterioration in people's confidence about the independence of the judiciary will in most cases lead to instability and chaos that will sometimes be difficult to control. Therefore it is very important to realize that the duty to maintain an independent judiciary is vital to the survival and progress of any nation. Efforts must always be made to strengthen the image and dignity of the judicial system and its functionaries.
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<br />In a wider context, apart from perception held by local masses about their judiciary, international public opinion is sometimes very active in shaping the kind of image a judiciary of a certain country has. Undoubtedly, these days no country stands in isolation and immune from the scrutiny of interest groups, lobbyists and international media in particular. However there are several dangerous elements present in the current debate about democracy and the rule of law and with it the notion of independence of the judiciary.
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<br />With the ensuing move towards globalization, there seems to be efforts by some quarters to impose certain values as "universal" forgetting the facts that in reality, people are different, their habitats and upbringing are different and the levels of their civilizations are also different. If certain universal values are to be accepted by the entire world, these values must be universal enough to be accepted by all. Certainly there are values that we universally have no argument about them like:
<br />1. one is presumed to be innocent unless proven guilty
<br />2 . Everyone has the right to be heard,
<br />3. the notion of right to fair hearing,
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<br />4. the right to provide defense of oneself upon accusation.
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<br />However, there are values that people may disagree about, in the context of prevailing local customs and religious belief. International conventions thus for instance recognize freedom of religion as one of the basic fundamental rights of each and every individual. Hence to force someone to abandon the creeds or rules as found in and taught by his religion is actually a denial of the right to religious freedom granted to him in the first place.
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<br />Islam for one, is a religion that is very clear about law and order as it comes with a well-embracing concept of shariah or divine law supplemented with what is known as jurist law or fiqh jurisprudence. Therefore, for Muslims, justice is both the question of religion and temporal necessity. As such the duty to administer justice is considered part of religious observance of the believers not less valuable than their worldly affairs for that matter.
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<br />Although Islam propagates sacred values as dictated by the Shariah or the divine law, yet in actual fact the Shariah itself contains both the elements of rigidity and flexibility at the same time. It is rigid when it deals with fundamental values like justice, tolerance, equity, respect for the elderly, fair distribution of property, prohibition of certain major criminal acts, just to mention a few, but still it is very flexible with respect to the way in which these principles or values are to be implemented. That flexible part of the Shariah (fiqh jurisprudence) may change with the change in time and place thereby allowing accommodation to take place for the sake of justice and equity.
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<br />Universal values, if they were to be respected, must be flexible enough that they can accommodate local circumstances, yet still relevant in a wider context. The irony is that sometimes in the pursuit of universal principles and values we forgot about the need to adjust ourselves to local circumstances and needs, thereby compromising our true quest for justice.
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<br />Independence of the judiciary is also related to the need to maintain freedom for judges to act within their powers as established by law. In order to curb unwarranted monopoly of power in a state, the doctrine of separation of powers was propounded whereby the three organs of the state ( legislative, executive and judiciary) are supposedly segregated such that each will act as a check on the others, culminating in the appearance of the notion of check and balance in constitutional thinking.
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<br />Additionally the judiciary is also empowered with judicial review over actions by executive agents to ensure that discretion is properly exercised. In practice however, such noble aim has been the most difficult task to achieve given the dominance of the executive branch in a day to day running of the state, not to mention the fact that in most cases, judges, especially at the highest level, are normally appointed by the head of the executive.
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<br />Apart from issues relating to appointment of judges, what we mean by the term independence of the judiciary is that judges who are so appointed should be able to exercise their unfettered discretion in the interpretation of laws and administration of justice, and that they are not influenced by anyone in discharging their duties as adjudicators for disputes. Only when this aim is achieved that the major condition of rule of law is fulfilled thus ensuring that justice is done and liberty established. The process that leads to the above noble aim is related, among others, to issues surrounding modes of appointment of judges, judicial tenure, removal of judges, judges’ salaries and also qualifications of judges.
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<br />Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-61053442286391454252011-08-09T10:24:00.000-07:002011-08-09T10:26:45.661-07:00"WAAD" (PROMISE) or CONTRACT?In the last post, we raised up an issue pertaining to “waad” or promise in Islamic finance and how it seems that this concept has been employed to achieve some objectives aimed at helping one party but denying justice to the other side in a transaction. Islamic law right from the outset has recognized a distinction between a promise and a contract where a contract has been viewed more important than a promise at least in the context of external binding effect. However even in the case of contracts, Islamic law does look at the nature of the contracts concerned when it comes to the question of their external binding effect that will define whether the court will enforce the ensuing obligations or not. In this connection there are at least three major contracts to talk about in terms of the binding effect of a contract. Firstly there are contracts held to be binding on both contracting parties upon their formation where none of the parties are allowed to unilaterally terminate the relevant contract, and among others this includes sale and purchase and leasing or contract of/for service known as ijarah. The second type comprises contracts that are held to be not binding on both of the parties such that at any time any one of them can unilaterally put an end to the relationship without any need to get approval from the other side like in the case of the contract of wakalah (agency), mudarabah, sharikah (partnership) and the likes. And lastly there are contracts that are viewed to be of special category when one of the party is allowed to terminate while the other is to stick to them with no right to terminate unless with the consent of the first party. One example is the contract of surety or guaranty, where the creditor can always free the guarantor from the contract at any time, but the guarantor has no such a right as he is to stick to it as per the term agreed.
<br />It is interesting to note, even in the case of the contracts that are supposed to be binding on both of the parties like sale and ijarah, both parties if they wish, can insert the right to terminate the contract in their agreement based on a concept known as khiyar al-shart provided in the contract according to which the party who asks for it will have the right to terminate such a contract within a specific time period. This concept is very similar to the modern notion of right of cooling off (cooling off period) where the parties can provide for its as part of the contractual terms, in which case they have right to set aside the duly formed contract within specific period of time.
