NEW DOCUMENTATION FOR SHARIAH COMPLIANT DERIVATES IN THE GCC

The International Swaps and Derivatives Association (ISDA) and the International Islamic Financial Market (IIFM) signed a Memorandum of Understanding as a basis for developing a master agreement for documenting privately negotiated Shariah compliant derivatives transactions

ISDA and IIFM aim for the agreement to be accepted by Shariah advisors and to become a standard document used for Shariah compliant privately negotiated derivatives in Gulf Cooperative Council member states and beyond. As part of this understanding, ISDA and IIFM have formed a joint working group open to members of both organizations, which will meet every four to six weeks. IIFM's Shariah Supervisory Committee will be charged with evaluating the Shariah compliance of the master agreement.


Unlike their conventional counterparts, Islamic financial institutions (IFIs) have at their disposal a limited range of 'allowed' investment instruments, particularly hedging instruments, a key use of derivatives. This constraint has hindered the development of an efficient and active Islamic financial market. The limited risk management options available to IFIs makes them less competitive and, most importantly, affects their profitability.

DERIVATIVES - ARE THEY SHARIAH COMPLIANT?

The ever-increasing application and innovation of the methodologies associated with derivative instruments have revolutionized the global financial industry over the past two decades. Simultaneously, document standardization in transacting derivative based transactions has reached the point of uniform application in conventional markets and products, thus removing an immense amount of uncertainty and risk previously associated with these types of transactions. In this day and age, it can safely be said that derivatives have become de rigueur in the international financial arena.

Yet the doubt associated with the permissibility of derivative instruments under Islamic finance generally remains. Derivative instruments also still remain an enigma to many, mostly due to the unfamiliarity with their basic mechanics and the highly technical language in terms of which explanations are often attempted. This is a hindrance in trying to get across a proper understanding and appreciation of the matters at hand.

What is a derivative?

A derivative is any financial instrument, whose payoffs depend in a direct way on the value of an underlying variable at a time in the future. This underlying variable is also called the underlying asset, or just the underlying. Usually, derivatives are contracts to buy or sell the underlying asset at a future time, with the price, quantity and other specifications defined today. Contracts can be binding for both parties or for one party only, with the other party reserving the option to exercise or not. If the underlying asset is not traded, for example if the underlying is an index, some kind of cash settlement has to take place. Derivatives are traded in organized exchanges as well as over the counter [OTC derivatives]. Examples of derivatives include forwards, futures, options, caps, floors, swaps, collars, etc

Here's one example: A miller and grain farmer conclude an agreement today for the delivery of a specified quantity and quality of grain on an agreed future date, let's say six months ahead. The important element of this transaction is that the price to be paid for the grain is fixed on today's date. The primary reason for the immediate price determination is to remove the uncertainty for both parties of what the actual spot price for grain would be six months from now. Either party may stand to lose or gain a great deal from this uncertainty if the price movement is against him or in his favour but it does not bode well for one's financial planning. Since the parties face risk in the opposite directions of price movement, it will make financial sense for them to meet and agree on a price, which will suit both of them, to eliminate the price movement risk in the commodity (called "hedging the price"). The grain farmer then knows what input costs he can safely invest in his harvest to still turn a profit; the miller, on the other hand, knows at what price he can sell flour into a competitive market six months into the future and can plan and market his product accordingly.

What has been explained above is a basic forward contract. The derivative element present in this simple set of facts is that, from the first day subsequent to this contract being concluded, the contract itself gains a value derived from the underlying price movements and future expectations of the spot price of grain on the agreed delivery date.

How does this work? The day the parties agreed the price of grain six months into the future it wasn't a matter of mere guesswork. Both parties probably considered a plethora of elements and contingencies in what they considered to be relevant in determining a fair price of grain six months into the future (e.g. market conditions, micro and macro economic indicators, price volatility, weather patterns, quality considerations and many more). Every day thereafter, the input data on these elements and contingencies will vary constantly to the extent that had the parties known about the changed conditions at the time they contracted on the price of the grain, they would have come to a different conclusion. For example, it does not rain in many farming areas during the early planting season and a bad harvest is forecasted, thus increasing demand and the expected future price of grain with it. The farmer who agreed on a price with normal weather patterns and rain forecasted now realizes that he is selling his bumper crop probably cheaper than he would have, had he known about the coming drought in certain areas.

This process of constantly monitoring the variations in the contingencies pertaining to the forecasted spot price of grain on the delivery date of the grain in our example (called "marking to market") can give the contracting parties an indication whether the contract is in their favor ("in-the-money") or not in their favour ("out-of-the-money"). If drought prevailed, as in our example above, the grain farmer would most probably have found his contract's mark-to-market value to be out-of-the-money. However, receiving a price lower than the expected market price was a risk he was willing to take at the outset, to hedge his position. Things might just as well have turned out the other way. It is this mark-to-market value (i.e. derived from translating present market conditions into an expected future price of the commodity on a future date) that represents the derivative value of the contract in question. It should be clear by now that this a value independent of the underlying commodity but at the same time it exists only because of changes in the variables determining the future price of the underlying commodity.

The objections of the scholars of the Shariah

From an outsider's perspective (i.e. not schooled in the Shariah and only having access to English papers written on the subject), the prevailing impression one gets is the inconsistency in arguments and opinion from the learned scholars regarding these instruments. Here are a few examples:

Futures

Mufti Taqi Usmani of the Fiqh Academy of Jeddah in an article answering a set of posed questions on the topic (New Horison, June 1996, pp 10-11), argues that futures contracts are invalid because:

"Firstly, it is a well recognized principle of the Shariah that purchase or sale cannot be effected for a future date. Therefore, all forward and futures contracts are invalid in Shariah; secondly, because in most futures transactions delivery of the commodities or their possession is not intended. In most cases the transactions end up with the settlement of the difference in price only, which is not allowed in the Shariah."

