Introduction

This paper seeks to investigate whether Foreign Exchange or Forex, is permissible

under Shariah principles as well as its rulings and relation to ribawi materials. Application and
importance of Forex in both conventional practice and Islamic finance practice will also be
discussed.

Foreign Exchange (Forex)

Foreign exchange, also known as Forex, or simply FX, is a decentralized global market
where the transfer of funds is processed without the need of any third party, such as banks or
government (FXCM n.d.). It is estimated that the average trading volume is at $5 trillion,
making it the most liquid market in the world. To give an illustration, the global equities trading
such as NYSE, KLSE, and others merely has a combined volume of $200 billion, and the forex
market is approximately 25 times larger than it. Despite its massive trading volume, the forex
market only contains one type of instrument, which is currencies from all around the world
(Nasdaq 2019).

The foreign currencies are categorized as major currencies, and minor currencies are
traded in pairs, similarly known as major pairs and minor pairs. Major currencies are currencies
that are most often traded, which includes seven currencies, namely USD, EUR, JPY, GBP,
CAD, CHF, and AUD. Major currencies that pairs with USD is known as major pairs, such as
USD/ EUR, or USD/ GBP. Minor currencies include currencies that are not in major currencies
and is known as minor pairs when paired with USD (Nasdaq 2019) — noted that USD is paired
with every other currency, because of its position as the reserve currency and are most trusted
and backed (Best 2019).

Contrary to popular belief, not every currency is traded in the forex market. For
example, Malaysia Ringgit (MYR) is restricted by Bank Negara Malaysia (BNM) and can only
be exchanged onshore for (1) international trade, (2) investment, (3) education, and other
purposes approved by the central bank. Hence, it is impossible to find MYR pairs in the forex
market outside of Malaysia (BNM n.d.). Similarly, china’s currency is also divided into two,
namely onshore yuan (CNY), and offshore yuan (CNH), the former can only be traded in China
with restriction, similar to Malaysia Ringgit while the latter is traded publicly in the forex
market and are paired with USD (Majaski 2019).

1
Ribawi materials

Ribawi materials refer to commodities and foods in the early times, in which those
items are measured by weight, measurement, or by the number of units. According to hadith
of “Ubadah bin al-Samit”, the Prophet Muhammad mentioned six ribawi materials, which are
gold, silver for commodities, wheat, barley, dates, and salt for foods. There are three rules on
the exchange of Ribawi materials, which is (1) exchange of same basis and same kind, such as
Gold with Gold, (2) exchange of same basis and different kind, such as Gold with Silver, and
(3) exchange of different basis and different kind, which is Gold with Wheat (Lateh, Oman &
Rejab 2018). Details of ribawi materials will be discussed in a section at a later part.

Shariah

In the context of Islamic Finance, Shariah refers to a financial product or services that
comply with the rules and requirements stated in the Quran. As long as the product or services
is not deemed prohibited, then it is permissible and can be used in the Islamic finance sector.
In Malaysia, rules and regulations on Islamic Finance are overseen by two parties, namely
Shariah Advisory Council (SAC) under Securities Commissions (SC) and SAC under Bank
Negara Malaysia (BNM). SAC comprises qualified legal scholars to can present their opinions
and help shape the framework of Shariah laws in Malaysia (Yazi, Morni & Song 2015).

We plan to discover the different perspectives by different schools of scholars on the

classification of foreign currency, as well as its relationship to ribawi materials to determine
the permissibility of Forex under Shariah principle, and under what conditions Forex is
permissible and when it is not. This paper only seeks to investigate foreign exchange currency,
currency futures, currency forwards, currency swap, and currency options. Commodities
futures such as Crude Palm Oil (CPO) futures are not taken into consideration.

2
Wong Yik Kwong 17WBR11534

Literature Review

Mohd Ma'Sum Billah and Dr. Faisal Mahmoud Atabani (2016) attempted to discuss the
issues concerning Foreign Exchange (Forex) under the Shariah Principles. The main concern
is that should currency fall under thaman haqiqi or thaman istalahi because it ultimately
affects the permissibility of Forex. There exist two different views by Islamic scholars. The
authors use qualitative research methodology.

The first school supports that money is limited to only gold and silver, which is thaman
haqiqi, because (1) The Prophet allowed the use of gold and silver in Makkah and Madinah
and making it falls under hukum shari. Thus, only these two commodities can be used as money,
(2) Verses in al-Quran stated that gold and silver are to be used as money, (3) Prohibition of
hoarding of gold and silver. The other school supports that money includes other than gold and
silver due to (1) The fact that Khalifah Umar ibn al-Khattab wanted to use leather as money
indicated that it is acceptable to use other than gold and silver, (2) Principles of ibahah,
everything is permissible unless stated otherwise in al-Quran, (3) Hardship will be apparent if
money is restricted to only gold and silver because the supply is limited, which contrary to the
purpose of Shariah, which is to remove hardship and protect the public interest.

Apart from different views as to currency should fall under thaman haqiqi or thaman
istalahi, scholars also have different views on whether the transaction involving paper
currencies is to be governed by bai al-sarf. The hadith affirms that the six ribawi materials
must be exchanged in the same amount and on the spot basis to avoid Riba. The first school
determined the illah of Riba if the items belong to the same genus and are weighable by weight
while the other school defined the illah of Riba to be their characteristic of being a medium of
exchange.

Following the first school, exchange of Malaysian Ringgit (RM) with US Dollar, both
RM and USD are not weighable and are of the same basis, and different kinds, exchange of
RM with USD can be done with gain and not required to be on the spot basis. If following the
second school, the exchange of RM with USD is equivalent to exchange gold with silver. Hence,
it has to be done on the spot, and no gain can be made on the exchange.

In Forex, Shariah permits a deferred basis on a floating exchange rate regime because
the market determines the value as opposed to the fixed exchange rate regime, in which
deferred basis in fixed exchange rate regime is not permissible. Because under the fixed

3
exchange rate, a deferred basis gives the chances to the bank to earn profit as the Forex rate is
highly unlikely to change in a short period. The floating exchange rate involves risk because
the market is volatile, and hence the gains can be justified.

As a result, the author suggests that a single currency system can be introduced that is
free from the element of Riba, such as Islamic Dinar. However, he also pointed out that it is
immensely difficult as it faces many issues.

A study was done in 2014 (Chong, Chang & Tan) to describe the determinants
influencing the use of financial derivatives such as Forex by firms to managing their exchange
rate exposure. A quantitative methodology was used, and surveys were sent to the financial
controller of 219 firms to carries out factor analysis. 190 out of 219 of the surveyors carry out
hedging to reduce their foreign exchange exposure, and most of them have a substantial sales
turnover of RM100 million to RM500 million annually. The journal lists out several facts of
hedging using Forex; (1) hedging was made more crucial in the wake of global economic crisis,
(2) hedging lessen exposure to currency exchange risk, (3) Young people tend to know more
about derivatives and those over 50 have less exposure to derivatives due to lack of products,
(4) regulatory bodies are proactively shielding investors. (5) It is also noted that smaller firms
still do not utilize derivatives to formulate their hedging disciplines.

The summary from the authors is that derivatives trading in Malaysia is still
comparatively small compared to neighboring countries, and businesses are to be tutored with
knowledge and skills to be able to facilitate hedging products effectively.

