Sharia’H Foreign Exhange Trading PDF

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Sharia’H Foreign Exhange Trading...

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UNIVERSITI KUALA LUMPUR OF BUSINESS SCHOOL

EBB10303 – ISLAMIC ECONOMICS

INDIVIDUAL ASSIGNMENT: SHARIA’H FOREIGN EXHANGE TRADING

GROUP IF21

PREPARED BY: NAME

STUDENT ID

Nur Balqish Binti Udin

62211220196

PREPARED FOR: Dr. Issoufou Chaibou

SUBMISSION DATE: 6th May 2020

Table of Contents Content

Page

Introduction

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Participants in the Forex Trading Market

2

Conventional Forex Trading Transactions

3-4

Shari‘ah Issues of Forex Trading

5-6

Shari‘ah-Compliant Forex Trading in Malaysia

7-8

Conclusion

Bibliography

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Introduction Today, Forex (FX) Trading has become one of the popular trading tools for almost everyone globally to invest and trade in the international market. ―Forex, or foreign exchange, trading is an international market for buying and selling currencies‖ (Amadeo, 2018, para.1). It is also a trading currency or foreign currency with other traders that do not involve physical the exchange, yet via an internet platform. FX has exists back centuries. It was first implemented in Egypt and after that, it was practiced by Babylonians with the use of paper notes. Current FX is entirely different when contrasted with the initial primitive currency trading. Aforex (2017) stated that online trading exists after 1994. Prior, FX trading was generally restricted to the bigger institutions and investors did not have the access to it. Only these big institutions could raise the capital which was needed to trade as a low amount of leverage was provided during those days. However, after the advent of the online trading platform, retailers have also become much more accessible. Trading FX can be done 24 hours a day, five days a week following the opening hours of banks in each region of the world. The price or exchange rate of a currency is determined on the international interbank transactions. The initial capital for FX is relatively small, only about $200-500 is an ideal amount, because of the leverage and margin. The transactions can also be done on online platform using Android, iPhone, and Windows. In addition, FX can only be done through a broker. Facilities are provided by the broker of FX trading including derivatives financial markets/alternative where a variety of other assets are also traded. Other than that, there is also a Commodity Index and all of which can be used as an instrument to gain profit.

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Participants in the Forex Trading Market The participants are the people involved in the exchange or trade of foreign currency. These include the buyers, sellers or the intermediaries (Prachi, 2019). The participants involved are such following: 1) Central Bank: The Central Bank regulates the exchange rates of the currency of its own country in order to ensure fluctuations within the preferred limits and to maintain control over the money supply on the market. 2) Commercial Banks: The commercial banks are a platform for FX transactions. They provide their customers with international trade, along with other FX functions, such as foreign investment. 3) Traditional Users: Traditional users include foreign tourists, companies engaged in global business, patients receiving treatment in other country's hospitals, and students studying abroad. 4) Traders and Speculators: Traders and speculators are the seekers of opportunities and look forward to making a profit by trading on short-term market trends. 5) Brokers: They are considered to be financial experts who act as intermediaries between dealers and investors by providing the best quotations.

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Conventional Forex Trading Transactions A FX market performs three significant operations which are explained as follow: 1) Spot Market Transactions This spot transaction is performed immediately or usually within two days1. It's a simple purchase of a currency using a different currency2. The trader buys a specific currency at the buy price from the market maker and sells a different currency at the selling price3. The difference between the two is referred to as the "spread".

2) Futures Market Transactions This future market transaction, where currency trading involves future delivery and payment, as well as the exchange rate, is predetermined. This exchange rate is known as the future rate. It protects the buyer from the risk of a rise in the value of the currency.

3) Forward Market Transactions The terms of the contract are negotiable, and any of the parties involved can amend them. Within a contract of options, the investor is not bound to but is entitled to buy or sell the specified quantity of assets at the agreed price in the specific future. The quantity of an asset, the date of execution and the contract price shall be fixed and standardized in a future contract. Commercial banks usually enter into swap contracts

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Such forex market is termed as a spot market, and the rate of exchange is called as spot rate. This is the transaction cost to the trader, which the return is profit earned by the market maker. 2 It's an agreement between the trader and the market maker, or dealer. 3 The buy price is somewhat higher than the selling price. 3

if they engage in forward-exchange business. They will sell a particular currency on the spot market to buy the same currency on the forward market. The rigorous purchase and sale of different currencies on the FX market to obtain gains from such transactions is called arbitrage.

