THE SHARIA PERSPECTIVE ON FUTURES
MOHAMMAD HASHIM KAMALI
The juristic debate over the validity or otherwise of Futures, revolves around five key points. One of these points is that the counter-values in these sales are both non-existent at the time of contract – no goods are delivered at that time and no price is paid. The contract is said to consist merely of an exchange of promises made for the sole purpose of speculative profit-making.
To validate a sale from the Sharia perspective, at least one, if not both, of the counter-values should be present at the time of contract.
Secondly, Futures involve short-selling in which the seller neither owns nor possesses the commodity he sells. The essence of sale is to transfer ownership. If the seller does not own the underlying commodity in the first place, he cannot transfer its ownership.
Thirdly, Futures sales fall short of meeting the requirement of Qabd, which is the taking into possession of the subject matter prior to resale. Fourthly, the deferment of both of the counter-values to a future date effectively turns a Futures sale into sale of one debt for another (bay al-dayn bi’l-dayn) which is said to be forbidden. And lastly. Futures trading partakes of speculation that verges on gambling and Gharar (uncertainty and risk-taking).
The gambling element in Futures is also said to be the cause of volatility in the price of commodities in the rash market. Most of these issues proceed entirely from a Sharia perspective over the validity of a conventional sale, except for the issue over gambling which features in Islamic as well as other literature on the subject.
Some early studies on Futures have recorded the view that Futures encourage price volatility and tend to destabilise the market. More recent research has actually supported the opposite view, that Futures tend to reduce price volatility and have a stabilising influence on the market.
Definition
In SFC Finance Company v. Masri, (All ER 1986), Legget J defined the Futures contract as, “a legally binding commitment to deliver at a future date, or take delivery of a given quantity of a commodity, or a financial instrument at an agreed price.”
It is a firm legal agreement between a buyer and seller, in an established commodity exchange or its clearing house, in which the trader agrees to deliver or accept delivery, during a designated period, of a specified amount of a certain commodity. The parties do not negotiate the terms of their agreement as these are all standardised and advertised in advance, except for the actual price, known as the ‘exercise price’, which is settled on the floor of the exchange.
Upon conclusion of the contract, a record of the transaction is made and following various checks, the contract is then registered with the clearing house – and it is at this point that the clearing house interposes itself between the buyer and seller and becomes effectively the other party to all contracts. The seller has a contract with the clearing house to sell his commodity and be paid for it, just as the buyer has a contract with the clearing house to receive delivery of the specified commodity at maturity.
The clearing house guarantees payment, whenever a net position warrants payment, on contracts that are to be closed out by offsetting transactions. In the history of Futures trading, the clearing house has always performed as promised. It is able to eliminate risk over contract performance partly through its daily settlement procedure, and also by ensuring that sufficient collateral is provided to cover their potential liabilities.
Legal research on Futures is still in its early stages. With the exception of a handful of Sharia scholars, who have considered Futures trading permissible, the general response of Sharia scholars on this issue is prohibitive and many have gone on record to declare Futures forbidden on various grounds.
In an article entitled “The Sharia Perspective on Bourse-related Issues,” (1982, Encyclopedia of Islamic Banks. – in Arabic) Ahmad Yusuf Sulayman reviewed the rules of Sharia on issues such as sale of objects that the seller does not own, sale prior to taking possession, deferred sales, and sale of the non-existent. Sulayman applied the rules of conventional sales in the Sharia on these issues directly to Futures and passed prohibitive judgements on almost every issue.
In support of his views, Sulayman has mainly relied on the Hadith that one must not sell what is not with one. This is also the position taken by another commentator, Badr al-Mutawalli ‘Abd al-Basit, Sharia Advisor to the Finance House of Kuwait, whose prohibitive views on Futures are entirely based on the conventional sale of Salam. Since Futures fail to fulfil all the requirements of a Salam sale, they are prohibited. But the views both of Sulayman and al-Basit were challenged and refuted respectively by two prominent commentators. Professor Ali ‘Abd al-Qadir and Majd al-Din ‘Azzam.
Both of these commentators have criticised the basic approach that Sulayman and al-Basit had taken to these issues, and emphasised, in turn, that Futures trading was a new mode of trading that called for a fresh response that must be formulated in the light of the operative procedures of Futures markets. Abd al-Karim al-Khatib admitted that Futures contracts did not fulfil all the requirements of a conventional contract, yet they were carefully regulated, and they satisfied the basic purpose and rationale of those rules. My own research on these issues refers directly to the Qur’an, and a fresh interpretation of the Hadith that is frequently quoted by those who invalidate Futures. The full version of the Hadith is as follows:
“Ja’far bin Abu Wahshiyah reported from Yusuf bin Mahak, from Hakim bin Hizam (who said): I asked the Prophet: ‘A man comes to me and asks me to sell him what is not with me, so I sell him (what he wants) and then buy the goods for him in the market (and deliver)’. And the Prophet said: ‘sell not what is not with you.’
