September 2008 Issue #21

Islamic Finance
Bulletin
..………….………………………………………………
Towards an informed market

Islamic Finance Bulletin, a …in this issue

quarterly release on the Islamic
capital market in Malaysia, is
dedicated to informing and
educating those active in the
growing market of Islamic finance
Forex – A Shariah Discussion
on issues, developments and
trends in the domestic Islamic
capital market.
Introduction to Islamic Trusts – Laws, Practices &
The contents are intended to be Distribution
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
An Introduction to the Laws and Practices of Islamic
enabling the Malaysian Islamic Trusts and the Distribution of the Trust Upon Maturity
capital market to effectively meet
the increasing sophistication of the
investment community.
Market Statistics
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 islamicratings@ram.com.my.
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 Major players in the forex market include
central banks, commercial banks, non-
banking international corporations, hedge

F
orex trading means the
simultaneous buying of one funds, private investors and “profit
currency and the selling of takers”.
another. The forex (or foreign exchange)
market exists wherever one currency is
traded for another. It is said that the forex Forex Products – Spot Forex,
market is the largest market in the world. Value-Today Forex, Value-
It is also reported to be the most prolific
Tomorrow Forex and Swap
financial exchange market, where the vast
majority of the currency or forex trading
In the forex market, the exchange rates
takes place, with a reported total daily
quoted vary according to the required
turnover of more than USD1.2 trillion.
delivery time. The most important rates
quoted in the market are the “spot” rates;
The currencies are always traded in pairs
settlement of the deal or contract is
such as US dollar/Japanese yen
expected to be made in two eligible
(USD/JPY), euro/US dollar (EUR/USD)
business days after the day of the
and British pound/US dollar (GBP/USD).
transaction or execution of the deal or
Forex trading is not centralised on an
contract.
exchange and is a 24-hour market.
Trading moves from major banking
Forex deals or contracts under this
centres like Wellington, Sydney, Japan,
delivery mode are called spot forex. A
London and New York - in that order.
deal or contract with a delivery or
settlement date which is earlier than the
The forex market is unique and
spot delivery date is termed as a “value
characterised by its high trading volume,
today” (same-day settlement) or “value
extreme liquidity, large number and
tom” (settlement to be made tomorrow)
variety of traders, vast geographical areas,
forex deal or contract. Where the required
long trading hours and also various
settlement or delivery date is more than
factors that affect exchange rates. The
two business days after the deal or
liquidity of the forex market ensures that
contract is made, then the deal is known
limit orders and stop-loss orders can be
as a forward forex deal or contract.
easily executed.

Islamic Finance Bulletin July-September 2008 Issue #21

IBFIM 1
TOWARDS AN INFORMED MARKET
FOREX - A SHARIAH DISCUSSION

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.financial-
guide.ch/ica/markets/foreign_exchange/fx_fund
amentals/wcba5.html

