assignment-ha junsheng 1000314

8/8/2019 Assignment-Ha Junsheng 1000314

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Abstract

Waad or promise has become more and more popular in the Islamic financial industry.Due to its one-sided nature, it provides the market participants flexibility and

convenience in designing and structuring products. As an emerging instrument, it brings

new opportunities and possibilities to the Islamic Financial market, and it also raises

debates and critics from the scholars and jurist. This paper aims to understand the

concept and the applications of the waad. By examining the current status and

implications to the Islamic financial market and discussing the current and potential

issues relating to waad, we find that on one hand, waad brings the hope of achieve

completeness of Islamic financial market; while on the other hand, it also opens a

backdoor that may be used by the hijackers of Islamic banking and finance.

Key terms of the research

1waad 2 promise 3 shariah compliant 4 currency forward/option .5 Islamic finance

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Table of content

Introduction

Concept

Basic shariah rulings

Current practice of Waad

Selected resolutions to certain practices involve waad

Shariah issue of the application of waad

Conclusions

Conclusion and finding

References

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waad. So we can see that the practice of the industry is somehow against the rulings of

the related bodies. It is worth discussing the issue of waad in order to understand deeply.

The discussion of the paper will start on the concept of waad itself and thenfollowed by the shariah rulings and current practices of its applications. And issues

related to waad and its application will be discussed through literature reviews and case

studies.

The concept

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Waad or wad is a Islamic financial product. The term appears frequently in the

Holy Quran. It literally means to promise or to firmly intend. A party promises todo or not do some activities to another party. And if the other party also promises to do

some activities but independent from the first promise then it is called double waad. If

the second promise and the first one are interdependent then it is called muwaad,

meaning bilateral waad2.

In Islamic law, this type of agreement normally involves a promisor, who promise

to purchase or sell, and a promisee, who enter a promise with the former. For example, A

promises B to buy Bs car. So A is bound to purchase Bs car while B is not bound by the

contract since this is a unilateral or one-sided promise. This example clearly illustrates

the difference between Waad and a contract that requires an offer and an acceptance that

binds both the buyer and the seller, meaning bilateral.

Due to its unilateralness in nature, waad is potentially useful and flexible to be

used to structuring transactions that conform to the shariah rulings in the competitive

financial market.

Waad is utilized in the financial derivatives such as put and call options however

it raises also many critics on its use. Other than that, the application of waad is also

observed in many Islamic financial instruments such as sale and purchase,

murabahah,ijarah, takaful and so on and so forth.

In the amendment of the Malaysian Accounting Standards Boards to the financial

reporting standard i-1 2004, the definition of ijarah mumahia bittamleek is mentioned as:

Ijarah Muntahia Bittamleek is an Ijarah contract with an undertaking by the

lessor to sell the Ijarah asset to the lessee and/or an undertaking by the lessee to

purchase the Ijarah asset from the lessor by, or at, the end of the Ijarah period.

The sale and purchase is effected by a separate contract.Undertaking is

translated from the Arabic word waad.

In the case above, we can see that the incorporation of waad helps to facilitate

the transactions. It is also the case when it is adopted in many other types of structured

products.

2This type of waad is normally not allowed.

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In the practical sense, waad has no specific definition of its own. To put it

another way, al waad can be understood as a commitment made by one party to another

to undertake either an actual or verbal disposal that would be beneficial to the otherparty.

To understand the concept of waad is not difficult. However, due to the

complexity of the its applications, it may take some effort to understand the arrangement

and structures, especially when there is doubt that waad may be used for bad purpose

that may harm the market participants and the industry as a whole. Thus, next section, we

will discuss on the shariah rulings that govern the practice of waad in order to set a

general ground for discussion.

The basic Shariah ruling

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Generally, Waad should be fullfiled for religious cause and it is something

related to morality and it is generally agreed by the scholars3. Most of the scholars,

including the ones from shafie, Hanafi, Hanbali and some from Maliks school agree thata waad made by one party to the other one should be Mulzim diyanatan, i.e. religiously

binding, yet mulzim qadhaan, i.e. legal obligation. The justification is that waad is part

of aqd tabarruat, i.e. a voluntarily contract. So the party that is promised posses only the

moral right but religiously, if a person does not fulfill a promise, he will be among the

hypocrites according to the Hadith. Therefore, Muslim investors should be careful in

involve in the transactions that contain the waad element.. However, due to its nature as

unilateral, waad is treated differently from contract. It is legally binding upon the parties

involved depends on the acceptance of its applicability and to the opinion of the jurists.

Different views and principles are upheld by different schools of thoughts and scholars in

the field of shariah and law.

