ISLAMIC CROSS CURRENCY SWAP: A CASE STUDY

OF BANK ISLAM MALAYSIA BERHAD AND

MAYBANK ISLAMIC BERHAD

BY

FARHANAH BINTI MOHD MOKHTAR

A research paper submitted in fulfilment of the requirement

for the degree of Master of Science in Islamic Banking and

Finance

IIUM Institute of Islamic Banking and Finance

International Islamic University Malaysia

DECEMBER 2015

ii

ABSTRACT

Islamic Cross Currency Swap (ICCS) is an Islamic financial hedging instrument that

is intended to protect cross-border investments from foreign exchange rate and profit

rate exposures. Despite its potential as a powerful tool in the Islamic banking industry,

current literatures have deemed the instrument as non-compliant to the Shari’ah

because of multiple reasons. Without a thorough research on its execution by the

Islamic financial institutions (IFIs) in Malaysia, it would seem unfair to conclude as

such. Therefore, the aim of this study is to assess the current market practice of ICCS

through evaluation on the mechanics of ICCS executed by two IFIs in Malaysia. In

accordance with the aim of this study, a case study methodology is adopted and

conducted by means of interviewing the Shari’ah and Treasury Department of Bank

Islam Malaysia Berhad (BIMB) and Maybank Islamic Berhad (Maybank). The

findings have to a great extent resolved the issues and Shari’ah concerns raised by

critically evaluating the mechanics of ICCS executed by the IFIs. Some of the issues

include the existence of element of riba (interest), gharar (ambiguity) and maysir

(gambling) in ICCS transaction, issues related to concept of risk management allowed

by the Shari’ah and usage of the instrument for speculation purposes. Moreover, the

concerns are also on the usage of wa’d principle that is similar to a contract, validity

of commodity murabahah transactions, recognition of muqasah principle and the issue

on combination of multiple contracts into one transaction. The findings also include

the similarities and differences in the mechanics of ICCS between the IFIs. Finally,

the study covers the effort made by the IFIs in resolving the issues as well as to

promote the usage of the product as a very valuable tool in cross-border financial

transaction. Therefore, further strengthening of the development of the product and

getting consensus among majority scholars are crucial to sustain its demand in the

financial market.

iii

خلاصة البحث

لتحلاط الملااا الإسلالاملى حما ةاالاة امسلاتتمالات العلاا ة لأداة ة كلامبادلة العملات المتقاطعة الإسلالام دفتهال غم ملالاط حممناااتهلالاا كلالاأداة طالالاة ة البيلالالا ة فبلالاللحلالاد د ملالاط لالااط اسلالاعال البيلالا ف ا اللالاح معلالاد اللالا

د ن عتبر ا داة غلا متطافقلاة ملال العلا اعة سلاباد متعلاددة تلاسات الحال ة ن الدحمم االمبي ف ة الإسلام ة، الق ام بحث شامل ط ك ف ة حما ائها مط بل المؤسسلاات المال لاة الإسلالام ة ة ملاال إن فمنلاغ ملاط غلا العلاد اسلالالات لال .للالالال للالالالهلل فلالالامن اللالالادف ملالالاط يلالالالهم الدلاسلالالاة يلالالاط تق لالالا م الممالسلالالاات السلالالاط ة الحال لالالاة لمبادللالالاة

اللا ةمط خلا حما اء تق م لى آل ات مبادلة العملات المتقاطعلاة الإسلالام ةعملات المتقاطعة الإسلام الالالاتم حما اايلالاا ملالاط بلالال المللالاا ملالاط المؤسسلالاات المال لالاة الإسلالالام ة ة ملالاال إن فقلالاا للالادف الدلاسلالاة ا تملالااد

للالاة ة للالال االخإ سلالام لىلعلالا ا القسلالامحمالالا اء مقلالاا لات ملالال ملالاط خلالالا ملهج لالاة دلاسلالاة الحاللالاة اللالا اا الالا يلالالااد حمسلالالالام ل ( ماابانلالالال Bank Islam Malaysia Berhadحمسلالالالام ملالالاال إن يلالالااد

