Reducing risk in foreign exchange

ECONOMIC

Question:

As salaam u alaikum

I am an importer of products and have large foreign exchange exposures. The south African currency is volatile and I would just like to know if there is any shariah compliant method of reducing my foreign exposure risk. Something similar to a commercial forward contract.

Jazakallah for your time and look forward to your response.

 
Answer:

In the Name of Allah, the Most Gracious, the Most Merciful.

As-salāmu ‘alaykum wa-rahmatullāhi wa-barakātuh.

Trading on the foreign exchange markets and in imports/exports is gaining momentum. However, Forex trading always carries risk. Almost all traders are looking for new ways to reduce their level of risk in Forex. This risk is known as transaction exposure.

Transaction exposure is the risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations.  Such exposure to fluctuating exchange rates can lead to major losses for firms.[i]

Consider a company whose business is to buy and sell goods from various foreign countries, and for whom purchases and sales are on several months credit. If such a company does not consider currency risk, it might incur exchange losses that seriously reduce its profit.

Often, when a company identifies such exposure to changing exchange rates, it will choose to implement a hedging strategy, using forward rates to lock in an exchange rate and thus eliminate the exposure to the risk.

Hedging in foreign exchange is a method of reducing risk where you can make a larger return on your forex investment with minimum risk. Foreign exchange hedging simply is a transaction that is made by a particular forex trader to protect an established position against an unanticipated or unwanted movement in the market.

In the current market, transaction exposure is hedged by means of hedging instruments like forwards, future trading, option trading, hedging and swap.  These devices designed to offset loss are impermissible as they consist of sales being suspended to future dates and sales of debts against debts.  Some of these mechanisms also incorporate the sale of commodities not in one’s possession.[ii]

Some of these devices can be manipulated and employed in such a way to make them shari῾āh compliant.

One solution is to use a Forward Exchange Contract which is modified to be Shariah Compliant.  There has to be possession from one party to eliminate the impermissible element.

This is unlike a forward exchange contract where there is an agreement between you and the Bank, in which the Bank agrees to buy or sell a foreign currency to you on a fixed future date at a fixed rate of exchange.   Here the client should hand over his currency immediately.

Hence, any change to the volatile currency will be avoided as the Dollars have been bought already and the sale is just a deferred sale.

Another solution is to determine the whole process of importing in one currency.  The client will pay the bank the same currency which the bank offers an L/C.

There is still a great deal of research required to offer viable solutions for Muslim traders.

And Allah Ta’āla Knows Best

Mufti Faraz Adam al-Mahmudi,
www.darulfiqh.com

 


[i] http://www.investopedia.com/terms/t/transactionexposure.asp#ixzz1dtwSIWgO

[ii] وفي سنن الدارقطني

عَنِ ابْنِ عُمَرَ , أَنَّ النَّبِيَّ صَلَّى اللهُ عَلَيْهِ وَسَلَّمَ «نَهَى عَنْ بَيْعِ الْكَالِئِ بِالْكَالِئِ» (رقم الحديث 3060)

وفي الأصل لمحمد الشيباني

وَلَا يجوز أَن يَبِيع مَا لم يقبض وَقد جَاءَ قي الْأَثر عَن رَسُول الله صلى الله عَلَيْهِ وَسلم أَنه نهى عَن بيع الرجل مَا لم يقبض (ج 5 ص 31 إدارة القرآن والعلوم الإسلامية – كراتشي)

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