Profit Rate Swap
An arrangement, which results into a similar cash flow as an interest rate swap. It is often based on Tawarruq, Commodity murabaha or Waad.
Contents
Profit-Rate Swap Using Commodity Murabaha
In a profit-rate swap (Mubadalatul Arbaah) using commodity murabaha, two parties enter into a series of separate contracts. For example, take a profit rate swap is undertaken to swap a five-year fixed rate contract for a variable rate which is adjusted annually. The fixed-rate side of the transaction is a commodity murabaha in which a commodity is sold with a markup where installment payments are equal to the fixed rate profit payments and there is a balloon payment of the pricipal at maturity in five years. Upon delivery of the commodity, it is sold for the current market price. On the floating-rate side, a commodity is sold with a markup priced with a spread over an interest rate benchmark where installments are equal to the floating rate profit payment and there is a balloon payment of the pricipal at maturity in one year. Upon delivery of the commodity, it is sold for the current market price. The parties repeat the floating-rate contract annually for five years using the interest rate benchmark at the time each contract is signed, with no contracts being dependent upon the existence of any others.
Profit Rate Swap Using Waad
In a profit-rate swap using Waad: Each of two parties issue an undertaking Waad to enter into a Murabha transaction if it is beneficial for the other party. The party out of the money at each date pays a premium above market price being the equivalent of the difference of the fixed rate versus variable rate.
Critics
The critics regarding Tawarruq apply to both methods. Addtionally there are concerns regarding the usage of two unilateral Waad from the perspective of closing the means to a forbidden end and that the two Waad amounting simply to a forward contract, which itself is prohibited by Shariah.
A counterargument is that risk management is a necessity, which could overrule a prohibition. Furthermore the formalistic differences on the contractual side show at least an effort for Sharia compliance.
Industry Standard
The International Islamic Financial Market has published in 2010 a standardised agreeement, called Ta'hawwut, which is approved by a wide variety of scholars to foster risk management among Islamic financial institutions.
References
- Uberoi, Priya; Evans, Nick: Profit Rate Swap
- Shariah Compliant Profit Rate Swap
- Developments of Islamic Swaps in Malaysia Azmi and Associates
- ISLAMIC DERIVATIVES SOLUTIONS: METHODOLOGY, ISSUES AND PRODUCT STRUCTURING WITH SPECIAL REFERENCE TO PROFIT RATE SWAP AND FORWARD FOREX Presentation by Sheikh Daud Bakar
- Profit Rate Swap templates related to the ISDA/IIFM Master Agreement