<br />Coming back to the issue of binding promise as previously discussed (refer to previous post), now it has become clear that if the concept is relied upon, it (binding promise) will take away the flexibility of the law of contracts itself by not allowing the relevant parties to have equal bargaining power in their dealings. The binding effect of a contract of exchange like sale and purchase derives its sanctity from the fact that if one of the parties unilaterally backs off from his contractual duty without agreement from the other side ( who is ever willing to provide his part of the bargain), then the one who is ready to continue can pursue the first party in the court of law for enforcement (for specific performance). Therefore in the case of a contract that is binding on both of the parties, there is an element of consideration where there are bargains on both sides which are not the case in a one-sided promise. How come a party (promisee) who himself has not made any commitment to provide any bargain/return/consideration to the other side is allowed to pursue the first party (promisor) for an enforcement of a promise. Promise itself is said to be not more than a statement by a person that he intends to carry out some good deeds in future, such that it is up to the promisor to fulfil it or not even though in a religious/moral term he is commanded to fulfil it unless there is any justified reason not to fulfil it. Given that the promisee has not made similar commitment, he cannot enforce the unilateral declaration of promise made by the promisor, as there is no equal bargaining in the equation. Apart from that there is always a general Shariah prohibition on taking away anything from an owner save on the owner’s consent either premised on a sale or gift contract. In short, if the notion of binding promise is to be widely applied, it will defeat the purpose of the law of contract in accordance to which people generally bargain their positions in a level playing field. Although the approach that allows for a promise to be made binding seems to address the issue of a customer not wanting to conclude a promised sale contract in limited scope, the danger of putting aside the general theory/rule of Islamic contract is far more serious than the anticipated benefit as it will defeat the very contractual framework that has been there for the general benefit/protection of all, not to mention the flexibility of the law of contract itself when it recognizes the different categories of contracts from their binding effect perspective.
<br />Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-3753500414062295222011-08-07T11:17:00.000-07:002011-08-07T11:32:45.418-07:00THE PROBLEM OF "WAAD" OR PROMISEPromise or “Waad” has been featured so prominently for quite sometime in Islamic finance circles such that it has been given more importance than Islamic contract itself. In what is frequently referred to as an effort aimed at helping Islamic finance to grow and be competitive in the world of finance, waad has been employed in structuring many Islamic financial instruments including Murabahah sale, swap and option where in most cases it is the customer who is made to be legally bound by any promise that he may be asked to make in favour of Islamic financial institutions. <br /><br />The concept invoked in this connection is what is known as the notion of binding promise premised on views as adopted by some mazahibs or Islamic schools of Jurisprudence. Although a great majority of Muslim jurists right from the earliest period of Islamic law have held the view that a promise is undeniably morally binding upon the promisor, but they accepted the view that in a law or judicial term it is not binding in the sense that if the promisor should break his promise he could not be sued in any Shariah court for such a breach. <br /><br />But the modern approach to Islamic banking and finance has always preferred the view of a small minority of the jurists who hold the opposite opinion when they opine that a promise is also judicially binding on the promisor. Not only that this approach sanctions such a view, if one were to look at many contracts/agreement used by Islamic financial institutions, it will become clear that any breach of promise by the promisor (client) will render him liable for any loss that may have been suffered by the other party (promisee/banks) and be required to fully indemnify the promisee. In many cases, part of the duty to compensate revolves around the need to pay the difference in price of the underlaying asset, to be purchased by the promisee from the bank, and the realized price if the same asset is to be sold to any other party after the breach of the promise by the promisor, i.e., when the promisor negates his promise to purchase the asset from the promisee/bank.<br /><br />Interestingly, although it seems that the promisee/bank generally accepts the notion of binding promise on the promisor as described, that concept is however not made applicable to the promisee/bank in most of the circumstances where normally the promisee/banks always reserves an absolute discreation whether to conclude the promised contract or not, as the promisee/bank right from the very beginning of the arrangement will not make any similar promise to sell the asset to the client/promisor. It is always claimed that to make this arrangement valid from Shariah perspective, there will always be only a unilateral promise from one of the parties that in most cases as previously said is the customer/client. The rationale for this approach as propounded by the practitioners/and their Shariah advisors is that if the promise to buy and sell was to be made on mutual basis, that will trigger Shariah compliance issue as far as the intended sale is concerned. Take the case of Murabahah for example, if it is allowed for both parties (the bank and the customer) to make mutual promise to buy and to sell at the same time then this arrangement will, as claimed, constitute a sale contract at a time when the asset of the murabahah has yet to be the property of the bank because at the time of the mutual promise the bank has yet to buy it from the distant supplier. This arrangement (mutual promise) if allowed will lead to selling something not in one’s possession or ownership that runs counter to a basic rule of sale. <br /><br />However, one big question remains to be answered: if it is true that any promise made by a client in favour of a bank is mandatory to be fulfilled by the client in any circumstances in line with the concept of binding promise as decribed, how come the promisee/bank at his absolute discreation reserves a right to himself not to agree to the performance of the promise by the promisor? Because if such a discreation is exercised by the bank/promisee it means that he prevents the promisor from performing his promise as dictated by the concept of binding promise. Hence the big question is, can it be possible for the promisee/bank to resort to such an act while insisting at the same time that the promisor must perform his promise under all circumstances?<br /><br />The tendency to rely on the concept of binding promise as explained above seems to be motivated by a desire on the part of the strong party/financier to take advantage of the needs of the weaker one/the client more than<br /> a true adherence to the spirit of justice as envisaged by Islam or Shariah.<br /><br />This analysis shows that what had been accepted by the majority of Muslim jurists on the nature of a promise which is not legally or judicially enforceable is more appropriate to be considered. Imam al- Shafi as one of the earliest jurist to talk about Murabahah for example, opined that should the two parties (in the context of Murabahah) enter into a mutual promise to do murabahah sale, such mutual promise is valid if both parties have option whether to subsequently enter into the murabahah sale or not to enter into it, otherwise the arrangement is not valid in his opinion because if such a promise is binding on them, that effectively will constitute a sale at a time where the seller has yet to own the asset. For him a promise or even a mutual one will have no binding effect on the parties from the judicial perspective.<br />Hence when the bank/promisee subscribes to the idea of a promise binding only on the promisor but the promisee/bank is free to accept the performance of the promisor or to reject it just because he has not made a similar promise is very absurd indeed.