Maybank Islamic Berhad )حما حلالالالاد كبلالالالا حلالالالال الق لالالالاان اسلالالالات ا اللتلالالالاائ فقلالالالاداللا ر اهلالاا ة اميتماملاات العلا ة ملاط خلالا التق لا م اللقلادت مل لالاات مبادللاة العملالات المتقاطعلاة الإسلالام

بعض الق لالاان تعلالامل الالاطد لبيلالا اللالا ا ال لالا ل الم سلالا ة مل لالاات مبادللالاة فلالاالمؤسسلالاات المال لالاة الإسلالالام ة ، الق لالاان المتبيلالالة مفهلالاطم حمدالة الم لالااط اللالا تسلالام لإلالاا العلالا اعة الإسلالالام ة ةالعملالالات المتقاطعلالاة الإسلالالام

ط لاد الاسلات دام مبلادا اا لاا تعلاملمن الم لاا ف داة غلا ا الم لاال ة لالا ة للاى .للال، فلاا است دام لعقد، صحة معاملات الم ابحة السلع ة، ام تراف مبلادا المقاصلاة لا ة ت ك لاو قلاطد متعلاددة ة ل عا غالم

معامللالالاة احلالالادة تت لالالامط اللتلالالاائ اا لالالاا ا الالالاغ التعلالالاا غ امخلالالاتلاف ة آل لالالاات مبادللالالاة العملالالالات المتقاطعلالالاة ت لى الدلاسة الجهطد ال تبلهلا المؤسسات المال ة الإسلالام ة ة حلال المسلاألة ا البلطك اخ ا ةالإسلام

كلالالالالهلل لتعإالالالالاإ اسلالالالات دام المللالالالات ا تبلالالالاالم اداة ملالالالاة الالالالادا ة المعلالالالااملات المال لالالالاة العلالالالاا ة الحلالالالاد د التلالالالااا اظ للالالاى فمطاصلالالالة تعإالالالاإ ت لالالاطا المللالالات الحبيلالالاط للالالاى تطافلالالاا ة اغلب لالالاة آلاء العلملالالااء اعتلالالابر حا لالالاا للحفلالالا

ال لو حطلغ ة السطق الماا

iv

APPROVAL PAGE

I certify that I have supervised and read this study and that in my opinion, it conforms

to acceptable standards of scholarly presentation and is fully adequate, in scope and

quality, as a research paper for the degree of Master of Science in Islamic Banking

and Finance.

…………………………………..

Engku Rabiah Adawiah Engku

Ali

Supervisor

This research paper was submitted to IIUM Institute of Islamic Banking and Finance

and is accepted as a fulfilment of the requirement for the degree of Master of Science

in Islamic Banking and Finance.

…………………………………..

Khaliq Ahmad

Dean, IIUM Institute of Islamic

Banking and Finance

v

DECLARATION

I hereby declare that this research paper is the result of my own investigation, except

where otherwise stated. I also declare that it has not been previously or concurrently

submitted as a whole for any other degrees at IIUM or other institutions.

Farhanah binti Mohd Mokhtar

Signature……………….……. Date …..........................................

vi

COPYRIGHT PAGE

INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA

DECLARATION OF COPYRIGHT AND AFFIRMATION

OF FAIR USE OF UNPUBLISHED RESEARCH

Copyright © 2015 by Farhanah binti Mohd Mokhtar. All rights reserved.

ISLAMIC CROSS CURRENCY SWAP: A CASE STUDY OF BANK

ISLAM MALAYSIA BERHAD AND MAYBANK ISLAMIC

BERHAD

No part of this unpublished research may be reproduced, stored in a retrieval system,

or transmitted, in any form or by any means, electronic, mechanical, photocopying,

recording or otherwise without prior written permission of the copyright holder except

as provided below.

1. Any material contained in or derived from this unpublished research

may be used by others in their writing with due acknowledgement.

2. IIUM or its library will have the right to make and transmit copies (print

or electronic) for institutional and academic purposes.

3. The IIUM library will have the right to make, store in a retrieval system

and supply copies of this unpublished research if requested by other

universities and research libraries.

Affirmed by Farhanah Mohd Mokhtar

……..……..…………… …………………..

