Ha Junsheng

Title
The promise (wa’d) in Islamic finance

Ha Junsheng @ Ibrahim

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Abstract

Wa’ad or promise has become more and more popular in the Islamic financial industry.
Due to its one-sided nature, it provides the market participants flexibility and
convenience in designing and structuring products. As an emerging instrument, it brings
new opportunities and possibilities to the Islamic Financial market, and it also raises
debates and critics from the scholars and jurist. This paper aims to understand the
concept and the applications of the wa’ad. By examining the current status and
implications to the Islamic financial market and discussing the current and potential
issues relating to wa’ad, we find that on one hand, wa’ad brings the hope of achieve
completeness of Islamic financial market; while on the other hand, it also opens a
backdoor that may be used by the hijackers of Islamic banking and finance.

Key terms of the research

1wa’ad 2 promise 3 shariah compliant 4 currency forward/option .5 Islamic finance

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Objectives of the research:

To understand the practice of wa’ad contract in Islamic finance

• To understand the shariah rulings on the wa’ad and its applications

• To examine its current status and implications in the market
• To discuss the current and potential issues

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Table of content

Introduction

• Concept
• Basic shariah rulings
• Current practice of Wa’ad
• Selected resolutions to certain practices involve wa’ad
• Shariah issue of the application of wa’ad
• Conclusions

Conclusion and finding

References

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Introduction

After decades of development, Islamic banking and finance is no longer a fancy

name in the industry. It has become more and more known to every corner of the world.
While having been a shining star ever since especially during financial crisis, it also faces
many challenges and problems. One of them is on the product line. To survive in the
modern financial world, it is necessary to bring innovations and creativity to the industry
to meet the needs of different market participants.
In the islamic financial industry, the bank for example, as required by the shariah
rulings, has to get exposure in the financial transactions directly in many cases rather
than only being a financial intermediary. As it is known well, to get more exposure
means to assume more risks. In order to make the transaction fairer and minimize the
risk, many products and instruments have been introduced and adopted in the market.
One of the most remarkable concepts is wa’ad, a promise. It started to be adopted
in the Murabahah sale contract and later on gained popularity in being adopted in many
other financial instruments and facilities that are based on sale, leasing and partnership.
In order to make it shariah compliant, more deliberately designed products incorporating
wa’ad elements are being introduced to the industry.
However, due to its one-sided nature and no clear agreement on its sharing
rulings, since its introduction, critics and debates have started and seemed to have no end
ever since. Scholars, jurists and industrial players all jump into the battlefield and no one
would surrender. The international shariah bodies have been making fatwas and
amendments in order to cater the needs of the market participants and also to ease the
tension of debate. One of the most recent updates on the issue related to wa’ad is the
regulation policy updated by the bank negarah of Malaysia1. The shariah advisory
council of the central bank Malaysia has made the policy that there should be no fees
should be charged for unilateral wa’ad currency hedging since it may turn the structure
into a bilateral wa’ad concept that is not allowed by the the shariah ruling that is agreed
by the majority of the scholars that only unilateral binding wa’ad without any fees
charged is allowed in a forward currency transaction for the purpose of hedging not
speculation. Having explained the new policy of the central bank, we realize that the
current practice is that the financial institutions actually are charging fees for entering
(Islamic Finance monthly Bulletin (September 2010 1

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wa’ad. So we can see that the practice of the industry is somehow against the rulings of
the related bodies. It is worth discussing the issue of wa’ad in order to understand deeply.
The discussion of the paper will start on the concept of wa’ad itself and then
followed by the shariah rulings and current practices of its applications. And issues
related to wa’ad and its application will be discussed through literature reviews and case
studies.

