Assoc. Prof. Dr. Asyraf Wajdi DusukiHead, Research Affairs

International Shari’ah Research Academy for Islamic Finance (ISRA)

INCEIF CLASSFN 6013 ISLAMIC FINANCE

TOPIC 3

Application of Hybrid Instruments in Islamic Finance6

Shariah Parameters in Combination of Contracts5

Concept of Wa’ad

Application of Wa’ad3

Hybrid Instruments4

Issues7

Distinction between Wa’ad, Wa’daan & Muwaadah2

Workshop on Islamic Banking

Operation

Conclusion8

Concept of Wa'd

• Al-Fayumi defines Wa'd (عذ)

linguistically as a promise whether

good or bad. Lexically, Wa'd is defined as

notification of good or bad news.

• In al-Mawsu’ah al-FiqhiyahWa'd is defined as a

notification of good news in the future, while a

promise of bad news is called wa’id (عيذ)

Cont’d

• Mukjam al-Mustalahat al-Fiqhiyah formulates Wa'd as

informing the action of one party towards another party that

is due in the future.

• Muwaadah is a bilateral promise that is agreed (ماعذج)

upon by both parties. If the promise is unilateral then it is

called ‘idah .(عذج)

فإن عذ أحذما دن األخش فزي انعذج, أن يعذ كم احذ صاحث

Fulfillment of Promise (الىفاء بالىعد)

• Wa'd is allowed because a person can voluntarily promise

a good deed in the future to another person.

• Ulama agree that the fulfillment of promise is required

.religious-wise (مطهب)

• However, is Wa'd binding and enforceable

from a legal point of view?

Is Promise Legally Binding and enforceable ?

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Legal Status of Wa’d

• A promise without any intention of fulfilling it, is not permissible (haram) – deemed to be a liar and pretentious (munafiq)

person who are seriously condemned by the religion.

• If the same promisor takes an oath to convince the promissee– will be subject to Allah’s condemnation – a fine or compensation (kaffarah) to relieve him

from his false oath.

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Legal Status of Wa’d (2)

• If a promise with an intention of fulfilling it, the jurists are divided whether its fulfillment is obligatoryor recommended.

• Those who opine the fulfilling a promise is obligatoryare further divided as to whether it is binding by religion (mulzim diyanatan) or enforceable by the court (mulzim qada-an).

• Islamic jurists have different views with regard to the liability imposed to the parties of the promise.

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Legal Status of Wa’d (3)

VIEW 1:Fulfilling a promise is recommended (mandub), not obligatory;

otherwise the promisor will be condemned (makruh).

promise must be fulfilled for religious reason only and it is a question of morality

al-Zarqa’- a promise does not initially bind the person who makes it (promisor), and it does not give any right to the promissee.

The Shafi’i, Hanbali and Zahiri Schools recommend the fulfillment of a promise, even if it is subject to certain condition.

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Legal Status of Wa’d (4)VIEW 2:

Fulfilling a promise is obligatory by religion; otherwise the promisor is deemed to be sinful. Its non-fulfiment will not be

enforced by the court.

Hanafi, Shafi’i, Hanbali, and a few from Maliki schools - a promise made by a person to the other is religiously binding (mulzim diyanatan) but not a legal duty (mulzim qadha-an). This is because wa’d is part of a voluntarily contract (‘aqdtabarru’at). Therefore, the judge has no way of such enforcement, because the second party has nothing more than a moral right.

Imam Nawawi - when a person promises another something (provided it is not illegal) he should fulfill his promise.

Al-Qarafi - promise is not binding at all

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Legal Status of Wa’d (5)

VIEW 3: Fulfilling a promise is obligatory by religion and can be enforceable

by the court

Ibn Al-‘Arabi - The promise is absolutely binding & must be fulfilled by all means unless if its fulfillment is impossible.