A study was done in 2019 (Abdul Rahim, A.Wahab & Yusoff) to analyze the impact of
shariah-compliant status on firms' decision to practice forex hedging. The authors use
qualitative methodology by performing regression on the audited annual report of 70 firms for
five years. In the Malaysian Capital Market, the shariah-compliant listed company occupies
nearly 72%, a 15% drop from 87% before the stricter revised guidelines by SAC. To be shariah-
compliance, the prohibited business must be less than 5% of the firm total turnover or profit
before tax. The prohibited business includes, but not limited to, riba-based activities, gambling,
pork, liquor, or tobacco-related activities. Islamic principles also require businesses to be freed
from riba, gharar, and maysir.

Shariah-compliant companies have to adhere strictly to the Shariah principles, and it

deprives shariah-compliant firms of hedging methods because most of the methods are
prohibited in Islamic principles. Since 2006, Islamic banks have started offering Islamic forex
hedging products, which is wa'd. Wa'd is similar to a forward contract in forex, in which the
4
buyer promises to exchange a certain amount of currencies at a specific date in the future to a
bank.

The authors found that there is a positive and significant relationship between shariah-
compliant status and hedging; the result suggests that shariah-compliant companies are twice
more likely to conduct hedging than their non-shariah-compliant counterparts. The authors
came up with three possible explanations. (1) Islamic hedging instruments may still be
considered as new products, and lack of awareness among shariah-compliant companies make
them did not comply with the law. (2) Shariah-compliant companies adopted the Islamic
hedging product but did not disclose them, (3) Shariah-compliant companies still use
conventional hedging products because the new Islamic hedging product does not suit the
business operation.

5
References

Abdul-Rahim, R, A. Wahab, A, Yusoff, N 2019, ‘Impact of shariah-compliant status on firms’

decision to practice forex hedging’, Journal of Islamic Accountign and Business Research, vol.
10, no. 5, pp. 756-769.

Chong, LL, Chang, XJ, Tan, SH 2014, ‘Determinants of corporate foreign exchange risk
hedging’, Managerial Finance, vol. 40, no. 2, pp.176-188.

Mohd Ma’Sum Billah & Dr. Faisal Mahmoud Atabani 2016, ‘Shari’ah Model of Foreign
Exchange’, Global Perspective on Islamic Finance, vol. 33, no. 2, pp.11-29.

6
Lim Chin Yen 17WBR11535

Literature Review

Mohammad Mahdi Mousavi, Balal Vosough, and Jalal Tabatabaei (2008) attempted to
discuss forex and its application in comparison with Islamic jurisprudence principles. The
authors used credible publications and online materials to critically evaluate the topic. There
are two main focuses in this paper: Review about the foreign exchange market and Islamic
justification of forex with jurisprudence principles.

The research showed that there are various levels of access for all participants in the
forex. Interbank market is the highest level of access, allocates more than 50% of transactions
volume. It is followed by investment banks, big international firms and hedge funds. Generally,
financial intermediaries such as pension funds, insurance companies, mutual funds, and other
institutional investors have had an increasing role in forex since the 2000s. The central banks
also increased their participation in forex to facilitate the policy implemented.

The authors suggested that the presence of forex is necessary to develop a sustainable
financial system. First and foremost, it helps the firm to manage its exchange rate risk through
the use of forward and futures contracts to reduce its exposure to significant fluctuations in the
exchange rates. However, Islamic jurists prohibited the conventional future and forward
contracts. Besides, speculators use forex to take advantage of their expectations. Speculators
are a significant group of investors in the financial market, as economists believed that
speculators increase the liquidity of the market. Similarly, speculation also refers to gharar in
the Islamic context, which means excessive uncertainty, and the trader does not have sufficient
knowledge in that game. Also, forex enables people to trade currency for all purposes, such as
investment in foreign countries, oversea trips, as well as international trade.

The authors also pointed out several conditions for financial instruments in the forex to
be valid. These included the authority of the parties, which means the trade must be of mutual
consent; there must be offer and acceptance in the contracts, as well as forbidden of riba, gharar,
and qimar, and the contract must be confirmed and free from any suspension.

Currency futures and forwards contracts are prohibited because of the existence of
gharar, meaning that the uncertain rate of exchange in the future is unlawful. The contracts’
party gained from the losses of another party resembles a gamble with zero-sum, and therefore,
it is illegal. Islamic context prohibited these financial derivatives for maqasid syariah, which is
to protect the interest of the public society. Similarly, the option contract is also prohibited as

7
it is a gamble of future prices because there is no way to know the future prices, hence the
contribution of gharar. Moreover, the options contract does not give ownership to the buyer.

Rafik Fakhry Omar and Eleri Jones (2015) seek to evaluate the compliance of online
Islamic forex products with shariah law and also the degree of similarity between conventional
forex products and Islamic forex products. Secondary data from online sources are being
collected and analysed in this paper. The information sources included four Islamic broker's
website that provides Islamic forex trading account; InstaForex, eToro, Easy Forex, and
markets.com. The research suggested that interest rate and commodity prices are two
significant factors that affect currency prices. A country's central bank controls interest rates
through monetary policy. Commodity prices are controlled by the supply and demand over
future contracts; it does not reflect either the ownership of commodity or the actual demand.
The characteristics contributed to gharar and riba in forex trading, which is in direct breach of
Islamic principles.

The authors clarified that Muslim forex traders are still able to trade currencies through
forex brokers that are willing to offer an Islamic forex trading account with no overnight
interests. Instead, the brokers charge a flat fee that is mutually agreed upon for providing the
service. The Islamic forex trading account is only offered to Muslims to prevent widespread
abuse; Muslim investors have to provide a religious affiliation to confirm their identity.

The authors revealed that there is skewness in the opinion of scholars towards the non-
permissibility of foreign exchange trading. The authors mentioned that the community needs
to redefine what is riba according to the modern-day conditions, and the value of riba should
be derived from other macro-economic factors that are out of the control of the people. Shariah
law should be more lenient on the purpose of using forex trading, whether it is to avoid losses,
or for someone who is just pursuing profit from online foreign exchange trading merely to
speculate and satisfy the risk appetite.

To wrap up this paper, different views from various scholars have led to a vast spectrum
of rulings and permissibility, from unacceptable use of forex to permissible, there is still
lacking a fixed answer due to changing views of scholars. Modern scholars realized that it is
nearly impossible for Islamic financial products to be completely abiding by shariah law and
being profitable at the same time. The authors described Islamic foreign trading from two sides;
the good view is that foreign exchange is significant for risk management; the bad view is that
foreign exchange involves riba and gharar that are unacceptable under the Islamic perspective.

8
 Studies by Ildus Rafikov and Buerhan Saiti in 2017 from the perspective of Maqasid
Shariah in terms of financial speculation also gave a more precise picture of how the Islamic
scholars look at speculative instruments in the financial market. The authors were focusing on
qualitative research through existing materials and documents. The paper included a
presentation on the analysis of findings in light of the objectives of Shariah and financial crises.
Authors did not carry out quantitative research as they perceived the topic is general and did
not require new empirical research.

Speculators bring in liquidity and market depth for the financial market. However, at
the same time, the excessive demand from speculators may cause financial distress to the
market, as seen in the case of the real estate bubble in the United States back in 2008. There is
also a question raised where the underlying asset of derivatives is a mere $61.96 trillion in 2011,
but the derivatives market was a booming $601 trillion. Furthermore, the turnover of $4 trillion
daily seems completely unrealistic.

