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ISLAMIC STRUCTRING

OF
SLAMIC FX FORWARD

SUBMITTED BY
MD.MIRAN SHAH CHOWDHURY,MBA,ACI
AL-ARAFAH ISLAMI BANK LIMITED
INTERNATIONAL DIVISION
PHONE: O88O27167237

• To buy or sale one currency against another.Trading in Currencies by Accounting and auditing Organization For Islamic Financial Institutions(AAOIFI) • Opinion By Dubai Islamic Bank backed by Justic Taqui Usmani • Opinion of Kuwait Finance House & Bank Islam Berhd. • Not allowed to get benefit from favorable movement of the currency • Bank has the right to claim for actual losses on MTM on termination date. • At an agreed rate determined on spot/majlis for future delivery. • To protect against unfavorable movement of exchange rate. EXECUTIVE SUMMARY Proposed name of Islamic FX Forward: Islamic Promissory FX Definition: Under the WAD (Promise) structure. • Before Two days’ of maturity.Malaysia Salient features: • A Unilateral Promise by clients on Deal date followed by akad(settlement) on value date. Dealing Procedure: • At the time of Deal . • Akad on Value date/for delivery/settlement on agreed future date or within the period of promise.the Client will uniliterly promise to buy/sell currency at future date at the price determine on Promise date. • To assist business to mitigate risk against genuine underlying assets of banks and clients. Pricing: The element to be considered for pricing Islamic FX Forward are: • Spot rate • For Profit rate differential o USD/EUR/GBP/JPY Commodity Murabaha rate (Reuters Code: o BDT Mudaraba Rate • Or Any Conventional benchmark rate for adjustment of deferential. . Opinion/Fatwa: In support of Islamic FX Forward the following opinions / Fatwa are available in this paper • Shariah Standard No:1. only one party (Obligor / Promisor) promise to buy/sell as the case may be wherein he is bound by that promise (Binding Promise). either Bank or Customer will send Offer letter to exchange Currency for settlement of Islamic FX Forward.

the bank will realize nothing form the Client. the client will need to deliver his currency to banks in clear FC funds. only the actual cost will be adjusted form the bai- al-Urbun A/c of the Clients. • If the bank incurs losses.Security Deposit : Urban/Earnest Money ( For Bank to Client Transactions) Documentation: • Master agreements/terms & conditions • Promise to purchase/sale • Offer to buy/sale • Acceptance to buy/sale Settlements: On value date/Maturity date. The Islami Bank will in turns deliver the agreed amount of the other currency in accordance with client’s instructions complying the documents. shipment not affected within the LC validity. • Early fulfillment of promise / Pre delivery • Extend /extension of the promise • Non utilization of promise against Islamic forex forward Cost of Amendment • If the amendment of Islamic forex forward incur no losses for the Bank or the exchange rate is in favor of the bank. the client may need to amend the FX Forward t due to early/delay shipment/. the client intent to extend the validity of the LC/early repatriation/documents/delay receipt of funds for import. Amendments/amendment of Islamic FX Forward: Due to the complexity of commercial transactions.. export and remittances business respectively for which the client may request for amendments that may be done by …. .

it is a pertinent need for islamically approved/acceptable derivatives to neutralize the risks of Bank/Clients against FC dominated genuine commercial transactions. consequence of which the face loss and can not compete with the Clients of Conventional bank(s) who can take forward Coverage against fluctuations of Currencies price. The clients of Islami Banks in Bangladesh can not take forward coverage against fluctuations of Foreign Currency. Proposed name of Islamic FX Forward: Islamic Promissory FX (Forex) 02. Such fluctuation affects the importers. As such. the Clients of Islami bank takes Forward Coverage directly from Conventional bank.__________________________________________________________________________________________ _________ Concept Paper on Islamic FX Forward _________________________________________________________________________ __ 01. Sometime. . At present. the present study is designed Bangladesh bank to address the Islamic alternative of traditional forward contract supported by fatwa of Accounting and Auditing Organization for Islamic Financial Intuitions (AAOFI) and opinion/views of Islamic jurisprudences and scholars for kind consideration. Risk overview: The value of foreign currencies in handling Foreign Exchange business does not remain stable. exporters and Remitter/Exchange houses. So. the problem being aggravated due to excessive volatility/fluctuation of exchange rates in both upward & downward directions that expose the Clients/Banks to the risk of significant loss.

