new horizon oct dec 2010

GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

ISSUE NO. 177OCTOBER–DECEMBER 2010

SHAWWAL-DHU AL HIJJAH 1431

IIBI RETROSPECTIVE:CELEBRATING 20 YEARS OFTHE IIBI

ANALYSIS:FX FORWARD

ACADEMIC ARTICLE:ORGANISED TAWRRUQ INPRACTICE

POINT OF VIEW:ISLAMIC OR ETHICAL FINANCE

IIBI CAMBRIDGE WORKSHOP REVIEW

PUBLISHED SINCE 1991NEWHORIZON

NewHorizon_pages_NewHorizon 07/10/2010 15:46

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www.newhorizon-islamicbanking.com IIBI 3

NEWHORIZON Shawwal-dhu al Hijjah 1431

Features

Regulars

CONTENTS

16

9

31 IIBI NEWS AND DIARYIIBI launches takaful certificate; Cambridge Workshop report; IIBIawards post graduate diplomas; diary.

37 TECHNOLOGY NEWSPath launch new cash flow monitoringcapability to support liquidity management; SWIFT automatesMurabahah Messaging; MashreqBank implement Oracle FLEXCUBE.

22 IIBI LECTURESJuly and August Lectures reviewed;October lecture preview.

30 APPOINTMENTS

05 NEWSA round-up of the important storiesfrom the last quarter around theglobe.

9 Celebrating 20 Years of the IIBIMohammad Ali Qayyum looks back at the first 20 years of the IIBI and lays out the Institute’s plans for the future, supporting the UK as a centre of Islamic finance and providing training, education and research services.

14 Islamic Perspectives on Islamic FX ForwardDr Asyraf Wajdi Dusuki examines the recognition and use of hedging in Islamic finance, focussing particularly on the FX Forward structure based on wa`dan.

16 Organised Tawarruq in PracticeDr Salman H. Khan, Head of Shari’ah Office (Dubai) at Abu Dhabi Islamic Bank analysesorganised tawrruq. He comes to the conclusion that, as practised today, it contravenes theprinciples laid down by both AAOIFI and ICFA. He suggests that both organisations andmany other stakeholders in Islamic commerce would be comfortable with its eradication.

27 Islamic or Ethical Finance

Usman Hayat ponders the question of whether the future in European retail markets lieswith Islamic or ethical finance. He compares ethical and Islamic finance and asks whetherthe promotion of Islamic finance in European retail markets on an ethical basis would offerthe best prospects for future growth.

39 Book Review

Raficq Abdulla reviews ‘The Islamic Moral Economy’ by Shafiel Karim.

HSBCAmanahBank

Cambridge Workshop


www.newhorizon-islamicbanking.com

NEWHORIZON October–December 2010

Executive Editor’s NoteAs we contemplate the first 20 years of the Institute’s work, theIslamic finance industry, if not at a crossroads in its development,certainly seems to be indulging in a bit of soul-searching. In thisedition of NewHorizon, the first published by our new partners,Cambridge Corporate Management, some of this self-examinationcomes to light.

Our book review is on ‘The Islamic Moral Economy’ written byShafiel Karim, an IIBI graduate. He challenges whether our industrylives up to the demands of Islamic morals and ethics, and askswhether it is bound to fail due to the contemporary pressures ofworld financial markets. Usman Hayat’s ‘Point of View’ is that insecular economies, Islamic finance should emphasise its ethicalfoundation in order to have broader appeal than just to the Muslimcommunity. There are also challenges to the validity of specificwidespread practices – organised tawarruq is decried by Dr SalmanKhan and the limitation of Islamic FX Forward transactions to truehedging operation is demanded by Dr. Asyraf Wajdi Dusuki.

To have a sound footing on which to develop, Islamic finance mustgo beyond the mimicry of conventional financial services engineeredto comply with Shari’ah principles. That said, it should also meetthe personal needs of Muslims and the business needs of those whomay have competitors using conventional finance. Above all, itshould be practiced with a professional rigour that providesexcellence in financial services as well as meeting the standardsbeing established within the industry.

So as the Institute looks forward to its next 20 years of service tothe industry, these challenges re-enforce our conviction that thedevelopment of professional standards based around a moral codeshould remain the cornerstone of our work. We also hope, however,to engage in research activities, which will lead to the developmentof products and practices, which will meet not only the letter, butalso the spirit of the Shari’ah.

Mohammad Ali Qayyum

Director General IIBI

EDITORIAL

This magazine is published to provide information on developments in Islamic finance, and not to provide professional advice. The views

expressed in the articles are those of the authors alone and should not be attributed to the organisations they are associated with or their

management. Any errors and omissions are the sole responsibility of the authors. The Publishers, Editors and Contributors accept no

responsibility to any person who acts, or refrains from acting, based upon any material published in the magazine. The Editorial Advisory Panel

exists to provide general advice to the editors regarding matters that may be of interest to readers. All decisions regarding the published content

of the magazine are the sole responsibility of the Editors, and the Editorial Advisory Panel accepts no responsibility for the content.

4 IIBI

EXECUTIVE EDITOR

Mohammad Ali Qayyum,Director General, IIBI

EDITORS

Andrea WhartonSue Dobson

IIBI EDITOR

Mohammad Shafique

PUBLISHER

Humphrey Tizard

IIBI EDITORIAL ADVISORY PANEL

Mohammed AminRichard T de BelderAjmal BhattyStella CoxDr Humayon Dar Iqbal KhanDr Imran Ashraf Usmani

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Cambridge Corporate Management LtdIckenham ManorIckenham UxbridgeUB10 8QTTel: + 44 (0)1895 625555Email: [email protected]: www.cambcorp.co.uk

CONTACT

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Cambridge Corporate Management LtdIckenham ManorIckenham UxbridgeUB10 8QTTel: + 44 (0)1895 625555Email: [email protected]: www.cambcorp.co.uk

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Mohammad ShafiqueInstitute of Islamic Banking andInsurance7 Hampstead Gate1A Frognal London NW3 6ALUnited Kingdom Tel: + 44 (0) 207 2450 404Fax: + 44 (0) 207 2459 769Email: [email protected]

©Institute of Islamic Banking andInsuranceISSN 0955-095X

Deal not unjustly,and ye shall not be dealt with unjustly.

Surat Al Baqara, Holy Quran




International law firm HoganLovells has acted asinternational counsel toCitigroup Global MarketsLimited and LiquidityManagement House forInvestment Company KSCC onthe inaugural US$100m sukukfor Kuveyt Türk KatılımBankası A.S. (“Kuveyt Türk”).

Kuveyt Türk’s US$100m sukukdue 2013 is the first sukuk ever

issued out of Turkey. Thetransaction was oversubscribedand has attracted a lot of globalinterest, including from theTurkish Government. MehmetSimsek, Turkish FinanceMinister, recently described thetransaction as ‘a turning point’and expressed his hope thatsukuk as an alternative financialtool ‘will make importantcontributions to thedevelopment of the country’.

The Hogan Lovells’ team wasled by Hogan Lovells’ GlobalHead of Islamic Finance,Rahail Ali, who was assisted bySenior Associate RogerFankhauser and AssociatesSema Kandemir and MarkBrighouse. Rahail Alicommenting on the issue of thesukuk, said:

‘It’s really pleasing to advise Citiand Liquidity House on such a

First Turkish Sukuk

landmark sukuk not only forKuveyt Türk but also forTurkey. Structuring the sukukwas challenging – the partieshad to reconcile requirementsunder the Turkish civil law,English common law andShari’ah principles. Turkey hasalways been a favoureddestination for Islamic financialinstitutions. This sukukpromises to open up a wholenew market.’

which has previously beenpresented to multi-nationalcompanies such as DeutscheBank and CIMB Islamic Bank,Malaysia. The award recognisesthe work my team has done instructuring and administeringIslamic capital marketsproducts for more than 15years.’

During the course of the Summit, Mr Normanparticipated as a panellist in the key debate betweenShari’ah Scholars and Islamic finance practitioners,this being the third year insuccession that he had been invited onto this panel.

Volaw Trust & CorporateServices Limited have beenawarded the Best IslamicAdmin istrator/Trustee Award inthe Islamic Finance Awards atthe recent Sukuk Summit held inLondon on 9–10 June 2010.Now in its fourth year, theSummit is generally regarded asthe leading Islamic CapitalMarkets forum in Europe andwas attended by over 200delegates, with attendees fromthe Middle East and the FarEast as well as Europe. TheSukuk Summit Awards panel ofjudges is made up of respectedindustry experts from across theGCC, Europe and the SouthEast Asia, who are responsiblefor nominat ing thoseinstitutions and individ uals thatthey deem to have attainedoutstanding achieve ments,success and excellence over thepast 12 months. The Award waspresented by Abdul Aziz AlHinai, Vice President of theIslamic Development Bank andDr Catherine Cowley, SeniorLecturer in Ethics and Finance

at University of London at theSummit’s Gala Dinner. It wasaccepted on behalf of Volaw byTrevor Norman, Volaw’sDirector of Islamic Finance andFunds Group.

Commenting on the award MrNorman said, ‘It is a greathonour to receive this award,

Volaw Judged to be Best Islamic Administrator/Trustee

NEWS


6 IIBI www.newhorizon-islamicbanking.com


HSBC Amanah opens its first dedicated Islamic banking branch in Qatar

being the first bank to install an ATM in 1986 and leadmanaging Qatar’s first Islamic sukuk for thegovernment in 2004. HSBC iscurrently the biggest foreign

bank in Qatar, offering retail,commercial, institutional andprivate banking servicesthrough a network of sixbranches, 22 ATMs and 550employees.

HSBC Amanah recently openedits first branch dedicated toShari’aah compliant productsand services in Qatar. Thebranch, HSBC’s first dedicatedIslamic banking branch in theMENA region outside SaudiArabia, will serve retail andcorporate customers.

Speaking at the openingceremony in Doha, MichaelGeoghegan, HSBC Group ChiefExecutive Officer said: ‘As theleading international bank inthe Middle East, HSBC isstrongly placed for thetremendous growthopportunities in providingIslamic banking services here inQatar and across the region. Bycombining our Islamic bankingexpertise in Saudi Arabia andMalaysia with our internationalreach, we can meet theincreasingly sophisticatedrequirements of Islamic banking

customers in many parts of theworld.’

Over the past 50 years, HSBChas reached a number ofmilestones in Qatar such as

Improving economic conditionsand the growth potential forinsurance in the region haveencouraged Bank NegaraMalaysia to grant two furtherfamily takaful licenses. Theoriginal two licenses weregranted in April 2009. The fourapproved organisations are:

American InternationalAssurance Berhad (70%) andAlliance Bank Malaysia Berhad(30%);

Two More Family Takaful Licenses Announced in Malaysia

NEWS

AMMB Holdings Berhad (70%)and Friends Provident Groupplc, UK (30%);

ING Management Holdings(Malaysia) Sdn Bhd (60%),Public Bank Berhad (20%) and Public Islamic Bank Berhad (20%);

The Great Eastern LifeAssurance Company Limited(70%) and Koperasi Angkatan

Tentera Malaysia Berhad(30%);

In granting the licenses theapplicants’ financial soundnessand resilience, track record,expertise, business plan andcontribution towards financialsector development in Malaysia, were taken intoconsideration. It is believed that the new family takafuloperators have strong valuepropositions that will further

enhance the development of the family takaful industry in Malaysia, in particular in penetrating untapped areas of business within the family takaful industryincluding microtakaful, medical and retirementproducts. Perhaps moreimportantly, this move plays to Malaysia’s ambitions to establish itself as aninternational Islamic financialhub.




In a July address to the 21stConference of Presidents of LawAssociations in Asia in KualaLumpur, Datuk MuhammadIbrahim, the recently appointedDeputy Governor of Malaysia’scentral bank, made a bid toposition Malaysia as analternative to the UK as the legal system of choice forresolving Islamic financialdisputes. He commented thatrecent cases tried in the Englishcourts have highlighted thehesitancy of UK judges todeliberate on issues concerningShari’ah principles in Islamicfinance transactions. He alsohighlighted the fact that whileevidence on Shari’ah matterscan be admitted in UK courts,such evidence or advice is notbinding.

In Malaysia, on the other hand,there is a dedicated High Courtfor Islamic finance-related cases,where judges can refer to theSAC (Shari’ah AdvisoryCouncil) on questions relatingto the Shari’ah and the rulingsare then binding. The next stepfor Malaysia would be toharmonise existing laws toaccommodate and facilitateIslamic finance in the mostlegally efficient way possible,because the future of Islamicfinance depended on its agilityand innovativeness indeveloping new products. Hebelieved that clear and easilyenforceable laws would serve to benefit the industryworldwide.

To that end he announced theformation of a Law

Harmonisation Committee,comprising key governmentstakeholders, including theAttorney General’s Chambers aswell as industry players andexperienced Islamic finance legalpractitioners. He alsoannounced that Tun AbdulHamid bin Mohamad, theformer Chief Justice of Malaysiaand a member of Bank Negara’sShari’ah Advisory Councilwould chair the committee. Theremit of the Law HarmonisationCommittee is to position andstrengthen existing laws as thelaws of choice for Islamicfinancial transactions.

At the end of the day, thesuccess or otherwise of thismove will depend on thewillingness of other countries,particularly the major financialcentres in the Middle East, to

accept Malaysian laws andparticularly the thorny issue of

Could Malaysia Rival the UK in the Resolution of Islamic Financial Disputes?

different interpretations ofShari’ah.

Qatar Islamic Bank’s (QIB)subsidiary, European FinanceHouse (EFH) has recentlyrebranded as QIB UK in orderto reinforce its positioningwithin QIB’s expanding globalnetwork. The primarymotivation behind therebranding is to further bringEFH under the umbrella ofQIB’s well-established identityas one of the regions foremostIslamic banking institutionsand the world’s 4th largestIslamic bank in terms of assets.

EFH obtained authorisationfrom the UK Financial Services Authority in 2008 and operates as a full service,stand alone Islamic investment banking institution located in BerkeleySquare, London. QIB UKbenefits from havingimmediate access to QIB’sextensive network ofcorrespondent financialinstitutions throughout the Islamic world and beyond.

European Finance HouseRebrands as QIB UK

NEWS




4th Annual Takaful Summit 2010

‘Making Takaful Fit for Purpose’was the theme of this year’ssummit, which took place inLondon in July. Subjects coveredranged from banctakaful andtechnology problems throughHalal insurance in the UK to thegrowth of ikhlas takafuloperators in Malaysia. Thespeakers came from as far afield

as Sudan, Malaysia, GCC andEurope. The Takaful Summit isbecoming a ‘must not miss’ inthe Islamic finance events’calendar, where takafulindustry experts from aroundthe globe gather to exchangeideas, discuss the challengesand how to tackle the obstaclesfaced by this burgeoning sector.

The Islamic Bank of Britain (IBB)opened its doors to a greatfanfare in 2004. Six years later inthe summer of 2010, The Timesnewspaper described the ventureas a flop. This is perhaps a harshjudgment on a brave attempt at atotally new type of UK institu -tion, a retail bank targeting theMuslim community – otherIslamic banks in Britain hadlargely limited their businesses tomanaging the wealth of privateindividuals from areas such asthe Gulf States and Malaysia.

It may also have been somewhatpremature. A couple of weeksafter The Times article appeared,IBB had secured a £20 millioncapital injection from foundingshareholder Qatar InternationalIslamic Bank (QIIB), takingQIIB’s stake in the bank to over80% via the issue of 2 billion 1pshares. Commenting on therefinancing of IBB, SultanChoudhury, CommercialDirector said, ‘This investment inIBB allows us to grow ourbusiness and remain the pioneerin providing innovative Islamicfinance products to retailcustomers in the UK and beyond.

Islamic Bank of Britain – Weathering the Storm

NEWS

Our customers will be reassuredthat one of our foundingshareholders has continued tocommit to us for the long termand work with IBB to achieve itsexciting objectives.’

For the record, IBB claims tohave grown its deposits, assetsand customers every year sinceits launch in September 2004. Itreported customer deposits ofmore than £186 million,customer financing at £46 millionand nearly 50,000 customers inits 2009 financial statements. Ithad, however already raised£7.5 million of additional capitalin January 2009 and losses roseto £9.5 million in 2009, anincrease of more than 75% overthe previous year. Despite thecapital injection, IBB has warnedthat it may have to moderate itsgrowth plans and possiblyreduce the numbers of branchesand employees.

That said, within weeks, IBBannounced that the additionalcapital would help to underpintheir plans to grow their Islamicmortgage alternative, the HomePurchase Plan and release new

The Takaful and Re-Takafulindustry is one of the mostvibrant sectors in the Islamicfinance space. It has been grow -ing at a rate of 30% year onyear and this expansion showslittle sign of slowing. High eco nomic growth, increas ingaware ness, a greater desire forShari’ah-compliant offerings and

increasing asset-based, Shari’ah-compliant financing are fuellingthe demand for Islamic insurance.

The industry, however, is stillworth less than US$5 billion andwith the global insurance marketvalued in excess of US$3.5trillion, there are good prospectsfor significant expansion.

products. These two new pro -ducts launched in August are a3.99% fixed rental rate productuntil January 2012 and a variablerental rate product at 4.99%.

