Amiri Capital, as part of their effort to set up Shariah-Compliant Hedge Funds and Prime Brokerage services, introduced a short-selling mechanism which has had the sign-off of a number of internationally prominent muftis, while they also have some prominent advisors on their panel including Dr Daud Bakar and Sh Hussein Hasan among others.
Their short-selling method involves offsetting wa'ad (plurual: wu'ud) between the Islamic Investor (noted as their fund AEAS in the illustration below) and the bank/prime-broker.
The text in the boxes in the illustration above reads:
(upper box, Wa'ad 1) At some time t, on or before an agreed future date, if Pt us greater than P0, AEAS [Islamic Investor] promises to sell N Shares of Stock X to Counterparty at an adjusted price P1.
(lower box, Wa'ad 2) At some time t, on or before an agreed future date, if Pt is less than P0, Counterparty promises to buy N Shares of Stock X from AEAS [Islamic Investor] at an adjusted price P2. (which is different to the adjusted price in Wa'ad 1 above)
Key steps in the transaction
1) At t=0 two independent, unilateral promises concerning an equity are entered into with the conditions as set out above;
2) At close of transaction at t, due to the conditions in the promises concerning the market price of the equity only one of the two promises is in effect, that promise is exercised with the transaction price of P2 (assuming Pt < P0 ) and the stock is delivered from AEAS [Islamic Investor] to the Prime Broker and in return the Prime Broker makes a payment of P2.
Definitions
P0, is price of equity in the market at time of entering into promises (t=0);
P1, is the initial price P0, adjusted for various fees;
P2, is the initial price P0, adjusted for various fees.
P1 and P2 are "adjusted strike prices".
Short Comment:
This is an interesting use of wa'ad or unilateral promise, especially because the transaction involves two wa'ad for counterparties facing one another. This muwa'adah or mu'ahidah (bilateral promise) is, I thought, disallowed, especially if it is in place of 'aqd (contract, always bilateral) where a contract would be disallowed.
The example I have heard to showcase exactly when muwa'adah is prohibited is using muwa'adah to synthesize a forward (Party I promises to buy from Party II for $P at time t=T. Party II promises to sell to Party I for $P at time t=T). The synthetic forward is explicitly mentioned as disallowed (see e.g., Md Ayub, Understanding Islamic Finance, p 115) since it is a bilateral exchange which manages to circumvent similar restrictions which would be in place in the case of contract.
Does the conditional wa'ad (i.e., only if Pt > P0, etc) make this structure different? Maybe yes, maybe no. How is it different from the forward transaction? Is it specifically point 2 above, that only one of the two promises is in effect at t=T due to their conditional nature. Note: not only are the two wa'ad conditional so that only one is in effect at one time, but the transaction prices are different. I suspect these isues are key to the Shariah-board's approval. We will look at Wa'ad in much more detail in future posts, insh'Allah.
I wanted to thank Richard Ellis and Bindesh Shah from Amiri Capital for generously allowing us to showcase their structure and for their efforts (irrespective of any constructive criticism which I or others may give!).
Please feel free to comment.
The waad mechanism was published some time ago in an academic paper by Deutsche Bank. My reservation is that the condition imposed is the market price. Why? An Undertaking is enforceable, if a damage could incure for relying on it - this is measured by the market price, hence there is no difference in writing higher or lower than p in this example; anyway only one side, which is emphasized in writing here is enforceable. As such the condition is not differentiated from an Undertaking without this very condition and should be treated equal to a forward contract; so far prohibited by majority of scholars.
ReplyDeleteI also appreciate Amiri's help in allowing us to deconstruct their engine.
ReplyDeleteThe major difference with Deutsche Bank's paper (and its many offspring) technically swap one major cashflow (halal) for another cash flow (haram). Lets call this a "Macro Waad" which has been allowed but is not exactly popular.
The Amiri solution can probably be characterized as a "Micro Waad" since the exchnage of promises/cashflows is done for every single trade/transaction. Furthermore, the exchnage does not involve a haram underlying investment (say, a hedge fund index), but instead all cashflows are structured from the ground up, so there is no trickery here.
Most likely there are several caveats as to how the "adjusted strike prices" are created, which might be the key to making this a valid exchange.