Problem/Underlying Price risk faced by Islami Banking Industry: 03.So. • Problem in managing Exchange position: The purchase of Export bills are to show in Assets side of Exchange Position which engulf the Open position limit to a great extent against which Islamic bank can not take any Forward Coverage to square up position.02 Risk of the Clients • Exchange houses & Exporters: o The exchange houses collets funds from Expatriate customer at their published rate daily and after collection of remittances from expatriate Clients. 03.01 Risk of the Bank: • Export bills: Bank Buys Export bills (Sight/Usance) from Clients paying BDT at spot and run the exchange rate risk until realization of proceeds in FC. Due to present Volatility in the market. • Importers: There remains a time gap ibetween the date of opening LC and date of requirement of FC and payment thereof. the Exchange houses are to make loss. the exchange houses remit the same to the concerned Bank.00 Concepts/Structure of Islamic FX Forward (Islamic Promissory FX): The procedural aspects of traditional Forward contracts/Booking of Foreign Currency is not correct according to shariah because the under the contract the concurrent possession and delivery of both of the countervalues by both parties . If the rate comes down below their published rate. 04.there is a risk of fluctuation in between the gap.03. o The Exporters are also to run the risk against the bills sent on collection basis. the exchange houses experiences a huge loss.The risk can not be covered by Forward Booking due to non availability of shariah approved such product.

does not take place. According to Islamic shariah Forward foreign exchange transaction may be done on promise/agreement instead of contract. A promise from one party only is permissible in currency exchange even it is binding (Shariah Standard no-1. • Binding promise from one party is not deemed as contract under Islamic law. Jeddah forwarded by (Annexure-02) . Promise by one party i.e. Fatwa by AAOIFI in support of one party promise: A promise from one party is permissible if the promise is binding.(See AAOIFI). in Forward foreign exchange transactions.Annexure 1(a) & 1(b) 05.e. The promise may be under Wad structure (One party promise) Wa’d Structure of Promise by one party: • Islamic law allows promise to buy sell currency on the date and delivery to be made on another date which construct WAD structuring Islamic version of forward transactions • Under WAD structure only one party promise to buy sell. • Above all. Islamic legislation (Fiqah) center. page 16 & appendix B (7))….01 Opinion of Dubai Islamic Bank backed by fatwa of Mohammed Taqi Usmani. either by seller or buyer to buy/sell Currencies is permissible as per Islamic shariah and is a legal binding. Financial intuitions have a customary practice of treating promises as binding. when formally they are not. as the case may be wherein he is bound to by that promise and other party will proceed with the promise undertaken by the promisor i. the deal may be considered as promise and the AKAD may only execute on the value date when the currency exchange takes place. Trading in currencies 2/9(9).00 Practicing Wa’d structuring Forward globally: 05.

But the actual sale or purchase would take place on 1St July 2010.Quote: The procedure outlined for forward booking of foreign exchange is not correct in its present form because according to shariah no sale for any future date can take place today. 2010. there is no restriction in the shariah with respect to fixing the rate in advance. in accordance with the shariah the parties can promise/agree between themselves that on a specific future date they would buy or sell specific goods or specific currencies at a specific rate. This would be a promise/agreement from both parties the fulfillment of which would be a moral responsibility of both.02 Kuwait Finance House (Malaysia) berhad Quote “KFH Promissory FX Contract is a written. The product is designed to .2010 and the seller could state that we promise/agree to sell a specific currency at a specific rate on the said date. Unquote: 5. There is also no need to get into the detail as to what factors the counter parties have taken into consideration whilst fixing such rate. Wording used in the deal by traditional bank is We have sold/Purchased It is not correct in accordance with shahiah Instead following wording should be used in the deal We promise/agree to sale to you… We promise/agree to buy Through the simple change the whole transactions would be in accordance with shariah. Moreover. For example if a particular currency is required on 1st July. dated and signed instrument by a party containing an unconditional promise to enter into an agreed foreign exchange contract with another party at a specified future date.we can not have a confirmed sale today but today we could state that we agree/promise to buy a specific currency at a specific rate on 1st July. However.

07.03 Bank Islam Malaysia. • At an agreed rate determined on spot/majlis for future delivery. bank is to follow the following hedging techniques: • Spot against Forward: The Bank will buy foreign currency from internal & external sources at spot basis and then sale the same to forward. In such case. Bank can first take possession of Currency(First leg Spot) then sale on promise(2nd Leg forward) to Clients.00 Hedging techniques in Islamic Forex Forward: In order to manage the exchange position of the bank & to match inflow with outflow at maturity. • To buy or sale one currency against another. (Annexure-04)” 06.assist business to mitigate the uncertainty and provide flexibility in managing foreign exchange open position”. • Forward against Forward: Both the leg of Buy and sale the foreign currencies are made on promise. • To protect against unfavorable movement of exchange rate. • To assist business to mitigate risk against genuine underlying assets of banks and clients.When a deal is made on a certain day that deal is only considered as Promise. • Not allowed to get benefit from favorable movement of the currency • Bank has the right to claim for losses on MTM on termination date. The AKAD (Settlement) is only executed on the value day when the currency exchange takes place.00 Delivery Type of Islamic Forward exchange . (Annexure-03) Un-quote 5. 8. • Akad on Value date/for delivery/settlement on agreed future date or within the period of promise. Berhad “Bank Islam has been doing Spot and forward transactions for covering position and trading .00 Features of Islamic Forex Forward • A Unilateral Promise by clients on Deal date followed by akad(settlement) on value date.