Having weathered the financialcrisis of the last two years, albeitwith the help of QIIB, can theylook forward to calmer waters?One of the issues with whichthey have to come to grips iswhether their position as a UKIslamic bank is tenable. They willalso have to deal with a morerigorous regulatory system. It hasbeen suggested that one of thereasons why IBB needed the£20 million capital injection inJuly was to comply with currentFSA regulations on capitaladequacy; those regula tions areabout to get a whole lot tougher.Add to that the fact that liquiditymanage ment can be a problemfor Islamic banks in the UK,because many of the liquidityinstruments approved by the FSAare not Sharia’ah compliant.

IBB will no doubt be lookingcarefully at their cost base, as thebanks comments about cuts togrowth plans, branches and

employee numbers imply, butperhaps it really needs to beexamining its basic propositionand appealing to the largerethical banking market ratherthan just the 2 million Muslimsin the UK. The Co-operativeBank’s 2009 Ethical Consumer -ism Report estimated that ethicalbanking in the UK had grown bymore than 225% between 1999and 2008. That sounds like atempting market for a bank thatis finding the going a little toughwith the rather limited market itis currently targeting, but againthey will need more capital tofund this growth andunfortunately, because of theissues with liquidity instruments,this will probably have to be heldas non-revenue-producing cash.

IBB has resolved its immediatefinancial problems, and with thesupport it clearly enjoys from itsprincipal backer, has everychance of achieving its laudableaims. If despite everything,however, they do not succeed, itwill be a major setback forIslamic retail banking, not only inthe UK, but across Europe, whichis watching to see what happens.



NEWHORIZON Shawwal-dhu al Hijjah 1431 IIBI Retrospective

The IIBI’s roots were planted firmly in themid-1980s when Mr Muazzam Ali set upthe International Centre for Islamic Studies(ICIS) in London to promote Islamicteachings, history and culture and, inparticular, the application of these tocontemporary problems. Gradually, theemphasis moved to Islamic banking andinsurance, with a focus on education,training and research. The activitiesassociated with Islamic finance began tooperate under the current name in 1990 andin 1994 moved on to be formallyincorporated as a company limited byguarantee in the UK.

A Pioneering Organisation

The IIBI was probably the first organisationof its kind and, since it was not closelyaffiliated to any particular group or country,it had a high degree of independence. Thisallowed it to set its own agenda. MrMuazzam Ali was the source of governanceand he surrounded himself by qualifiedpeople and advisory groups that continue toassist to this day.

He had been associated with Dar Al MaalAl Islami Trust (DMI), a pioneer in the fieldof Islamic banking, since its inception in theearly 1980s, becoming DMI’s vice-chairmanand was also involved with other financialorganisations. He was keenly aware that asuccessful move to Islamic banking woulddepend heavily on education, training andresearch; a realisation that ultimately ledhim to set up the IIBI, with the fullendorsement of His Royal Highness, PrinceMohamed Al Faisal Al Saud, chairman of

DMI and of the International Association ofIslamic Banks.

Mr Muazzam Ali was also an importantcontributor as a thinker and educator on thesubject. In setting up the IIBI, he providedthe earliest forum for western bankers tolearn about Islamic finance and to networkwith those involved. This contributeddirectly to the opening of Islamic windowsin banks and ultimately to the setting up ofdedicated Islamic banking subsidiaries bymajor western banks.

Qayyum’s own involvement with the IIBIbegan in 2003, when he was asked by amutual friend to help Mr Muazzam Ali withthe management of the IIBI’s premises andhis involvement increased until he waspersuaded to accept his present full-timerole in 2004. ‘Since my own backgroundwas in conventional banking, Mr MuazzamAli would use me as a sounding board forhis ideas and shared with me his passion forthe Institute and for Islamic finance ingeneral,’ he recalls.

Qayyum saw the contribution Mr MuazzamAli was making to the developing industry.‘I recognised his stature in the market andthe great respect he enjoyed amongprofessionals and with the UK regulator. Hewas consulted by many, many people – evenby the late Lord Eddie George on occasion,the then governor of the Bank of England.’

Broader than Religious Beliefs

The IIBI’s mission is to pursue originalresearch and run programmes of education

Celebrating 20 Years of the IIBI

As the Institute of Islamic Banking and Insurance (IIBI) reaches its 20th anniversary,Mohammad Ali Qayyum, current director general and executive editor ofNewHorizon, reflects on the organisation’s achievements over this period and itssupport for the burgeoning Islamic finance sector, in line with the vision of its founderand Islamic finance pioneer, the late Mr Muazzam Ali.

The late Muzzam Ali



NEWHORIZON October–December 2010IIBI Retrospective

and training, which will help to develop awider knowledge base and deeperunderstanding of the world of finance,based on those principles emphasised inIslamic economics that promote equity,socio-economic justice and inclusiveness inall dealings.

‘Mr Muazzam Ali wanted to maximise thecoverage we could give, so we worked withstudents from all over the world,’ saysQayyum. ‘At our peak we had studentsenrolled from 80 different countries. Wesubsidised fees for disadvantaged studentsfrom developing countries and ourinformation services could also be accessedfree of charge via our website. We continueto operate in this way today.’

The demand for education and training inIslamic finance grew rapidly, in line with thedevelopment of the industry, as it becameevident that there was an acute worldwideshortage of appropriately skilled personnel.At that time there was no institution gearedto producing people who were well-versedin the principles and concepts of Islamicfinance. This led the Institute to firstdevelop a diploma, which was laterupgraded to the post graduate diplomacourse in Islamic banking and insurance.

In the early days the growth in Islamicfinance tended to be top-down, drivenprimarily by governments or governmentagencies in the Gulf and Middle East, whichhad excess liquidity. The movement,however, was also driven by the desire ofhigh net worth individuals (HNWIs) in theGCC region to invest in a manner that wasShari’ah-compliant. Importantly, the AlBaraka Banking Group in Bahrain, led bySheikh Saleh Abdullah Kamel and PrinceMohamed Al Faisal Al Saud’s Switzerland-based DMI Trust contributed substantiallyto the development of Islamic finance fromthe early 1980s onwards, takingshareholdings in leading Islamic banks andinvestment companies.

More recently there has been rapid growthin the retail sector and wealth management,with Islamic offerings competing withconventional banking products for

consumers and HNWIs. This comes inresponse to widening interest amongMuslim communities, whose members wantto ensure that aspects of their daily life,including their commercial dealings, are intune with their religious beliefs. They arenot the only audience for IIBI services,however.

‘Many of our students are non-Muslims,’says Qayyum. ‘They are attracted to themoral code that governs Islamic finance andto its ethical basis – the avoidance ofinterest; the avoidance of links to prohibitedactivities like speculation, gambling andalcohol and the fact that it must be used fora productive purpose, rather than for thegeneration of money for its own sake. Suchprohibitions are not unique to Islam.Throughout history people haveendeavoured to create a fair and prosperouseconomic system, based on the bedrock ofcertain core human values such astruthfulness, honesty, fairness, justice andthe rule of law. These values are notconfined to religion alone, but encompasscare for people, nature, creation and theenvironment.’

Mohammed Amin, Islamic FinanceConsultant and previously UK Head ofIslamic Finance for PricewaterhouseCoopersLLP, has worked closely with the Instituteover the years and supports the importantrole it plays in the growing market, ‘The UKhas grown rapidly in Islamic finance and isnow ranked eighth worldwide in terms ofShari’ah-compliant banking and takafulassets. Training and education are essentialto the UK’s ability to compete in Islamicfinance and have been pioneered by the IIBI,whose independence from financialinstitutions and from Muslim majoritycountries has enabled it to concentrate onthe quality of its programmes without beingconstrained by commercial or politicalconsiderations.’

IIBI Achievements

In the courses and training that it runs theIIBI emphasises the need for Islamic bankersand members of the Shari’ah advisoryboards to be committed to the principles

underlying Islamic finance; it is not enoughsimply to develop Islamic financial productsthat mimic conventional products. As theseproducts become more complex, ensuringthat this is the case is increasingly difficult.

IIBI training and education programmeshave helped hundreds, if not thousands, todevelop their knowledge of and skills inapplying theory to practice and identifyinghow best to meet their clients’ requirements.

Warren Edwardes, CEO of Delphi RiskManagement, the product development andrisk management consulting firm and amember of IIBI Islamic Banking AdvisoryGroup, feels that the IIBI’s greatest and mostlasting contribution to Islamic finance hasbeen to facilitate the exchange of ideas andtherefore encourage development. ‘It hasbeen my privilege to chair lectures andspeak on various themes at IIBI meetings inLondon, going back to my first lecture in1995, right up to my most recent inSeptember 2010. The networking andfellowship at meetings has created a strongbond amongst participants with a commonpurpose of taking Islamic finance forward,whilst keeping to its roots and basicprinciples.’

The IIBI monthly lectures, which started inOctober 1994, continue today to benefitCity professionals and instruct the widercommunity in the concepts and applicationsof Islamic finance, while more in-depthinstruction can be gained through the IIBI’sthree-day residential workshop held at theUniversity of Cambridge – the lastworkshop was attended by Islamic andconventional bankers, fund managers,regulators, accountants, lawyers and riskmanagers.

‘Going forward,’ adds Mr Edwardes, ‘Iwould hope the IIBI continues to developand strengthen its education and trainingprogrammes to provide a solid foundation,but also continues to encourage andfacilitate debate.’

The IIBI has played a key role in promotingLondon as a leading hub of Islamic finance.In order to further strength London’s role in



NEWHORIZON Shawwal-dhu al Hijjah 1431 IIBI Retrospective

Islamic finance it signed an agreement withthe Chartered Institute for Securities andInvestment (CISI) in 2009 based on themutual promotion of each other’squalifications.

The Institute also works closely withindustry organisations to promote Islamicfinance globally. It is closely involved withglobal, standards-setting bodies in theindustry such as the Accounting andAuditing Organisation for Islamic FinancialInstitutions (AAOIFI) and provides supportto their students from the UK and EU. It hasa similar working agreement withMalaysia’s International Shari’ah ResearchAcademy for Islamic Finance (ISRA) withwhom a second one-day conference is beingheld on 29 November 2010 in London.

Feedback from students and colleagues inthe industry suggests that IIBI qualificationsare well accepted by employers, with theInstitute’s graduates serving in all of themajor markets including GCC, Europe, theIndian Sub-continent and Malaysia.

Professor Rodney Wilson, from DurhamUniversity’s School of Government andInternational Affairs confirms that, ‘the IIBIhas played a major role in Islamic finance inLondon through its lectures, seminars andcourses. Its diplomas are internationallyrecognised, and have been taken byhundreds of Muslims and non-Muslimsinterested in Islamic finance.’ He isconfident that, with London likely toremain the leading centre for Islamic financein the West, ‘the IIBI will continue to play apivotal role with the support of the bankingand financial community in the UK.’

Into the Future

Mr Muazzam Ali was undoubtedly apioneer. His vision was for the IIBI to have apermanent role in setting professionalstandards; in promoting education, trainingand research and in information sharingabout Islamic finance. This, combined withhis stature in the industry, has left the IIBIwith a legacy that has inspired its membersand helped it to move forward over the last20 years. Its role has been replicated too; as

interest in Islamic finance has grown aroundthe world; similar institutions have been set up in various countries, forming useful forums where members can exchangeideas.

‘The Institute is striving hard to developthese standards and to reach out to moreand more people who want to be trained inthe principles of Islamic finance,’ saysQayyum. ‘This is reflected in the gradualimprovements we are making in the keyfunctions of education and training. Wehave recently introduced new courses likethe Diploma in Islamic Banking and theCertificate in Takaful to widen the choicefor potential students and we have alsoincreased the frequency and range of ourtraining programmes and conferences.’

As Islamic financial transactions becomemore widespread and more complex,Qayyum would also like to see the IIBIbecome a centre of expertise, whereinterested parties could come and seek helpin analysing Islamic product offerings. ‘Inthe future, we would also like to add therole of advocacy to the IIBI’s activities,’ hecomments.

Of course, increased activity and the greaterinterest in the education offered by the IIBIputs a constant strain on resources, whichare in any case limited. The Institute hasapplied for charitable status and looks tohave this confirmed before the end of theyear. ‘This will enable us to reach out topatrons and potential donors; to bring inextra resources to help us run additionalprogrammes and carry out more originalresearch for the public benefit,’ affirmsQayyum.

Islamic finance has an established niche nowin many countries around the world andthere are even moves at an internationallevel to coordinate and standardise activitiesso setting it on a firmer foundation –through AAOIFI, for example.

It is perhaps worth remembering, however,that when the IIBI (and its precursor) wasfounded by Mr Muazzam Ali, more than 20years ago, this was done at time when

His was the vision of what couldbe achieved and, in theintervening period, his Institutionhas provided not only a forumand meeting place where theprinciples of Islamic financecould be shared, discussed andset out for the future, but a keyeducational and researchresource to demonstrate toMuslims and the widercommunity that a fairer financialsystem is possible.



NEWHORIZON October–December 2010IIBI Retrospective

Islamic banking was in its infancy and stillvery fragmented.

His contributions have not goneunrecognised. This year the MalaysiaInternational Islamic Financial Centre(MIFC), under a plan devised by BankNegara Malaysia (Central Bank) and theSecurities Commission Malaysia, isproposing to give Mr Muazzam Ali aposthumous mention and put on record hisuntiring contribution to the development ofIslamic finance.

Reflecting on the significance of IIBI’scontribution, Richard T. de Belder, Partnerand Global Head of Islamic Finance withDenton Wilde Sapte LLP, comments, ‘Overthe last 20 years the IIBI has proved to be amost durable and invaluable organisation.In the mid 1990s, when Islamic Finance wasnot as mainstream as it is now, it was one ofthe very few bodies where you could getinformation on Islamic finance. The way inwhich the IIBI has expanded its training andeducational programmes is to be highlycommended; it is thanks to the foresight ofMr Muazzam Ali, whose work hascontinued under the dedicated stewardshipof Mr Qayyum, that so many people overthe years have been able to obtainknowledge about Islamic finance. The workof the IIBI has helped to raise the profile ofthe UK as a leading Islamic finance centreand I am confident that it will continue tobe a key provider of education, training andresearch services in the years to come.’

State of the Industry: A Long and WindingRoad

In 2004, the late Mr Muazzam Ali wrote toDr Abbas Mirakhor, who was the first tohold the INCEIF Chair of Islamic Finance,following a long and distinguished career asan economist and having made a considerablecontribution in the field of Islamic economics,finance and banking. He spoke of his sadnessthat not enough was being done to realise thebenefits of Islamic finance for mankind. Hewas concerned with the divergence of viewsamong Muslim Fuqaha (jurists) on thepermissibility of various transactions inIslamic finance in particular and Islamic law

in general. He expressed disappointment atthe lack of a codified, consensus-basedIslamic law that could be taught inuniversities the world over. He lamented thefact that with all the resources that Allah(S.W.T.) has bestowed upon the Muslim, verylittle financial support is given to research,academic positions in universities and generalscholarship on Islamic law, finance andeconomics.

Mr Muazzam Ali believed that Muslimscould learn useful lessons from the financialdevelopments in the West and expressed theview that ‘if Islamic banking has to develop,one has to take advantage of innovativeproducts wherever available.’ Equally, heoften admonished the Westerners to learnfrom Islam for their own benefit, as he didin his opening speech to the IIBI Conferenceon the Documentation of Islamic BankingProducts, where he said, ‘I would suggestthat Western bankers and financial expertsshed their deep-rooted prejudice againstIslam and examine the Islamic parameters.You will, if you look with an open mind,note that therein lies the solution for mostof the financial ills of the present age. Foryour own sake, accept anything goodwherever you find it. Do not stick tostereotyped philosophies.’

There is no denying that Islamic bankingand insurance have made impressiveprogress in a short period – some 500Islamic financial institutions are functioningaround the world today. This is no meanachievement, considering that the pioneersof Islamic banking had to start from scratchand without the benefit of past experience.

Western countries with significant Muslimpopulations are looking to make thenecessary regulatory and legal reforms thatwould facilitate the market in Islamicfinancial products. There is significantpotential too in North and East Africancountries, with Kenya fast developing as theIslamic finance hub of East Africa and inRussia, where there are more than 30 million Muslims.

It should not be forgotten, however, thatIslamic finance still has a long way to go

before it can claim to have ‘arrived’ andwhat has been achieved so far is no morethan a tiny fraction of what is possible andnecessary.

In future issues of NewHorizon, we will betrying to establish where barriers remain tofurther progress, in a ‘State of the Industry’series which will be looking in depth at eachof the major challenges likely to shape thefuture of the industry over the next 10-20years.

In the January-March 2011issue, we begin our ‘Stateof the Industry’ series bylooking at constraints onthe development of a trulyglobal market in somefinancial instruments as theresult of differentinterpretations of what ispermissible according toShari’ah and in theabsence of definedstandards across markets.



NEWHORIZON Shawwal-dhu al Hijjah 1431 ANALYSIS

The Recognition of Hedging in Islam

Islam recognises the concept of hedging andits importance particularly with respect tomanaging risk to protect wealth. One of themost important objectives of Shari’ah (alsopopularly known as Maqasid al-Shari’ah) is,in fact, to preserve and protect wealth frombeing exposed to harm and damage or loss.Many Quranic verses and Hadith of theProphet Muhammad (peace be upon him)have clearly indicated the importance oftaking every strategic measure to curb andminimise anticipated risk that coulddetriment one’s property. The jurists of boththe past and the present have, however,consistently asserted that the instrumentsand mechanisms used to manage risk mustnot in any way violate a Shari’ah ruling.

