FORWARD FOREIGN CURRENCY EXCHANGE

Bismillah and assalamualaikum. May this super simple explanation help your understanding on the practice of forward forex in Islamic finance. Wide smilesss! :D :D :D 

Your duit raya in advance! ^,^

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Islamic financial derivative instruments such as swaps, forwards and options have been introduced in Islamic finance as one of the hedging mechanisms to enhance risk management capability of market participants. A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date. It can be both for hedging and speculation. While foreign exchange is the exchange of one currency for another or the conversion of one currency into another currency. The term foreign exchange is usually abbreviated as "forex" and occasionally as "FX”. Thus in short, forward forign currency exchange is the exchange of one currency for another at a specified price on a future date agreed by both contracting parties.

In Malaysia, generally the practice of currency exchange is divided into two which are, spot and forward. Payment in spot would normally settle on T+2 basis, meaning two days after the transaction and on the other hand transaction in forward is executed on agreed future date, for example, one month or three months after transaction date or specific date stipulated in the contracts. One of Islamic banks that offer such this product is Exim Bank under the name, Forward Foreign Exchange-i. It is available for Exim Bank’s customers who are exposed in foreign exchange risks in their normal businesses and to make them qualified, this facility has to be tagged along with financing facility.

The Shariah contracts that underlie this product are, (1) waad (unilateral promise) and (2) bai’ sarf (currency exchange) which obviously made it differ from conventional system. Modus operandi of the product is very clear applying both concepts to ensure it is Shariah compliant. For example, a customer has to pay USD1mil for his imports in six months-time (T6) and he then enters forward foreign exchange to hedge risk of USD against MYR. At T0, the customer gives waad to buy USD for USD/MYR 4.0 at T6. During maturity, customer fulfills waad and buy USD at agreed price (bai’ sarf takes place) and he hedges the spot rate USD/MYR 4.6.

Opportunities of this forward foreign currency exchange highlight only two important points firstly, it offers complete hedge to the customers who involve in foreign exchange risks, also as the second point, it gives price protection as it would not be effected by the spot price rate during the exchange. Even though, forward contract associated with foreign currency exchange is doing good, there still some challenges in its application because it subjects to a default risk from one of the parties. Furthermore, sometimes contract may be difficult to cancel if they have to and will require a compensation due to some losses that may occur.

Despite of the wide acceptance of this contract, it still an ongoing debate among scholars due to its controversial issues. The main issues involved in this forward contract when transacting with currencies is the presence of riba because currencies are not exchanged on the spot using spot price rate as per condition. Besides, excessive uncertainty (gharar) may also occur as the contracting parties are uncertain wht will happen in the future and third issue is, this contract leads to speculation or gambling (qimar) which is prohibited in Islam.

As for the courses of action, the  Shariah Advisory Council (SAC), in its 38th meeting dated 28 August 2003, has resolved that the delivery and settlement of a spot foreign exchange transaction based on T+2 is permissible based on the customary of business practices nowadays. Moreover, regarding the waad concept, the SAC, in its 49th meeting dated 28 April 2005, has also resolved that Islamic financial institutions are allowed to conduct forward foreign exchange transactions based on unilateral waad mulzim (binding promise) which is binding on the promissor. In addition, the party who suffers losses due to non-fulfillment of promise may claim compensation. At the same time, SAC prohibited of the application of binding bilateral promise (muwaadah mulzimah) because of its nature that brings to selling debt with debt.

In brief conclusion, the forward foreign currency exchange is actually a good practice in Islamic finance and its permissibility helps in hedging and managing the risks as well as diversifying the range of investment products offered to sophisticated investors.

THANK YOU :*