Asiamoney: What’s in a fatwa?

Asiamoney, August 2010

In August 2009, Bursa Malaysia launched a new Islamic platform with considerable fanfare and pride. Bursa Suq Al-Sila’, the exchange boasted, would be the world’s first Shariah-compliant commodity trading platform: a multi-commodity, multi-currency, fully electronic landmark with ambitions to streamline commodity trading, and therefore bank liquidity, not just in Malaysia but across the Islamic world.

If successful, the new platform will not only add much-needed efficiency to these crucial liquidity instruments, until now handled in laborious one-by-one bilateral deals through commodity brokers, but will make Malaysia the centre for these trades worldwide. That makes it a centrepiece of the Malaysian International Islamic Finance Centre, which seeks to make the country the global hub for Islamic finance rather than just a sophisticated domestic industry.

But there was a fly in the ointment. There still is.

Four months earlier, the International Council of the Fiqh Academy, one of the most powerful academic institutions in the Islamic world, had issued a fatwa (religious opinion) declaring that one of the main contracts that underpin the new platform is unIslamic. In Islamic finance, the endorsement of key scholars like the Fiqh academy is absolutely vital to the success of a product or structure: it’s what tells Muslims that what they’re buying is consistent with their faith.

So when Bursa launched its new platform, it did so knowing it was going against of one of the most revered scholarly voices around. Yet, far from failing or being shunned, Bursa has enjoyed steady volumes and claims it is on the cusp of signing up participants from the most strict Islamic nation of all, Saudi Arabia, including Al Rajhi, arguably the most powerful and conservative Islamic bank in the world. How can this be? The explanation tells us a lot about Islamic finance in the modern world: the tension between classical Islamic thought and modern commerce, and just what a fatwa actually means.

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First of all, it’s useful to understand the problem Bursa Suq Al-Sila’ seeks to address. Commodity murabahah are perhaps the most controversial trades in Islamic finance. Typically they are a form of cost-plus financing which are equivalent to a deposit in the conventional financial world. One example is if a customer wants to deposit $100; the bank can’t pay him interest, because that’s prohibited in Islam; so instead it sells the customer $100 of commodities and promises to buy it back in a month for $110. In the meantime the bank uses the $100 to invest in other securities that will gain it more income, just as a conventional bank would with a deposit.

If this sounds like cheating to you – an exercise in semantics – then you’re not alone. Some Islamic scholars cry foul about commodity murabahah in this style because they say no real trade has taken place: one party sells it and buys it back, and the commodity market doesn’t benefit. In Islam, trades have to be real, with tangible objects, fulfilling some demonstrable benefit, rather than just money turning into more money without serving some purpose along the way. The structure and its various permutations have divided the industry, with Malaysians much more likely to approve it than those in the Gulf.

Despite the questions about its validity, many Islamic banks love commodity murabahah because they desperately need the liquidity they create and don’t have many other obvious sources of getting it. “There is no other instrument so far that is as widely used as commodity murabahah, especially in the short term money market,” says Mohd Effendi Abdullah, head of Islamic markets at AmInvestment Bank Group. “It helps Islamic banks to manage their liquidity and funding problems.” In the absence of a better answer, banks – including many in the Gulf – have pressed on with the structure as the lesser of two evils, since they can barely be viable without it.

On top of that, these deals are typically done on a private and bilateral basis, which is inefficient, untransparent and unregulated. “Bilateral agreements are slow,” says Raja Teh Maimunah, global head of Islamic markets at Bursa Malaysia and a driving force between the new platform; in her pre-Bursa days in banking she recalls seeing commodity murabahah deals take years to come together. And, in a market that conducts billions of dollars of trades each day, “if you do that amount of volume bilaterally, you’re bound to have one or two unfortunate trades.” By this she means contracts underpinned by collateral that, for example, is being used in multiple transactions at once, or may not even exist at all.

