Commodity Murabahah Concerns_ Challenges and Market Appetite

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					Commodity Murabahah:
 Concerns, Challenges
 and Market Appetite
Commodity Murabahah has presented a challenge to market
practitioners due to concerns ranging from the abuse of
practices to the permissibility of the structure under Shariah,
Commodity Murabahah is based on the concept of                  Institutions (AAOIFI) proceeded to issue a standard
Tawarruq, that is, receiving cash for a debt of a higher        guideline on the requirements of Tawarruq (Shariah
amount. The structure attracted considerable attention          standard no 31). “I see this as an acknowledgement
when, in 2003, the OIC Islamic Fiqh Academy likened             by the body that the concept of Tawarruq in itself is
commodity Murabahah to “organized” Tawarruq which               acceptable though the standards of its application need
it deemed a synthetic and fictitious transaction and            to be regulated,” Raja Teh explained.
therefore impermissible under Shariah.
                                                                The commercial viability of commodity Murabahah
While it is easy to mistake this ruling as a criticism of       In place of commodity Murabahah, the OIC Fiqh Academy
the contract of commodity Murabahah or Tawarruq,                recommended the use of Qard Hassan, a loan between
according to Bursa Malaysia’s Islamic markets global            two parties with no contractual increment to the creditor;
head Raja Teh Maimunah, the concerns raised by the OIC          in other words, a benevolent loan. In Raja Teh’s view, this
Islamic Fiqh Academy in arriving at its conclusion related                                                 .
                                                                “is simply not a commercially viable option”
to the practices regarding the application of commodity
Murabahah or Tawarruq and not the contract itself. In           Many proponents of commodity Murabahah share this
particular, the academy expressed concern over the              view. In particular, Azizul Azmi Adnan, partner of the
existence of fraudulent trading contracts or an absence         Islamic banking practice group of Wong & Partners
of physical commodities underlying the commodity                (a member firm of Baker & McKenzie International),
Murabahah structure.                                            considers that “while the use of instruments such as
                                                                commodity Murabahah may not be in strict compliance
                                                                with the rulings of the OIC Fiqh Academy, or similar
  “It will take time for an                                     academies, it is necessary to consider the application of
                                                                Islamic finance in the real world” he said, recognizing that
  understanding and                                             Islamic finance is developing against a backdrop of an
                                                                established conventional finance framework and needs
  appreciation of Islamic                                       to be commercially viable.
  principles to develop”
                                                                In Adnan’s view, to follow the rulings of such academies
                                                                would involve a wholesale change to the existing
The distinction between the contract and the practice of        framework of Islamic finance which realistically cannot
commodity Murabahah or Tawarruq is an important one.            happen overnight.
In Raja Teh’s opinion, “it should be the practices that ought

to be tightened and not the rule on the permissibility of       “It will take time for an understanding and appreciation
the contract itself”                                            of Islamic principles to develop,” he said. “Malaysia
                                                                appreciates that it is a progressive process. Continuous
Despite the ruling by the OIC Islamic Fiqh Academy, the         improvements are being introduced in order to develop
Accounting and Auditing Organization for Islamic Financial      Islamic finance.” The development from the widespread

                                                                                    February 2010   . Islamic Finance Asia      31
                     The structure of a common commodity Murabahah financing arrangement

                                                              1. Bank purchases
                                                              commodity from
                                                              Commodity Broker
                                                              A on spot basis.
                                      Broker A                                                            Bank

                                                                               2. Bank sells the commodity to
                                                                               the customer on deferred basis
                                                                               at cost price plus profit margin
                                               3. Bank, acting as
                                               Wakeel, sells commodity
                                               to Commodity Broker B
                                               on spot basis on behalf             Bank (acting
                                               of the customer                      as Wakeel
                                                                                    (agent) on
                 Broker B
                                                                                     behalf of

          use of the Bai al Inah contract in favor of Tawarruq-                       .
                                                                          the old days” “It is the evolution of the trading mechanism
          based instruments such as commodity Murabahah is                as things become more sophisticated,” she said.
          an example of the constant improvement of the Islamic
          finance systems in Malaysia. According to Adnan,                “The practice of leaving things to chance is simply not
          “incremental steps are important in increasing awareness        conducive in today’s complex financial system. The
          and improving the system” .                                     absence of organization will expose banks and their
                                                                          clients to ‘unhedged’ risks and would certainly not be
          Citing the maxim found in Islamic jurisprudence, “severe        entertained in today’s financial markets, especially in the
          harm is avoided by a lighter harm” or “choosing between         aftermath of the global credit crisis.”
          the lesser of two evils” some proponents of commodity
          Murabahah maintain that the choice is between having            Structural features of commodity Murabahah
          to resort to liquidity management instruments, which            Compared to a simple one-step conventional financing
          are imbued with clear-cut riba elements, or to pursue           between a lender and borrower, one could be forgiven
          the alternative practice of controversial Tawarruq-based        for being somewhat confused by the structure of the
          instruments for the time being.                                 comparable commodity Murabahah financing, as
                                                                          illustrated above.
          According to Dr Asyraf Wajdi Dusuki, head of research
          affairs at the International Shari’ah Research Academy for      “There is invariably an additional complexity when using
          Islamic Finance (Isra), “it is thought that to choose what is   Islamic finance as the basis of financing,” Adnan said, in
          disputed or doubtful (shubhah) is of lesser evil than to opt    recognition of the additional steps involved in structuring
          for a transaction that is clearly prohibited (haram)”.          and carrying out an Islamic transaction.

