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ISLAMIC CROSS CURRENCY SWAP: A CASE STUDY
OF BANK ISLAM MALAYSIA BERHAD AND
MAYBANK ISLAMIC BERHAD
BY
FARHANAH BINTI MOHD MOKHTAR
A research paper submitted in fulfilment of the requirement
for the degree of Master of Science in Islamic Banking and
Finance
IIUM Institute of Islamic Banking and Finance
International Islamic University Malaysia
DECEMBER 2015
ii
ABSTRACT
Islamic Cross Currency Swap (ICCS) is an Islamic financial hedging instrument that
is intended to protect cross-border investments from foreign exchange rate and profit
rate exposures. Despite its potential as a powerful tool in the Islamic banking industry,
current literatures have deemed the instrument as non-compliant to the Shari’ah
because of multiple reasons. Without a thorough research on its execution by the
Islamic financial institutions (IFIs) in Malaysia, it would seem unfair to conclude as
such. Therefore, the aim of this study is to assess the current market practice of ICCS
through evaluation on the mechanics of ICCS executed by two IFIs in Malaysia. In
accordance with the aim of this study, a case study methodology is adopted and
conducted by means of interviewing the Shari’ah and Treasury Department of Bank
Islam Malaysia Berhad (BIMB) and Maybank Islamic Berhad (Maybank). The
findings have to a great extent resolved the issues and Shari’ah concerns raised by
critically evaluating the mechanics of ICCS executed by the IFIs. Some of the issues
include the existence of element of riba (interest), gharar (ambiguity) and maysir
(gambling) in ICCS transaction, issues related to concept of risk management allowed
by the Shari’ah and usage of the instrument for speculation purposes. Moreover, the
concerns are also on the usage of wa’d principle that is similar to a contract, validity
of commodity murabahah transactions, recognition of muqasah principle and the issue
on combination of multiple contracts into one transaction. The findings also include
the similarities and differences in the mechanics of ICCS between the IFIs. Finally,
the study covers the effort made by the IFIs in resolving the issues as well as to
promote the usage of the product as a very valuable tool in cross-border financial
transaction. Therefore, further strengthening of the development of the product and
getting consensus among majority scholars are crucial to sustain its demand in the
financial market.
iii
خلاصة البحث
لتحلاط الملااا الإسلالاملى حما ةاالاة امسلاتتمالات العلاا ة لأداة ة كلامبادلة العملات المتقاطعة الإسلالام دفتهال غم ملالاط حممناااتهلالاا كلالاأداة طالالاة ة البيلالالا ة فبلالاللحلالاد د ملالاط لالااط اسلالاعال البيلالا ف ا اللالاح معلالاد اللالا
د ن عتبر ا داة غلا متطافقلاة ملال العلا اعة سلاباد متعلاددة تلاسات الحال ة ن الدحمم االمبي ف ة الإسلام ة، الق ام بحث شامل ط ك ف ة حما ائها مط بل المؤسسلاات المال لاة الإسلالام ة ة ملاال إن فمنلاغ ملاط غلا العلاد اسلالالات لال .للالالال للالالالهلل فلالالامن اللالالادف ملالالاط يلالالالهم الدلاسلالالاة يلالالاط تق لالالا م الممالسلالالاات السلالالاط ة الحال لالالاة لمبادللالالاة
اللا ةمط خلا حما اء تق م لى آل ات مبادلة العملات المتقاطعلاة الإسلالام ةعملات المتقاطعة الإسلام الالالاتم حما اايلالاا ملالاط بلالال المللالاا ملالاط المؤسسلالاات المال لالاة الإسلالالام ة ة ملالاال إن فقلالاا للالادف الدلاسلالاة ا تملالااد
للالاة ة للالال االخإ سلالام لىلعلالا ا القسلالامحمالالا اء مقلالاا لات ملالال ملالاط خلالالا ملهج لالاة دلاسلالاة الحاللالاة اللالا اا الالا يلالالااد حمسلالالالام ل ( ماابانلالالال Bank Islam Malaysia Berhadحمسلالالالام ملالالاال إن يلالالااد
