Islamic Finance Bulletin - Sept 2008

September 2008 Issue #21

Islamic Finance Bulletin ..………….………………………………………………

Towards an informed market Islamic Finance Bulletin, a quarterly release on the Islamic capital market in Malaysia, is dedicated to informing and educating those active in the growing market of Islamic finance on issues, developments and trends in the domestic Islamic capital market. The contents are intended to be educational, to accelerate the learning curve of those new to Islamic finance and to stimulate further discussions, research and development - all with a view to enabling the Malaysian Islamic capital market to effectively meet the increasing sophistication of the investment community. Should you wish to share any views or comments, or to contribute to the bulletin by way of editorials, please send your e-mail to [email protected].

…in this issue

Forex – A Shariah Discussion

Introduction to Islamic Trusts – Laws, Practices & Distribution

An Introduction to the Laws and Practices of Islamic Trusts and the Distribution of the Trust Upon Maturity

Market Statistics

Ringgit Sukuk Market Report

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TOWARDS AN INFORMED MARKET FOREX - A SHARIAH DISCUSSION

Forex – A Shariah Discussion Islamic Banking and Finance Institute Malaysia Sdn Bhd

Forex Operations and Markets

F

orex trading means the simultaneous buying of one currency and the selling of another. The forex (or foreign exchange) market exists wherever one currency is traded for another. It is said that the forex market is the largest market in the world. It is also reported to be the most prolific financial exchange market, where the vast majority of the currency or forex trading takes place, with a reported total daily turnover of more than USD1.2 trillion. The currencies are always traded in pairs such as US dollar/Japanese yen (USD/JPY), euro/US dollar (EUR/USD) and British pound/US dollar (GBP/USD). Forex trading is not centralised on an exchange and is a 24-hour market. Trading moves from major banking centres like Wellington, Sydney, Japan, London and New York - in that order. The forex market is unique and characterised by its high trading volume, extreme liquidity, large number and variety of traders, vast geographical areas, long trading hours and also various factors that affect exchange rates. The liquidity of the forex market ensures that limit orders and stop-loss orders can be easily executed.

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Major players in the forex market include central banks, commercial banks, nonbanking international corporations, hedge funds, private investors and “profit takers”.

Forex Products – Spot Forex, Value-Today Forex, ValueTomorrow Forex and Swap In the forex market, the exchange rates quoted vary according to the required delivery time. The most important rates quoted in the market are the “spot” rates; settlement of the deal or contract is expected to be made in two eligible business days after the day of the transaction or execution of the deal or contract. Forex deals or contracts under this delivery mode are called spot forex. A deal or contract with a delivery or settlement date which is earlier than the spot delivery date is termed as a “value today” (same-day settlement) or “value tom” (settlement to be made tomorrow) forex deal or contract. Where the required settlement or delivery date is more than two business days after the deal or contract is made, then the deal is known as a forward forex deal or contract.

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A forward contract or deal can also involve a simultaneous transaction of purchase and sale, and is called a “swap”. Swaps are normally used by banks to cover their forex deals or contracts with commercial customers against future adverse exchange-rate movements.

Forex Products – Focus on Forward Forex Deal or Contract

Forward value dates are calculated from spot value dates, which are in turn based on the transaction date. As elaborated on earlier, the spot settlement or payment or value date is two business days after the transaction date. So, for a 1-month forward deal struck on Wednesday, 3 March 2000, the spot value will be Friday, 5 March and the forward value will be Monday, 5 April.

A forward forex deal or contract is a forward deal or contract in the forex market that locks in the price at which an entity can buy or sell a currency on a future date. It is also known as an "outright forward currency transaction", "forward outright" or "FX forward".1

In other words, a forward forex contract is a deal to exchange currencies, i.e. to buy or sell a particular currency at an agreed date in the future, at a rate or price agreed upon now. This rate is called the forward rate.2

1

http://www.investopedia.com/terms/c/currency forward.asp 2

http://www.financialguide.ch/ica/markets/foreign_exchange/fx_fund amentals/wcba5.html

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Traditional forex forwards are available for maturities from 3 days out to about 2 years. As such, forward forex is the overthe-counter (OTC)1 equivalent of currency futures.2 Both contract types allow transactors to take a view on the direction and extent of future spot forex rates.

Uses of Forward Forex Forward forex deals or contracts have two broad uses: hedging and “profit taking”.

Hedging strategies are also employed by professional fund managers to control the risk exposure of large managed funds. In this context, hedging is a more complex process as it involves a whole portfolio of different investments - each with its own unique risk/return profile. Hence, this product will be used by currency hedgers. These hedgers fall into three broad categories: i.

Corporate and retail clients with underlying business reasons to use forward forex are typically riskaverse. They like the comfort of fixed future revenue from international transactions. For example, when a UK corporate will receive USD in 30 days, the future value of that USD in terms of GBP can be fixed now by entering into a forward forex deal with a bank to sell its USD for GBP in 30 days, at a pre-agreed rate.

ii.

International portfolio managers may also use forward forex for much the same reason - to secure the value of future investment returns (e.g. foreign-currencydenominated bond coupon payments).

iii.

Banks use forward forex contracts mainly for liquidity management. They combine a forward forex trade with a spot forex trade to create a two-leg deal called a forex swap.

The main function of a forward forex is hedging. Hedging is a risk-reduction strategy where investors and traders take offsetting positions in an instrument to reduce their risks. The practice usually involves taking both long and short positions in an instrument, and usually necessitates using financial derivatives which make it possible to sell short.

1 An off-exchange market where securities transactions are conducted by dealers through telephones and a computer network. The Over-the-Counter or OTC market is made by the trading desks of investment banks. OTC products are tailored to meet specific client needs and can be contrasted with exchange-traded products, which are standardised in terms of amounts (contract sizes), delivery dates (maturities) and terms. The tailored character of OTC products tends to make them more expensive than their exchange-traded alternatives. 2 Futures contracts are contracts to buy or sell a specific underlying instrument at a specific time in the future, for a specific price. All futures are single-period, exchange-traded contracts and they are standardised in terms of delivery date, amount and contract terms. Currency futures are contracts to buy or sell a specific underlying currency at a specific time in the future, for a specific price.

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Forward forex are also sometimes used by “profit takers”, even though they are more likely to use currency futures to take

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a straight, directional view on future exchange rates in major currency pairs. This is because the exchange-traded futures market allows positions to be highly leveraged and the standardised contracts (price, size, maturity) create the liquidity to allow speculators to trade contracts before their expiry date. The limited number of currency pairs available and their standard size and limited settlement dates are factors which all contribute to the liquidity of futures contracts and make them attractive to speculators. However, these are the very qualities that make currency futures unattractive to clients wishing to hedge a precise currency exposure. More Illustrations on Forward Forex The illustration below of a forward forex indicates the following: Two parties (a bank and its customer) have entered into a forex forward deal or contract, where the bank has agreed to sell a USD deal and the customer agrees to buy a USD deal on the contract or transaction date, say, 11 December 2006. But the exchange of the two currencies would only be made on the value or settlement or payment date of 12 March 2007, i.e. three months after the transaction or contract date of 11 December 2006. The payment by the customer to the bank would be made in Malaysian ringgit (RM). The USD deal value of USD50 million (M) and the ringgit equivalent of RM200 M is based on the contracted or agreed exchange rate of USD1 = RM4. Thus a buy and sell contract has been entered into by both

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parties on the contract date, but no payment is made on the date of the deal or contract of 11 December 2006. The customer has agreed on the deal above as he has imported machinery on 11 December 2006 from an exporter in the United States, valued at USD50 M, payable 3 months from 11 December 2006, i.e. 12 March 2007. On 12 March 2007, the market exchange rate could be lower than the quoted or contracted rate of RM4.00, say RM3.90; or equal to the contracted rate; or higher, say, RM4.10. The market rate then, however, has no effect on the customer as far as his deal with the bank is concerned, although in reality, he may have gained if the rate is higher or incurred an opportunity loss if the rate on the settlement date is lower than the contracted date.

Product Description: Treasury Products – Money-Market Products Under treasury products, the main money-market products include the excess funds of a bank “placed” or deposited in the inter-bank market and the acceptance of other parties’ funds as placement at the bank concerned. It also involves the buying or selling of papers, bonds and other financial instruments by the said bank.

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Shariah Discussions on Treasury Instruments The discussions in this segment are as follows: Treasury forex products, namely for forex spot, forward together with

money-market dealings, with a focus on forward forex.