The concept

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Wa’ad or wa’d is a Islamic financial product. The term appears frequently in the
Holy Qur’an. It literally means “to promise” or “to firmly intend”. A party promises to
do or not do some activities to another party. And if the other party also promises to do
some activities but independent from the first promise then it is called double wa’ad. If
the second promise and the first one are interdependent then it is called muwa’ad,
meaning bilateral wa’ad2.
In Islamic law, this type of agreement normally involves a promisor, who promise
to purchase or sell, and a promisee, who enter a promise with the former. For example, A
promises B to buy B’s car. So A is bound to purchase B’s car while B is not bound by the
contract since this is a unilateral or one-sided promise. This example clearly illustrates
the difference between Wa’ad and a contract that requires an offer and an acceptance that
binds both the buyer and the seller, meaning bilateral.
Due to its unilateralness in nature, wa’ad is potentially useful and flexible to be
used to structuring transactions that conform to the shariah rulings in the competitive
financial market.
Wa’ad is utilized in the financial derivatives such as put and call options however
it raises also many critics on its use. Other than that, the application of wa’ad is also
observed in many Islamic financial instruments such as sale and purchase,
murabahah,ijarah, takaful and so on and so forth.
In the amendment of the Malaysian Accounting Standards Boards to the financial
reporting standard i-1 2004, the definition of ijarah mumahia bittamleek is mentioned as:

Ijarah Muntahia Bittamleek is an Ijarah contract with an undertaking by the

lessor to sell the Ijarah asset to the lessee and/or an undertaking by the lessee to
purchase the Ijarah asset from the lessor by, or at, the end of the Ijarah period.
The sale and purchase is effected by a separate contract.’Undertaking’ is
translated from the Arabic word “wa’ad”.
In the case above, we can see that the incorporation of wa’ad helps to facilitate
the transactions. It is also the case when it is adopted in many other types of structured
products.

.This type of wa’ad is normally not allowed 2

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In the practical sense, wa’ad has no specific definition of its own. To put it
another way, al wa’ad can be understood as a commitment made by one party to another
to undertake either an actual or verbal disposal that would be beneficial to the other
party.
To understand the concept of wa’ad is not difficult. However, due to the
complexity of the its applications, it may take some effort to understand the arrangement
and structures, especially when there is doubt that wa’ad may be used for bad purpose
that may harm the market participants and the industry as a whole. Thus, next section, we
will discuss on the shariah rulings that govern the practice of wa’ad in order to set a
general ground for discussion.

The basic Shariah ruling

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Generally, Wa’ad should be fullfiled for religious cause and it is something

related to morality and it is generally agreed by the scholars3. Most of the scholars,
including the ones from shafie, Hanafi, Hanbali and some from Malik’s school agree that
a wa’ad made by one party to the other one should be Mulzim diyanatan, i.e. religiously
binding, yet mulzim qadha’an, i.e. legal obligation. The justification is that wa’ad is part
of aqd tabarru’at, i.e. a voluntarily contract. So the party that is promised posses only the
moral right but religiously, if a person does not fulfill a promise, he will be among the
hypocrites according to the Hadith. Therefore, Muslim investors should be careful in
involve in the transactions that contain the wa’ad element.. However, due to its nature as
unilateral, wa’ad is treated differently from contract. It is legally binding upon the parties
involved depends on the acceptance of its applicability and to the opinion of the jurists.
Different views and principles are upheld by different schools of thoughts and scholars in
the field of shariah and law.
There are basically four types of opinions on Wa’ad4:
1) to satisfy a Wa’ad is honorable but not obligatory.( Imam Abu Hanifah, Imam Al-
shafai’ and some Maliki scholars.)
2) Wa’ad binds the promisor with a legal obligation to fulfill the contract. ( Samura
b. Jundub and some Maliki scholars)
3) Only if the promisee ends up with a loss or any costs in order to fulfill the Wa’ad,
then the contract is binding.
4) The generally accepted opinion by the Islamic Fiqh Academy insists that three
conditions must be fulfilled to validate a Wa’ad:
a. unilateral promise
b. cost or loss caused by making effort to meet the promise by the promisee
c. the completion of the actual sale or purchase

Because of the debate and controversy among the current jurists on wa’ad, Islamic
Fiqh Academy (1409H) has made some decision to give some fatwa that:
1. That a unilateral promise is religiously binding upon the promisor. And it is also
judicially binding if it is made contingent upon a cause and if the unilateral promise

