KEY ISLAMIC FINANCE ISSUES ARE REVIEWED

 Islamic liquidity management and financing were discussed at a key forum held in Bahrain.

The Bahrain Financial Exchange (BFX) and Bursa Malaysia organised a forum which also discussed contemporary issues relating to commodity Murabaha transactions and Tawarruq practices.

The forum was part of a two-day event marking the inauguration of a commercial relationship between the two exchanges.

The underpinning for this relationship is to provide financial products to Islamic market participants and strengthen bilateral ties between both organisations.

The event, held at the BFX offices, attracted over 50 key players from the Islamic financial markets and was attended by three eminent Sharia scholars within the industry.

Dr Mohammed Ali Elgari, Shaikh Nizam Yaqubi and Bursa Malaysia Sharia adviser Dr Aznan Hasan participated with the objective of providing insights and expert opinion on the concept of Tawarruq and its application and practices to facilitate Islamic liquidity management and financing.

"The use of Tawarruq and its role in money markets and risk management is important in further developing the industry and through discourses such as this, we hope to provide industry participants with greater understanding of the concept from a Sharia perspective as well as its commercial importance," said Bursa Malaysia global head of Islamic markets Raja Teh Maimunah Raja Abdul Aziz, who was also the moderator for the panel discussion,

The event also introduced a newly developed regulated Islamic commodity trading platform to industry participants specifically designed to facilitate Islamic financing and liquidity management aimed at tightening the application and enhancing integrity of Tawarruq practices.

Tawarruq is a sale of an asset to a purchaser on deferred payment with an onward sale by the purchaser to a third party on cash.

"It gives me great pleasure to host such a high-profile panel and audience from the Islamic finance community," BFX director Arshad Khan said.

"I am confident I can say from all involved, that this was an extremely informative and thought-provoking discussion with the practitioner community."

Link: http://www.gulf-daily-news.com/NewsDetails.aspx?storyid=269517

Shari’ah scholars discuss Tawarruq practices

The Bahrain Financial Exchange (BFX) and Bursa Malaysia recently organised a forum to discuss matters related to Islamic liquidity management and financing and in particular contemporary issues relating to commodity Murabaha transactions and Tawarruq practices.

The forum was part of a two-day event marking the inauguration of a commercial relationship between the two exchanges.  The companies said in a press release that, “the underpinning for this relationship is to provide financial products to Islamic market participants and strengthen bilateral ties between both organisations.”

“The event, held at the BFX offices, attracted over 50 players from the Islamic financial markets and was graced with the attendance of three of the most eminent Shari’ah scholars within the industry. Dr. Mohd Ali Elgari, Sheikh Nizam Yaqubi and Dr. Aznan Hasan participated with the objective of providing insights and an opinion on the concept of Tawarruq and its application and practices to facilitate Islamic liquidity management and financing,” the media statement said.

Raja Teh Maimunah Raja Abdul Aziz, the Global Head of Islamic Markets, Bursa Malaysia, who was also the moderator for the panel discussion commented, "The use of Tawarruq and its role in money markets and risk management is important in further developing the industry and through discourses such as this, we hope to provide industry participants with greater understanding of the concept from a Shari’ah perspective as well as its commercial importance.”

The event also introduced a newly developed regulated Islamic commodity trading platform to industry participants specifically designed to facilitate Islamic financing and liquidity management aimed at tightening the application and enhancing integrity of Tawarruq practices.

Tawarruq is a sale of an asset to a purchaser on deferred payment with an onward sale by the purchaser to a third party on cash.

Link: http://www.cpifinancial.net/v2/News.aspx?v=1&aid=4201&sec=Islamic%20Finance

‘ME banks moving away from organised tawarruq’

Some Middle Eastern banks are avoiding organised tawarruq after a ruling against the practice, an industry official said, a trend that could signal a shake-up for the $1 trillion Islamic financing sector.

Shrugging off criticism of the OIC Fiqh Academy’s controversial decree, the organisation’s secretary-general said some institutions have heeded the call to abandon the popular financing arrangement.

“I have been hearing that some banks have agreed that what they were doing is wrong and they have begun changing the method of their tawarruq transaction,” Abdul Salam Al-Abadi said in an interview on the sidelines of a sharia scholars meeting in Malaysia.
“They are trying to do it the way it should be done.”
He did not identify the banks.

The International Council of Fiqh Academy, a powerful group of scholars led by the OIC, rocked the industry in April this year with an order forbidding the use of organised tawarruq, a cornerstone of the sharia banking sector.

With the global tawarruq market estimated at more than $100 billion, practitioners had warned of catastrophic results if the rule were to be implemented strictly.

“If tawarruq were suddenly withdrawn, this would have a dramatic effect because many Islamic financiers routinely use this instrument as a means of liquidity management and to provide their customers with working capital facilities,” law firm Denton Wilde Sapte had said in a note.
Tawarruq is widely used as a source of financing. It involves the sale of an asset to a purchaser with deferred payment terms. The purchaser then sells the asset to a third party to get funds. Organised tawarruq is similar, although the transactions are executed through banks. Some scholars say it is wrong to pre-arrange the parties’ contractual obligations although bankers want this for legal protection and commercial certainty.

Al-Abadi said the Muslim World League’s fiqh academy had similarly prohibited the use of organised tawarruq.

“After all these discussions, the majority of the scholars say it is forbidden,” said Al-Abadi, a Syria and Egypt-trained sharia expert and former Jordanian government minister.

“Our council consists of more than 70 scholars and at the meeting, there were more than 20 experts besides these 70 scholars and the majority said it’s forbidden.”
Several influential sharia scholars have defended the use of tawarruq, although some say the structure needs further refinement.

“It’s the right of any scholar to say ‘That’s my view, it’s not forbidden’,” Al-Abadi said.
“We say to the people ‘The way in which you deal is not correct’ and let the people decide in future.”
Some scholars have said organised tawarruq is a mere paper shuffle, without assets actually changing hands, violating the sharia’s rule that financial transactions must involve specific assets.
Islamic banks and their clients rarely, if ever, take delivery of commodities used in tawarruq transactions, as their purpose is to use the assets as fund-raising tools.
What makes this contract popular with the bankers? Tawarruq is not only easy to use, but it is also flexible.

In an industry that is very short on Sharia compliant products that provide cash “today”, the Tawarruq contract was seen as an alternative.

Secondly, it is also possible to roll over the contract, hence providing additional funding.
According to the Fiqh Academy there is a real distinction between “classical” and “contemporary” practice of Tawarruq. The cash obtained in the classical Tawarruq is determined by market forces, whereas, in the contemporary version the contract is “arranged”... that is “simultaneously, the mustawriq and the financier executes the transactions, usually at a lower spot price”.

With this in mind, the Fiqh Academy has thrown its weight behind the classical version of the tawarruq contract, whilst declaring the widely used contemporary version impermissible.
Are there any other alternatives? The Fiqh Academy suggests that the market should embrace Qard Hasan (benevolent or interest free loans) and “institutions are encouraged to set up special Qard Hasan Fund.”

One thing is for certain — the ruling by the Fiqh Academy is certainly brave and the implications of this announcement might be huge. In an industry, where the vast majority of transactions are “arranged” rather than left to market forces, many practitioners will be worried about other products coming under the Fiqh Academy’s radar, including the ubiquitous Murabaha contract.

Link: http://www.arabtimesonline.com/kuwaitnews/pagesdetails.asp?nid=39537&ccid=12

INTERVIEW-Top scholar sanctions Islamic tawarruq structure

* Scholar says tawarruq structure valid if conditions met

* Structure must comply with AAOIFI rules

* Structure should be part of a series of transactions

* Debate over validity has split Islamic finance sector

KUALA LUMPUR, Aug 11 - Tawarruq must meet the standards of industry body AAOIFI and cannot be a standalone funding tool, a top scholar said, outlining conditions for the use of a structure that has split the sharia banking sector.

Tawarruq is a bedrock of the $1 trillion Islamic finance industry and is widely used as a financing and liquidity management instrument.

But growing disputes about the permissibility of some forms of tawarruq under the sharia have thrownmarkets into disarray, with practitioners warning of catastrophic consequences if the structure were to be revoked.

Seeking to calm investor worries, influential sharia scholar Sheikh Yusuf Talal DeLorenzo said tawarruq is allowed when it is applied properly, adding arguments against it are removed from commercial realities.

"Tawarruq from my perspective has been carefully researched and explained by AAOIFI," the 60-year old American scholar told Reuters in an interview, referring to the Accounting and Auditing Organisation for Islamic Financial Institutions, which sets guidelines used by much of the industry.

"AAOIFI has developed a standard through its own methodology which is very thorough and that standard, as far as I'm concerned, still stands. There's a great deal of misunderstanding in the marketplace that's a disconnect between scholars who are actively involved in the field of finance and scholars who are not."