Foreign-Currency Exchange (al-Mutajarah fi al-‘Umlaat) Bank

Corporate Customer

Sells USD 50M* (Customer buys USD 50M) Sells RM 200M* (Bank buys RM200M)

BNM

a)

Others such as other banks, money brokers, etc.

Background

In the early days of Islam, gold and silver performed all the functions of money (thaman). Currencies were made of gold and silver, with a known intrinsic value (quantum of gold or silver contained in them). Such currencies are described as thaman haqiqi, or naqdain in fiqh literature. These were universally acceptable as principal means of exchange, accounting for a large chunk of transactions. Many other commodities, such as various inferior metals, also served as means of exchange, but with limited acceptability. These are described as fals in fiqh literature. These are also known as thaman istalahi because their

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acceptability stems not from their intrinsic worth, but from the status accorded by society during a particular period of time. These two forms of currency have been treated very differently by early Islamic jurists from the standpoint of permissibility of contracts involving them. b)

Issues

The issue that needs to be resolved is whether the present paper currencies fall under the former category (thaman haqiqi, or naqdain) or the latter (thaman istalahi):

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i.

From the perspective of the majority of Shariah scholars, modern currency exchange should be covered under the classical fiqh topic of sarf. It is held by the OIC Fiqh Conference that paper currency, being legal currency, is governed by Shariah provisions applied to gold and silver, particularly for rules relating to riba and zakah and advance payment in general.1 The majority of the jurists have used (qiyas) analogy to argue that the hadith on gold and silver represents all forms of medium of exchanges, and that therefore all forms of currency should obey the rules established for gold and silver exchanges (sarf). This means that since bimetallic (especially gold and silver) standard has now been universally replaced by paper currency, therefore paper currency should be validly subjected to all Shariah injunctions regarding receipt, payment, calculation of zakah on wealth, repayment of loans, etc, in the same manner as when the bimetallic standard had prevailed.

ii.

This position is not, however, unanimous, and there are those who argue that the rules do not apply to other items. Opponents of categorisation of currency exchange with bay’-sarf, however, point out that the exchange of all

1 Resolution No. 9 adopted during 3rd Session, Majallah Majma’ al-Fiqh al-Islamiy, No. 3, Vol. 3 (1987A.D – 1408H) pg. 1965

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forms of currency (thaman) cannot be termed as bay’-sarf. According to this vie,w bay’-sarf implies exchange of currency made of gold and silver (thaman haqiqi or naqdain) alone and not of money pronounced as such by the state authorities (thaman istalahi). The present currencies are examples of the latter. These scholars find support in writings which assert that if the commodities of exchange are not gold or silver (even if one of these is gold or silver), then the exchange cannot be termed as bay’-sarf. Nor would the stipulations regarding bay-sarf be applicable to such exchanges. They argue that “we should deal with it as we deal with fuloos (copper currency).2 They state that paper money is not included under the rules of sarf based on some classical scholars such as alSarakhsi. He stated that "…when an individual purchases fals or coins made out of inferior metals, such as copper for dirhams, and makes a spot payment of the latter, but the seller does not have fals at that moment, then such exchange is permissible…”3 Hence, the exchanges of currencies of two different countries, which can only qualify as thaman istalahi, cannot be categorised as baysarf. Nor can the constraint regarding spot 2 Al-Zuhayli, Wahbah (2003), Fatawa Mu’asirah, Dar al-Fikr: Dimasyq, pg.107-108, see also alAshqar, Muhammad Sulaiman (1998), “alNuqud wa Taqallub Qimah al-‘Umlah”, Buhuth Fiqhiyyah fi Qadhaya Iqtisadiyyah Mu’asirah, Dar al-Nafa’is: al’Abdaliy, pg. 277-288 3

Al-Sarakhsi, Shams al-Din ( 2000), al-Mabsut, vol.14, Dar al-Fikr: Beirut, pg. 22

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settlement be transactions. c)

imposed

on

such

The Suggested Opinion

It is proposed that the view that currency exchange should be treated in a manner similar to bay’-sarf should be adopted. Besides the fact that it is the opinion of the majority, this view also derives support from the writings of eminent Islamic jurists. It should be noted that most jurists agree that where an item is used as money by custom (urf) among a local population, it should obey the rules that are stated in the hadith regarding gold and silver. According to Ibn Taimiyyah: "…anything that performs the functions of medium of exchange, unit of account, and store of value is called thaman…” [not necessarily limited to gold and silver]. Similar references are available in the writings of Imam Ghazzali. As far as the view of Sarakhsi is concerned regarding exchange involving fals, some additional points need to be taken note of. In the early days of Islam, dinars and dirhams made of gold and silver were mostly used as mediums of exchange in all major transactions. Only the minor ones were settled with fals. In other words, fals did not fully possess the characteristics of money or thamaniyyah, and was hardly used as a store of value or unit of account and was more in the nature of a commodity. Hence there was no restriction on the purchase of the same for gold and silver on a deferred basis. The present currencies have all the features of thaman and are meant to be

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thaman only. The exchange involving currencies of different countries is the same as bay-sarf, with the difference of jins; hence, deferred settlement would lead to riba al-nasiah.

Foreign-Currency Exchange vis-à-vis ‘Aqd al-Sarf a)

Background

Since it has been proposed that the opinion that the present paper currencies fall under the category of thaman haqiqi, or naqdain, the exchange of these currencies should be discussed within the parameter of the contract of sarf. This would be in line with Ibn Rushd’s statement: When two commodities are exchanged, one may serve as a currency and the other as a priced commodity, or both may be currencies. When a currency is exchanged for a currency, the sale is called 'sarf', and when a currency is exchanged for a priced commodity, the transaction is a sale proper ('bay'). 4 The legal definition of the currencyexchange (sarf) contract is: “the exchange of one monetary form for another in the same or different genera, i.e. gold for gold coins, silver for silver, gold for silver, silver for gold, etc, whether it is in 4 Ibn Rushd, Abu al-Walid (1995), Sharh Bidayat al-Mujtahid wa Nihayat al-Muqtasid wa bi Hamishi al-Sabil al-Mursyid ila Bidayat alMujtahid wa Nihayat al-Muqtasid, vol.3, Dar alSalam: al-Qaherah, p.g. 1555-1556

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the form of jewelry or minted coins”.5 Such trading is permitted since the Prophet (saw) permitted the exchange of properties for which riba applies hand-tohand in equal quantities in the same genus, or with differences in, quantities in different genera. b)

Thus, if the contracting parties were to part prior to receipt of one or both compensations, the contract is considered defective by the Hanafis, and invalid by the other schools of jurisprudence, since the condition of receipt would be violated. Once the condition is violated, the contract would in effect become a trade of deferred liabilities, or debt for debt, rendering it riba, especially if the two quantities thus traded were not equal. In this respect, mutual receipt is a condition, regardless of whether the two compensations are of the same or different genera.

Essential Elements and Necessary Conditions of Sarf

There are four general conditions for the currency-exchange contract: i. ii. iii. iv.

mutual receipt prior to the contracting parties’ parting; equality of quantities if money of the same genus is traded; inapplicability of options; and non-deferment.

Physical parting of the contracting parties refers to moving away from the contract session’s location in different directions or the movement of one away from the contract location while the other remains there. Thus, if both parties remain in the same place of the contract session, no parting would have taken place, regardless of the length of their stay physically in that place. This applies even if one or both parties were to sleep or faint at the place of the contract session, or if they were to move together in the same direction for any distance. Thus, “physical parting of the contracting parties” is to be interpreted literally in this case.

The discussion of those four conditions in more detail is as follows:6 •

Mutual receipt prior to the physical parting of the two contracting parties is postulated as a condition to avoid the danger of effecting the forbidden riba al-nasi’ah. This follows from the saying of the Prophet (saw): “Gold for gold, in equal amounts, hand-to-hand; and silver for silver, in equal amounts, hand-to-hand,” as well as His (saw) saying: “Do not trade one of them absent (thus, deferred) for the other immediately delivered.”