Resolution of the 28th Dallah al-BarakahSymposium

This assertion is strongly entrenched in theShari’ah principle that ‘end does not justifymean’. This was explained in detail in the28th Dallah al-Barakah Symposium in Jeddahon September 16 2007, which specificallydiscussed the issue of hedging (tahawwut).The resolution issued was as follows:

1. In Islamic financial activities, the pre-condition is that investors bear the risks.This is based on the principle of ‘al-ghunmu bi al-ghurmi’ which means thatentitlement to profit is accompanied byresponsibility for attendant expenses andpossible loss. This is backed by theHadith “Inna al-Kharaj Bi al-Dhaman”,which means the entitlement to profitfrom something is dependent onresponsibility for attendant expenses andpossible loss and defects (Hadith narratedby al-Tirmizi, Abu Dawud, Ibn Majahand Ahmad). Therefore, any investmentactivities based on the separation between‘al-ghunm’ (profit) and ‘al-ghurm’(losses), where investors are qualified toreceive profits without bearing ‘daman’(responsibility for losses or risks), are notallowed. Any contracts or contractualterms which are meant to guaranteeinvestment capital and profit arecontradictory to the Shari’ah.

2. Minimising and avoiding risks arepermissible if managed in line withShari’ah mechanisms, contract andinstruments, as long as they do not bringabout matters that contravene Shari’ahprinciples (Resolution No. 2:28).

Islamic Perspectives on Islamic FX Forward

Associate Professor Dr Asyraf Wajdi Dusuki is currently the Head of Research Affairs,International Shariah Research Academy for Islamic Finance (ISRA). Prior to joiningISRA he was an Assistant Professor of Islamic Banking at the Kulliyyah of Economicsand Management Sciences, International Islamic University Malaysia (IIUM). He alsoserves as a Chairman of Affin Group Shariah Committee and Shariah consultant andadvisor to several financial institutions and advisory firms including London-basedMortgage Company Chain Mender Limited, London-based Halal Industries PLC, US-based Islamic Financial Institution United Chartered Bank (UCB), Singapore-basedIFIS Business Advisory Pte Ltd and AFTAAS Shariah Advisory Sdn. Bhd. He holds aMaster of Science degree in Islamic Economics, Banking and Finance and a Ph.D inIslamic Banking and Finance from Loughborough University in the UK.



NEWHORIZON October–December 2010ANALYSIS

Realising this fact, many Islamic financialinstitutions today have come up withvarious Islamic versions of hedginginstruments to minimise the risk of marketfluctuations including foreign currencyexchange rate risk. Apparently thefluctuations in currency rates could severelyaffect the profitability and sustainability ofa firm.

The Conventional and Shari’ah Viewpoints

In conventional finance, FX forward hasbeen used predominantly to manage andhedge against the risk of fluctuations incurrency exchange rates. FX forward isessentially a derivative instrument thatinvolves an arrangement between twoparties to conduct a sale in future at a pricefixed today. Both settlement and deliverywill only happen on future agreed dates,while the contract is sealed today.

From the Shari’ah viewpoint, the problemwith the conventional FX forward structurearises when the parties involved want to

exchange the currency sometime in thefuture, but have already fixed a rate today,while the contract is also sealed today. Thiscontravenes the basic Shari’ah rulesgoverning the exchange of currency (bay’ al-sarf). In bay’ al-sarf, it is a requirement foran exchange which involves two differentcurrencies to be transacted on an on spotbasis.

There are many Hadith which govern therules regarding the exchange of currencies.The best known Hadith is the one reportedon the authority of Ubadah ibn al-Samit, tothe effect that the Prophet (peace be uponhim) said, ‘Gold for gold, silver forsilver’ until he said ‘equal for equal, like forlike, hand to hand; if the kinds of assetsdiffer, you may sell them as you wish,provided it is hand to hand (spot).’(Reported by Muslim in his Sahih). Here thereference made to gold and silver isanalogous to paper and coin money as amedium of exchange in today’s world. Thecurrency of each country is considered asbeing of a kind that is different from that of

other countries, as they are ‘constructivemoney’ according to the decision of theInternational Islamic Fiqh Academy (basedin the Kingdom of Saudi Arabia).

Consequently, Islamic FX Forward is basedon Shari’ah principles and contracts aimedat achieving the same objectives as itsconventional counterpart, which is mainlyto hedge against currency rate fluctuationrisks. For the Islamic FX forward there arethree main structures that are commonlyoffered in the Islamic financial markettoday. One structure is based on thecontract bay’ al-tawarruq (commoditymurabahah transaction); the second isstructured using the concept of promise orwa’d and the third is based on twounilateral promises or wa’dan. This articlefocuses on the FX Forward structure basedon wa’ dan.

Wa’dan

Wa’d is an Arabic word which literallymeans “a promise”. The value of the wa’d

Customer

CustomerBank

Bank

Promises to sell USD1 million at the rate of 3.5 ifexchange rate USD/MYR >3.5

Promises to buy USD1 million at the rate of 3.5 ifexchange rate USD/MYR is below or equal 3.5

1

2

Diagram 1: Islamic Currency Forward Based on Wa’dan (Two Unilateral Promises)



NEWHORIZON Shawwal-dhu al Hijjah 1431 ANALYSIS

in Shari’ah is similar to the value of a socialpromise in Common Law. The promise mayhave moral force in that breaking it mayprovoke opprobrium (social blame), but itdoes not entail legal obligations or legalsanctions. The Islamic Fiqh Academy hasdecided that the wa’d is ‘obligatory not onlyin the eyes of God but also in a court oflaw’ when it is made in commercialtransactions; it is a unilateral promise and ithas caused the person to whom the promisehas been made to incur liabilities. It is also arequirement that the actual sale – if thepromise was in respect of selling a certainasset – be concluded at the time of exchangeof the offer and the acceptance (known inArabic as majlis al-aqad) and not at the timeof the wa’d. The person to whom thepromise is made also has the possibility toclaim actual damages from the personmaking the promise, if the latter backs outon a wa’d

On the other hand, wa’dan is two unilateralpromises given by two parties to each otherin which the two promises are notconnected to each other and its applicationdepends on two different conditions.Diagram 1 on page 14 illustrates how thesetwo unilateral promises are used instructuring an Islamic currency forward.The Customer promises the Bank that it willsell USD1 million for MYR at a USD/MYRexchange rate of 3.50 (i.e. for MYR 3.5million) on 2 October 2010; if theUSD/MYR exchange rate is above 3.50.

The Bank promises the Customer that it willbuy USD1 million for MYR at a USD/MYRexchange rate of 3.50 (i.e. for MYR 3.5million) on 2 October 2010; if theUSD/MYR exchange rate is below or equalto 3.50.

Let us assume the USD/MYR rate on 2 October 2010 is above 3.50 (example3.60), the bank will then exercise its rightunder the first promise made by thecustomer, to buy the USD for MYR at theagreed rate of 3.50 as it is cheaper thangoing out to the market and buying at 3.60.Conversely, if the rate on 2 October 2010falls below 3.50, say 3.40, then thecustomer will exercise their right, under the

second promise made by the bank, to sellthe USD for MYR at the pre-agreed rate of3.50 as it will get more MYR than goingout to the market and selling at 3.40.

In all the possible scenarios discussed above, therefore, the actual trade ofcurrencies will only take place on thematurity date (as in our example above2 October 2010) and hence, it is claimedthat the structure does not violate theShari’ah requirements pertaining tocurrency trading, which require thecurrencies to be traded on a spot basis.

The major concern pertaining to thisstructure is the similarity of two unilateralpromises (wa’ dan) to bilateral promises(muwa’ adah), which has been a contentiousShari’ah issue for a long time. A bilateralpromise is a promise given by two parties to each other on the same subject matterand the effect of the promise will take place at the same time. This promise might be associated with certain conditionsor without any conditions. An example of such a promise is when A promises to sell a certain commodity to B at a certaindate and B in return promises A to buy the same commodity on the same date. The two promises might be connected tocertain situations such as fluctuations in theprice of the commodity at the time oftransaction.

The objection to this kind of promise is theeffect of such promise is similar to acontract, taking the view that a promise isbinding. This means, when two unilateralpromises are agreed, it will give the effect ofa contract as the obligations of both partiesare established at the point of the promise,which is similar to a contract. (Islamic FiqhAcademy Decision No. (3/2). In addition,some argue, if such a contract is binding toboth parties, then it falls within theprohibition of selling a debt for a debt andis, thus, not permitted. If, however, it is not binding on either party then it ispermitted. (First Barakah Conference,Fatwa No. 13)

In fact, the Accounting and AuditingOrganisation for Islamic Financial

Institutions (AAOIFI) in its Shari’ahStandard No.1 on trading currencies clearlystates that, ‘A bilateral promise is prohibitedin currency trading when it is binding uponboth parties, even when it is done to treatthe risk of decline in a currency’s value. Asfor a unilateral promise from one partyonly, that is permissible, even if it isbinding’.

Despite the criticisms, unresolved Shari’ahmatters and the complexities inherent in theissue of two unilateral promises instructuring the Islamic forward currencyproduct, many Islamic financial institutionsespecially in the Middle East are applying it.Few discussions have taken place related tothis topic; however, many scholars haveapproved it and deem it different frommuwaadah.

Conditions of Use

The approvals, however, given by manyShari’ah committees of the respectivefinancial institutions are subject to thecondition that the instrument is exclusivelyused for hedging purposes. This means thatan Islamic forward product can only beused as an insurance activity aimed atprotecting an asset from any unexpected orundesirable change in the value of an asset.This also implies that an Islamic forwardcannot be used for funding and tradingactivity by means of speculation to generateprofit as widely practiced in conventionalfinance.

To ensure this, some financial institutionsgive a written representation to get aguarantee and declaration from thecounterparty subscribing to the Islamic FX forward product, thereby making surethat the FX forward is only used for thepurpose of hedging and not speculation. For other financial institutions, the FXforward is only used for hedging when there is a clear underlying transaction and contract, for example the ijarahcontract. This is to ensure that theunderlying asset or asset foundation for theforward instrument is based entirely onactual and real economic activity and not afictitious one.




Tawarruq – ICFA’s Position

The ICFA’s Resolution 179 on organisedtawarruq states:

‘It is not permissible to execute bothorganised and reverse tawarruq, becausesimultaneous transactions occur between thefinancier and the mustawriq (party seekingfinance), whether it is done explicitly orimplicitly or based on common practice, inexchange for a financial obligation. This isconsidered a deception, i.e. in order to getthe additional quick cash from the contract;hence, the transaction is considered ascontaining the element of riba.’

Clearly, the ICFA’s concern is with aconcealed buy-back transaction, where themetal (or other commodity) is used as aprop to justify a transaction in which thereal purpose is to exchange money now formore money later. Moreover, the phrase‘simultaneous transactions between thefinancier and the mustawriq, whether it isdone implicitly or explicitly’ deliberatelyhighlights the reality that in today’s Islamicfinancial sphere both transactions ofpurchase and sale of the tawarruqcommodity are in effect made between thesame financier and the customer,notwithstanding cosmetic arrangements adopted by IIFSs that purport to demonstrate the use of ‘brokers’ or ‘third parties’. This is‘implicitly’ done via various ‘nettingarrangements’.

To sum up, the ICFA prohibits tawarruqwhere any of the following occur:

❑ There are effectively only two parties, i.e.no real, unconnected third party

Background

Organised tawarruq has been heavily usedby institutions offering Islamic financialservices (IIFSs) in substantial volumes formany years, largely for the purposes ofliquidity management (often referred to as‘commodity murabaha’) and the provisionof cash-in-hand, i.e. ‘neutral’ consumerfinance. Typically, party A purchases acommodity on deferred payment andrapidly sells the same commodity on spot,where the seller in the first trade issupposedly a different party to the buyer inthe second. As a result, party A is left with a cash lump sum on one hand and a corresponding higher debt obligation on the other. The overalltransaction will be arranged or ‘organised’by an IIFS.

The OIC’s (Organisation of IslamicConference) International Council of FiqhAcademy (ICFA) in Makkah ruled in April2009 that organised tawarruq and reversetawarruq were not permissible, since theywere a ‘trick’ to get cash now for more cashpaid later. This pronouncement has stirredstrong emotions. For some, it seemed to berather hasty, not well thought out andopposed to the needs of the Islamic financeindustry. In the view of others, however, itwas no less than a very welcome and longoverdue breath of fresh air for the industry.

Among the various critics who havequestioned the validity of the ICFApronouncement, some have made thespecific point that, inter alia, the judgementgoes against the AAOIFI’s ruling on thepermissibility of tawarruq, as laid out underAAOIFI Shari’ah Standard 30.

Organised Tawarruq in Practice: A Shari’ah Non-Compliantand Unjustified Transaction

The Joint Stance of the OIC Fiqh Academy, and AAOIFI

By Dr Salman H. Khan, Head of Shari’ah Office (Dubai) at Abu Dhabi Islamic Bank

ACADEMIC ARTICLE

The view expressed in thispaper is that rather thancontradicting each other, theICFA’s judgement on tawarruqand AAOIFI’s Shari’ahStandard 30 on tawarruq areactually both in agreementwith each other, even thoughthis agreement may not havebeen explicitly stated.



NEWHORIZON Shawwal-dhu al Hijjah 1431 ACADEMIC ARTICLE

❑ There is concealed buy-back

❑ The transaction is a ‘trick’ with anembedded fixed return

Since the above three features typicallycharacterise virtually all organised tawarruqtransactions done by IIFSs, the ICFA holdsthat ‘organised’ tawarruq should bedisallowed.

Tawarruq – AAOIFI’s Standard 30

What does AAOIFI Shari’ah Standard 30say? The key clause in Shari’ah Standard 30is Article 4/5:

‘The commodity (object of monetisation)must be sold to a party other than the onefrom whom it was purchased on a deferredpayment basis (third party), so as to avoide’na which is strictly prohibited. Moreover,the commodity should not return back tothe seller by virtue of prior agreement orcollusion between the two parties oraccording to tradition.’

In practice, Article 4/5 is not followed inorgan ised tawarruq. In addition to Article4/5, Articles 4/7, 4/8, 4/9 and 4/10 (all inStandard 30) also highlight the divergencebetween AAOIFI’s permitted tawarruq andthe tawarruq that is typically practiced. Insummary, Articles 4/7 to 4/10 say thefollowing:

❑ The bank or its agent should not sell thecommodity on the customer’s behalf, if thecustomer initially bought that commodityfrom the bank – neither should the bankarrange a proxy third party to sell thiscommodity

❑ Rather, the client should sell thecommodity either himself or through hisown agent. At the most, the bank shouldprovide the client with the informationneeded to sell the commodity.

In reality, quite clearly, AAOIFI Shari’ahStandard 30 is therefore also implicitlysaying that:

‘If your organised tawarruq cannot fulfilthese stringent conditions, then you cannotdo organised tawarruq.’

The key conditions laid out by AAOIFIShari’ah Standard 30 are, therefore, that thetransaction should not in essence be twoparty (ignoring the ‘cosmetic involvement’of third parties); it should be real, i.e. themetal being traded should genuinely movefrom seller to buyer; there should be no‘trick’ or collusion involved and hence, nofixed embedded return. These conditionsactually describe a type of tawarruq that bydefinition cannot be the organised tawarruqthat is typically used in today’s Islamicfinance industry.

All these conditions are based on concernsthat are identical or very similar to thoseheld by the ICFA. Therefore, it is correct tosay that AAOIFI’s organised tawarruq isconsistent with the ICFA’s implicit definitionof unorganised tawarruq. The key lies in theseparation of ‘how it is’ (thereforeprohibited by ICFA) and ‘how it should be’(if permitted by AAOIFI). Althougheveryone may not perceive it thus, in effectthe ICFA has passed the recent resolutionagainst organised tawarruq in light of thefact that the conditions for the permissibilityof tawarruq (as laid out by AAOIFI) arevirtually never followed. Rather than therebeing a conflict, in reality the ICFA agreeswith and reinforces AAOIFI Shari’ahStandard 30.

Why Organised Tawarruq Must Go

The joint stance of AAOIFI and the OICFiqh Academy is, ‘Do it properly, or don’tdo it at all.’

In the light of AAOIFI Standard 30,theoretically, the only way for tawarruq tooperate properly would be via three real anddistinct parties, namely:

❑ Customer A

❑ Seller-1

❑ Buyer-1

And two distinct and unconnected sales:

Sale-1 i) Customer A buys metal ondeferred payment from Seller 1

ii) Customer A takes constructive/real possession of the metal

Sale-2 iii) Customer A sells same metal toBuyer 1 (a genuine third partyother than Seller 1)

iv) Metal actually moves from thewarehouse of Seller 1 to Buyer 1and Buyer 1 completes possession

In fact, point (iv) in Sale-2 is what musthappen, as a necessity, as implied byAAOIFI Shari’ah Standard 30, clause 4/5:

Moreover, the commodity should not returnback to the seller by virtue of prioragreement or collusion between the twoparties or according to tradition.