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-75242434111961835562011-08-03T22:18:00.000-07:002011-08-04T19:55:44.353-07:00ISLAMIC BANKING VIA CONVENTIONAL FRAMEWORKISLAMIC BANKING VIA CONVENTIONAL FRAMEWORK<br />Banking if it is to be understood conventionally as the business of collecting deposit and provision of loan is truly out of context as far as Islamic perspective is concerned, basically because Islam prohibits any act of commercialization of credit and loan. Loan is supposed to be at all times viewed as an act of benevolence the motivation of which is to help people in needs free of charge. <br />However problems arise when 30-40 years ago some Muslims wanted to have their own banks albeit based on their own version where there was no loan given on interest as this would constitute commercialization of debt and credit. But they had to face the reality of that time where they found out that in many parts of the Muslim land, nearly all laws governing banking and provision of credit were (and still in many jurisdictions) based on a framework that authorized financial intermediation by banks and credit institutions where interest was paid and charged. So in the beginning Islamic banks were allowed to operate within such a framework in a way that they were said to be different from their conventional counterparts because they did not manifestly charge interest. This was generally known then as Interest-free Banking Scheme/System.<br />Up to a certain level it was later realized however that to be banks within the conventional framework they were allowed to operate in, the Islamic banks had to face stiff competition from the interest based banking institutions. Given that they were business entities whose objective was to make profit for their shareholders this position in the market was not viewed lightly by the players. To ensure their survival they had to continue to be in business in a profitable manner, facing all the competition from their conventional peers. Whether they liked it or not it was a matter of life and death for them that profit must be made otherwise they had to close their doors. <br />The problem is that profit as it is understood in Islam can only be created out of real trading activities where real (as opposed to financial ones) assets are traded for profit. In banking, real assets are of no relevance because bankers by definition are supposed to deal with financial assets rather than real physical ones such that in the majority of cases, in line with regulatory laws in many jurisdictions including the Muslim one, banks were not allowed to hold real assets except in a very small proportion. The catch here is that how come an Islamic bank be said to have made certain amount of profit where there has been no clear proof that it had conducted real trading of (physical) assets during the relevant period. On the other side of the river, they could see very clearly their conventional counterparts were freely making profit out of their so called business of selling loan/credit based on interest which is in real fact selling money/debt for money/debt at a differential rate for profit. Such profit if viewed from Islamic perspective is no other than Riba’; the unlawful profit from Islamic point of view. <br />Hence the dilemma faced by the early Islamic banks was centered upon the question of how they can continue operating as banks but at the same time would not be involved in the same practice as undertaken by the conventional ones. Soon it was discovered that the Islamic concept of Murabahah (including sale on credit-BBA) sale was very close to the conventional act of provision of credit and loan although it did not involve money lending as such given the fact that Murabahah is a sale contract be it on cash or deferred payment basis. So the early Islamic banks moved to adopt this transaction as the backbone for their business activities. The end result was that more and more transactions were done on the basis of Murabahah with deferred payment as a standard practice, the manner of which was gradually heavily criticized by the early proponents of the Islamic banking movement like Dr. Al-Qardawi and the late Dr. al-Najjar and some other concerned ulama like Dr. Al-Salus. Dr. Qardawi for example, although initially had forcefully defended the legality of Murabahah as a transaction, however after seeing that Islamic banks had over indulged in it, had called on them to minimize their reliance on this transaction. The criticism by many was centered around the issue of Islamic bank’s over indulgence in Murabahah such that they had neglected other modes of trading allowable in Islam, and that by creating debts out of Murabahah transactions in a massive scale they had behaved more like conventional banks as far as provision of credit was concerned. (This is not however in any way related to the controversy pertaining to commodity murabahah which is more serious in nature.)<br />Another associated problem faced was related to the fact than once these banks were involved in Murabahah debt creation in a massive scale as described above, they had to address the issue of owning too much assets (in their balance sheets) in the form of financial assets i.e debt owed to them by customers as a result of murabahah transactions that were in the majority given on deferred payment basis. With this situation they were said to be starved for not knowing how to liquidate the non liquid assets (debts). At that time many Islamic bankers were heard saying that there were not enough instruments in the market for them to manage this liquidity problem. Meanwhile their conventional peers had all the freedom to liquidate their debts in various debt/interest –based instruments available in the money or capital market. For them this was quite natural and well within the framework within which they were regulated; a framework that allow for financial asset or debts to be sold and purchased freely on prices that are known as interest rate. <br />Islamic banks could not do just that given the interest factor in trading financial assets not at par value that without doubt would gave rise to riba’. Conceptually what Islamic banks should do was to use the debts to purchase real assets for the purpose of trading with a view to creating profit for themselves and their customers. But the reality was that, not many were willing to become real traders and be involved in real treading of physical assets. One common reason given was that as bankers they were not supposed to do that because bankers had no concern with assets except the financial ones. The problem is that profit cannot be made out of trading in financial assets that naturally gives rise to riba.<br />Because of the above predicament, it was claimed that the Islamic banks had behaved in a manner similar to any other bank where they wanted to remain as mere financial intermediaries truthful of course to the framework within which they were allowed to operate. Even though they may claim that they were actually involved in trading of real assets, they were said to be doing all they could to free themselves from all risks associated with owning the assets they were supposed to be trading with. All risks were shifted to their customers such that hardly that any form risk was left with the bank although like even in the case of ijarah for instance, the bank was said to be the owner of the leased asset, but the customer needs to bear all the risk.