• 5

Al-Zuhaili, Wahbah (1997), al-Fiqh al-Islamiy wa Adillatuhu, Vol.5, 4th edition, Dar al-Fikr: Dimasyq, pg. 3659

6

Ibid, pg.3660-3662

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If money is exchanged for another money of the same genus (e.g. gold for gold or silver for silver), then the two compensations must be equal in weight, even if one of the

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two compensations is of a higher quality or workmanship than the other. This follows from the above referenced hadith “gold for gold in equal amounts”. Thus, the quantity of gold (measured by weight) is the only consideration, irrespective of the quality, following the juristic principle that “its high quality (jayyid) and low quality (radi’) are equivalent.”7 •

The currency-exchange contract is binding, i.e. devoid of any conditional options, since mutual receipt is a condition of the contract. Thus, since a conditional option would prevent the establishment of final ownership, it would violate the condition of receipt, thus rendering the contract defective. However, if the person with the stipulated conditional option drops it prior to parting, the two parties thus leave the contract session with final receipt, and the contract would revert to being valid. This is in contrast to the opinion of Zufar, who did not allow the reversion of the contract to validity. However, it is a consensus that if the condition were to remain after parting, then the contract is rendered defective.

•

However, the inspection and defect options are established, since they do not prevent the establishment of ownership and thus do not prevent

7

Al-Marzuqi, Salih bin Zabin (1996), “Tijarah alZahab fi Ahammi Suwariha wa Ahkamiha”, Majallah Majma’ al-Fiqh al-Islamiy, 9th Session, v.1, 1996A.D-1417H, pg. 154

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complete receipt. Even if the two parties were to part after receipt, the contract would be concluded for the likes of the exchanged money and not the exact same ones that changed hands, thus rendering the inspection and defect options effective.8 •

8

In short, classical fiqh has provided regulations for governing sarf transactions. Therefore, if we were to apply the rules of sarf to the modern practice of foreign exchange, this would render some current currency exchanges permissible and others not. A fundamental condition of the currency-exchange contract is the absence of any deferment; otherwise the contract would be defective. This follows immediately from the requirement of mutual receipt prior to parting, as discussed above, since deferment prevents immediate receipt, thus rendering the contract defective. The legal proof for the condition of non-deferment is the number of hadiths on riba,9 which require hand-to-hand exchange of goods eligible for riba, as well as the hadith narrated by Al-Bukhari and Muslim on the authority of Abu Al-Minhal: “There is no harm in whatever is exchanged hand-tohand, but any deferment would render it riba”.

Al-Zuhaili, Wahbah (1997), opcit.

9

For example please see al-Nawawi, Muhyiddin (2004), al-Minhaj Sharh Sahih Muslim bin Hajjaj, v.11Dar al-Ma’rifah: Beirut, pg. 11-18

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Foreign-Currency Transaction

Exchange:

Spot

This form of sarf contract involving the exchange of countervalues on a spot basis is almost beyond any kind of controversy. There is almost general consensus among the majority of Shariah scholars on the view that currencies of different countries can be exchanged on a spot basis at a rate different from unity, since currencies of different countries are distinct entities with different values or intrinsic worth, and purchasing power. This is due to the compliancy of the transaction to the rules, arkan and conditions of sarf mentioned above. This means that the present concept and practices of foreign-currency spot transactions do not involve riba alnasi’ah and also do not violate the Shariah principle of delivery with respect to exchange of currencies – “hand to hand”(yadan bi yadin). It may be noted here that the real-life spot markets for currencies often provide for actual delivery within 48 hours or two banking business days due to practical reasons (for example, time differences among various global markets). Some scholars have argued that this practice of allowing a two-day lag cannot be accepted in the Islamic framework due to the deferment factor in the contract of sarf. Others consider this position to be too rigid and find this practice to be Islamically acceptable on the basis of al‘urf (in this context, al-‘urf al-masrafiy). This view is also justified on the ground that the so-called time lag involved in the spot transaction is not a time lag between

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the delivery of one currency compared to the delivery of the other, but rather is a lag between the deal date and the execution date. Furthermore, even if there is a time lag, the same does not affect the price or the exchange rate between the two currencies involved.

Foreign-Currency Exchange: Forward Transaction There also seems to be a general agreement among the majority of scholars on the view that currency exchange on a forward basis is not permissible; that is, when the rights and obligations of both parties relate to a future date.10 This is due to the fact that it is established opinion in the sarf transaction that the exchange must be made on the spot. Because both countervalues in sarf must be settled immediately, a forward transaction (in which one of the countervalues is delivered on a future date) is not allowed. In other words, such contract is not Islamically permissible since it violates the Islamic principle of delivery with respect to exchange of currencies “hand to hand”. The OIC Fiqh Academy, Jeddah, in its seventh session, clearly rules out the permissibility of such contracts. It makes no difference whether these contracts are entered into for the purpose of speculation or for hedging.11 10

Al-Zuhaili, Wahbah (2002), al-Mu’amalat alMaliyah al-Mu’asirah Buhuth wa Fatawa wa Hulul, Dar al-Fikr: Dimasyq, pg. 165-166

11 Resolution no. 7/1/65, in Majallah Majma’ alFiqh al-Islamiy, 7th Session, no.7, vol.1, 1992A.d-1412H, pg. 716

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It can be inferred and concluded that the prohibition of forward foreign exchange is, by and large, discussed in the framework of the deferment issue of riba al-nasi’ah. Although there are some prohibitive arguments which focus on the issue of bay’ al-ma’dum and gharar, the issues are not so relevant since in a foreign-exchange market with full and free convertibility or no constraints on the supply of currencies, the probability of failure to deliver the same on the maturity date should be no cause for concern. Furthermore, the standardised nature of forex contracts and transparent operating procedures in the markets is believed to minimise this probability. a)

Proposed Shariah Solution

Since the conventional forward contract of foreign exchange, in which delivery of both the countervalues is deferred to a future date, is not acceptable from the Shariah point of view, then the Shariah solution to this kind of issue is through the establishment of “wa’ad mulzim” or “promise” to transact an exchange business on a future date, and that such an agreement is “morally” enforceable. To elaborate further on this wa’ad tool, it is an established fact that Islamic law requires delivery to be made on the day of the contract. However, Islamic law does not prohibit the promise to buy and sell currencies on one date and for delivery to be made on another date, because the proper contract only concludes on the day of delivery. This premise of argument has led to the argument/construction of unilateral wa‘ad (promise) in structuring the Islamic version of forward foreigncurrency exchange.

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Under the unilateral wa’ad structure, only one party (obligor/promisor) promises to buy/sell, as the case may be, where he is bound by that promise (binding promise). However, the other party/promisee/obligee is not bound to proceed with the promise undertaken by the promisor. A binding promise from only one party is not deemed under Islamic law as a contract. Therefore, this can facilitate forward forex. Binding promises from both parties are deemed to lead to contract conclusion and, therefore, prohibited. The prohibition of a binding bilateral promise in an exchange of currencies is supported by the majority of Shariah scholars, because binding bilateral promises from two parties are equivalent to a contract, and also for the reason that the bilateral promise is not immediately followed by taking possession of the countervalues, since it is not the wish of the parties to take possession at that time. A promise from one party only (as opposed to a bilateral promise) is permissible in currency exchange, even it is binding.12 In 2005, the SAC of Bank Negara Malaysia approved a mechanism for forward foreignexchange transactions based on a binding unilateral promise that does not amount to a contract before the settlement date. In the event of default of the binding promise, the compensation charge is allowed to be imposed on the defaulter.

12

AAOIFI, Shari’a Standards 1425-6H / 2004-5, Shari’a Standard No.1, Trading in Currencies, See Appendix B of the Standard,(Basis of the Shari’a Rulings, pg. 14, see also, Al-Zuhaili, Wahbah (2002), op.cit, pg. 168

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The Wa’ad Issue

ii.

A number of the Muslim jurists are of the view that fulfilling a promise is mandatory and a promisor is under moral as well as legal obligation to fulfil his promise. According to them, promise can be enforced through the courts of law. This view is ascribed to Umar b. Abdul Aziz, Hasan al-Basri, Sa‘id b al-Ashwa‘, Ishaq b Rahwaih and Imam al-Bukhari. The same is the view of some Maliki jurists, and endorsed by al-Ghazzali, the famous Shafi‘i jurist, who says the promise is binding if it is made in absolute terms.14 This is the same as the view of Ibn Shubrumah15 and preferred by Ibn-al-‘Arabi and Ibn-al-Shat.16

iii.