The findings in this paper are online foreign trading is not a necessity for investors if
their purpose was to speculate and gain profit. However, it is perceived to be a necessity for
businesses and travellers. The absence of online forex trading also does not put many forces on
the current financial system because it was not a necessity. Forex also cannot be seen as an
added advantage because it does not make life any easier. Financial speculation does bring
harm to traders and the public, and it is clear that derivatives bring an adverse impact on society
from the perspective of maqasid shariah. Thus, it should be significantly prohibited.

9
References

Ildus Rafikov, Buerhan Saiti 2017, ‘An analysis of financial speculation: from the MaqasidAl-
Shari’ah perspective’, Humanomics, vol. 33, no. 1, pp. 2-14.

Mohammad Mahdi Mousavi, Balal Vosough, Jalal Tabatabaei 2008, ‘Forex and its application
in comparison with Islamic jurisprudence principles’, viewed 8 December 2019,
<https://www.researchgate.net/publication/228120034_FOREX_and_its_Application_in_Co
mparison_with_Islamic_Jurisprudence_Principal>.

Rafik Fakhry Omar, Eleri Jones 2015, ‘Critical evaluation of the compliance of online Islamic
FOREX trading with Islamic principles’, International Journal of Islamic and Middle Eastern
Finance and Management, vol. 8, no. 1, pp. 64-84.

10
Chong Huai Xin 17WBR12243

Literature Review

To further discuss the research paper, the literature review is prepared based on the
topic chosen that is related to the foreign exchange, which also known as FX or Forex, in
Islamic perspectives. Literature reviews discover the topic related to the principles of Shariah,
the alternation of forex products based on the Shariah and the impact of conventional exchange
rate and Islamic exchange rate towards the stability of international exchange rate. This
literature review is to provide a wider picture of Islamic foreign exchange and to support the
research paper. The literature reviews can be categorized into several parts to discuss the three
literatures.

Diah Krisnaningsih (2017) conducted the qualitative research by collecting the primary
and secondary data on the conventional exchange rate and the Islamic exchange rate, looking
into their impact on the stability of the global exchange rate. The conventional exchange rate
of a country could be determined by two methods, either by the fixed exchange rate determined
by the local government or by the floating exchange rate which combines the market factors
with the fixed exchange rate. Purchasing power parity theory ("PPP") explained that the same
good can be purchased at the same price in different countries and currencies where there is no
arbitrage opportunity. However, the real exchange rate against the PPP where there is no equal
rate to purchase the same good. The foreign currency rate is affected by two major causes, non-
engineered or non-manipulated changes and engineered or manipulated changes to establish
their country's exchange rate regimes. He also listed out some of the research conducted before
to support his statement. There are two regimes to determine the exchange rate, the fixed
exchange rate regime and the flexible exchange rate regime which the former is determined by
the government and the latter is determined by the balance of the currency in the market. At
the same time, the flexible exchange rate is the most commonly used regime around the world.

From the Islamic perspectives, the author also concluded that the exchange rate is
mainly affected by two factors, the natural factor and the human error factor. The exchange
rate policy in Islam is determined by the managed floating system where the government
control the exchanged rate by implementing the relevant proper policy. This resulted in a stable
currency rate where the government would not intervene the balance occurred in the market.
Under the Islamic system, inflation is caused by the natural exchange rate fluctuation and the
human error exchange rate fluctuation. Before the Islam occurs, the use of gold dinar and silver
dirham is common in international trade for goods and services. The Islamic dinar currency act
11
as a steady money and the proper exchange medium which can mitigate the speculation,
manipulation and arbitrage activities. By using the dinar in international trade, it can decrease
and minimize the risk in the exchange rate, reduce the currency's speculation, manipulation and
arbitrage activities, lower the transaction cost, increase the collaboration within the countries
and lower the authority power of the country to dominate the world. The author concluded that
the introduction of dinar money as the instrument to achieve the stability of exchange rate in
international trade takes time and require the proper moves.

Nor Fahimah and Ahmad Sufian (2016) investigated and analyzed on the Islamic
products designed and offered by the Islamic financial institutions that compliant with Shariah
principles by collecting the primary and secondary data from several sources. They focused
their research on the methods to create the foreign exchange options, which are based on the
principles of Bay' al-Urbun, the combination of Urbun and commodity murabahah and Wa'd.
Under the Bay al-Urbun, the urbun is treated as the deposit to the seller from the buyer. It
makes up one part of the price if the deal proceeds while it also treated as a hibah means a gift
to the seller while the deal failed. The urbun formed part of the price in Islam as a deposit
which differs from the conventional option where the premium is the profit for seller and does
not deduct from the actual contract price of the buyer. It consists of the shariah issue either the
buyer or the seller of the option is entitled to the dividend declared. However, this issue is being
covered while the other shariah issue arises, where the seller may sell the options without
having the ownership. For the combination structure of urbun and commodity murabahah, both
buyers and sellers transacted through the respective brokers, involving a bank to hold the
ownership of the commodity and reduced the buyer's risk. It increases the leverage of the bank
within the contract period to perform the on-balance sheet transaction. For the third structure,
the Wa'd is the verbal promise of one party to another party to execute the transaction within a
period in the future. It is a unilateral verbal contract from a buyer to a seller to perform the
predetermined action in the future. Under the wa'd, the Islamic foreign exchange options are
finalized and approved by two structure which involved the tawarruq and murabahah
transaction, playing a significant role in hedging the foreign currency exchange risk. The
authors also highlighted the features of Shariah-Compliant Option ("FXOP-i") which involve
the concepts of tawarruq, bay' al-inah, wa'd and bay' al-sarf to cater to the needs of the
customers. Hedging is the main purpose of Islamic foreign exchange products where the
shariah advisory bodies have to regularly monitor the Islamic foreign exchange products and
make sure the rules and regulations of Shariah are strictly adhered to. The authors concluded

12
that the Islamic foreign exchange options are still under the stage of debatable on the
perspective of Shariah principles.

The qualitative research done by Asyraf Wajdi Dusuki (2009) discovered the Shariah
principles which apply on the Islamic foreign exchange swap and highlighted on the formation
of Islamic forex exchange swap. He also introduced several functions of the foreign exchange
swap as a hedging mechanism in Islamic perspectives to mitigate the interest rate risk and the
currency exchange rate risk. He also pointed out the speculating activities carried by the player
in the market which against the principles of Shariah. He examined two structures of the swap
which is the tawarruq structure and the wa'd structure that compliant with Shariah by pointing
what contradicting the principles: the timing to transact and the objects to transact. The author
also discussed the Fiqh maxim to execute the contracts. The author concluded two points of
Islamic swap different from the conventional swap: the sole purpose of Islamic swap for
hedging risk without involving in the speculation activities and the formation of Islamic swap
which strictly bind to the principles of Shariah. The author also suggested two categories of the
Shariah parameters for the Islamic foreign exchange swap: the guidelines to combine several
contracts into one single contract and the guidelines to separate the purpose of the Islamic swap
in hedging and in speculating.

13
References

Diah Krisnaningsih 2017, ‘Exchange Rate: International Money Value Stability, Toward
Islamic Perspective’, Islamic Economics Science, vol. 1, no. 1, pp. 10-27.

