ISLAMIC STRUCTRING

OF
SLAMIC FX FORWARD

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

Proposed name of Islamic FX Forward: Islamic Promissory FX

Definition: Under the WAD (Promise) structure, only one party (Obligor /
Promisor) promise to buy/sell as the case may be wherein he is
bound by that promise (Binding Promise).

Opinion/Fatwa: In support of Islamic FX Forward the following opinions / Fatwa

are available in this paper
• Shariah Standard No:1,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,Malaysia

Salient features:
• A Unilateral Promise by clients on Deal date followed by akad(settlement)
on value date.
• To buy or sale one currency against another.
• To assist business to mitigate risk against genuine underlying assets of
banks and clients.
• At an agreed rate determined on spot/majlis for future delivery.
• To protect against unfavorable movement of exchange rate.
• Akad on Value date/for delivery/settlement on agreed future date or within
the period of promise.
• 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.

Dealing Procedure:

• At the time of Deal ,the Client will uniliterly promise to buy/sell currency at
future date at the price determine on Promise date.
• Before Two days’ of maturity, either Bank or Customer will send Offer
letter to exchange Currency for settlement of Islamic FX Forward.

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.
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 client will need to deliver his currency to banks
in clear FC funds. The Islami Bank will in turns deliver the agreed amount of the
other currency in accordance with client’s instructions complying the documents.

Amendments/amendment of Islamic FX Forward:

Due to the complexity of commercial transactions, the client may need to amend
the FX Forward t due to early/delay shipment/, shipment not affected within the
LC validity, the client intent to extend the validity of the LC/early
repatriation/documents/delay receipt of funds for import, export and remittances
business respectively for which the client may request for amendments that may
be done by …..
• 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 bank will realize nothing form
the Client.
• If the bank incurs losses, only the actual cost will be adjusted form the bai-
al-Urbun A/c of the Clients.
__________________________________________________________________________________________
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Concept Paper on Islamic FX Forward
_________________________________________________________________________
__

01. Proposed name of Islamic FX Forward: Islamic Promissory FX

(Forex)

02. Risk overview:

The value of foreign currencies in handling Foreign Exchange business does not
remain stable. Such fluctuation affects the importers, exporters and
Remitter/Exchange houses. At present, 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. The clients
of Islami Banks in Bangladesh can not take forward coverage against fluctuations
of Foreign Currency, 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. Sometime, the Clients of Islami bank takes
Forward Coverage directly from Conventional bank. So, it is a pertinent need for
islamically approved/acceptable derivatives to neutralize the risks of Bank/Clients
against FC dominated genuine commercial transactions. As such, 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.
03. Problem/Underlying Price risk faced by Islami Banking
Industry:

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.
• 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.

03.02 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, the exchange houses remit the same to the
concerned Bank. If the rate comes down below their published rate,
the Exchange houses are to make loss. Due to present Volatility in
the market, the exchange houses experiences a huge loss.
o The Exporters are also to run the risk against the bills sent on
collection basis.

• Importers: There remains a time gap ibetween the date of opening LC

and date of requirement of FC and payment thereof.So,there is a risk of
fluctuation in between the gap.The risk can not be covered by Forward
Booking due to non availability of shariah approved such product.

04.00 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
does not take place. According to Islamic shariah Forward foreign exchange
transaction may be done on promise/agreement instead of contract. 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, 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.e. Promise by one party i.e.
either by seller or buyer to buy/sell Currencies is permissible as per Islamic
shariah and is a legal binding.
• Binding promise from one party is not deemed as contract under Islamic
law.
• Above all, in Forward foreign exchange transactions, the deal may be
considered as promise and the AKAD may only execute on the value date
when the currency exchange takes place.

Fatwa by AAOIFI in support of one party promise:

A promise from one party is permissible if the promise is binding.(See AAOIFI).
Financial intuitions have a customary practice of treating promises as binding,
when formally they are not. A promise from one party only is permissible in
currency exchange even it is binding (Shariah Standard no-1, Trading in
currencies 2/9(9), page 16 & appendix B (7))….Annexure 1(a) & 1(b)

05.00 Practicing Wa’d structuring Forward globally:

05.01 Opinion of Dubai Islamic Bank backed by fatwa of

Mohammed Taqi Usmani, Islamic legislation (Fiqah) center,
Jeddah forwarded by (Annexure-02)
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.
However, 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.

For example if a particular currency is required on 1st July, 2010,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,2010 and the seller could state that
we promise/agree to sell a specific currency at a specific rate on the said date.

