Understanding Islamic Finance - Doha Academy of Tertiary Studies

Overview of Financial Institutions and Products 2098.8.7 Foreign Exchange Market in the Islamic FrameworkA foreign exchange market can function in the Islamic financial structure keeping in mindthe limitations set by the Sharī´ah. IFIs can engage in direct placement or investment inSharī´ah-compliant F.E. denominated securities like Solidity Trust Certificates issued byIDB in 2003 and many other Sukuk.A foreign currency forward cover facility is also available in the present Islamic financialstructure. Contemporary Sharī´ah scholars have observed that forward cover is permissiblesubject to the following conditions:• The amount of foreign currency is needed for genuine trade or payment transactions.This need will have to be supported by appropriate documents so as to prevent forwardcover for speculative purposes. It implies that money changers or forex dealers relyingon book-out transactions cannot take such cover.• The forward cover shall be through a formal promise to sell or purchase and it shallnot be a sale and purchase agreement. This means that sale/purchase shall take placesimultaneously at the agreed time in future at the rate agreed upon initially at the time ofagreement to sell or purchase.• While it will be permissible to fix the price of foreign currency in terms of local currencyaccording to the agreement, no forward cover fee shall be recovered. However, an amountmay be demanded by the bank from its client in advance by way of earnest money(Hamish Jiddiyah) against foreign currency agreed to be purchased/sold at a future date.If, at the agreed time, the promisor does not perform, the bank can recover the differentialand adjust the earnest money there against.8.8.8 Derivatives and Islamic FinanceConventional options, swaps and futures stem from debts and involve sale and purchase ofdebts/liabilities. As a group, such instruments are called derivatives, i.e. they are derived fromthe expected future performance of the respective underlying assets. These are very complexand risky contracts with a present market value of trillions of dollars around the world. It hasbeen observed, however, that the global financial market is becoming increasingly fragile asmore and more derivatives and “hedging” instruments emerge.Conventional options confer merely rights and not liabilities. An option has a nominalsize, this being the amount of underlying asset that the option holder may buy or sell atthe strike price – the price at which the holder may like to buy or sell the underlying assetupon exercise of the option. If the price moves favourably, the option is exercised and thecommodity is bought/sold at the agreed price. If the price moves unfavourably, the buyerof the option simply abandons it. This is against the principle of the Sharī´ah, according towhich delivery has to be given and taken pursuant to the sale contracts without regard tomovement in prices. The buyer of the option pays a price (the premium) to the seller (thewriter) of the option. Hence, the feature that an option contract confers the right but not theobligation to enter into an underlying contract of exchange at or before a specified futuredate (the expiry date) makes the contract non-Sharī´ah compliant.Some writers have discussed the possibility of put and call options 26 in legitimate goodsand stocks on the basis of ‘Arbūn and reverse ‘Arbūn (for example, putting a condition in the26 A call option is the right to buy while the right to sell is referred to as a put option.