Other prominent sharia scholars such as Sheikh Nizam Yaquby, Mohd Daud Bakar and Mohammad Akram Laldin have also recently defended the use of tawarruq.

The International Council of Fiqh Academy, a leading industry body driven by the Organisation of Islamic Conferences, had earlier ruled organised and reverse tawarruq to be "a deception" that seeks to disguise the use of usury.

Confusion over the structure's status has been compounded by by the fact that compliance with standards of Islamic finance industry bodies such as AAOIFI and IFSB is voluntary, and there is no ultimate arbiter incase of disputes.

In its basic form, tawarruq is an asset sale to a purchaser with deferred payment terms. The purchaser then sells the asset to a third party to get funds. Organised tawarruq is similar although the transactions are executed through banks.

Reverse tawarruq is akin to organised tawarruq, although the buyer would be a financial institution seeking liquidity.

"If tawarruq were suddenly withdrawn, this would have a dramatic effect because many Islamic financiers routinely use this instrument as a means of liquidity management and to provide their customers with working capital facilities," law firm Denton Wilde Sapte had said in a note in May.

DeLorenzo, however, said tawarruq should not be used as a financing instrument on its own.

"Modern tawarruq is not intended as a transaction in and of itself. Rather it is intended as a means to an end," said DeLorenzo, a scholar of Islamic transactional law, who sits on about 15 sharia boards including AAOIFI.

"What people don't understand unfortunately is that they think tawarruq is just a way of disguising a loan. It's really a link in a transactional chain."

Link: http://news.alibaba.com/article/detail/markets/100152911-1-interview-top-scholar-sanctions-islamic-tawarruq.html

Tawarruq resolution raises many questions

The International Council of Fiqh Academy (ICFA), which is an organ of the Organization of the Islamic Conference (OIC), has published a resolution on Tawarruq, a cash management instrument used by some Islamic banks.

The International Council of Fiqh Academy (ICFA), which is an organ of the Organization of the Islamic Conference (OIC), has published a resolution on Tawarruq, a cash management instrument used by some Islamic banks. The resolution was adopted by the ICFA at its recent session held in Sharjah. While bankers have welcomed the resolution in principle, a number of them are keen to get further clarification as to whether the resolution also applies to commodity Murabaha contracts as they are currently practiced. Badlishah Abdul Ghani, CEO of CIMB Islamic Bank, stressed that "The classical concept of Tawarruq is acceptable under Shariah principles". He said: "There are certain applications of Tawarruq that have caused concern in the market. We would like further clarification between the so-called organized Tawarruq and reverse Tawarruq on the one hand and the classical commodity Murabaha contract." In the classical Tawarruq, the third party has to be identified and cannot have any link with the financier or bank. In a commodity Murabaha this is not necessarily the case. Resolution 179 reads: "Tawarruq can be defined as a person (Mustawriq) who buys a merchandise at a deferred price, in order to sell it in cash at a lower price. Usually, he sells the merchandise to a third party, with the aim to obtain cash. This is the classical Tawarruq, which is permissible, provided that it complies with the Shariah requirements on sale." The ICFA jurists clearly stipulate in Resolution 179 that: "It is not permissible to execute both organized and reverse Tawarruq because simultaneous transactions occurs between the financier and the Mustawriq, whether it is done explicitly or implicitly or based on common practice, in exchange for a financial obligation. This is considered a deception, i.e. in order to get the additional quick cash from the contract. Hence, the transaction is considered as containing the element of riba." The Fiqh Academy recommends: "To ensure that Islamic banking and financial institutions adopt investment and financing techniques that are Shariah-compliant in all its activities, they should avoid all dubious and prohibited financial techniques. All transactions must conform to Shariah rules in order to ensure it meets the objectives of Shariah (Maqasid Shariah). In addition, such a move will ensure the progress and actualization of the socio-economic objectives of the Muslim world. If the current situation is not rectified, the Muslim world would continue to face serious challenges and economic imbalances that will never end. The council encourages the application of Qard Hasan and establishment of Qard Hasan funds by financial institutions to shift the people who are in need of fund from Tawarruq." Shariah resolutions relating to Fiqh Al-Muamalat (Islamic law relating to financial transactions) can have a direct and sometimes negative unintended impact on the Islamic financial market. The statement by the Shariah Committee of the Bahrain-based Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI) in February 2009 relating inter alia to ownership rights and guaranteeing of principal in Musharaka and Mudaraba Sukuk, for instance, did unwittingly cause confusion in the market especially relating to retrospective application of the ruling. Some Islamic capital market players confirmed that it partly contributed to the slowdown in the market, which was already being affected by the fallout of the credit crunch and the global financial crisis. Another major decision relating to Shariah issues was the ruling in April 2009 by the Malaysian Appeal Court that the Al-Bai Bithaman Ajil (BBA) deferred payment contract as practiced in Malaysia is a valid Islamic sale contract. The appeal court overturned a ruling earlier by a lower court that it was not a valid Islamic contract and is tantamount to a loan, which is riba and therefore not permissible. The earlier judgment had caused considerable anxiety amongst Islamic financial institutions in Malaysia for fear of potential increases in defaults in their BBA contracts and uncertainty as to the validity of BBA agreements. The Malaysian Appeal Court ruled that BBA agreements are valid and binding in Malaysia; these agreements must not be compared to loan agreements, as the BBA contracts are sale transactions and not money lending transactions. In Bahrain in May 2009, the senior Saudi Shariah advisory, Mohamed Elgari, appealed for a more scientific approach to issuing resolutions by Shariah scholars and organizations relating to Fiqh Al-Muamalat and suggested a rigorous peer review process and market consultation before any resolution is adopted. Tawarruq has hitherto been practiced in most countries where Islamic finance is provided except perhaps in Qatar where the Shariah scholars have discouraged its use per se. However, more and more Islamic banks in countries including Saudi Arabia, Malaysia, Kuwait and UAE, are now shunning Tawarruq, even the accepted form, perhaps to avoid market confusion. Link: http://www.cibafi.org/NewsCenter/English/Details.aspx?Id=3891&Cat=0

