Islamic Compliant FX Forwards
Jonathan Lawrence
Derivatives and Structured
Products Group Meeting
4 August 2011
Copyright © 2011 by K&L Gates LLP. All rights reserved.
Background
 US regulatory issues for cash-settled FX business
i.e. non-deliverable currency forwards
 Characterisation as swaps therefore potential
regulation as swap dealers
2
Recognition of Hedging in Islam
 Important objective of Shariah is to preserve and
protect wealth
Many Quranic verses indicate importance of taking
strategic measure to minimise anticipated risk to
property
3
Conventional and Shariah Viewpoints on FX
Forward
Conventional views:
Shariah Views:
 Used to manage/hedge
against risk of fluctuations in
exchange rates
 Is a derivative instrument
conducting a sale in the future
at a price fixed today
 Contract sealed today but
settlement & delivery in the
future
 Problem with FX: parties
wish to exchange currency in
future but have already fixed a
rate today
 Contravenes Shariah rules
of bay’ al-sarf: exchange
should involve transactions on
a spot basis
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Structuring
 Contracts and principles in accordance with Shariah
rules and principles
 Not to be used as an excuse for practising the
charging of interest
 Each contract to be separate
 Each contract to be actual – not fictitious
 Each contract to have its own effect
5
Execution
 Each contract to be executed separately
 Execution of contracts to follow correct and logical
sequence
 A real transaction must occur each time
 Independent and separate nature of each contract
6
Usage
Instruments only to be used for hedging and not
speculation
Must be an underlying “real” transaction and not
merely a sham
Must be a real need to undertake the transaction
7
Wa’dan
 Two unilateral promises given by two parties to one
another
 The two promises are not connected
 Application depends on two different conditions
shown in diagram below
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Islamic Currency Forward Based on Wa’dan
(two unilateral promises) at Dealing Date
1
Customer
Bank
Promises to sell USD1 million
at the rate of 3.5 if exchange
rate USD/MYR >3.5
2
Customer
Bank
Promises to buy USD1 million
at the rate of 3.5 if exchange
rate USD/MYR is below or
equal to 3.5
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Islamic Currency Forward Based on Wa’dan
(two unilateral promises) at Value Date
 Scenario 1: If USD/MYR > 3.50 (e.g. 3.60), bank
exercises its right under the first promise, to buy USD
for MYR at agreed rate of 3.50
Scenario 2: if USD/MYR< 3.50 (e.g. 3.40), customer
exercises its right under the second promise, to sell
USD for MYR at agreed rate of 3.50
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Tawarruq contract
A financial institution, either directly or indirectly, will
buy an asset and immediately sell it to a customer on
a deferred payment basis. The customer then sells
the same asset to a third party for immediate delivery
and payment, the end result being that the customer
receives a cash amount and has a deferred payment
obligation for the marked-up price to the financial
institution. The asset is typically a freely tradeable
commodity such as platinum or copper.
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FX Forward Based on Tawarruq
Payment of US$ 10 Million at
Value Date
Bank
Broker B
US$ 10 Million
Pay RM35
Million at Value
Date
RM35
Million
US$ 10 Million
Broker A
Customer
Payment of US$ 10 Million at
Value Date
Forward Rate:
US$/MYR =3.50
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Conditions of Use
Approval given by Shariah committees only if the
instrument is exclusively for hedging purposes. This
means:
 can only be used as insurance activity
 cannot be used for funding and trading by means of
speculation
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