Maybank Islamic Berhad )حما حلالالالاد كبلالالالا حلالالالال الق لالالالاان اسلالالالات ا اللتلالالالاائ فقلالالالاداللا ر اهلالاا ة اميتماملاات العلا ة ملاط خلالا التق لا م اللقلادت مل لالاات مبادللاة العملالات المتقاطعلاة الإسلالام
بعض الق لالاان تعلالامل الالاطد لبيلالا اللالا ا ال لالا ل الم سلالا ة مل لالاات مبادللالاة فلالاالمؤسسلالاات المال لالاة الإسلالالام ة ، الق لالاان المتبيلالالة مفهلالاطم حمدالة الم لالااط اللالا تسلالام لإلالاا العلالا اعة الإسلالالام ة ةالعملالالات المتقاطعلالاة الإسلالالام
ط لاد الاسلات دام مبلادا اا لاا تعلاملمن الم لاا ف داة غلا ا الم لاال ة لالا ة للاى .للال، فلاا است دام لعقد، صحة معاملات الم ابحة السلع ة، ام تراف مبلادا المقاصلاة لا ة ت ك لاو قلاطد متعلاددة ة ل عا غالم
معامللالالاة احلالالادة تت لالالامط اللتلالالاائ اا لالالاا ا الالالاغ التعلالالاا غ امخلالالاتلاف ة آل لالالاات مبادللالالاة العملالالالات المتقاطعلالالاة ت لى الدلاسة الجهطد ال تبلهلا المؤسسات المال ة الإسلالام ة ة حلال المسلاألة ا البلطك اخ ا ةالإسلام
كلالالالالهلل لتعإالالالالاإ اسلالالالات دام المللالالالات ا تبلالالالاالم اداة ملالالالاة الالالالادا ة المعلالالالااملات المال لالالالاة العلالالالاا ة الحلالالالاد د التلالالالااا اظ للالالاى فمطاصلالالالة تعإالالالاإ ت لالالاطا المللالالات الحبيلالالاط للالالاى تطافلالالاا ة اغلب لالالاة آلاء العلملالالااء اعتلالالابر حا لالالاا للحفلالالا
ال لو حطلغ ة السطق الماا
iv
APPROVAL PAGE
I certify that I have supervised and read this study and that in my opinion, it conforms
to acceptable standards of scholarly presentation and is fully adequate, in scope and
quality, as a research paper for the degree of Master of Science in Islamic Banking
and Finance.
…………………………………..
Engku Rabiah Adawiah Engku
Ali
Supervisor
This research paper was submitted to IIUM Institute of Islamic Banking and Finance
and is accepted as a fulfilment of the requirement for the degree of Master of Science
in Islamic Banking and Finance.
…………………………………..
Khaliq Ahmad
Dean, IIUM Institute of Islamic
Banking and Finance
v
DECLARATION
I hereby declare that this research paper is the result of my own investigation, except
where otherwise stated. I also declare that it has not been previously or concurrently
submitted as a whole for any other degrees at IIUM or other institutions.
Farhanah binti Mohd Mokhtar
Signature……………….……. Date …..........................................
vi
COPYRIGHT PAGE
INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA
DECLARATION OF COPYRIGHT AND AFFIRMATION
OF FAIR USE OF UNPUBLISHED RESEARCH
Copyright © 2015 by Farhanah binti Mohd Mokhtar. All rights reserved.
ISLAMIC CROSS CURRENCY SWAP: A CASE STUDY OF BANK
ISLAM MALAYSIA BERHAD AND MAYBANK ISLAMIC
BERHAD
No part of this unpublished research may be reproduced, stored in a retrieval system,
or transmitted, in any form or by any means, electronic, mechanical, photocopying,
recording or otherwise without prior written permission of the copyright holder except
as provided below.
1. Any material contained in or derived from this unpublished research
may be used by others in their writing with due acknowledgement.
2. IIUM or its library will have the right to make and transmit copies (print
or electronic) for institutional and academic purposes.
3. The IIUM library will have the right to make, store in a retrieval system
and supply copies of this unpublished research if requested by other
universities and research libraries.
Affirmed by Farhanah Mohd Mokhtar
……..……..…………… …………………..