So a key question relating to point (iv) is:Does the commodity bought by thecustomer in Sale 1 (on deferred payment)eventually definitely leave the warehouse ofSeller 1, as Standard 30 clause 4/5 aboveclearly requires? The answer is, by andlarge, no. There are a number of reasons forthis. Firstly, the fact remains that the overallpurpose of the seller in the transaction (whoeffectively provides the liquidity by sellingon deferred payment) is:

❑ To advance liquidity

❑ To make a return on the money advanced,built into the price of Sale-1

Not to trade, and therefore, certainly not totake on the kind of risk that is associatedwith normal and genuine commoditytrading activities

Therefore, from the seller’s point of view:

❑ There is no purpose or intention tophysically transport any of the commoditiesthat he holds in his warehouse

❑ In fact, this activity would in the seller’sview incur unfeasibly high costs andmoreover, this is precisely not the purpose of their involvement with suchliquidity provision mechanisms as tawarruq.



NEWHORIZON October–December 2010ACADEMIC ARTICLE

❑ Rather, this is much more similar to theprovision of a loan on interest, where themetal from Sale-1 is stored as a securityagainst the stream of receivables relating tothe deferred price in Sale-2.

❑ Moreover, any necessity to physicallymove the ‘traded’ commodities in tawarruqfrom one location to another, as should bedone, but is typically not done, wouldseverely restrict the total volume andprofitability of tawarruq transactions to theextent of eliminating the commercialfeasibility of organised tawarruq altogether.

As an added point, banks always organisethe onward sale of the metal bought by thecustomer. This again is a violation ofAAOIFI Shari’ah Standard 30.

Thus having defined and implicitly agreedupon what tawarruq should and should notlook like, AAOIFI and ICFA are well awarethat the reduced profitability of doing this‘reformed’ version of tawarruq may wellrender it economically unfeasible to dotawarruq at all. Both institutions are quitecomfortable with such an eventuality:‘either do it properly, or don’t do it at all’ istheir combined implicit message to IIFSs.

‘Movement’ of the Commodity/Metal

Let us return to the question, ‘What doeshappen to the metal in reality?’

There are certain parties who are active inthe tawarruq sphere. These may becommodity trading companies who have thefinancial depth to hold reasonably largestocks of metal in their warehouses.Alternatively, they may be brokers, whohave links with such trading companies andare also active in this market.

With regard to tawarruq, the above partiesact as buyers and/or sellers often in a largenumber of separate transactions andtypically they operate a netting facilitybetween their different storage facilities,whereby in reality metal either rarely ornever really gets physically transferred fromSeller 1 to Buyer 1, as it should. Typically,these parties possess a certain stock or

quantity, e.g. ‘x’ tons of metal. Furthermore,these parties use and reuse this same stockmany times during the same day innumerous consecutive sales. Almost exactlylike the concept of fractional reservebanking in conventional banking, thereforethese commodity stockers (for with regardto their tawarruq activities they are stockersmore than traders) could hold one hundredtons of metal in their warehouse valued at$2.5 million and yet conduct tawarruqtransactions amounting to any multiple ofthat, e.g. $25 or $50 million or even muchmore. Throughout these transactions, themetal would not need to move an inch.

This is made possible, because eachtawarruq transaction will normally have animplicit short holding period after which itis ‘released’ or ‘freed’. Thus, as an example,in a standard transaction:

❑ 10.00am, September 10, 2010: Seller-1books four tons of aluminium for a deferredsale at $2,500 per ton to a customer for a$10,000 sale

❑ 10.30am, September 10, 2010: Thecustomer takes constructive possession butnever sees the metal and may simply receivea certificate, usually indicating hisconsignment is placed in some namedwarehouse. At this point, Seller-1 ‘holds’ thefour tons for the customer

❑ 11.00am, September 10, 2010: Thecustomer sells same aluminium to Buyer-1,for a spot price of $8,000; subsequently,according to the netting facility, four tons ofaluminium are netted off between thestorage facilities of Seller-1 and Buyer-1through some direct or indirect method,without the metal needing to physicallymove at all.

This should make it clear that AAOIFIShari’ah Standard 30 is not being followed,since a prior agreement or collusion agreesbetween the two parties Seller-1 and Buyer-1for such deals and effectively the metal doesreturn back to the original seller as per thenetting arrangement or rather, theownership of the metal returns back; themetal itself, in actuality, never really moves.

Incidentally, despite there being collusionbetween the Seller-1 and Buyer-1, which ineffect contravenes Clause 4/5 of Standard30, the example given is actually a goodscenario case in which, by implication,Seller-1 properly demarcates the four tons of metal in his warehouse to denotethe customer’s constructive possession until Seller-1’s netting arrangement isfinalised.

In practice, however, it is doubtful whethersuch demarcation of the subject commodityoccurs for each and every transaction, as itneeds to do. Available evidence suggests thatwhat typically happens is a daily or otherperiodic netting, in which, rather thanspecifically identifying and subsequently‘releasing’ the metal for each transaction, all the transactions for a certain day arecarried out without such specificdemarcation and hence even this minimaltransfer of constructive ownership does notreally happen in most cases. Daily netpositions dictate the overall stock balances,i.e. how much is encumbered and howmuch is free to be used for new tawarruqtransactions.

The simple fact is that, in the absence ofphysical movement of the metal, it followsthat tawarruq ‘traders’ would necessarilyhave to operate such a netting arrangement.It is one or the other; no third avenue ispossible.

Tawarruq: Quashing the ‘Justification’Arguments

The defenders of organised tawarruq haveput forward various arguments to justifywhy tawarruq should be allowed.

Claim 1: Tawarruq traders often buy andsell metal with physical movement of themetal and hence that tawarruq is conductedby genuine traders.

Reply: Although some movement of metalmay happen, let us be clear about thecircumstances in which it happens. Thelikelihood is that there are most probablyonly two scenarios in which the commoditymoves:




a) Some traders apart from their tawarruqactivities may conceivably also begenuine traders of the metal. The keypoint here, however, is that while theymay physically receive, transport andtrade metal in their other sales, withregard to their tawarruq transaction, themetal rarely or never moves.

b) Alternatively, what may happen fromtime to time is that for a certain party,their tawarruq transaction volume risesor falls, which may prompt them to buyor sell more metal from the market forthe purposes of equalising the amount ofmetal stocked with the expected multipleof periodic tawarruq transactions. Forexample, if $1 million of stocks enables$20 million of transactions daily anddaily ‘demand’ goes up to say$30 million, then proportionately theparty would now stock $1.5 millionworth of metal.

However, this is hardly trade; rather, it isstocking of sorts, where the inventoryeffectively acts as a security against theliquidity transactions undertaken over therelevant period; quite similar to thegoldsmiths of the 17th century, who lent outthe paper claims to gold against their goldstocks on which they received interest.

Claim 2: Commodities are genuinely beingbought and sold and this is trade: how cantrade be forbidden?

Reply: Assume that tawarruq happens withcorrect demarcation of the subjectcommodity vis-à-vis Sale-1 in all cases.Despite that, the fact is that typically:

❑ A small stock of metal of a certain valuewill enable tawarruq sales of a largemultiple of that value

❑ This will happen on a daily and repeatedbasis

❑ The metal does not move at all in relationto these tawarruq sales; this renders themetal virtually wholly irrelevant since itserves simply as a prop to ‘enable’ thesemonetisation deals to be transacted.

For example, if a metal stock worth$1 million is used to perform tawarruq salesworth $30 million on a daily basis, iteffectively means that the same physicalstock of metal is ‘sold’ and ‘resold’ 30 timesper day, without moving an inch. Can it berealistically claimed that these are genuine‘trade’ deals? This concern is even morevalid given that they are in directcontravention of Shari’ah AAOIFI Standard30 as well as the ICFA’s fatwa.

Claim 3: It is said that tawarruq isquestionable because the metal is‘unwanted’, ‘irrelevant’ or a ‘fake prop’.How is that so? After all, in real tradesellers buy their merchandise not becausethey want it per se, but because they wantto sell it on and earn profit, so therefore,isn’t the merchandise also ‘irrelevant’,‘unwanted’ and a ‘fake prop’ in real trade?

Reply: It is true that traders do not wanttheir merchandise per se; they aim to sell iton. The crucial difference is that, in genuinetrade, there will always be an ultimategenuine user of the sold commodity. Incontrast, in tawarruq, two spurious sales(with no movement of metal) are alwaysfollowed by an accounting netting-off that isdone only in the books of the brokers.There is no ultimate user, and absolutely no-one will ever want that metal for genuineend use.

Claim 4: The bank does a favour to theclient by arranging the second sale, givingthe client the best price possible, i.e. themarket price. The customer thereby avoidspotential loss.

Reply: If the customer ends up making aloss because he engages in unassistedtawarruq, let it occur. Unassisted tawarruqis precisely similar to the genuine concept oftrading, i.e. buying and selling with thehope of making a profit, an activity that willalways involve risk just as it will alwaysprovide an opportunity to profit as well.How might profit accrue? Even inunassisted tawarruq, the liquidity achievedvia Sale-2 is often used for investment orbusiness purposes. If invested shrewdly, thereturns on that investment could be higher

than the liability of the deferred price ofSale-1.

Moreover, banks can hardly be creditedwith organising tawarruq because they wantto help their clients ‘avoid extra loss’ byhelping them secure a ‘good price for theirmetal’ in Sale-2. In reality IIFIs favourorganised tawarruq because:

❑ The transactions are virtually ‘riskless’with ‘secured returns’;

❑ Transaction costs are very low;

❑ IIFSs are able to carry out a huge volumeof transactions specifically because thistawarruq is organised and they thereforeenjoy huge profitability in such deals.

It is no coincidence that all of the abovethree features are also the key characteristicsof the regular conventional products of aninterest-bearing loan. This, then, is also anadditional source of unease for those not infavour of organised tawarruq.

Claim 5: Organised tawarruq transactionsare sound, with proper constructivepossession and transfer of ownership at theright time.

Reply: Another sobering point is wellworth mentioning here. The clearing systemused for organised tawarruq by majorbrokers in the metal trade is such that it islogistically impossible to transfer ownershipfollowing Sale-1 prior to executing Sale-2,i.e. the brokers’ system physically does notallow it. This clearly renders all theirintended tawarruq transactions asfundamentally invalid, even within thehighly generous and flexible space beingafforded to tawarruq in the current financialframework of constructive possession, useof agency, etc.

Moreover, if major players are doing this,quite naturally the smaller players are alsounable and unwilling to make sure thattawarruq is followed even vis-à-vis Sale-1.AAOIFI’s Shari’ah Standard 30 is but adistant mirage and there is little attractionto pursuing it, given that institutions



NEWHORIZON October–December 2010ACADEMIC ARTICLE

ignoring the AAOIFI standards or anyothers do not face any effective penalties.Until a regulatory system is meaningfullyenforced where penalties for noncompliance are real and they hurt, it israther futile to expect IIFSs to change any oftheir past patterns of behaviour. Suchenforcement, again, is largely dependent onboth political will and vision. In the presentset-up, these are rare commodities in theindustry.

Claim 6: If the metal price rises after thecustomer buys the metal from us, he is freeto benefit by selling it in the market to get ahigher price.

Reply: Effectively, this is merely atheoretical possibility, which never happensin practice. Tawarruq brokers and banks arehardly likely to provide a ‘sell in the marketby yourself’ option to the customer, since, ifit were really a genuine option, this wouldeliminate their own profit from thetransaction. All parties are well aware thatthe customer has neither the contacts northe ability to effect Sale-2, so this is aredundant option, which is ‘cosmetically’offered to ‘boost’ the justification fortawarruq. It’s like offering to buy lunch foryour guest (which you cannot afford to buy)in the full knowledge that he is unable toaccept the offer due to other factors – andthen proclaiming how ‘generous’ you are formaking the offer.

Claim 7: The ICFA’s viewpoint on tawarruqis contradictory. Firstly, the ICFA agrees thattawarruq on an individual level is permitted;thus, if ‘A’ buys a commodity in the marketon deferred payment and sells the same onspot, by his own efforts, then that isallowed. At the same time, the ICFA alsosays that, where the bank organises the fulltawarruq transaction in particular thesecond sale, such transactions should not bepermitted. How does this represent aconsistent viewpoint?

Reply: The very basis of the opposition toorganised tawarruq is that it is very difficultto maintain overall Shari’ah permissibility, ifthe deal, especially the second sale, isorganised by the IIFSs, since the metal by

design is not meant to move and effectivelyit becomes a ‘money now for more moneylater’ transaction with no real economicactivity in between. In unassisted tawarruq,the commodity is individually bought by ‘A’in step 1, physically possessed by ‘A’ andthen genuinely sold to Buyer-1 such that realdelivery occurs. Unassisted tawarruq,therefore, is simply a form of real trade,similar to the fruit seller buying his dailyinventory in the morning from the fruitwholesale market on credit and selling thisstock during the day for cash, with the hopeof making more money from his sales toearn a profit.

Agreeing Why Organised Tawarruq MustGo

Organised tawarruq as it is currentlypractised in the Islamic finance industry isclearly not in compliance with basicShari’ah principles. The metal is explicitlynothing more than a prop, which virtuallynever moves due to the netting-off process.No genuine trade really occurs; onlystocking of metal takes place, similar toretaining collateral against an interest-basedloan thus reducing the transaction to littleless than money now for more money later.In addition, the involvement of the IIFSs inorganising the second sale is a keycomponent in the process, which helps toundermine the genuineness of the overalltransaction as highlighted by the ICFA andAAOIFI. For all these reasons, the ICFA(directly) and AAOIFI (indirectly) havedisallowed it. Moreover, these very concernsheld by ICFA and AAOIFI are also sharedby a large number of industry practitioners,Islamic economists and other stakeholders.

Points to Ponder

Phased Withdrawal from OrganisedTawarruq

Let us not forget the realities. First of all, asignificant majority of Islamic banksconduct a large volume of tawarruqtransactions on a regular basis in relation totheir treasury operations. This, in theopinion of their Shari’ah boards, ispermitted on the basis of need or ‘daroora’,

since the view is that there is no otheroption available.

Even if a decision were made to follow theopinion of the ICFA and AAOIFI, inpractice it is doubtful that IIFSs would be ina position to cease their existing tawarruqtransactions immediately. Even under a best-case scenario tawarruq would mostprobably need to be phased out.

If Islamic banks, however, decide to bringtheir dealings in tawarruq to a gradual halt,they have to demonstrate some tangiblecommitment and willingness to move in thisdirection. The present reality of the Islamicfinance industry is that levels of regulation,adherence to any kind of standards andpenalties for non-compliance are poor ornon-existent, all factors which suppress theincentive for IIFSs to eliminate tawarruq(and in fact all questionable products) sinceit is so profitable.

Alternatives for Liquidity Management

Since tawarruq is heavily used by mostIslamic financial institutions for liquiditymanagement purposes, an alternativeworkable solution must be available in theevent that tawarruq is phased out. The bestsolution is to return to the ‘honesty’ of a100% cash reserve ratio and shift the focusto genuine investment-based andprofit/loss-sharing products, which rule outthe need for the fractional banking systemthat is based on liquidity management. Sucha move, however, represents a paradigmshift that challenges the very basis of theexisting banking structure and wouldrequire strong political will to institute. Itwould, moreover, be most likely to happenin conjunction with an overall philosophicalreview and revision of the basis and practiceof the Islamic commercial industry. Whilethere appears to be an increasing demandfor such a revision, particularly in theaftermath of the recent economic crash, it isdifficult to predict when this may happen.

In the more immediate future, as a parallelmove, steps to assist liquidity managementinclude improving financial markets’infrastructure to enhance the tradability of




sukuk, and using mudaraba, musharaka andwakala-based, inter-bank deposits.

Alternatives for ‘Cash-in-Hand’ ConsumerLiquidity Needs

If tawarruq is to be made redundant, therewould be a heightened need to providegenuine Shari’ah-based product solutionsthat offer neutral liquidity, i.e. ‘cash-in-hand’ to the client. For such needs, theproduct of salam (a sale with full paymentupfront at T0 and delivery deferred to T1) isone genuine alternative product that wasspecifically sanctioned by the Prophet(SAWS) precisely for meeting the liquidityneeds of agricultural producers. Salam cancomfortably be utilised beyond theagricultural sector, although it remainsgrossly underused and disliked by banksbecause of the perceived ‘price risk’associated with this product. The reluctanceto use salam, however, persists despite theexistence of various risk-mitigating toolssuch as the use of parallel salam, andobtaining a foreign exchange,promise-based currency hedge, where goodsare paid for in foreign currency, etc. Salam,moreover, needs to be used with care and inconjunction with in-built checks andcontrols to prevent banks from obtainingextortionately low prices from indebted andunder-duress customers. Another alternativeis mudaraba and musharaka mini-investment projects, which may be specificor general in scope, where liquid funds areadvanced to the customers. There arevarious methods for reducing the usualmoral hazard in such transactions, but toelaborate on these would be beyond thescope of this article.

Frank and Meaningful Acknowledgement

The very first step towards anyimprovement must begin with a frank,unqualified and meaningful appraisal andacknowledgement of the situation. Anycorrective measures taken must necessarilybe a subsequent step. This acknowledge -ment, it seems, cannot be readily observedat present in the Islamic finance industry.