Signature Date

vii

DEDICATION

For mom and dad

viii

ACKNOWLEDGEMENTS

All glory is due to Allah, the Almighty, whose Grace and Mercies have been with me

throughout the duration of this research studies. Although it has been tasking, His

Mercies and Blessings on me ease the herculean task of completing this research.

It is my utmost pleasure to dedicate this work to my dear parents, Professor Dr.

Mohd Mokhtar Saidin and Ruslaini Othman, who have instill passion towards

knowledge and education on my siblings and me. Their gift of unwavering support is

highly appreciated as well.

I am most indebted to my supervisor, Professor Dr. Engku Rabiah Adawiyah

Engku Ali for her teaching, time, support and kindness during the entire research

period. Special thanks are also in order to all IIiBF lecturers who’s never tired of

sharing the knowledge that they have in this particular field.

This research would have taken much longer time without the dedicated

personnels from BIMB and Maybank. I thank them for their precious time to answer

every question that I had on ICCS, diligently and truthfully.

Finally, I would like to thank my favourite people on earth, who had put up

with me when I was completing this research study. I thank Didiq, Bebe and Ika, who

would immediately stop using the Internet at home whenever I need to download data

for this study. I thank Hiera and Liyana for the weekend getaways and Ali for the late

night calls to remind me that I can complete this study. I thank Mizah and Nabila for

the company, snacks and coffees to keep me writing. Lastly, I thank my course mates

at IIiBF for the supports and friendships.

Thank you all very much!

ix

TABLE OF CONTENTS

Abstract .................................................................................................................... ii Approval Page .......................................................................................................... iv Declaration ............................................................................................................... v

Copyright Page ......................................................................................................... vi Dedication ................................................................................................................ vii Acknowledgements .................................................................................................. viii List of Tables ........................................................................................................... xii List of Figures .......................................................................................................... xiii

List of Abbreviations ............................................................................................... xiv

CHAPTER ONE: INTRODUCTION .................................................................. 1 1.1 Background of Study .............................................................................. 1

1.2 Purpose of the Study ............................................................................... 6 1.3 Statement of the Problem........................................................................ 7 1.4 Research Objectives................................................................................ 7 1.5 Research Questions ................................................................................. 7

1.6 Significance of the Research .................................................................. 8 1.7 Limitations and Assumptions ................................................................. 8

1.8 Overview of Methodology ...................................................................... 9 1.9 Organization of Research Paper ............................................................. 10

CHAPTER TWO: LITERATURE REVIEW ..................................................... 11 2.1 Introduction............................................................................................. 11

2.2 the Malaysian FX Market ....................................................................... 11 2.2.1 Overview ...................................................................................... 11 2.2.2 Malaysian Legal Framework on Currency Derivatives ............... 15

2.2.3 Types of Currency Derivatives .................................................... 16 2.2.3.1 The FX Forward and FX Futures ...................................... 17

2.2.3.2 The FX Options ................................................................. 17 2.2.3.3 The Swap ........................................................................... 18

2.3 The Conceptual Framework of Islamic Finance ..................................... 18 2.3.1 Basic Prohibitions ........................................................................ 19

2.3.1.1 Riba .................................................................................... 19 2.3.1.2 Gharar ............................................................................... 20 2.3.1.3 Maysir ................................................................................ 21

2.3.1.4 Other Elements of Prohibitions ......................................... 22

2.3.2 Principle of Risk Management ..................................................... 22

2.3.3 Usage of Islamic Cross Currency Swap for Speculation Purposes

............................................................................................................... 24 2.3.4 Overview of Underlying Contracts of Islamic Cross Currency Swap

............................................................................................................... 24 2.3.4.1 Bay’ Al Sarf ....................................................................... 24

2.3.4.2 Wa’d................................................................................... 26 2.3.4.3 Commodity Murabahah .................................................... 28 2.3.4.4 Muqasah ............................................................................ 30

x

2.3.2 Prohibited Transaction: Combination of Multiple Contracts Into One

............................................................................................................... 31 2.4 The Cross Currency Swap ...................................................................... 32

2.4.1 Overview ...................................................................................... 32 2.4.2 History of Currency Swap ............................................................ 33 2.4.3 Mechanics of Cross Currency Swap ............................................ 34 2.4.4 Feature Variations ........................................................................ 35

2.4.4.1 Types of Cross Currency Swap ......................................... 35

2.4.4.2 Term of Swap .................................................................... 35 2.4.4.3 Deliverability of Currency ................................................. 36 2.4.4.4 Exchange of Principal Payment ......................................... 36

2.5 The Islamic Cross Currency Swap ......................................................... 36 2.5.1 Overview ...................................................................................... 37

2.5.2 Mechanics of Islamic Cross Currency Swap ............................... 37

CHAPTER THREE: RESEARCH METHODOLOGY .................................... 39 3.1 Introduction............................................................................................. 39 3.2 Research Design ..................................................................................... 39

3.2.1 Qualitative Approach ................................................................... 39 3.2.2 Constructivist Knowledge Claims ............................................... 40

3.2.3 Exploratory Case Study ............................................................... 40 3.3 Research Method .................................................................................... 41

3.4 Research Population and Sampling ........................................................ 42 3.5 Data Analysis .......................................................................................... 42

CHAPTER FOUR: CASE STUDY ...................................................................... 43 4.1 Introduction............................................................................................. 43

4.2 Overview of The Islamic Financial Institutions ..................................... 43

4.2.1 Bank Islam Malaysia Berhad (BIMB) ......................................... 43 4.2.2 Maybank Islamic Berhad (Maybank) .......................................... 44

4.3 Execution of Islamic Cross Currency Swap By The IFIs ....................... 45 4.3.1 Process of Execution .................................................................... 45 4.3.2 Documentations ........................................................................... 46 4.3.3 Mechanics of Islamic Cross Currency Swap Executed by the Banks

............................................................................................................... 48 4.3.3.1 Situation 1 .......................................................................... 49 4.3.3.2 Situation 2 .......................................................................... 52

CHAPTER FIVE: FINDINGS AND RECOMMENDATION .......................... 56 5.1 Introduction............................................................................................. 56

5.2 Shari’ah Issues on Islamic Cross Currency Swap .................................. 56

5.2.1 The Existence Of Elements of Riba, Gharar, Maysir and Others

............................................................................................................... 57 5.2.1.1 Riba .................................................................................... 57 5.2.1.2 Gharar ............................................................................... 57 5.2.1.3 Maysir and Other Elements ............................................... 59

5.2.2 The Concept Of Risk Management Under Islamic Cross Currency

Swap ...................................................................................................... 60 5.2.3 Usage of ICCS: Hedging or Speculating?.................................... 61 5.2.4 The Strong Similarity Between Wa’d Mulzim And A Contract ... 63

xi

5.2.5 The Validity of Commodity Murabahah (Tawarruq) Transactions

............................................................................................................... 64 5.2.6 The Recognition of Muqasah Principle ....................................... 67

5.2.7 The Combination of Multiple Contracts Into One Transaction ... 67 5.3 Similarities and Differences in Execution of Islamic Cross Currency Swap

by the Selected Islamic Financial Institutions .............................................. 68 5.4 The Efforts Made By Islamic Financial Institutions............................... 70

CHAPTER SIX: CONCLUSIONS ....................................................................... 72 6.1 Introduction............................................................................................. 72 6.2 Conclusions ............................................................................................ 72

