Shariah Compliant Swap I: Shariah "conversion" or subversion?

We will stretch this topic over a few posts since there are numerous components to discuss, initially we detail the justification of Deutsche Bank for their Islamic swap product (a major developer and promoter of this instrument), later going over the structure in much more detail, and finally the criticisms that this solution has received from other industry participants.

The Shariah Justification
The structure is discussed (to a limited extent) in DB's now famous White Paper. In fact the white paper, whether you agree with the product or not is a toure de force. It is probably the best single article on the rationale for Wa'd to be legally binding.

The paper has two main arguments

1. Wa'd must be legally binding. The arguments involve maqasid, principles of commutative justice (derived from the thesis of Dr Hussein Hassan--sorry copyright prevents posting pdf), and is probably the best single source for this sort of argument.
2. Pricing of Islamic Contracts can be determined at the time of execution (see, e.g., Bay' bi Sirr al Suqq/Istijrar Revisited) and when indexed, markups need not be related to halal activities, e.g., LIBOR itself (and examples are given from Taqi Usmani's allowance of Murabaha markups related to many other more-complex payoffs).

Notably missing from their discussion are:

1. Should consideration be permissible in a wa'd? Can you pay for a wa'd?
2. Can bilateral wa'd (muwa'adah) be allowed? (Most jurists would disagree with this as a means of circumventing prohibitions on forward-starting contracts).
3. Should wa'd be legally enforceable only if there is detrimental reliance on the part of the promissee? (Maliki view). Is Wa'd the same a Promissory Estoppel?
4. Actual details of the structure of Shariah Compliant Swaps

Wa'd: Shariah-Specific Details
Wa'd, or unilateral promise has the following features/restrictions

1. Consideration is not permissible with Wa'ad. You cannot pay for a promise. (we will find an striking exception to this permitted by some scholars with Promissory Notes!)
2. Bilateral wa'd (muwa'adah) is not allowed. (Most jurists would disagree with this as a means of circumventing prohibitions on forward-starting contracts). (Note: We have already seen exceptions to this with Short-Sales Contracts using Muwa'adah)
3. Is wa'd legally enforceable only if there is detrimental reliance on the part of the promissee? (Maliki view). Is Wa'd the same a Promissory Estoppel? (this is dismissed and rather it is claimed Wa'd should be legally, not just morally upheld even if there are no damages).

For more on wa'd and on the wa'd swap, please see the following:

• al Masri, R, The Binding Unilateral Promise (wa’d) in Islamic Banking Operations: Is it Permissible for a Unilateral Promise (wa’d) to be Binding as an Alternative to a Proscribed Contract?
  
• Nurdianawati Abdullah, The Status of Wa’ad and its Implications in Contemporary Islamic Banking
  
• Aznan Hassan, Pengertian Al-Wa’ad, Al-Wa’dan Dan Al-Muwa’adah (dalam Bahasa Melayu)
• Islamic laws of Contract and Sale and purchase, Iqra University (pp 14-16)
  
• Vogel & Hayes, Islamic Law and Finance: Religion, Risk & Return (pp 125-8)
• Islamic Bankers Blog: Is Wa'ad the Next Star of Islamic Banking
• Barakat & Mehrej: The Structure and Use of Wa'ad
  
• Humayon Dar, Islamic Economist, Sharia Advisor and Transformational Thinker (for details of his seminal input from the man, the myth, the legend)
  
• Humayon Dar, Incentive Compatibility of Islamic Financing, Handbook of Islamic Finance, pp 85-96 (for a very western critique of Islamic contracts as not being "incentive compatible" except for the amazing Wa'ad swap, a matter of much possible disagreement. One might even say Islamic Finance in its current incarnation, just plain sucks according to Humayon. (sorry Humayon, but it really does sound like that!). Perhaps we can ask Mahmoud El-Gamal to critique the view that the Wa'd swap is doing a great service to Islam by allowing access to all these amazing products?)

Note that with this amazing swap, anything and everything is possible. As one Belgian banker said with excitement, "yes, it is possible to have Shariah Compliant pork bellies" (Astaghfirullah!).

For the pious, this should already raise red flags. And, presumably this should have raised red flags for the Structurers, for the Shariah board (the esteemed Dr Hussein Hamed Hassan, Dr Ali al Qaradaghi, Dr Abdul Sattar Abu Ghuddah, Dr Mohamed Elgari, and Dr Mohammed Daud Bakar) and for the Investors (which were terribly slow to take it up, and now are a bit hush-hush about it, but we suspect these include some large name public hedge funds, and DIB has been documented) .

Just given the controversial nature of this Islamic "wrapper" there is much more Shariah risk, including the risk of a change of heart of a scholar (please see: Global Islamic Funds & Sukuk, Linked In Discussion on this topic).

Please stay tuned for more details on the Shariah Compliant Swap, and the Criticisms. We will also detail other methods for constructing Shariah Compliant PRS (Profit Rate Swaps) in later posts, InshAllah.

Shariah Compliant Swap I: Shariah "conversion" or subversion?