Ibn Shubramah made the fulfillment of promise as compulsory. "يكن عذا مهضما قضاء دياوح, ال يحشو حالال, أن كم عذ تانتضاو ال يحم حشاما"

(Meaning: every concluded promise which does not allow prohibited thing, and not prohibit permissible thing, is binding legally and religiously)

"انعذ كه الصو يقض ت عه اناعذ يجثش"

(Meaning; all promises are binding, and the promisor is compellable in fulfilling it)

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Legal Status of Wa’d (6)

VIEW 4: Where a promise is subject to certain conditions, its fulfillment is obligatory and enforceable although the

promissee has not acted upon the promise yet.

• Hanafi School - distinguished between absolute promise and conditional promise.

• The latter is binding in contract of exchange to avoid gharar (unknown element) in the subject matter of promise.

• This rule is very similar to the concept of guarantee established by kafalah contract.

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Legal Status of Wa’d (7)

VIEW 5: Where a promise is subject to conditions, its fulfillment is obligatory

and enforceable only if the promissee has indeed acted on the basis of the promise & incurred loss.

• Ibn Al-‘Arabi - if the promise results in particular consequence, its fulfillment is obligatory; but if it is a promise per se without any consequential effect, fulfilling it is not made obligatory.

• The enforceability of a binding promise judicially can be upheld if it entails to the performance of promisee in reliance to the promise. As such, fulfilling the promise is obligatory, or the promisee will suffer loss or difficulties as a result of the non-fulfillment. This is a preferred opinion in the Maliki School which was expounded by Malik, Ibn Al-Qasim and Sahnun.

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FULFILMENT OFPROMISE

Recommended Obligatory

1. The Shafi‟i School 2. Abu Hanifah 3. Some Maliki jurists4. Al-Qarafi (Maliki)

1. Majority of Maliki jurists• Ibn Al-„Arabi : absolutely• Malik, Ibn Al-Qasim and Sahnun:- obligatory, or the promisee will

suffer loss or difficulties2. Ibn Shubramah

إذا وعد أحدكن أخا وهي يت أى يفي ولن يجئ للويعاد،

فال شيء علي

يا أيها الريي آهىا لن تقىلىى ها ال تفعلىى

د اهلل أى تقىلىا ها ال تفعلىى , كبس هقتا ع

ب ز ولا يسيد يس م ٱلڪيسيد ٱلل

ز عس م ٱلڪب حسج فى ٱلديي هي كن وها جعل علي

إذا حدث كرب، وإذا وعد : آية الوافق ثالث

أخلف، وإذا ائتوي خاى

A man asked the Prophet (S.A.W.), “Can I lie to my wife”. The Prophet said, “There is no good in lying.” The man said, “Shall I make her a promise and tell her?” The Prophet said, “It will not be held against

you

promise (wa‟d) is like a gift (hibah) which is not binding on its promisor except after

delivery has taken place

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Overview of Classical Juristic Opinions

• a promise per se (without any condition attached to it) is binding

– its non-fulfillment amounts to lying and non-obedience which is sinful to Allah.

– is binding by religion.

• If the promise is conditional upon fulfilling certain condition, the opinion of Maliki School is well-justified.

– If the non-fulfillment causes difficulty or loss to the promisor, then the promise become binding judicially and thus, is enforceable against the promisor.

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Overview of Contemporary Juristic Opinion

• Contemporary jurists have been posed with many issues in financial products which require them to exercise an ijtihad and produce a new ruling (ifta’) to such effect.

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IJTIHAD & IFTA’ ON WA’D

Sheikh Badr Al-Mutawalli Abdul Basit, Shari‟ah advisor of KFH

every unilateral promise that neither permit unlawful thing nor prohibit lawful thing is binding judicially and by religion (mulzim qada-an wa diyanatan

Sheikh Abdul Aziz bin Baz, Mufti of Saudi Arabia

promises to sell are permissible provided that the goods that have been pledged are owned by those who made the promise.