Nor Fahimah, M.R. & Ahmad Sufian, C.A. 2016, ‘Application of shariah principles in Islamic
foreign exchange options’, in International Conference on Accounting, Management,
Economics and Social Sciences, 30 April 2016, Jakarta, Indonesia.

Asyraf Wajdi Dusuki 2009, ‘Shariah Parameters on Islamic Foreign Exchange Swap as
Hedging Mechanism in Islamic Finance’, in International Conference on Islamic Perspectives
on Management and Finance, 2-3 July 2009, University of Leicester.

14
Ng Pei Fen 17WBR11627

Literature Review

Literature reviews that are related to Foreign Exchange Currency (Forex) from Islamic
Finance is furnished under this segment. The literature review regarding the application of
wa’dan in FX contract, Islamic hedging management and illah of currency exchange. The
literature reviews aim to provide additional understanding and to support the findings on the
forex trading in Islamic Finance. The content is categorized into 4 parts that is the use of
Wa’Dan in Islamic Contract FX Forward: Weighting between Maslahah and Mafsadah, the
Islamic hedging management: Paving the Way for Innovation in Currency Options and
Currency Exchange, Its Illah and Implications.

Ahmad, Yaacob and Zain (2014) studied the application of Wa’Dan (two unilateral
promise) in Islamic Foreign Exchange (FX) Forward Contracts and weighted in between
Maslahah and Mafsadah. This journal evaluates the employ of Wa’Dan in Islamic FX contracts
contributes to accomplishing either Maslahah or Mafsadah to the people and the economy at
huge. The authors had conducted multiple research through qualitative, focus group, qualitative
case study methods to attain the research’s goal as mentioned. The primarily qualitative test
assessed the concept of Wa’dan through the directly understood the idea of Wa’d (unilateral
promise). The secondary theory of Maslahah is deeply evaluated to evaluate the relationship
between the employ of Wa’D with Maslahah. Next, the authors study the mismatch between
Maslahah and Mafsadah in the implementation of Islamic Foreign Exchange Contract on which
theory is more persuasive. This is due to absence of clear evidence in impermissibility and
permissible of wa’dan. Thus, through this test, the authors illustrate the realization of Maslahah
to support the application of Wa’Dan in the Islamic Forex Forward contract and discuss the
drawbacks of Wa’Dan towards Mafsadah. As a result, the application of Wa’Dan in Maslahah
are assisting in economic growth, investor confidence, surge potential investment in the Islamic
sector, competitiveness in a financial institution and introduced innovative risk management
Islamic products. While the drawbacks that lead to Mafsadah are open for speculation, growth
of currency trading activities in the occurrence of weak regulation incur, copying the
conventional contracts, resulting in the collapse of the economy when trading FX for quick
profit. The authors conclude that the implications of wa’dan in the Islamic FX Forward contract
are significant to assist in achieving maqasid al-sharia’ah that benefits people and the economy
as a whole.

15
 Nordin, Rahman, and Omar (2014) examine the Islamic hedging management in
covering the way for innovation in the foreign currency option. The main objective of this
journal is to study the Shariah compliance feature in the Islamic FX Options introduced by
Islamic Bank in Malaysia. Moreover, the application of tawarruq and wa’ad as a form of
hedging tool in the Islamic Forex (FX) Options. Moreover, the authors allocated the research
into 5 segments, likewise Introduction, Methodology, Findings and Discussion, Conclusion.
Several findings are done in order to achieve the journal’s objective. The journal had studied
the similarity and different interview information with the data collected. The data gathered are
from multiple sources such as classical books, hadith, contemporary books, and journals. While
the authors interviewed people that expertise in this field such as Islamic jurisprudence, Shariah
advisor and practitioners in Islamic Industry Malaysia. First, the primary findings of the
research are modus operandi of the Islamic option that prove the process of Islamic FX options
positioned with tawarruq, bay al-inah, wa’d and bay al-sarf. The following findings are the
Islamic principles that comprise in implementing Islamic Option. The Islamic principles
included tawarruq (trading among more than two parties) through the method of commodity
murabahah (sale at cost plus), bay al-inah (trading between two parties), wa’ad (unilateral
promise) as well as bay al-sarf (contract of exchange money for money). The third assessment
is to assess the FX Option contract from a Shariah perspective. The authors concluded that the
introduction of Islamic FX options is a vital alternative to provide efficiency and
competitiveness in risk management of Islamic Finance. Nevertheless, the implementation of
derivative tools for hedging ought to be refined and in line with the objective of the contract.

16
Reference:
Ahmad, A & Yaacob, S & Zain, M 2014, “ The Use of Wa’Dan in Islamic Contract FX Forward:
Weighting between Maslahah and Mafsadah”, Asian Social Science of Canadian Center of
Science and Education , vol.10, No.22.
Nordin, N & Rahman, A & Omar, H 2014, “ The Islamic Hedging Management: Paving the
way for Innovation in Currency Option”, International Journal of Management Studies, vol
21(1), pp. 23-37.
Oziev, G & Omar,M & Zaidon, M & Kamis, M 2016, “ Currency Exchange, Its Illah and
Implications”, Journal of Islamic Finance vol 5, no 1, pp. 45 – 52.

17
Eileen Wong 17WBR11737

Literature Review

Modern Islamic Banking is financial system comply with the principle of Islamic Law.
Forex trading is one of the main issue that always deal with under Islamic banking law. This
chapter discuss and provide the some literature review regarding the forex trading in Islamic
perspective. Literature review included currency trading in modern Islamic bank in Malaysia,
Islamic justification of forex option contract as a tool of risk management and the effect of
foreign exchange risk management practice on financial performance in Kenya which can give
further understanding and support in this topic studied.

Firstly, The Clute Institue, CC-BY (2015) which studied that the currency trading in
modern Islamic bank in Malaysia. It believed that Islamic bank in Malaysia will bear the risk
of loss if it generated from the foreign exchange transactions . Bank Negara Malaysia actively
participated in market transactions in the 1980’s and fairly share their history of foreign
exchange transactions. A result in this journal indicate that the foreign trading was haram is
only applicable to real-time personal spot forex transactions through electronic media. The
study also reveals that the service-oriented capabilities, such as banking hedging instruments
in modern Islamic Banking system based on Islamic Sharia. Council of Sharia Advisers
(Resolutions NO.25) indicate that such financial transactions in Islam must not involve interest
(riba), gambling (maysir), and ambiguity (gharar) that is not in accordance with Shariah law.

The author mentions the bible quote that “deal not unjustly, and ye shall not be dealt
with unjustly” (The Qu’ran 2:279). Sharia law believes and imposes that Muslims should be
giving in the name of giving instead of gaining anything in exchange for it. In addition, Islamic
forex account is like ordinary trading account without interest payment while Islamic Foreign
Exchange Swap (tawarruq and wa’ad) in currency trading act as shield mechanism in the
market that should based on concept of Shariah. OIC Resolution Conference of Fiqh Ulama
(Resolution no.9) indicate rules applicable to metallic currencies ie gold and silver should apply
to maturity notes due to its inherent value known as i’tibariy money. Bay’al-Sarf considered
as trade where forex is involved. Hadith narrated by Abu Bakar (r.a.) should be applied in
currency for currency trading on spot basis. Therefore, in Malaysia, currency trading in Islamic
Banking managed by SAC of Central Bank of Malaysia.