Signature Date
viii
ACKNOWLEDGEMENTS
All glory is due to Allah, the Almighty, whose Grace and Mercies have been with me
throughout the duration of this research studies. Although it has been tasking, His
Mercies and Blessings on me ease the herculean task of completing this research.
It is my utmost pleasure to dedicate this work to my dear parents, Professor Dr.
Mohd Mokhtar Saidin and Ruslaini Othman, who have instill passion towards
knowledge and education on my siblings and me. Their gift of unwavering support is
highly appreciated as well.
I am most indebted to my supervisor, Professor Dr. Engku Rabiah Adawiyah
Engku Ali for her teaching, time, support and kindness during the entire research
period. Special thanks are also in order to all IIiBF lecturers who’s never tired of
sharing the knowledge that they have in this particular field.
This research would have taken much longer time without the dedicated
personnels from BIMB and Maybank. I thank them for their precious time to answer
every question that I had on ICCS, diligently and truthfully.
Finally, I would like to thank my favourite people on earth, who had put up
with me when I was completing this research study. I thank Didiq, Bebe and Ika, who
would immediately stop using the Internet at home whenever I need to download data
for this study. I thank Hiera and Liyana for the weekend getaways and Ali for the late
night calls to remind me that I can complete this study. I thank Mizah and Nabila for
the company, snacks and coffees to keep me writing. Lastly, I thank my course mates
at IIiBF for the supports and friendships.
Thank you all very much!
ix
TABLE OF CONTENTS
Abstract .................................................................................................................... ii Approval Page .......................................................................................................... iv Declaration ............................................................................................................... v
Copyright Page ......................................................................................................... vi Dedication ................................................................................................................ vii Acknowledgements .................................................................................................. viii List of Tables ........................................................................................................... xii List of Figures .......................................................................................................... xiii
List of Abbreviations ............................................................................................... xiv
CHAPTER ONE: INTRODUCTION .................................................................. 1 1.1 Background of Study .............................................................................. 1
1.2 Purpose of the Study ............................................................................... 6 1.3 Statement of the Problem........................................................................ 7 1.4 Research Objectives................................................................................ 7 1.5 Research Questions ................................................................................. 7
1.6 Significance of the Research .................................................................. 8 1.7 Limitations and Assumptions ................................................................. 8
1.8 Overview of Methodology ...................................................................... 9 1.9 Organization of Research Paper ............................................................. 10
CHAPTER TWO: LITERATURE REVIEW ..................................................... 11 2.1 Introduction............................................................................................. 11
2.2 the Malaysian FX Market ....................................................................... 11 2.2.1 Overview ...................................................................................... 11 2.2.2 Malaysian Legal Framework on Currency Derivatives ............... 15
2.2.3 Types of Currency Derivatives .................................................... 16 2.2.3.1 The FX Forward and FX Futures ...................................... 17
2.2.3.2 The FX Options ................................................................. 17 2.2.3.3 The Swap ........................................................................... 18
2.3 The Conceptual Framework of Islamic Finance ..................................... 18 2.3.1 Basic Prohibitions ........................................................................ 19
2.3.1.1 Riba .................................................................................... 19 2.3.1.2 Gharar ............................................................................... 20 2.3.1.3 Maysir ................................................................................ 21
2.3.1.4 Other Elements of Prohibitions ......................................... 22