Dr. ‘Ala’ Eddin 3

(Islamicbanker.com (2010 4

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incurs a expense. In such case, it is either to fulfill the unilateral promise or to

compensate the losses resulted from non-fulfillment of the unilateral promise.
2. if a bilateral promise is optional for both or either party, then it is permissible in
murabahah. Otherwise, it is not allowed since it will be equivalent to a sale contract
if it is a binding bilateral. And in such case, the seller should possess or have
ownership on the goods sold other according to hadith.
These decisions have drawn attention in the industry and criticisms. It is argued
that :
First of all, the decision did not distinguish the unilateral promise in the case of
plain promise and in the resale contract. And another criticism is that it seems that
the two decisions are to be hijacked in such way that if the market participants are in
favor of making unilateral promise binding then they would go for the first decision
otherwise they may go for the second decision.
And furthermore, it is argued that the decision is arbitrary in a sense that it does
not allow the bind on both party but on one of them. It is said that this is not logical and
acceptable and in contrary to the opinion of Imam Al-Shafi’i.

Current practices of Wa’ad

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The wa’ad has gained more and more popularity in the past years due to its
flexibility. Two conditions must be fulfilled in order to validate any contacts: price
awareness and ownership of the subject matter. However, in the case of wa’ad, these two
conditions are not required. Thus wa’ad seems to be much more attractive and
convenient to adopt than any other types of contracts for the market participants.
Below we will discuss some applications of wa’ad in structuring some sharia-
compliant financial products.
1. currency option
wa’ad could be used in structuring Forex option. The reason that it is allowed
is because creation of option for real trade hedging purposes is considered as
halal since it reduces uncertainty hence beneficial to the public interest5.
Conceptually, many scholars accept currency option. The cash flows
arrangement by using wa’ad acutally imitates to the cash flows patterns of the
conventional counterpart.
Case study of the currency option6:
The customer makes an wa’ad to the bank that he will buy or sell some
amount of currency A against the other currency B on a pre-determined date
at certain fixed rate. On the other hand, the bank accepts the wa’ad but makes
no wa’ad back. Then the bank pays a premium that is non-refundable to the
customer no matter if the bank exercises his option by using the wa’ad or not.
The bank will make its decision by observing the future exchange rate. If it
goes to the direction that is in favor of him, then he may choose to exercise
the option by accepting the wa’ad otherwise the bank may inform the will of
cancellation to the customer. And it is also stated that this kind of
arrangement/instrument is only for the purposes of hedging or cost reduction
but not for speculation 7

2. Short selling
Conventional short selling is prohibited by the shariah rulings since the seller
is actually selling what he does not actually own. According to Hadith, one
(Dr. Obaidullah (1999 5
(Priya et al (2009 6
(Calyon.com (2006 7

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must sell what he owns8. And the seller must assume risk in the transactions,
meaning he cannot be a free runner. In order to make a shariah compliant
instrument, wa’ad can be adopted to emulate the cash flows of the
conventional short selling yet still in accordance to the shariah rulings. As
proposed by Priya at al (2009), the structure of the short selling could be as
follows:
A broker buys securities from an shariah compliant hedge fund using
murabaha contract at a murabaha sale price(say RM1000) that is payable by
deferred payment. Then the broker sells the securities to the market at the
market spot price (RM 1000) for cash. At the same time, “A” enters two
double-wa’ad with the broker and with the hedge fund each. The one with the
broker is whereby “A” makes an unilateral wa’ad to purchase the securities
for a predetermined price( say RM 920, RM 900+spread RM 20) while the
broker makes an unilateral wa’ad to sell the securities. On the other hand, “A”
makes another unilateral wa’ad to the hedge fund to sell the securities at a
predetermined price( say RM 900) and in return, the hedge fund also makes a
unilateral wa’ad to purchase the securities at the same price. And “A” will be
paid fees by both the hedge fund (pays RM 10) and the broker( pays RM 20)
for entering into the double wa’ad with each party. So if the price of securities
decreases to be RM 900, then first the broker will purchase the securities from
the market at this price by using the cash received by the first sale he did. And
he then will enforce the double wa’ad with “A” to sell the securities to “A” at
RM 920. And the hedge fund will also enforce the double wa’ad with “A” to
buy the securities from “A” at RM 900. And then under murabaha, the hedge
fund will then receives they payment from the broker at RM 980 (RM1000
deducts the spread of the broker of RM 20).
Then the final outcome is that:
1) for the hedge fund: the return is equal to the money of RM 980
receives under murabaha from the broker minus the price spent on buying
the securities from “A” and the fees paid to “A” for entering the double
wa’ad. So the final proceeds for the hedge fund is RM 980-RM 800-
RM10=RM 170.
(Prohibition on riba and gharar (2002 8

