Time to Slash Down Industry Over-reliance on Commodity Murabahah

In an effort to reduce the industry’s reliance on a limited range of Shariah compliant instruments, Jalal Khan Momand discusses the IIFM’s new risk-sharing Interbank Unrestricted Master Investment Wakalah Agreement, which the IDB hopes will meet the deficiency of instruments in the investable Islamic liquidity management market.

The international standard-setting non-profit Islamic finance industry body, the International Islamic Financial Market (IIFM), of which the IDB is a founding member, recently announced the launch of the IIFM Inter-Bank Unrestricted Master Investment Wakalah Agreement (IUMWA) at the IIFM Industry Seminar recently held in Singapore. This aspirant global standard document is supplemented with a unique feature of an Operational Guidance Memorandum that explains how the standard document is to be used and comes with additional comprehensive recommendations.

The document was developed after consulting with the IIFM Shariah advisory panel consisting of 11 Shariah scholars as well as other market players reportedly including KPMG and external legal counsel Norton Rose. The IIFM expects that: “This standard documentation for the Wakalah agreement will provide the Islamic financial institutions [with] robust, transparent, sound operational practices and Shariah harmonisation to manage their liquidity requirements, which include practices such as co-mingled asset pools as well as segregated asset pools.”

Triggering rationalities for the need of IUMWA

First, the limited options available to Islamic finance institutions to manage their asset and liability gaps due to the absence of a liquid inter-bank market and the deficiency in investable liquidity management instruments has always been a real challenge. Secondly, the over-reliance on commodity Murabahah, primarily used as a short-term whole sale liquidity management tool providing common cost-plus-profit arrangement in Islamic finance, dwarfs other Islamic money market instruments, but has been subject to severe criticism lately, with accusations of a high cost of commodity brokerage and concerns over the basic Shariah principle of real economic activity. This over-reliance situation could possibly only be resolved by introducing some substantial alternative.

Thirdly, a need has always been felt from, inter alia, practitioners, regulators, Shariah scholars and economists for diversification, standardisation and harmonisation of Islamic finance money market transactions that could help spur the growth of the Islamic financial markets. Finally, another triggering factor could probably be the fact that the Islamic financial institutions themselves, due to changes in the internal Shariah interpretations and some Shariah scholars’ attitudes of reluctance towards commodity Murabahah-based liquidity management products, were losing market confidence. Such concerns even prompted Oman’s regulator to go to the extent of imposing statutory prohibitions on commodity Murabahah last year.

Hence, the IIFM has developed a standardised Interbank Unrestricted Master Wakalah Agreement (IUMWA) that is aimed to act as a substantial alternative and a starting point for money market transactions. The agreement appears to have been widely welcomed.

Potential deliverable targets

It is hoped that the IIFM’s IUMWA will harmonise industry practices and help achieve the much-needed global standardisation of Islamic money and capital markets. It is also hoped that it could prove a substantial liquidity management alternative option to commodity Murabahah and help reduce the over-reliance of Islamic financial institutions on this instrument in managing their liquidity requirements. This might also possibly help expedite the convergence of Islamic finance practices across the various regions.

Potential alternatives to Murabahah

The growing discontent against the standard interbank commodity Murabahah, a common cost-plus-profit, primarily short-term liquidity management arrangement whereby a bank agrees to purchase merchandise for another bank that promises to buy it at an agreed mark-up; is here aimed to be replaced with a risk-sharing structure of Wakalah. Islamic Wakalah-based contractual arrangements are gaining more popularity and appear to be garnering a larger share in the Islamic interbank markets than before. It is assumed that commercial banks in Oman are also looking into substantial alternatives like Ijarah or tradable Sukuk to manage their funds.

On the other hand, the Dubai Multi Commodities Center (DMCC) is also trying to deal with the concerns about commodity Murabahah by planning to come up with further Shariah compliant solutions that might possibly improve the ways the commodity Murabahah is actually conducted. Greater ownership and risk-transferring mechanisms are apparently aimed to be introduced to ensure real occurrence of exchange of commodities rather than just a paper transaction.