2.3.2 Principle of Risk Management ..................................................... 22
2.3.3 Usage of Islamic Cross Currency Swap for Speculation Purposes
............................................................................................................... 24 2.3.4 Overview of Underlying Contracts of Islamic Cross Currency Swap
............................................................................................................... 24 2.3.4.1 Bay’ Al Sarf ....................................................................... 24
2.3.4.2 Wa’d................................................................................... 26 2.3.4.3 Commodity Murabahah .................................................... 28 2.3.4.4 Muqasah ............................................................................ 30
x
2.3.2 Prohibited Transaction: Combination of Multiple Contracts Into One
............................................................................................................... 31 2.4 The Cross Currency Swap ...................................................................... 32
2.4.1 Overview ...................................................................................... 32 2.4.2 History of Currency Swap ............................................................ 33 2.4.3 Mechanics of Cross Currency Swap ............................................ 34 2.4.4 Feature Variations ........................................................................ 35
2.4.4.1 Types of Cross Currency Swap ......................................... 35
2.4.4.2 Term of Swap .................................................................... 35 2.4.4.3 Deliverability of Currency ................................................. 36 2.4.4.4 Exchange of Principal Payment ......................................... 36
2.5 The Islamic Cross Currency Swap ......................................................... 36 2.5.1 Overview ...................................................................................... 37
2.5.2 Mechanics of Islamic Cross Currency Swap ............................... 37
CHAPTER THREE: RESEARCH METHODOLOGY .................................... 39 3.1 Introduction............................................................................................. 39 3.2 Research Design ..................................................................................... 39
3.2.1 Qualitative Approach ................................................................... 39 3.2.2 Constructivist Knowledge Claims ............................................... 40
3.2.3 Exploratory Case Study ............................................................... 40 3.3 Research Method .................................................................................... 41
3.4 Research Population and Sampling ........................................................ 42 3.5 Data Analysis .......................................................................................... 42
CHAPTER FOUR: CASE STUDY ...................................................................... 43 4.1 Introduction............................................................................................. 43
4.2 Overview of The Islamic Financial Institutions ..................................... 43
4.2.1 Bank Islam Malaysia Berhad (BIMB) ......................................... 43 4.2.2 Maybank Islamic Berhad (Maybank) .......................................... 44
4.3 Execution of Islamic Cross Currency Swap By The IFIs ....................... 45 4.3.1 Process of Execution .................................................................... 45 4.3.2 Documentations ........................................................................... 46 4.3.3 Mechanics of Islamic Cross Currency Swap Executed by the Banks
............................................................................................................... 48 4.3.3.1 Situation 1 .......................................................................... 49 4.3.3.2 Situation 2 .......................................................................... 52
CHAPTER FIVE: FINDINGS AND RECOMMENDATION .......................... 56 5.1 Introduction............................................................................................. 56
5.2 Shari’ah Issues on Islamic Cross Currency Swap .................................. 56
5.2.1 The Existence Of Elements of Riba, Gharar, Maysir and Others
............................................................................................................... 57 5.2.1.1 Riba .................................................................................... 57 5.2.1.2 Gharar ............................................................................... 57 5.2.1.3 Maysir and Other Elements ............................................... 59
5.2.2 The Concept Of Risk Management Under Islamic Cross Currency
Swap ...................................................................................................... 60 5.2.3 Usage of ICCS: Hedging or Speculating?.................................... 61 5.2.4 The Strong Similarity Between Wa’d Mulzim And A Contract ... 63
