Sharia-compliant derivatives – a contradiction in terms?

Quoted from Financial Times. Available at: http://ftalphaville.ft.com/blog/2009/02/11/52352/sharia-compliant-derivatives-a-contradiction-in-terms/

Reuters is running an interesting story on Islamic banks’ struggles to develop hedging tools to cope with market volatility. Not all Islamic scholars believe the use of derivatives is permitted by Sharia law – which leaves more conservative institutions with “few instruments to guard against wild swings in currency and interest rate movements,” according to the Reuters story.

“To the extent there are not enough sharia-compliant liquidity and risk management products, then clearly Islamic finance would be disadvantaged compared to conventional banks and would be less able to manage their liquidity risks,” said Hussein Hassan, head of Islamic structuring at Deutsche Bank . The $1 trillion industry bans banking structures that are vague or ambiguous to avoid exploitation — a rule which some argue shuts out the use of common hedging instruments such as currency and interest rate swaps and futures contracts.

There are two major schools of thought on derivatives in the the world of Islamic finance. One view is that derivatives are necessarily speculative, and so would contravene the prohibition on gambling. Scholars who take this approach also tend to argue that since it is not always clear what the underlying assets referenced by a derivative are, use of the product violates the prescription that only tangible assets can be bought or sold.

The second, less conservative view is that derivatives are permitted as long as they are used solely to hedge existing positions. Of course, derivatives do exist in Islamic finance. Reuters cites some examples: Last year, CIMB Islamic, the world’s top arranger of Islamic debt, launched a forex hedging tool where investors enter into an Islamic transaction with the bank.

The net proceeds — which are similar to the premium paid for conventional options — gives investors the right to exercise the option at the agreed rate on the maturity date. Another type of options contract is ‘arbun’, which Reuters explains thus: Under an arbun contract, a purchaser makes a deposit (which forms part of the purchase price) to buy particular assets at a later date. Should the sale not proceed, the seller keeps the deposit.

Much of the impetus for the creation of Sharia-compliant derivatives has come from industry groups like ISDA, which has long been working to standardise derivatives contracts and documentation in a way that would facilitate their use in Islamic finance. And for a time – up to and including those halcyon days of June 2007 – it looked like more scholars were coming around to the use of derivatives. Now, months into a crisis which is being blamed at least in part on these products, the case is less convincing.

Put another way, among the few institutions to have emerged relatively unscathed from the crisis are Islamic banks, as the FT’s David Oakley noted late last year. This apparent resilience is not just due to a restrained relationship with derivatives, of course – these insitutions also tended to be conservative in their lending and underwriting and have little, if any, exposure to mortgage-backed securities. But the crisis – and its components – has caused both scholars and practitioners of Islamic finance to take a step back, and in some cases, to adopt a more conservative view. Which brings one back to the initial question – what, then, is a worried Sharia-compliant banker to do?

Best Regard
ZULKIFLI HASAN
DUBAI, UAE

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    The Social Contract: A Must Know Document for All Fellow Malaysian

    Assalamualaikum,

    In view of the recent political issues in Malaysia, I always believe that it is extremely important for us to really understand the actual history of our nation. This time I would like to touch on the issue of social contract which is considered a basis for our independence in 1957. Surprisingly, without knowing the existence of such important document, there was actually a written agreement on social contract that unanimously agreed by the three main political parties i.e. UMNO, Malayan Chinese Association (MCA) and Malayan Indian Congress (MIC). I attach herewith the said document concerning the Political Testament of the Alliance, a memorandum by Tunku Abdul Rahman which was duly signed by representatives from UMNO, the MCA and the MIC. This document is scanned from a three-volume book entitled “British Document on the End of Empire: Malaya”. Just read and ponder.

    Enjoy reading!
    Best Regard
    ZULKIFLI HASAN
    DUBAI, UAE

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  • My Story: A Journey Begins

    Assalamualaikum,

    Alhamdulillah, on 14th February 2009, I arrived Dubai for a very essential mission with two-pronged objectives i.e. to conduct my empirical study as well as to gain international exposure, working with the world class institution, the Dubai International Financial Centre (DIFC). I’ll be here in Dubai for the next three months from February until May. Within this period I have been planning to travel throughout the whole GCC countries from UAE to Oman, Kuwait, Qatar, Yemen, Bahrain and more importantly Saudi Arabia to perform umrah. InsyaAllah, with Allah’s Mercy and Bounty, I am planning to bring my whole family to Dubai and afterward if possible to visit Makkah and Madinah.

    I would like to express my extreme gratitude to Mr. Shamsulfaiz, a very good friend of mine who is working as a solicitor in one of the prominent legal firms in Dubai that kindly offer me free accommodation at the Dubai International City. I really appreciate his generosity, kindness and may Allah gives His blessing to him and his family. Deep in my heart, to my beloved wife and my adorable Ameen, Iffah and Izzah, I crazily miss you all.

