Research Paper (printed copy)
EXECUTIVE SUMMARY (Preview)
Tawarruq has been extensively used by Islamic financial institutions (IFIs) recently, mainly to address liquidity shortages and to structure risk management tools. The common term used in the market today to denote tawarruq is “commodity murabahah” or sometimes “commodity musawamah”. However, the widespread practice of organized tawarruq has been disapproved by many contemporary scholars. The International Islamic Fiqh Academy of the Organization of Islamic Cooperation, in its 19th session, held in Sharjah in 2009, resolved that the current tawarruq practice is impermissible.
The OIC Fiqh Academy’s decision was prompted by numerous criticisms of the manner in which organized tawarruq is structured and transacted in modern Islamic financial operations. Many Shariah scholars have criticized the structure for lacking credibility as a real transaction. The concern over tawarruq among contemporary scholars is not about the essence of the contract but, rather, about several violations in its modern application. There are at least four major Shariah issues in the modern application of organized tawarruq: the issue of the commodity, the issue of possession and delivery, the issue of prearrangement (tawatu'), and the issue of agency.
The issue of the commodity arises as many commodities used in the practice of modern organized tawarruq are spoiled commodities that no one would agree to purchase if they actually wanted the commodity for its own sake. Some scholars have also raised concerns about the lack of proper monitoring of the practice by certain segments in the market, which could lead to the same commodity being simultaneously used as the subject of multiple transactions. Furthermore, the issues of possession and delivery arise because the legal documents are embedded with clauses that indicate the buyer’s lack of intention to take delivery. In some cases, the buyer is prevented from taking any delivery, either explicitly or implicitly by the standard operating procedure of the market. This is particularly true in the case of transactions performed on the London Metal Exchange (LME). A ‘netting arrangement’, which has become standard practice in the LME, accentuates the fact that delivery and possession do not actually take place.
Moreover, the issue of prearrangement (tawatu' exists because the transacting parties operate a netting facility arrangement between their different storage facilities. Thus, in reality, the commodity rarely gets physically transferred from seller to buyer as it should according to the Shariah requirement of a sale contract. Lastly, the issue of agency arises because the customers in modern banking organized tawarruq do not buy the commodity themselves. The customer authorizes the agent—i.e., the bank—to buy it from the market on the customer’s behalf. Then the customer buys it from the bank at a delayed price and later sells it to a third party. The custom adopted in many banks is that the bank will not pay the price to the original seller but, rather, to the customer, as he is the customer’s agent in buying and selling the commodity. In other words, the bank plays its classical role as a financial intermediary, arranging the deferred payment purchase of the commodity from an exchange on behalf of the customer. Then, by a condition either stipulated in the contract or known by custom, the bank proceeds to act as the customer’s agent to sell the commodity to another party for cash. The inclusion of the element of agency into the tawarruq contract authorizing one party to buy the commodity on behalf of another and then sell the commodity to oneself on behalf of the principal renders the contract similar to the prohibited i'nah and causes it to depart from the true tawarruq (tawarruq haqiqi), which was approved by the majority of classical jurists.
Against this backdrop, two platforms, namely Bursa Suq al-Sila’ Malaysia (BSAS) and Jakarta Future Exchange (JFX) Shariah Indonesia, have been introduced in the market to address the Shariah concerns over the practice of organized tawarruq. BSAS is an Islamic commodity trading platform for the Islamic banking and capital market that was introduced by Bursa Malaysia in 2009. It was designed as a multi-commodity exchange for tawarruq transactions that addresses the scholars’ concerns about Shariah issues in the existing practice of organized tawarruq. At the outset, BSAS started out by trading in local crude palm oil (CPO) and plastic resin (PE), but other Shariah-approved commodities are planned for the future, including cars, air conditioning units, oil, copper and aluminum. In April 2012, Bursa Suq al-Sila› added RBD (refined, bleached & deodorised) palm olein as a new commodity to meet greater demand from local and international players for commodity-based Islamic financing and investment.
Pursuant to the introduction of BSAS, JFX Indonesia launched Jakarta Future Exchange (JFX) Shariah in late 2011 as a platform to accommodate the Islamic finance industry’s need for Shariah-compliant commodity-based instruments. The platform was initiated by the National Shariah Board-Indonesian Council of Ulama (DSNMUI) to provide a means for liquidity management by incorporating multiple Shariah-compliant contracts and employing various underlying Shariah-compliant commodities such as palm oil and chocolate.