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Shari’ah Issues of Forex Trading 1) Leverage Activity ―Leverage involves borrowing a certain amount of the money needed to invest in something‖ (Lioudis, 2019, para.1). In the case of forex, money is normally borrowed from a broker. High leverage is offered in forex trading as a sense of an initial margin requirement, a trader can build up — and control — a huge amount of money. Based on a dictionary of Islamic Finance by Khorshid (2011), leverage means magnifying one‘s buying power to make a purchase4. According to El-Gamal (1999), option is a leveraging device used for trading in risk. The reason is that this technique allows investors to use only a small amount of money to make significant profits. As a result, leverage gives more financial power. The degree of leverage provided by the Options Contract may be so high that large unpredictable market movements in underlying prices may one day lead to the insolvency of major financial institutions. (Ayub, 2007)5.

2) Gambling In Islamic finance, transactions involving excessive risk are prohibited. Gharar here refer as uncertainty or hazard. This is caused by lack of price transparency in the contract or exchange. According to Al-Qarafi, the definition of gharar is "that which has a pleasant appearance and a hated essence". It is prohibited to trade an option without accompanying any real asset, as it is equivalent to gambling. The possibility 4

i.e, by borrowing money to buy more assets than could be afforded, in hope that they can be sold for a greater profit. Once the loan and interest is repaid, the profit will be more than the cost. 5 There will be no gain if there is no risk. Therefore, in order to earn legitimate earnings in any economic venture, people should take risk and responsibility, not to get easy money by way of leveraging. 5

of risk and returns are magnified and the gains of the buyer being equal to the losses of the seller and vice versa6. Hence, the purchase and sale of options is a risky zero-sum game (Obaidullah, 1999). Zero-sum game is similar to gambling as one wins at the loss of the other. This kind of activity is prohibited in Quranic verse ( Al-Maidah: 90)7. The gains are therefore in the nature of maysir and maysir cannot exist without the existence of excessive gharar (Iqbal, 2012).

3) Interest (Riba‘)8 In conventional practice, the issue of riba (usury) arises from a foreign exchange option contract when the parties concerned fix a rate on the day the contract is concluded, but the exchange of currency will take place in the future. The element of riba' exists in the presence of the interest rate when two financial institutions or any other financial institution, with their corporate clients, are not trading on the counter and are not trading on the spot (Siti Noor Aini & Hassillah, 2012). Therefore, FX options involves riba‘, and it is impermissible in Islam as a fundamental condition of the currency exchange contract is the absence of any deferment, otherwise the contract will be defective (Islamic Finance Bulletin, 2008).

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This is due to the leverage of the option trading activity. “O you who have believed, indeed, intoxicants, gambling, (sacrificing on) stone alters (to other than Allah), and divining arrows are but defilement from the work of Satan, so avoid it that you may be successful‖. (5:90) 8 “A surplus or an excess in return without counter value stipulated as condition in a contract.‖ – Hanafi‘s School (imam Sarakhsi, Al-Mabsut) 7

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Shariah-Compliant Forex Trading in Malaysia All FX trading must comply with the following conditions: 1) Like for Like - If the currency exchanged is of the same type (e.g. MYR for MYR), the transaction shall be effected: (1) on the spot (i.e. without deferment) and (2) at par value. 2) Hand to hand - If the currency exchanged is of different types (e.g. MYR for USD), the transaction shall be effected: (1) on the spot and (2) at the prevailing currency rate or at any mutually agreed rate at the time of execution of the contract (i.e. foreign currency exchange). Although the Islamic FX option is not widely offered by Islamic financial institutions, some Islamic banks, such as CIMB, have offered it for risk management and investment purposes. CIMB Islamic has expertise and a range of FX-Risk Management solutions to assist clients in meeting their FX-Risk Management requirements. It is based on the principle of Shari'ah Bay‘ al-Sarf, which refers to an exchange contract of the same or different currency. The transaction must involve two parties, the seller and the buyer. The seller and the buyer shall enter into an offer and acceptance 9. At the time of the execution of the contract, both parties shall determine and agree on the currency and the rate. An exchange contract is of a binding nature. Any termination must be mutually agreed upon10. Once the terms of execution have been agreed, both parties shall inform each other of the terms of delivery of the currencies. Upon completion of the Bay‘ al-Sarf, both parties cease to have any additional obligations. 9

May be expressed orally, in writing or by any other method recognized by Shari'ah. Neither of the contracting parties shall terminate the contract unilaterally.

