Compensation for an Obligation to Sell Currency in the Future (Hedging)

All praise is Allah's, Lord of the Worlds! Peace and Blessings be upon the Prophet, Muhammad, his Family, and his Companions! I. INTRODUCTION This Article establishes a Shari'ah ruling1 for an important contemporary issue that has been the subject of much inquiry: whether Islamic law permits forward currency contracts (that is, hedging against currency risk). Specifically, this Article addresses what happens when a financial institution offers an obligation to sell or buy a specific currency at a specified time in the future at a pre-determined rate of exchange in return for a specified amount, regardless of whether the buyer decides to proceed with the exchange contract. Is it lawful for the client (a trader, manufacturing company, Islamic bank, government, or other transaction participant) to purchase that obligation in order to avoid potential losses resulting from market fluctuations in the prices of currencies? In other words, is it lawful, with respect to the Shari'ah, to hedge against currency risk by purchasing a forward currency contract? This issue is particularly significant given the needs of Islamic financial institutions, trading houses, manufacturers, and even governments and their agencies. But the issue has yet to become the subject of serious academic research or proficient legal scholarship by those qualified to establish a Shari'ah ruling on the matter. Since this Article focuses on the issue of "selling obligations" or "obtaining compensation for obligations," part II of this Article will discuss the meaning of an "obligation" as understood here. Part III will provide context to the definition of "obligation" by considering how Islamic law, or fiqh, characterizes compensation for obligations. After this introductory, but essential, review, this Article will discuss, in part IV, the legal justifications for the conclusion that the obligations described above are consistent with the requirements of Islamic law. Finally, this Article will conclude with a discussion of the practical effect of the approval, from an Islamic law perspective, of the use of options. II. OBLIGATION: CONCEPT AND TYPES The categorization of an idea depends upon how it is conceptualized. Thus, we must begin with a definition of "obligation" and an explanation of its meaning in Islamic law. As Zaruq stated in his Maxims, "a discussion of anything is actually an offshoot of how its essence and benefit are conceptualized through acquired or obvious intellectual perceptions, to which reference may be made when considering the instances of its occurrence, in terms of accepting or rejecting [the concept] and in terms of assigning generalities and details [to the concept]."2 An obligation is the requirement that a person act, or refrain from acting, in the interests of another. For example: (a) A person who destroys valuable property is responsible (daman) to the owner of the property for its destruction. This responsibility is an obligation. Likewise, delivering an item that has been sold and guaranteeing the item against hidden defects are obligations that fall upon the seller in the interest of the buyer. Similarly, where a deed brings something from a state of nothingness into a state of being, paying the purchase price of the deed and taking delivery of it are obligations that fall upon the buyer in the interest of the seller. All of these are positive obligations. (b) Not transgressing against the body, wealth, or reputation of another is an obligation required by the Shari'ah on all who are subject to the Shari'ah. Likewise, the deposit (wadi'ah) contract imposes an obligation upon a deposit holder-in the interest of the depositor-not to transgress upon or neglect a deposit. Also, in a sale of an option of stipulation (kbayar al-shart) or for an 'urbun, theption specified in each of the two contracts obligates the seller not to refuse or otherwise obstruct the buyer from voiding the sale during the prescribed period. …