The third view is presented by some Maliki jurists. They say that in normal conditions, a promise is not binding; but if the promise has caused the promisor to incur some expenses or undertake some labour or liability on the basis of that promise, it is mandatory for him to fulfil his promise, which he may be compelled to by the courts. Some contemporary scholars have claimed that the jurists who have accepted the binding nature of a

As stated above, a solution to this problem is sought in the forward sarf arrangement, by asking the client to sign a promise to purchase the currency when it is acquired by the financier. Instead of being a bilateral contract of forward sale, it is a unilateral promise from the client, which binds himself and not the financier. Being a one-sided promise, it is distinguishable from the bilateral forward contract. This solution is subject to the objection that a unilateral promise creates a moral obligation but cannot be enforced, according to Shariah, by the courts of law. This leads to the question whether a one-sided promise is enforceable in Shariah. A thorough study of the relevant material in the books of Islamic jurisprudence shows that the fuqaha’ (the Muslim jurists) have different views on the subject. Their views may be summarised as follows: i.

Many of them are of the opinion that 'fulfilling a promise' is a noble quality, and it is advisable for the promisor to observe it, and its violation is reproachable, but it is neither mandatory (wajib) nor enforceable through the courts. This view is attributed to Imam Abu Hanifah, Imam al-Shafi‘i, Imam Ahmad and to some Maliki jurists.13

13 Al-Asyqar, Muhammad Sulaiman ((1998), “Bay’ al-Murabahah Kama Tujrihi al-Bunuk alIslamiyyah”, Buhuth Fiqhiyyah fi Qadhaya Iqtisadiyyah Mu’asirah, Dar al-Nafa’is: al’Abdaliy, pg. 85-89

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14

Al-Qaradhawi, Yusuf (1998), “al-Wafa’ bil Wa’ad”, Majallah Majma’ al-Fiqh al-Islamiy, 5th Session, no.5, vol.2, 1988-1409H, pg. 841-859 15

Ibn Hazm, Abu Muhammad (2001), alMuhalla bi al-Athar, vol. 6, Dar al-Fikr: Beirut, pg.278 16

Ibn al-Shat (2003), Idrar al-Shuruq ‘ala Anwa’ al-Furuq, within al-Qarafiy, Shihab al-Din, alFuruq, vol.4, Muassasah al-Risalah: Beirut, pg. 49

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promise have done so only with regard to unilateral gifts or other voluntary payments, but none of them has accepted the binding nature of a promise to effect a bilateral commercial or monetary transaction. 17

courts in the manner explained above. This promise does not amount to an actual sale. It will be simply a promise and the actual sale will take place after the commodity is acquired by the financier, for which exchange of offer and acceptance will be necessary.

If promises are not enforceable in commercial transactions, this may seriously jeopardise commercial activities. There is nothing in the Holy Qur’an or Sunnah which prohibits the making of such promises enforceable. It is on these grounds that the OIC Fiqh Academy has made the promises in commercial dealings binding on the promisor, with the following conditions:

In short, the Muslim jurists have allowed unilateral promises to be enforceable based on the principle that “the promise can be made enforceable at a time of need”. The unilateral promise that is given in a particular structure is independent of the underlying transaction and is not a condition for the enforcement of that particular structure. Hence, if the sale is without any condition, but one of the two parties has promised to do something separately, then the sale cannot be held to be contingent or conditional upon fulfilling of the promise. A sale will take effect irrespective of whether or not the promisor fulfils his promise. This makes it clear that a separate and independent promise to purchase does not render the original contract conditional or contingent. Therefore, it can be enforced.

It should be a one-sided binding promise religiously; and if the promise have caused some liabilities due to the promisor backing out of his promise, the court may force him to either purchase or pay actual damages to the seller. The actual damages will include the actual monetary loss suffered by him, but will not include the opportunity cost. 18

On this basis, it is allowed that the client promises to the financier that he will purchase after the latter acquires it from the supplier. This promise will be binding on him and may be enforced through the 17 Abu Zaid, ‘Abd al’Azim (2004), Bay’ alMurabahah wa Tatbiqatuhu al-Mu’asirah fi alMasarif al-Islamiyyah, Dar al-Fikr: Dimasyq, pg. 163-167, see also Al-Asyqar, Muhammad Sulaiman ((1998), “Bay’ al-Murabahah Kama Tujrihi al-Bunuk al-Islamiyyah”, opcit, pg. 85-89 18

Majallah Majma’ al-Fiqh al-Islamiy, Session, no.5, vol.2, 1988-1409H, pg. 1599

Islamic Finance Bulletin IBFIM

5th

To sum up, for Islamic forex forward transactions, the underlying Shariah concept during the transaction is Wa’ad Mulzim min Taraf Wahid (Unilateral Binding Promise). This is to facilitate the settlement process and to satisfy market convention for a forward contract, where the delivery of the exchange is done on a specified future date. In other words, Wa’ad is made on the transaction date and the Sarf akad is performed on the settlement date. The agreement mechanism on Islamic forward forex agreements is as follows:

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TOWARDS AN INFORMED MARKET FOREX - A SHARIAH DISCUSSION

•

Between Islamic banks and customers: The customer performs a Wa’ad Mulzim while the bank is Waad Ghair Mulzim.

•

Between Islamic banks: The bank that initiates the transaction (unless otherwise objected to by the counterparty) is always the one performing Wa’ad Mulzim.

and the payment date based on trade finance documents supporting the forward deal. •

•

Between conventional anks and Islamic banks: Conventional banks treat all forward contracts as binding, which can be treated as Waad Mulzim. Islamic banks will be Waad Ghair Mulzim.

•

•

•

Workflow in Islamic Forward Forex Agreement •

The customer must first establish forex lines with the bank.

•

•

Upon acceptance of the offer, the customer must submit to the Treasury a list of authorised officers to deal in forex on behalf of the company.   The minimum forward amount for hedging is USD50,000.   The customer must determine the type of foreign currency, the amount

•

•

•

Islamic Finance Bulletin IBFIM

July-September 2008

The customer must provide documentary evidence prior to each booking.   The customer calls the dealer to apply for the forex forward agreement and negotiates the rate. Once agreed, a reference number will be assigned for future correspondence. The customer will then forward the Wa’ad application to the bank.   The bank then sends a confirmation letter agreeing to enter into a forward agreement, based on the agreed details.   Upon utilising the forward deal, the customer must submit the particulars together with the forward deal number to the trade finance officer, who will then reconfirm the rates with the Treasury.   The forward deal must be utilised by the customer, failing which the bank will be exposed to market risk for the outstanding amount.

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TOWARDS AN INFORMED MARKET FOREX - A SHARIAH DISCUSSION

Illustration

Foreign-Currency Exchange: Swap Transaction With regard to the current conventional practice of currency swap, it is one of the principles of the Shariah that two financial transactions cannot be tied together in the sense that entering into one transaction is made a precondition to entering into the second. The majority of scholars view that this kind of practice is not in line with the rules and conditions of ‘aqd in general, due to the issue of bay’atayn fi bay’ah/safaqatayn fi safaqah and bay’ wa syart. It is worth noting that certain Islamic banks offer some innovative financial treasury products to overcome this issue. However, this paper will not delve into this issue.

Islamic Finance Bulletin IBFIM

July-September 2008

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TOWARDS AN INFORMED MARKET FOREX - A SHARIAH DISCUSSION

For more information, please contact:

Islamic Banking and Finance Institute Malaysia Sdn Bhd (340040-M) Level 3, Dataran Kewangan Darul Takaful Jalan Sultan Sulaiman 50000 Kuala Lumpur, Malaysia Tel: +603-2031 1010 Fax: +603-2031 9191 E-mail: [email protected] Website: www.ibfim.com.my

ISLAMIC BANKING AND FINANCE INSTITUTE MALAYSIA SDN BHD Islamic Banking and Finance Institute Malaysia Sdn Bhd (IBFIM) is an institute dedicated to producing well-trained, highcalibre individuals and management teams with the required expertise in the Islamic finance industry. Based on the industry’s demands and customers’ needs, we provide complete assistance to our clients through a wide spectrum of inter-related services: training and education, advisory and consultancy, and research and development in Islamic finance. Our close relationship with the industry gives us the opportunity to share knowledge and resources. We also enjoy a strong network with local and international authorities and financial institutions. Having assisted numerous governments, financial institutions, and other organisations in this arena, we are driven to serve the need for further enhancement and development of the industry in years to come.

