Forward Foreign Currency Transaction

Forward Foreign Currency Transaction

Transactions in foreign currencies, either spot or forward, are among the necessary transactions for an Islamic banking institution. In the current banking practices, delivery and settlement in foreign currency transactions sometimes do not take place on spot, at the same time and date of the conclusion of the contract. In a foreign currency spot transaction, delivery and settlement will normally take place on T+2 (two days after transaction day), whereas, in a forward transaction, settlement will be made on a pre-determined future date, for example, after one month or three months, according to the terms of the contract. There is no issue for spot currency trading, as contemporary Shari’ah jurists regarded such settlement at T+2 as spot, based on `urf tijari (customary business practice). A similar arrangement, which is based on the concept of promise, is introduced by Islamic banking institutions, whereby both parties promise to sell and buy currency at an agreed rate. As such, the actual contract takes place on T+2 for a spot transaction and on a pre-determined future date for a forward transaction. In its actual operations, an Islamic banking institution will immediately secure a contract booking number after both parties reach an agreement and promise each other. This booked contract will be marked to the market. In addition, there will be no actual signing of agreement on the settlement date. The issue from the Shari’ah point of view is whether this practice, which is based on promise, is permissible or not. Resolution The Council, in its 49th meeting held on 28th April 2005 / 19th Rabiul Awal 1426, resolved that an Islamic banking institution is allowed to enter into forward foreign currency transaction, based on unileteral binding promise (binding only on the promisor) and the compensation for breaching of promise could be implemented. This permissibility is only applicable for currency hedging purposes. Such a transaction may be arranged between the Islamic banking institution and its customers, or between the Islamic banking institutions, or between the Islamic banking institutions and conventional banking institutions. Issuer: Shariah Advisory Council, Central Bank of Malaysia.