Conclusions

This article has sought to demonstrate thatdespite the perceived conflict betweenAAOIFI’s Shari’ah Standard 30, whichpermits tawarruq and the ICFA’s rulingforbidding organised tawarruq that, inactual fact, there is no real disagreementbetween the views held by these twoorganisations.

The key point to note is that AAOIFIpermits a reformed version of tawarruq,which is not practised virtually anywhere inthe industry at the moment. As a necessaryaccompaniment, AAOIFI by implicationclearly forbids the existing form oftawarruq, as does the ICFA. In effect theICFA says ‘the prevalent form of tawarruqis not permissible, to which AAOIFIimplicitly nods and adds ‘if you must dotawarruq, Shari’ah Standard 30 will showyou how.’ By further implication, both ICFAand AAOIFI add the comment: ‘. . .although it is quite possible that, if you dotawarruq according to Standard 30, youmay not want to do it at all due todramatically reduced profitability andfeasibility concerns, which is fine.’ Bothinstitutions, therefore, are quite comfortablewith eradication of organised tawarruq as itexists presently, a sentiment shared by manyother stakeholders in Islamic commerce.

Dr Salman Khan is Head of Shari’ahOffice (Dubai) at Abu Dhabi IslamicBank. Dr Khan possesses multifacetedexperience and expertise across a widerange of activities including Islamicfinance instruction and training, Shari’ahconsultancy, Shari’ah-based productdevelopment and structuring, Shari’ahreview and Shari’ah coordination.Previously, Dr Khan worked in the fieldof Shari’ah advisory in London, UK. DrKhan obtained a Doctorate in Economicsfrom Oxford University, an MPhil inDevelopment Studies from CambridgeUniversity and a BSc (Hons) inEconomics from University CollegeLondon. He is a strong advocate of the‘substance and form’ viewpoint withregard to Islamic finance.

All ideas and views expressed by DrKhan in his articles, lectures andtrainings are based entirely on hispersonal convictions and do not seek torepresent the views of any organisationor other person in any way.


www.newhorizon-islamicbanking.com22 IIBI


July: The Regulation and

Taxation of Islamic

Finance in the UK

Promoting Islamic finance

Mohammed Amin set the scene, explainingwhy the UK needed a special tax law forIslamic finance to level the playing fieldwith their conventional counterparts. Hefocussed particularly on changes to the lawin 2007and 2009.

Changes in 2007

In 2007, a basic tax law was enacted toenable sukuk to work. On creation of thesukuk, two requirements were stipulated -one person (the bond holder) had to pay asum of money (the capital) to another (thebond issuer) and the assets (the bondassets), which the bond issuer would acquireto generate income or gains, had to beidentified.

In addition there must be a specified periodwhen the arrangements would end (thebond term) and the bond issuer mustundertake:

❑ To dispose of any remaining bond assetsat the end of the bond term.

❑ To make repayments of capital during orat the end of the bond term.

❑ To make other payments to the bondholder (additional payments). Theseadditional payments must not exceed areasonable commercial return on a loanequivalent to the capital.

A number of further requirements were alsoset out in the legislation:

❑ The bond issuer must undertake tomanage the bond assets;

❑ The bond holder is able to transfer his

rights to other persons, who thereby becomebondholders;

❑ The arrangements should be listed on arecognised stock exchange, as defined in theIncome Tax Act 2007;

❑ The arrangement should be treated as afinancial liability of the bond issuer, ifaccounted for under InternationalAccounting Standards (IAS).

The provisions of the 2007 law meant thatin tax terms, for the issuer, the AFIB wastreated as a loan relationship and waseffectively treated the same as debt, whereperiodic payments were treated asdeductible interest; the issuer was taxed as ifthey were the beneficial owner of the assetsand the relevant section of ICTA 1988,which treats profit-related interest as anon-tax-deductible distribution, wasoverridden.

For investors, the 2007 law treated the AFIBlike a security for tax purposes. Investorswere therefore taxed in the same way as fordebt instruments. For the corporate investor,this was the same as a loan relationship andfor the individual investor it was theequivalent of interest bearing debt. Therewas no Capital Gains Tax (CGT) if theAFIB was denominated in sterling and wasnot convertible; there was no VAT, SDLT orstamp duty on transfers and issue discountwas taxable as if it were interest.

Changes in 2009

In 2009 changes were made to the wayAFIBs were handled with the objective ofeliminating Stamp Duty Land Tax (SDLT)charges on the creation and transfer back ofthe asset; eliminating the taxation of built-incapital gains and leaving capital allowanceswith the original owner. The provisionswould apply only to AFIBs based on landand buildings. Yet again further conditionsprescribed exactly how these transfers had

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to take place in order for the changes toapply. In particular the value of the AFIBissued had to be greater than 60% of theland value and termination was to be lessthan 10 years.

To avoid abuse of the system it wasstipulated that control of the land must not be acquired by a bond holder or a group of connected bond holders.Additionally, arrangements must be for‘genuine commercial reasons’ and not ‘forthe avoidance of a liability to tax’.

If all the conditions were met, then therewould be:

❑ No SDLT on transfer to SPV (SpecialPurpose Vehicle) which is going to issue theAFIB

❑ No SDLT when SPV transfers back toowner

❑ No CGT on transfer to SPV

❑ No CGT when SPV transfers back toowner

❑ No tax depreciation recapture on transferto SPV

❑ The owner would keep receiving capitalallowances while the SPV owned thebuildings.

In practice, the owner gives a purchaseundertaking to the SPV, which is basically aput option; the SPV gives a sale undertakingto the owner, which equates to a call option,both at the same strike price. Theoverwhelming commercial likelihood is thatthe asset will be transferred, because theprice will inevitably have changed from thestrike price, making it attractive to one orthe other party. This, however, does amountto a contractual obligation, so it does notmeet the HMRC rules. Whether they willuse their discretion or not is to be tested


(Amendment) Order provides a freestanding regulatory definition of anAFIB and excludes AFIBs from CIS rules.The regulatory changes introduce clarityand create a level playing field betweencomparable instruments. Regulating AFIBs in an equivalent manner toconventional debt securities reducescompliance and legal costs for theseinstruments and thus facilitates theirissuance in the UK.

Prospective Change

Amin highlighted a change that is likely tobecome law in the near future regardingproperty refinancing. Under the Islamicsystem refinancing begins with selling theproperty, then buying it back in ‘slices’through the payment of rent. This model,however, incurs a liability to CGT on thehistoric appreciation of the property,because of the sale element.

Following extensive consultations, the UKgovernment has agreed to change thisanomaly, modelling the new law on theAFIB changes which occurred in 2009.

Liquidity Management

Finally, Amin considered the issue ofliquidity management for Islamic banks.Bank deposits are normally of shortermaturity than bank assets; banks never holdenough cash and ‘near cash’ instruments torepay all of their deposits and there is,therefore, the danger of bank runs ashappened with Northern Rock. The keyquestion is how much liquidity banksshould hold and what kind of assets qualifyas cash and ‘near cash’. The problem for

IIBI 23www.newhorizon-islamicbanking.com


soon. It will be difficult for them to reject it,because in contrary circumstances, when theexistence of equal and opposite optionswould create a tax liability, HMRC alwaysargue that the put and call option pairing isequivalent to a binding contract.

The 2009 changes also affected takaful andwakala.

The tax law was extended to includeinsurance companies as defined for UK law,but also included ‘a person who isauthorised in a jurisdiction outside theUnited Kingdom to carry on a businesswhich consists of effecting or carrying outcontracts of insurance or substantiallysimilar business’, thus taking in takafuloperators.

Under the 2006 law wakala was asymmetricsince the wakil had to be a recognisedfinancial institution in order for the wakala(profit share agency) rules to apply. In 2009this was changed. It is now sufficient foreither the wakil or the principal in a wakalaagreement to be a recognised financialinstitution.

Amin also covered a recent regulatorychange concerning sukuk and the collectiveinvestment scheme rules.

The structure of certain sukuk instrumentsmeans that for regulatory purposes theyappear to fall within the definition of acollective investment scheme, although theyhave similar economic characteristics toconventional debt instruments and shouldbe regulated in a way which reflects thissimilarity. The Financial Services andMarkets Act 2000 (Regulated Activities)

IIBI LECTURES

Islamic banks is that none of theinstruments recommended in the FSAconsultation paper of December 2008comply with Shari’ah law.

Conclusions

Amin concluded by saying that the UK wasfar ahead of other non-OIC (Organisationof Islamic Conference) countries inaccommodating Islamic finance, but thatcontinuing legislative changes are expectedto equalise the treatment of Islamic financeand conventional banking.

August: Equity screening

and purification.

The idea that financial markets need to havea sense of morality and responsibility is not

new and is not confined to Islamicscholarship. Long before the recent crisisthe eminent British economist LionelRobbins said, “The pursuit of self-interest,unrestrained by suitable institutions, carriesno guarantee of anything but chaos.” It

was, therefore particularly appropriate thatthe IIBI’s (Institute of Islamic Banking andInsurance) August lecture was on the topicof equity screening and purification.

Asim Khan began with a stripped-down

Promoting Islamic Finance

Amin is a graduate of Clare College,Cambridge, later training as a charteredaccountant and chartered tax advisor. Mostrecently he spent 19 years as a tax partnerat PriceWaterhouseCoopers LLP beforeretiring at the end of 2009.




overview of Islamic finance explaining thatit is principle based, rather than rule basedand hence provides room for interpretation.Further, everything is permissible in Islamicfinance, except for those things which are incontradiction with the guidelines as set outin Shari’ah. In common with the world ofbusiness in general, however, it is importantthat the Islamic financial transactions makeeconomic sense and be legally enforceablealongside being fully Shari’ah compliant.

Equity Screening

Equities need to be assessed for Shari’ahcompliance before any investments can bemade. Under the guidelines as set out inShari’ah, scholars have developed Shari’ahscreens, which need to be passed before anystock can be considered as Shari’ahcompliant. Shari’ah screens take intoaccount both business activities andfinancial ratios.

The business activities that are considered tobe non compliant include alcohol, tobacco,gambling and those businesses involvedwith pork or non-Halal meat fairlyobviously, but also hotels, music,entertainment, cinema, adult entertainment,defence and weaponry and perhaps cruciallyconventional financial services. If however5% or less of the income of a business,including interest income, comes fromnon-compliant sources then it can beconsidered to be Shari’ah compliant, subjectto appropriate purification.

In addition, for listed equities, Shari’ahscholars have prescribed three financialratios, all of which need to be within therequired threshold.

1. Interest bearing financing should bewithin specified limits

2. Interest generating assets should bewithin specified limits

3. Testing tradability of the financialinstrument.

Limit interest bearing financing

This ratio screens out companies that makeexcessive use of interest bearing liabilities to

finance their business activities. The ratioused to measure this aspect is:

Total interest bearing debt/total assetsshould not exceed 33%

‘Interest- bearing debt’ means all funds raisedby the company on which interest is paidsuch as bank loans and overdrafts, notespayable, preference shares, loans from relatedparties, credit facilities, debentures, notesissued, advance from suppliers, finance leases,etc. Certain liabilities, which themselves maynot generate interest income, but are relatedto non-Shari’ah-compliant activities such asderivatives and fair value of financialinstruments should also be included as part ofthis calculation. It should be noted that anyfinancing through an Islamic financialinstitution or via an Islamic mode of financesuch as sukuk is not included in the interest-bearing debt’.

Limit interest generating assets

This principle screens out companies thatmake excessive use of investments ininterest-bearing assets such as bank balancesand deposits, loans to related parties,advances to customers, long-termreceivables, investments in notes,commercial papers and treasury bonds andfinance leases, as part of their business. Theratio used to measure this aspect is:

Total interest income generating assets/totalassets should be not exceed 33%.

Certain assets, such as derivatives,investments in non-Shari’ah-compliantbusinesses and fair value of financialinstruments, which may not generateinterest income, but are related tonon-Shari’ah-compliant activities, shouldalso be included as part of this calculation.

Testing the tradability of financialinstrument

This principle is used to screen outcompanies that do not have a significantportion of ‘real and tangible’ assets on theirbalance sheet – fixed assets, stocks andinvestments in equities for example. Theratio used to measure this aspect is:

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(Cash+Accounts Receivables+Pre-payments)/Total assets should not exceed 70%

For the purpose of the above ratio, the term‘Accounts Receivable’ used by the Shari’ahscholars is more conceptual and muchbroader than just the accounting term. Itincludes any and all assets which arereceivable in nature and not backed by ‘realand tangible’ assets, whether interestbearing or not, such as trade debtors,receivables from related parties, advances tosuppliers, advances to customers,investments in notes, commercial papersand treasury bonds, finance leases andderivatives. Similar to the other financialratios, any investment with an Islamicfinancial institution or in an Islamicfinancial instrument such as sukuk isconsidered as ‘real and tangible’ and is notconsidered as part of this above ratio.

Shari’ah screening for Islamic financialinstitutions?

Asim Khan also highlighted the fact that,for investment in equity of an Islamicfinancial institution, there is no need forscreening (and purification) if the Islamicfinancial institution is:

❑ a separate legal entity and established todeal only in Shari’ah compliant transactions

❑ has appointed a Shari’ah SupervisoryBoard which provides oversight and sign-offon all product development, implementationand monitoring along with providing on-going guidance on all Shari’ah relatedmatters, and issuing Fatwa(s) to that effect

❑ the above aspects are formallydocumented in its formation documents (i.e.articles and memorandum of association)and reported along with its annual auditedfinancial statements.

Common Mistakes in Shari’ah Screening

There are a number of common mistakesthat can occur during the Shari’ah screeningprocess. In relation to business activities, forexample, organisations sometimes fail toanalyse their activities in sufficient detail orsimply consider the list of non-compliantactivities in the Fatwa as an exhaustive list;


WORLD EXCHANGESGLOBAL INDUSTRY OUTLOOK AND INVESTMENT ANALYSIS

MARCH 2010




they also sometimes fail to take intoaccount companies which are not directlyinvolved, but facilitate the non-compliantactivities. There is also the issue where thebusiness activities of the company are in the‘grey areas’ on which further interpretationis required from the scholars before thesecan be deemed as compliant. Organisationsneed to make a very comprehensiveexamination of the interconnected web ofholding companies, subsidiaries andinvestments to be certain that the holdingcompany is Shari’ah compliant.

In relation to calculating financial ratiosthere is sometimes a failure to consider allof the interest-bearing liabilities andinterest-generating assets on the balancesheet such as debentures, preference shares,derivatives, investments in non-compliantequity instruments, notes payable andlong-term receivables. Similarly some itemsare incorrectly included, e.g. cash and bankbalances and investments with Islamicfinancial institutions. It should also benoted that the most recent financialstatements available, at the time of thescreening, should be used.

What is Purification?

Purification is the process by which thenon-Shari’ah compliant income element isidentified, calculated and given forcharitable purposes. It is important to notethat the concept of ‘purification’ in relationto equity stocks is only applicable where thenon-compliant income is 5% (or less) of thetotal revenues. If the non-Shari’ahcompliant income is more than 5%, thenthe stock is deemed to be non compliantand the organisation should dispose of thestock.

There are two main approaches forpurification of equity stocks – dividendpurification and haram income purification.Dividend purification is calculated bydividing prohibited income (includinginterest income) by total income andmultiplying by the dividend received.Haram income purification is calculated bydividing total prohibited income (includinginterest income) by the number of sharesissued at the end of the period and

multiplying by the number of shares held.The latter method is the one preferred byShari’ah scholars.

Shari’ah Monitoring and Reporting

Shari’ah scholars require that Islamic fundsneed to be independently monitored forShari’ah compliance on a periodic basis.The purpose of Shari’ah monitoring is bothto re-confirm compliance with the approvedFatwa and generally accepted Shari’ahguidelines and to provide comfort to Islamic investors about the on-goingShari’ah compliance of the Islamic fund.Upon completion of Shari’ah monitoring,the working papers are reviewed by theShari’ah scholars and an ‘Opinion onShari’ah Compliance’ for the period

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reviewed is issued which is signed by the Shari’ah monitor and the Shari’ahscholar.

Grey Areas of Compliance

Audience questions focussed on the greyareas of compliance, particularly in relationto a business, which, although otherwisecompliant, facilitated a non-compliantbusiness. One example given was of aninvestment in a building that wassubsequently let to a number of shops, someof which may have been selling prohibitedgoods. Asim Khan explained Shari’ahscholars look at each instance of ‘grey area’and provide guidance for that specific issue,hence, all “grey areas” should be discussedwith the Shari’a scholars.

Asim Khan is a chartered accountant with more than 15 years experience in financialservices (including conventional and Islamic financial institutions) and the oil and gasindustries across the Asian sub-continent, the Middle East and Europe.



NEWHORIZON Shawwal-dhu al Hijjah 1431 POINT OF VIEW

Usman Hayat is the Director of IslamicFinance and Environmental, Social andGovernance (ESG) Investing at theEurope, Middle East, and Africa (EMEA)office of CFA Institute, a globalassociation for investment professionals.He was previously with Asia Pacific officeof CFA Institute in Hong Kong and hasalso worked as an independent consultantin the capital markets of Pakistan and asJoint Director at Pakistan’s Securities andExchange Commission.