xi
5.2.5 The Validity of Commodity Murabahah (Tawarruq) Transactions
............................................................................................................... 64 5.2.6 The Recognition of Muqasah Principle ....................................... 67
5.2.7 The Combination of Multiple Contracts Into One Transaction ... 67 5.3 Similarities and Differences in Execution of Islamic Cross Currency Swap
by the Selected Islamic Financial Institutions .............................................. 68 5.4 The Efforts Made By Islamic Financial Institutions............................... 70
CHAPTER SIX: CONCLUSIONS ....................................................................... 72 6.1 Introduction............................................................................................. 72 6.2 Conclusions ............................................................................................ 72
REFERENCES ....................................................................................................... 76
APPENDIX A ........................................................................................................ 83
xii
LIST OF TABLES
Table 4.1 Terms of Transaction 48
Table 4.2 The Wa'd and Bay' al Sarf Model by BIMB 49
Table 4.3 The Wa'd and Bay' al Sarf Model by Maybank 50
Table 4.4 The Wa'd, Commodity Murabahah and Muqasah Model by BIMB 52
Table 4.5 The Wa'd, Bay' al Sarf, Commodity Murabahah and Muqasah
Model by Maybank 55
Table 5.1 List of Wa'd Used For ICCS 68
xiii
LIST OF FIGURES
Figure 2.1 The Movement of MYR Against USD (2010-2015) 12
Figure 2.2 The Volume of Interbank Transactions in KL FX Market 13
Figure 2.3 Conventional Cross Currency Swap Structure 34
Figure 2.4 Structure of Islamic Cross Currency Swap 38
Figure 5.1 Illustration of Rates Being Swapped 62
xiv
LIST OF ABBREVIATIONS
AAOIFI Accounting and Auditing Organization for Islamic Financial Institution
AIBIM Association of Islamic Banking Institutions Malaysia
BIMB Bank Islam Malaysia Berhad
BNM Bank Negara Malaysia
CCS Cross Currency Swap
CCCS Conventional Cross Currency Swap
CPO Crude Palm Oil
EUR European Dollar
FCM Foreign Currency Mudharabah
FEA Foreign Exchange Administration
FSPSR Financial Stability and Payment System Report 2014
FX Foreign Exchange
ICCS Islamic Cross Currency Swap
ICRA Islamic Callable Range Accrual
IFI Islamic Financial Institution
IFSA Islamic Financial Services Act 2013
IIFM International Islamic Financial Market
IIUM International Islamic University Malaysia
IMF International Monetary Fund
IPRS Islamic Profit Rate Swap
ISDA International Swaps and Derivatives Association
KL Kuala Lumpur
MA Master Agreement
Maybank Maybank Islamic Berhad
MtM Mark-to-Market
MYR Malaysian Ringgit
PDS Profit Disclosure Sheet
RENTAS Real Time Electronics Transfer of Funds and Securities
ROMS Ringgit Operations Monitoring System
SAC Shari’ah Advisory Committee
SC Securities Commission
SGD Singaporean Dollar
TC Trade Confirmation
TMA Tahawwut Master Agreement
TS Term Sheet
USD U.S. Dollar
1
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF STUDY
Islamic cross currency swap (ICCS) is a controversial Islamic financial derivative that
has sparked major debates among scholars1 since it was introduced in Malaysia in
2006. Even so, the instrument is the only option for Islamic finance market players to
hedge cross-border cash flow movement against foreign exchange (FX) rate risk
(Zaharuddin, 2014). The instrument is especially important in Malaysia with the
strong development of sukuk market. The Financial Stability and Payment System
Report of 2014 (FSPSR 2014) states that the foreign currency asset in Islamic banking
sector has increased from MYR 19.3billion in 2013 to MYR 27.7billion a year later.
In the same year, the country has issued five ‘Emas’ foreign currency-denominated
sukuk and the first Japanese yen-denominated sukuk (FSPSR, 2014). Moreover,
Malaysia is also working towards becoming a major multicurrency sukuk issuer
(FSPSR, 2014). As such, cross-border transactions have become exceptionally
important in Malaysia.
Despite the growth of the sukuk market, the market players are also worried
with the movement of Malaysian Ringgit (MYR) since the mid of 2014. According to
Piana (2001), the currency exchange or FX rate “expresses the national currency’s
quotation in respect to foreign ones”. The value of MYR has gone down against the
U.S. dollar from MYR3.20/USD in mid 2014 to MYR4.24/USD in September 2015.
The exchange rate is very alarming to international corporations and financial
1 The prominent scholars that have discussed ICCS are Asyraf Wajdi Dusuki and Shabnam
Mokhtar (2010), Zaharuddin Abd Rahman (2014), Muhammad Ayub (2011) and Andreas
Jobst (2013).
2
institutions (FIs) that deal with cross-border transactions. As such, the usage of
currency hedging tools is very important to protect their investments. When the
investments involve a series of cash flows, the Islamic finance market players may
execute ICCS as a hedging tool against the alarming movement of MYR.
ICCS refers to Shari’ah compliant cross currency swap (CCS), which adapts
similar objective and functions as conventional CCS (CCCS) (Zaharuddin, 2014).
