Commodity Murabaha: Better the devil you know?

Controversy
The commodity Murabahah contract has been under the spotlight in the last few years due to the 2009 ruling by the OIC Fiqh Academy that commodity Murabahah was essentially organized Tawarruq and therefore deemed to be a “synthetic and fictitious” transaction impermissible under Shariah. As an alternative, the Fiqh recommended the use of Qard Hassan, a benevolent loan. However, as noted by Raja Teh Maimunah, the former head of global Islamic markets at Bursa Malaysia: “This is simply not a commercially viable option.”

The vast majority of market players and many Shariah scholars accept that as a cash management tool and liquidity facility, the Islamic finance industry currently has no alternative. The use of commodity Murabahah is central to Islamic liquidity management, and is also playing a pivotal role in industry innovation, being used to develop personal financing products, Islamic derivative and structured products, and to back Sukuk structures. The industry, and its Shariah advisory boards, appear to have reached an uneasy consensus that although Tawarruq where possible should be considered a product of last resort, its use is acceptable.

Regulation
In fact, the use of Tawarruq in commodity Murabahah is largely dependent on region. While in the GCC tax structures mean that commodity Murabahah without using the Tawarruq structure is commercially viable (and thus widespread), in other countries there are different regulations. Rodney Ballard, the head of trade fi nance at Bank of London and The Middle East (BLME), following the Fiqh ruling, explained that in European and OECD countries the tax treatment puts Islamic banks at a disadvantage. “We don’t promote the Tawarruq but because of tax reasons our scholars allow us to use it as the Murabahah structure generates a lot of taxes and stamp duties that we can’t recover. This has been the only way to grow Islamic trade finance against conventional finance in Europe. If the Tawarruq was removed without providing an alternative to the Murabahah taxing structure, Islamic trade finance would disappear in Europe and the OECD.”

Malaysia too, has decided that Tawarruq is permissible if regulated. Raja Teh explained that at least as far as Malaysia was concerned, the prohibition was not due to the practice itself but rather its questionable execution. “The industry had suffered some reputational issues regarding rogue trades whereby commodities purchased for this purpose were either encumbered, i.e. they cannot be freely dealt with; the same commodities were being sold to several parties simultaneously; or, in some cases, simply didn’t exist.” As a result, since then there has been an industry wide effort to standardize and regulate the market, kickstarted by the launch in August 2009 of the Bursa Suq Al Sila’.

The platform is a continuation of the Commodity Murabahah House (CMH) initiative by the Malaysian International Islamic Financial Center (MIFC), first mooted in 2007; an international spot commodity platform which facilitates commodity-based Islamic financing and investment transactions. Raja Teh commented upon its inception that: “Instead of disallowing Tawarruq we set some rules. No one has ever regulated commodity Murabahah – what constitutes a proper commodity Murabahah trade, what makes it invalid – this is exactly the rationale of setting up Bursa Suq Al Sila’.”

Liquidity management
Despite the debate surrounding its structure, commodity Murabahah fulfi ls a vital function in the Islamic money market, and is widely used across all major Islamic fi nancial markets to manage liquidity. In fact, it has been described by Raja Teh as:
“The one Islamic money market tool that can help provide liquidity in the Islamic banking system. There is no other instrument that is as widely used as commodity Murabahah, especially in the short-term money markets. Sukuk are generally of medium to long tenure whilst other contracts, for example Wakalah, may not appeal to some risk managers.”

Malaysia has quite literally put its money where its mouth is. In March 2007, Bank Negara Malaysia launched the Commodity Murabahah Program (CMP), a cash deposit program to help Islamic institutions manage liquidity, and added Bank Negara Monetary Notes Murabahah to its stable of money management instruments. In 2009, Malaysia introduced two standardized interbank master agreements for
Islamic deposit-taking and placement transactions (the Corporate Murabahah Master Agreement and Master Agency Agreement) to promote the uptake of commodity Murabahah as an interbank tool; as well as launching the Bursa Suq Al Sila’ the same year.

Following Malaysia’s example, several other financial exchanges have either launched or expressed interest in launching liquidity management services that incorporate Tawarruq or Murabahah components. The Bahrain Financial Exchange through Bait Al Bursa, its Islamic division, in March 2011 launched e-Tayseer, a fully automated platform for transactions in the supply, purchase and sale of
assets for facilitating Murabahah transactions. e-Tayseer allows suppliers to place their assets onto the platform ready to be purchased by financial institutions. Financial institutions can then purchase these assets and conduct Murabahah transactions with counterparties to fulfil their liquidity management requirements. In January 2011 the Jakarta Futures Exchange also announced its intention of launching commodity Murabahah products by July, although no product has as yet come to market.

Diversification
Eldred Buck, the managing director of Eiger Trading Advisors, confirms that: “Commodity Murabahah is seeing a recovery in demand from the much lowered levels of activity in 2009 and 2010.” With its application now generally accepted, and its use increasingly well regulated, the market is once more starting to push the limits of the structure, expanding from a vanilla money market tool into a diverse range of instruments backing an increasingly wide variety of Islamic financial services including trade finance, personal finance and Sukuk. “Bank treasuries remain the most significant users [but] looking forward, the development of retail products is also spurring growth,” says Buck. “We are seeing a real growth in specific transactions across a multitude of jurisdictions and products, from agricultural products to construction materials. There is definitely a very sharp move towards developing personal finance products backed by commodity Murabahah.”

Along with the diversification of applications, commodity Murabahah structures are increasingly spreading into new asset classes for their underlying commodity base. Buck confirms that: “There is clearly a desire to diversify away from the traditional commodities.” While Islamic banks in the Middle East have traditionally used contracts based on the London Metals Exchange (LME) to manage their liquidity positions, Malaysia took a step forward in 2007 by using its own abundant crude palm oil resources to back its commodity Murabahah monetary notes. However, both of these commodity classes are subject to disadvantages including volatile price fluctuations and (in the case of LME contracts) forex fluctuations, and other potential asset classes have proliferated. “We are seeing a number of potential assets, particularly those that are held at a regional level, such as rice, steel and cement,” comments Buck.

Bahrain’s e-Tayseer now offers multiple Shariah compliant assets including cars, car parts, industrial equipment, soft commodities and metals, while the Jakarta Futures Exchange plans to create commodity Murabahah products based on olein, coffee, and gold.
In August 2009 RHB Islamic signed a groundbreaking agreement with Sedania Media Group and E-Pay to use mobile phone airtime as a commodity Murabahah asset class for its classical Tawarruq products (including its personal financing facility), asserting that the asset not only increases efficiency and reduces operating cost but is highly liquid and not subject to price or forex volatility.

There is no doubt that commodity Murabahah has its limitations. Yet the industry continues time and again to return to it as a stalwart fall-back option. Although alternatives have been promoted (such as the Ijarah lease structure to finance the purchase of equipment, Wakalah to replace Tawarruq, and Musharakah for project finance) none have yet gained enough traction to represent a realistic substitute.

It looks as though for the time being, having survived everything the industry has thrown at it, commodity Murabahah is here to stay.

Source: IFN 3rd August 2011.