• Approved bilateral promise (muwa‟adah) provided that: bank owns the goods& put in possession, Bank sells goods to purchase orderer with an agreed profit, Bank must bear ownership risk until the goods are delivered, Bank must accept redelivery if there is hidden defect in the goods

• also resolved - unilateral promise becomes binding to the promisor -subject to the approval of Shari‟ah supervisory committee

2nd Conference of Islamic Banking in Kuwait (21-23 March 1983)

Islamic Fiqh Academy in resolution no. 40-41

Fulfilling a promise is allowed subject to certain conditions as enumerated in the next slides

First Conference of Islamic Banking in Dubai (May 1979)

Fulfilling such promise may become judicially obligatory in the event of necessity, eg. if the non-fulfillment of promise entails difficulties or loss to the promisee.

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• a promise (wa’d) which is made unilaterally by

the purchase orderer or the seller is morally

binding on the promisor, unless there is a valid

excuse.

• It becomes legally binding if:

– it is made conditional upon the fulfillment of an

obligation, and

– the promissee has already incurred expenses on the

basis of such a promise.

Islamic Fiqh Academy Position on Promise

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• binding effect means such promise must be

fulfilled,

– otherwise a compensation must be paid for damages caused

due to the unjustifiable non-fulfilling of the promise.

• Mutual promise (muwa’adah) is also permissible

provided that the option is given to one or both

parties.

– Otherwise, it is not permissible, since mutual and binding

promise is like a sale contract which requires the seller to be in

full possession of the goods to be sold.

Islamic Fiqh Academy Position on Promise (2)

What‟s the difference

between Wa‟ad, Wa‟adan and Muwa`adah?

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Concept of Wa’d

• wa’d = a unilateral promise given by one party to another to perform an obligation. E.g.– a customer’s promise to buy the leased asset upon

expiry of the leasing (ijarah) period in the al-ijarahthumma al-bay’ (Islamic hire-purchase) transaction.

– Other usage of unilateral promise in the form of sale or purchase undertaking can also be found in mushrakah mutanaqisah (diminishing partnership), murabahah sale to purchase orderer and sukukstructures.

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Concept of Wa’daan

• Wa’dan = 2 unilateral promises given by 2 different parties which are independents from each other and subject to different independent conditions. E.g.

– in certain Islamic-structured product, a customer promises to sell securities to a bank for an agreed settlement price with certain conditions.

– At the same time, the bank also undertakes to buy the securities for certain price with another different conditions.

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Concept of Wa’d• Muwa’adah = bilateral promises that can be

conditional or unconditional with or without consideration. – Unconditional bilateral promise occurs when one

party undertakes to sell an asset during a particular time, while the other party undertakes to buy it during the same time.

– Conditional bilateral promises happen when one party promises to sell an asset and another party promises to buy the same asset if certain condition X occurs.

Application of Wa’d in Modern Transactions

Wa’d as a Sign of Commitment

Wa’d & Options

Wa’d in Event of Default

& Total Loss

Wa’d & Liquidity Facility

Wa’d & Exit Mechanism

Wa’d in Hedging and Risk Management

Wa’d as a Sign of Commitment

• This form of wa’d is to show parties’ commitment to complete the transaction according to their ultimate intention.

• This form of promise is used to formulate the basic structures of murabahah, musawamah, salam and istisna’ in today’s financial transactions.

How to ensure the fulfillment of

Wa’d?

Hamish Jiddiyah is a security deposit in case the

customer does not fulfill his promise, i.e. cancel the

purchase, the deposit will serve as a remedy to any

loss suffered by the bank.

Hamish Jiddiyah

How different is Hamish Jiddiyah form

downpayment (urbun)?

request from the purchaser to make sure that the orderer is serious in his demand for the asset.

Urbun is a down payment that is non-refundable and is constitutes as an initial installment payed in the beginning of signing the contract

Hamish Jiddiyah a payment made before the signing of the contract in case the customer does not complete the transaction the amount of hamish jiddiyah is going to be deducted by the amount of loss suffered by the bank

otherwise it is refundable

Both are defined as the amount paid by

the orderer of the purchase upon a

Wa’d in Event of Default & Total Loss

• Binding wa’d has been applied to mitigate the risk faced by the bank

and investors from events of default or total loss.

• In sukuk, it is applied through a Purchase Undertaking (Islamic put

option).

Ex.: Dubai Islamic Bank (as co-owner) will undertake to purchase SPV’s

share in the co-ownership assets at maturity or in case of event of

default or change in circumstances at a pre-agreed

exercise price.

Wa’d Non-Fulfillment

• The opinion of the Fiqh academy states that in case a promising party (wa’id) does not undertake his promise, the counterpart (mustafid) can not force him to fulfill his promise but has the right to ask for compensations over the actual losses (sharar fi’liy) incurred in the court of law.

فإو يجثش قضاء عه إوجاص انعقذ أ , إرا تخهف أحذ طشف انماعذج عما عذ تتحمم انضشس انفعه انز نحق انطشف األخش تسثة تخهف عه عذي

• Prof. Hussin Hamad states that the promisor can not be forced to fulfill his promise, but the counterparty can ask for the appropriate compensation based on occurred losses.

How Can Compensation be determined in case of Wa’d non-fulfillment?

AAOIFI standards on the issue ofCompensation:

1. Financial institutions have the right over the hamish Jiddiyah in case of wa’d non-fulfillment

2. The amount of compensation is based on the detriment (dharar) and actual losses (dharar fi’liy) that resulted from the wa’id action, and not the opportunity lost.

3. As for Ijarah (leasing), the amount of actual loss can be determined by the difference between the cost of leased asset and the total amount of lease if tt was leased to another, or the selling price if the leased object was sold to another

Hybrid contracts orCombination of contracts is a process that takes place between two parties or more; and entails the simultaneous conclusion of more than one contract.

What is Hybrid Contract?(الجمع بين العقود)

Forms of Combination of Contracts

Without imposing any of them as a condition in the

other, and without prior agreement (muata‟ah) to do so.

Subject to prior agreement but without imposing any of

them as condition in the others.

Agreement to conclude the deal through any of the

different contractual forms decided in the future.

Imposing some of them as conditions in the others,

without prior agreement (muata‟ah) to do so.

Forms of Combining Contracts

Ex. Selling a house to the other for RM1000 and at the same time renting a car to the same party for RM100 per month

Stipulated as conditions in the other contractEx. One party tells the other party I will sell you my house for RM10000 on

condition that you undertake to rent it to me for a RM1000 per year for two years

Having single lump sum counter value (عىض)Ex. Selling a piece of land to the other and at the same time renting a car to the same party for a specifies period both against RM1000

Exhaustive contractual statement comprising a number of successive parts and stages to realize the desire of both parties to conclude the deal in question

Ex. Ijarah muntahiah bitamlik, diminishing musharakah, etc

Concluded for separate values

Islamic Project Finance Through Syndicated Financing

• It refers to the participation of a group of institutions in a joint financing operation through one of the Shariah-permitted modes of financing.

• The accounts of the syndicated financing operation are kept independent from the accounts of participating institutions.

• The main reasons for syndicated financing is to share the risk exposures amongst the participating financial institutions, which may otherwise not plausible to be assumed individually due to large exposure limitation imposed by regulator.

What is Syndicated Financing?

Shariah Parameters on Syndicated Financing

Shariah Compliant Investment Activities

Shariah Compliant Financing Structure

Can Conventional institutions involve in

Islamic Syndicated Financing?

YES!

• As long as subscription and utilization of funds are arranged according to Shariah-compliant forms

Can Conventional institution become the lead arranger?

YES!

• Only if the contracts, project financed and the modes of financing are all Shariah-compliant

Can IFIs partake to finance a project which is also partially financed via conventional modes?

YES! With a condition that the accounts and lead manager arrangements of the two types of financing are kept separate. It is well known that usurious lending and borrowing is a Shariah-banned practice and the responsibility thereof falls right on the party who commits it.

Mudarabah Structure of Syndicated Financing

Syndication Manager(Mudarib)

Participating Banks(Rabbul Maal)

Project to be Financed

Provides Financing

Invest in the Development

Share Profits

In Essence Mudarib Cannot Guarantee Capital Nor Return Unless Negligence

or Misconduct!

How to Protect the Interest of Investors (Rabbul Maal)?

