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Futures , Forwards and Islamic Law

Updated on September 18, 2018

Commodites Market, Futures and Manupulation

 

We have seen oil going to $ 147 per barrel last year and sky rocketing of the all commodities prices on the commodities exchanges. Then collapse of the market. Have the things changed so fast that $ 147 oil dropped to $37 in no time. The real issue is manipulation of prices in the market. This is making more and more people hungry and making basic necessities of life out of reach for most of poor people. Rich traders are making huge profits at the expense of poor. Islam does not allow such manipulation of market. It can be seen clearly from the basic do’s and don’t of Islamic contract.

 

Basic Do’s and Don’t of Islamic Contract

 

  1. Prohibition of riba- (charging and receiving interest)
  2. Application of al-bay’ (trade and commerce)
  3. Avoidance of gharar (ambiguities) in contractual agreements. (uncertainty and misleading terms in contracts)
  4. Prohibition of maisir (gambling) (excessive risk taking, speculation)
  5. Prohibition from conducting business involving prohibited commodities such as pork, liquor and pornography.

 

Elements of a Valid Sale Contract

There are three elements of a valid sale; the subject matter, the parties (buyer and seller) and the contract.

Briefly, the subject of a sale should be

• Existing / Existable

• Valuable

• Lawful and Usable

• Capable of ownership/title

• Capable of delivery/possession

• Specific & Quantified

• Seller must have title (ownership) along with related risk

The sale of a thing having an element of absolute uncertainty or speculation is not valid, like the sale of milk still in the udder of a cow is not a valid sale.

The commodities market – Forward and Future

A forward contract is an agreement between two parties to exchange at some fixed future date a given quantity of a commodity for a price defined today. The fixed price today is known as the forward price. Islamic Forward Contracts are made with the express intention of delivering the currency on the specified future date. In common practice it is called a ‘sale’.

 In a conventional forward contract where both payment and delivery is made at a future date is deemed un-Islamic, as the transaction is agreed and binding whereas both payment and delivery remains uncertain. The conventional “deferred contract” therefore carries the potential losses to one party. Generally, the forward purchase is not considered to be permissible as it contravenes the general rule ‘do not sell what you do not own’, an established principle of Islamic jurisprudence. Therefore the normal contract for shorting shares is not permissible under Shari’ah rules.

Tradable forwards in principle were known and established more than 1200 years ago. But these futures differ from contemporary futures in two fundamental aspects: advanced payment and delivery. In all Salam contracts, the full price must be paid in advance. Further, the underlying commodity must be delivered at maturity, and there are several restrictions on subsequent canceling and settling of the contract without delivery. Specifically, forward sales with respect to agricultural produce used to be allowed by Prophet Muhammad provided the price, quality, quantity and period of delivery are specified at the time of transaction. Based on this principle, it is lawful to perform forward sales which are exactly what one does in the Commodity Market. However, one often does not take delivery of the commodity purchased.

There are several contracts that create deferred obligations that are permissible in Islamic Banking. The ones that are commonly used are:

Murabaha (cost plus mark-up).

Bai Muajjal - Deferred payment of goods which are delivered upfront.

Bai Salam - Payment upfront or in advance for delivery of goods in future for which a regular market exists and involves short-term positions

Bai Istisna’a - Payment upfront or in stages for manufacture and/or delivery of goods in future involving long-term positions.

Arbun - A non-refundable down-payment for right to buy and sell an asset in a certain time in future.

Wa’ad (promise)

 

Futures Market

In the Futures market also the commodity or currency sold is agreed to be delivered/paid at a future date like in a forward sale, but there is a difference between the two. In a Forwards market, the article is actually delivered and the price is actually paid on the agreed future date, but in a Futures market, actual delivery or payment is very rare; only the difference in market price of the Item on the agreed future date and the contracted price is paid or received by the seller. The primary purpose of futures trading is not to receive or deliver the contracted goods but to minimise risks. Organised futures, where most contracts end up in settling price differences, are relatively recent phenomenon. The buyer of a Futures contract does not have to put up the full price of the contract at the time of purchase. As the delivery/payment never takes place, only the price difference is settled. One party gains, the other loses, and there is no benefit for the country’s real economy. A stronger party can also easily exploit small new investors. So the Shari’ah does not permit ‘Futures’ trading.

Mufti Taqi Usmani, considers that Futures transactions not permissible. For two reasons;

i. According to Shari’ah, sale or purchase cannot be affected for a future date.

ii. In most futures transactions delivery or possession is not intended.

The foreign exchange, or forex, market handles the trading of one currency with another. Though there is no physical existence of this market, the foreign exchange market is the largest financial market in the world. Foreign exchange is restricted by Shari’ah by the rules of exchange of currencies (Sarf), requiring spot transactions. Currency trading is of three types, viz; spot, forwards and futures. In addition there is a Swap market in currencies where a foreign exchange dealer can simultaneously concludes two contracts, one spot and the other forward. The difference in exchange rates represents interest from the spot to the maturity dates of the Forward deal, and hence Swaps are not permitted in the Shari’ah.

Alternatives

If we want to avoid one more financial crisis and global exploitation then there are very few alternatives available. For sustainable and inclusive growth of the global economy the markets must be governed and controlled by legislation. 1996 has seen collapse of the Asian currencies and later on the pain for Asian nations. The manipulation must go, so market must be governed. The whole regime or the concept of currency trading is against the poor nation and there economy which is manipulated by rich and developed nation. In whole of this poor gets poorer and rich gets richer day by day.

  • Future and forwards market must be governed and controlled for manipulation. All transaction should be delivery basis.
  • All transactions must be delivery basis and not for manipulation.
  • All transaction in virtual, non existent product must go. (Future, derivatives and financial products like SWAPS etc.) For clean and ethical economy.
  • All foreign exchange future must be controlled and change to spot basis.

 

These are the only hopes to avoid one more financial crisis and pain of financial crisis.

Comments

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    • profile image

      abou imrane 

      7 years ago

      There are some types of swaps that were deemed permissible by scholars, these can be based on concepts such as Wa’ad, Murabahah, Musawamah and Tawarruq.

      http://www.financialislam.com/foreign-exchange.htm...

    • profile image

      Thameem 

      8 years ago

      Dear Brother Sallams, Can we trade in the commodity market in India? Is it halal or haram. please give your explanation.

      Syed

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