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When carrying out a Bay‘ al-Sarf transaction, the purpose for which the transaction was entered into must at all times are in accordance with the rules and regulations set out in the provisions of the FEA. The products offered in Islamic CIMB FX trading are: 1) Value Today: FX transaction under Bay 'al-Sarf, foreign currency settlement arrangement on the same day. 2) Value Tomorrow and Spot: FX transaction under Bay 'al-Sarf, made today for foreign currency settlement on the next business day or two days. 3) Fixed Forward: FX transaction under Bay' al-Sarf & Wa'ad, arrangement for settlement of foreign currency at a future date beyond 2 business days/maximum 365 days. 4) Long Term Foreign Exchange: FX transaction under Bay 'al-Sarf & Wa'ad, a foreign currency settlement arrangement for a future period of more than 1 year / maximum 15 years. 5) Foreign Exchange Forward Limited Option: FX transaction under Bay 'al-Sarf & Wa'ad, a multi-purpose arrangement for a specific future period. 6) Islamic Foreign Exchange Option Equivalent: FX transaction under Bay 'al-Sarf, Wa'ad11 & Commodity Murabahah12 / Bay' al-Innah13 that gives you the right, but not the obligation, to exchange currency at a predetermined strike price on a specific future date. A premium equivalent payment is payable in advance.

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Customers can protect the value of their future foreign currency proceeds, fix their hedge cost at a premium, and even make a profit if foreign exchange rates move in their favour. Only Wa‘d without any consideration is permissible in a forward currency transaction (Arab News, 2010) 12 The Mudarabah Interbank Investment (MII) or any other suitable asset is used for the al-'inah contract. 13 On the other hand, the Murabahah contract uses commodities such as crude palm oil (CPO) or London Metal Exchange (LME). 8

Conclusion In a nutshell, the conventional practice of the FX option contract raises returns by way of leveraging which is clearly opposite to the principles of Islamic risk management. Option trading is the most important element that can lead to the insolvency of major financial institutions and, as a result, to an economic crisis. This is because, at the secondary level of trading, people will only speculate and have no real underlying asset. They are just buying and selling out of nothing to get a quick and easy return. This activity is totally contrary to the principles of Shari‘ah. Islamic financial transactions are bound by strict Islamic law rules and regulations. Any Islamic financial transaction must be free from prohibited elements such as riba, gharar and maysir as well as fairness to the parties involved in the contract. The conventional FX option, on the other hand, is impermissible as it involves the element of leverage, gambling, right trading and rib trading. All of these elements are totally prohibited in Islam. In order to meet the need for hedging, therefore, the alteration and modification of conventional products is required in the current market. As Islamic banks and financial institutions are now well aware of the need for a rigorous approach to risk management, products such as the option of Islamic FX based on the principles of wa'd, al-'inah, commodity murabahah and bay al-sarf have been developed. The development of the Islamic FX option is simply the provision of an innovative Shariahcompliant risk management tool against currency risks. Although the Islamic FX option gives similar economic effect to the conventional FX option, the contract must only be used strictly for hedge purposes if there is a clear underlying transaction.

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Bibliography Aforex. (2017, June 22) A History of Forex: How Online Forex Trading Developed. Aforex. Retrieved from: https://www.aforex.com/articles/history-forex-online-trading- developed/

Al-Qarafı, A. n.d. Al-Furuq. Beirut: ‗Alam Al-Kutub.

Amadeo, K. (2018, December 17) Forex trading and how it determines the dollar‘s value. thebalance. Retrieved from: https://www.thebalance.com/what-is-forex-trading-3306253

CIMB Islamic. Forex exchange. CIMBISLAMIC. Retrieved from: https://www.cimbislamic.com.my/en/business/products/treasury/foreignexchange.html

El-Gamal, Mahmoud A. (1999) Discussion forum Islamic Financial Dervatives. International Journal of Islamic Financial Services. No. 1.

Iqbal, I., Kunhibava, S., Ashraf Wajdi Dusuki. (2012) Application of Options in Islamic Finance. Research Paper no. 46. International Shariah Research Academy for Islamic Finance.

Islamic Fianance Bulletin. (2008) Forex- A Shariah Discussion. Islamic Banking and Finance Institute Malaysia Sdn Bhd. Issue 21 July-September. IBFIM. Pp1-16.

Khorshid, A. (2011). Dictionary Of Islamic Fianance. London: Euromoney

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Muhammad Ayub. (2007). Understanding Islamic Finance. England: John Wiley & Sons, Ltd.

Obaidullah, Mohammed. (1999). Islamic Fianancial Options: Potential Tool for Risk Management. Journal of Kingabdulaziz University (Islamic Economics), Saudi Arabia. 11:3-28.

Parker, M. (2010, September 13) Bank Negara Says No Fee For Wa‘d Currency Hedging. Arab News. Retrieved from: http://www.arabnews.com/node/355017

Prachi. M (2019, March 7) Foreign exchange market. TheInvestorsBook Retrieved from: https://theinvestorsbook.com/foreign-exchange-market.html

Siti Noor Aini Suhaimi and Hasillah Salleh. (2012). A New Theory of Islamic Option based on Mudharabah Principle. UMT 11th International Annual Symposium on Sustainability Science and Management. 9-11 July. Pp. 317-323.

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