Does its future lie in being developed asIslamic or ethical finance in European retailmarkets? This question is beginning todemand an answer. Contrary to theirexpectations, some institutions offeringIslamic financial services in the retail market in the UK the leading centre ofIslamic finance in the West – have found itchallenging to be profitable or, at least inone case, even to continue operating. This is a situation often attributed in part to their focus on Muslims, estimated at around just 4% of the total UKpopulation.

While Islamic finance in the UK retailmarket is facing these challenges, the secularethical finance sector with its broad-basedappeal is not. In fact, it is reported to begrowing. Islamic finance is also supposed tobe ethical finance, but, in reality, the two arestructured and marketed differently andprobably perceived as being different too.With other European countries, such asFrance, Germany and Spain looking to learnfrom the UK’s experience in Islamic finance,when the issue of allowing Islamic financialservices at a retail level is raised, it is worthrevisiting the question.

Ethics in Financial Services

Ethics in financial services refers to theinclusion of moral values in financialdecisions. It is, however, difficult to separate‘ethics’ from ‘social responsibility’ and‘sustainability’ – these are often differentlabels put on similar ideas and the finedistinctions made are not widely appreciated.

Since it is faith based, Islamic financearguably has an obligation and not an optionto be ethical and this is one way itdifferentiates itself from conventionalfinance. Following Islamic principles infinance, however, does not necessarilyrequire an institution to market itself asIslamic. It is a business decision and weobserve different practices in Islamicfinancial institutions (IFIs) and the Islamicwindows of conventional financialinstitutions, where some use their religious credentials more than others.

Ethics in Islamic Finance

The attributes that people seem to associatewith ethics in Islamic finance range from theminimum juristic requirements to theaspirational - avoiding ‘sin’ industries suchas alcohol; abiding by the two coreprohibitions of riba and excessive gharar;promoting economic justice; wideningaccess to finance; enhancing human welfareand caring about the environment amongothers. Some may argue that the two coreprohibitions provide the foundation forwider ethics in Islamic finance. Prohibitionof riba avoids making money from moneyand promotes assets and enterprise; theprohibition of excessive gharar avoidsspeculative excesses and promotes risksharing and together the two should keepfinance tied to the real economy.

Beyond the core prohibitions, much of whatmay be considered as ethical in Islamicfinance is covered in the standard,‘Corporate Social Responsibility Conductand Disclosure for IFI’ by the Accountingand Auditing Organisation for IslamicFinancial Institutions (AAOIFI). Table 1 onpage 28 gives a top-line view of thestandard covering both mandatory andrecommended conduct. The standard statesthat it is based on Islamic ideas such thatman is vicegerent of and accountable toGod.

Ethics in the Secular Space

In the secular space, ethics tends to revolvearound environmental, social or corporategovernance (ESG) issues. This is also shownby the UK-focused websiteYourEthicalMoney.org, a non-profitinitiative of the charity EIRIS Foundation.

The website tells you where a UK bankstands on a three point scale - worse, okayor better, using the eight criteria shown inTable 2. The highest rated bank fared“better” on all except responsible lendingwhere it was only okay; 10% of its directorswere female. An Islamic bank got “better”on the first two criteria; okay on financialexclusion and “worse” on others; 27% ofthe senior management positions were heldby women. The lowest rated entity was“worse” on all criteria and there was nodata on the gender composition of theboard. (Site accessed on 9 Aug 2010)

Similarities and Differences

Everyone may not see the website’s criteriaor AAOIFI’s standard as an accurate repre -sentation of ethics. The comparison of thetwo, nevertheless, suggests that both Islamic

Islamic or Ethical Finance:Where is its Future in European RetailMarkets?




finance and secular ethical finance areconcerned with the purpose of financingand the financier’s actions, with a similarESG perspective, which encourages theavoidance of harm and the doing of good.There are differences as well. Within theESG focus, it seems the AAOIFI standardputs more empha sis on society, whereas thewebsite’s criteria put more emphasis on theenvironment.

Narrowing the scope of ethics in Islamicfinance is likely to produce more differenceswith the secular space and may not even

meet the expectations of all Muslims. Forinstance, an otherwise ‘Shari’ah-compliant’institution without an environmentalagenda may not be seen as favouringsustainability even though sustain ability is apriority in the secular space. Moreimportantly, because of the two coreprohibitions in addition to the purpose offinancing, Islamic finance is also concernedwith the structure of financing, which doesnot stand out as an ethical concern in thesecular space.

Islamic Finance is More Constrained

In the secular space, the source of ethics isthe people. What is ethical ‘depends onyou’, which means that ethics could changeacross place and time. People may besensitive to one issue, but not another andfinancial institutions may target specificissues, such as environmental sustainability.

That may not be true to the same degree inIslamic finance, where the source of ethics isthe religion; it is the interpretation and notthe source that changes and an IFI has totake the given ethics as a whole. Forinstance, in general, an Islamic equity fundhas to screen out all ‘sin’ industries (fromalcohol to conventional banking); avoidhighly leveraged companies and donatetainted dividend income, whereas a secularfund may present itself as ethical by only

POINT OF VIEW

excluding tobacco. On the whole Islamicfinance seems to put more ethicalconstraints on financing than secular ethical finance though critics may argue that the Islamic finance industry respectsthese constraints more in form than insubstance.

Ethics and Business Viability

Given the core prohibitions in Islamicfinance that an IFI must abide by and thesmall size and relative youth of IFIs ingeneral, trying to beat conventionalfinancial institutions at their own game doesnot seem feasible in the European retailmarkets. Add to that the facts that not everyMuslim can be expected to be sensitive toIslamic teachings in finance; those who aresensitive may not be willing to accept whatis offered to them as religiously authenticand those who are willing to accept what ison offer may not have the income andwealth that would suit the financialinstitution. Such repeated filtering of thetarget universe may not leave enoughcustomers to make a viable business. Anethical proposition for the wider populationcould be a possible means of creating adifferentiated and viable business withoutlosing out on the Muslim community, butthat may require a legal structure and amarketing strategy that are tied to widerethics.

Ethics and Mutuals

Historically a mutual legal structure hasbeen common in ethical finance. Mutualityis seen as more amenable to ethical pursuitsin financial services. It is not subject to thedichotomy between shareholders andcustomers; one membership means one voteand the entity may not single mindedlypursue a one-point agenda of profitmaximisation under the watchful eyes ofstock market.

Mutuality has not been the structure ofchoice in Islamic finance except inestablishing takaful (or insurance) fundswhich, again, are usually managed by afor-profit operating company. A non-profitmutual structure may also help allay thefears of those who see modern Islamic

Table 1: AAOIFI’s standard on CSR

Mandatory Conduct, policy on… Recommended Conduct, policy on…

• Screening clients (client’s business is not against • Qard Hasan (or interest free loan)Islamic teachings or core CSR aspects of this standard, etc.)

• Responsible dealings with clients (avoiding • Reduction of adverse impact on the environmentimposing onerous terms, encouraging (waste management, renewable energy, etc.)inappropriate consumption, etc.)

• Earnings and expenditure prohibited by Shari’ah • Social, development and environment-based(identification, disposal, etc.) investment quotas

• Employee Welfare (equal opportunity, etc.) • Par excellence customer service

• Zakah (an obligatory religious contribution) • Micro and small business and social savings and investments

• Charitable activities

• Waqf (Islamic endowment) management

Table 2: Criteria used for banks byyourethicalmoney.org

• green/ethical products (e.g. green mortgages)

• ethical lending or insurance (e.g. screeningclients on human rights)

• responsible lending (e.g. checking on borrower’sability to pay)

• financial exclusion (e.g. no frills bank accountsfor low-income)

• environment (e.g. energy and wastemanagement)

• carbon neutral (e.g. offsetting emissions)

• equal opportunities (e.g. race, gender inemployment)

• percentage of women in board of directors orsenior management



NEWHORIZON Shawwal-dhu al Hijjah 1431 POINT OF VIEW

finance as Shari’ah arbitrage, where, in thename of religion, Muslims are asked to paymore to for-profit companies for what isotherwise available for less.

Professor Mahmoud El Gamal, known forhis criticism of the modern Islamic financeindustry for putting religious form oversubstance has also advocated mutuality onreligious, economic, and regulatorygrounds. This is not to say that mutuality byitself can overcome all challenges. Forinstance, mutual or not, the organisationwould need to offer service standards thatwould meet the expectations of itscustomers and shape its governance to dealwith ethical demands in both an Islamic andsecular context.

Mutuality may also bring challenges of itsown in terms of accessing capital,particularly in the initial years. Mutualshave dwindled in numbers after a wave ofdemutualisation, though some in the ethicalfinance sector are expecting the wind tostart blowing in favour of mutuals in theaftermath of the financial crisis.

Ethical Finance in the UK

Ethical finance is marketed differently fromIslamic finance. For instance, it targets alarger section of the population emphasisingcompetitive services, a strong environmentalappeal, a focus on the common man and noreligious symbolism. This is also why thetwo are probably seen as different.

Where prospects of Islamic finance in theUK’s retail market are being questioned,reports are somewhat more bullish on theprospects for ethical finance. According toEthical Investment Research Services(EIRIS), a subsidiary of EIRIS Foundation,the money invested in Britain’s green andethical retail funds was £9.5 billion at theend of 2009 representing approximately750,000 investors, up from around £2.4 billion and 200,000 investors in 1999.

The Ethical Consumerism Report 2009 bythe Cooperative Financial Services group,which includes the Co-operative Bank,states that overall the ethical finance market

in the UK was worth £14.35 billion in 2008compared to £5.17 billion in 1999. Thegroup also reported that despite thefinancial crisis, 2009 was the ‘thirdsuccessive year of double digit growth ingroup sales and profit’ and ‘switching ofcustomer accounts from the so-called ‘bigfive’ banks to the Co-operative Bankincreased significantly.’

Islamic Finance in European Retail Markets

Like the UK, other European countriesinterested in Islamic finance will setobjectives tailored to their own particularcircumstances but they are likely to lookclosely at the UK experience, which suggeststhat in the retail market focusing only on

Muslims with a mainly religious propositionis unlikely to be the best approach.

There is much in common between ethicaland Islamic finance and this could be usedto create an alternative approach. Onepossible alternative is a mutual structurewith an ethical proposition for the broaderethical market, but one which also takesinto account the unique requirements ofIslamic finance.

It would be interesting to observe whatconclusion other European countries drawfrom the UK experience and if and how theyfacilitate development of Islamic finance intheir retail markets on an ethicalfoundation.

Disclaimer: The views expressed here are solely those of the writer and not of his employer.


APPOINTMENTS

International law firm Pinsent Masons hasstrengthened its banking and finance serviceoffering with the appointment of AmirAhmad. Ahmad, who will be based inPinsent Masons’ Dubai office, will report toAl-Harith Sinclair who heads the firms’ newIslamic Finance practice. Together they willwork on three key areas – growing thefirm’s Islamic finance practice in Londonand the Gulf; Gulf financial regulatorymatters and Gulf project finance and otherfinance matters.

Ahmad, aSeniorAssociate, joinsPinsent Masonsfrom DLA PiperDubai where hewas previouslypart of Al-Harith Sinclair’steam. Ahmadhas 10 years offinance-basedexperiencegathered in the

Netherlands, Bahrain and Dubai.

Bahraini retail and commercial bankinginstitution, BMI Bank (BMI), recentlyannounced the appointment of BahrainiSalah Khalifa to the position of Head ofIslamic Financial Services (IFS). Salah,whose previous position was as a Directorof Investments and Capital Markets at FirstInvestment Bank (FIB), a Bahrain-based,Shari’ah-compliant investment bank, will beresponsible for driving the IFS strategy.

In his previous role at FIB, Salah lookedafter corporate finance and structuring,asset management, treasury, financialinstitutions and debt capital markets (sukukand securitisation). Prior to joining FIB,Salah was the Head of Islamic capitalmarkets at Calyon Credit Agricole,responsible for the development of Islamic

institutional banking in the region andstructuring and sales of Islamicised capitalmarket/debt capital markets products andservices. His prior posts included Head ofIslamic Financial Services Department ofBankMuscat, Bahrain branch and Manager,Structured Finance at Al Shamil Bank.

EIIB (European Islamic Investment Bank)has appointed Yaser Abduljalil Ali Alsharifito its board of directors as a non-executivedirector effective from 27 July 2010. Mr.Alsharifi is Managing Director, Investments,at Al Rajhi Holdings and was previously apartner at Ernst & Young, Bahrain. He is aCertified Public Accountant and holds aBachelor of Business Administration(Accounting), Cum Laude from theUniversity of Massachusetts at Amherst,USA and an Associate Accounting Diplomafrom the University of Bahrain.

International legal practice Norton Rose(Middle East) LLP has announced thatMohammed Paracha is to join the bankingpractice in Bahrain as a partner and deputyglobal head of Islamic finance. Mohammedjoins from Al Salam Bank-Bahrain B.S.C.,where he was Executive Vice President andHead of Europe. He previously spent threeyears in Norton Rose Group’s Londonbanking team before working for two yearsin the bankingteam of theBahrainpractice.

Mohammed’sappointmentfurtherstrengthensNorton RoseGroup’s Islamicfinance presencein the MiddleEast, following

the relocation of Global Head of IslamicFinance, Neil D Miller to the Dubai office in2009 and demonstrates its continuingcommitment to the Islamic financial sector.

UnicornInvestment Bankheadquartered inBahrain hasannounced theappointment ofMr IkbalDaredia asinterim CEO ofthe Bank. Mr.Daredia is theGlobal Head ofthe Bank’s

Capital Markets, Institutional Bank ing andTreasury areas and has more 20 years ofexperience of Islamic finance. having He waspreviously Deputy CEO of Noriba, UBS’sformer global Islamic product plat form. Mr.Daredia replaced Mr. Majid Al Refai, formerMD and CEO of Unicorn Investment Bank atthe beginning of August 2010.

Bahrain-based Ithmaar Bank has announcedthe appointment of Mohammed AbdulRahman Bucheerei, a member of theIthmaar Board of Directors, as the Bank’sChief Executive Officer. He currently alsoserves on the Board of Directors of theIslamic Investment Company of the Gulf(Bahamas) Limited, Faysal Bank Limited(Pakistan), the Overland Capital Group(USA) and Solidarity Group (Bahrain).

Bucheerei commenting on his appointmentsaid, ‘Ithmaar Bank heads one of the mostdiversified financial services groups in theMiddle East. It is a formula that has workedexceptionally well for the Group, but wecannot afford to get complacent and,following the Ithmaar-Shamil reorganisation,our focus moving forward must be on theefficient implementation of the Bank’s newthree-year strategic plan 2010–2012.’

On the move


mwww.newhorizon-islamicbanking.com30 IIBI


31 IIBIwww.newhorizon-islamicbanking.com

investment (SRI) funds would avoid such as weapons trafficking,pornography, tobacco, alcohol and gambling.

Certificate in takaful Course Syllabus

Module 1 – InsuranceLesson 1 Risk and insuranceLesson 2 The nature of insurance and its benefits to societyLesson 3 Legal aspects of insuranceLesson 4 Insurance contractsLesson 5 Insurance company operations

Module 2 – The Framework of takafulLesson 1 The character of Islamic insuranceLesson 2 The concept of takafulLesson 3 The operating principles for takaful business

Module 3 – Takaful BusinessLesson 1 Family takaful (life) – key products and operational

issuesLesson 2 General takaful (non-life) – key products and

operational issuesLesson 3 Retakaful of takaful business (Reinsurance)Lesson 4 Investment considerationsLesson 5 Marketing and distribution of takaful products

Module 4 – Governance and Regulation of takafulLesson 1 The regulation of insurance businessLesson 2 Governance and Shari’ah complianceLesson 3 Accounting and financial issues

The Certificate in takaful requires proficiency in the Englishlanguage, writing and reading, as well as computer literacy. It hasbeen developed keeping in mind the expectation of employers andwill offer students an integrated programme of learning andpractical knowledge. Individuals who have insurance qualificationsfrom other professional Institutions would be entitled to apply forexemption from certain lessons.

Course Fee

The promotional price is only £195 inclusive of registration fee,one year IIBI membership, course study material, tutor support anda one-time examination fee.

For more information about the course, please visit the coursesection of the IIBI’s website www.islamic-banking.com.

As part of its strategy to widenthe choice of professionalqualifications, the Institutelaunched a Certificate in takafulin July 2010, which is aimed atindividuals who wish to developan understanding of the natureand basis of takaful and itsapplications as an alterative toconventional insurance. Thecomprehensive course, like otherIIBI courses, assumes noprevious knowledge ofinsurance or Islam and isintended to fill thehuman-resource gap in thetakaful sector. The course isopen to a worldwide audienceand the method of study is bydistance learning, allowingstudents to work at their ownpace and from home.

Insurance plays a vital role insociety supporting both nationaland international economicdevelopment and growth. Inrecent years, takaful (commonly

IIBI Launches Certificate in Takaful

IIBI NEWS

referred to as Islamic insurance)has emerged as one of thefastest growing segments of theIslamic finance industry. Thegrowing Muslim middle classworldwide and the relativelylow insurance penetration ratepresent enormous opportunitiesfor the takaful business. Theworld population of 1.5 billionMuslims represents a hugepotential customer base and themoral element is also a powerfulbusiness argument for attractingnon-Muslims to takaful.

