SHARIAH REVIEW OF ISLAMIC PROFIT RATE SWAP STRATEGIES IN ISLAMIC FINANCIAL INSTITUTIONS: THE CASE OF MALAYSIA BY SYED EHSANULLAH AGHA A research paper submitted in fulfillment of the requirement for the degree of Master of Science in Islamic Banking and Finance IIUM Institute of Islamic Banking and Finance International Islamic University Malaysia AUGUST 2015
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SHARIAH REVIEW OF ISLAMIC PROFIT RATE SWAPSTRATEGIES IN ISLAMIC FINANCIAL
INSTITUTIONS: THE CASE OF MALAYSIA
BY
SYED EHSANULLAH AGHA
A research paper submitted in fulfillment of the requirementfor the degree of Master of Science in
Islamic Banking and Finance
IIUM Institute of Islamic Banking and FinanceInternational Islamic University Malaysia
AUGUST 2015
ii
ABSTRACT
“Nothing ventured, nothing gained” is the first principle of investment. The possibilityof an adverse outcome is an essential part of business activities. This uncertainty aboutfuture outcomes is defined as risk. The broad perspective on risk and its managementis embodied in the essential objectives of Shari’ah, which is wealth protection.However, in the light of the Shari’ah legal maxim that states ‘al-ghurm Bi al-ghunm’(liability accompanies gain) and ‘al-kharaj Bi al-Daman’ (benefit goes with liability)risk cannot be isolated from economic affairs. The legitimacy of revenue generationrequires that it has to be created based on real economic activities that involve realbusiness risk and liability. On the other hand, exposing to excessive risk not onlyhurdles investment, but also deters economic growth, which might be against themaqasid al-Shari’ah (objectives of Shari’ah). As Islamic finance industry grows 15 to20 percent annually, the need of hedging tools to mitigate certain risks in a volatilemarket increases. For instance, with a rapidly emerging market of Sukuk, bothinvestors and issuers are exposed to currency fluctuation risk. Similarly, in the case ofIslamic REITS, if the fund is invested in overseas properties. Islamic Profit Rate Swap(IPRS) is a contract designed as a hedging mechanism to minimize marketparticipants' exposure to the risk of inflation and rate of return. By nature Swapproducts are derivatives which violate Shari`ah principles. According to Sami Al-Suwailem 97.30% of derivatives products are being used for speculation. Thisresearch aims to review from Shariah perspective the legality of the structure andmechanism of Islamic profit rate swap as currently offered by many Islamic financialinstitutions in Malaysia. Specifically the paper highlights the Shariah parameters andguidelines in structuring IPRS. It is observed that IPRS products may involve thefollowing Shariah Issues: Combination of Several Contracts, Use of the samecommodity for various Murabaha transitions, Organized Twarruq, PrematureTermination and Mark to Market. Finally, an improved new structure of IPRS isproposed to reduce operational cost and Shari`ah non-complaint risk for Islamicfinancial institutions.
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ملخص البحث
وهي سمة لايمكن أن ينفك عنها أى ،الاستعداد لتحمل المخاطرة هو المبدأ الأول للاستثمارلامي. ومع النمو نشاط اقتصادى. تشهد الساحة المالية نموا ملحوظا للتمويل والاستثمار الاس
ت ومن ابرزها المخاطرة. وقد نجحت ، المطرد تبرز الحاجة لادوات تعالج مايواجهه من الصعوالمؤسسات المالية الاسلامية في تطوير هذاالغرض.هذه الورقة تدرس من منظور شرعي ح كما هي المستخدمة في المؤسسات الاساليب والادوات التي تعالج مخاطرة التضخم والار
ح". وهي اتفاقية لتبادل المالية الاسلامية الماليزية. هذا المنتج يعرف "بمبادلة معدلات الاربت وطرف معدل ربح متغير ح بين طرف معدل ربح أو العكس. ويتم معدلات الأر
تنفيذها من خلال تنفيذ سلسة من العقود الأساسية المتفقة مع مبادئ واحكام الشريعة التالية: الجمع بين العقود، استخدام تايلاكشلااظ أن هذا قد ينطوي على ولوحالإسلامية.
اء المبكر. وأخيرا، يقترح هيكل نفس السلعة لمختلف عقود المرابحة، التورق المنظم والإمتطور لهذا المنتج .
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APPROVAL PAGE
I certify that I have supervised and read this study and that in my opinion, it conformsto acceptable standards of scholarly presentation and is fully adequate, in scope andquality, as a research paper for the degree of Master of Science in Islamic Bankingand Finance.
………….……………………………….Younes SoualhiSupervisor
This research paper was submitted to the Institute of Islamic Banking and Finance andis accepted as a partial fulfillment of the requirements for the degree of Master ofScience in Islamic Banking and Finance.