02 Settlement / Akad date/spot date/Before two days of maturity • Bank/Customer will offer to buy/sale of foreign currency(s). • .e.00 Documents • Master agreements/terms & conditions (Annexure-05) • Promise to purchase/sale • Offer to buy/sale • Acceptance to buy/sale 11. • Option dated Forward: The delivery of the Foreign exchange can take place at the agreed rate any time during the existence/validity of the promise. the delivery of the Foreign exchange to be made at the date fixed in the agreement.01 At the time of Promise/Deal date: • Against the proposal of the Customer. This is a form of promise to buy/sale given by the customer to the Bank.00 Security: • Urbun / Earnest money: To minimize the risk of counterparty for non performance of promise.00 Dealing Process of Islamic FX Forward (Islamic Promissory FX) 9. 9. the client will pay only a small part of the price of the commodity at the time of entering such transactions on the understanding . which Bank/customer will sign/stamp and send back to bank/Customer • Bank/Customers will send an acceptance of the offer. • Fixed dated forward: A specific delivery date is agreed upon i. 10. • The customer will sign/stamp and send back the Deal confirmation to the bank. the Customer will unilaterally promises to buy/sale a currency at a future date at a price determined at majlis. Bank will acknowledge the promise to buy/sale. this concluding the purchase of currencies. 09.

• The Islamic Banking Industry depends on Conventional Cost of capital which is not technically violation of Shariah but has to develop its own set of rate of return. the Bank will recompense the actual loss of liquidity from Urbun A/C of Clients. o Bank to Client: The urbun is required only for Bank to Customer Islamic FX Forward and the amount of Urbun depends on Banks-Clients relationship. export and remittances . the client will need to deliver his currency to banks in clear FC funds. o Bank to Bank: In case of Bank to Bank Islamic FX Deal. 14. the Thomson Reuters Limited are quoting Profit Rate/rate of return on different Islamic product traded in the global market especially on Commodity Murabah on major currency(s) on different Islamic principles which may be considered as Islamic benchmark rate of Foreign Currency(s) leg. ( Reuters Code:……. that the Bank will retain the amount as margin till maturity of the transactions. the client may need to amend the Forward Foreign Exchange agreement due to early/delay shipment/.(AAOFI Resolution-Annexure…6(a)(b) 13. there requires no urbun but have to allow Counterparty limit for such transactions. the Rate of return of FC RR with that of RR of BDT Mudarabah rate may be considered as profit rate differential for adjustment with Spot Rate. the client intent to extend the validity of the LC/early repatriation/documents/delay receipt of funds for import. 12. shipment not affected within the LC validity.00 Pricing of Islamic Forex Forward • Presently. Settlements of Islamic FX Forward On value date/Maturity date (Date when exchange of currency takes place). But due to the complexity of commercial transactions. If the deal(s) is/are not finally concluded. Amendments/amendment of Islamic FX Forward: Banks usually protect themselves matching forward purchase/receivables with payable considering the maturity date. If there is reminder to be retuned to the clients and if the retained amount is insufficient the client should pay the rest. The Islami Bank will in turns deliver the agreed amount of the other currency in accordance with client’s instructions complying the documents.)Therefore.

14.a Early fulfillment of promise / Pre delivery 14.c Non utilization of promise against Islamic forex forward 14. the bank will realize nothing form the Client. b Extend /extension of the promise 14. .business respectively for which the client may request for amendments that may be done by …. we propose that Islamic FX Forward (Propose name : Islamic Promissory FX) may work flexibly than Traditional Forward Contract .. 15.00 Conclusion: Considering the need for both Bank’s & Clients and the shariah aspects explained in this paper.02 Cost of Amendment • If the amendment of Islamic forex forward incur no losses for the Bank or the exchange rate is in favor of the bank. • If the bank incurs losses. only the actual cost will be adjusted form the bai- al-Urbun A/c of the Clients.