FUTURES, OPTIONS, SWAPS AND EQUITY INVESTMENTS
JUSTICE MUFTI MUHAMMAD TAQI USMANI
A number of financial contracts are in use by conventional banks, for example, for risk reduction, hedging and speculation involving options. Futures, Swaps and direct and indirect Equity Investments. How far are such contracts permissible under the Sharia?
To clarify the issue, four hypothetical situations were formulated and referred to eminent jurist Justice Mufti Muhammad Taqi Usmani, Deputy Chairman, Islamic Fiqh Academy, Organisation of Islamic Conference (OIC) Jeddah, and Vice President of Darul Uloom, Karachi. His comments follow each situation described below:
Situation 1 – Futures Contracts in Shares
i) Two individuals, A and B, enter into a contract on 1st January, 1996 under which A would sell a share of Company X at a price of $100 to B after an expiry of six months. B has an obligation to purchase at this price irrespective of the market price on 30th June, 1996.
ii) Can this contract or the rights and obligations of A and B be transferred by either of them to a third-party C?
iii) If the object of transaction is any commodity, or gold, silver or currency and not shares, as in the case above, in what way is the validity or otherwise of the contract affected? It may be noted that the non-transferability of rights and obligations severely limits the possibility of speculation on Futures Exchanges.
A commonly held belief is that Futures contracts are prohibited when they are used for speculation. Does this imply that Futures contracts are permissible when these are used for hedging?
Comment by Mufti Taqi Usmani
i) This is an example of a Futures transaction. The Futures transactions as in vogue in the stock and commodities markets today are not permissible for two reasons. Firstly, it is a well-recognised principle of the Sharia that sale or purchase cannot be affected for a future date. Therefore, all forward and Futures transactions are invalid in the Sharia.
Secondly, because in most of the Futures transactions, delivery of the commodities or their possession is not intended. In most cases, the transactions end up with the settlement of difference of prices only, which is not allowed in the Sharia.
ii) As Futures are not permissible, no rights or obligations can emanate therefrom. Therefore, the question of transferring these rights and obligations does not arise.
iii) Futures transactions, as explained above, are totally impermissible regardless of their subject matter. Similarly, it makes no difference whether these contracts are entered into for the purpose of speculation or for the purpose of hedging.
Situation 2 – Option Contracts in Shares
i) Two individuals, A and B, enter into a contract on 1st January, 1996 under which A grants a right to B without any obligation on B’s part. Under the contract B gets a right to purchase a share of company X from A any time on or before 30th June, 1996 at a price of $100, irrespective of the market price on the day of purchase. B, however, does not have any obligation to purchase. A accepts a consideration of $5 from B for granting him this right without obligations. This is known as a “Call” Option in shares.
ii) A and B enter into a contract on 1st January, 1996 under which A grants a right to B without any obligation on B’s part. Under the Contract, B gets a right to sell a share of Company X to A any time on or before 30th June, 1996 at a price of $100 irrespective of the market price on the day of sale. However, B does not have any obligation to sell. A accepts a consideration of $5 from B for granting him this right without obligations. This is known as a “Put” Option in shares.
iii) A and B enter into a contract on 1st January, 1996 by which A sells 100 shares of Company X to B at a price of $100 per share. The transaction is settled with exchange of cash for the shares. A also grants a right to B under which B can sell back the shares to A on the expiry of six months, that is 30th June, 1996 at a price of $120 per share. This right, however, is cancelled if the price of the shares increases beyond $120 and remains at that level for 21 consecutive days before 30th June, 1996.
Unlike the previous two instances of transactions in pure Options, the above is a case of an Option as an additional feature of an equity sale and purchase.
iv) If the object of transaction is any commodity, or gold, silver or currency and not shares as in the above three cases, in what way is the validity or otherwise of the contract affected?
v) Is the validity of the above contract affected with an added provision that B can now transfer this contract to a third-party C?
Comments by Muhammad Taqi Usmani
i), ii), iv) & v) According to the principles of the Sharia, an Option is a promise to sell or purchase a thing on a specific price within a specified period. Such a promise in itself is permissible and is normally binding on the promisor. However, this promise cannot be the subject matter of a sale or purchase. Therefore, the promisor cannot charge the promisee a fee for making such a promise.
