UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for December 23, 2010

Interest/Profit Rate Swap /Exchange in Islamic Finance

 

 

 

Profit Rate Swap

“The Profit Rate Swap seeks to achieve Sharia’h compliance by using reciprocal Murabaha transactions through the life of a single contract, using commercial arrangements long accepted by Sharia’h scholars. Through multiple Murabaha transactions, a financier purchases goods from a supplier (at the cost price) and then on-sells them to a counterparty at a deferred price that is marked-up to include the financier’s profit margin. This profit margin is deemed justified since the financier takes title to the goods.”

(http://www.eigertrading.com/web/guest/islamic-banking-glossary)

Islamic Profit Rate Swaps

http://www.qfinance.com/financial-risk-management-best-practice/risk-management-of-islamic-finance-instruments?page=4

“This instrument, pioneered by Commerce International Merchant Bank (CIMB) of Malaysia in 2005, allows financial institutions to manage their exposures to fixed and floating rates of return. That is, through the PRS, institutions can restructure the nature (fixed vs. floating) of their existing rates of return.

As in the CCS, profit-rate swaps are based on the combination of two commodity murabaha contracts (see Figure 2).

The floating-rate leg involves the periodic murabaha sale of a commodity by the protection seller in exchange for future installments at the fair value (market) price plus a floating-rate profit portion (“cost-plus”) that varies according to changes in some pre-agreed benchmark (e.g. some interbank funding rate like the London or Kuala Lumpur Interbank Offering Rate).

The fixed-rate leg stipulates the one-off sale of a commodity by the protection buyer in exchange for a stream of future predetermined payments.

As in the cross-currency swap, both parties may sell their commodities in order to recoup their initial disbursement.

Note that the floating-rate payer (or interest rate protection buyer) purchases commodity B in periodic increments—unlike the fixed-rate payer (or interest rate protection seller), who receives commodity A in full at inception.” (Read More)

Interest /Profit Swap Involves:

  1. A swap of fixed-for floating interest rates.
  2. A master agreement for a fixed-rate interest.
  3. A floating or variable rate which is reset periodically.
  4. A set-off (Muqash) exercise at every reset time to swap a fixed-for-floating interest rate.
  5. The floating interest rate is based on a certain benchmark.
  6. The counterparty making fixed-rate payments in the swap is usually the less creditworthy party. (AMANIE)

 

And Consists of three main documents.  (1) Master-Fixed – Rate Transaction; (2) Master Revolving Floating – Rate Transaction; (3) Settlement Agreement.   (AMANIE)

“Islamic Cross Currencies Swap (ICCS)

Enhancing the capabilities for Islamic Hedging, Bank Islam has successfully initiated the first USD/MYR ICCS in the world with the introduction of ICCS in the  Malaysian market in June 2007, where the bank and its customers alter their exposure to interest-rate fluctuations, by swapping fixed-rate obligations for floating- rate obligations.

This product is heavily being used with the expectation of a change in interest rates or the relationships between them.  The existence of an interest rate is eliminated with a Profit Rate. Commodity Murabahah will be used as the main vehicle for ICCS and WFRA.” (Read More)

http://en.wikipedia.org/wiki/Bank_Islam_Malaysia

Sharia’h Profit Rate Swaps

http://www.ifre.com/sharia-profit-rate-swaps/566038.article

Islamic Currency Swap/Foreign Exchange

 

 

Islamic Forex  SWAP

“Currencies in Islamic law are only permitted to be exchanged at spot (today) according to AAOIFI Shariah Standards. Certain structures based on Murabaha or Waad replicate the outcome of a forward currency exchange.

A conventional Forex swap is the exchange of two loans in different currencies of equal value at spot, which are both paid back on the same date in the future. This implies a forward rate of the currencies involved. The loans at spot are netted and not paid out.

An Islamic Forex swap could be replicated by use of two Tawarruq in different currencies of equal value at spot:

A sells to B 1000 USD of Platin at 1050 payable after one year. B sells A 750 Euro of Aluminium at 780 Euro payable after one year. Exchange rate at spot is assumed at 1.33.

After one year 1050 USD has to be paid by B and A has to pay 780 Euro to B. This implies a currency forward rate.”  (http://wiki.islamicfinance.de/index.php/Forex_Swap)

Sharia’h Parameters on Islamic Foreign Exchange Swap as Hedging Mechanism in Islamic Finance

http://www.kantakji.com/fiqh/Files/Finance/N398.pdf

Islamic Swap Transactions

http://www.qfinance.com/financial-risk-management-best-practice/risk-management-of-islamic-finance-instruments?page=4

The Money Markets

http://www.islamic-finance.com/c_moneymarket.htm

Islamic Currency Trading

http://halalforex.net/

Islamic Derivatives

http://wiki.islamicfinance.de/index.php/Islamic_Derivatives

Islamic Hedging, Speculation, and Risk Management

 

 

Hedging v Speculation in Islamic Finance

 

According to AMANIE, Islamic hedging mitigates risk which arises from a real transaction such as a sale, lease, or investment.  Speculation is an activity used to enter the market using derivative instruments without having any real and bona fide interest for protection.

The difference between Islamic and conventional derivative instruments can be summarized as follows:

  1. Islamic derivative instruments are motivated by real risk and not speculative venture with the purpose of benefiting from market performance.
  2. Islamic derivative instruments are not tradable (i.e.) options, swaps, forwards, and futures.

According to Amanie, although Islamic Finance allows some risk management tools, it is still essentially an asset-based transaction free from speculation. (AMANIE)

Opinion Number TWO: (Hedging is a Form of Speculation)

“Question:: Why is hedging haram?

Answer: As a method for protecting a profit position from risk, it is easy to understand why hedging is popular. In conventional finance, risk-hedging takes the form of derivatives, swaps, futures, options, and other risk-shifting devices. The common perception of hedging in Islamic law is that it interferes with one of the law’s basic principles, which is that gain accompanies liability for loss or the link between risk to gain. Moreover, derivatives often contain elements of gharar which clearly renders them unacceptable in an Islamic legal framework for the reason that they lead to undue speculation, which is the practical equivalent of gambling. Even so, hedging in the sense of risk management is not prohibited outright because the management of risk may take many forms, from portfolio diversification to leveraging equity capital through Islamically-acceptable leases.” (http://muslim-investor.com/answers/hedging.html)

Download Paper:  Islamic Hedging: Gambling or Risk Management? http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1260110

Tahawwut Master Agreement

http://www.isda.org/media/press/2010/press030110.html

http://arabnews.com/economy/islamicfinance/article42061.ece

The launch of the Tahawwut (Hedging) Master Agreement (TMA) earlier in March 2010 by the Bahrain-based International Islamic Financial Market (IIFM) in cooperation with the International Swaps and Derivatives Association, Inc. (ISDA) gives the global Islamic financial industry the ability to trade Shariah-compliant hedging transactions such as profit-rate and currency swaps, which are estimated to represent most of today’s Islamic hedging transactions.” (Read More)

Explanation of Tahawwut Master Agreement Given at the World Islamic Banking Conference 2010 in Bahrain ( I was in this seminar!)

http://www.iifm.net/media/PDF/WIBC-2010/tahawwut%20master%20agreement%20-%20intro,%20iifm%20seminar%20@%20wibc%20nov%202010,%20bahrain%20-%20mr.%20alvi.pdf

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance