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OIC Fiqh Academy fatwa prohibits tawarruq as a 'deception'
Posted: 10-May-2009
Posted: 10-May-2009
The recent fatwa from the OIC Fiqh Academy condemning tawaruq as a deception will have a significant impact on the Islamic finance industry, perhaps a greater one than the AAOIFI ruling on sukuk in February 2008. The tawaqrruq product is one where a bank buys metal on the spot market, sells it to the customer for the spot price plus a profit margiin and then acts as the customer's agent to sell the metal again on the spot market. The economic result of the transaction is that no physical commodity (metal in the most common cases) exchanges hands but the customer ends up with cash as well as a deferred liability (a debt) to the bank that equals the cash received plus a pre-agreed, fixed rate of profit. It has been frequently used in the Islamic finance industry but has always been rather controversial because the trades involved have been executed to synthesize a conventional loan with little other activity. Neither the bank nor the customer have a use for the metal involved in the transaction.
Beyond its direct effect on tawarruq, the OIC Fiqh Academy ruling could have a greater impact on the industry as a whole by questioning whether the means justify the ends: that is, whether ensuring that products are structured in a way that is Shari'ah-compliant provides sufficient justification for creating an outcome that looks very similar to conventional financial products. In many cases, products will continue to be viewed as necessary compromises that, although creating economic effects that look like interest, are used in a way that directly facilitates economic activity.
In contrast to the tawarruq transaction described above where neither the bank nor the customer plan on using the metals involved is an ijara transaction like the ones used in many sukuk. In this case, a company owns a property and sells it to an SPV that has raised money for the purchase from selling ownership interests to investors. Upon selling the property to the SPV, the company then leases back the property for use in its business. The company also retains an option to repurchase the property at the conclusion of the lease, although the price at which it will do so is not fixed at the outset to avoid falling afoul of the AAOIFI rules on sukuk issued last year. In the ijara transaction, the company receives money from investors, pays regular lease payments tied to LIBOR and at the conclusion of the lease redeems the certificates by repurchasing the property from the SPV.
In both cases, tawarruq and ijara sukuk, the economic outcome remains the same--financing is provided and repayment is made later at a higher value than the initial amount--but in the former case, the traded commodity is used only for effecting the transaction but in the latter case, the commodity is used in the underlying business for which the transaction is structured. This, I believe, will become a more frequently used test to determine whether Islamic financial products are structuring for sake of replicating interest-based transactions or transactions created to finance business activity. This does not seem like an overly tight restriction, although it has huge implications for the industry and could restrict the industry's growth. It will now be a test for the industry to come up with replacement products tawarruq (and commodity murabaha) to provide unsecured financing such as that used to start businesses, pay for education and offer Islamic banks short-term liquidity management.
Originally posted (with full text of the fatwa) on SharingRisk.org Main Blog
Beyond its direct effect on tawarruq, the OIC Fiqh Academy ruling could have a greater impact on the industry as a whole by questioning whether the means justify the ends: that is, whether ensuring that products are structured in a way that is Shari'ah-compliant provides sufficient justification for creating an outcome that looks very similar to conventional financial products. In many cases, products will continue to be viewed as necessary compromises that, although creating economic effects that look like interest, are used in a way that directly facilitates economic activity.
In contrast to the tawarruq transaction described above where neither the bank nor the customer plan on using the metals involved is an ijara transaction like the ones used in many sukuk. In this case, a company owns a property and sells it to an SPV that has raised money for the purchase from selling ownership interests to investors. Upon selling the property to the SPV, the company then leases back the property for use in its business. The company also retains an option to repurchase the property at the conclusion of the lease, although the price at which it will do so is not fixed at the outset to avoid falling afoul of the AAOIFI rules on sukuk issued last year. In the ijara transaction, the company receives money from investors, pays regular lease payments tied to LIBOR and at the conclusion of the lease redeems the certificates by repurchasing the property from the SPV.
In both cases, tawarruq and ijara sukuk, the economic outcome remains the same--financing is provided and repayment is made later at a higher value than the initial amount--but in the former case, the traded commodity is used only for effecting the transaction but in the latter case, the commodity is used in the underlying business for which the transaction is structured. This, I believe, will become a more frequently used test to determine whether Islamic financial products are structuring for sake of replicating interest-based transactions or transactions created to finance business activity. This does not seem like an overly tight restriction, although it has huge implications for the industry and could restrict the industry's growth. It will now be a test for the industry to come up with replacement products tawarruq (and commodity murabaha) to provide unsecured financing such as that used to start businesses, pay for education and offer Islamic banks short-term liquidity management.
Originally posted (with full text of the fatwa) on SharingRisk.org Main Blog
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