Islamic Finance Bulletin IBFIM

July-September 2008

Issue #21 16

TOWARDS AN INFORMED MARKET ISLAMIC TRUSTS – LAWS, PRACTICES & DISTRIBUTION

An Introduction to the Laws and Practices of Islamic Trusts and the Distribution of the Trust Upon Maturity Dr Aimi Zulhazmi Bank Islam Trust Company (Labuan) Limited

Overview

T

his article will generally cover 2 main areas: firstly, the Islamic trust law concepts and practices; and secondly, understanding how the distributions of the Islamic trust are made. Nevertheless, for better understanding, the order of the article will be as follows: 1. 2. 3. 4. 5.

Trust concept in Islam Islamic trust development Islamic trust products Distribution of Islamic trust Summary

Trust Concept in Islam The Majelle, one of the oldest Islamic texts printed in the 1800s, is a popular source of reference on modern Islamic banking and finance. The literature, initially written in Arabic, has been translated into many languages, beginning with French and then followed by English, Malay and others. The Majelle, in 2 articles, defines trust as follows: in Article 762, Al-Ameen is described as being in charge of something he was entrusted with. ‘Al-Ameen’ was also the nickname of Prophet Muhammad (saw), given by his people even before he was elevated or appointed as Prophet. The Islamic Finance Bulletin BITC

name describes someone that is fully entrusted with assets; hence this describes the existence of trustee. Furthermore, in Article 769, the role of trustee is further defined in its responsibilities; if it is due to the negligence of the trustee the entrusted asset is damaged or destroyed, then the trustee shall be responsible. The holy book of Muslims, the Al-Quran, also elaborates on the trust fundamentals in Islam. In verse 23:8 of Al-Mu’minun, God describes good Muslims as those who faithfully observe their trusts and covenants. Furthermore, in verse 4:58 of Al-Nisa, God teaches Muslims that they must render back their trust to the right people, especially when judging between 2 people. By language, trust is also described as “amanah”, i.e. seeking the action of another party to keep the asset safe. Another popular description is the “wadiah” concept, used by Islamic banks to describe the act of holding customers’ deposits in savings accounts.

Islamic Trust Development Islam certainly encourages Muslims to seek wealth; this is a very important point as there are certain quarters that believe

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TOWARDS AN INFORMED MARKET ISLAMIC TRUSTS – LAWS, PRACTICES & DISTRIBUTION

Muslims should concentrate and focus on Ibadah alone for the next world, i.e. “akhirat” or the hereafter. To illustrate that the world we are living in as equally important, God in verses 62:10 of AlJumaat instructs Muslims that after completing their prayer, they should work hard to obtain wealth and become rich. Only when we are rich can we help people, although it does not mean that we cannot help others if we are poor. By being rich, we have a larger capacity to help more people. God certainly encourages the sharing of wealth; verse 5:2 describes that Muslim should help others with full sincerity. The sharing of wealth in Islam during the days of Prophet Muhammad (saw) and his companions 1,400 years ago had given rise to the establishment of an institution called “Baitulmal”. Literally, “Bayt” is a house and “Mal” is property, thus giving rise to the public treasury, where usury or “zakat” collected as a form of tax from the people is accordingly collated and then distributed to the needy. Later on, when Arab and Indian traders started travelling around the world, especially in the Asian region, the role of trustee became more prominent. The traders entrusted the assets and families to trusted family members or heads of the clans/tribes until their return, and even laid out their distributions should they never return. Since then, there has been rapid development of assets and issues that must be taken into considerations. Sophistication arises from complexities of asset forms, various movable assets from such as bonds, debentures, company shares, gold certificates, Safe Keeping Receipt of craft, paintings and artifacts at different countries and jurisdictions. Different laws from continental laws, Islamic Finance Bulletin BITC

common laws, civil laws, offshore laws, customs govern the assets forms and locations. The September 11 incidence has changed the geo political global landscape as terrorism now recognised as major global treat, anti-money laundering scope previously only from drugs and arm trades now includes terrorism. The Western and Muslim worlds now at more different polar of opinions than before. Muslims certainly has greater awareness of their needs, wanting to please their faith on their daily activities especially banking and finance. The rise of Islamic banking and takaful, sukuk, Islamic unit trust/mutual funds, REITs have expanded the varieties of Islamic financial services as well as pushing for more offer Shariah compliant offerings. The sizable private wealth of Muslims especially in Middle East (estimated at US1.5 trillion in 2007) gives rise to demand of Islamic wealth management and Islamic private banking. These are some of the issues need to be addressed in the setting up of trust and its compliance to the Islamic Shariah laws as the guiding principles, i.e. from al Quran and the teachings/practices of the Prophet Muhammad (saw). It also describes “Halal” meaning acceptable and the opposite is “Haram”, the forbidden ones; obviously both attract good and bad deeds accordingly. The guidelines then define types of asset, debt and investments that are halal and haram. For example, income from business related to gambling, liquors, pig rearing are haram, similarly interest income arises from conventional banking is also haram. When discussing about trust, knowledge of Faraid or forced heir ship distribution must be attained at the fundamental level. Approval from the Shariah supervisory council must be obtained in order to provide credibility on the Islamic products and services. However even

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TOWARDS AN INFORMED MARKET ISLAMIC TRUSTS – LAWS, PRACTICES & DISTRIBUTION

Shariah councils have differing opinions on certain issues.

jurisdiction, the product launched in July 2004.

Before we move to the next area in the various Islamic trust products, there is the need to emphasize the importance of witnesses in the execution. This is underline by the Quranic verse 5:106 of Al-Maidah, in making bequest, there should be two witnesses preferably fellow Muslims however non Muslims can also act as witness should there be no others. The preferred orders of witnesses are as follows:

Islamic Will

1. 2. 3.

two male witnesses, if not available then One male witness and two female witnesses, if not available then Four female witnesses

had

been

Before we elaborate further on Islamic trust products, we need to understand how Will is prepared and executed according to the Shariah rules. By definition, will is defined in Islam as an admission (iqra) of honour made by a person during life time; the purposes of preparing will can be of charitable nature or any other purposes permissible by Islam. Even the holy book, Al-Quran, in verse 2 from 180 to 182 of Al Baqarah, extensively elaborated the importance of Muslim to write Will. Writing of Islamic Will would require 2 witnesses (as described earlier) and comprises of 2 main categories that is divided into 2 main portions 1/3 and 2/3.:

Islamic Trust Products 1. Waqf The first type of Islamic Trust is Waqf, also currently the most popular term to be used in Islamic Trust. The setting up of Waqf is normally intended for charitable person, by definition, Waqf can be dedication of asset in perpetuity for charitable and religious objective, secondly Waqf, can also be on the use of an asset for specified cause. There are 2 categories of waqf i.e. Waqf Am (general) normally for public causes and Waqf Azzuri (limited to family members). Furthermore 4 main areas need to be considered: 1. Waqif (The asset owner) 2. Mauquf (asset to be waqf) 3. Mauquf allaih (beneficiary) 4. Sighah (the contract) One example of Waqf, is Cash Waqf at Labuan, Malaysia, an offshore Islamic Finance Bulletin BITC

July-September 2008

One third portion, is defined as Up to one third, meaning the portion must be met however not necessarily to the maximum of 33%, it can be in less amount as long as the amount is allocated. The allocation is at the liberty of the testator (one who make the will) but must not be for those relatives entitled under the forceheirship ruling (2/3). Example of these entitle for the 1/3 portion are: a. Adopted children/ Foster parents/siblings b. Non Muslim immediate family members (parents and siblings) c. Relatives not entitled under force heir ship ruling, for example, in laws and grandchildren d. Institutions and organizations either charitable or noncharitable. Issue #21

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TOWARDS AN INFORMED MARKET ISLAMIC TRUSTS – LAWS, PRACTICES & DISTRIBUTION

One the other hand, Islam recognizes that more than 1/3 portion can be made to the above beneficiaries, however such agreement would be required from those relatives entitled under the 2/3 portion at the death of the testator, if not it will revert back to 1/3 portion. 2.

Two third portion or the balance after allocating the one third portion is allocated to the relatives or family members. This distribution can be allocated according to the following: a.

Directly follows the Faraid distribution - close family members with bloodlines and spouse only, also known as main beneficiaries; or

b.

The testator can also suggest or propose that instead of following Faraid, the assets are to be distributed according to their wishes. However the suggestion or proposition is subject to the agreement of the main beneficiaries after the testator’s demise; or

c.

Conversely, the main beneficiaries may amicably agree to divide the asset according to their common agreement instead of following Faraid distribution. This is documented as family deed.