In an attempt to ascertain the precise meaning of this Hadith, the jurists have advanced three different interpretations, which are as follows:
1. “Sell not what is not with you,” means not to sell what you do not own at the time of sale. Many prominent scholars of the various schools have recorded the view that the seller must own the object of sale when he sells it, failing which the sale is not concluded, even if the seller acquires ownership afterwards. The only exception to note in this context is the forward sale of Salam where ownership is not a prerequisite.
2. The jurists and scholars of Hadith have generally held that the Hadith under discussion only applies to the sale of specified objects, but not to fungible goods, as these can easily be substituted and replaced. It is thus stated that the prohibition in question is confined to the sale of objects unspecified (buyu al-a’yan) and does not apply to the sale of goods by description (buyu al-sifat). Imam Shafi has also held that one may sell what is not with one provided that it is not a specific object. For delivery cannot be guaranteed of a specific object if the seller does not own it.
The commentators Ibn Qayyim al-Jawziyyah and al-Mubarakfuri, in their respective commentaries on this Hadith, have both subscribed to the view that the Hadith under discussion contemplated the sale of specified objects and not the sale by description of goods that are commonly available in the market. This would effectively take Futures out of the purview of this Hadith simply because Futures trading only takes place in fungible commodities and cannot be expected to apply to specific objects of unique qualities.
3. The third position that some jurists have taken on the interpretation of this Hadith is that the sale of “what is not with you” means sale of what is not present and the seller is unable to deliver. This is the view oi Ibn Taymiyyah and the Maliki jurist al-Baji, who have stated that the emphasis in the Hadith is on the seller’s inability to deliver, which entails risk-taking and uncertainty. If the Hadith were to be taken on its face value, it would proscribe Salam and a variety of other sales, but this is obviously not intended.
It is quite possible that the seller owns the object and yet is unable to deliver, or that he possesses the object but does not own it – in either case he would fall within the purview of this Hadith. The emphasis in the Hadith is therefore not on ownership, nor on possession, but on the seller’s effective control and ability to deliver. Thus, the effective reason for the prohibition is uncertainty on account of inability to deliver.
Among modern writers, Yusuf Musa, Ali Abd al-Qadir, and Yusuf al-Qaradawi have drawn attention to the fact that the marketplace of Madina during the Prophet’s time was small, so much so that it did not offer the assurance of regular supplies at any given time. The Hadith, therefore, prohibited the sale of objects that were not available at the time of sale.
In contrast, the modern markets are regular and extensive, which means that the seller can find the goods at almost any time and make delivery as may be required. Given the means and facilities that are available today, the fear of failure to find the goods and make delivery, which was the basic rationale of the original prohibition, is no longer present.
There is normally no fear, in Futures trading, of the seller’s inability to find an equivalent contract with which to offset his position, or to find and deliver the underlying commodity in the event he wishes to make delivery. The seller is, in other words, not faced with the prospect of searching for the underlying commodity in the open market or of making detailed preparation for delivery.
The clearing house guarantee function, in this context, precisely means that delivery of the exact quantity and grade (or of the nearest grade) is guaranteed. This is a peculiarity of Futures trading, which provides systematic guarantees over delivery and payment, something which the open market does not provide.
Qabd (Possession)
I now address the issue of sale prior to taking possession (Qabd). One of the requirements of a valid sale in Islamic law is that the purchaser may not sell the goods he has bought until they are in his possession. In support of this ruling, the jurists have referred to the following Hadith:
1. “He who buys foodstuff should not sell it till he has received it.”
2. “He who buys foodstuff should not sell it unless he is satisfied with the measure with which he has bought it.”
3. “He who buys foodstuff should not sell it until he has taken possession of it.” Ibn ‘Abbas said: “I think it applies to all other things as well.”
As we note, all the three reports are substantially concurrent. The third Hadith has an added element which is clearly not a part of the original Hadith and represents an addition by Ibn ‘Abbas himself. The word Ta’am (foodstuff) occurs in precisely the same way in all the three reports and constitutes the only theme that is addressed.
As for the basic rationale of these Ahadith, it is stated that the Prophet prohibited the sale of commodities, especially perishable ones, which the seller did not possess, because of uncertainty and doubt in their delivery to the buyer. All the leading jurists have consequently held that it is not right for the seller to sell foodstuff before taking possession of it.
According to Imam Shafi, it is not right to sell anything – foodstuff, land or a garden – before taking possession. Imam Abu Hanifah and Ahmad Ibn Hanbal are of the view, however, that possession is not a requirement in the sale of real property as there is usually no fear of destruction and loss.