There are basically four types of opinions on Waad4:

1) to satisfy a Waad is honorable but not obligatory.( Imam Abu Hanifah, Imam Al-

shafai and some Maliki scholars.)

2) Waad binds the promisor with a legal obligation to fulfill the contract. ( Samura

b. Jundub and some Maliki scholars)

3) Only if the promisee ends up with a loss or any costs in order to fulfill the Waad,

then the contract is binding.

4) The generally accepted opinion by the Islamic Fiqh Academy insists that three

conditions must be fulfilled to validate a Waad:

a. unilateral promise

b. cost or loss caused by making effort to meet the promise by the promisee

c. the completion of the actual sale or purchase

Because of the debate and controversy among the current jurists on waad, Islamic

Fiqh Academy (1409H) has made some decision to give some fatwa that:

1. That a unilateral promise is religiously binding upon the promisor. And it is also

judicially binding if it is made contingent upon a cause and if the unilateral promise

3Dr. Ala Eddin4Islamicbanker.com (2010(

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incurs a expense. In such case, it is either to fulfill the unilateral promise or to

compensate the losses resulted from non-fulfillment of the unilateral promise.

2. if a bilateral promise is optional for both or either party, then it is permissible inmurabahah. Otherwise, it is not allowed since it will be equivalent to a sale contract

if it is a binding bilateral. And in such case, the seller should possess or have

ownership on the goods sold other according to hadith.

These decisions have drawn attention in the industry and criticisms. It is argued

that :

First of all, the decision did not distinguish the unilateral promise in the case of

plain promise and in the resale contract. And another criticism is that it seems that

the two decisions are to be hijacked in such way that if the market participants are in

favor of making unilateral promise binding then they would go for the first decision

otherwise they may go for the second decision.

And furthermore, it is argued that the decision is arbitrary in a sense that it does

not allow the bind on both party but on one of them. It is said that this is not logical and

acceptable and in contrary to the opinion of Imam Al-Shafii.

Current practices of Waad

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must sell what he owns8. And the seller must assume risk in the transactions,

meaning he cannot be a free runner. In order to make a shariah compliant

instrument, waad can be adopted to emulate the cash flows of theconventional short selling yet still in accordance to the shariah rulings. As

proposed by Priya at al (2009), the structure of the short selling could be as

follows:

A broker buys securities from an shariah compliant hedge fund using

murabaha contract at a murabaha sale price(say RM1000) that is payable by

deferred payment. Then the broker sells the securities to the market at the

market spot price (RM 1000) for cash. At the same time, A enters two

double-waad with the broker and with the hedge fund each. The one with the

broker is whereby A makes an unilateral waad to purchase the securities

for a predetermined price( say RM 920, RM 900+spread RM 20) while the

broker makes an unilateral waad to sell the securities. On the other hand, A

makes another unilateral waad to the hedge fund to sell the securities at a

predetermined price( say RM 900) and in return, the hedge fund also makes a

unilateral waad to purchase the securities at the same price. And A will be

paid fees by both the hedge fund (pays RM 10) and the broker( pays RM 20)

for entering into the double waad with each party. So if the price of securities

decreases to be RM 900, then first the broker will purchase the securities from

the market at this price by using the cash received by the first sale he did. And

he then will enforce the double waad with A to sell the securities to A at

RM 920. And the hedge fund will also enforce the double waad with A to

buy the securities from A at RM 900. And then under murabaha, the hedge

fund will then receives they payment from the broker at RM 980 (RM1000

deducts the spread of the broker of RM 20).

Then the final outcome is that:

1) for the hedge fund: the return is equal to the money of RM 980

receives under murabaha from the broker minus the price spent on buying

the securities from A and the fees paid to A for entering the double

waad. So the final proceeds for the hedge fund is RM 980-RM 800-

RM10=RM 170.

8Prohibition on riba and gharar (2002(

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2) By the similar calculation, we find that for the broker, he will

receive RM 20 in net.

3) For A, he will receive RM 10 in net after exercising the twosimultaneous double -waad with the broker and the hedge fund each.

As we can see from above example, the final outcomes of this arrangement

actually emulate the returns when using conventional short-selling, yet it is

shariah compliant if we examine the each transaction that has been done.

Selected Resolutions to certain practices invovle waad:

Although in general, the promisor is not bound to fulfill his promise, in dealing with the

promissory elements such as the sale and buy-back agreement, when issue transaction

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and forward foreign currency transactions, one should be cautious to check the

transactions if the promisor is breached that causes the costs to the promisee.9

1. Sale and buy-bank agreement : both parties of the contract promise to buyor re-sell the asset in the future time. This type of agreement is widely

adopted in the interbank money transactions. The shariah issue related to this

case is that what the legal effect of waad on the contract and the

permissibility to buy or re-sell the same asset in a sale contract. The resolution

of the Shariah Advisory Council is that waad in this kind of agreement is

allowed if it is not put as the condition for the sale and purchase of the asset.