Since the Options transactions, as in vogue in the Options market, are based on charging fees on these promises, they are not valid according to the Sharia. This ruling applies to all kinds of Options, no matter whether they are Call Options or Put Options. Similarly, it makes no difference if the subject matter of the Option sale is a commodity, gold, silver or a currency; and as the contract is invalid ab-initio, the same cannot be transferred.
iii) This contract has two aspects. Firstly, if the Option of selling back the shares to A has been made a pre-condition for the original sale transaction, the whole transaction will be invalid because, according to the Sharia, a sale transaction cannot accept such a condition. Secondly, if the Option is an independent promise without being a precondition for the original sale, no fee can be charged for such a promise, as mentioned earlier. Although a complimentary promise of this kind is permissible in the Sharia, it cannot serve the purpose of the Options market.
Situation 3-Swaps
Two banks enter into an agreement to exchange deposits for a period of six months in different currencies on 1st January, 1996 at the prevailing exchange rates. Bank A exchanges Rupees 30 million with bank B for US dollars one million, and the Rupee-Dollar exchange rate prevailing on the date is 30:1. During these six months, each bank utilises the deposits it received at its own risk.
At the and of six months, bank A pays back one million dollars to bank B and receives Rupees 30 million from it irrespective of the Rupees-Dollar rate prevailing on June 30, 1996. For example, the Rupee-Dollar exchange rate might have become 35:1 or 25:1 on Jun e 30, 1996. Is this contract Islamically permissible?
Comments by Muhammad Taqi Usmani
It is one of the principles of the Sharia that two financial transactions cannot be tied together in the sense that entering into one transaction is made a precondition of entering into the second. Keeping this principle in view, the Swap transaction referred to above is not permissible because the deposit of one million dollars has been made a precondition for accepting the deposit of 30 million rupees.
Since both the parties will use the deposits for their own benefit, they are termed in the Sharia as loans (Qard) and not as trusts (Wadee’a). Therefore, advancing one loan has been made a precondition for receiving another, which means that two financial transactions are tied together. This is my opinion about this transaction. However, it needs further study and research.
Situation 4 – Direct and Indirect Investments in Equity
i) Company A raises funds by selling shares and interest-leasing bonds and invests the funds in predominantly Halal and profitable activities. Is it permissible to purchase shares of company A for an individual?
ii) Company B raises all its funds by selling shares and invests all its funds in shares of company A above, and other similar companies. Is it permissible for an individual to purchase shares of company B?
iii) Company X sells financial securities on which it promises dividends at a rate of 10 per cent on its total sales during the year. Is it permissible to purchase these securities where dividends are paid as a predetermined proportion of sales revenue and not profits?
Comments by Muhammad Taqi Usmani
i) If company A raises funds by issuing shares and interest bearing-bonds and invests all funds in predominantly Halal and profitable activities, the permissibility of purchasing shares of such a company depends on four conditions:
a) All the business activities of the company should be Halal.
b) The shares of such a company have to be purchased after it has acquired illiquid assets like machinery, buildings, raw materials or stock-in-trade.
c) If it becomes evident from the income statements of the company that a part of its income consists of interest given by the bank on its deposits, that proportion of the dividend must be given to charity.
For example, if the total profit of the company is £100 and 5% of it has accrued through interest received on bank deposits, then 5% of the dividend must be given to charity.
d) The shareholder should express his disagreement over depositing surplus funds in an interest-bearing account and raising funds through interest-bearing loans. A preferable method would be to raise his voice against such interest-bearing transactions in the Annual General Meeting of the company.
If the four conditions are strictly fulfilled, it is hoped that purchasing the shares of such a company will be permissible in the Sharia.
A possible objection which may be raised against this ruling would be that because the company had raised a considerable amount of its funds by issuing interest-bearing bonds, a substantial part of its funds is impure according to the Sharia; therefore, it should not be permissible to participate in such a business.
This objection may be refuted on the ground that although taking an interest-bearing loan is strictly prohibited in the Sharia, yet the effect of this prohibition is that the persons responsible for taking such loans will be committing a sin. However, the amounts so borrowed are treated by the Sharia as their own. Although they will be liable to punishment in the hereafter, the money borrowed comes into their ownership and anything purchased by that money will not be treated in the Sharia as Haram.
Therefore, if the capital raised by the company consists of some amounts borrowed on interest, it will not render the whole capital impure.
ii) If the four conditions mentioned above are fulfilled, it will also be permissible to purchase the shares of company B, which has invested all its funds in the shares of company A.
iii) It is necessary for the permissibility of Musharaka that the profits of the joint venture are distributed among the partners in an agreed proportion of the actual profit and not in proportion to the sales revenue. Therefore, it is not permissible to purchase the securities issued by Company X.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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