Imam Malik has confined the application of the Hadith under consideration to food grains, which means that commodities other than food grains, (such as cotton, palm oil etc) may be sold prior to taking possession.
In general, Qabd or possession is seen as a relatively open concept that is amenable to the changing influences of commercial reality and custom.
If we apply the foregoing Ahadith to Futures, we can perhaps readily say that Qabd is not a requirement in Futures trading in commodities such as cotton, rubber and tin, which are not foodstuffs. We may further add here that measurement and weighing, which is the recommended mode of Qabd in the sale of foodstuffs, was designed to ensure propriety in weighing and prevent fraud, which is not an issue in Futures trading.
Futures contracts in food grains are bought and sold in standardised quantities and packages that are weighed and measured once, and the packages are sealed and labelled accordingly, there remaining no need for weighing each time they are sold.
Our analysis of Qabd would naturally apply to that part of Futures in which the contracts are held to maturity and delivery takes place. Moreover, trading in stock index and financial Futures and currencies does not involve any physical exchange of assets, which means that delivery and Qabd therein is a matter of the debiting and crediting of accounts.
As for the bulk of Futures contracts in which the contracting parties close out their position by entering a reverse transaction, this is another issue that needs to be separately addressed.
Since the Sharia in principle validates the sale of a physical object (bay al-ayn) as well as the sale (involving exchange) of debts (bay al-dayn), delivery and possession in bay al-dayn is no longer a matter of physical delivery or retention of an actual asset, but of appointment and computation of a debt that is established on the person of the bearer of that debt.
Sale of Debts
An offsetting transaction in Futures consists essentially of sales in which two parties transact over a debt that one owes to the other and settle their debts through the modality of sales and purchases. The subject here is somewhat technical and juristic writings are not consistent over the nature of this transaction nor its validity in the Sharia.
A large variety of sales have been included under bay al-dunyun (sale of debts, also known as bay al-kali’ bi’l-kali) and many of them have been disputed as to whether they do in fact qualify as ‘sale of debts.’
General consensus is said to have materialised on the prohibition of the sale of debts, but since each school of thought has recorded divergent rulings on this issue, the claim of consensus having materialised is unfounded. Then there remains the evidence in the Sunnah that the Prophet reportedly prohibited the sale of debts.
This Hadith appears only in some collections, and many prominent scholars have considered it to be less than reliable. AI-Shawkani has stated that its authenticity is weak and Ibn Qudamah and Ibn Taymiyyah have concurred with the conclusion that no Hadith has been verified on the prohibition of the transaction at issue.
Some jurists have validated the sale of one debt for another if it is to the debtor himself but not if it is to a third party, on the analysis that uncertainty over delivery is greater when a third party is involved.
While reviewing the evidence on this issue, Siddiq al-Darir has stated in categorical terms that: “In my opinion. Sale of Debt is lawful absolutely, whether the sale is to the debtor or to a third party, for cash or for credit, provided that the sale is clear of interest and no textual injunction has declared it forbidden.”
I now turn to a discussion of the Qur’anic ruling on sales involving debts and here we note that the Qur’an validated deferred transactions involving future obligations as follows: “O you who believe! When you deal with each other in transactions involving future obligations for a fixed period of time (idha tadayantum bi-daynin ila ajalin musamman) reduce them into writing. Let a scribe write down faithfully as between the parties…” (2:282)
The subsequent portion of the text further accentuates the importance of accurate documentation in future transactions. Transactions of this kind, whether large or small, must be for a fixed period and all the material facts as well as the rights and obligations of the parties therein must be certain, reduced into writing and witnessed.
The text thus leaves no doubt as to the validity of future transactions in which the parties’ rights and liabilities, and the time in which they fall due, are clearly defined and documented. The question is whether “transactions involving future obligations for a fixed period of time” should also include futures trading.
‘Dayn’, being the key term in this text, calls for some elaboration. Dayn in this context means deferred liability, which arises from a contract involving exchange of values. Typical among these is the contract of sale in which one of the countervalues, either the payment of price, or delivery of the subject matter, is deferred to a future date.
Our information of the commercial life of the Arabs indicates that deferred transactions, which contemplated the seasonal patterns of agriculture, were commonly practised. Some of the well-known varieties of contract of exchange that were in vogue at the time of the advent of Islam included deferred sale Murabaha (cost-plus-profit sale), Ijara (leasing), Salam (forward sale), and Istisna (manufacturing contract). All of these were contracts of exchange in which delivery of one of the countervalues was deferred to a future date. Th e deferred liability that arose from these transactions was generally known as ‘dayn’.