2. When Issue Transaction: in order to secure a price of a transaction in debt

securities that will normally be issued in about a week, both parties of the

contract make a waad. And to guarantee the market transparency for all the

stakeholders in the market, the when issue should be recorded in the Bond

Information Dissemination System. This arrangement is also a mean to help

the market participants to estimate the accurate price of the securities. In

practice, if the actual sale and purchase of the securities will take place in the

future and if the issuance is cancelled later, then the waad is also ended. So

the shaiah concern on this practice is the permissibility of promising to sell

and purchase in future. The resolution provided by the shariah advisory

council is that this kind of transaction is allowed given the permissibility of

promising to sell and purchase.

3. Forward Foreign Currency Transaction: In a foreign currency spot

transaction, the real delivery and settlement usually is done two days after the

transaction day and in a forward currency transaction, it is done in a pre-

determined future date. To facilitate this kind of transaction with shariah-

compliant arrangement, a waad contract is adopted that both parties of the

contract promise to sell and buy currency each needs on a predetermined date

for forward and two days after for a spot contract at an agreed price rate. In

the real practice, no actual signing of agreement will take place on the

settlement day. The shariah concern in this case is whether the waad forward

and spot currency transaction is allowed or not. The resolution of the Shariah

Advisory Council is that it is allowed and the compensation could be imposed

9Shariah resolutions(2007(

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on the promisor for breaching the promise. And it is only allowed in the case

of currency hedging and can be between customers and IFIs, between IFIs

and even between IFIs and conventional financial institutions.As we can see, waad can be adopted into different transactions to facilitate the

needs of the market participants. However, it should be carefully examined to make sure

it is in accordance to the shariah rulings.

Shariah issue of the application of waad

Unlike the Islamic contract, waad is less legislated for its use and applicability

by no or few standards of the international bodies such as IFSB and AAOIFI. Therefore,

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many issues, controversies and debates have appeared along the adoption of waad into

different financial transactions.

1. first issueOne of the issue is the enforceability of the waad. Since waad is unilateral.

The promisor may tend not to fulfill his promise. This may affect the

effectiveness of waad and further harm the financial market. The market players

become more cautious in dealing with financial transactions that incorporate

waad. As Frank and Samuel ( 1998) has pointed out that in the modern legal

environment, Islamic financial institutions are attracted to incorporate waad into

the transaction in most of the case when both parties have very strong extra

incentives to fulfill the promise, regardless of whether its binding or not. They

gave two very good examples:

- First is that a lessee is promised to receive the title to property at the end of the

lease by the lessor. In order to preserve his own reputation and for the future

ability to sell his products, he is discouraged to breach his own promise in this

waad financial contract.

- Second case is whereby banks enter into mutual promise to conduct currency

exchange. To ensure the healthiness of the business relationship among them it is

in their best interest to fulfill the promise to each other.

As we can see that in both cases, the promisors have strong incentives to make

sure their promises are fulfilled. Hence, it is well realized that the enforceability

of the waad is a major concern of the participants in the Islamic financial market

given the convenience and flexibility provided by adopting waad into the

different financial transactions.

As a result, many fatawas have been given in order to facilitate the

implementation of the financial transactions that incorporate the waad element.

These fatawas should be carefully learned and applied with the right knowledge

in order to generate best outcome.

As in the case of murabaha sales, the client promise the bank to purchase the

goods from the bank at a mark-up price once the bank purchases the goods from

the market or the supplier. In this case, bank is taking the risk if the client does

not fulfill his promise after the bank has purchased the goods and taken the

ownership. The bank will have to find a way to return or dispose the bought

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future of Islamic Finance. In other words, while up until now the Shariah

supervisory boards of modern Islamic financial institutions have focused

almost exclusively on the rules for transacting in compliance with theShariah, it is now time for them to focus as well on the higher purposes of

Islamic law or the maqasid al-Shari`ah."

Dr. Yusuf proves that this kind of product actually help the investors to receive

cash flows from investment in haram businesses. So the money of the Muslim investors

are actually used to invest in the businesses that are not in accordance to shariah rulings

meaning that the returns are determined by the performance of non-shariah-compliant

funds that can invest in haram businesses. So the investments of the Muslim investors

actually cause potential haram activities. And furthermore, he shows that the pricing

based on the performance of non-shariah-compliant assets cannot be justified by

conducting the analogy or qiyas that LIBOR is allowed to be used for pricing for in the

case of the latter, LIBOR is just used for benchmarking the fair return of the market and

the former is used to deliver the return. In his article, Dr. Yusuf shows his serious

concerns on this case. Due to the easiness and cost efficiency of this kind of structure, all

the market participants will tend to adopt it if it is allowed and this will make all the past

three decades of effort in the industry gone since no one would bother to go through the

process of conducting true-sales, lease backs and other necessary transactions to validate

the contract normally.