    “A journey of a thousand miles begins with a single step”. (Lao-tzu, 604 BC – 531 BC)

    Best Regard
    ZULKIFLI HASAN
    DUBAI, UAE

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  • My Thought: Perak Constitutional Conundrum

    Assalamualaikum,

    Dear Readers,

    It has been quite sometime that I have not pen down my thought on Malaysian politic. From my personal observation, money politics, corruption, accusation, cronyism and unethical norms of the politicians become mundane in the Malaysian political arena. I am not sure whether the sense of brotherhood, nationhood, solidarity is still embedded in the heart of the politicians. People put their eminent hopes to the politicians but it seems that they are just too busy with their political pinata.

    Let me briefly analyse the current constitutional conundrum in Perak. Soon after the betrayal of PKR’s duo (coincidently, unfortunately and shamefully, one of them is from my constituency) and DAP’s assemblyman, the Perak’s Chief Minister has requested the Sultan to dissolve the State Assembly and called for snap poll while the Barisan Nasional claimed to form a new government. This position has led to constitutional dilemma and ultimately, the Sultan of Perak (retired Chief Justice) has decided to refuse the Chief Minister’s application because he had lose the confidence of the majority of the State Assembly members. It is worth highlighting two main views on this current constitutional issue:-

    (1) The Sultan should dissolve the State Assembly and calls for a new election.
    Perak state constitution: Artikel XVI(6): If the Mentri Besar ceases to command the confidence of the majority of the Legislative Assembly, then unless at his request His Royal Highness dissolves the Legislative Assembly, he shall tender the resignation of the Executive Council.
    This provision states that the Chief Minister is only legally obliged to step down when a motion of no confidence on him has been passed in the state assembly, but not otherwise.

    (2) Unnecessary election should be avoided and the Sultan has his discretionary or prerogative power to decide.
    At this point, I tend to concur with Prof Dr Abdul Aziz Bari of International Islamic University of Malaysia (IIUM) where he said that several provisions in the Constitution indicated that unnecessary elections and by-elections should be avoided. It is for the Sultan who has power to decide whether to dissolve the State Assembly or not. As long as any political coalition has the composition to form a new government, unnecessary election should be avoided which may lead to furthering unneeded cost, time and efforts. Whatever it is, the people of Perak have opportunity to decide and cast their votes in the 13th general election and this constitutional conundrum should provide a great lesson to both disputed parties. Just a matter of waiting for another few years.

    “THERE ARE NO TRUE FRIENDS IN POLITICS. WE ARE ALL SHARKS CIRCLING AND WAITING FOR TRACES OF BLOOD TO APPEAR IN THE WATER”. (ALAN CLARK 1928-1999)

    Best Regard
    ZULKIFLI HASAN
    DURHAM UNIVERSITY

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  • With Yang Amat Berhormat, Datuk Dr. Zambry Abdul Kadir, a new Chief Minister of Perak (second from right) in Cape Town, South Africa. It is a great hope regardless of political ideology that he can serve the people well with integrity and honesty.

    Promoting Shari’ah-compliant finance violates the United States Constitution: In the Case of Kevin J. Murray v Henry M. Paulson, Jr

    Assalamualaikum,

    I am delighted to share this very recent case in the United States District Court for the Eastern District of Michigan Click Here

    The Plaintiff filed an application on 15 December 2008 to challenge the Emergency Economic Stabilization Act of 2008 enacted by the US Congress in which appropriated USD40 billion to bail out the AIG that engaged in Shari’ah-compliant activities. It is alleged that the Shari’ah-compliant financial products are anti-Christian, anti-Jewish and anti-American and therefore violates the First Amendment of the United States Constitution. In this instance, the plaintiff claims for declaratory and injunctive relief as authorized by 28 United States Constitution.

    Interestingly, the plaintiff in this case is a retired US Marine who has experiences working in Iraq and Kuwait and claiming that Shari’ah-compliant finance has ties with Islamic terrorist. He alleges that by promoting, endorsing, approving, supporting and funding the AIG which involves in Shari’ah-compliant finance has contributed to the propagation of Islamic beliefs and practices which forms the basis for the global jihadist war against the US. The plaintiff asserts that one of the AIG Shari’ah supervisory board members has blood and intimate relationship with Justice Taqi Usmani who has authored a book on jihad which indicates the element of terrorism and hatred against the non-believers. Not only that, he also alleges that the zakat religious tax of the company is used to support Islamic charities some of which have affiliations with terrorist organisation.

    This 18-page application in the US Court appears to be a very historic and celebrated case pertaining to Islamic finance. Although, the application for admission to this court is still pending, the notion of bringing the case into the court of justice and challenging the government’s decision and policy to involve in Shari’ah-compliant finance seems to be very polemical. InsyaAllah, I’ll discuss and examine the overall issue highlighted in this case and come out with a proper academic article in the near future that would be useful for further discourse.

    “Ignorance of the law excuses no man: not that all men know the law, but because ’tis an excuse every man will plead, and no man can tell how to confute him” (John Selden 1584-1654)

    Best Regard
    ZULKIFLI HASAN
    DURHAM UNIVERSITY