Feasibility Study or Business Plan as a form of (دساسح انجذ )

Accountability!

What is Feasibility Study or Business Plan ( دراسة الجدوى) ?• Feasibility studies aim to objectively and rationally

uncover the strengths and weaknesses of the existing business or proposed venture, opportunities and threats as presented by the environment, the resources required to carry through, and ultimately the prospects for success. In its simplest term, the two criteria to judge feasibility are cost required and value to be attained.

• As such, a well-designed feasibility study should provide a historical background of the business or project, description of the product or service, accounting statements, details of the operations and management, marketing research and policies, financial data, legal requirements and tax obligations.

• Generally, feasibility studies precede technical development and project implementation.

Business Plan Makes Mudarib Accountable

• If say under Business Plan, the Mudarib projects the return to be 12% per annum, if there is a shortfall of 2%, then the Mudarib need to compensate for the shortfall which he had earlier promised under the Business Plan.

• This is the opinion of Sheikh Hussain Hamid Hassan based on legal maxim:

أن انتغشيش تانقل كانتغشيش تانفعم يجة انضمان

“that deception by words entails compensation/indemnification in the same way as deceiving by acts requires”

• For example, if someone digs a well or a hole on a thoroughfare and covers it with some paper or palm leaves, then he will be responsible for loss or damage caused to property or life of any one due to his act. It means that he shall be responsible both under criminal and civil laws. The same rule applies to a party who has presented a feasibility study to lure a financial institution into extending financing to him on the basis of his study should he fail to achieve the estimated returns and the promised results

Burden of Proof is on Manager of Funds

• Producing evidence is the duty of the party which lodges a claim while the party denying the claim is required to take oath that his stand is correct (انثيىح عه انمذعي انيميه عه مه أوكش). Jurists unanimously hold that Al Muddai (the Claimant) refers to a person who claims occurrence of an event which is not common or the norm.

• When applied in case of a Fund Manager who claims loss or destruction of the Investment assets, it means that such a claim shall not be acceptable unless he produces evidence that the assets have been destroyed totally or partially or a loss has been incurred; and that the above loss or damage or defect is not due to his default, negligence, misconduct or breach.

• In other words, he should prove that the loss has happened for reasons or circumstances beyond his capability to foresee or power to rectify.

• The reason for the above position is that the Investment Manager will be considered to be claiming what is uncommon and abnormal.

• It is quite common and normal that an asset/fund taken by someone for the purpose of investment remains intact or grows. Therefore the claim that it has been destroyed or incurred a loss needs to be substantiated by evidence.

Musharakah Structure of Syndicated Financing

Joint CommitteeForm Musharakah

PartnersProject to be

Financed

Profit

Loss

Select Joint Committee

Finance the Development

Shared according to predetermined ratio

Shared according to capital contributed

Wakalah Structure of Syndicated Financing

Paid/Non-Paid AgentForm Musharakah

PartnersProject to be

Financed

Profit

Loss

Appoint Agent

Invest on behalf banks

Shared according to predetermined ratio

Shared according to capital contributed

Pay remuneration

Case Studies on Islamic Shipping Finance

Case Studies on Istisna’• This is an Istisna’ arrangement in relation

to construction of vessel for Brunei Gas Carrier Sdn. Bhd.

• The structure involves BGC SPV as the owner and user of the gas tanker but the ownership is split between beneficial (Orphan SPV) and legal (BGC SPV) to justify the repayment of cost + profit.

• Essentially, the structure was designed to ensure effective repayment mechanism to the participants (financial institutions).

What is Orphan SPV?• Orphan company - A company which has no identifiable shareholder/

owners - e.g., an SPV owned by a charitable trust. If the trust is a public charitable trust, there is no identifiable beneficial owner of the SPV.

• In most UK securitisations, the SPV is structured as "an orphan subsidiary" with the shareholding transferred to a charitable trust. Therefore, even though there is no direct control of the originator on the SPV, it is a matter of common knowledge that the SPV is a figment of the originator. The originator does maintain operational control over the SPV.