          Is commodity Murabahah too organized?                           Does this complexity carry a risk that the structure will
          By likening today’s commodity Murabahah to “organized”          not be upheld by the courts? According to him, “since
          Tawarruq, the OIC Fiqh Academy criticized commodity             Malaysia has a system of law which operates separately
          Murabahah for being too pre-arranged. While many                from Shariah, as long as the documentation does not

          practitioners have responded to this criticism by trying to     contradict that system of law, there is freedom of contract,
          disguise the pre-arranged nature of modern commodity            so it is unlikely that a structure, if well documented,
          Murabahah transactions, Raja Teh considers the pre-                                                  .
                                                                          will not be upheld by the courts” The multiple roles
          arrangement of a commodity Murabahah transaction as             that a financial institution may occupy in a commodity
          “a necessary development from how things were done in           Murabahah transaction is also worthy of note. As shown

 32       Islamic Finance   Asia .   February 2010
in Diagram 1, a bank may act both as itself as well as          and each other simply because there is no other viable
wakeel (agent) on behalf of the customer.                                                   .
                                                                alternative at this juncture”

While permitted under common law, there have been               “Commodity Murabahah is the one Islamic money market
concerns regarding the risks of having one party acting         tool that can help provide liquidity in the Islamic banking
in several capacities. Adnan, however, does not see this        system. There is no other instrument that is as widely used
as a risk that cannot be addressed in documentation.            as commodity Murabahah, especially in the short term
                                                                money markets. Sukuk are generally of medium to long
“As long as it is clear what the duties of the bank are while   tenure whilst other contracts, for example Wakalah, may
acting in differing capacities and as long as the docu-         not appeal to some risk managers in the management of
mentation anticipates and addresses what rights and ob-         short term liquidity,” she explained.
ligations might arise, it becomes a question of the parties
getting comfortable that the transactions do not pose any       It appears that the response from some practitioners to
serious risks,” he explained.                                   the ruling of the OIC Fiqh Academy has been to continue
                                                                to develop commodity Murabahah products but with
“The challenge is getting the promoters and investors           a view to maintaining the integrity of the underlying
more comfortable with the multiple roles that one party         contracts and processes. “In response to the ruling, what
can perform,” he added.                                         we have done is to design the world’s first regulated end-
                                                                to-end commodity trading platform specifically to facilitate
These “complexities” do not appear to have translated into      Tawarruq transactions,” explained Raja Teh, referring to
a higher risk rating for a commodity Murabahah based            the recent achievement of Bursa Malaysia.
financing in Malaysia as opposed to its conventional
counterpart. This could be suggestive of the level of           “The structure of the trades to be undertaken via the
comfort that the Malaysian market has developed with            platform addresses major concerns raised (such as) the
Islamic products and their underlying structures, however       validity of the contracts and the presence of physical
more complex than their conventional equivalent.                commodities which are deliverable.

                                                                Those wishing to trade through the platform must first
  “Commodity Murabahah                                          be admitted as members and are governed by a set of
  is the one Islamic money                                      trading rules. Shariah audits are carried out intermittently
                                                                by the exchange and members themselves may compel
  market tool that can help                                     a Shariah audit to be undertaken upon issuance of a
                                                                notice to the exchange.
  provide liquidity in the
                                                                “Commodity suppliers are first screened and trading
  Islamic banking system”                                       flows are scrutinized before seeking approval from the
                                                                national Shariah Advisory Council for the admission of a
Adnan pointed out, however, that for US dollar issuances,       particular commodity. The whole structure of the platform
investors may demand a higher premium for Sukuk as              is designed to ensure integrity in the trade flows.”
opposed to conventional bonds (as they did for the recent
US dollar-denominated combined issue of conventional            While the platform started out to provide for ringgit
bonds and Sukuk by Petronas). Nevertheless, “this is likely     denominated trades, Raja Teh explained, it has since
to be a reflection of the need for investors to take time to    expanded to undertake non-ringgit denominated trades.
understand and get comfortable with the structuring of an       “In addition, we have also moved to provide for a hybrid
issue of Sukuk rather than of any inherent additional risk      market, thus providing customers access to voice broking
in the structure itself,” he explained.                         in addition to electronic trades (initially only electronic
                                                                trades). We are also admitting other commodities in
What does the future hold for commodity                         addition to our home star product, that is, crude palm oil,”
Murabahah?                                                      she added.
It is estimated that commodity Murabahah has an annual
turnover of over US$1 trillion and in Raja Teh’s opinion,       It appears that for the moment, the future of commodity

“demand remains strong” While the ruling by the OIC Fiqh        Murabahah is bright. While it is likely that criticisms of
Academy may have resulted in significant discourse on           the practices or structure of commodity Murabahah will
the subject of commodity Murabahah and its practices,           continue to arise, until a commercially viable alternative
in Raja Teh’s experience, it “has not caused any major          can be offered, it seems that practitioners will continue to
change in the way banks transact with their customers           enjoy its effectiveness as a liquidity management tool.

                                                                                    February 2010   . Islamic Finance Asia      33

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