<br /><br />The issue here is that if they had only functioned as mere financial intermediaries and not like real traders who assumed ownership risk associated with the assets under possession, then it was doubtful as to whether they had conducted real or actual trading of physical assets in the manner prescribed by the Shariah to justify their profit. The basic rule of sale is that a trader can only trade with assets that are truly in their ownership and possessions, the premise that is out of context as far as banking is concerned given the framework that asks of them to be merely holders of financial assets (money/debts) only. <br /><br />Even today where in some jurisdictions with the introduction of specific legislation that does not prohibit Islamic banks from holding real assets, it seems the same conventional framework is still being followed in practice,, where Islamic bankers are still skeptical to take on the role of real traders of physical assets with all the necessary risks that they cannot free themselves from. Thus it is doubtful according to some observers whether the so called Islamic banks have properly managed to conduct themselves within the necessary trading framework as explained above. <br /><br />Additionally, the indication is that more and more Islamic banking products are introduced where the practice points toward the widespread trading of financial assets rather than the real ones although in many circumstances real assets were brought in to give the cloak of legitimacy to many practices said to be doubtful. In many occasions some Islamic banks without reservation involved themselves in sale and purchase of debt at discount via many financial instruments invented for financing purposes. Some other even were actively involved in Private Debt Securities where debts were sold and purchased at discount, not to mention other forms of debt-based securitization and the so called Islamic derivative contracts that are said to be badly needed for risk management. The truth is that by operating within the conventional framework where market instability is self-induced by allowing financial assets to be freely traded, Islamic banks have created trouble for themselves. Those so called derivative instruments are actually meant to address the problems created by interest-based system that has caused so much trouble to the world financial stability. It is a pity indeed to find out that some Islamic institutions being enticed into the black hole without proper comprehension on their parts.<br /> <br />In the same context, if one were to look at any financial statement issued by Islamic financial institutions currently in operation hardly that one could find any statement related to the number or unit of real assets recorded in the statement (the balance sheets) as if throughout the period under reporting the institutions concerned had taken in no real asset whatsoever into their ownership. If this situation is true, from where did they generate profits as reported in the financial statement as profit must have come from trading of real assets in the of ownership the trader. This fact shows either that truly the institutions did not effectively own any asset or the financial statement was prepared in the conventional manner when the institutions were viewed as traders of financial assets rather (just like their conventional peers) than the real ones as required by the Shariah. Either way the issue begs more questions than answers as to why the reporting had failed to reflect the true state of affairs of the relevant parties.<br />Perhaps Islamic banks need to be taught a lesson by a massive financial crisis like the ones faced by their conventional peers to make them pay attention to the true teaching of Islam that profit shall only be created out clear real trading of real assets and not the financial ones. By then hopefully the financial statement would have undergone changes!Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-65669709803068310292011-01-12T08:04:00.000-08:002011-01-12T08:08:36.343-08:00SUKUK, SPV AND BORROWING WITH COLLATERAL??SUKUK, SPV AND BORROWING BACKED BY COLLATERAL??<br /><br />In the world of securitization or sukuk issuance, SPV (Special Purpose Vehicle) is normally established based on the common law distinction between legal and equitable right/ownership where the trustee i.e. the SPV is considered to assume legal ownership (right as recognized by court of law) of the underlying asset used in sukuk or securitization for the benefit of the beneficiary (whose interest or right is recognized by the court of equity), and as such a split is thereby caused to the concept of ownership as a result of which the beneficiary is not empowered to take or assumed all rights as an established owner of the asset as is required by Shariah law if he is truly to be considered as a true owner as per the Shariah provisions that will give him several rights that include right of free disposal and possession without restriction. <br />It can be argued that having what is called beneficial interest in the underlying asset as described above is not enough to give the respective holders of the sukuk a full right of ownership as envisaged under the Shariah as all their rights are exercisable only through the trustee/SPV. The purpose to have this structure involving SPVs is to achieve what is said to be bankruptcy remoteness meaning that whatever happens to the originator will not make the asset in the custody (legal ownership) of the SPV vulnerable to any action by possible creditors of the originator thank to the fact that it is transferred to the legal ownership of the trustee; the fact that will insulate the same from any possible recovery action by other potential creditors of the originator. <br />This above effect will however only arise if the SPV is truly an independent entity that has no connection with the originator, and such an entity is known as orphan SPV rather than a subsidiary of the originator. What actually happens is that it is normally the potential originator (the party seeking the funding) that will make effort to establish the SPV, and this SPV is not supposed to hold any asset other than the underlying asset to be transferred to it upon the issuance of the sukuk. The SPV also will normally have a very minimum share capital and staff, and in fact it is a mere tool to facilitate the transfer and issuance of the sukuk/bond, and as such is not supposed to conduct any real business activities or trading for the benefit of the sukuk holder notwithstanding the fact that in the case of sukuk al-ijarah for example, the asset will be rented back to the originator and the resulting rental streams from the originator will be used to pay the sukuk holders on periodic basis as a form of profit or income. <br />Unless and until true/full ownership is duly transferred to the sukuk holders in its fullest sense, it is difficult to treat the structure using SPVs as truly truthful to the concept of ownership as envisaged under the Shariah. Additionally if at the end of the tenure, the originator is obliged to redeem (repurchase) the asset, then this is another indication that what is intended is no more than lending and borrowing arrangement between the originator and the sukuk holders where the SPV will in real sense effectively act as the trustee appointed to hold the underlying asset as collateral.<br />In contrast, under a traditional mudarabah structure, the mudarib/manager of the mudarabah investment fund is in fact a trading agent to the capital providers/investors and as such assumes the role of a “trustee” from Islamic law perspective. However this mudarib cum “trustee” is not supposed to be a non-active party as far as business or trading activities are concerned unlike the trustee in the context of the structure using the SPV. The mudarib is supposed to conduct trading for the benefit of the investor with a view to create profit that is to be shared based on an agreed ratio. At the end of the mudarabah tenure, all trading assets that are still under the custody of the mudarib, if any, need to sold in an open market to turn them into cash again to know whether there is any profit (or loss) out of the trading activities conducted during the duration. In the case of many sukuk however, the underlying asset is normally to be repurchased by the originator at the end of the tenure as part of an undertaking or binding promise to repurchase at nominal value. If the reason and motivation for the establishment of the SPV, as it seems from this interpretation, is just to create an element of collateral for the benefit of the sukuk/bond holder (especially in the case where there has been no true sale affected between the originator and the SPV or where there is an undertaking (or binding promise) to redeem or repurchase the sukuk/asset) i.e. when the underlying asset under the control of the trustee (SPV) is more in essence of a collateral rather than the one truly belongs to the sukuk holders in the true Shariah sense then the Shariah compliance aspect of the sukuk as investment certificates will be compromised. Therefore it is very important to ensure that true ownership with all its risk and return implications including all rights accorded to a true owner as granted by Shariah are assumed by the sukuk holders, otherwise their entitlement to the income streams will remain doubtful. In this connection sukuk investors need to be warned and be truthfully told about the basic different between investing in sukuk and purchasing conventional bonds where, in the case of bonds, without doubt the SPV is a party who holds the underlying asset as collateral for the borrowing.