18
 Secondly, Leyla Ahmed (2015) carried out the study regarding the effect of foreign
exchange risk management practices in financial performance on commercial in Kenya. The
author believe that the rapid depreciation of the national currency of Kenyan shillings has
adversely affected Kenya economy. Butler (2008) refers to foreign exchange risks as risks
related to unexpected risks. The degree of change in exchange rates and foreign exchange
exposure affects the value of a company’s assets or liabilities. The performance of commercial
banks is highly financial in nature in Kenya (Bank Supervision Annual Report,2009). In
addition, the average foreign exchange risk is high for commercial banks in Kenya. He carried
out that this reflect the lack of financial tools that using by Kenya Bank to hedge the financial
exchange risk or inexperienced banks in managing foreign exchange risk. Kenya.

Njunge (2012) conducted a survey regarding forex rate risk management risk practices
that carried out by MFI’s in Kenya while Mutua (2013) investigates foreign exchange risks
management practices of foreign commercial banks in Kenya. It involves taking decisions to
minimize and eliminate the effect of currency fluctuations on balance sheet and income
statement. External hedging techniques would be the creativity by the managers and the
financial innovation tools have been provided to mitigate the effects of foreign currency
exchange rates. It used to prevent possible losses that may occur. Internal hedging techniques
that used by the company which can be implemented without involving any market-based
financial instruments to offset or minimize the exchange risk of losses on the assets or liabilities.

Contemporary foreign exchange theory (Buckley, 2000; Levi, 1996; Shapiro,2003)

believes that the exchange rate fluctuations will affect the value of currency. Mainly companies
just focusing on doing a lot of business aboard, but they have not shown the significant impact
of exchange rate fluctuations on the share prices of multinational companies. So, Bahtia (2004)
conducted a research which found out that there is a clear-trade off between investors to protect
the benefits of currency against fluctuation in the form of contract in commercial bank Kenya.
Next, Kimani (2012) examine the technique used by Kenyan banks to manage foreign
exchange risk through the strategy and technology. Central Bank of Kenya operate 42
commercial banks to collect information or results that may happen the foreign exchange risk.
In conclusion. The strategies techniques that used by Kenya Banks to manage the foreign
change risk which is through the internal and external hedging method.

Next, this study carried out the Islamic justification of Forex option contract as a tool
of risk management. It stated that some of the Shariah principles for example wa’ad, bay’ al-
sarf and bay’ al-inah can used to avoid the concept of riba. FX Option that involves in riba is

19
highly impermissible in Islam as a fundamental condition of currency exchange contract. This
study suggests that Forex option contract should not done in the secondary market as currency
trading is prohibited in Islam unless it comply with Shariah. According to Usmani (1996), it
indicate that an option considered as a promise to see or buy something on a specific price
within a specified period. A few scholars prefer to include the benefit that observed to be
permissible (Obaidullah,1999). When a option is traded in a larger transactions, a fee paid for
the option contract is permissible which similar to “urbun”.

(Aznan,2008) carried out that CIMB offered FX Option as a tool of risk management
and investment purposes. It has grown rapidly in recent years because the high technology and
innovations was carried out to make it as a tool of risk management. The author believes that
an option considered as a contract that deals with an underlying asset. Foreign option contract
act as a financial instrument to hedge against the foreign currency risk. (Azlin Alisa & Mustafa
Afifi 2014) indicate that some of the Muslim jurists will develop a legal maxim to mention the
gain is justified with the risk. In Islam, there will be no gain if there is no risk. (Kunihibava
2010) clearly justify forex option contract only can be used as a tool of risk management but
not fall under the category of wealth. Unfortunately, not all the banks offering FX Contract
because trading rights in currency option is not recognized by all Islamic Scholars and it must
get the approval from their Shariah Advisory Board. Therefore, the contract must bound by
strict rules and regulation of Islamic Law. Those hedging products such as Islamic FX Option
contract based on principle of wa’ad, al’-urbun are used to approach to risk management.
Therefore, the author believe that an innovative sharia-compliant risk management tool could
be able to against the currency risk.

20
References

Google Scholar 2015, justification of fx option as a tool of risk management, viewed on 12

December, 2019.
<https://scholar.google.com/scholar?start=10&q=Islamic+Justification+of+Forex+option+co
ntract+as+a+tool+of+risk+management+&hl=en&as_sdt=0,5>

Google Scholar 2015, currency trading in modern islamic bank in Malaysia, viewed on 12
December, 2019.
<https://www.researchgate.net/publication/292378254_Currency_Trading_In_Modern_Islam
ic_Bank_In_Malaysia>

Google Scholars 2015, effect of foreign exchange risk practices in Kenya, viewed on 13
December, 2019.
<https://www.researchgate.net/publication/327699675_Effect_of_Foreign_Exchange_Risk_
Hedging_Techniques_on_Financial_Performance_of_Listed_Firms_in_Kenya>

21
Research Methodology

This paper attempt to seeks the permissibility as well as the rulings of forex in an
Islamic finance context. Qualitative methods were used to tackle this question effectively, as
we believed that quantitative methods were not appropriate for this theoretical question
problem. We aim to compile different perspectives drawn by various Muslim scholars and
derived the permissibility and rulings of Foreign exchange.

In order to gain a better insight into the different perspective of Muslim scholars, we
use existing data, such as conference paper, journal article, thesis, as well as rulings that were
approved by regulators and organization, such as Shariah Advisory Council of Bank Negara
Malaysia, Shariah Advisory Council of Securities Commission Malaysia, as well as
Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). The
outcome of the meeting by Shariah

Advisory Council was used to determine the permissibility and rulings since it is the
governing body of Shariah law in Malaysia, transactions or contracts that were not mentioned
by Shariah Advisory Council of Malaysia were referenced to AAOIFI.

Conference papers and journal articles that were dated too long ago was not used, due
to the perspective was addressed during the meeting, or the concept may already become
obsolete, which may skew our result.

22
Forex in conventional practice

Businesses that operate in the domestic and international markets are often exposed to
exchange rate risk because the currency that they receive in the international market is different
from its home currency. Hence, the business has to manage its exchange rate risk well to
maximize its profit and minimize the loss if it does incur through either transaction risk or
translation risk.

Importance of Forex in conventional practice

International trade

As mentioned earlier, companies that are involved in the international market are
exposed to foreign currency, and hence, they are either paying their suppliers in foreign
currency or receiving foreign currency from their customers. Usually, transactions done
oversea will be paid or receive in foreign currency; unless the local company has stronger
bargaining power over another, then the local company can determine whether they want to
receive home currency for foreign currency (Lander & Preece 2014). However, it is not always
the case, some local company would still prefer to receive foreign currency if their businesses
involved in oversea is large enough, the purpose is to perform natural hedge, the natural hedge
will be discussed in details later.

Oversea

Very often, when traveling to oversea countries, foreign countries may not accept your
home currency. For example, merchants in the United States do not wish to receive Malaysian
Ringgit (MYR) because the value is significantly lower, or if they do, they will provide a
conversion rate that is much beneficial to them (Ooi T 2019). Hence, Malaysian are advised to
exchange their currency into US Dollars before their trip to get a more attractive conversion
rate at a local currency exchange booth. When using a credit card overseas, cashiers often ask
travelers whether they wish to pay in home currency or foreign currency, and the cashier’s
advice is to pay in the home currency because travelers can know how much they are spending.
However, reality shows that paying in foreign currency is much cheaper than paying in the
home currency because paying in home currency uses Dynamic Currency Converter (DCC) by
Visa or MasterCard, which will have a higher fee charge and the exchange rate is slightly higher
(Ooi T 2019).