The jurists have held different views on the interpretation of the word ‘dayn’. While some have confined dayn to certain types of debts, others have applied it generally to all deferred liability transactions that can fall within its broad meaning. The Qur’an has evidently not specified the general meaning of ‘dayn’ and there is no compelling evidence to warrant a departure from this position.
The language of the text should therefore convey its general and unqualified meaning and it may be concluded that the language of the text is general and applies to all debts, which would imply the basic legality of deferred transactions in all of its varieties in the Sharia.
Uncertainty and Risk
Since the Qur’an validates sale and commerce generally, as well as deferred liability transactions, and there is no specific prohibition in the Qur’an or Sunnah on future sales, then these may be said to be lawful, provided that they are clear of Gharar (uncertainty) usury and gambling.
As already noted, Futures sales are generally clear of Gharar in almost all of its varieties, including, that is, uncertainty over the knowledge of material details that would prevent unwarranted risk, and Gharar, which involves the parties, ability to obtain and deliver the subject matter of their agreement.
Broadly speaking Futures trading in commodities is also clear of Riba. This is because in a Futures sale nothing changes hands at the time of contract: the buyer does not pay the price nor does the seller deliver the goods at the time of the bargain. Hence no interest is earned by either party between the moment of contract and the final conclusion of the round-turn transaction.
I should add here though that even if the Futures contract itself precludes Riba, in the event where the underlying instrument derives its substance from Riba, such as the interest-rate Futures, these should, for obvious reasons, be precluded from the purview of our analysis.
There remains the question of speculation and gambling. Defining speculation or identifying the speculator is always difficult and many have stated that no clear definition can be given. This is because the distinguishing lines between investment, speculation and gambling are not always clear and the grey areas between them tend to persist regardless of particular definitions.
Speculation deals in risks that are necessarily present – in the process of marketing goods and services in a free market economy. As a wheat crop grows and is harvested, concentrated and dispersed, the obvious risks of price changes must be taken by those who own the wheat or have commitment to buy it. These risks would be present whether Futures markets existed or not. If the speculators were unwilling to take them someone else would have to do so.
The motivation of many individual speculators could well be identical with that of gamblers, the main difference being that Futures speculation reallocates risk from those who do not want it to those who do. Futures speculation, in other words, directs the appetite for risk-taking into an economically productive channel.
Speculators in commodities are not simply gamblers. In commodities-trading the risks are real commercial risks, quite a different matter to the activity of a gambler, who does not assume any risk other than that created by the rules of the game.
Major price movements are usually caused by basic changes in the supply or demand, or both, for a given product and only rarely by a group of speculators successfully creating self-fulfilling prophecies. The weight of the evidence obtained from the considerable research carried out suggests that: “speculation probably does more to smooth price fluctuation then to increase it”.
In an attempt to ascertain the relationship between gambling and Gharar and their bearing on commercial transactions, Ibn Taymiyyah pointed out that if a sale that partook in Gharar also involved devouring the property of others, then it became indistinguishable from gambling, which is clearly forbidden.
Unlawful devouring of the property of others occurs in two forms, namely usury and gambling. The Qur’an has forbidden both and the Sunnah of the Prophet on these subjects has only explained and elaborated on the Qur’an. It is then added that the Gharar sales, which the Prophet had forbidden generally, involve some form of gambling. There were certain varieties of sales that were common among the Arabs, and the Prophet declared them forbidden on these grounds.
Ibn Taymiyyah has thus attempted to establish a common denominator between Gharar and gambling, which is devouring and unlawful appropriation of the property of others. A commercial transaction may therefore not be equated with gambling unless it is accompanied lay this factor.
It thus appears that risk-taking which involves unlawful appropriation and gain of one party at the expense of the other is central to Ibn Taymiyyah’s understanding of the Quranic concept of gambling. When this is applied to Futures trading, the question before us would be whether financial speculation in Futures exposes the other party to the sale to risk, and if so whether it also involves unlawful gain and appropriation of the property of others.
There is evidently no misappropriation of the property of others in Futures in the sense that the buyer in a Futures contract is engaged in a transaction aimed at making profit through trading but not through dishonest appropriation of the property of others.
Speculative risk-taking in commerce which involves investment of assets, labour and skill is not forbidden; nor is there any restriction on the size of trade or the amount of profit one might make. What is forbidden is excessive risk-taking and gambling. Financial risk-taking is likely to involve gambling if it is staged and created for its own sake, but not if it is incidental to a beneficial economic activity and trade.
The speculative risk that is undertaken in Futures bears an affinity with commercial risk-taking for profit rather than with gambling. Thus it may be concluded that Futures trading falls under the basic principle of permissibility, with the proviso that we engage ourselves in a continuous process to enhance vigilance, and develop more refined safeguards against abuse, excessive speculation, and risk and uncertainty.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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