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-36552261444172159622011-01-10T17:09:00.000-08:002011-01-11T07:23:32.968-08:00REITS, SUKUK AL-IJARAH AND MUDARABAHBETWEEN ISLAMIC REITS, SUKUK AL-IJARAH AND MUDARABAH<br /><br />The guideline on Islamic REITS issued by the Malaysian Securities Commissions several years ago is a step in a direction to further develop Islamic finance, and such an initiative should be viewed as part of continuing efforts undertaken by the regulatory body in line with the vision to make Malaysia a leading player in Islamic finance. In essence, the Guideline seeks to address important issues surrounding asset classification with regard to investment in real estate to ensure Shariah compliance. It provides for criteria according to which a certain real estate or property is considered permissible for an investor to acquire with other investors as co-owners who are also holders of the investment trust fund. <br /><br />Generally these criteria deal with the way the estates are utilized rather than their physical aspects; if they are utilized for purposes not repugnant to Shariah then they are considered permissible. Of course permissibility of an asset is also in the first place decided on the basis of whether it is halal asset or otherwise. Halalness of an asset is an issue which is entirely different from the way it is used or utilized in actual fact. Halal assets may be used both in Shariah and non-Shariah compliance ways. However, as it is clearly stated in the guideline, if the non-halal usage exceeds a certain benchmark, than the investors need to be advised by their relevant Shariah advisors to sell off their holding in the unit trust.<br /><br />An example given in the FAQ section of the Guideline is a clear indication that the utility aspect of an asset is given prominence in deciding the Shariah compliant status of the relevant investment.<br /><br />Any Islamic REIT as it is envisaged under the current scenario is still governed by another Guideline issue earlier by the SC in respect of normal REITs. In one aspect, the introduced Guideline on Islamic REITs can be considered as a supplement to the mentioned conventional Guideline which in itself is of general application governing all aspects of investment in REITs in Malaysia. Basically REITS are unit trusts where investors purchase units which form part of a larger pool of fund contributed by all investors who purchase units offered for sale by any unit trust or investment management companies. In every unit trust scheme there must be a trustee appointed to ensure that the fund management company functions in accordance with the duties as listed in the prospectus and also in accordance with the trust deed. Returns or income in REITs can come in two ways, firstly through dividends payout if the investors still keep their investment or any increased value of the units if sold by the investors. <br /><br />From Islamic perspective the act of buying a unit in a unit trust fund/REIT may be said to constitute a financial or capital contribution or investment in a mudarabah scheme whereby such a contribution is handed over to the management company so that the later can purchase some assets to be used for income generation purpose. If these assets are rented out based on ijarah contract, an income stream is expected to flow throughout the duration of the investment period. This model or process is said to be governed by both mudarabah and Ijarah principles. The first principle governs the relationship between the investor and the asset or investment management company whereas the second as between the management company and the tenants. In short what is meant here is an investment scheme structures based on Mudarabah for the purpose of an acquisition of a certain piece of tangible asset so that it can be rented to third parties in a way that profitable returns or proceeds be made for the interest of the investor. <br /><br />Notwithstanding this characteristic, one major different between Mudarabah and Islamic REITs investment scheme run as described above is that in Mudarabah the manager is to share profit based on a ratio agreed with the investor/owner of capital at the outset. In REITs however, the manager will not share any profit in the above manner but to be paid management fees as per the terms as normally expressed in the Prospectus. This fact makes Islamic REITs is said to be outside the scope of the normal mudarabah structure where there is going to be profit sharing between the manager and the investors as the first will not be paid any fee whatsoever for the management effort he is to be involved throughout the duration of the investment. When fees are collected by the manager, the structure may be said to have changed into a form of a fee-based agency relationship between the parties, and as such must follow all the established Shariah rules governing the same. Among others, management fees need to be fully specified so does the duration of the contract to avoid potential disputes, and more importantly it has to be made clear that as a paid agent the manager is to conduct the management in the best possible manner failing which a breach of an agency contract would occur.<br /><br />HOW DO ISLAMIC REITS DIFFER FROM SUKUK AL-IJARAH<br />As an interesting comparison, there are many similarities between Islamic REITS and sukuk al-ijarah as both schemes envisage acquisition of tangible assets that are to be rented out to third parties for an income stream payable to the investor during the relevant period he keeps his investment in the fund or sukuk. In the case of Islamic REITs there is an involvement of 3 other parties apart from the investor; the unit trust management company, the trustee and the third party tenant of the asset. In the case of sukuk al-Ijarah, according the way they have been structured all these while, instead of having a unit trust management and a trustee company in between, there is an SPV company specially established to issue the sukuk and another trustee/management company which function is similar to the scenario as applicable in the unit trust scheme as previously stated to manage the real estates. What will happen here is that the SPV will invite subscription from the potential investors to purchase sukuks for which certificates are issued to them in acknowledgement of their contribution or purchase. It may be said again that what the investors do is no other than providing money capital to the SPV in the context of mudarabah so that the later can use the fund or pool of fund contributed by all sukuk buyers to purchase certain real tangible assets to be employed for income stream generation in order to pay the investor periodically as agreed in the sukuk document or contract. <br /><br />In both instances as describe above, income or return to sukuk investors/holders of unit trust will come from the projected income stream generated through the utilization of the relevant assets and also from capital gain, if any, if the sukuk are sold back to or redeemed by the issuer (based on market value which is more that nominal value) or in the case of unit trusts when the holders dispose of their units in the market (ETF) at any given time or have them be repurchased by the unit trust management company at the current purchase price which is calculated on the basis of the NAV of the unit less management fees or charges.<br /><br />The only issue that may be asked here relates to the Shariah position with regard to the fees as paid to the management company in the case of unit trusts including Islamic REITs in the context of our discussion. In classical mudarabah, return or income to the mudarib (the manager) is payable from a share of profit of the scheme if it turns out to be profitable, based on an agreed ratio say 40:60 for example. In the case of unit trust however the managers received their income from the fees charged to the fund irrespective of whether the scheme is profitable or not. Thus this scheme is not a straight forward mudarabah, but rather it can be classified as al-wakalah bi'l ujur meaning hiring someone to act as an agent with fee.