REFERENCES ....................................................................................................... 76

APPENDIX A ........................................................................................................ 83

xii

LIST OF TABLES

Table 4.1 Terms of Transaction 48

Table 4.2 The Wa'd and Bay' al Sarf Model by BIMB 49

Table 4.3 The Wa'd and Bay' al Sarf Model by Maybank 50

Table 4.4 The Wa'd, Commodity Murabahah and Muqasah Model by BIMB 52

Table 4.5 The Wa'd, Bay' al Sarf, Commodity Murabahah and Muqasah

Model by Maybank 55

Table 5.1 List of Wa'd Used For ICCS 68

xiii

LIST OF FIGURES

Figure 2.1 The Movement of MYR Against USD (2010-2015) 12

Figure 2.2 The Volume of Interbank Transactions in KL FX Market 13

Figure 2.3 Conventional Cross Currency Swap Structure 34

Figure 2.4 Structure of Islamic Cross Currency Swap 38

Figure 5.1 Illustration of Rates Being Swapped 62

xiv

LIST OF ABBREVIATIONS

AAOIFI Accounting and Auditing Organization for Islamic Financial Institution

AIBIM Association of Islamic Banking Institutions Malaysia

BIMB Bank Islam Malaysia Berhad

BNM Bank Negara Malaysia

CCS Cross Currency Swap

CCCS Conventional Cross Currency Swap

CPO Crude Palm Oil

EUR European Dollar

FCM Foreign Currency Mudharabah

FEA Foreign Exchange Administration

FSPSR Financial Stability and Payment System Report 2014

FX Foreign Exchange

ICCS Islamic Cross Currency Swap

ICRA Islamic Callable Range Accrual

IFI Islamic Financial Institution

IFSA Islamic Financial Services Act 2013

IIFM International Islamic Financial Market

IIUM International Islamic University Malaysia

IMF International Monetary Fund

IPRS Islamic Profit Rate Swap

ISDA International Swaps and Derivatives Association

KL Kuala Lumpur

MA Master Agreement

Maybank Maybank Islamic Berhad

MtM Mark-to-Market

MYR Malaysian Ringgit

PDS Profit Disclosure Sheet

RENTAS Real Time Electronics Transfer of Funds and Securities

ROMS Ringgit Operations Monitoring System

SAC Shari’ah Advisory Committee

SC Securities Commission

SGD Singaporean Dollar

TC Trade Confirmation

TMA Tahawwut Master Agreement

TS Term Sheet

USD U.S. Dollar

1

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF STUDY

Islamic cross currency swap (ICCS) is a controversial Islamic financial derivative that

has sparked major debates among scholars1 since it was introduced in Malaysia in

2006. Even so, the instrument is the only option for Islamic finance market players to

hedge cross-border cash flow movement against foreign exchange (FX) rate risk

(Zaharuddin, 2014). The instrument is especially important in Malaysia with the

strong development of sukuk market. The Financial Stability and Payment System

Report of 2014 (FSPSR 2014) states that the foreign currency asset in Islamic banking

sector has increased from MYR 19.3billion in 2013 to MYR 27.7billion a year later.

In the same year, the country has issued five ‘Emas’ foreign currency-denominated

sukuk and the first Japanese yen-denominated sukuk (FSPSR, 2014). Moreover,

Malaysia is also working towards becoming a major multicurrency sukuk issuer

(FSPSR, 2014). As such, cross-border transactions have become exceptionally

important in Malaysia.

Despite the growth of the sukuk market, the market players are also worried

with the movement of Malaysian Ringgit (MYR) since the mid of 2014. According to

Piana (2001), the currency exchange or FX rate “expresses the national currency’s

quotation in respect to foreign ones”. The value of MYR has gone down against the

U.S. dollar from MYR3.20/USD in mid 2014 to MYR4.24/USD in September 2015.

The exchange rate is very alarming to international corporations and financial

1 The prominent scholars that have discussed ICCS are Asyraf Wajdi Dusuki and Shabnam

Mokhtar (2010), Zaharuddin Abd Rahman (2014), Muhammad Ayub (2011) and Andreas

Jobst (2013).

2

institutions (FIs) that deal with cross-border transactions. As such, the usage of

currency hedging tools is very important to protect their investments. When the

investments involve a series of cash flows, the Islamic finance market players may

execute ICCS as a hedging tool against the alarming movement of MYR.

ICCS refers to Shari’ah compliant cross currency swap (CCS), which adapts

similar objective and functions as conventional CCS (CCCS) (Zaharuddin, 2014).