Takaful allows Muslims to availthemselves of the financialprotection offered through aninsurance contract withoutviolating their religious beliefs,but it also provides compellingbenefits to both religious andsecular customers. Unlikeconventional insurance wherethe motive is to generate profitfor the benefit of theshareholders, in takaful, as withmutual insurance, the business is

conducted for thebenefit of theparticipants(policyholders) whoare also entitled toshare in the profit ofthe takaful business.

The Shari’ahprohibits investmentin businesses that areengaged in activitiesthat are consideredunlawful or immoral,which includes mostof the businesspractices andactivities that sociallyresponsible

The mission of the IIBI is to be a centre ofexcellence for professional education,

trainng, research and related activities, tobuild a wider knowledge base and

deeper understanding of the world offinance promoting the Islamic principles

of equity, socio-economic justice and inclusiveness. The Institute holds

regular lectures on topical issues, deliveredby industry experts. For information onupcoming lectures and other events,

please visit the IIBI’s website:www.islamic-banking.com



www.newhorizon-islamicbanking.comIIBI 32

October

27–28: Malta Islamic FinanceConference: A new Beginning 2010,Floriana, MaltaOrganised by the Malta Institute ofManagement, the conference will discusspractical issues and opportunities, particu -larly those in the EU and North Africa.Applications and further details:www.maltamanagement.com

25–27: 2nd Annual World Islamic RetailBanking Conference, DubaiThis conference series was prompted by thecomments of Saudi Arabia’s central bankgovernor Muhammad Al Jasser, who said,‘Islamic retail banking is to lead assetgrowth of the Islamic finance industry.’ Arange of topics will be covered includingharnessing technology, an analysis of theconventional banking competition andsatisfying the demand for new products.Contact: Lucia KasanickaTel: +9181 0580 5411Email: lucia.kasanicka@fleming gulf.comwww.fleminggulf.com

November

22–24: 17th Annual World IslamicBanking Conference (WIBC), BahrainConference to discuss the key issues,developments and challenges ofSharia’ah-compliant banking and financeworldwide. Investment leader and emergingmarkets guru, Mark Mobius will deliver thekeynote address – Shifting Perspectives fromCrisis to Recovery to Sustainable Growth.Contact: Andrew ChopraTel: +971 4 343 1200Email: [email protected]

Diary of Events endorsed by the IIBI

IIBI NEWS

29: The Polemics of Governing Law in Islamic Finance – RecentDevelopments and the Way Forward,LondonThe 2nd Annual International ThematicWorksop 2010 is a one-day event organised by ISRA, IIBI and ThomsonReuters. The two keynote speakers will be the Deputy Governor of Bank NegaraMalaysia and the Lord Mayor of London.Attendance by invitationContact: Mohammad ShafiqueTel: +44 (0)20 7245 0404Email: [email protected]

Throughout 2010 IIBI is organising a number of training workshops to build the skill

base and share ideas among practitioners within the Islamic finance industry. The

objective of the Institute’s training is to fill the human resource gap and to enhance the

professional skills of personnel who are either interested in building their careers or are

already involved in the Islamic finance sector. Training programmes are delivered by

experienced professionals; the number of participants is kept small to enable sessions

to be as interactive as possible and the objective is to provide a practical learning

experience for the participants with the help of appropriate case studies. For more

information about upcoming programmes, please visit: www.islamic-banking.com.

In March 2009 Murat Hasan Unal ofFunds@Work published his report aboutthe involvement of Shari’ah scholars infinancial services institutions across theworld, bringing substantial transparency tothe topic. In the 18 months since then therehas been a lot of discussion about Shari’ahscholars, their board memberships andproper Shari’ah governance.

In October’s lecture he will highlight thelatest results of Funds@Work’s analysis ofthe Islamic financial services industrycovering almost 1,400 board positions,

October lecture preview:

The Small World of Islamic Finance – Social Capital’s Impact on Shari’ah

Governance

more than 320 scholars and 400organisations engaged in this sector. He willdiscuss the IFSB, Bank Negara Malaysia andAAOIFI standards for Shari’ah governance ascurrently met by financial services institutionsand will recommend governance measuresthat go well beyond the existing frameworks.

To register, please visit:www.islamicbanking.com

The lecture will take place on 13 October2010 at 6.15pm at:

British Bankers’ Association, Pinners Hall,105108 Old Broad Street, London EC2N 1EX




17th Annual

22, 23 & 24 November 2010, The Gulf Hotel, Kingdom of Bahrain

Supported By

MEGA Brands. MEGA Clients. Market Leaders.Shaping the Future of the Global Islamic Finance Industry Since 1993

WIBC is a MEGA Brand

Contact us: t:+971 4 343 1200 | f:+971 4 343 6003 | P.O. Box 72045, Dubai | www.megaevents.net/islamic_banking

In collaboration with

Mark MobiusExecutive Chairman

Templeton Emerging Markets Group – Singapore

UK Pavilion

Platinum Strategic Partners

Shari’ah Advisory Associate

Platinum Strategic Partners

Jurisdiction Partner

Islamic Finance Administration Partner

Strategic Associate

Ratings Partner

Dispute Resolution Partner

Gold Strategic Partner & Gala Dinner Host

Gold Strategic Partner & Conference Luncheon Host Day 2

Gold Strategic Partner & Refreshment Break Host

Index Partner

Gold Strategic Partners

Islamic Professional Services Partner

Silver Strategic Partners

Singapore @ WIBC Hosted by

Knowledge Partner

Media Associate

Innovation Partner Strategic Exchange Partner

Investment Management Partner

Islamic Financial Services Associate & Award Auditor

Showcasing

Showcasing Luxembourg for Islamic Finance

Platinum & Transaction Banking Partner

Keynote Address by:

Multilateral Strategic Partners

To participate in this prestigious event contact: [email protected] | t:+971 4 343 1200 | f:+971 4 343 6003 | megaevents.net/islamic_banking



NEWHORIZON October–December 2010IIBI NEWS

The IIBI’s Post GraduateDiploma (PGD) course inIslamic banking and insurance ,offered since 1994, is highlyregarded worldwide.

PGD holders may obtain an MAdegree in Islamic banking,finance and managementoffered by the UK-basedMarkfield Institute of HigherEducation (MIHE). It will admitholders of the PGD to the MAin Islamic Banking programme,for which they need onlycomplete a researchmethodology module and adissertation. The degree isvalidated and awarded by theUniversity of Gloucestershire.

The UK-based University ofDurham has accorded thiscourse recognition as an entryqualification for itspostgraduate degrees in Islamicfinance and the Research MA.Applicants will also have tofulfil the specific entryqualifications for each specialistdegree programme.

To date students from nearly 80countries have enrolled in thePGD course. In the period Julyto September 2010, thefollowing students successfullycompleted their studies:

❑ Babar Jamil, ProductManager, Emirates GlobalIslamic Bank , Pakistan

❑ Krishnan-Unni Madathil,Trainee Chartered Accountant,KPMG LLP, UK

❑ Bello Abdulazeez Adeiza,Shari’ah Council Member/

Sharia’ah Compliance Auditor,Hala Takaful Nigeria

❑ Jabeen Zehra Raza, Pakistan

❑ Omar Iqbal Hassen, SriLanka

❑ Abdul Majid Saddique,Assistant Director, Deloitte UKLLP, UK

❑ David Lee, Chief Actuaryand SVP, PT Asurani JiwaSequis Life , Hong Kong

❑ Farhan S Mustafa, UnitedStates

❑ Muhammed BadurdeenMuhammed Nawaz, SeniorExecutive Shari’ah, AmanaTakaful PLC, Sri Lanka

❑ Sunbal Iqbal, MalcolmGaskill Insurance Services Pvt,Pakistan

❑ Sureya Ahmed, UK

❑ Omar Swaleh Mohamed,Branch Manager, Gulf AfricanBank, Mombasa, Kenya

IIBI Awards Post Graduate Diplomas

Ebadullah Bin Siddiq,Singapore

Overall, I was satisfied withthe course as the tutor wasvery knowledgeable and hiscomments after each lesson’sassessment were excellent.

Farida Siddiqui, AssociateProfessor, Maulana AzadNational Urdu University(MANUU), India

The design of the course andthe procedure of submittingthe assignments are verystudent friendly. The contentof the course gave me an in-depth understanding of thefunctioning of Islamicbanking.

Sheheryar Azhar, UnitedArab Emirates

The programme, overall, washelpful in my pursuit of anunderstanding of Islamicbanking and insurance. Ihave already recommendedthis program to a couple offriends.



NEWHORIZON Shawwal-dhu al Hijjah 1431 IIBI NEWS

The Islamic finance sector is oneof the fastest growing segmentsof the global financial industry.It has received tremendousattention recently due to itsavoidance of the worst effects ofthe recent financial storm.Among the factors that shieldedIslamic financial institutions(IFIs) are the facts that theIslamic financial industry aimsto support real economicactivities rather than purefinancial ventures; the Islamiceconomic framework offerscertain rules for the trading ofdebt and therefore preventsIslamic financial institutionsfrom the trading of debt aspractised in conventionalfinancial markets and Islamicinvestment guidelines excludehighly leveraged companies. As the effects of this crisis,however, started to appear inreal economic activities and thevalue of real assets plummeted,IFIs especially those with assetsconcentrated in a few sectors ofthe economy such as real estate,began to feel the pinch. In thelast 18 months or so there havea number of Islamic finance dealdefaults, notably sukuktransactions and others are inthe process of beingrestructured. This scenario hascreated new challenges forIslamic finance practitionerstrying to grow and expand theirbusiness in the aftermath of theworldwide financial crisis andeffectively serve their clients andthe markets in which theyoperate.

Against this backdrop, theInstitute’s 4th annual three-day

residential workshop,‘Structuring Innovative IslamicFinancial Products’ was held atthe University of Cambridge’sChurchill College from 30 Julyto 1 August 2010. Theworkshop was attended bybankers, fund managers,regulators, accountants, lawyersand heads of finance as well asother senior managers in Islamicand conventional financialinstitutions, who came from asfar afield as France, Greece,Lebanon, Luxembourg, Kenya,Kuwait, Mauritius, Nigeria,Saudi Arabia and Trinidad andTobago. The workshop wassupported by Path Solutions – aleading system provider for theIslamic financial servicesindustry and Kuwait-basedRasameel Structured Finance,which specialises in Islamicsecuritisation - raising,structuring and distributingIslamic debt through financialengineering as well as mergersand acquistions. Thepresentations and discussions atthe three-day interactiveworkshop sought to define theunderlying concepts andtechniques that may be used indeveloping innovative Islamicfinancial products.

The workshop, led by DrHumayon Dar, CEO of BMBIslamic – an internationaladvisory firm and a member ofthe IIBI Editorial Advisory Panelfor NewHorizon, began with adiscussion of the key ingredientswhich are essential for Islamicfinancial innovation. Theseinclude cutting-edge knowledgeof the latest financial

technology, a deepunderstanding of the Shari’ahprinciples related to transactionsand a proper understanding ofthe clients’ requirements, as wellas trends in the Islamic financialindustry. He followed up withan exploration of the innovativeapplications of traditionalIslamic finance contracts such asmurabaha, musharaha,mudarabaha and ijarah forfinancial structuring. He movedon to consider the possible useof the some of the conventionalstructures such as UCITS(Undertakings for CollectiveInvestments in TransferableSecurities) for Islamicinvestment and corporatebanking. Dr Dar examined thepossibility of using UCITS forrestructuring Islamic banks andtheir businesses while keeping inview the legal and regulatoryissues.

Mohammed Shafique of theInstitute of Islamic Banking andInsurance then discussed theconcept and applications ofsukuk, normally referred to asIslamic bonds. According to theBahrain-based Accounting andAuditing Organisation forIslamic Financial Institutions(AAOIFI) – an international andcredible standards – setting bodyfor the Islamic financial servicesindustry, ‘Investment sukuk arecertificates of equal valuerepresenting undivided shares inthe ownership of tangible assets,usufructs and services or (in theownership of) the assets ofparticular projects or specialinvestment activity’. Shafiquethen went on to analyse the

evolution and growth of thesukuk market; how they differfrom conventional bonds; keyunderlying structures in sukuktransactions and, using ijarahsukuk as an example, he lookedat the various stages of a sukuktransaction. He then examinedthe impact of the February 2008AAOIFI statement on sukuk,which coincided with theliquidity crisis in the financialmarkets and resulted in a majorslowdown in sukuk activity in2008. The sukuk market,however, has gradually pickedup in late 2009 and 2010 withthe revival of investorconfidence and an improvementof liquidity conditions in thefinancial markets.

Muhammad Nurullah Shikder,EVP and Head of Shari’ahAdvisory and Shari’ahCompliance at Gatehouse BankUK elaborated the key Shari’ahconsiderations to be observedwhile structuring sukuktransactions. These include theconcept of ownership inShari’ah in the context ofsukuk, AAOIFI rulings and theuse of purchase undertaking insukuk deals as well profitdistribution mechanisms forsukuk investors and managers.

Ms Haliza Abd Rahim, Head ofProject Mangement at BMBIslamic followed with apresentation aboutdocumentation issues withIslamic financial products. Asthere is often a trade-offbetween achieving Shari’ahcompliance and conformity tothe local regulations, Ms Rahim

Structuring Innovative Islamic Financial Products4th Annual Three-Day Residential Workshop



NEWHORIZON October–December 2010IIBI NEWS

discussed these issues and thesolutions.

Richard T de Belder, Partner andHead of Islamic Finance atDenton Wilde Spate – aninternational law firm,examined the Tamweel, SunFinance (Sorouh), Aldar,Tabreed and Purple IslandSukuk deals. He pointed outthat in practice very few sukukare asset backed, whereinvestors’ returns are based onincome generated from theunderlying assets; theoverwhelming majority of thesukuk deals are asset based,where investors rely on thepurchase undertaking by theoriginator, instead of theperformance of the underlyingasset for return and repaymentof the initial investments.

Mian Muhammad Nazir, SeniorVice President at Dar Al Shari’ah,a legal and financial consultancyorganisation, which is asubsidiary of the Dubai IslamicBank, discussed the innovationsin Islamic capital marketinstruments. He highlighted thatsale, lease or investment are three

basic structures that are usedeither standalone or incombination with otherstructures in developing Islamicfinancial instruments. He pointedout that the choice of aparticular structure in developingan Islamic financial productdepends on many factors such ascommercial and legalconsiderations as well astaxation issues. He explained thekey risks inherent in Islamiccapital market instruments andelaborated the risk managementtechniques. He also discussed thesubordination process in Islamicfinance transactions and the useof guarantees and collateral inthe subordination process. Hediscussed the process forrestructuring of sukuktransactions, which is one of thekey areas of debate in thecontemporary Islamic financeindustry as many sukuk deals arein the process of restructuring.

He rounded out his presentationwith a discussion aboutstructuring Islamic swapcontracts and elaborated Islamicswap models based onmurabaha and wa’d (promise).

He included an analysis of thevarious types of swap contracts,which are being offered in themarket and examined thechallenges and issues instructuring such contracts.

Dr Dar returned to the podiumto discuss mechanisms for thestructuring of Islamic optioncontracts and examined theIslamic call and put optioncontracts based on the conceptof arbun and wa’d. (Arbun is anon-refundable down paymentfor attaining the right to buycertain goods at a certain pricein future.)

Clive Lang, Chief Risk Officerat Peak Partners SA looked atthe conventional optioncontracts, their structures andapplications and the formulaeused to determine premiums. Hedescribed how Islamic optionsmay be priced while keeping inview all the requirements ofShari’ah compliance.

In the final session, a groupdiscussion led by Dr Dar tookplace about a structuredapproach to Islamic financial

innovation. This interactivegroup discussion drew on theformal presentations to debatepractical considerations such asclient requirements, choice ofstructures and thecompetitiveness of products.

Mohammed Amin, IslamicFinance Consultant and amember of the IIBI EditorialAdvisory Panel for NewHorizondelivered the closing address.He emphasised the importanceof financial knowledge andskills for Islamic financepractitioners if they areeffectively to meet clients’requirements. At the end of theworkshop, he presentedcertificates to the participants.

The Institute’s 5th Annualthree-day residential workshopon structuring innovativeIslamic financial productswill beheld at the University ofCambridge’s Clare College from22-24 July 2011. For moreinformation, please contactMohammad Shafique at +44(0)207 245 0404 or by [email protected]




Islamic banking systemspecialist, Path Solutions, hasextended its suite of financialservices applications to covercash flow monitoring, whichpresents a major challenge to allbanks. If not carried outeffectively, it can have a hugeimpact on performance andultimately lead to financialinstability. The improvement ofcash flow monitoring practicescan result in reduced risks,improved profit margins,increased visibility andenhanced forecastingcapabilities.

While relevant to all financialinstitutions, there are someliquidity issues encountered byIslamic banks, which make theeffective monitoring of cashflow particularly important interms of controlling risk and

increasing net profits. SalamSlim, senior product managerwith Path, explains, ‘Islamicfinancial institutions are affectedby liquidity risk as a result ofShari’ah restrictions on access tofunds. No ‘cash clean financing’is permissible. The financingpart must always result from atrade cycle, so Islamic productsare different from engineering,operations, workflow,accounting and reportingperspectives.’