Hence the new platform. It started out with contracts over crude palm oil, Malaysia’s key commodity, and uses three commonplace structures, murabahah, tawarruq and musawwamah. The idea is that, by involving a marketplace, it helps with Shariah compliance by making trades genuine and legitimate; by using the exchange as a regulator it is able to police rogue trades and operators, either on the buy or the sell side, who are not Shariah compliant (it can compel audits at any time, demand to see spot commodities, and requires banks to sign an undertaking that they will only use funds for Islamic purposes); and by going electronic it helps with efficiency and risk management. “In a bilateral deal, if I need a billion dollars of a commodity, I’m going to have to call a couple of guys,” says Raja. “Here, you just put your order through the exchange and take the counterparty risk of the exchange.”

So far so good: until, with Bursa’s new platform approaching launch, the Fiqh Academy got involved.

This centre for the advanced study of Islam, created in 1974 and based in conservative Jeddah, matters more than most because it was created by the Organisation of the Islamic Conference (OIC), a group of 57 member states from across the Islamic world which has its own permanent delegation to the United Nations. One consults the Fiqh Academy when one wants classical Islamic guidance. “It’s important,” says Raja, “because it’s supposed to represent all of us,” a collective institution of the Muslim world.

In April 2009, its international council met for five days in Sharjah. Among the subjects on its agenda was the Shariah status of tawarruq, which is one of the key contracts Bursa proposed to use. After much discussion, it came out with Resolution 179 (19/5) – something Bursa’s staff really didn’t want to hear. While classical tawarruq – someone buying merchandise at a deferred price so they can sell it to someone else for cash at a different price – was ruled OK, organised tawarruq, with a simultaneous purchase and sale, was not. “It is not permissible to execute [organised tawarruq] because simultaneous transactions occur…in exchange for a financial obligation. This is considered a deception,” the academy said.

A deception? That sounds damning. But the fact is, it hasn’t stopped the new platform from working at all. It is understood to have had daily trades since August 17 last year, with generally at least one large transaction of RM2 billion or so on most days; typically volumes are equivalent to at least US$1 billion overall each day, although the exchange will not be more specific. Raja does say that within about three and a half months about 90% of the Malaysian market had been captured, and also suggests that a lot of the trades coming through Malaysian banks are actually being done on behalf of multinationals.

But what’s really surprising is what’s happened next. With the low hanging fruit already picked in Malaysia – where the Shariah issues around commodity trading are less frowned upon anyway – Bursa headed to the trickier but more lucrative ground of the Gulf, and picked the hardest possible target first. “We decided to go into the world’s biggest [Islamic] market, which is Saudi Arabia,” Raja says. “We’ve focused on that for the last six months.” And it seems to be paying off: it is understood Saudi Hollandi Bank has been admitted as a member, and that three significant Islamic banks in Saudi Arabia have received fatwas from their Shariah councils permitting them to follow too, and should be admitted to membership by the fourth quarter of this year following due diligence. Bursa won’t name names, but since there are only three purely Islamic banks in Saudi Arabia, it must include Al Rajhi. 

Al Rajhi is the world’s largest Islamic banking group and is considered a benchmark for Shariah conservatism. Those who have worked within it say that the Shariah advisory council employed by Al Rajhi is the toughest in the world to get new products approved by, so determined is it to remain on the right side of compliance. The council’s four key members are all active and senior academics at prestigious Islamic universities, rather than the more commercially-minded full-time scholars commonplace on other bank advisory councils. If the Saudis do come on board and start migrating their trading to the new platform, then not only could it provide as much as US$5 billion of trades per day, it will also underwrite the platform’s legitimacy in the Islamic world.

But how can that be? Didn’t the Fiqh Academy already say it was unlawful? For non-Muslims, it seems a puzzling contradiction. What’s the point in a fatwa if it makes such little difference to a business in practice?

The most important thing to realise is that fatwa are considered guidance, not binding, and are almost inevitably going to differ from one another. “We don’t operate like the Roman Catholic church,” says Raja. “We don’t believe in intermediaries: if you want to ask something, you ask God directly. If you want to understand something, you read all the sources and find various ways of interpretation.” The way you read them will likely depend on which school of Islam you adhere to: even within the most widely-practised Sunni branch of Islam, there are still four separate schools with different interpretations. Malaysia is mainly Shafi’i, for example, while Kuwait, Bahrain and the UAE are Maliki and Saudi Arabia a mix of Maliki and Hanbali. Malaysia’s school is, in the Islamic finance perspective, seen as more open and progressive, Saudi’s more conservative.