Peculiar features of the IUMWA

Similar to a basic unrestricted Wakalah contractual arrangement, under the IUMWA as a master investment agreement primarily between two Islamic financial institutions for inter-bank transactions, the investor (or Muwakkil) will appoint the Wakil as its agent to invest its funds in a Shariah compliant manner, in a pool of assets selected by the Wakil, in exchange for a fee.

The Wakalah pool will be managed, as per the Wakil’s offer notice, on a segregated asset pool or co-mingled asset pool basis at the Wakil’s discretion. Comingled funds are invested collectively with Wakil’s own pool of funds and invested in the Wakil’s general treasury pool. There is a minimum limit for the investment amount and subsequent investment transactions are subject to the terms of the IUMWA and Wakalah contract. The Wakil offer notice specifies a fixed Wakalah fee to be paid to the Wakil, irrespective of the performance of the Wakalah pool, which could contractually be mutually agreed to be paid either on the investment date or the maturity date. Nevertheless, the Wakil is entitled to retain any amount over the anticipated profit rate, as a good performance bonus. Performance risks including any losses, however, are exclusively born by the Muwakkil. The Wakil could be held liable only for breach of IUMWA, willful misconduct, misrepresentation or negligence.

If the Muwakkil does not want to accept a lower profit rate it is provided with the discretion to terminate the relevant Wakalah Investment transaction and get its investment amount back, once notified by the Wakil about a possible lower than anticipated profit rate. However, as the Wakalah transaction period runs from the investment date to the maturity date, the Muwakkil cannot demand withdrawal of the investment amount before the maturity date of the relevant Wakalah investment transaction. The Wakalah transaction period could only come to an early end upon occurrence of an event of default, illegality, revision to the profit rate or mutual agreement. The calculation treatments of events of default are well defined by the document itself. The Wakil is entitled to be compensated for total actual costs and out-of-pocket expenses it has incurred in the case of early termination by the Muwakkil.

Subject to amendment by mutual agreement, well defined market standard representations and warranties, undertakings, events of default and set-off options in such events are provided by the document itself. Additionally, penalty provisions in the case of delay by either party in making a payment due, in the form of a late payment amount and actual costs incurred by the affected party, are available. However, excess of the actual costs must be donated for charitable purposes.

Conclusion and recommendation

The InterBank Unrestricted Master Investment Wakalah Agreement has yet to undergo thorough tests and trials of various industry stakeholders. Clearly claiming to be preferable from a Shariah perspective as it has been approved by 11 esteemed Shariah scholars of IIFM, it has yet to pass through the potential tests as to how the Wakalah structure for treasury type transactions can actually be put into practice. Once enacted, subsequent potential tests will be conducted as to the adequacy of the mechanisms put in place, to deal with situations in the cases of events of default, failure to earn anticipated rate, permissibility of offsetting and the extent of disclosures required for incentive fees.

Shariah compliance approval on a greater industry-wide level, regulatory and accounting requirements of various jurisdictions are also some potential challenges yet to be overcome. With regards to the operational concerns related to the product shared within Islamic finance industry, the industry could certainly benefit from the IDB’s exposure to similar operational issues in its Master Wakalah Agreement, with similar characteristics, that has already been approved by its Shariah committee and is in operation by the IDB as a risk-sharing interbank liquidity management tool. On an institutional level, the IDB’s Master Wakalah Agreement has successfully tested the operational issues pertaining to the unrestricted investment facility, allowing a co-mingled pool of assets arrangements, events of default treatments, early termination provisions and setting off arrangements etc.

The Islamic finance industry must congratulate the IIFM for its brilliant track record of taking a pioneering role in producing standard documentation for the Islamic finance industry resulting in Shariah standardisation, harmonisation, global best practices and transparency. The IIFM also deserves all due appreciation and admiration for its foresightedness and thoughtfulness in analysing the growing discontent against the standard inter-bank commodity Murabahah and accordingly responding in a timely and adequate manner to help the Islamic finance industry achieve greater compliance with Maqasid-al-Shariah and develop global best practices therein.

Jalal Khan Momand is a legal counsel with the IDB.

This article first appeared in Islamic Finance News (28 August 2013, Volume 10, Issue 34, Page 18 - 19). For more information, please visit