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Mon 16 Aug 2010 01:43 PM

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Muwa'adah valid for forward forex contracts - scholar

Adviser challenges a widely held view which has limited the range of Islamic hedging tools.

Muwa'adah valid for forward forex contracts - scholar
ISLAMIC FINANCE: Some Islamic scholars permit derivatives as long as they are used to hedge risks and not for speculation. (Getty Images)

Muwa'adah is a permissible basis for forward currency transactions, a respected sharia adviser said on Monday, challenging a widely held view which has limited the range of Islamic hedging tools.

The use of muwa'adah or mutual promise in forward foreign exchange contracts has drawn strong criticism from a broad section of the industry who say it can lead to riba or usury which is forbidden by Islam.

Islamic banks have limited risk management tools, as most conventional hedging instruments such as currency and interest rate swaps and futures contracts fall foul of the sharia's ban on gambling and speculation.

Shamsiah Mohamad, who is part of a Malaysian central sharia advisory body, said muwa'adah was not a contract and was only a promise to execute an agreement, which nullified objections to its use in forward currency transactions.

"The issue is one of differing interpretations, whether muwa'adah is a contract," said Shamsiah, a member of the Securities Commission's Sharia Advisory Council which rules on sharia principles involving the Malaysian Islamic capital market.

"My view is that it is not a sale and purchase contract because specific words must be used to enter into a contract in Islam."

This view runs counter to that of influential industry body AAOIFI which ruled that a binding muwa'adah is regarded as a contract and should not be allowed for currency trading. This ruling by Bahrain-based AAOIFI has contributed to widespread opposition to the use of muwa'adah in forward currency contracts.

But some classical scholars such as Imam Shafi'i, as well as several scholars from Mazhab Maliki permit the use of muwa'adah in this context on the basis that it is not a contract of sale.

"Economic transactions evolve and depend on people's needs so sharia scholars need to explore new contracts and principles that do not run counter to the quran and the hadith," said Shamsiah, who also advises Standard Chartered's Islamic banking arm in Malaysia.

"If we rely only on the established principles, we may be limiting the scope of Islamic hedging instruments."

Some Islamic scholars permit derivatives as long as they are used to hedge risks and not for speculation, but some bankers say the industry may have grown more cautious after the role of derivatives in triggering the global financial crisis.

Malaysia's CIMB Islamic Bank, the world's top sukuk arranger, earlier launched a forex hedging tool where investors enter into an Islamic transaction with the bank.

The net proceeds - which are similar to the premium paid for conventional options - gives investors the right to exercise the option at the agreed rate on the maturity date. (Reuters)

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