With mounting pressure to compete for a piece of the global trading pie, Islamic market players are in top gear when it comes to innovation. NAZNEEN HALIM explores the prospect of foreign exchange trade in line with Shariah principles.

Islam prohibits the act of making money from money, which perhaps makes the concept of foreign exchange (FX) in congrous with in the Islamic trading realm. However, market participants are aggressively finding means for innovative solutions and the application of modern trading methods to this 1,000 year old practice.

From a Shariah perspective, conventional FX swaps structures pose a problem when futures are involved. This basically implies that the parties involved want to exchange currencies in the future, but fix the rates on the same day the contract is signed off. This in itself goes against the Shariah, in which participants are not allowed to enter a foreign currency contract in which the concurrent possession of counter values by both parties do not take place.

According to Jim Nuzum, CEO of GCC Markets, in order to make a FX trade Shariah compliants, four elements have to be taken into consideration. This includes eliminating interest or interest rate differentials, diminishing speculation or short position in a currency, having a legitimate, underlying cross-border trade or investment transaction, including hedging and risk management, and that the swap cannot be in support of haram elements such as pork and alcohol.

Current practice
In the conventional space, an FX swap usually involves two foreign currency monetary exchanges – at the beginning and upon the expiry date, which distinguishes a FX swap from a forward contract, in which the exchange only happens once.

The two most popular forms of Islamic FX swaps currently are Tawarruq, otherwise known as commodity Murabahah, and Wa’ad which basically involves a promise or undertaking.

In a Murabahah FX transaction, compliance is gained by mapping cash flows which usually exists via the swaps to the purchase and sale of commodities with similar cash flow implications for the customer.
In other words, a customer acquires the metal value spot and sells it to the bank for the purchase price plus an agreed profit, which is payable on a deferred basis, in line with the delivery of the deal. The Wa’ad transaction delivers a similar outcome to the Murabahah transaction in terms of cash-flow, but in the form of promissory notes.

What traders need
In order to comply with Shariah principles, industry experts believe that single and multibank platforms available need to follow the real economy as closely as possible.

Elements such as price discovery, convenience and better liquidity are currently lacking in the Islamic trading space, according to Nuzum. This, he says, can be remedied with an improvement in standards and regulatory convergence.

Global solutions such as a multi-bank eCommerce platform are also needed to place Islamic FX instruments on par with standards-based compliance models and documentation.

Testament to the growing popularity of FX-based Shariah instruments and growing demand from players is the emergence of such trading counters among prominent Islamic banks, such as CIMB Islamic, Bank Islam and Bank Muamalat in Malaysia.

These banks have made available spot trading and Islamic FX forward trading which play on the concept of Aqad, or promise, involving a promise on the trading date and on the value date. Banks such as Bank Islam have also upped the ante by providing its customers a level pricing range to conventional FX forward instruments.

With the advent of technology and its application to Islamic trading tools, market players predict Shariah compliant FX trading to become a major catalyst in the opening up of the secondary markets and increasing market liquidity.