23
Inflation control

Forex reserves are of utmost importance to maintain inflation of a country. In Malaysia,

forex reserves are made up of (1) Foreign currency reserves, (2) International Monetary Fund
reserves, (3) Special Drawing Rights, and (4) Gold. These reserves are used to finance exports
and imports, as well as to pay back Malaysia’s debt if Malaysia were to declare bankruptcy
(Bernama 2019). Reserves are also crucial in times of inflation and deflation. During deflation,
the Malaysian Government will reduce the interest rate as stipulated in the monetary policy,
which will make Malaysia Ringgit relatively weaker than other currencies, and the government
will also sell domestic currency to purchase reserve currency to ensure that the home currency
remains weaker to increase import and encourage spending. Vice versa, during inflation, the
interest rate will be increased, and domestic currency will be purchased back by selling reserve
currency to increase the value of the home currency, thus, discourage spending (EarnForex
n.d.).

Hedging

Perhaps the first thing that comes to mind with forex is hedging. Companies and
investors use forex as a hedging tool to decrease their exchange rate risk when dealing with
international parties. Hedging enables companies to maintain predictive cash flow and to attain
a sustainable business, with hedging, companies are less exposed to volatile currency exchange
rate because the portion of the foreign currency is expected. There are several tools involving
foreign exchange that can be used as hedging tools, namely (1) Currency futures, (2) Currency
forwards, (3) Currency swaps, and (4) Currency options, (5) Natural hedge, which will be
discussed shortly.

Application of Forex in conventional practice

Currency futures

It is a futures contract where the exchange rate is fixed today for delivery in the future.
Currency futures are also an exchange-traded contract, which means the contract is
standardized in terms of contract size and delivery date. The most commonly traded currency
futures are US Dollar, Euro, Yen, and British Pound (Milton 2019). Why do currency futures
exist when investors and companies can just purchase spot forex? The reason is that companies
may foresee that they need to make a payment in a future date, say six months from now, and
they want to lock in the current exchange rate. Hence, by purchasing a futures contract, they
can secure the exchange rate and get the delivery of currency precisely 6 months later. This can

24
minimize the volatility of cash flow as the business already know what the outflow will be
(Chen 2019).

For example, a United States company that deals in London, foresee that they need to
make a payment six months from now, totaling an amount of €250,000. And they see that the
current exchange rate of €1.00 equals $1.10 is attractive, and they enter into a two futures
contract that delivers €250,000 because one euro futures contract is €125,000. Effectively six
months from now, they will pay $275,000 for delivery of €250,000 regardless of the spot
exchange rate of the settlement time.

Currency forwards

Similar to currency futures, currency forwards are also a contract where the exchange
rate is determined on the spot for delivery in the future. However, a forward contract is a non-
standardized contract and can be tailored to meet the needs of different investors in terms of
the notional amount and delivery date (Hargrave 2019). Hence, it is not exchange-traded and
is traded over-the-counter (OTC). For example, a company with exposure to Canadian Dollar
(CAD) worth of CAD 800,000 in three months can enter into a forward contract with a notional
amount of CAD 800,000 exactly that will mature in three months. It gives the flexibility for
the company to manage its cash flow and exchange rate exposure. The company uses forward
contracts when the futures contract is too complicated and does not suit the requirement of the
company (Thomas 2018).

Currency swaps

It is a contract where two parties swap their currency for a period longer than futures
or forwards contracts can provide. Currency swaps are more commonly done for better interest
rates and conversion of fixed to floating rate or vice versa. To illustrate the context of better
interest rates, a Malaysian company wanted to finance a project in the United States, and the
current interest rate in Malaysia is 3.40%, where if the company were to direct borrow in the
United States, the interest rate would be 4%. Another party in the United States wanted to
finance their project in Malaysia, can get an interest rate of 2% in the United States but 5% in
Malaysia. Hence, to take advantage of the interest rate parity, the Malaysian company would
swap its Ringgit Malaysia (RM) plus 3.40% interest with the United States company, and
receive US Dollar plus 2.00% interest. At the maturity of the contract, the notional amount
would be swapped back, and exchange rate risk is eliminated (Segal 2019).

25
Currency options

Apart from the aforementioned contracts, which requires the company to fulfill its
obligations by paying the contract amount at maturity, options, on the other hand, is a right but
not an obligation to buy or to sell. Hence, it gives the company the freedom to exercise their
right if the option is in a favorable term. Currency options are frequently used by investors to
speculate, if the exchange rate move in the same position as the investor expect it to be, the
investor will then exercise the right and gain from the spread. Similarly, when the exchange
rate moves in the opposite direction, investors will not exercise the right as it would result in a
loss, and ultimately, the investors only losses the premium paid upfront. Currency options are
beneficial when investors and companies face uncertainty, with options, they can choose to
exercise when it is profitable to them. However, with other contracts, they have to fulfill their
obligations even when the situation is against them (Western Union n.d.).

Natural hedge

By its name, a natural hedge is receiving and paying foreign receivable and payable in
the same currency. It is an effective way to manage exchange rate risk because the company
does not have to exchange from home currency to foreign currency when paying its receivable
in a foreign country, and also does not have to transfer its foreign currency received to its home
currency. It effectiely minimize the risk because the outflow and inflow uses the prevailing
spot rate that have no meaning towards the company. For example, a Malaysian company that
do business in New Zealand, uses New Zealand Dollar (NZD) for all its business in New
Zealand without exchanging it into Malaysian Ringgit, or vice versa.

Conclusion

In a nutshell, the forex market is essential for the financial market, as it provides
liquidity and a way to channel funds from and into the international market. Companies are
starting to adopt hedging through the use of a forex instrument to minimize the exchange risk
in terms of transaction and translation risk.

Before getting into Forex in the Islamic view, we should perhaps have a look at ribawi
materials and judgments as well as permissibility to have a better view of the product.

26
Ribawi Materials, Bai al-Sarf, Wa’d, Rulings, and Permissibility of Forex

Ribawi materials, as mentioned in the Hadith, contains six items, which is gold and
silver in the commodities category; wheat, barley, dates, and salt in the food category. The
payment of ribawi materials must be made on the spot regardless of the species. There are three
rules on the exchange of ribawi materials, (1) Exchange of the same basis and the same kind,
such as gold for gold, then it must be of the same quantity, measurement, and exchange on the
spot. (2) Exchange of the same basis and different kind, such as gold for silver, then it can
differ in quantity, obviously one has a higher value over another, but it must be exchanged on
the spot. (3) Exchange of different basis and different kinds, such as Gold for Dates, then it can
differ in quantity or measurement as well, and no requirement to be on the spot; thus, no
condition is applied (Qazi Irfan 2011).