…………………….…………………….Khaliq AhmadDean, IIUM Institute of Islamic Bankingand Finance
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DECLARATION
I hereby declare that this research paper is the result of my own investigations, except
where otherwise stated. I also declare that it has not been previously or concurrently
submitted as a whole for any other degrees at IIUM or other institutions.
Syed Ehsanullah Agha
Signature …………………………… Date ……………………..
vi
COPYRIGHT PAGE
INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA
DECLARATION OF COPYRIGHT AND AFFIRMATION OFFAIR USE OF UNPUBLISHED RESEARCH
THE EFFECTS OF DEBT ON VALUE OF THE FINANCIALFIRMS AND THEIR BANKRUPTCY COSTS: A CASE OF
MALAYSIA
I hereby affirm that the International Islamic University Malaysia (IIUM) holds all
rights in the copyright of this work and henceforth any reproduction or use in any
form or by means whatsoever is prohibited without the written consent of IIUM. No
part of this unpublished research may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying,
recording or otherwise without the prior written permission of the copyright holder.
Affirmed by Syed Ehsanullah Agha
…………………… …………………
Signature Date
vii
DEDICATION
This work is dedicated to the most pious and loving woman I have ever known, my
mother. For all her sacrifices, love and the way she takes care of me in my student
life, I will always be grateful. May Allah Almighty give her healthy long life.
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ACKNOWLEDGEMENTS
All praises be to Allah Almighty, Lord of the Universe, and Peace and blessing ofAllah be upon His final Messenger Prophet Muhammad (P.B.U.H), his Family andCompanions.
I take this opportunity to express my deep regards and profound gratitude tothose who have contributed and helped me both directly and indirectly in thecompletion of this research. Firstly, I would like to give special appreciation to myfavorite lecturer and my respected supervisor, Associate Professor Dr.Younes Soualhifor his exemplary guidance, diligence and continuous monitoring throughout thecourse of this research and I am also grateful for the time he gave me, without whichcompletion of this research in due time would not have been possible.
Finally, I would also like to acknowledge my special gratitude and appreciationto my parents for their continuous support and prayers, my brothers and sisters fortheir kind words of encouragement. May Allah Almighty reward all of them for theircontinuous support.
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TABLE OF CONTENTS
ABSTRACT............................................................................................................. iiAbstract in Arabic .................................................................................................... iiiApproval Page.......................................................................................................... ivDeclaration ...............................................................................................................vCopyright Page.........................................................................................................viDedication ................................................................................................................viiAcknowledgements..................................................................................................viiiList of Tables ...........................................................................................................xiList of Figures ..........................................................................................................xii
CHAPTER ONE: INTRODUCTION .................................................................11.1 Background of the Study ........................................................................11.2 Statement of the Problem........................................................................31.3 Research Objectives................................................................................31.4 Research Questions.................................................................................41.5 Research Methodology ...........................................................................41.6 Structure of the Study .............................................................................51.7 Limitations..............................................................................................61.8 Significance of the Research ..................................................................6
CHAPTER TWO: LITERATURE REVIEW....................................................72.1 Introduction.............................................................................................72.2 General discussion on derivatives ..........................................................7
3.2.1 An Overview of Risk Management from ConventionalPerspective....................................................................................12
3.2.2 Risk Management from Maqasid al-Shari’ah Perspective ............143.2.2.1 Risk Management in Qur’an .............................................153.2.2.2 Risk Management in Prophetic Tradition .........................17
3.3 Risk taking and risk sharing: Reconciliation ..........................................193.3.1 The Essential risk ..........................................................................213.3.2 The Forbidden risk ........................................................................233.3.3 The tolerable risk to be avoided....................................................24
CHAPTER FOUR: ISLAMIC PROFIT RATE SWAP ....................................274.1 Introduction.............................................................................................274.2 Swap as a Risk Management Tool .........................................................28
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4.3 Mechanism of Swap Product..................................................................294.4 Main Objectives of Swap Instruments....................................................294.5 Islamic profit rate swap ..........................................................................304.6 Murabaha structure of IPRS...................................................................324.7 Conclusion ..............................................................................................36
CHAPTER FIVE: Discussion ..............................................................................375.1 Introduction ............................................................................................375.2 Wa`ad......................................................................................................375.3 Validity of Tawarruq in Swap................................................................415.4 ISSUES of speculation ...........................................................................435.5 Combination of Several Contracts..........................................................445.6 Premature Termination and Mark to Market ..........................................465.7 Proposed Model for IPRS (Single Commodity Murabaha) ...................475.8 Conclusion ..............................................................................................49