Islamic Finance Bulletin BITC

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TOWARDS AN INFORMED MARKET ISLAMIC TRUSTS – LAWS, PRACTICES & ITS DISTRIBUTION

For more information, please contact:

Bank Islam Trust Company (Labuan) Ltd –LL04013 Level 5(J) Main Office Tower, Financial Park Complex Jalan Merdeka 87000 F.T Labuan, Malaysia Tel: +60 87-451806 Fax: +60 87-451808 Website: www.bankislamtrust.com.my

BANK ISLAM TRUST (LABUAN) LIMITED

COMPANY

Bank Islam Trust Company (Labuan) Ltd (BTL) is wholly owned by Bank Islam Malaysia Berhad. Its ultimate holding company BIMB Holdings Bhd, is a public listed company on the Main Board of Bursa Malaysia. BTL was incorporated in 23th November 2003 and commenced its full operation in January 2005. BTL is the trustee of choice to Corporate Lenders, Equity Trust Fund Managers and Individuals. We aim to meet the everchanging and challenging demands of the industry with utmost dedication and professionalism. With support from the Bank Islam group and the strength of her dynamic and committed professionals, BTL aims to be a pioneer in Islamic Personal and Corporate Trusts providing superior service at par with the best in the region. As Trustee to properties and other assets of the Muslims and as Executor and Administrator of Deceased Estates, we provide peace of mind and assurance that your wishes and desires will be well taken care of in the most professional manner.

Islamic Finance Bulletin BITC

July-September 2008

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TOWARDS AN INFORMED MARKET RISKS IN ISLAMIC CONTRACTS

Risks Associated with Islamic Financial Contracts: Part 4 Meor Amri Meor Ayob Bond Pricing Agency Malaysia Sdn Bhd

Introduction As highlighted in earlier parts (please refer to the series of articles published in previous Bulletins), a strong foundation in risk identification and assessment is a prerequisite to becoming a competent pricing specialist. From this understanding, plus an in-depth knowledge of financial engineering, the fair valuation of any financial asset can be done. This skill set is not only relevant to the conventional bond market, but also to the sukuk market. The purpose of this series of papers is to provide some essential reading for anyone who is serious about the science of sukuk valuation. These papers are the basis for the underlying valuation methodology for Islamic financial assets, developed by Bond Pricing Agency Malaysia Sdn Bhd (“BPA Malaysia”). Part 4 will highlight, as completely as possible, all the identifiable risks associated with the Ijarah and Ijarah muntahia bittamleek contracts.

Islamic Finance Bulletin BPAM

Types of Risk Associated with the Contracts of Ijarah and Ijarah Muntahia Bittamleek Typical Ijarah and Ijarah muntahia bittamleek contracts can be segmented into 7 transaction stages. Each stage has its own unique risks. The following sections detail the risks identified for each stage of the two contracts. 1. Agreement to Lease When a customer requests an institution (the lessor) to purchase a specific asset, the customer enters into an agreement to lease. The institution should first purchase the asset prior to the execution of an Ijarah contract. The asset can be purchased from the customer and subsequently leased back to them (sale and leaseback). The institution can appoint a purchasing agent. The agent can be the customer or a person having a blood or marital relationship with the customer. If the agent is a company owned by the customer, they should not hold more than a third of its equity.

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The institution executes an agency contract with the agent. During this stage, a number of risks affect the parties involved, such as supply risk. The supplier is to deliver the asset and must be able to meet the specified quality. Another possible risk is when the lessor acquires an asset which is already on lease. The lessor may well have to sign a ‘new’ leasing contract with the existing lessee, based on existing terms that may not necessarily be better than those in the existing contracts. The appointment of the customer as an agent may also give rise to conflict of interest or such purchase not being conducted on an arms-length basis, which may result in price manipulation. 2. Order/Receipt of Asset The financing institution takes possession or ‘constructive possession’ of the assets and subsequently offers the asset for lease to the customer. The financing institution is responsible for the risks associated with the asset. Price risk becomes present in this phase of the transaction. When the customer opts not to fulfil the promise or agreement to lease, the financing institution has to lease (or sell) at lease rentals (or a selling price), which can be lower than the original total rental (or selling price) to the original customer. One way to mitigate or reduce the severity of this risk is for the financing institution to request for a security deposit; this is to guarantee the customer’s commitment to leasing the asset. The financing institution can deduct the difference between the total lease rental (or a selling price to a third party) and the cost of the asset when the customer breaches the agreement to lease.

Islamic Finance Bulletin BPAM

Although the financing institution can still claim on the remaining amount of damages in the event the security deposit is insufficient, it remains to be seen whether such claims can be realised (litigation cost, loss of claims). 3. Contract The customer (as lessee) executes an Ijarah contract with a financing institution (as lessor), requesting the lessor to acquire an asset or acquire the usufruct of an existing asset which the customer wishes to lease. The contract can be drawn via a master agreement (to be followed by the execution of multiple confirmations of offer and acceptance of individual Ijarah transactions) or individual contract. The contract is binding and cannot be cancelled unilaterally. The lease period should commence from the date of execution, unless the parties have agreed on a specific future commencement date. Future Ijarah is allowed, provided that the lease rentals are payable by the lessee after the leased asset is delivered to the lessee. The lease rental may be paid in cash, kind (goods) or usufruct. The rental must be specified, either in a lump-sum payment in advance or in arrears, or in instalments throughout the duration of the lease. The rental can be fixed or variable. It is also important to note that the lessor can sell the leased asset without the consent of the lessee. A number of risks are present at this stage; settlement risk is one of them. For example, this could occur when the customer is unable to service the lease rental as and when it falls due. This inability can be due to variable lease

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rentals that may distress the customer’s ability to pay (loss of rental receivables). To buffer against this risk, the financing institution can request for a deposit from the customer and deduct for damages. The deposit can also be taken as an advance payment of lease rental. Alternatively, the financing institution as the owner - has the right to repossess the asset. Another risk is that of the rate of return. Long-term Ijarah with fixed rental is susceptible to changes in market conditions, e.g. higher returns demanded by investors. A possible mitigant is to have renewable short-term leases with price re-fixing, subject to mutual consent, or to adopt variable lease rentals which are determined according to a certain benchmark (e.g. rate of interest). The financing institution can enter into a lease contract with the condition that the lease rental shall be increased according to a specific proportion after a certain period (e.g. one year). Other risks are takaful risk, i.e. insufficient takaful to cover the mishap during the delivery and rental period; and Shariah-compliance risk, i.e. compliance with Shariah principles in terms of usage, operations, risk bearing and ownership transfer (non-recognition of income). 4. Reject/Defective Goods The lessee can reject delivered goods that are not within specifications. The lessor is responsible for defects throughout the Ijarah period, unless such defects are due to the lessee’s misconduct or negligence. The leased asset in the possession of the lessee is held in a

Islamic Finance Bulletin BPAM

fiduciary capacity. When the usufruct of a leased asset is wholly or partially destroyed due to nature or not the lessee’s misconduct, the lessee may terminate the Ijarah contract or renegotiate the rental based on the prevailing market rate. When the usufruct of a leased asset is wholly or partially destroyed as a result of the lessee’s misconduct, the lessee is obligated to restore or repair the leased asset. At this stage, there are legal risks to the lessor. For example, claims against the lessee that refuses to pay for the damaged goods. There is also an asset-impairment risk. i.e. when the leased asset is destroyed (not due to the lessee’s misconduct). In this case, the lessor has to provide an alternative asset; failure to do so entitles the lessee to terminate the lease without paying rental for the remaining duration of the contract. One way to mitigate this risk is for the lessor to insure the leased asset (cost to be borne by the lessor) against damages. The insurance cost can be included as part of the fixed lease rental and cannot be charged separately to the lessee. 5. Early Settlement The contract can be terminated by mutual consent. Unilateral termination is allowed in cases of force majeure, defect in the leased asset that materially impairs its use, total destruction of the leased asset or when a termination option is stipulated in the contract. When the leased asset is returned by the lessee without the lessor’s consent, the lessee is obligated to continue paying the