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2) By the similar calculation, we find that for the broker, he will

receive RM 20 in net.
3) For “A”, he will receive RM 10 in net after exercising the two
simultaneous double -wa’ad with the broker and the hedge fund each.
As we can see from above example, the final outcomes of this arrangement
actually emulate the returns when using conventional short-selling, yet it is
shariah compliant if we examine the each transaction that has been done.

Selected Resolutions to certain practices invovle wa’ad:

Although in general, the promisor is not bound to fulfill his promise, in dealing with the
promissory elements such as the sale and buy-back agreement, when issue transaction

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and forward foreign currency transactions, one should be cautious to check the
transactions if the promisor is breached that causes the costs to the promisee.9
1. Sale and buy-bank agreement: both parties of the contract promise to buy
or re-sell the asset in the future time. This type of agreement is widely
adopted in the interbank money transactions. The shariah issue related to this
case is that what the legal effect of wa’ad on the contract and the
permissibility to buy or re-sell the same asset in a sale contract. The resolution
of the Shariah Advisory Council is that wa’ad in this kind of agreement is
allowed if it is not put as the condition for the sale and purchase of the asset.
2. When Issue Transaction: in order to secure a price of a transaction in debt
securities that will normally be issued in about a week, both parties of the
contract make a wa’ad. And to guarantee the market transparency for all the
stakeholders in the market, the “when issue” should be recorded in the “Bond
Information Dissemination System. This arrangement is also a mean to help
the market participants to estimate the accurate price of the securities. In
practice, if the actual sale and purchase of the securities will take place in the
future and if the issuance is cancelled later, then the wa’ad is also ended. So
the shaiah concern on this practice is the permissibility of promising to sell
and purchase in future. The resolution provided by the shariah advisory
council is that this kind of transaction is allowed given the permissibility of
promising to sell and purchase.
3. Forward Foreign Currency Transaction: In a foreign currency spot
transaction, the real delivery and settlement usually is done two days after the
transaction day and in a forward currency transaction, it is done in a pre-
determined future date. To facilitate this kind of transaction with shariah-
compliant arrangement, a wa’ad contract is adopted that both parties of the
contract promise to sell and buy currency each needs on a predetermined date
for forward and two days after for a spot contract at an agreed price rate. In
the real practice, no actual signing of agreement will take place on the
settlement day. The shariah concern in this case is whether the wa’ad forward
and spot currency transaction is allowed or not. The resolution of the Shariah
Advisory Council is that it is allowed and the compensation could be imposed
(Shariah resolutions(2007 9

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on the promisor for breaching the promise. And it is only allowed in the case
of currency hedging and can be between customers and IFIs, between IFIs
and even between IFIs and conventional financial institutions.
As we can see, wa’ad can be adopted into different transactions to facilitate the
needs of the market participants. However, it should be carefully examined to make sure
it is in accordance to the shariah rulings.

Shariah issue of the application of wa’ad

Unlike the Islamic contract, wa’ad is less legislated for its use and applicability
by no or few standards of the international bodies such as IFSB and AAOIFI. Therefore,