Within this framework people, including scholars, can come to different conclusions, and one does not necessarily overrule another: if Fiqh disagrees with, say, Kuwait Finance House’s Shariah council, that doesn’t create an immovable logjam, just a difference in guidance. “We don’t have one guy who overrules the rest.”

Badlisyah Abdul Ghani, CEO of CIMB Islamic, puts it this way. “Shariah is always a right versus right discussion, not right versus wrong,” he says. When it is suggested the new platform – in which CIMB is an active participant, and was the first – is going against the Fiqh Academy, he says: “It’s not going against anybody, it’s just following a fatwa that allows it. There are clients who will follow the Fiqh Academy ruling, and I will service their needs using other products.”

One problematic consequence of this idea is that one could theoretically keep looking around for a Shariah opinion one wants to hear. Ask banks about the Fiqh pronouncement, for example, and they’re much more likely to refer you to the standards that the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in Bahrain issued for commodity murabahah. In their eyes, if AAOIFI has issued standards, it must be OK, and since banks really want to use these products for liquidity, it’s certainly much more convenient to listen to AAOIFI than Fiqh. “AAOIFI has proceeded to issue a standard on commodity murabaha, and I read that as endorsing it,” says a banker in Bahrain – who, tellingly, preferred not to be quoted on this divisive subject. “It’s a standard setting body, whereas the Fiqh Academy is more for guidance counsel.”

But the clincher here really is the suggestion that Al Rajhi has come down on the side of the new platform. “To me, the endorsement of these big, ultra-conservative banks – it is players like them who can influence the market,” Raja says. “If they come out and say I am migrating to this because of Shariah integrity as well as for commercial risk management issues, I hope it will influence how things are done.” Thus the banks are already proving themselves more powerful in modern Islamic interpretation than the academic institutions, a sea change.

Certainly Malaysian banks are onside. Badlisyah says the new platform “give us market transparency and ease of price discovery that we didn’t have in bilateral transactions” and that it “resolves a lot of the concerns” that have previously existed about commodity murabahah. Effendi says it “solves some of the major issues, such as validity of contracts and the presence of physical commodities” and “is perhaps the only Islamic money market tool available that can help provide liquidity in the overall Islamic banking system.”

It is easier to prove that a transaction is real on an exchange because there are more parties involved: the buyer of the commodity will generally not be the same person that sold it. The checks and balances to ensure underlying commodities are real and properly used are clearly better than the shadowy alternative under bilateral deals. And Malaysia’s key commodity, crude palm oil, is actually quite helpful in ensuring compliance because it can’t sit in a warehouse for 10 years like a metal and be used indefinitely as recycled collateral for multiple overlapping transactions – because crude palm oil goes bad after a month. “It has a real use, it pumps through the tank,” Raja says.

“Some people still do not agree on the issue of commodity murabaha. As far as I see it, it is their prerogative not to embrace it, because the realm of interpretation is wide. But what I would like to reiterate is that if there will be those who embrace it, surely there has to be some regulation about how it is done.”

One can ask whether it ought to be the role of Bursa to do that regulation; it may be that central banks step up to this role in the future. But nevertheless, Raja argues that an exchange doing the regulating is a step forward. “That [the ability to compel an audit] doesn’t exist anywhere else in the world right now,” she says [and this includes the London Metals Exchange, where many such trades are conducted]. “If I have a bilateral agreement with you and you do a stink on me, where can I go? Which court can I seek redress from? I can’t.”

Bursa does hope to go back to Fiqh – probably through governing bodies like AAOIFI and the Islamic Financial Services Board rather than directly – and get a revised opinion once the academy can see what’s been done to alleviate its concerns. In the meantime, while not thrilled about being in breach of a Fiqh Academy fatwa, Bursa is not about to abandon an apparently thriving and lucrative new platform. “You have to acknowledge the maxim of the lesser of two evils,” says Raja. “You try to do the best you can for now.”

(NB: The Fiqh Academy provided Asiamoney with a copy of its fatwa in Arabic but otherwise did not comment; Al Rajhi did not respond to requests for comment.)