According to BusinessDictionary, cross currency swap (CCS) is a foreign exchange
(FX) hedging instrument that is designed to limit or offset probability of loss from
movement of FX rate. The operation is by means of a party borrowing a currency
from its counterparty and at the same time, lends another currency of equal value to
the same counterparty, based on the exchange rate (spot FX rate) of the contract date
until maturity (Baba and Sakurai, 2009). There are three stages of CCS (Baba, Packer
and Nagano, 2008). At the initial stage, the parties will swap a principal2 amount at the
contract date (FX spot rate). During the term of the CCS, each party will make
periodic exchanges of interest amount. At maturity, the CCS transaction ends with
parties making principal repayment to one another (Baba et al, 2008).
There are a few types of CCS, which depends on the type of interest rate at the
end of each leg. According to Zaharuddin (2014), the ICCS can replicate all types of
CCCS, which are fixed-for-fixed swap, fixed-for-floating swap or floating-for-fixed,
floating-for-floating and different types of rate. The CCS is also known by a few other
names, depending on its type. Cooper and Mello (1991) use the term ‘currency swaps’
that represents both CCS and FX swap. The difference between the two is that CCS
includes series of interest payments, while FX swap involves only the exchange of
principal amount at the initial and maturity period. The International Swaps and
2 The term “principal amount” will be used interchangeably with the “notional amount”.
3
Derivatives Association (ISDA) use the term ‘cross currency interest rate swap’ to
represent either fixed-for-fixed swaps, fixed-for-floating swap or vise versa (ISDA
webpage, 2015). Eales and Choudhry (2003) talk about ‘cross currency basis swap’,
which refers to floating-for-floating swap. It is basically a swap for the purpose of
hedging the FX rate risk only.
It is important to note that the CCS is also commonly issued with the issuance
of bond because it can be customized into the movement of cash flow during the term
of the bond (Eales and Choudhry, 2003). Under this agreement, the notional amount
of a bond is used as the CCS principal amount (Eales and Choudhry, 2003). Apart
from that, according to Durbin (2011), the other benefit of CCS is that it allows the
parties involved to get cheaper fund as compared to borrowing fund from the
international market. It also allows the parties to tap into a country’s capital market
that it otherwise, will not be able to, if it were to borrow funds from the international
market (Durbin, 2011).
As the objectives and functions of ICCS are similar to CCCS, there are many
Shari’ah concerns on the mechanics and operations of the instrument raised by the
current literature. When it comes to Islamic finance, Dusuki (2009) concludes that the
CCCS is non-compliant to the Shari’ah because the real exchange will happen at a
later agreed time but the rate at which, the currency is to be exchanged is fixed at the
contract date. As such, it contravenes with the principle of bay’ al sarf, which refers to
the exchange of currencies. Under the principle, currencies can only be traded if it is
exchanged on spot and hand-to-hand (Zaharuddin, 2014). The important thing to note
is that ICCS is also “locking” the future rate of exchange based on the rate of the
contract date, as a way that is Shari’ah compliant.
4
The second concern is on the Islamic principle of risk management particularly
on separation of risk from ownership (Ayub, 2011). According to principle of al-
ghunm bil-ghurm, which refers to principle of “no reward without risk” (Asmadi and
Yazid, 2013) implying that the risk associated with the transaction cannot be
transferred to another party and should always remain with the ownership (Ayub,
2011). While acknowledging the need for risk management tool (Sami Suwailem,
2012), the Islamic finance industry has to evaluate conventional hedging tools to
safeguard itself from prohibited elements under Shari’ah regulation.
Additionally, any derivative instrument is viewed as, “trend that ignores value,
commonalities and accepted professional ethics, which have caused repercussion”
(Nour, AbuSabha, Al Kubeise and Nour, 2013). Apart from that, Sami Suwailem (2006)
records the Office of the Comptroller of Currency statistical reports stating that 97.3%
from derivatives executed is used for speculation purposes, while only a small amount
of 2.7% is used for hedging purposes. This type of speculation may lead to earning
from devouring another person’s wealth, which is prohibited in Islam. As such, the
question at stake here is whether usage of ICCS is safe from speculative activities.