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many issues, controversies and debates have appeared along the adoption of wa’ad into
different financial transactions.
1. first issue
One of the issue is the enforceability of the wa’ad. Since wa’ad is unilateral.
The promisor may tend not to fulfill his promise. This may affect the
effectiveness of wa’ad and further harm the financial market. The market players
become more cautious in dealing with financial transactions that incorporate
wa’ad. As Frank and Samuel ( 1998) has pointed out that in the modern legal
environment, Islamic financial institutions are attracted to incorporate wa’ad into
the transaction in most of the case when both parties have very strong extra
incentives to fulfill the promise, regardless of whether its binding or not. They
gave two very good examples:
- First is that a lessee is promised to receive the title to property at the end of the
lease by the lessor. In order to preserve his own reputation and for the future
ability to sell his products, he is discouraged to breach his own promise in this
wa’ad financial contract.
- Second case is whereby banks enter into mutual promise to conduct currency
exchange. To ensure the healthiness of the business relationship among them it is
in their best interest to fulfill the promise to each other.
As we can see that in both cases, the promisors have strong incentives to make
sure their promises are fulfilled. Hence, it is well realized that the enforceability
of the wa’ad is a major concern of the participants in the Islamic financial market
given the convenience and flexibility provided by adopting wa’ad into the
different financial transactions.
As a result, many fatawas have been given in order to facilitate the
implementation of the financial transactions that incorporate the wa’ad element.
These fatawas should be carefully learned and applied with the right knowledge
in order to generate best outcome.
As in the case of murabaha sales, the client promise the bank to purchase the
goods from the bank at a mark-up price once the bank purchases the goods from
the market or the supplier. In this case, bank is taking the risk if the client does
not fulfill his promise after the bank has purchased the goods and taken the
ownership. The bank will have to find a way to return or dispose the bought

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goods that will normally incur losses for the bank. In order to settle the issue,
fatwas have been issued that the wa’ad made by the client to the bank should be
binding to him, if not fully, at least he should pay the costs and losses for the
bank in meeting the promise if the client changes his mind not to purchase the
goods10. The fatawa also indicates carefully that the wa’ad should be unilateral.
Bilateral promise is not allowed under shariah rulings.

2. -The case study of Deutsche bank Islamic Swap

One of the current applications of wa’ad is the contract of Wa’ad swap. This type
of contract enables two parties to swap the return from one basket of assets to another.
This mechanism, due to its design, enables the shariah compliant or Muslim investors to
expose to the haram assets that are not shariah compliant.
The remarkable debate on the Islamic swap product that was introduced by the
Deutsche Bank has become a hot topic on the application of wa’ad. This bank discussed
the structure of the instrument in the one of its paper11.
In this paper, the Deutsche bank justifies the shariah compliant of its Islamic
return swap by referring to the study of Dr. Hassan (2003) that according to Shariah
rulings, wa’ad should be legally binding because by doing this it will protects the values
of commutative justice and liberality. And further more the paper is trying to prove that
at the time of execution the pricing of the contracts could be determined in Islam and by
using the examples of Taqi Usmani’s permission of murabaha markups that is related to
some more-complex payoffs it tries to show that markups is not necessarily required to
be related to permissible activities when indexed, in this case, the LIBOR itself. Many
points of discussion are missing in this paper12 such as:
1. Permissibility of consideration in wa’ad and the permissibility of
muwa’adah (bilateral wa’ad).
2. The actual details of the structure of the Islamic swaps.
Therefore, many criticisms have been raised towards using this kind of double
wa’ad structure. Sheikh Yusuf Talal DeLorenzo (2007) calls for attention that:
"I believe that due consideration must be given to not only the literal
structure of products and processes, but also to their consequences for the
(Fiqh Academy Journal (198810
Deutsche Bank Academic white paper 11
(Islamic finance resources (2009 12

