BNM consults market on Shariah parameter for Istisna contracts

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Author: MUSHTAK PARKER | ARAB NEWS

Monday 3 January 2011

LATEST STORIES IN Islamic Finance

Bank Negara Malaysia (BNM), the central bank, last week published the draft of its latest Shariah consultation on Islamic financial products, the "Concept Paper of Shariah Parameter Reference 5: Istisna Contract (SPR5)". According to BNM, SPR5 is aimed at becoming the true source of reference on the nature and features of the Istisna contract for the Islamic financial services industry and to facilitate the consistent implementation of the contract in the Malaysian financial market.

Malaysia has championed the development of a modern scientific and systemic approach to the Shariah governance process in the Islamic finance industry. In this context, the Malaysian banking regulator started developing its Shariah parameter initiative in 2009 to provide a standard guidance on operations and application of the main Shariah contracts in Islamic finance and to promote harmonization of Islamic finance market practice in Malaysia.
The identified Shariah contracts under this initiative are Murabahah, Ijarah, Mudarabah, Musharakah, Istisna and Wadiah. Bank Negara issued consultative concept papers for Ijarah (SPRC 2) and Murabahah (SPRC 1) in July and August 2009. In December 2009, it published a draft concept paper — a Shariah parameter reference 3 (SPRC 3) on the Mudarabah contract.
This follows the publishing in October 2009 of a “Concept Paper — Guidelines on Takaful Operational Framework” which outlines the parameters governing the operational processes of Takaful business. In August 2010, BNM published a concept paper for Musharaka (SPR4), and in December 2010 it published this latest one, SPR5 on the Istisna contract. This leaves the Shariah parameter on Wadiah (current accounts) still to be finalized and published in draft form for consultation with the industry stakeholders.
This concept paper, SPR5, sets out the Shariah requirements for the application of the Istisna contract, and Bank Negara has invited all relevant stakeholders particularly Islamic financial institutions to provide feedbacks on the concept paper by Jan. 28, 2011.
According to the SPR5 concept paper, the essential elements of the Istisna contract include legal capacity of contracting parties; the offer and acceptance; and the condition that the subject matter of the contract must be lawful which in turn includes the works and asset specification.
In addition, the principal features of Istisna derived from the essential elements of the contract are a binding contract; the asset of the Istisna; the price of the Istisna; the Istisna work; and the delivery of the Istisna asset.
Indeed, there are useful illustrations of the binding nature of the Istisna’ Contract; the nature of the Asset; the price and mode of payment; and the Istisna Work and delivery. It also discusses and illustrates where applicable the enhanced features of the Istisna’ contract including parallel Istisna.
The SPR5 will serve as guidance for Istisna transactions and to ensure Istisna business activities and innovations are within their risk management capacity and do not compromise long-term sustainability of the business. The guidelines also aim to promote operational efficiency and best practices that would safeguard the interests of stakeholders and in particular participants.
As with all the SPRs and guidelines, this latest parameter on Istisna contracts is endorsed by the Shariah Advisory Council (SAC) of Bank Negara Malaysia. Specific definition and guidelines on the basis of legitimacy in adopting the Istisna contract are described to facilitate the understanding of the Shariah contract requirements.
The Shariah legitimacy extraction process is thorough and tried and tested. The features identified in this parameter, as in the previous ones, serve to assist the Islamic financial services industry to identify, understand, apply and distinguish the contract from other contracts prevalent in the industry.
The features identified and described in this parameter, as in the ones before, are extracted from the text of fatwas opined by Shariah boards or committees of financial authorities and financial institutions. For each of the fatwa, on a particular conditionality, activity, situation or context relating to the contract, the underlying concepts and principles were deduced and synthesized to guide the development of the Shariah parameter.
Bank Negara stresses that the features outlined in this parameter may serve as general guidance for the application of the Istisna contract. Any practice by the Islamic financial institutions (IFIs) that are not specified in the parameter may be conducted as long as it does not contradict the features outlined in the parameter.
In other words the guidelines that will become the actual Shariah parameter, once adopted, will be the guidelines of last resort or the apex guidelines which will be applicable to the Malaysian Islamic banking sector per se. The draft allows for other structures as long as they do not contradict the features of the Istisna’ principles outlined in SPR5.
The scope of the parameter, according to BNM, is confined to the Istisna’ contract as endorsed by the SAC of BNM and adopted by the Islamic financial institutions under the purview of the central bank.
This parameter also takes into consideration pertinent mechanisms and contracts such as Ijarah, Wa’d, Wakalah, Kafalah, Urbun and Rahn where relevant. These are identified as secondary features mentioned in this parameter.
The draft SPR5 defines "Istisna" as requesting someone to construct, build or manufacture an asset. Technically, Istisna is an agreement to sell to a customer a non-existent asset that is to be manufactured or built according to the agreed specifications and delivered on a specified future date at a predetermined selling price.
Generally, it refers to the production of materials into finished products by a manufacturer or contractor at the request of a customer. The use of an Istisna’ contract enables flexibility to the purchaser to specify the required asset in accordance to his needs and made payment based on agreed terms. In the context of modern financial practice, the construction and manufacturing of financing facilities have been structured by the Islamic Financial Institution (IFI) based on the contracts of Istisna, parallel Istisna and combination of Istisna’ and Ijarah Mawsufah fi Zimmah.
The legitimacy of the Istisna contract, says BNM, is based on the Sunnah of the Prophet Muhammad (peace be upon him) and the consensus of Muslim jurists (Ijma).

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