The study found that most of the Shariah issues in organized tawarruq have been well taken care of by both BSAS and JFX Shariah. The issue of the commodity is resolved by BSAS as it only allows real Shariah compliant commodities to be transacted on the platform. With regards to potential redundancy in the commodities used, BSAS provides a fully electronic system that will recognize and verify ownership through e-certificates. Contract specifications are also given to every single asset and made known to all parties (Mansor, 2009). Similarly, JFX Shariah uses various underlying Shariah compliant commodities, such as palm oil, rubber and tea. The platform’s Shariah Supervisory Board (SSB) and Board of Directors (BOD) make sure that the asset to be transacted is available and that the same commodities are not the subject of multiple transactions.
The issues of possession and delivery are also addressed by both platforms. In BSAS, the procedure allows for physical delivery of the commodity. According to the BSAS procedure for delivery, the buyer needs to directly inform Bursa Malaysia Islamic Services Sdn Bhd (BMIS), which runs the Exchange. Once acknowledged by BMIS, the commodity supplier will then be notified. The delivery by the commodity supplier to the buyer will take place within seven days upon receipt of the commodity certificate endorsed by BMIS. In JFX Shariah, the buyer has legal ownership of the commodity as represented by the electronic certificate. He also has direct control over the commodity and the option to receive delivery within seven days. Should the buyer opt to receive the physical commodity, JFX will ensure that delivery takes place by the stipulated date. In fact, the mechanism of JFX Shariah is designed to make the delivery of commodities the first option in transactions to ascertain that the sale contract is real and not fictitious. Nevertheless, for sceptics, the issue of possession and delivery might still be invoked since the modern financial tawarruq is predominantly practised in such a way that the delivery of physical commodity is improbable even if, theoretically, possible. This is because these platforms are mainly designed to facilitate the market meeting liquidity shortages on the part of some of its players by using the tawarruq instrument. This is particularly true since the price of commodities traded on the platforms are relatively higher than the actual market, which creates a disincentive for players to take actual delivery or to sell the commodities outside the platforms. For some critics, such arrangement will make the trades tantamount to fictitious transactions since consideration is normally based on predominant market practice, not infrequent occurrences.
The issue of prearrangement is addressed by BSAS by explicitly providing that the sale to the commodity supplier be done on a random basis. The suppliers are required to bid for the best price, which replicates the real market. Once ownership goes back to a supplier, all unencumbered commodities may or may not be re-offered into the BSAS market for other trades. In line with Circular III of Bank Indonesia, JFX Shariah does not allow commodity trader members to conduct transactions with a party that acts as both the commercial member and the commodity consumer. Likewise, the transaction is done on a random basis to assure that the same commodity does not go backto the same supplier via the netting arrangement.
Finally, BSAS has no specific measure to address the issue of authorization since the issue lies largely in the hands of the platform users. Thus, a customer who needs personal financing, for instance, can go to the bank that offers a tawarruq financing facility. The bank will then have to purchase the CPO from a supplier on the BSAS platform and subsequently sell it to a customer for a deferred price. The customer can then appoint the bank to sell the CPO to BMIS using the BSAS platform. BSAS explains that this is mainly to protect customer confidentiality but also addresses the accessibility issue, since the BSAS platform is only accessible to registered members, who are mainly IFIs. The issue of agency arrangement is, however, beyond the control of the BSAS, since the decision is exclusively the right of the contracting parties, whereas BSAS merely serves as a platform to facilitate the transactions. On the other hand, this issue is well taken care of in JFX Shariah as the business model allows commodity users (customers) to transact online and deal directly with commodity trading members. Moreover, Circular 3 of Bank Indonesia does not allow an Islamic bank in Indonesia to act as both the commercial member and commodity consumer at the same time in one transaction.
Based on the discussion above, the present study concludes that despite the criticisms and some unresolved Shariah matters entangling the practice of tawarruq, the effort made by Bursa Malaysia and Jakarta Future Exchanges to introduce platforms such as BSAS and JFX Shariah is commendable. Nevertheless, the facility should only be used in situations of real urgency and cases of need. As AAOIFI has made clear in its Shariah Standard Number 30, Paragraph 5/1, tawarruq should only be resorted to as a last option when an institution faces the danger of a liquidity shortage that could harm its viability and sustainability. AAOIFI has also stressed that tawarruq should not be used as a mode of investment or financing with the aim to make more profits.
The Application of Commodity Murabahah in Bursa Suq Al-Sila’ Malaysia vis-a-vis Jakarta Future Exchange Shariah Indonesia: A Comparative Analysis