Islamic Finance Bulletin July-September 2008 Issue #21

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TOWARDS AN INFORMED MARKET
FOREX - A SHARIAH DISCUSSION
Traditional forex forwards are available
for maturities from 3 days out to about 2
years. As such, forward forex is the over-
the-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”.
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 may also use forward forex for
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.
iii.
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.
Islamic Finance Bulletin July-September 2008
IBFIM
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 risk-
averse. 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
much the same reason - to secure
the value of future investment
returns (e.g. foreign-currency-
denominated bond coupon
payments).
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.
Forward forex are also sometimes used
by “profit takers”, even though they are
more likely to use currency futures to take
Issue #21
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TOWARDS AN INFORMED MARKET
FOREX - A SHARIAH DISCUSSION
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
Islamic Finance Bulletin July-September 2008
IBFIM
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.
Issue #21
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TOWARDS AN INFORMED MARKET
FOREX - A SHARIAH DISCUSSION
Shariah Discussions on
Treasury
Instruments
The discussions in this segment are as
follows: Treasury forex products, namely
for forex spot, forward together with
Foreign-Currency Exchange (al-Mutajarah fi al-‘Umlaat)
Bank
Sells USD 50M*
(Customer buys USD 50M)
Sells RM 200M*
(Bank buys RM200M)
BNM
a) 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
Islamic Finance Bulletin July-September 2008
IBFIM
money-market dealings, with a focus on
forward forex.
Corporate
Customer
Others such as other
banks, money
brokers, etc.
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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TOWARDS AN INFORMED MARKET
FOREX - A SHARIAH DISCUSSION
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
Islamic Finance Bulletin July-September 2008
IBFIM
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 al-
Sarakhsi. 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 bay-
sarf. Nor can the constraint regarding spot
2
Al-Zuhayli, Wahbah (2003), Fatawa Mu’asirah,
Dar al-Fikr: Dimasyq, pg.107-108, see also al-
Ashqar, Muhammad Sulaiman (1998), “al-
Nuqud 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
Issue #21
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TOWARDS AN INFORMED MARKET
FOREX - A SHARIAH DISCUSSION
settlement be imposed on such
transactions.
c) 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
Islamic Finance Bulletin July-September 2008
IBFIM
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 currency-
exchange (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 al-
Mujtahid wa Nihayat al-Muqtasid, vol.3, Dar al-
Salam: al-Qaherah, p.g. 1555-1556
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 TOWARDS AN INFORMED MARKET
FOREX - A SHARIAH DISCUSSION
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-to-
hand in equal quantities in the same
genus, or with differences in, quantities in
different genera.
b) Essential Elements and Necessary
Conditions of Sarf
There are four general conditions for the
currency-exchange contract:
i. mutual receipt prior to the
contracting parties’ parting;
ii. equality of quantities if money of
the same genus is traded;
iii. inapplicability of options; and
iv. non-deferment.
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.”
• If money is exchanged for another
5 money of the same genus (e.g. gold
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
Islamic Finance Bulletin July-September 2008
IBFIM
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.
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.
for gold or silver for silver), then
the two compensations must be
equal in weight, even if one of the
Issue #21
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TOWARDS AN INFORMED MARKET
FOREX - A SHARIAH DISCUSSION
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 8
Al-Marzuqi, Salih bin Zabin (1996), “Tijarah al-
Zahab fi Ahammi Suwariha wa Ahkamiha”,
Majallah Majma’ al-Fiqh al-Islamiy, 9th Session,
v.1, 1996A.D-1417H, pg. 154
Islamic Finance Bulletin July-September 2008
IBFIM
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
• 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-to-
hand, 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
Issue #21
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TOWARDS AN INFORMED MARKET
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Foreign-Currency Exchange: Spot
Transaction
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 al-
nasi’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
Islamic Finance Bulletin July-September 2008
IBFIM
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 al-
Maliyah al-Mu’asirah Buhuth wa Fatawa wa
Hulul, Dar al-Fikr: Dimasyq, pg. 165-166
11
Resolution no. 7/1/65, in Majallah Majma’ al-
Fiqh al-Islamiy, 7th Session, no.7, vol.1,
1992A.d-1412H, pg. 716
Issue #21
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TOWARDS AN INFORMED MARKET
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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 foreign-
currency exchange.
Islamic Finance Bulletin July-September 2008
IBFIM
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 foreign-
exchange 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
Issue #21
11
TOWARDS AN INFORMED MARKET
FOREX - A SHARIAH DISCUSSION
The Wa’ad Issue
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 al-
Islamiyyah”, Buhuth Fiqhiyyah fi Qadhaya
Iqtisadiyyah Mu’asirah, Dar al-Nafa’is: al’Abdaliy,
pg. 85-89
Islamic Finance Bulletin July-September 2008
IBFIM
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
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), al-
Muhalla 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, al-
Furuq, vol.4, Muassasah al-Risalah: Beirut, pg.
49
Issue #21
12
TOWARDS AN INFORMED MARKET
FOREX - A SHARIAH DISCUSSION
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
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:
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’ al-
Murabahah wa Tatbiqatuhu al-Mu’asirah fi al-
Masarif 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, 5th
Session, no.5, vol.2, 1988-1409H, pg. 1599
Islamic Finance Bulletin July-September 2008
IBFIM
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.
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.
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:
Issue #21
13
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.
• 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 July-September 2008
IBFIM
and the payment date based on trade
finance documents supporting the
forward deal.
• 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.
Issue #21
14
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 July-September 2008 Issue #21

IBFIM 15
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: info@ibfim.com
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, high-
calibre 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 July-September 2008 Issue #21