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future of Islamic Finance. In other words, while up until now the Shariah
supervisory boards of modern Islamic financial institutions have focused
almost exclusively on the rules for transacting in compliance with the
Shariah, it is now time for them to focus as well on the higher purposes of
Islamic law or the maqasid al-Shari`ah."
Dr. Yusuf proves that this kind of product actually help the investors to receive
cash flows from investment in haram businesses. So the money of the Muslim investors
are actually used to invest in the businesses that are not in accordance to shariah rulings
meaning that the returns are determined by the performance of non-shariah-compliant
funds that can invest in haram businesses. So the investments of the Muslim investors
actually cause potential haram activities. And furthermore, he shows that the pricing
based on the performance of non-shariah-compliant assets cannot be justified by
conducting the analogy or qiyas that LIBOR is allowed to be used for pricing for in the
case of the latter, LIBOR is just used for benchmarking the fair return of the market and
the former is used to deliver the return. In his article, Dr. Yusuf shows his serious
concerns on this case. Due to the easiness and cost efficiency of this kind of structure, all
the market participants will tend to adopt it if it is allowed and this will make all the past
three decades of effort in the industry gone since no one would bother to go through the
process of conducting true-sales, lease backs and other necessary transactions to validate
the contract normally.
However, in his article, Dr. Yusuf does not blame the structure of using double
wa’ad but rather putting the criticism on the use of the structure which means that if the
arrangement is regulated to be adopted in dealing with only shariah compliant activities,
then it may turn out to be some powerful instrument ever.
On the other hand, Dr. Hassan (2007), in supporting this structure introduced by
the Deutsche Bank, indicates that the investments of the Muslim investors are isolated
and protected from haram businesses or transactions by the bank according to the shariah
audits conducted by the bank.13 However, it can be argued that further transparency
should be guaranteed since the shariah audit is carried out by the bank not by the
independent shariah body. Another supporting argument is that the use of the use of a
reference index is similar or same to using LIBOR as benchmarking for suku issuance14.

Daniel, 2008 13
Ibid 14

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Both sides are having their own arguments and will not agree with each other on
the same ground. However, as far as the industry perspective is concerned, the use of
wa’ad to imitate the conventional shorting is considered more appropriate than using
arbun or salam.

Conclusion

The long run survival of the Islamic banking and finance calls for more
innovation and creativity. However, the process is not an easy one since, different from
the conventional counterpart, it is compulsory to make sure all the new products and
instruments are in accordance to the shariah rulings while at the same time they can be

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competitive in terms of pricing, costing and operations in the integrative financial

market.
Wa’ad as a unique instrument with special natures and characteristics does brings
exciting possibilities and opportunities to the financial market. It is of the best interest of
all the market participants to not allow it to be abused and end in bad reputation. The
shariah bodies should work together with the industrial players to make sure that the
benefits of incorporating and utilizing wa’ad in the financial transactions are maximized
while the disadvantages and harms of which are minimized.

References:

Al-Shafi`i, Al-Imam, Al-Umm. Cairo, Tab`at Al-Sha`ab’

‘Ala’ Eddin Kharofa (Dr.). (2002). The loan Contract In Islamic Law (Shariah)- A
Comparison with positive law. International Islamic University Malaysia: Kuala
Lumpur.

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Decision 2 and 3, fifth session (1988), Fiqh Academy Journal, 1599-1600

Daniel Stanton, Don’t fear the riba, 24 January 2008 available at
www.arabianbusiness.com/509145-dont-fear-the-riba
Dr. Mohammed Obaidullah (1999), Islamic Financial Options: Potential Tools for Risk
Management, Journal of King Abdulaziz University (Islamic Economics), Saudi
Arabia, Vol. 11
Frank E. Vogel, Samuel L. Hayes (1998), Islamic Law and finance: religion, risk and
return, Kluwer Law International, p125-127
H. Hassan (2003), “Islamic Contract Law: Between Commutative Justice and
Liberality”, 13 (3) Journal of Islamic Studies
Islamic Banking and Takaful Department, Bank Negara Malaysia, Resolutions of Shariah
Advisory Council of bank negara Malaysia, p33.
Islamic Fiqh Academy, (1409 H.), Majallat Al-Majma` (The Academy Journal), Volume
V, Part II, Jeddah.
Priya Uberoi, Rahul Chatterji and Dany Bidar (2009), Promises on the Horizon: An
com/business-lines/calyon-at-the-heart-of-the-development-of-islamicbanking.htm
Prohibitions on riba and gharar (2002), available at
http://www.witness-pioneer.org/vil/Books/MG_CIBF/chapter_1.htm.

Wahba Al Zuhaili (2003), Financial transaction in Islamic jurisprudence, Beirut: Dar al-
Fikr al-Mouaser, First Edition, Vol.1: p50.
Yusuf Talal DeLorenzo (2007),“The total returns swap and the 'Shariah conversion
technology' stratagem.” Online at: www.dinarstandard.com/finance/DeLorenzo.pdf
www.cibafi.org

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