This document discusses various Sharia issues and challenges related to synthetic commodity transactions. It provides an overview of Dar Al Istithmar and its services in Islamic finance consulting and monitoring. It then examines the growth of Islamic treasury markets and different types of commodity transactions over time. Key Sharia perspectives from AAOIFI and the International Council of Fiqh Academy on permissibility of tawarruq structures are presented.

1. Synthetic Commodity TransactionsShari’a Issues and ChallengesSayd FarookPhD,BBus,LLB,CIPASenior Consultant | Structuring and Legal06 December 2009

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10. Commodity transactions growth directly aligned with Treasury and Derivatives evolution 2010-2020 Global Islamic Treasury Market Real Time Transactions Exchange traded Profit Rate Swap Islamic Credit Default Takaful 2002-2010 Wakala/Mudaraba Forward Wa’d FX OTC Profit Rate Swap Market players Conventional banks and technology platforms bringing about market makers to trade real-time 1975-2001 Interbank Commodity Murabaha Spot FX Market players Entrance of conventional financial institution treasuries with global liquidity and FX capabilities Market players Islamic banks transacting with each other Islamic Finance Treasury v1.0 -> v2.0 3

11. Commodity MurabahaGrowth Drivers Growth Increased use of Shari’a compliant derivative equivalents (SCDE): Profit Rate Swap FX Forward FX Option Increase in Shari’a compliant syndicated and debt financing Liquidity management where wakala is not a viable alternative Decline Shari’a preference for alternatives to commodity based transactions: Wakala Sukuk 4

12. 5 Execute Master Hedging Agreement (T0) Customer requiring variable rate and paying fixed rate Multinational Bank (MB) offering variable rate and receiving fixed rate 1 Undertakings to sell commodity for notional value + fixed rate at each exchange date TX (T0) 2 Undertakings to sell commodity for notional value + variable rate (T0) at each exchange date TX (T0) 3 At each exchange date (TX), sell commodity for notional value + variable rate (Tx) 4 At each exchange date (TX), sell commodity for notional value + fixed rate (Tx) 5 The payments are netted off with and one parties pays the other the difference between the fixed and floating (Tx) 6 Commodity in Profit Rate SwapWa’d Application

13. Commodity in Profit Rate SwapMurabaha Application 6 Multinational Bank (MB) as principal offering variable rate and receiving fixed rate First Leg: Provides revolving “variable rate” US100m Murabaha financing every 6 months for 5 years 1 4 Variable Rate Profit + Principal every six months are notionally distributed to MB Customer requiring variable rate and paying fixed rate Net-off: Difference between Variable rate and fixed rate (3-4) are netted off and counterparty pays /receives the difference between variable and fixed 5 Fixed Rate Profit + Principal every six months are notionally distributed to Customer Multinational Bank (MB) as AGENT for Customer 3 2 Second Leg: Invests the funds through “fixed rate” 6 month revolving Murabaha

14. Shari’a PerspectivesAAOIFI Shari’a Standard No. 30 Monetization Common Shari’a compliance issues 4/2 Identification and distinction 4/5 No return of commodity to original seller and no collusion 4/7 No delegation to counterparty or agent of counterparty to sell commodity purchased from counterparty 4/8 No proxy of third party should be arranged 4/9 Sale should be arranged first hand or through agent (not appointed or nominated by counterparty) 7

15. International Council of Fiqh Academy19th Session, 26-30 April 2009 8 1. …Technically, according to the Fiqh jurists, tawarruq can be defined as: a person (mustawriq) who buys merchandise at a deferred price, in order to sell it in cash at a lower price. Usually, he sells the merchandise to a third party, with the aim to obtain cash. This is the classical tawarruq, which is permissible, provided that it complies with the Shari’ah requirements on sale (bay’). 2. The contemporary definition on organisedtawarruq is: when a person (mustawriq) buys merchandise from a local or international market on deferred price basis. The financier arranges the sale agreement either himself or through his agent. Simultaneously, the mustawriq and the financier executes the transactions, usually at a lower spot price. Reverse tawarruq: it is similar to organisedtawarruq, but in this case, the (mustawriq) is the financial institution, and it acts as a client. …It is not permissible to execute both tawarruq (organised and reversed) because simultaneous transactions occurs between the financier and the mustawriq, whether it is done explicitly or implicitly or based on common practice, in exchange for a financial obligation. This is considered a deception, i.e. in order to get the additional quick cash from the contract. Hence, the transaction is considered as containing the element of riba.

16. Permissible application of Tawarruq 9 LME BROKER D LME BROKER C No collusion is allowed between the brokers (4) A sells commodity to D for spot delivery and spot payment (5) A instructs C to transfer commodity to D (1) B purchases commodity from C for spot delivery and payment BANK A (Requires liquidity) BANK B (Surplus Funds) (2) B sells to A for deferred payment and spot delivery (3) B instructs C to transfer commodity to A’s account with C

17. Contentious application of Tawarruq 10 LME BROKER D LME BROKER C (3) B sells to D on behalf of A (3a) B instructs C to credit the commodity to D (3b) B instructsD to transfer proceeds to A’s account (1) B purchases commodity from C for spot delivery and spot payment BANK B (Surplus Funds) BANK A (Requires liquidity) (BANK Bacting as agent) (2)B sells to A for deferred payment and spot delivery (2a) B instructs C to transfer commodity to A account held with C

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