In 2006, the first ICCS was introduced in Malaysia, which adopts multiple
principles of Islamic finance. Despite the inclusion of the Shari’ah principles, the
ICCS is still debatable due to the nature of the principles. The first principle is wa’d,
which refers to “an expression of commitment given by one party to another to
perform certain action(s) in the future” (BNM Exposure Draft on Wa’d,, 2013). The issue
with wa’d is its similarity to a contract, especially when the wa’d is binding. Apart
from that, DeLorenzo (2007) states that wa’d is a very powerful tool and can be used
for Shari’ah non-compliant purposes. As such, the implementation of wa’d principle
has to be thorough.
5
Another Shari’ah principle used is commodity murabahah or more commonly
known as tawarruq in Malaysia. According to Dusuki (2010), there are four main
concerns associated with tawarruq transaction. The first concern is on its similarity to
bay’ al inah, which is another controversial transaction and is prohibited according to
some Shari’ah Standard (i.e the Accounting and Auditing Organization for Islamic
Financial Institutions, AAOIFI). Other concerns include the existence and
deliverability of the underlying commodities as well as the agency issue.
Apart from commodity murabahah, principle of muqasah is also included as
additional underlying principle of ICCS (Zaharuddin, 2014). The principle of
muqasah allows for cash settlement of the difference in rates on each settlement date.
It does not necessarily include a real swap transaction of the rates. Zaharuddin (2014)
questions the validity of the muqasah agreement for ICCS execution.
There are many principles used as underlying principles of ICCS, which are
bay’ al sarf, wa’d, commodity murabahah and muqasah. It also includes execution of
either a series of bay’ al sarf transaction or commodity murabahah transaction. The
execution of multiple contracts calls for another issue, which is the combination of
several contracts into one transaction that is prohibited according to the Shari’ah
(Dusuki, 2009).
Since Shari’ah compliancy is important for development of Islamic product,
the issues mentioned above should be resolved. Hence, this paper evaluates the
operation of IFIs in executing ICCS for the purpose of resolving the Shari’ah issues.
Current literature has included a few operational concerns on ICCS. Jobst (2010) has
raised the issue associated with any Islamic swap agreement, which is the
documentation of the product. Since ICCS is a customized treasury product, the
documentation of ICCS is fairly difficult (Jobst, 2010). Hence, the International
6
Islamic Financial Market (IIFM) and ISDA launched the ISDA/IIFM Tahawwut
Master Agreement (TMA) in 2010 to help with the issue. Even with a standardized
agreement, Jobst (2010) concludes that the document lacks operational description of
derivative instrument, which is crucial to Islamic transactions. With the current issues
on hand, it is important to shed some lights on the mechanics and operation of ICCS
by Islamic financial institutions (IFIs) in Malaysia.
Due to lack of standardization in documentation and mechanics of ICCS
among the IFIs, the treasury and Shari’ah department of each IFI are required to act on
their own and ensure that the hedging product is compliant to the Shari’ah. As such,
this study will also look at the similarities and differences in executing ICCS between
two selected prominent IFIs in Malaysia.
1.2 PURPOSE OF THE STUDY
The study focuses on resolving seven Shari’ah concerns on ICCS and explains how
the selected IFIs in Malaysia execute the product to constructively manage the
concerns. The selected IFIs are Bank Islam Malaysia Berhad (BIMB) that is a full-
fledged IFI and Maybank Islamic Berhad (Maybank) that is an Islamic financial
subsidiary. The long-term purpose of this study is to provide recommendation for the
IFIs and Malaysian legal authorities to seek improvements in further development of
the product.
It is hoped that this study can further assist in providing information on the
practical aspect of the ICCS. Results of the study may become a platform for further
research by those institutions that are interested in development of derivative products
and practices in the financial market.
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1.3 STATEMENT OF THE PROBLEM
Regardless of the prolonged criticism on the Shari’ah and legal aspect of ICCS, the
product has been executed by the treasury department of a few IFIs in Malaysia. Thus
far, there are no researches being made on the current operation of ICCS executed by
the IFIs. Hence the criticisms on the product are without fair evaluation of current
practice of ICCS. The intention of this research is to assess current market practice of
ICCS through evaluation of the operation of ICCS by BIMB and Maybank, with
particular reference to whether and how the institutions address the Shari’ah issues at
hand.