The fact that Islamic financialinstitutions are not allowed toborrow from conventional,international money markets,denies them access to probablythe easiest way to plug fundinggaps. Islamic banks, therefore,need a liquidity platform thatwill create an awareness of theirfunding structure and their

ability to handle short tomedium-term liquidityproblems; help them to adopt amore efficient and ongoingliquidity measurement andmanagement capability andprovide a better way ofassessing the present and futureliquidity position.

iMAL*CashFlowMonitoringfrom Path is a web-based,front-office engine, whichenables the treasury departmentto gain a comprehensive view ofthe entire institution’s positionat any given point in time;forecast the cash required andplan how to get it at optimalcost. Projects such as privateequity deals, real estate funds,financing products, financiallines, treasury operations,capital market activities andventure capital developments

Path Launches New Cash Flow Monitoring Capability toSupport Liquidity Management

can be scheduled, forecast andfinancially monitored. It isstructured around the cash flowmovements (inflows andoutflows) of the wholeorganisation, with the outputpresented through dashboardsshowing all the financialimplications and projections,segregated into predefinedtimeframes and buckets.

According to Path, the engineshould enable banks to developmore timely and accurateforecasts and achieve bettercontrol over their global cashbalances. Analytics andreporting features will helptreasury departments to gain anoverall picture of their cash flowmovements, make moreinformed decisions and managetheir liquidity and cash moreeffectively.

Mashreq Bank, the largestprivate bank in the United ArabEmirates (UAE), is implementingthe Oracle FLEXCUBE bankingsolution to help it to improveoperational efficiency, reducecosts and provide support for itsnational and internationaloperations. Mr Somnath Menon,Group Head, Technology andOperations Mashreq Bank,commenting on the decision,said, ‘The Oracle FLEXCUBEproduct portfolio provides uswith a best-in-class set of

solutions that will improve ouroperational efficiency and ouroverall business performance.This is an exciting project for theBank and we look forward tousing the Oracle FLEXCUBEplatform across our other globallocations to differentiate us fromour competitors and deliverexcellent customer service.’

With a branch presence in UAE,where one in every twohouseholds uses its services, plusoffices in Egypt, Qatar, Bahrain,

India, Hong Kong, UK and USA,Mashreq specialises in corporate,retail and Islamic banking.

Oracle Flexcube IslamicBanking is also beingimplemented to allow Mashreqto capitalise on growthopportunities in the Islamicfinancial market. WhenMashreq launched its IslamicBanking Division, ‘Mashreq AlIslam’, throughout all of its 58branches in the UAE inMarch 2010, H.E. Abdul Aziz

Al Ghurair, Mashreq’s CEO,commented that Islamic bankingwas expected to account foraround 30% of the totalbanking sector in the UAE overthe next three years and wasbecoming increasingly preferredas an alternative to mainstreambanking. The Bank said that itwould ‘focus on offering a fullsuite of Shari’ah-compliantproducts and services, with ahost of new products to berolled out during 2010 to bothretail and corporate customers’.

TECHNOLOGY NEWS

Oracle FLEXCUBE May Help Mashreq Capitalise on IslamicFinance Growth



NEWHORIZON October–December 2010TECHNOLOGY NEWS

SWIFT Helps to Reduce Cost and Risk by AutomatingTreasury Murabahah Messaging

The society for world inter-bank payments, SWIFT, willshortly go live with automatedmessaging to support murabahatransactions. A pilot has beenunder way since December2009, in conjunction withSWIFT partner and provider ofIslamic banking software, PathSolutions and a number ofIslamic banks from the MiddleEast, Malaysia and UK. Some240 Islamic banks, existingSWIFT members, were alreadyusing the standard messagetypes to send a total of50 million messages throughthe network in 2009, when thecarrier took the decision tofocus on their specificrequirements and replacethe highly manual processingof treasury murabahatransactions with ISO messagestandards.

Treasury murabaha is animportant component in banks’liquidity management. It isusually based on a commoditiestransaction – normally a metaltransaction through the LondonMetal Exchange or similar. Thebank’s treasury arranges thepurchase of metal throughbrokers in London for valuespot and sells the same withprofit to counterparties on adeferred payment basis.

SWIFT’s industry programmes’manager, Peter Ware, explainedwhy this was the area selected.

‘It was previously very much apaper-based process. Eachagreement was appended by anumber of schedules, whichoutlined the specific details andelements of the transaction,with each schedule needing tobe faxed back and forthbetween all of the banks andbrokers involved. Theautomation of this manual cyclecould reduce the cost and riskincurred.’

On investigation SWIFT foundthat three of the existingCategory 5 securities messagesused in equities trading couldalso be used to support tradingin commodities such as metals.The standards would be used ina slightly different way and anew rule book was developed,but a major new softwaredevelopment could be avoided.

‘Feedback from the banksinvolved in the pilot has beenextremely positive and theircomments and changes havebeen incorporated in the rulebook as we have gone along,’Ware added.

The new message standards willgo live in December. SWIFT isalready looking at other Islamictransactions that can be couldbe automated, with thepossibility of derivatives beinggiven a standard message typefurther down the line.



NEWHORIZON Shawwal-dhu al Hijjah 1431 BOOK REVIEW

Shafiel Karim, who took a religious studiesdegree at an American university beforecompleting his post-graduate certificate inIslamic banking with the Institute of IslamicBanking and Insurance in London, haswritten a short and somewhat subversiveaccount of Shari’ah finance both in terms ofits principles and with regard to thepragmatic implementation of thoseprinciples in modern financial markets.Karim bases his thesis on the notion of the‘Islamic Moral Economy’ (the title of hisbook), which he sees as ethically pure, butdemanding; in fact a utopian ideal distantfrom the perennial and often underhandmanipulations of the marketplace; in short,from reality. Karim defines it as ‘... a utopiantheocracy and social economy that containselements of free-market capitalism andcommunism’. A heady brew of contrasting,if not contradictory values, therefore, makeup the Islamic moral economy.

As Karim points out, Islam’s moraleconomic universe is an idea rather than areality; it asks for participants to give anaccount of themselves in moral terms ratherthan exercise their acumen in order toacquire riches and power. He gives a diligentif occasionally laboured account of the

various types and effects of Shari’ahcontracts and well-rehearsed precepts thatunderpin Shari’ah finance. Thus we areforbidden riba or interest (a pervasive andnecessary catalyst in conventional finance,which is a more contested idea amongstShari’ah scholars than is generallyrecognised), uncertainty, speculation andinvestment in forbidden products andactivities such as gambling, armsmanufacture, porcine products and so on.

These strictures are based upon rigorousethical injunctions that all Muslims areexhorted to follow as found in the Qur’an,the Prophet’s exemplary life or Sunna andthe sayings of the Prophet and hisimmediate followers, known as Hadith.These rules or injunctions are embellishedand developed by the timely accruals ofjurisprudential opinions over the ages,which make up Fiqh or the implementationof the Shari’ah into legal practice, authorityand judgements. The Islamic MoralEconomy, however, as envisaged by Karim,goes further than ad hoc injunctions; thereis a seamless ethos which gives theinjunctions their energy and cohesiveness. Itdemands from Muslims completereciprocity, integrity, an obligation to serve

and to be responsible for the community.This worthy expectation of how peopleshould behave virtuously does not translateinto how they do behave in modern secularsocieties, which are becoming increasinglyimpersonal, self-centred and complex.Karim questions the possibility of actingmorally in accordance with the Islamicmoral economy in modern contemporaryfinancial markets. His cogent andchallenging thesis is threaded with anabiding scepticism about truly realising theethics underpinning Shari’ah finance, asopposed to indulging in window dressing bymouthing complacent slogans rather thanmaking a reality of Shari’ah precepts.

Karim points out that there are three degreesof legitimacy with regard to financialproducts and contracts within the Islamicmoral economy, namely Shari’ah tolerance,compliance and dependence. ‘Tolerance’ isthe lowest degree of compliance with therequirements of Islamic law and‘dependence’ is the highest. In all thesecontracts and products, however, there liesthe danger of re-branding being regarded asa change in substance. Thus, riba or thepayment of interest may in fact continue toexist in ubiquitous murabaha transactions

‘The Islamic Moral Economy: A Study

of Islamic Money and Financial

Instruments’by Shafiel A. Karim. Publisher: Brown Walker Press (2010)ISBN: 978- 1599425399Raficq Abdulla, an Oxford-educated lawyer, as well as a writer, poet, public speaker,and broadcaster, reviews this book. He advises on Shari’ah finance and on corporateissues. He is a Visiting Fellow of the Faculty of Business and Law at KingstonUniversity. In 1999, Raficq Abdulla was awarded an MBE for his interfaith workamong Muslims, Jews, and Christians.



NEWHORIZON October–December 2010BOOK REVIEW

although it is no longer named as such.

Karim tells us that in the Islamic moraleconomy’s market place, Allah or God isalways the other omniscient and necessarypartner in all transactions. According toKarim, He ‘...sets the prices.’ He does morethan that. He sees all and knows all. He is theeternal policeman of our deeds and intentions.He abjures monopolies and unfair dealings,which imply asymmetrical knowledge, whichin turn gives unfair advantage to one partyagainst another. Risk and reward should beshared equally between all parties to a

commercialtransactionaccording to therules of theShari’ah.Omniscient andomnipotentimmortality clearlyhas its drawbacksfor venal mortalsbusy gainingadvantage in themarketplace. Infact, after readingKarim’s critique,one wonderswhether theprinciples ofShari’ah financecould ever becompletely realised,given the vagariesof human nature inthe marketplace andthe perennial greedand desire toaccumulate thatdrives most of us.Karim worries notonly about theapplicability of theobvious rulesgoverning Shari’ahfinancialtransactions, he alsocomplains about thelack of ‘...a criticaland holisticexamination of

conventional money, banking, and insurancemodels that may or may not be soluble [sic]with the utopian Islamic moral economy.’ Hecalls for a new Shari’ah perspective which isindependent of ‘...conventional money,banking, or insurance.’

As it is, Shari’ah finance as presentlypractised and developed (it is a developingart, in fact it demonstrates the flexibility offiqh, which is time-bound, but based on theeternal ethical principles of the Shari’ah) isnew and in spite of the existence of arepertoire of Shari’ah finance contracts,

which Karim analyses with varying degreesof clarity, it is limited in scope. As presentlyconstituted it is unable to address the ever-expanding and increasingly sophisticatedplethora of financial products thatconstitute the Leviathan – some may call it amany-headed Hydra – that is the 24/7casino of contemporary finance.

Recently, Moody’s Investor Service reported that the global Islamic financialmarket is calculated to be worth between$750bn and $1 trillion USD and mayexpand to $2.8 trillion by 2015 accordingto an estimate by the Kuala Lumpur-basedIslamic Financial Services Board. WhilstIslamic finance is moving fast into themainstream of global finance, when youcompare those figures with one asset classof conventional finance – that of FXtrading, – which runs at around $3,981bn aday, you get a sense of the relative stature ofIslamic finance in the global market. It isinteresting to note also that most FXtrading, which is a high-speed, algorithmicbusiness, has little to do with either trade orinvestment, but is a market for speculatorswith an instinct for gambling. It wouldnever pass muster by the Shari’ah even as atolerant practice, never mind beingcompliant or dependent.

Karim discusses many issues that cannot becovered in a short review of his book, hecalls into question the compatibility ofmoney creation by banks (by way of thepervasive use of the fractional reservemodels in conventional banking) and bygovernment with Shari’ah compliance; hepoints out the differing stances taken byvarious Shari’ah scholars and schools ofthought on many points of law. Opinion isdivided, authority questioned, precedentsare sometimes vague and unreliable. Karimcovers much ground in a concise space. Thebook’s short text of 93 pages has a long tailof a bibliography that runs to 24 pages. Itappears that Karim has thrown ineverything including the kitchen sink andone wonders who will be served by such avast compendium of books. However, thebody is well worth reading and ponderingupon without the distraction of the tail.



DIRECTORYNEWHORIZON Shawwal-dhu al Hijjah 1431

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NEWHORIZON October–December 2010GLOSSARY

arboun

An Islamic version of option, a deposit for the delivery ofa specified quantity of a commodity on a predetermineddate.

bai al-ina

This refers to the selling of an asset by the bank to thecustomer on a deferred payments basis, then buying backthe asset at a lower price, and paying the customer incash terms.

commodity murabaha

A murabaha contract using certain specifiedcommodities, through a metal exchange.

fatwa

A ruling made by a competent Shari’ah scholar on aparticular issue, where fiqh (Islamic jurisprudence) isunclear. It is an opinion, and is not legally binding.

gharar

Lit: uncertainty, hazard, chance or risk. Technically, saleof a thing which is not present at hand; or the sale of athing whose consequence or outcome is not known; or a sale involving risk or hazard in which one does notknow whether it will come to be or not.

Hadith

A record of the sayings, deeds or tacit approval of theProphet Muhammad (PBUH).

halal

Activities which are permissible according to Shari’ah.

haram

Activities which are prohibited according to Shari’ah.

ijara

A leasing contract under which a bank purchases andleases out a building or equipment or any other facilityrequired by its client for a rental fee. The duration of thelease and rental fees are agreed in advance. Ownership of the equipment remains in the hands of the bank.

ijara sukuk

A sukuk having ijara as an underlying structure.

ijara wa iqtina

The same as ijara except the business owner iscommitted to buying the building or equipment orfacility at the end of the lease period. Fees previouslypaid constitute part of the purchase price. It is commonly used for home and commercial equipmentfinancing.

istisna

A contract of acquisition of goods by specification ororder, where the price is fixed in advance, but the goodsare manufactured and delivered at a later date.Normally, the price is paid progressively in accordancewith the progress of the job.

maysir

Gambling – a prohibited activity, as it is a zero-sumgame just transferring the wealth not creating newwealth.

mudarabah

A form of business contract in which one party bringscapital and the other personal effort. The proportionateshare in profit is determined by mutual agreement at thestart. But the loss, if any, is borne only by the owner ofthe capital, in which case the entrepreneur gets nothingfor his labour.

mudarib

In a mudarabah contract, the person or party who actsas entrepreneur.

murabaha

A contract of sale between the bank and its client for thesale of goods at a price plus an agreed profit margin forthe bank. The contract involves the purchase of goods bythe bank which then sells them to the client at an agreedmark-up. Repayment is usually in instalments.

musharakahAn agreement under which the Islamic bank providesfunds which are mingled with the funds of the businessenterprise and others. All providers of capital are entitledto participate in the management but not necessarilyrequired to do so. The profit is distributed among thepartners in predetermined ratios, while the loss is borneby each partner in proportion to his contribution.

musharakah, diminishing

An agreement which allows equity participation andsharing of profit on a pro rata basis, but also provides a method through which the bank keeps on reducing its equity in the project and ultimately transfers theownership of the asset to the participants.

qard hasan

An interest-free loan given for either welfare purposes or for fulfilling short-term funding requirements. Theborrower is only obligated to pay back the principalamount of the loan.

rab-al-maal

In a mudarabah contract the person who invests thecapital.

retakaful

Reinsurance based on Islamic principles. It is amechanism used by direct insurance companies toprotect their retained business by achieving geographicspread and obtaining protection, above certain thresholdvalues, from larger, specialist reinsurance companies andpools.

riba

Lit: increase or addition. Technically it denotes anyincrease or addition to capital obtained by the lender as a condition of the loan. Any risk-free or ‘guaranteed’rate of return on a loan or investment is riba. Riba, in allforms, is prohibited in Islam. Usually, riba and interestare used interchangeably.

salam

Salam means a contract in which advance payment ismade for goods to be delivered later on.

Shari’ah

Refers to the laws contained in or derived from theQuran and the Sunnah (practice and traditions of theProphet Muhammad (PBUH).

Shari’ah board

An authority appointed by an Islamic financialinstitution, which supervises and ensures the Shari’ahcompliance of new product development as well asexisting operations.

shirkah

A contract between two or more persons who launch a business or financial enterprise to make profit.

sukuk

Similar characteristics to that of a conventional bondwith the key difference being that they are asset backed;a sukuk represents proportionate beneficial ownership inthe underlying asset. The asset will be leased to the clientto yield the return on the sukuk.

ta’awuni

A principle of mutual assistance.

tabarru

A donation covenant in which the participants agree to mutually help each other by contributingfinancially.

takaful

A form of Islamic insurance based on the Quranicprinciple of mutual assistance (ta’awuni). It providesmutual protection of assets and property and offers joint risk sharing in the event of a loss by one of itsmembers.

tawaruq

A sale of a commodity to the customer by a bank ondeferred payment at cost plus profit. The customer thensells the commodities to a third party on a spot basis and gets instant cash.

ummah

The diaspora or ‘Community of the Believers’ (ummatal-mu’minin), the world-wide community of Muslims.

wa’ad

A promise to buy or sell certain goods in a certainquantity at a certain time in future at a certain price. It is not a legally binding agreement.

wakala

A contract of agency in which one person appointssomeone else to perform a certain task on his behalf,usually against a certain fee.

waqf

An appropriation or tying-up of a property in perpetuityso that no propriety rights can be exercised over theusufruct. The waqf property can neither be sold norinherited nor donated to anyone.

zakat

An obligation on Muslims to pay a prescribed percentageof their wealth to specified categories in their society,when their wealth exceeds a certain limit. Zakat purifieswealth. The objective is to take away a part of thewealth of the well-to-do and to distribute it among the poor and the needy.


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new horizon oct dec 2010

Economy & Finance