Some scholars argued that paper currency, or fiat money, cannot be considered as
ribawi materials, since paper currency cannot be weighted, and thus, can be exchanged with or
without excess and on the spot or deferred. On the other hand, if the paper currency is
considered to be a medium of exchange, that is similar to gold and silver in terms of usage. It
would be considered as ribawi materials, and can only be traded at par value for the same
currency, or a different value for different currency only if the exchange is hand-to-hand.
Majority of the scholars concluded that paper currency is a ribawi material due to (1) it is
commonly accepted as a medium of exchange, (2) components of riba on fiat money must be
shunned, (3) wealth in fiat money that reached the level of nisab of gold or silver must pay
zakat, (4) prohibition of Muslims to work in conventional work as it exists riba also further
enhance the point that paper currency is indeed a ribawi material (Gapur Oziev et al. 2016).

To conclude up the different perspectives on ribawi material in the context of currency,

Malaysian Ringgit (RM) can be exchanged with Malaysian Ringgit provided that the exchange
must be of the same value, which is RM 1 to RM 1, and must be done on the spot. RM exchange
for US Dollars can be of different quantity because the US Dollar is much stronger than RM,
but the exchange must be done on the spot as well.

Therefore, foreign exchange is to be ruled under the Bai Al-Sarf concept. Bank Negara
Malaysia published a guideline on bai al-sarf that effect on 1st of April 2019, which aims to
promote shariah compliance in application to the Islamic finance context. Under the concept,
two parties are involved, which is the seller and buyer of the foreign currency, and there must
be offer and acceptance for the contract to be valid, and most importantly, the subject matter,
which is the foreign currency in this case. If the currency exchange is of the same currency,
27
such as RM to RM, then the transaction must be done at par value, and on the spot, which is
RM 1 to RM 1. However, if the currency exchange is of different currency, such as RM to USD
or vice versa, then the transaction can be done at a different value that is mutually agreed by
both parties, provided that the transfer is on the spot (BNM 2018).

The context of on the spot also arises as a problem as different scholars have a different
perspective as well. In conventional practice, on the spot delivery usually takes 1-2 days,
depending on the currency exchange due to time differences across countries. Thus, in most
cases, on the spot delivery does not mean the settlement is done on the spot, but rather at a date
in the future, and according to some scholars, it is regarded as riba as it does not fulfill the
requirement of hand-to-hand (Ahmed Fazel Ebrahim 2007). Muhammad Akram Khan (1998)
also has a similar view that 1-2 days is not an acceptable delay for on the spot exchange as it
incurs extra cost that would constitute as riba. His suggestion was to establish a bank in all
countries that would execute the transaction on the spot. Other scholars criticized it as too rigid
and difficult to achieve (Gapur Oziev et al. 2016).

In the 168th meeting of Shariah Advisory Council (SAC) of Bank Negara Malaysia
(BNM), standards of Bai Al-Sarf was discussed critically to determine the contract session,
ownership of counter values, and the payment of debt in different currency. First and foremost,
some Muslim scholars view that 1-2 days delivery time is deemed unacceptable because it
would create riba. Notwithstanding, SAC of BNM supported that T+2 is still is permitted due
to difficulties as well as operational restrictions as foreign exchange involves more than one
party and country. Secondly, SAC of BNM also decided that contracting parties, in this case,
the buyer and seller of the foreign currency, do not need to have ownership of the foreign
currency. Still, the delivery of foreign currency must happen before the contract session ends.
Lastly, SAC also decided that debt payment can be made in another currency, provided that
the exchange rate is mutually agreed upon (BNM 2016).

It is also worth mentioning the fixed and floating exchange rate system. Due to paper
currency is considered as ribawi materials, the same basis and same kind only can be traded
and par and on the spot, while the same basis different kinds can be sold freely but on the spot.
Take the case of a fixed exchange rate system, 1 USD equals to RM 3.80, if the currency is
exchanged at 1 USD to RM 4.00, it will constitute riba, since the exchange rate does not change
in the short period, and there is no exchange rate risk. Thus there should not be excess gain. If
it is in a floating exchange rate system, then the seller can sell at RM 4.00 because they face a
volatile exchange rate, and it justifies the need for excessive gain (Billah & Atabani 2016).

28
 It is clear by now that Shariah principles forbid futures and forwards contracts due to
time differences because they cannot be executed on the spot, and the settlement time is out of
the scope that SAC of BNM has allowed, which is only T+2 days. Hence, to tackle this problem
and to make use of futures and forwards contracts, wa’d was invested.

Wa'd is a unilateral promise, which expresses the commitment of one party, given that
another party fulfills its promise. Therefore, the rules are less rigorous as it is merely a promise
and is a non-binding contract (BNM 2017). Wa’d is most commonly used in forward contract,
coupled with Bai al-Sarf. Due to the flexibility of wa'd, its existence has made known to the
conventional bank, and its demand is expected to grow further in the coming years. Details of
wa'd will be discussed shortly.

To conclude up the rulings and permissibility, here are some critical points to take note
of. First and foremost, according to the Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI 2017) Shariah Standard number one, "Trading in currencies",
trading in currencies is permissible if (1) both parties possess the counter value before
transacting, (2) the value must be equal regardless coins or paper money if the currency is the
same, (3) cannot contain option or deferment contracts, (4) shall not be carried out in futures
or forwards market. Moreover, the standard also pointed out that (1) institutions can hedge
against exchange rate risk by recourse, which means no riba is applicable, (2) bilateral promise
to buy or sell currencies is prohibited, but a unilateral promise is permissible. In terms of futures,
all forms of trading of futures are not permitted under AAOIFI Standard Number 20, 5/1.
Similarly, all sorts of options are prohibited as well under 5/2, but Arboun is allowed. All types
of swaps are also forbidden under 5/3.

But to promote the Islamic financial market in Malaysia, the Shariah Advisory Council
(SAC) of Bank Negara Malaysia has agreed that (1) both parties need not possess the counter
value before transacting, (2) contract session is extended to T+2, (3) debt payment can be made
in foreign currency that is mutually agreed upon.

29
Forex in Islamic Finance practice

With higher demand from the Muslims society and investors, the Islamic Finance
society has been rolling out new products, as well as taking conventional bank's products can
repackage it into a shariah-compliant product that is free from riba, gharar, and maysir.

In Islam, money is seen as a medium of exchange, which means to purchase something,

one has to exchange something in return for the item. Hence, gold and silver were primarily
used as a medium of exchange. Still, due to its scarcity, the medium of exchange has evolved
into paper or fiat currency, cards, as well as several financial instruments. Thus, the concept of
Zarr, which refers to an item that can be classified as money, has been widened to include more
medium. Secondly, money has to be widely accepted as a medium of exchange for the society
to function effectively, all must agree on the value of the money, and hence, it can serve as a
uniform and standard measure of exchange (Manaf & Markom 2015).

Perhaps the most critical difference between the conventional principle and Islamic
principle in terms of foreign exchange is in online forex trading. In conventional practice, the
forex trading account involves swap if you hold the currency overnight, which will constitute
riba from the Islamic perspective. Forex trading is often associated with Gharar, which means
excessive uncertainty; speculation in forex trading is not permissible as the trader has to bear
unreasonable risk. To tackle this problem, brokers have come up with an Islamic Forex trading
account to accommodate the increasing number of Muslims investors; it is said to be halal and
shariah-compliance. There are several distinct differences between conventional forex trading
account, and Islamic forex trading account, (1) Islamic trading account is swap-free, which
means that they do not charge interest on rollover contracts, (2) Islamic trading account also
does not receive interest on deposit, because it would constitute riba, (3) short selling is also
prohibited on Islamic trading account (Ibrahim Khan 2018). Although the Islamic forex trading
account is generally slightly better than conventional accounts, the application process can be
somewhat tedious to prevent non-Muslims from taking advantage, and often an application has
to include relevant religious affiliation (Hawk 2019).