Tawarruq declared impermissible by the OIC Fiqh Academy

Analysis on Islamic Banking, June 2009

As the key product in the Islamic banking industry is declared impermissible and attention turns to AAOIFI - the industry standards body - for direction, Islamic Banker investigates the ruling and its repercussions.

Tawarruq, also known as Reverse Murabaha or Monetization, is a widely used instrument to obtain cash immediately.

As shown by the below diagram, Tawarruq is essentially very similar to the standardMurabaha structure, with one additional leg. The standard part of the structure involves the Bank buying the commodity from the "Goods Supplier", paying £100. The bank then sells the commodity to "UK Purchasing Company" on a deferred basis, that is, the bank charges "UK Purchasing Company" £110 due in, say, five years time. The final step involves UK Purchasing company selling the commodity to the "Goods buyer" for an immediate cash payment of £100.

Source: Tax Adviser; Mohammed Amin Islamic Finance Blog,

What makes this contract popular with the bankers? Tawarruq is not only easy to use, but it is also flexible. In an industry that is very short on Sharia compliant products that provide cash "today", the Tawarruq contract was seen as an alternative. Secondly, it is also possible to roll over the contract, hence providing additional funding.

OIC Fiqh Academy Ruling

According to the Fiqh Academy there is a real distinction between "classical" and "contemporary" practice ofTawarruq. The cash obtained in the classical Tawarruq is determined by market forces, whereas, in the contemporary version the contract is "arranged"... that is "simultaneously, the mustawriq ("UK Purchasing Company") and the financier executes the transactions, usually at a lower spot price".

With this in mind, the Fiqh Academy has thrown its weight behind the classical version of the Tawarruq contract, whilst declaring the widely used contemporary version impermissible.

Are there any other alternatives? The Fiqh Academy suggests that the market should embrace Qard Hasan(benevolent or interest free loans) and "institutions are encouraged to set up special Qard Hasan Fund."

One thing is for certain - the ruling by the Fiqh Academy is certainly brave and the implications of this announcement might be huge. In an industry, where the vast majority of transactions are "arranged" rather than left to market forces, many practitioners will be worried about other products coming under the Fiqh Academy's radar, including the ubiquitous Murabaha contract.

This point can be cemented further - AAOIFI standards 2/1/3, for Murabaha, state: "... it is permissible to prepare a single set of documentation to include both the customer's stated wish that the institution should buy the item from the supplier and a promise to buy the item from the institution, which the customer signs..."

Indeed, speaking at the Utrujj foundation in the UK, Shaykh Nizam Yaqubi, a leading scholar and a member of the AAOIFI Sharia' board, expressed disappointment that a compromise was not reached.

In particular, Shaykh Nizam rejected the idea of Qard Hasan as a solution arguing that Islamic banks were socially responsible banks that had to deliver returns to their shareholders.

