Friday, September 15, 2006

Short Selling and the Travesty of Islamic Finance

I received an email this morning from a young practitioner in the Islamic finance field:

Dear Professor El Gamal

I would like to pick your brains regarding some recent developments In Islamic finance, if I may.

I have just returned from an Islamic Funds conference in Dubai. I was somewhat surprised to find there was a widespread assumption amongst the fund managers speaking that taking short positions was now Islamically acceptable and basically a done deal. Names of Sharia scholars who had accepted it were bandied about

2 questions please.

1. How does it work ? I was told that there was some combination of Murabah + Arboun but no one would tell me exactly how it worked, for obvious proprietary reasons.

2. Is it a done deal Sharia speaking ?

3. If it is a done deal why is everybody not doing it ? Or are they ?

Here is my response:

Dear Mr. ______:

As I have argued repeatedly, every contract can be "Islamized" in the age of financial engineering. That is why the industry's obsession with the Islamicity of contracts, and the identities of jurists-for-hire who certify them, is a disastrous combination.

Every beginner's textbook in financial engineering shows how to synthesize short sales and leveraged buying from forwards. The easiest way to get a forward "Islamically" is with the use of salam, which has an element of short-selling already built-in. The use of `urbun as call option allows you to use call-put parity to do the same and synthesize a forward.

It is a silly game. The distinction between contracts that are "now allowed in Islam" and those that aren't is only a function of who is willing to pay sufficient fees for the rent-a-jurists to certify an engineered product, and how high are the transaction costs of the reengineering.

Those people have made a mockery of Islam.

In my recent book, I have shown in detail how to synthesize a forward from salam and a credit facility characterized as murabaha or tawarruq, depending on preference and cost. From forwards, we can then synthesize everything. That is a theorem. So, why are we wasting everyone's time with those big announcements of "the first ever Islamic this or that"? Because it is the selective prohibition of some modern practices and synthesis of others from medieval contracts that creates rent-seeking Shari`a arbitrage opportunities, and that is -- regrettably -- the nature of Islamic finance as practiced today.

Unfortunately, my interlocutor responded back with this:

Yes the Salam route was discussed but the Murabaha Arboun route was the one alluded to throughout. I will try to find out how it works.

I responded as follows:

Why do you care about the specific mechanics?

Short-selling is short-selling. So do it in the most efficient manner possible, or don't do it at all.

I obviously don't get it.


Blogger Unknown said...

Hello Dr. ElJamal,
Do you know any banks or financial institutions (or even governments) that are looking at the real intentions of islamic finance?

I think your book is a breakthrough in the way to think about islamic finance issues. How do you see the future of this approach? is it prevalent in academic circles yet? is it making it to the real-market yet? what is your vision? and what do you hope for?

2:59 PM  
Blogger Islamic Law, Etc. said...

I don't get it either.
I guess its all part of the Islamic identity politics that people are forced to play or forced into playing because of the ignorance of the masses.
One problem that I see with all of this is the problem of the "Islamic" economy.
The only way you will have a truly 'Islamic' economic policy is through staunch regulation, but that would contradict the concept of the free market which is alluded to in various hadith and is testified to by history.

6:34 PM  
Blogger Mohammad said...

I totally agree with Dr elJamal assertion.People are making a mockery out of Islam.They are only hurting themselves.AS everything is based on intention.There is a rule that says when fish stinks dont eat it.In other words Prophet pbuh has said if you have doubts about doing something stay away.
Short selling is Haram and it is very clear.We can go around it and decieve ourselves only.
Just my limited knowledge.
Hope you keep looking for the truth but listen to your heart first always.

11:56 PM  
Blogger ZSK said...

Dear Dr. El-Gamal,

I have some questions relating to Urbun agreements from a Sharia’a perspective. The facts are as follows: Seller and Buyer agree that Buyer pay Seller on Jan 1, a $5 Urbun payment for the option to buy 10 shares of company X on Jan 30 for $500. The Urbun will be credited against the payment to be made on Jan 30. At the time the Seller receives the Urbun, he owns 10 shares of company X. The Seller and the Buyer agree that if the Buyer does not buy the shares on Jan 30, he loses his $5. The Seller and Buyer agree that Buyer’s option cannot be exercised before Jan 30. No other conditions are made.

The questions:

1. Is the contract enforceable under Sharia’a?
2. Does the buyer have the right to come before Jan 30 and demand the Seller to sell the 10 shares for $500?
3. Can the Seller sell some of the shares of Company X on Jan 15, and then buy again on Jan 29 to ensure that he would be able to sell to Buyer?

Please do let me have your thoughts on this.


1:16 PM  
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Blogger Sufian said...

Hi ZSK please see my comments below

1. Is the contract enforceable under Sharia’a? YES, I think so, I can not identify any wrong element to be not Shariah compliant.
2. Does the buyer have the right to come before Jan 30 and demand the Seller to sell the 10 shares for $500? of Course no.
3. Can the Seller sell some of the shares of Company X on Jan 15, and then buy again on Jan 29 to ensure that he would be able to sell to Buyer? With some hesitation for the period from 15 to 29 Jan, but I think yes if the seller is certain that he can buy shares beofre 30 Jan.
Many thanks

1:04 PM  

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