As mentioned in the rulings on forex in the previous chapter, conventional futures and
forwards contracts are generally forbidden as it involves time differences that constitute riba,
as well as Gharar in futures contracts. Futures and forwards contracts are essential for a
business to perform hedging; without those contracts, hedging would be extremely difficult.
Hence, a slight modification and rebranding have been done to forward contracts, with the
introduction of wa'd, and bai al-sarf, Islamic banks, and institutions can combine these two
30
contracts and perform the same as forwards contracts. Wa'd, and bai al-sarf will be critically
discussed in a section below. Futures contracts, however, are still not permissible.

Application of Forex in Islamic Finance

Foreign currency trading involving only Bai al-Sarf

Generally, all spot foreign exchange contracts consists of the concept of Bai al-sarf,
which means the settlement must be made hand-to-hand in the same contract session, and
allowed by SAC of BNM, an extension until T+2. CIMB Islamic offers "Value Today" and
"Value Tomorrow and Spot"; "Value today" is a foreign exchange that can be arranged for
same-day delivery, usually restricted to several currencies only. In other words, Value Today
means the trade date, and the value date is the same day. "Value Tomorrow" means the value
date is one day after the trade date, and "Value Spot" means the value date is two days after the
trade date, which most currencies are traded on (CIMB Islamic n.d.)

Foreign currency trading involving Bail al-Sarf and Wa’d

Since the maximum extension time given by SAC of BNM is T+2, all transactions after
two days, or 48 hours, are considered as prohibited. Hence, wa'd is introduced to prolong the
period. As mentioned earlier, Wa'd is a unilateral promise, which expresses the commitment
of one party, given that another party fulfills its promise. Therefore, the rules are less rigorous
as it is merely a promise and is a non-binding contract (BNM 2017). There are two parties in
wa'd, which is the promisor and the promisee. Wa'd also involve a subject matter that must be
shariah-compliant, which is a commitment to perform a transaction in this case, at a specific
time in the future. Although wa'd is not a contract, it has a binding effect on the promisor.
Hence, the promisor cannot unilaterally terminate his wa'd and must fulfill the pre-agreed-on
transaction. In the case of termination, the promisee, or the customer in the case of foreign
exchange, has the right to claim compensation arises from the actual loss suffered (BNM 2017).

Wa'd most commonly used as a forward currency exchange that is for hedging. It is a
promise to execute Bai al-sarf in an agreed future date. Islamic foreign exchange forward
contracts mean the bank will purchase or sell a specific amount to currency on a future date to
a customer on an exchange rate agreed today (MD. Faruk Abdullah 2016). The modus operandi
of Wa'd is shown below:

(1) The buyer provides wa'd to the bank on a date, says 6th of February 2018, to buy
$500,000 on the 19th of February 2018, at the exchange rate of RM 5.00 per US Dollars.

31
 (2) On the 19th of February 2018, the bank will pay $500,000 to the customer at the
rate of RM 5.00 per US Dollars, if the customer pays RM 2,500,000 to the bank.

The product offered by CIMB Islamic includes (1) "Fixed Forward", which settlement
date is beyond two days but less than 365 days, (2) "Long Term Foreign Exchange", which
settlement date is beyond one year but less than 15 years (CIMB Islamic n.d.).

Islamic Cross Currency Swap (ICCS)

ICCS is similar to conventional currency swap, but several elements of the contracts
have been modified to comply with shariah law. ICCS is a contract between two parties that
exchange the profit, as well as the notional amount dominated in different foreign currencies.
Since conventional swap is prohibited, ICCS became an effective way to hedge foreign
currency risk. There are seven steps in ICCS. (1) The customer finds the bank and offers to
deliver commodity murabahah with the bank in two different currencies with a fixed exchange
rate. (2) The customer buys a commodity from a broker through the bank that acts as agent. (3)
The customer then sell the commodity to the bank at a cost-plus KLIBOR in Malaysian Ringgit
(RM). (4) The bank then receives the commodity and sells to the broker and receives cash. (5)
Bank will purchase the commodity from the broker on a cash basis again, (6) and sell the
commodity to the customer at a cost-plus basis at other currency, says US Dollar. (7) And the
customer finally sells the commodity to the broker. To conclude ICCS, the wa'd here is the
promise of the customer to execute the said number of commodity murabahah transactions,
where the customer sells a commodity to the bank at cost-plus sale in RM, and purchase the
commodity from the bank in USD. The profit earned by the bank is the difference between the
profit rate and KLIBOR (MD. Faruk Abdullah 2016).

32
Limitation and future research

There are some limitations that we have encountered when writing this paper. First and
foremost, conference papers and journals were dated differently, and it is not very easy to
chronologically arrange the reference in a way that we can understand how Islamic Finance
practices and products have evolved. Moreover, we are also uncertain whether the information
that we have is the latest and most updated version. Secondly, several concepts were not
appropriately introduced, and the permissibility and rulings were not clear due to different
opinions from various scholars. We see no initiative that the Muslim scholars are working
towards achieving the same objective.

Our suggestion to tackle these problems is that Islamic Financial Institutions or

regulators, such as Shariah Advisory Council (SAC) and the Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI) to compile what is prohibited and
what is permissible, instead of scattering all the information from each meeting without
reference to each other.

For future research purposes, futures contracts in the Islamic finance context should be
researched; such as Bai' al-Salam and Istiana, we did not include Salam and Istiana contracts
because it was not appropriate for foreign currency exchange purpose. Perhaps researchers
could come up with invention and modification from current contracts that could mimic the
properties of a futures contract.

33
Conclusion

Foreign exchange is of utmost importance to the benefit of the society because it allows
investors and companies to perform international trade, for travelers to enjoy their oversea trip,
for government to implement inflation control, as well as for corporations to perform hedging
practice that can minimize their exposure in terms of exchange rate risk, transaction risk, and
translation risk.

Application of forex in conventional practice is much broader than Islamic practice,

due to fewer constraints, contracts such as futures, and swap and be carried out more fully and
without restriction that they would face if it were in Islamic practice, such as the prohibition of
riba, gharar, and maysir. Rulings of paper currency under Bai al-Sarf also provided insight that
currency can only be traded on par value if it is in the same currency, a different value can be
applied if different currencies were used, provided that all of the exchange must be done hand-
in-hand.

We conclude that paper currency is indeed treated as Ribawi materials, and governed
under the rule of Bai al-Sarf. Foreign exchange with Bai al-Sarf is permissible for a period of
T+2, Shariah Advisory Council of Malaysia also provided that Bai al-Sarf can be used together
with Wa'd, to mimic forward contracts, in which can be used if the maturity if more than two
days.

In conclusion, we foresee that Islamic finance is improving to meet the higher demand
from all over the world, not just limited to Muslim countries and Muslim investors. However,
we believe that not every Islamic product will take off since the majority of the product merely
mimic the concept of the conventional product, and it just a loophole to avoid prohibited
activities and to comply with Shariah law.

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