The need for cash...

Ultimately, this boils down to one question: what do you say to an individual/institution that wants cash immediately? Should they be referred to the conventional system (where there is universal agreement on theimpermissibility) or should Islamic banks come up with solutions?

We can deal with the question head on, by asking: why does the individual need cash immediately? Certainly, Islam encourages people to live within their means and simply placing emphasis on credit will cause long term damage. However, in reality, the vast majority of people choose to live beyond their means, with the banking industry facilitating this process.

As attention turns to AAOIFI, there is no doubt that the OIC Fiqh Academy's ruling will be a wake-up call to many market participants. To the idealists in the industry, it is hoped that the focus will shift from debt to equity. However, the realists continue to argue that as long as the industry remains in the "nascent" stage, it has no choice, but to replicate conventional products.

Notes:

1. Mohammed Amin, et al., (Sept. 2008), Islamic finance: the tax adviser's role, Tax Adviser

2. Mohammad Nejatullah Siddiqi (Feb. 2007), Economics of Tawarruq

3. AAOIFI (2008), Sharia Standards for Islamic Financial Institutions,

4. Mohammed Amin, (Feb. 2007), Foreign investors applying Shariah compliant finance when investing into the United Kingdom, Islamic Finance Blog

5. ISRA (Apr. 2009), OIC Fiqh Academy Ruled Organised Tawarruq Impermissible

Link: http://www.islamicbanker.com/tawarruq-fiqh-academy-aaoifif.html

Debate over commodity murabahah (tawarruq)

The concept of commodity murabahah (or tawarruq in some jurisdictions) has only recently been widely applied in Islamic finance, along with other syariah contracts such as mudarabah, musharaka and bai murabahah.

The application of this trade-related structure with a pre-determined profit rate (or pre-agreed “margin” or “mark-up”) is possible in syariah-compliant financing and deposit products as well as in liquidity management/treasury instruments and other investment products/securities.

However, resistance still exists on the ground from some critics who say that commodity murabahah-based financial products bear a striking resemblance to interest-based products.

For instance, the Islamic Fiqh Academy of Rabbitah ‘Alam Islami, Makkah ruled in 2003 that any product structure based on the commodity murabahah or tawarruq munazzam concept should be considered as haram, or forbidden by Islamic law.

By and large, it is not unusual for both Islamic finance and its conventional counterpart to mirror each other given the identical nature of their business of receiving funds, usually by way of deposits, which subsequently will be re-directed towards productive use in various economic activities.

Indeed, in undertaking financial intermediation functions, both Islamic and conventional finance serve as a medium to mobilise funds from savings surplus economic units, which will be channelled subsequently to savings deficit economic units.

The commodity murabahah debate entered the fray in Malaysia following Bank Negara’s favourable ruling in 2005 on the permissibility of such a concept.

As a rule of thumb, a financial contract does not contravene syariah rules as long as its application complies with the essential elements/tenets of any syariah contracts such as cost-plus sale (bai murabaha) and agency (wakalah), as practised in a commodity murabahah structure.

To clearly draw the lines between Islamic and conventional finance, the application of the commodity murabahah concept is restricted to a handful of financing products such as working capital, personal financing and credit cards whereby the financing is solely for the purpose of providing cash to customers.

Does the commodity murabahah violate Islamic principles?

The answer is, no. Not only is it permissible in Malaysia based on a ruling by the Syariah Advisory Council (SAC), it is in fact a globally acceptable syariah compliant structure in particular in the Gulf Cooperation Council (GCC) region, being sanctioned by the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI).

Still, the AAOIFI is of the view that the commodity murabahah structure is only acceptable if it involves four parties (a buyer, a seller, the buyer’s commodity broker and the seller’s commodity broker) instead of a tripartite transaction.

Is there a better alternative financing structure?

For certain types of financing products such as personal financing and credit cards, commodity murabahah appears as the most ideal structure.

However, for working capital, Islamic banks may consider a profit-sharing structure such as mudarabah and musharaka although the risks associated with this kind of structure could be relatively higher.

Indeed, Islamic banks are encouraged to consider this profit-sharing structure for their financing products, deemed as the most acceptable by the majority of syariah scholars.

Nonetheless, it is of utmost importance that Islamic banks are equipped with appropriate risk mitigation mechanisms, backed by risk officers with the right expertise. — Reuters


*Comment by Dato' Zukri Samat - the managing director of Bank Islam, Malaysia’s second biggest Islamic bank by assets. The views expressed in this article are those of the author