Islamic Finance / Commercial Law

Here we will look at some broad aspects of commercial law that governs Islamic Finance.

In a previous article (HERE) we looked at the concept of Islamic law in general and Shariah. We discussed that commercial law (which governs Islamic banking and finance) is a part of fiqh al Muamalat.

There are two broad aspects of commercial law (or transactions law). The first concerns general guiding principles, and the second concerns specific rules.


General Principles

These can be separated into two further aspects – the first is general principles which derive from general (non-commercial) rules, and the second relates more specifically to commerce.


General rules

We have several principles that are applicable to many (or all) aspects of life in general, and these also translate across to commercial law. Here are some examples

  • do not lie – this is considered a sin, in general. And it extends to business – do not lie when entering into a transaction or making statements about the nature of the goods (in a sale contract)

  • no coercion – just as you can not force anyone to do anything against their will, you can not force anyone to enter into a contract against their will. The point being that if you are forcing them to do that, the contract is clearly not seen to be fair by the other party.

  • cause no detriment to any key aspects that are protected by law. The five key principles (Maqasid) that Shariah is designed to uphold concerns support for and protection of the following:

  1. Our deen (or faith) – we are not permitted to do anything that will compromise our faith

  2. Our life

  3. Our intellect

  4. Offspring

  5. And property or wealth

Hence any contract that negatively impacts these things will fall foul of Shariah rules.

Now let us look at principles that relate to commerce and finance in general


Commerce principles

There must be justice in contracts – this can be equated to the parties being treated justly, that contracts must be fair, and must not result in oppression or clear damage to any of the maqasid of Shariah

Transparent – the contracts should be clear to all parties, to prevent one party taking advantage of the other

Fairness – the outcome for the parties should be commensurate (in general terms) with the risk and liabilities faced by the parties. If there is a clear disconnect here, the implication is that one party is in a position of power over others, and this makes it difficult to result in a fair contract

Circulation of wealth – circulation here takes place through the exchange of value and countervalue (this includes services delivered at value)

Communal prosperity – a transaction or project that results in profit for one party but also results in negative impacts for the wider community (or society) is not permitted. This has significant resonance with aspects such as respect for the environment and social impact.

Validation of ownership – if we wish to sell something, we must demonstrably own that asset first.

As well as general principles, there are more specific rules for commerce and transactions.


Specific rules in commercial law

Riba must be avoided

Riba is vast topic, however the general understanding is that interest falls within the definition of Riba. So, interest must be avoided. This relates to both the paying and receiving of interest.

Unfair ambiguity must be avoided (Gharar)

For example in a sale contract, the asset must be described adequately, such that the seller can not substitute an inferior product.

No short selling

If you wish to sell something, you have to own it first.

No forward transactions

For example, if I purchase an asset tomorrow and agree to pay the price tomorrow, then this is a forward transaction. This is not permitted. The main reason for this is that events may occur that make this future exchange impossible, and these events may be out of the hands of either party. In fact, this introduces Gharar into the transaction

Currency

Currency can be exchanged only at spot (eg no forward currency transactions).

No trading of debt

If debt is created (and this means debt without interest, of course!) then this debt can not be traded at a market price, but it can only be transferred to another party at par (or the value of the debt) – this has significant impact on the trading of Sukuk, for example, and explains why the markets go to such lengths to ensure that Sukuk are indeed tradeable.

Derivatives

In terms of modern application of contracts, items such as derivatives are seen as questionable. This is because they often involve the payment of cash now, for the possibility to receive more (or less, or none at all) cash later. There is no genuine transaction or sale of real assets here. In practice, some derivatives are permitted for the hedging of certain risks, and I will discuss these in more detail later.

There are, of course, other general and specific rules that apply to commerce and Islamic banking, but the above is a solid base to improve our understanding of the core principles involved.

In the next article we will look at how these principles are combined to create transactions that can be executed and they do not involve interest.