According to BusinessDictionary, cross currency swap (CCS) is a foreign exchange

(FX) hedging instrument that is designed to limit or offset probability of loss from

movement of FX rate. The operation is by means of a party borrowing a currency

from its counterparty and at the same time, lends another currency of equal value to

the same counterparty, based on the exchange rate (spot FX rate) of the contract date

until maturity (Baba and Sakurai, 2009). There are three stages of CCS (Baba, Packer

and Nagano, 2008). At the initial stage, the parties will swap a principal2 amount at the

contract date (FX spot rate). During the term of the CCS, each party will make

periodic exchanges of interest amount. At maturity, the CCS transaction ends with

parties making principal repayment to one another (Baba et al, 2008).

There are a few types of CCS, which depends on the type of interest rate at the

end of each leg. According to Zaharuddin (2014), the ICCS can replicate all types of

CCCS, which are fixed-for-fixed swap, fixed-for-floating swap or floating-for-fixed,

floating-for-floating and different types of rate. The CCS is also known by a few other

names, depending on its type. Cooper and Mello (1991) use the term ‘currency swaps’

that represents both CCS and FX swap. The difference between the two is that CCS

includes series of interest payments, while FX swap involves only the exchange of

principal amount at the initial and maturity period. The International Swaps and

2 The term “principal amount” will be used interchangeably with the “notional amount”.

3

Derivatives Association (ISDA) use the term ‘cross currency interest rate swap’ to

represent either fixed-for-fixed swaps, fixed-for-floating swap or vise versa (ISDA

webpage, 2015). Eales and Choudhry (2003) talk about ‘cross currency basis swap’,

which refers to floating-for-floating swap. It is basically a swap for the purpose of

hedging the FX rate risk only.

It is important to note that the CCS is also commonly issued with the issuance

of bond because it can be customized into the movement of cash flow during the term

of the bond (Eales and Choudhry, 2003). Under this agreement, the notional amount

of a bond is used as the CCS principal amount (Eales and Choudhry, 2003). Apart

from that, according to Durbin (2011), the other benefit of CCS is that it allows the

parties involved to get cheaper fund as compared to borrowing fund from the

international market. It also allows the parties to tap into a country’s capital market

that it otherwise, will not be able to, if it were to borrow funds from the international

market (Durbin, 2011).

As the objectives and functions of ICCS are similar to CCCS, there are many

Shari’ah concerns on the mechanics and operations of the instrument raised by the

current literature. When it comes to Islamic finance, Dusuki (2009) concludes that the

CCCS is non-compliant to the Shari’ah because the real exchange will happen at a

later agreed time but the rate at which, the currency is to be exchanged is fixed at the

contract date. As such, it contravenes with the principle of bay’ al sarf, which refers to

the exchange of currencies. Under the principle, currencies can only be traded if it is

exchanged on spot and hand-to-hand (Zaharuddin, 2014). The important thing to note

is that ICCS is also “locking” the future rate of exchange based on the rate of the

contract date, as a way that is Shari’ah compliant.

4

The second concern is on the Islamic principle of risk management particularly

on separation of risk from ownership (Ayub, 2011). According to principle of al-

ghunm bil-ghurm, which refers to principle of “no reward without risk” (Asmadi and

Yazid, 2013) implying that the risk associated with the transaction cannot be

transferred to another party and should always remain with the ownership (Ayub,

2011). While acknowledging the need for risk management tool (Sami Suwailem,

2012), the Islamic finance industry has to evaluate conventional hedging tools to

safeguard itself from prohibited elements under Shari’ah regulation.

Additionally, any derivative instrument is viewed as, “trend that ignores value,

commonalities and accepted professional ethics, which have caused repercussion”

(Nour, AbuSabha, Al Kubeise and Nour, 2013). Apart from that, Sami Suwailem (2006)

records the Office of the Comptroller of Currency statistical reports stating that 97.3%

from derivatives executed is used for speculation purposes, while only a small amount

of 2.7% is used for hedging purposes. This type of speculation may lead to earning

from devouring another person’s wealth, which is prohibited in Islam. As such, the

question at stake here is whether usage of ICCS is safe from speculative activities.