However, in his article, Dr. Yusuf does not blame the structure of using double

waad but rather putting the criticism on the use of the structure which means that if the

arrangement is regulated to be adopted in dealing with only shariah compliant activities,

then it may turn out to be some powerful instrument ever.

On the other hand, Dr. Hassan (2007), in supporting this structure introduced by

the Deutsche Bank, indicates that the investments of the Muslim investors are isolated

and protected from haram businesses or transactions by the bank according to the shariah

audits conducted by the bank.13 However, it can be argued that further transparency

should be guaranteed since the shariah audit is carried out by the bank not by the

independent shariah body. Another supporting argument is that the use of the use of a

reference index is similar or same to using LIBOR as benchmarking for suku issuance14.

13Daniel, 200814Ibid

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Both sides are having their own arguments and will not agree with each other on

the same ground. However, as far as the industry perspective is concerned, the use of

waad to imitate the conventional shorting is considered more appropriate than usingarbun or salam.

Conclusion

The long run survival of the Islamic banking and finance calls for more

innovation and creativity. However, the process is not an easy one since, different from

the conventional counterpart, it is compulsory to make sure all the new products and

instruments are in accordance to the shariah rulings while at the same time they can be

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competitive in terms of pricing, costing and operations in the integrative financial

market.

Waad as a unique instrument with special natures and characteristics does bringsexciting possibilities and opportunities to the financial market. It is of the best interest of

all the market participants to not allow it to be abused and end in bad reputation. The

shariah bodies should work together with the industrial players to make sure that the

benefits of incorporating and utilizing waad in the financial transactions are maximized

while the disadvantages and harms of which are minimized.

References:

Al-Shafiì, Al-Imam, Al-Umm. Cairo, Tabàt Al-Shaàb

Ala Eddin Kharofa (Dr.). (2002). The loan Contract In Islamic Law (Shariah)- A

Comparison with positive law. International Islamic University Malaysia: Kuala

Lumpur.

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Decision 2 and 3, fifth session (1988), Fiqh Academy Journal, 1599-1600

Daniel Stanton, Dont fear the riba, 24 January 2008 available at

www.arabianbusiness.com/509145-dont-fear-the-ribaDr. Mohammed Obaidullah (1999), Islamic Financial Options: Potential Tools for Risk

Management, Journal of King Abdulaziz University (Islamic Economics), Saudi

Arabia, Vol. 11

Frank E. Vogel, Samuel L. Hayes (1998), Islamic Law and finance: religion, risk and

return, Kluwer Law International, p125-127

H. Hassan (2003), Islamic Contract Law: Between Commutative Justice and

Liberality, 13 (3) Journal of Islamic Studies

Islamic Banking and Takaful Department, Bank Negara Malaysia, Resolutions of Shariah

Advisory Council of bank negara Malaysia, p33.

Islamic Fiqh Academy, (1409 H.), Majallat Al-Majma` (The Academy Journal), Volume

V, Part II, Jeddah.

Priya Uberoi, Rahul Chatterji and Dany Bidar (2009), Promises on the Horizon: An

com/business-lines/calyon-at-the-heart-of-the-development-of-islamicbanking.htm

Prohibitions on riba and gharar (2002), available at

http://www.witness-pioneer.org/vil/Books/MG_CIBF/chapter_1.htm.

Wahba Al Zuhaili (2003), Financial transaction in Islamic jurisprudence, Beirut: Dar al-

Fikr al-Mouaser, First Edition, Vol.1: p50.

Yusuf Talal DeLorenzo (2007),The total returns swap and the 'Shariah conversion

technology' stratagem. Online at: www.dinarstandard.com/finance/DeLorenzo.pdf

www.cibafi.org
http://www.arabianbusiness.com/509145-dont-fear-the-ribahttp://www.witness-pioneer.org/vil/Books/MG_CIBF/chapter_1.htmhttp://www.dinarstandard.com/finance/DeLorenzo.pdfhttp://www.cibafi.org/http://www.arabianbusiness.com/509145-dont-fear-the-ribahttp://www.witness-pioneer.org/vil/Books/MG_CIBF/chapter_1.htmhttp://www.dinarstandard.com/finance/DeLorenzo.pdfhttp://www.cibafi.org/

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