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lease rental while the lessor cannot lease the asset to another lessee. 6. Default Default in payment is when the lessee, who is in a solvent state, fails to honour the payment when due. In a situation when the financing institution is legally allowed to repossess goods without initiating a bankruptcy order, the financing institution can sell or lease the asset to a third party to recover the selling price of the goods. Late payment, penalty charges or price increase is not allowed. Any extension or rescheduling of payment can be done without additional charges or price increase. Typical risks at this stage are assetrepossession risk, i.e. the leased asset, which is in the possession of the customer, cannot be located/repossessed. If repossessed, the asset cannot be sold or leased to another party; rental-acceleration risk, i.e. the inability to recover the future rentals that are accelerated or declared immediately due upon default by the lessee; legal risk, i.e. the financing institution takes legal action when the asset cannot be repossessed; business risk, i.e. new leasing arrangement may generate lower returns and the rental may differ when there is early repossession by the financing institution, as well as disposal of the leased asset after repossession, at a price which is not sufficient to recover the amount due.

loss due to the fair value of the asset falling below its residual value, estimated at the start of the lease contract (low fair value). In the case of Ijarah muntahia bittamleek, the agreement to lease is not binding on the lessee although the lessor is unilaterally bound to transfer ownership of the leased asset to the lessee. The option to transfer legal title/ownership of the lased asset must be documented separately from the Ijarah contract, and be effected either as a gift, or a token of consideration, or as a final instalment of the lease rental. In the event that the customer decides not to proceed with the purchase, the financing institution will bear the potential loss due to the fair valuation of the asset falling below its residual value (estimated when the contract was made). Under Ijarah muntahia bittamleek, the lessee normally pays lease rentals that are higher than the prevailing rate, as consideration of the lessor’s promise to transfer ownership at the end of the lease period. When the asset is permanently impaired and the lessee cannot purchase the asset, the lessor may be required to refund the ‘purchase price’ to the lessee. The rental payment in excess of market rate can be regarded as the ‘purchase price’ paid in advance.

7. Maturity The asset is returned to the financing institution.

The next article will look at the risks associated with the contract of musharakah.

There is residual value risk as the financing institution will have to bear the potential

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Bibliography Rating Islamic Debt Securities: A Primer, RAM BNM (November 1999). The Central Bank and the Financial System in Malaysia - A Decade of Change. BNM BNM Annual Reports from 1996 to 2005, BNM BNM’s website: www.bnm.gov.my Bursa Malaysia (previously known as Kuala Lumpur Stock Exchange, www.bursamalaysia.com Capital Market Masterplan (February 2001), Securities Commission Ismail, Mohd Izazee (March 2002). Islamic Private Debt Securities: Issues & Challenge, RAM IFSB’s website: www.ifsb.org Securities Commission (Malaysia), www.sc.com.my Securities Commission’s Quarterly Bulletin of Malaysian Islamic Capital Market (May, August, November 2006), Securities Commission

Islamic Finance Bulletin BPAM

July-September 2008

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This article was prepared by Meor Amri bin Meor Ayob. He is the Chief Operating Officer of Bond Pricing Agency Malaysia Sdn Bhd (previously known as Bondweb Malaysia Sdn Bhd). Meor has in aggregate over 16 years of professional work experience as a regulator with Bank Negara Malaysia and as a credit analyst with Rating Agency Malaysia Berhad (now known as RAM Holdings Berhad). In RAM, Meor Amri’s last position had been Head of Financial Institutions Ratings. He has a wealth of experience, especially on the risk elements of the bond market. He also has vast experience in the sukuk market.

For more information, please contact:

Bond Pricing Agency Malaysia Sdn Bhd (formerly Bondweb Malaysia Sdn Bhd)

No. 17-8 & 19-8, The Boulevard Mid Valley City Lingkaran Syed Putra 59200 Kuala Lumpur Malaysia Tel: +603 2772 0899 Fax: +603 2772 0808 Website: www.bpam.com.my

Islamic Finance Bulletin BPAM

BOND PRICING AGENCY MALAYSIA SDN BHD (formerly known as BondWeb Malaysia Sdn Bhd) BPAM, as Bondweb Malaysia Sdn Bhd, was incorporated on 27 September 2004 under the Malaysian Companies Act 1965. It was registered as a bond-pricing agency (“BPA”) by the Securities Commission on 28 April 28 2006, and has met and exceeded the requirements outlined in the Guideline on the Registration of Bond Pricing Agencies. On 15 September 2008, Bondweb Malaysia Sdn Bhd changed its name to Bond Pricing Agency Malaysia Sdn Bhd (or BPAM). This coincides with BPAM’s aim of consolidating its position as Malaysia’s pioneer bondpricing agency, and to further strengthen its position by focusing on its core business evaluated bond pricing. The bond-pricing agency is an initiative by the Securities Commission of Malaysia to boost the transparency and quality of pricediscovery mechanisms and valuation practices in the Malaysian bond market. BPAM was officially appointed Malaysia's first bondpricng sgency on 18 April 2006. With this status, BPAM is recognised as one of the official sources for evaluated prices on ringgit bonds.

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TOWARDS AN INFORMED MARKET MARKET STATISTICS

Malaysian Islamic Capital Market Malaysian Rated Corporate Sukuk Market League Table of Lead Managers as at 30 September 2008 RM Million

%

CIMB Investment Bank Berhad

6,198

41.6%

Aseambankers Malaysia Berhad

2,265

15.2%

AmInvestment Bank Berhad

1,100

7.4%

OSK Investment Bank Berhad

800

5.4%

MIDF Amanah Investment Bank Berhad

605

4.1%

OCBC Bank (Malaysia) Berhad

590

4.0%

Citibank Berhad

550

3.7%

Bank of Tokyo-Mitsubishi UFJ (Malaysia) Berhad

500

3.4%

Hong Leong Bank Berhad

500

3.4%

Bank Muamalat Malaysia Berhad

370

2.5%

HSBC Bank Malaysia Berhad

348

2.3%

RHB Investment Bank Berhad

348

2.3%

Bank Islam Malaysia Berhad

250

1.7%

Kuwait Finance House (Malaysia) Berhad

250

1.7%

Affin Investment Bank Berhad

150

1.0%

70

0.5%

KAF Discounts Berhad

14,894

100.0%

The value of consortium issues have been equally divided by the number of lead managers of a consortium Source : RAM Ratings

Islamic Finance Bulletin Market Statistics

July - September 2008

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TOWARDS AN INFORMED MARKET MARKET STATISTICS

Malaysian Islamic Capital Market Issued Sovereign & Corporate Bonds Gross figures (not inclusive of redemptions) RM Million

End-Sept

Instruments Malaysian Government Securities

2004

2005

2006

2007

2008

43,172.8

28,276.0

26,830.0

43,187.4

951.8

833.2

2,000.0

524.4

Government Investment Issues

3,422.9

4,000.1

9,500.0

10,000.1

Malaysia Savings Bonds

1,942.8

1,578.6

Cagamas Bonds

8,290.0

2,540.0

6,950.0

1,750.0

541.0

57,780.3

37,227.9

45,280.0

55,461.8

35,693.6

4,312.5

3,868.9

8,667.1

7,008.4

13,919.4

Khazanah Bonds

Total Sovereign & Near-Sovereign (1) Straight Bonds Bonds with warrants Convertible Bonds

60.0 4,300.9

-

-

-

3,744.7

-

-

24,669.5 9,000.0 1,483.1

-

155.8

30.8

220.9 5,967.5

Islamic Bonds

9,104.5

9,697.3

4,780.6

12,127.0

Asset Backed Bonds *

2,957.5

6,049.3

1,545.9

4,005.0

1,200.0

Medium Term Notes *

7,314.6

12,145.9

16,587.5

41,766.0

17,629.0

Total Corporate Issues (2)

28,050.0

35,506.1

31,736.9

64,937.2

38,936.9

Total Bonds Issued (1 + 2)

85,830.3

72,734.0

77,016.9

120,399.0

74,630.4

Proportion of Total Bonds Issued: Sovereign & Near Sovereign

67.3%

51.2%

58.8%

46.1%

47.8%

Corporate Issues

32.7%

48.8%

41.2%

53.9%

52.2%

Note: * Includes Islamic issues - no breakdown available Source: BNM

Islamic Finance Bulletin Market Statistics

July - September 2008

Issue #21

29

TOWARDS AN INFORMED MARKET MARKET STATISTICS

Malaysian Islamic Capital Market Outstanding Bonds (RM Million) Source: Bank Negara Malaysia

Asset Backed Securities

As at end 2007 Conventional

End -September 2008 Islamic

Conventional

Islamic

11,985

5,552

11,163

-

-

-

-

1,037

-

1,561

-

Bonds

49,985

70,870

61,120

70,565

Medium Term Notes

20,740

55,072

27,810

66,396

Commercial Papers

4,701

5,738

3,454

5,975

Commercial Papers-CPN

2,865

720

4,755

725

Loan Notes

1,146

-

857

-

Loan Stocks

11,374

-

9,208

-

Asset Backed Securities (Commercial Papers) Asset Backed Securities (MTN/IMTN)