<br /><br />In the context of sukuk al-ijarah, this is not an issue given the fact that in many cases as it has been practiced, these sukuk are issued by companies or governments to fund infrastructure projects whereby certain assets are sold by the originators (public or private) to the SPVs (the issuers) which will purchase them with the use of the fund collected through sukuk subscription, and then the originators will rent the assets from the SPVs for a certain period of time commensurate with the lifespan of the sukuk by making periodic rental payments to the investors through the SPVs. Normally these SPVs are formed by the originators specifically for the purpose of facilitating the whole securitization as these SPVs are there to ensure that the pool of investment of the sukuk holders are utilized to purchase the assets that are to be rented out to generate incomes in the form of a rental stream that will subsequently be passed on to them at the relevant intervals. In the normal Mudarabah structure, the Mudarib/manager is to engage in trading/renting activities with truly third parties or the market at large and not with the providers of capital as seen in the context of the originators as described above. So as far as this aspect is concerned, it seems that the REITs is closure to the original spirit of the Mudarabah ( except for the issue related to fees collected by the REIT manager) where assets are rented out to true third parties to generate income streams. It the case of sukuk al-ijarah, the major Shariah issue is whether there is a true sale between the originator and the SPV (at the start of the process) as to warrant a transfer of true ownership to the investors through the SPV given the fact that the SPV is established by the originator or sometimes its subsidiary. Secondly there is an issue of redemption of the sukuk by the originator at the end of the tenure of the sukuk; whether it is again a true sale as between the parties (based on market value) or a redemption of a collateral by an assumed borrower (the originator) if such a sale/resale is based on a nominal value in which case the true ownership by sukuk holders are not correctly reflected.<br /><br />In the Middle-east particularly in the past 20-25 years, there used to be another method to achieve similar objectives that seems to be well within the framework of a true Mudarabah. There were many so-called Islamic investment companies that established and managed special real estate funds on the basis of Mudarabah. The general public were invited to contribute to these funds that would be used specifically for real estate investment both in local and oversea markets. Interestingly, in many instances one of the clauses of the mudarabah agreement employed for this purpose would say " whatever will be bestowed upon us by Allah as a result of this scheme will be shared between us in the ratio of so and so…". This is a typical mudarabah scheme whereby the manager is to be remunerated when there are actual profits generated by the venture. <br /><br /><br />In conclusion, whether potential investors would prefer to buy sukuk al-ijrah, Islamic REITs or to take part in the traditional mudarabah scheme with less Shariah compliance issues as explained, the underlying Islamic rule is that by buying such sukuk or Islamic REIT units or to participate in traditional mudarabah funds, they in fact need to be ensured to acquire the ownership in the relevant assets or real estates which justify their entitlement to the associated returns or incomes. However as owners they should never forget the fact that according to the Shariah law, they also bear the ownership risk (daman al-milk) in respect of the underlying assets or real estates that they own, as Islam dictates that income or return is in exchange for ownership risk assumed ( al-Ghunm bi'l ghurm). Notwithstanding what has been previously stated, investment in real tangible assets and the employment of the ijarah principles relating to the utilization of these assets to create income streams are held to be valid (if done correctly) according to almost all Muslim jurists in contrast to the investment in debts securities which is not generally or globally accepted especially when these securities are not structured, negotiated or sold/purchased in a manner that is consistent with the generally accepted view on money exchange and debt trading in Islamic law.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-56361316245401672332010-03-29T08:03:00.000-07:002010-03-29T08:08:22.596-07:00WHERE IS DEBT IN SUKUK?WHERE IS DEBT IN SUKUK?<br />I was shocked today when one national daily quoted a senior officer in-charged of Islamic rating at a well-known Rating Agency as referring to Sukuk as Islamic debt paper. I am perplexed as to the fact that that statement, which is far from the truth about Sukuk that is globally defined as investment rather than debt certificate came from someone who is supposed to know the basic. However the maker of the statement can be excused if what he meant was that type of the so-called sukuk structured based on sale of debt that have been flooding the market for quite sometimes. This type of sukuk is no sukuk as far the international perspective is concerned, at least in theory. The truth is that sukuk if they are to be understood correctly must refer to certificates issued as evidence of investment and not of money lent to the issuer. But unfortunately, given the conventional framework within which many sukuk have been hitherto issued, that original basic concept has been forgotten more frequently than ever. It is perhaps thus not surprising to find series of reports that talk about defaults in sukuk as similar to default in loan repayment or point towards the need for any relevant issuer of sukuk to redeem the sukuk at the designated time at par value or to pay as a matter of contractual obligation the profit as contracted. If this is the true description of sukuk, then why in the first place there is any need to name the same as sukuk; just name them as bonds where money is borrowed and lent based on a contracted price@ interest. <br />Just because sukuk were viewed as no different from fixed income instruments based on debt, any failure to pay the so-called profit will constitute a default irrespective of whether such non-payment is due to fault or negligence or breach of rules or not. If this is truly what is intended by the relevant parties they have to accept that they are not issuing sukuk but just any other bond or fixed income instrument in respect of which Islam has nothing to do with.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-78512735989158415822010-03-14T09:25:00.000-07:002010-03-14T09:29:40.658-07:00SHARIAH ISSUES IN TAKAFULTAKAFUL: SOME ISSUES FROM SHARIAH COMPLIANCE PERSPECTIVE<br /><br /> The restriction in Shariah regarding commercial conventional insurance has led to the establishment of a number of Takaful (Islamic insurance) company worldwide providing insurance coverage for the general public. In the majority of cases the companies are run as limited companies owned by shareholders. Some Takaful companies are also listed on the stock exchange, where their shares are actively traded, and thereby going public.<br /><br /> Generally, many Takaful companies (especially those using the Mudaraba principle) claim that their operations are based on the concept of mutual or co-operative insurance as approved by the Muslim jurists. This claim is on the basis that:<br />i) They receive the premium or contribution from the insured on the basis of the Mudaraba principle, whereby the company becomes the entrepreneur (Mudarib) and the insured party the capital provider (Rab al-Mal).<br />ii) The insured party agrees to donate a certain percentage (or in some cases as in General Takaful the whole of the amount paid) of the premium/contribution to a special fund used to pay compensation or benefits to contributors.<br />iii) Any surplus left in the fund after settlement of all claims is shared by the company and the insured as profit in a ratio as agreed in the contract. An insured party who has received compensation, the amount of which is greater than what he could have received as a share of the surplus had he made no claim, is not entitled to share such a surplus.