This would be a promise/agreement from both parties the fulfillment of which

would be a moral responsibility of both. But the actual sale or purchase would
take place on 1St July 2010.

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, there is no restriction in the shariah with respect to fixing the rate in
advance. 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.

Unquote:
5.02 Kuwait Finance House (Malaysia) berhad

Quote

“KFH Promissory FX Contract is a written, 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. The product is designed to
assist business to mitigate the uncertainty and provide flexibility in managing
foreign exchange open position”. (Annexure-03)
Un-quote

5.03 Bank Islam Malaysia, Berhad

“Bank Islam has been doing Spot and forward transactions for covering position
and trading .When a deal is made on a certain day that deal is only considered as
Promise. The AKAD (Settlement) is only executed on the value day when the
currency exchange takes place. (Annexure-04)”

06.00 Features of Islamic Forex Forward

• A Unilateral Promise by clients on Deal date followed by akad(settlement)
on value date.
• To buy or sale one currency against another.
• To assist business to mitigate risk against genuine underlying assets of
banks and clients.
• At an agreed rate determined on spot/majlis for future delivery.
• To protect against unfavorable movement of exchange rate.
• Akad on Value date/for delivery/settlement on agreed future date or within
the period of 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.

07.00 Hedging techniques in Islamic Forex Forward: In order to manage

the exchange position of the bank & to match inflow with outflow at maturity,
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.
• Forward against Forward: Both the leg of Buy and sale the foreign
currencies are made on promise.

8.00 Delivery Type of Islamic Forward exchange

 • Fixed dated forward: A specific delivery date is agreed upon i.e. the
delivery of the Foreign exchange to be made at the date fixed in the
agreement.
• 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.

09.00 Dealing Process of Islamic FX Forward (Islamic Promissory FX)

9.01 At the time of Promise/Deal date:

• Against the proposal of the Customer, the Customer will unilaterally
promises to buy/sale a currency at a future date at a price determined at
majlis. This is a form of promise to buy/sale given by the customer to the
Bank.
• The customer will sign/stamp and send back the Deal confirmation to the
bank.
• . Bank will acknowledge the promise to buy/sale.

9.02 Settlement / Akad date/spot date/Before two days of

maturity

• Bank/Customer will offer to buy/sale of foreign currency(s), which

Bank/customer will sign/stamp and send back to bank/Customer
• Bank/Customers will send an acceptance of the offer, this concluding the
purchase of currencies.

10.00 Documents
• Master agreements/terms & conditions (Annexure-05)
• Promise to purchase/sale
• Offer to buy/sale
• Acceptance to buy/sale

11.00 Security:
• Urbun / Earnest money: To minimize the risk of counterparty for non
performance of promise, the client will pay only a small part of the price of the
commodity at the time of entering such transactions on the understanding
 that the Bank will retain the amount as margin till maturity of the
transactions. If the deal(s) is/are not finally concluded, the Bank will
recompense the actual loss of liquidity from Urbun A/C of Clients. If there is
reminder to be retuned to the clients and if the retained amount is insufficient
the client should pay the rest.

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.
o Bank to Bank: In case of Bank to Bank Islamic FX Deal, there requires
no urbun but have to allow Counterparty limit for such transactions.

12.00 Pricing of Islamic Forex Forward

• Presently, 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:…….)Therefore, 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 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.(AAOFI Resolution-Annexure…6(a)(b)

13. Settlements of Islamic FX Forward

On value date/Maturity date (Date when exchange of currency takes place), the
client will need to deliver his currency to banks in clear FC funds. The Islami Bank
will in turns deliver the agreed amount of the other currency in accordance with
client’s instructions complying the documents.

14. Amendments/amendment of Islamic FX Forward:

Banks usually protect themselves matching forward purchase/receivables with
payable considering the maturity date. But due to the complexity of commercial
transactions, the client may need to amend the Forward Foreign Exchange
agreement due to early/delay shipment/, shipment not affected within the LC
validity, the client intent to extend the validity of the LC/early
repatriation/documents/delay receipt of funds for import, export and remittances
business respectively for which the client may request for amendments that may
be done by …..
14.a Early fulfillment of promise / Pre delivery
14. b Extend /extension of the promise
14.c Non utilization of promise against Islamic forex forward

14.02 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, the bank will realize nothing form
the Client.
• If the bank incurs losses, only the actual cost will be adjusted form the bai-
al-Urbun A/c of the Clients.

15.00 Conclusion:

Considering the need for both Bank’s & Clients and the shariah aspects explained
in this paper, we propose that Islamic FX Forward (Propose name : Islamic
Promissory FX) may work flexibly than Traditional Forward Contract .