Total Corporate Issues

103,833

Aggregate Corporate Issues Bank Negara Bills/Negotiable Notes

137,953

119,929

241,786

6,286

149,947 269,876

-

-

-

7,000

-

-

-

41,500

17,600

56,000

14,500

Bank Negara Monetary Notes-IPB

-

2,500

-

1,000

Bank Negara Monetary Notes-NF

500

-

3,000

-

Cagamas Bonds

9,895

-

4,180

-

Cagamas Notes

200

-

-

-

Cagamas Notes-CPN

-

-

-

-

Danaharta Bonds

-

-

-

-

Danamodal Bonds

-

-

-

-

1,000

6,350

1,000

4,350

-

28,000

-

35,000

Islamic Cagamas Papers

-

4,295

-

2,925

Sukuk Bank Negara Malaysia Ijarah

-

400

-

400

Bank Negara Monetary Notes-CB Bank Negara Monetary Notes-DB/IDB

Khazanah Bonds Government Investment Issues

Malaysian Government Securities

-

190,200

-

202,401

Malaysian Government Securities Callable

1,500

-

2,000

-

Malaysian Treasury Bills

2,320

2,000

2,320

2,000

Total Sovereign & Near-Sovereign

254,115

61,145

270,901

60,175

Total Debt Securities

357,948

199,098

390,831

210,122

AGGREGATE

Islamic Finance Bulletin Market Statistics

557,046

July - September 2008

Issue #21

600,952

30

TOWARDS AN INFORMED MARKET MARKET STATISTICS

Sukuk Rated by RAM Ratings

Islamic Finance Bulletin Market Statistics

July - September 2008

Issue #21

31

TOWARDS AN INFORMED MARKET MARKET STATISTICS

Sukuk Rated by RAM Ratings

Islamic Finance Bulletin Market Statistics

July - September 2008

Issue #21

32

TOWARDS AN INFORMED MARKET MARKET STATISTICS

Malaysian Islamic Banking Market

 

 

Islamic Finance Bulletin Market Statistics

July - September 2008

Issue #21

33

TOWARDS AN INFORMED MARKET RINGGIT SUKUK MARKET REPORT

Ringgit Sukuk Market Report 10 Most Active Bonds Traded between 1 July and 30 September 2008

PROFIT- BASED GII 3/2008 14.02.2014 PROFIT-BASED GII 2/2008 30.06.2011 BNMN-IDB 18/2008 182D 11.09.2008

100.6

4.15

NR(LT)

TOTAL VOLUME TRADED LAST QTR 4422

101.05

3.95

NR(LT)

2505

99.94

3.54

NR(ST)

1310

BNMN-IDB 28/2008 273D 22.01.2009

98.59

3.45

NR(ST)

1300

BNMN-IDB 25/2008 273D 08.01.2009

99.06

3.43

NR(ST)

1135

BNMN-IDB 72/2007 273D 11.09.2008

99.97

3.43

NR(ST)

1035

SILTERRA CAP 3.900% 06.06.2014

96.83

4.54

NR(LT)

806

BNMN-IDB 8/2008 273D 30.10.2008

99.47

3.52

NR(ST)

790

BNMN-IDB 27/2008 182D 16.10.2008

99.45

3.45

NR(ST)

700

BNMN-IDB 39/2008 91D 04.09.2008

99.94

3.5

NR(ST)

680

STOCK NAME

LAST TRADED PRICE

LAST TRADED YIELD/DISCOUNT

RATING

YTM Curves as at 30 September 2008

Tenure

LT IslmGov-GII

LT IslmQuasi GovKhazanah

LT IslmCorporateAAA

LT IslmCorporateAA2

3m 6m 1y 2y 3y 5y 7y 10y 15y 20y

3.5 3.53 3.59 3.8 3.99 4.14 4.32 4.65 4.9 5.1

3.55 3.61 3.77 3.94 4.12 4.28 4.54 4.94 5.19 5.42

3.85 3.9 4.15 4.41 4.7 5 5.32 5.67 6.05 6.44

4.07 4.15 4.46 4.78 5.12 5.48 5.85 6.23 6.63 7.04

Information on this page is intended solely for the purpose of providing general information on the Ringgit Bond market and is not intended for trading purposes. None of the information constitutes a solicitation, offer, opinion, or recommendation by Bond Pricing Agency Malaysia Sdn Bhd (formerly Bondweb Malaysia Sdn Bhd) (“BPAM”) to buy or sell any security, or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any security or investment. Investors are advised to consult their professional investment advisors before making any investment decision. Materials provided on this page are provided on an "as is" basis, and while care has been taken to ensure the accuracy and reliability of the information provided in this page, BPAM provides no warranties or representations of any kind, either express or implied, including, but not limited to, warranties of title or implied warranties of fitness for a particular purpose, accuracy, correctness, noninfringement, timeliness, completeness, or that the information is always up-to-date.

34

TOWARDS AN INFORMED MARKET RINGGIT SUKUK MARKET REPORT

Ringgit Sukuk Market Report 5-YEAR YTM Historical Chart (weekly closing, last 6 months)                               Sukuk - Total Traded Amount for the Quarter ended 30 September 2008  

Information on this page is intended solely for the purpose of providing general information on the Ringgit Bond market and is not intended for trading purposes. None of the information constitutes a solicitation, offer, opinion, or recommendation by Bond Pricing Agency Malaysia Sdn Bhd (formerly Bondweb Malaysia Sdn Bhd) (“BPAM”) to buy or sell any security, or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any security or investment. Investors are advised to consult their professional investment advisors before making any investment decision. Materials provided on this page are provided on an "as is" basis, and while care has been taken to ensure the accuracy and reliability of the information provided in this page, BPAM provides no warranties or representations of any kind, either express or implied, including, but not limited to, warranties of title or implied warranties of fitness for a particular purpose, accuracy, correctness, noninfringement, timeliness, completeness, or that the information is always up-to-date.

35

TOWARDS AN INFORMED MARKET RINGGIT SUKUK MARKET REPORT

Ringgit Sukuk Market Report YTM Spread (5-YEAR GII) as at 30 September 2008 YTM Matrix – Item Spread Principle: Islamic Date: 30 September 2008

Class1

Class2

3M

6M

1Y

2Y

3Y

5Y

7Y

10Y

15Y

20Y

Government

GII

3.5

3.53

3.59

3.8

3.99

4.14

4.32

4.65

4.9

5.1

Quasi Government

Khazanah

0.05

0.08

0.18

0.14

0.13

0.14

0.22

0.29

0.29

0.32

Corporate

AAA

0.35

0.37

0.56

0.61

0.71

0.86

1

1.02

1.15

1.34

Corporate

AA2

0.57

0.62

0.87

0.98

1.13

1.34

1.53

1.58

1.73

1.94

Information on this page is intended solely for the purpose of providing general information on the Ringgit Bond market and is not intended for trading purposes. None of the information constitutes a solicitation, offer, opinion, or recommendation by Bond Pricing Agency Malaysia Sdn Bhd (formerly Bondweb Malaysia Sdn Bhd) (“BPAM”) to buy or sell any security, or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any security or investment. Investors are advised to consult their professional investment advisors before making any investment decision. Materials provided on this page are provided on an "as is" basis, and while care has been taken to ensure the accuracy and reliability of the information provided in this page, BPAM provides no warranties or representations of any kind, either express or implied, including, but not limited to, warranties of title or implied warranties of fitness for a particular purpose, accuracy, correctness, noninfringement, timeliness, completeness, or that the information is always up-to-date.

36

Information contained in this publication is obtained from sources believed to be reliable and correct at the point of writing; however, its accuracy or completeness cannot be guaranteed. Opinions in this publication are expressed from the point of view of the writers and are not necessarily those of the Publisher. The views or opinions expressed are subject to change at any time. No statement in this publication is to be construed as a recommendation to buy, sell or hold securities. All rights reserved. No part of this publication may be copied or otherwise reproduced, repackaged, further transmitted, transferred, disseminated, redistributed or resold or stored for subsequent use for any such purpose, in whole or in part, in any form or manner or by any means whatsoever by any person, without prior written consent from the Publisher and/or the writers.