<br />iv) The company uses normal actuarial principles to calculate risk and premium. Since this Takaful company operation is claimed to be based on the Mudaraba principle, the question arises as to whether such an operation can be considered to be Shariah-compliant.<br /><br /> In this case, the parties to the contract are the company (which is owned in most cases by the shareholders) on the one hand and the group of the insured parties on the other hand. In other words, the company does not belong to either the insured parties or the contributors. In fact, the company is a separate legal entity distinct from the shareholders. Since the operation of the Takaful company is based on the Mudaraba principle (as claimed), the insured parties are considered capital providers (arbab al-amwal), and the company as an entrepreneur (Mudarib). Therefore, both the insured parties (Arbab al-amwal) and the company (Mudarib) according to the scheme are entitled to share the surplus (or profit) in line with the contract, based on an agreed ratio or percentage.<br /><br /> Compensation or benefits to the insured parties are paid from the amount in the Takaful fund, receiving the money from the premium or contribution paid by the insured, which agree to pay the whole amount (or part thereof) as a donation (Tabarru’). This Takaful operation up to this point, is Shariah-compliant, but the Mudaraba contract should be examined in greater detail. Under the Takaful operation, the money in the Takaful compensation fund belongs legally to the company and not to the insured-cum-investors (as in the case of A Family takaful fund), and it is claimed (in line with the tabarru’ principle) that by making the donation (Tabarru’), that is when the insured pay the premium or contribution, an individual insured party is considered to waive his/her right to the money paid. However, if a general view of Shariah is to be relied upon with regard to all the insured parties as a group, the whole amount collected by the Takaful fund (particularly in the case of the general takaful i.e. the compensation fund) must be considered either as trust money or as a trust fund for the benefit of all the contributors. It can in no way be treated as funds belonging to the Takaful companies.<br /> Furthermore it is not lawful in Mudaraba to stipulate that either or both parties to the contract should be entitled to a certain amount of guaranteed proceeds or benefits in kind or money other than a share of the profit in an agreed ratio or percentage. If, for instance, the investor / Mudarib should stipulate that he is to be guaranteed an amount of money or benefit other than the share of profit, the contract becomes void, because of the possibility that the venture might not yield a profit. This would badly affect the interest of the party who is not entitled to such favourable treatment due to the existence of the said unfair terms.<br /><br /> In a Takaful operation, there is seemingly a favourable stipulation for the benefit of the investors/insured parties that in the case of certain events, they are entitled to an agreed amount of compensation/benefits, or alternatively they may be helped to discharge the specified civil monetary liabilities as listed in the contract. Technically and legally this term in itself will render the Mudaraba contract void on the grounds of unfair terms in the contract. In practice, however, the Takaful company agrees to the insertion of such ‘unfair terms’ because the company’s actuaries have already calculated (as is usual in conventional insurance) that under normal circumstances there will be a surplus in the Takaful fund. <br /><br /> Thus such seemingly unfair terms are arguably not unfair to the Takaful Company which is fully aware of the truth behind the matter. But the matter is not fully known to the insured parties as individuals who will still hope to receive the benefits stated in the contract. The Takaful Company knows from the very beginning that only a small proportion of the insured will in the end claim benefits. There seems to be a manipulation, some would argue, by the Takaful Company against the insured parties, both as individuals and as a group. <br /><br /> In the case of the group, the accumulated contributions, which in fact belong to the group (or at least held in trust for their benefit), will be shared in the end by the company after all claims are paid. As for an individual insured, there is uncertainty as to whether he will receive the stipulated Takaful benefits. In the end, what is shared by the Takaful Company is nothing other than the proportion of the group’s money left in the Takaful account. It is therefore like paying the Mudaraba profit from the capital provided by the investors, a practice which is not acceptable according to the rules of the Mudaraba contract. On top of that according to mudaraba principles, in case of loss, the remaining capital of the mudaraba should be returned back to the mudaraba investors, and not to be shared with the mudarib since what is supposed to be shared is profit if there is any. This because in such a contract, the profit needs to be paid or shared out of the actual profit (ribh) of the business. In the case of Takaful, what is shared is a part of the capital left (after deduction made for payment of claims) provided by all the insured as a group of investors (Arbab al-amwal). After paying all the necessary claims, what normally happens is that the Takaful fund’s account would register a loss not a profit i.e. total amount of premium / contribution paid (capital of the Mudaraba) minus total claims paid. This means that there is no Mudaraba profit to be shared bearing in mind that profit is defined in Sharia law as any amount in excess of the original amount of capital in Mudaraba.<br /><br /> In accordance with Mudaraba principles and rules, there is thus no profit to be shared as the business registers a loss. This clearly shows that the Takaful Company shares what it is not entitled to share according to the principle of the Mudaraba contract. It seems that there is no real difference between a conventional insurance operation and its Mudaraba-based Takaful counterpart in this particular aspect. Above all, both are owned by a certain group of people who are there to make a profit from the business based on contingencies.<br /> This fact alone makes the mudaraba-based Takaful Company and its operations doubtful if the test adopted for mutual or co-operative insurance is to be faithfully applied. According to Abu Jayb in his book “al-Ta’min bayn al-hazar wa’l ibahah”, mutual or co-operative insurance is principally valid under the Shariah according to nearly all modern Islamic jurists.<br /> One major ground for the validity of truly mutual or co-operative insurance is based on the Shariah principle that says uncertainty (Gharar) can be tolerated in Tabarru’at contracts (contracts without consideration) whereby the parties concerned do not basically seek to gain from the arrangement as they do in normal commercial contracts (Mu’awadat).<br /> Since mutual or co-operative insurance / Takaful is entered into on the basis of a voluntary donation (Tabarru’), as opposed to a contractual price or premium as in conventional insurance, the rule of certainty can be relaxed because in agreeing to the Tabarru’, the parties are not really concerned about who gets what and at the expense of whom since the core idea is to help one another in times of need, a true spirit of solidarity and mutuality, which is generally absent in commercial dealings where the prime motive is to make profit. The situation is akin, for instance, to when one makes a donation or contribution to the tsunami relief fund. One does not expect any particular return from one’s donation. The intention is to help the victims of the tsunami.<br /> Additionally, in mutual insurance or Takaful, all contributors are partners in the relevant entity having equal rights and obligations. The prime objective of the arrangement is to provide help and assistance to all participating members. Management of the entity is normally put in the hands of some of the members acting on behalf on the rest. Salaried staffs, if any, are paid by the entity to run the same for the benefit of all the members. Members of mutual or co-operative insurance companies are owners of the entities, while at the same time receivers of benefits of the coverage. It is thus unlikely that the entity will act in ways prejudicial to the interest of its members.