In 2006, the first ICCS was introduced in Malaysia, which adopts multiple

principles of Islamic finance. Despite the inclusion of the Shari’ah principles, the

ICCS is still debatable due to the nature of the principles. The first principle is wa’d,

which refers to “an expression of commitment given by one party to another to

perform certain action(s) in the future” (BNM Exposure Draft on Wa’d,, 2013). The issue

with wa’d is its similarity to a contract, especially when the wa’d is binding. Apart

from that, DeLorenzo (2007) states that wa’d is a very powerful tool and can be used

for Shari’ah non-compliant purposes. As such, the implementation of wa’d principle

has to be thorough.

5

Another Shari’ah principle used is commodity murabahah or more commonly

known as tawarruq in Malaysia. According to Dusuki (2010), there are four main

concerns associated with tawarruq transaction. The first concern is on its similarity to

bay’ al inah, which is another controversial transaction and is prohibited according to

some Shari’ah Standard (i.e the Accounting and Auditing Organization for Islamic

Financial Institutions, AAOIFI). Other concerns include the existence and

deliverability of the underlying commodities as well as the agency issue.

Apart from commodity murabahah, principle of muqasah is also included as

additional underlying principle of ICCS (Zaharuddin, 2014). The principle of

muqasah allows for cash settlement of the difference in rates on each settlement date.

It does not necessarily include a real swap transaction of the rates. Zaharuddin (2014)

questions the validity of the muqasah agreement for ICCS execution.

There are many principles used as underlying principles of ICCS, which are

bay’ al sarf, wa’d, commodity murabahah and muqasah. It also includes execution of

either a series of bay’ al sarf transaction or commodity murabahah transaction. The

execution of multiple contracts calls for another issue, which is the combination of

several contracts into one transaction that is prohibited according to the Shari’ah

(Dusuki, 2009).

Since Shari’ah compliancy is important for development of Islamic product,

the issues mentioned above should be resolved. Hence, this paper evaluates the

operation of IFIs in executing ICCS for the purpose of resolving the Shari’ah issues.

Current literature has included a few operational concerns on ICCS. Jobst (2010) has

raised the issue associated with any Islamic swap agreement, which is the

documentation of the product. Since ICCS is a customized treasury product, the

documentation of ICCS is fairly difficult (Jobst, 2010). Hence, the International

6

Islamic Financial Market (IIFM) and ISDA launched the ISDA/IIFM Tahawwut

Master Agreement (TMA) in 2010 to help with the issue. Even with a standardized

agreement, Jobst (2010) concludes that the document lacks operational description of

derivative instrument, which is crucial to Islamic transactions. With the current issues

on hand, it is important to shed some lights on the mechanics and operation of ICCS

by Islamic financial institutions (IFIs) in Malaysia.

Due to lack of standardization in documentation and mechanics of ICCS

among the IFIs, the treasury and Shari’ah department of each IFI are required to act on

their own and ensure that the hedging product is compliant to the Shari’ah. As such,

this study will also look at the similarities and differences in executing ICCS between

two selected prominent IFIs in Malaysia.

1.2 PURPOSE OF THE STUDY

The study focuses on resolving seven Shari’ah concerns on ICCS and explains how

the selected IFIs in Malaysia execute the product to constructively manage the

concerns. The selected IFIs are Bank Islam Malaysia Berhad (BIMB) that is a full-

fledged IFI and Maybank Islamic Berhad (Maybank) that is an Islamic financial

subsidiary. The long-term purpose of this study is to provide recommendation for the

IFIs and Malaysian legal authorities to seek improvements in further development of

the product.

It is hoped that this study can further assist in providing information on the

practical aspect of the ICCS. Results of the study may become a platform for further

research by those institutions that are interested in development of derivative products

and practices in the financial market.

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1.3 STATEMENT OF THE PROBLEM

Regardless of the prolonged criticism on the Shari’ah and legal aspect of ICCS, the

product has been executed by the treasury department of a few IFIs in Malaysia. Thus

far, there are no researches being made on the current operation of ICCS executed by

the IFIs. Hence the criticisms on the product are without fair evaluation of current

practice of ICCS. The intention of this research is to assess current market practice of

ICCS through evaluation of the operation of ICCS by BIMB and Maybank, with

particular reference to whether and how the institutions address the Shari’ah issues at

hand.