Conversely Fahim Khan (Islamic Futures and their Markets, Research Paper No.32, Islamic Research and Training Institute, Islamic Development Bank, Jeddah, Saudi Arabia, 1996, p.12) states that:

"we should realize that even in the modern degenerated form of futures trading, some of the underlying basics concepts as well as some of the conditions for such trading are exactly the same as were laid down by the Prophet (PBUH) for forward trading. For example, there are clear sayings of the Prophet (PBUH) that he who makes a Salaf (forward trade) should do that for a specific quantity, specific weight and for a specified period of time. This is something that contemporary futures trading pays particular attention to." (Fahim Khan does go on, however, to criticize the modern futures contract for its exploitation of small farmers.)

Options

A number of scholars have found option contracts objectionable (Ahmad Muhayyuddin Hasan, Abu Sayman and Taqi Usmani to mention a few notable ones). However, in perhaps the most comprehensive study of the subject thus far, Hashim Kamali (Islamic Commercial Law: An Analysis of Options, 1995), concluded that:

"there is nothing inherently objectionable in granting an option, exercising it over a period of time or charging a fee for it, and that options trading like other varieties of trade is permissible mubah and as such it is simply and extension of the basic liberty that the Quran has granted."

It appears that most scholars agree that, in principle, futures and option contracts may be compatible with Shariah principles. What makes them worth objecting to, is the manner in which they have found application in the marketplace in certain instances, such as with speculation and exploitation of certain counterparties. The objections of the learned scholars differ in accordance with their individual interpretation of the Shariah and their understanding of the instruments under discussion.

As this deprives businesses from an array of benefits and advantages that, if understood and appreciated properly, appear to be halal in many instances, a concerted effort may be necessary to address the social disadvantages it is placing on such businesses in today's global economy.

(Note : Some parts of this post is extracted from Iqtisad al-Islami)

NATIONAL CELEBRATION ON MAULIDUR RASUL IN MALAYSIA 2009

At the Dataran Merdeka in Kuala Lumpur, the Yang di-Pertuan Agong Tuanku Mizan Zainal Abidin reminded Malaysians to remain united as solidarity was crucial to the development of a nation.

In George Town, some 3,000 Muslims took part in a 2.6km-long procession along the main streets led by Deputy Chief Minister (II) Mohammad Fairus Khairuddin.

Religious teacher Abdul Aziz Abdul Rahman, 73, who formerly taught various state muftis, was conferred the Tokoh Maulidur Rasul.

In Seremban, the Yang di-Pertuan Besar Tuanku Muhriz Tuanku Munawir led more than 9,000 people in the state-level Maulidur Rasul procession at the Seremban Municipal Council field.

In Ipoh, Sultan Azlan Shah said one should start by telling the truth when preaching.

Regent of Pahang Tengku Abdullah Sultan Ahmad Shah told Muslims in Kuantan that everyone could preach and propagate Islams’ good life values because it was not a job restricted only to preachers.

In Kuala Terengganu, some 3,680 people joined a procession from the Sultan Ismail Nasiruddin Shah Stadium to the state stadium in Jalan Sultan Mahmud.

In Malacca, some 7,000 people joined the Yang di-Pertua Negri Tun Mohd Khalil Yaakob and Chief Minister Datuk Seri Mohd Ali Rustam in a 3.5km procession.

In Alor Setar, Kedah Sultan Tuanku Abdul Halim Mu’adzam Shah called on Muslims to appreciate the teachings of Islam in facing whatever difficulties and surrender themselves completely to Allah.

In Kota Kinabalu, more than 7,000 Muslims joined the Yang di-Pertua Negri Tun Ahmadshah Abdullah in a procession from Padang Merdeka to the Islamic Religious Council building in Sembulan.

In Kota Baru, Tengku Mahkota Tengku Muhammad Faris Petra Sultan Ismail Petra attended the state-level celebration at Masjid Muhammadi.

(News is courtesy of The Star)

MAULIDUR RASUL 2009

The birthday of Prophet Muhammad is celebrated on the 12 th day of Rabi-al-Awwal by the Sunni Muslims mainly. It is regarded as an auspicious day and on this day Muslims send their blessings to Prophet Muhammad with recitation of praises and blessings. Sometimes Muslim organizations arrange for lectures in mosques in order to remember the life history of Prophet Muhammad and his good deeds. The birthday of Prophet Muhammad is also known as Milad, Milad an-Nabi, Mevlid Serif, Mawlid ar-Rasul, Yawm an-Nabi or Milad-un-Nabi.

Prophet Muhammad is considered to be the last Prophet of God and the last messenger of God by the Muslims. He was born on 12 Rabiul Awwal, the third month of Muslim calendar. His birthday was first celebrated during the 13 th century followed by a month long celebration. The original celebrations included a sermon, honoring of religious deities, giving gifts, recitation of litanies followed by a feast. Nowadays, however, it is far more subdued although march pasts are still held at different places.

Since the birthday of Prophet Muhammad is based on the Islamic calendar, the date varies every year on the Western calendar because of the differences between both of them. The Islamic calendar is based on lunar movements and the Western calendar is based on solar calendar.

There is a difference of opinion as to whether the birthday of Prophet Muhammad should be considered as a time of celebration. There are evidences that the Prophet, his Companions and the early followers never celebrated on this day. However, some people argue that though it was not celebrated initially, the remembrance of Prophet Muhammad on his birthday is a good innovation in Islam.