<br /> In commercial insurance/ Takaful, the situation is different. When the insurance or Takaful companies sell their products to the insured parties (who do not own the company), the companies’ main concerns are to safeguard the interest of the shareholders (who are in the business to make profit), and not, as a general rule, that of the premium prayers or contributors or at least there is a conflict of interest situation.<br /> Although the commercial Takaful operation as is practiced today seems to be the only viable Islamic alternative to conventional insurance, it is not fully conforming to the rule or concept of al-Ta'min al-Ta’awuni, or mutual or co-operative insurance. Modern commercial Takaful companies are more akin to normal business ventures whose prime objectives are to make profit based on contingencies. It is undeniable that they have provided the society with an alternative, which is closer to the spirit of the Shariah, compared with those products available under conventional insurance.<br /> However, there remain some dubious elements in the Mudaraba-based Takaful operation which needs to be tackled to make it fully Shariah-compliant. The emergence of new Takaful models in some parts of the world, based on the true concept of Takaful Ta’awuni or mutual Takaful is something that must be welcomed by all of us. The establishment of such mutual or co-operative societies providing insurance or Takaful coverage to their members must be supported, primarily to remedy the shortcomings of current Takaful operations, many of which are run on the Mudaraba model.<br /> Another alternative would be to run the Takaful operation on a basis similar to the method applied in the running of Islamic unit trust companies, whereby the managers of the fund are paid professional fees for the services rendered. The advantage of this method is that it will make it clear that all funds collected belong to the contributors/investors/insured as a group, and are held in trust for their benefit.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-43211501302048095182009-11-30T06:53:00.000-08:002009-11-30T06:59:05.409-08:00ISLAMIC FINANCE DISPUTE SETTLEMENTParties in a contract involving Islamic finance are free to structure their dealing to take into account Shariah requirements governing transactions, and have their terms documented in the relevant contractual documents. They can insert whatever clauses of their choice in so far as these clauses are not in any way repugnant to any established Shariah rules and principles. In many jurisdictions it is the requirement of regulatory laws that these parties need to ensure that their transactions are free from any element inconsistent with Islamic teachings. However it is very sad indeed to find out that some parties may sometimes indicate through their agreements that in case any dispute should arise in future between them, they would like to settle the possible dispute not in accordance with any Shariah compliant mechanism of dispute settlement. <br /><br />What may happen is that the parties would instead prefer to settle such a future dispute through trials conducted by courts that are very clear from the very way they are constituted are far from being a suitable forum to dispose of the case in a Shariah compliant manner. Given that these courts are conventional courts in various jurisdictions that as a matter of judicial process are not from the outset suppose to decide cases brought before them in line with Shariah requirements. Hence the big question is how can it be said that the relevant dispute is to be disposed of in an Islamic way?<br /><br />It is important that dispute related to Islamic financial transactions is settled in a Shariah compliant manner for two major reasons. Firstly when the parties hold out that they are conducting their affairs in Shariah compliant ways, they thereby make a representation to the general public that they are going to abide by the Shariah requirements in all their dealings. So when it turns out to be that they prefer to settle their future disputes in the above described manner, and to turn a blind eye on Islamic alternatives, the general public has all the reasons to ask why it remains so when other Shariah compliant alternatives are available. Secondly, assuming that an award may have been made by the non-Shariah compliant courts, does it mean that the amount so awarded in the judgment cannot be treated as halal/legitimate incomes for the relevant parties, or at least be described as questionable incomes that need to be purified. <br /><br />What happened in Malaysia recently in the context of the latest amendment to the Malaysian Central Bank law is very interesting development to note. The amendment made it clear that the Malaysian civil courts and arbitrators must consider the published Shariah resolution passed by the Shariah Advisory Council of the Central Bank in deciding Islamic banking cases brought before them. The amendment also made it mandatory for the Court and the Arbitrator to refer any Shariah issue raised in the dispute which is not yet addressed by any published resolution mentioned above, and they must abide by any decision that the SAC may provide. <br /><br />It remains to be seen whether this approach will solve the dilemma faced by Islamic finance in this respect. Strictly speaking, from an Islamic classical perspective, a Muslim judge is always reminded to consult learned parties before issuing any judgment, and it is held that this approach, although is not mandatory to be taken, is accepted to be a highly recommended thing to be done by any presiding judge. But to put it in the manner that it is mandatory to be undertaken is something new, firstly because at the end of the day it will be the judge himself who is going to be responsible for the issued judgment. <br /><br />Secondly, with respect to any opinion that may be possibly given by the consulted learned party the most that can be said is that it is a form of fatwa or shariah opinion that is basically not binding. Any court judgment on the contrary is binding on the disputing parties as a matter of authoritative expediency. Perhaps the reason that may have been relied upon by the Malaysian Parliament when the house passed the amendment is based on the fact that civil court judges were not trained in Islamic law, hence they need to abide by the SAC resolutions. But then, judgments are normally not given solely based on rules or law but they are based also on facts of the cases in question for which only the trial judges have the opportunity to establish. Furthermore trials in the civil court do not involve the same procedural process as normally employed in the Shariah court especially in the context of the role that can be played by oaths in establishing civil claims. The fact is that to dispose any given Islamic finance case is not just limited to the law aspect alone, but also the evidential and procedural aspects as well. Unless the relevant additional issues are properly addressed taking into consideration all that need to be considered in terms of Shariah requirements, the hope to achieve full settlement based on Islamic principle will remain something to be very genuine.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-31773757588435722502009-07-14T07:20:00.000-07:002009-07-14T08:09:47.707-07:00BOOK ON ISLAMIC VIEW ON DERIVATIVESThere 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.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-30351221040500452462009-07-03T08:02:00.000-07:002009-07-03T08:04:52.567-07:00TAWARRUQ, COMMODITY MURABAHAH AND MONEY LENDING IN DISGUISETAWAARUQ, COMMODITY MURABAHAH AND MONEY-LENDING IN DISGUISE<br />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. <br />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. <br />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. <br />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.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6145800193446476796.post-91871067964389991482009-07-02T10:43:00.000-07:002009-07-02T11:03:07.937-07:00SHARIKAH AND MODERN CORPORATIONS: ARE THEY THE SAME?<br />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. <br />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.<br />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?<br />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.<br />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.<br />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.Unknownnoreply@blogger.com