1.4 RESEARCH OBJECTIVES
The key objective of the research is to evaluate the ICCS executed by two IFIs in
Malaysia. It is intended to add to current scholarly literature on the implementation of
Islamic derivative products that are subject to a lot of scrutiny and skepticism. The
specific objectives include:
1. To identify and address the Shari’ah issues in execution of ICCS.
2. To compare and evaluate the structure of ICCS executed by two selected
IFIs in Malaysia.
3. To evaluate the effort made by the IFIs in resolving the Shari’ah issues on
ICCS.
1.5 RESEARCH QUESTIONS
In order to attain the desired objectives mentioned above, the research questions for
the study include:
1. What are the Shari’ah issues associated in the execution of ICCS?
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2. How do the IFIs structure the ICCS and are there any differences in the
structure of ICCS between the IFIs?
3. What are the efforts made by the IFIs in resolving the Shari’ah issues on
ICCS?
1.6 SIGNIFICANCE OF THE RESEARCH
The findings of the study will provide information on the practical aspect of execution
of ICCS. The current root of lack of literature is probably due to the complexity of
ICCS as a derivative product with layers of Islamic rulings surrounding it. Since
current literature focus mainly on the theoretical aspect of the instrument, this study
will assist both Shari’ah scholars and market practitioners to come into understanding
on operation and the issues related to the instrument.
Apart from that, the study is also intended to further elaborate on efforts made
by the IFIs in ensuring the effectiveness of the Islamic banking and finance (IBF)
industry. Malaysia, standing among the pioneer countries in promoting the industry,
has become the reference country for the development of IBF, especially in Islamic
capital market. As such, being able to critically evaluate ICCS will also help the
progress of IBF industry internationally.
1.7 LIMITATIONS AND ASSUMPTIONS
For the purpose of the study, the focus is only given to the Shari’ah and legal aspect of
the mechanics of ICCS in Malaysian financial system. The study does not include the
benefits of ICCS or how it is better from CCCS. It is potentially a subject of
subsequent research that is hoped to be further discussed in the future.
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It is important to note that only two IFIs are selected for this study, which are
BIMB and Maybank. As such, the findings from this study do not represent the
operation of ICCS by other or all IFIs in Malaysia. Further research is necessary here.
Besides that, the study also includes a case study with hypothetical factual details,
designed from discussion during the interview sessions with the selected IFIs. Hence,
the calculation part is made easy to understand the mechanics of ICCS.
Another important detail on the finding is that it is not designed to capture all
the customization of the product, but just the mechanics of the product. It does not
include a case study on floating-for-floating ICCS nor the event where the final stage
of re-exchange of the principal amount takes place.
1.8 OVERVIEW OF METHODOLOGY
The research methodology adopted to achieve the objectives of this study is
qualitative approach with constructivist knowledge claim and exploratory case study
design. The importance of qualitative approach is to evaluate the Shari’ah, legal and
mechanics of ICCS executed by IFIs. The study incorporates constructivist knowledge
claim as to evaluate complexity of views and derives subjective meanings from data
collected. Exploratory case study design is adopted to help with understanding the
ICCS in depth from many perspectives derived from data collected.
Research method refers to process of collecting information and data to
accomplish the objectives of the study. The method adopted for this study is open-
ended interview sessions. The data from the open-ended interview sessions include
audio-visual, document and observation data. The data will be discussed in Chapter
Four under case study of the IFIs on their execution of ICCS.
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1.9 ORGANIZATION OF RESEARCH PAPER
Chapter One is an introductory and overview of the study, particularly in highlighting
the focus and areas that are evaluated. Following the overview, Chapter Two provides
literature reviews on the FX market in Malaysia, Islamic finance principles, the CCCS
and issues associated with ICCS written by many prominent scholars. Chapter Three
explains the research methodology adopted to achieve the objectives of this study.
Additionally, Chapter Four presents the case study based on interview sessions with
the IFIs. Chapter Five covers the result from the interview into three types of analysis,
which includes main concerns and potential Shari’ah issues, evaluation of ICCS
executed by the two selected IFIs in Malaysia and the IFIs’ effort in resolving the
issues. It also includes some recommendation to further develop the instrument.
Finally, Chapter Six concludes the entire paper.