1.4 RESEARCH OBJECTIVES

The key objective of the research is to evaluate the ICCS executed by two IFIs in

Malaysia. It is intended to add to current scholarly literature on the implementation of

Islamic derivative products that are subject to a lot of scrutiny and skepticism. The

specific objectives include:

1. To identify and address the Shari’ah issues in execution of ICCS.

2. To compare and evaluate the structure of ICCS executed by two selected

IFIs in Malaysia.

3. To evaluate the effort made by the IFIs in resolving the Shari’ah issues on

ICCS.

1.5 RESEARCH QUESTIONS

In order to attain the desired objectives mentioned above, the research questions for

the study include:

1. What are the Shari’ah issues associated in the execution of ICCS?

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2. How do the IFIs structure the ICCS and are there any differences in the

structure of ICCS between the IFIs?

3. What are the efforts made by the IFIs in resolving the Shari’ah issues on

ICCS?

1.6 SIGNIFICANCE OF THE RESEARCH

The findings of the study will provide information on the practical aspect of execution

of ICCS. The current root of lack of literature is probably due to the complexity of

ICCS as a derivative product with layers of Islamic rulings surrounding it. Since

current literature focus mainly on the theoretical aspect of the instrument, this study

will assist both Shari’ah scholars and market practitioners to come into understanding

on operation and the issues related to the instrument.

Apart from that, the study is also intended to further elaborate on efforts made

by the IFIs in ensuring the effectiveness of the Islamic banking and finance (IBF)

industry. Malaysia, standing among the pioneer countries in promoting the industry,

has become the reference country for the development of IBF, especially in Islamic

capital market. As such, being able to critically evaluate ICCS will also help the

progress of IBF industry internationally.

1.7 LIMITATIONS AND ASSUMPTIONS

For the purpose of the study, the focus is only given to the Shari’ah and legal aspect of

the mechanics of ICCS in Malaysian financial system. The study does not include the

benefits of ICCS or how it is better from CCCS. It is potentially a subject of

subsequent research that is hoped to be further discussed in the future.

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It is important to note that only two IFIs are selected for this study, which are

BIMB and Maybank. As such, the findings from this study do not represent the

operation of ICCS by other or all IFIs in Malaysia. Further research is necessary here.

Besides that, the study also includes a case study with hypothetical factual details,

designed from discussion during the interview sessions with the selected IFIs. Hence,

the calculation part is made easy to understand the mechanics of ICCS.

Another important detail on the finding is that it is not designed to capture all

the customization of the product, but just the mechanics of the product. It does not

include a case study on floating-for-floating ICCS nor the event where the final stage

of re-exchange of the principal amount takes place.

1.8 OVERVIEW OF METHODOLOGY

The research methodology adopted to achieve the objectives of this study is

qualitative approach with constructivist knowledge claim and exploratory case study

design. The importance of qualitative approach is to evaluate the Shari’ah, legal and

mechanics of ICCS executed by IFIs. The study incorporates constructivist knowledge

claim as to evaluate complexity of views and derives subjective meanings from data

collected. Exploratory case study design is adopted to help with understanding the

ICCS in depth from many perspectives derived from data collected.

Research method refers to process of collecting information and data to

accomplish the objectives of the study. The method adopted for this study is open-

ended interview sessions. The data from the open-ended interview sessions include

audio-visual, document and observation data. The data will be discussed in Chapter

Four under case study of the IFIs on their execution of ICCS.

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1.9 ORGANIZATION OF RESEARCH PAPER

Chapter One is an introductory and overview of the study, particularly in highlighting

the focus and areas that are evaluated. Following the overview, Chapter Two provides

literature reviews on the FX market in Malaysia, Islamic finance principles, the CCCS

and issues associated with ICCS written by many prominent scholars. Chapter Three

explains the research methodology adopted to achieve the objectives of this study.

Additionally, Chapter Four presents the case study based on interview sessions with

the IFIs. Chapter Five covers the result from the interview into three types of analysis,

which includes main concerns and potential Shari’ah issues, evaluation of ICCS

executed by the two selected IFIs in Malaysia and the IFIs’ effort in resolving the

issues. It also includes some recommendation to further develop the instrument.

Finally, Chapter Six concludes the entire paper.