IBFIM 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. Trust concept in Islam
2. Islamic trust development
3. Islamic trust products
4. Distribution of Islamic trust
5. 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 July-September 2008
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
Issue #21 17
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 Al-
Jumaat 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 July-September 2008
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
Issue #21 18
TOWARDS AN INFORMED MARKET
ISLAMIC TRUSTS – LAWS, PRACTICES & DISTRIBUTION
Shariah councils have differing opinions
on certain issues.
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:
1. two male witnesses, if not available
then
2. One male witness and two female
witnesses, if not available then
3. Four female witnesses
Islamic Trust Products
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 July-September 2008
BITC
jurisdiction, the product had been
launched in July 2004.
Islamic Will
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.:
1. 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 non-
charitable.
Issue #21 19
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 July-September 2008 Issue #21 20

BITC
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 COMPANY

(LABUAN) LIMITED

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 ever-
changing 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 July-September 2008 Issue #21 21

BITC
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 Types of Risk Associated with

the Contracts of Ijarah and
As highlighted in earlier parts (please
Ijarah Muntahia Bittamleek
refer to the series of articles published in
previous Bulletins), a strong foundation
Typical Ijarah and Ijarah muntahia
in risk identification and assessment is a
bittamleek contracts can be segmented
prerequisite to becoming a competent
into 7 transaction stages. Each stage has
pricing specialist. From this
its own unique risks. The following
understanding, plus an in-depth
sections detail the risks identified for each
knowledge of financial engineering, the
stage of the two contracts.
fair valuation of any financial asset can be
done. This skill set is not only relevant to
1. Agreement to Lease
the conventional bond market, but also to
When a customer requests an institution
the sukuk market.
(the lessor) to purchase a specific asset,
the customer enters into an agreement to
The purpose of this series of papers is to
lease.
provide some essential reading for anyone
who is serious about the science of sukuk
The institution should first purchase the
valuation. These papers are the basis for
asset prior to the execution of an Ijarah
the underlying valuation methodology for
contract. The asset can be purchased from
Islamic financial assets, developed by
the customer and subsequently leased
Bond Pricing Agency Malaysia Sdn Bhd
back to them (sale and leaseback). The
(“BPA Malaysia”).
institution can appoint a purchasing
agent. The agent can be the customer or a
Part 4 will highlight, as completely as
person having a blood or marital
possible, all the identifiable risks
relationship with the customer. If the
associated with the Ijarah and Ijarah
agent is a company owned by the
muntahia bittamleek contracts.
customer, they should not hold more than
a third of its equity.

Islamic Finance Bulletin July-September 2008 Issue #21 22

BPAM
TOWARDS AN INFORMED MARKET
RISKS IN ISLAMIC CONTRACTS
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 July-September 2008
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
Issue #21 23
TOWARDS AN INFORMED MARKET
RISKS IN ISLAMIC CONTRACTS
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 July-September 2008
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
Issue #21 24
TOWARDS AN INFORMED MARKET
RISKS IN ISLAMIC CONTRACTS
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 asset-
repossession 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.
7. Maturity
The asset is returned to the financing
institution.
There is residual value risk as the financing
institution will have to bear the potential
Islamic Finance Bulletin July-September 2008
BPAM
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.
The next article will look at the risks
associated with the contract of
musharakah.
Issue #21 25
TOWARDS AN INFORMED MARKET
RISKS IN ISLAMIC CONTRACTS

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 July-September 2008 Issue #21 26

BPAM
TOWARDS AN INFORMED MARKET
RISKS IN ISLAMIC CONTRACTS
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 July-September 2008
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 bond-
pricing 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 price-
discovery mechanisms and valuation practices
in the Malaysian bond market. BPAM was
officially appointed Malaysia's first bond-
pricng sgency on 18 April 2006. With this
status, BPAM is recognised as one of the
official sources for evaluated prices on ringgit
bonds.
Issue #21 27
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%
KAF Discounts Berhad 70 0.5%

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 July - September 2008 Issue #21 28

Market Statistics
 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 2004 2005 2006 2007 2008