• This ownership structure of the SPV is devised to avoid consolidation, both from bankruptcy as well as accounting viewpoint.

• To avoid consolidation from legal and accounting viewpoint, the originator must hold no equity interest, and no residual interest in the SPV. Therefore, very convoluted methods are followed in UK practice for extraction of the originator's profit from the transaction. These include: deferred consideration, an intermediary trust holding legal interest on behalf of both the originator and the issuing SPV, interest swap, retained interest, management fee, brokerage, etc.

Ship Builder

Seller/Lessee

ORPHAN SPV(Mudarib/Purchaser

/ Lessor

Forward Lease Agreement

Istisna’ Agreement

MudarabahAgreement

(1) Lessor is the beneficial owner of the vessel and the lessee is the registered owner and operator of the vessel

(2) Lessor will lease its beneficial interest in the vessel

(1) Purchaser and the Seller agree that the Seller will build the Vessel

(2) Purchaser agrees to pay the Istisna‟ cost as the price for the Seller per forming the works

(3) Seller agrees to sell by way of Istisna‟ to Purchaser its beneficial interest in the constructed Vessel and Purchaser agrees to purchase the constructed vessel for the Istisna; cost. Financiers

(Rabbul-Maal)

Engage in construction

Hybrid Structure of Syndicated Financing

Case Study onMurabahah Shipping Facility to

Hay Denizcilik Ticaret(Turkish-based Shipping Company)

Case Studies on Murabahah• This is an USD18 million Murabahah Shipping

Facility granted by Amsterdam-based GarantiBank International (GBI) to Turkish-based Shipping Company, Hay Denizcilik Ticaret(HDT).

• The structure involves GBI as the financier and seller of the vessel. While HDT is the GBI’s client to purchase the vessel.

• Essentially, the structure was designed to based on the principle of Murabahah to the Purchase Orderer (Murabahah Lil Amri Bi Shirak)

Purchaser (HDT)

Agent

Vendor

Vessel Purchase Agreement

MurabahahAgency

Agreement

MurabahahAgreement

Pay on deferred sale terms

Pay at cost price

MurabahahArrangement

to Purchase Vessel

Vessel Purchase Confirmation

(a) Identification Notice

(b) Pay Deposit

What is the Shari`ah

Status on Combining Contracts?

Shariah Status

• It is permissible in Shariah to combine more than one contract in one set, without imposing one contract as a condition in the other, and provided that each contract is permissible on its own.

• Freedom of contracting & honoring commitments is acknowledged in principle by the general teachings and directives of Shariah –unless such contracts and commitment lead to violation of rulings.

Cont’d

• Ibn Qayyim states “it is permissible in principle to form up contracts and conditions, except for what has been prohibited by Shariah”

و األصل فى العقود و الشروط الصحة اال ما أبطله الشارع ””أو نهى عنه

• Combining contracts in this manner is acceptable unless it encounters a Shariah restriction that entails its prohibition on exceptional basis.

Permissibility ofContract Combining

1st Opinion

Majority of Hanafis, Shafi`is, & Hambalis

The set of combined contracts can be judged in the light of its individual components.

Hence, if the transaction comprises a number of contracts that individually satisfies the permissibility requirements, the combined contract is permissible.

2nd Opinion

Some Hambali and Shafi’is Fuqaha

Permissibility of combining two contracts for the same contract value, even if the two contracts differ with regard to Shariah Status and rulings.

Indicates permissibility of combining two contract having separate values

(عقذيه تعضيه مختهفيه)

3rd Opinion

Ibnu Taimiah

Exceptions

• Al-Shatibi indicates prohibition of combining contracts in

specific cases on exceptional basis.

Combining could generate Shariah restrictions that do not

hold true when the combined acts are taken up individually.

• Ex.: combining sale & lending, marrying two

sisters, or marrying a woman and her aunt.

Does not include cases

banned by Shariah

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Not used as a trick to

circumvent for riba

Not used as an excuse for

practicing riba

Not contradicting with underlying

rulings & ultimate goal

Shariah Parameters/Controls on Contract Combining