Malaysian Government Securities 43,172.8 28,276.0 26,830.0 43,187.4 24,669.5

Khazanah Bonds 951.8 833.2 2,000.0 524.4 -
Government Investment Issues 3,422.9 4,000.1 9,500.0 10,000.1 9,000.0
Malaysia Savings Bonds 1,942.8 1,578.6 - - 1,483.1
Cagamas Bonds 8,290.0 2,540.0 6,950.0 1,750.0 541.0
Total Sovereign & Near-Sovereign (1) 57,780.3 37,227.9 45,280.0 55,461.8 35,693.6

Straight Bonds 4,312.5 3,868.9 8,667.1 7,008.4 13,919.4

Bonds with warrants 60.0 - - - -
Convertible Bonds 4,300.9 3,744.7 155.8 30.8 220.9
Islamic Bonds 9,104.5 9,697.3 4,780.6 12,127.0 5,967.5
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 July - September 2008 Issue #21 29

Market Statistics
 TOWARDS AN INFORMED MARKET
MARKET STATISTICS

Malaysian Islamic
Capital Market
Outstanding Bonds (RM Million) As at end 2007 End -September 2008
Source: Bank Negara Malaysia Conventional Islamic Conventional Islamic
Asset Backed Securities 11,985 5,552 11,163 6,286
Asset Backed Securities (Commercial Papers) - - - -
Asset Backed Securities (MTN/IMTN) 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 -
Total Corporate Issues 103,833 137,953 119,929 149,947
Aggregate Corporate Issues 241,786 269,876
Bank Negara Bills/Negotiable Notes - - - -
Bank Negara Monetary Notes-CB 7,000 - - -
Bank Negara Monetary Notes-DB/IDB 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 - - - -
Khazanah Bonds 1,000 6,350 1,000 4,350
Government Investment Issues - 28,000 - 35,000
Islamic Cagamas Papers - 4,295 - 2,925
Sukuk Bank Negara Malaysia Ijarah - 400 - 400
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 557,046 600,952

Islamic Finance Bulletin July - September 2008 Issue #21 30

Market Statistics
TOWARDS AN INFORMED MARKET
MARKET STATISTICS

Sukuk Rated by RAM

Ratings

Islamic Finance Bulletin July - September 2008 Issue #21 31

Market Statistics
TOWARDS AN INFORMED MARKET
MARKET STATISTICS

Sukuk Rated by RAM

Ratings

Islamic Finance Bulletin July - September 2008 Issue #21 32

Market Statistics
TOWARDS AN INFORMED MARKET
MARKET STATISTICS

Malaysian Islamic
Banking Market

Islamic Finance Bulletin July - September 2008 Issue #21 33

Market Statistics
TOWARDS AN INFORMED MARKET
RINGGIT SUKUK MARKET REPORT

Ringgit Sukuk
Market Report
10 Most Active Bonds Traded between 1 July and 30 September 2008
TOTAL VOLUME
LAST TRADED LAST TRADED
STOCK NAME RATING TRADED LAST
PRICE YIELD/DISCOUNT
QTR
PROFIT- BASED GII 3/2008 100.6 4.15 NR(LT) 4422
14.02.2014
PROFIT-BASED GII 2/2008 101.05 3.95 NR(LT) 2505
30.06.2011
BNMN-IDB 18/2008 182D 11.09.2008 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

YTM Curves as at 30 September 2008

LT Islm-
LT Islm- LT Islm-
LT Islm- Quasi
Tenure Corporate- Corporate-
Gov-GII Gov-
AAA AA2
Khazanah

3m 3.5 3.55 3.85 4.07

6m 3.53 3.61 3.9 4.15
1y 3.59 3.77 4.15 4.46
2y 3.8 3.94 4.41 4.78
3y 3.99 4.12 4.7 5.12
5y 4.14 4.28 5 5.48
7y 4.32 4.54 5.32 5.85
10y 4.65 4.94 5.67 6.23
15y 4.9 5.19 6.05 6.63
20y 5.1 5.42 6.44 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 34
(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, non-
infringement, timeliness, completeness, or that the information is always up-to-date.
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 35
(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, non-
infringement, timeliness, completeness, or that the information is always up-to-date.
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
Khazanah 0.05 0.08 0.18 0.14 0.13 0.14 0.22 0.29 0.29 0.32
Government

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 36
(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, non-
infringement, timeliness, completeness, or that the information is always up-to-date.
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.