Complex Made Simple

Shariah-compliant commodity trading gathers pace in Dubai

Islamic Finance is not only dedicated to Islamic bonds (sukuk) or to funds investing in the stocks of firms which operate in a Shariah-compliant way.

It also has a prominent role to play in commodity trading. With the current boom in the commodity sector and in Islamic finance, financial institutions find themselves in a win-win-situation.

While Islamic Finance grows at an average of 20% p. a., according to Dr. David Rutledge, CEO of the Dubai Multi Commodity Centre (DMCC), the number of commodity managed funds has been growing at a compound annual rate of 98.2% in recent years.

Commodity receipt guarantees

With the Global Multi-Commodities Receipt (GMR) the DMCC offers owners of commodities a standardised system with which they can place their goods (such as gold, tea, wheat or crops) in a dedicated storage area.

By storing the goods, the owners receive a receipt, the Dubai Commodities Receipt (DCR) with which they can get a loan from a partner bank of the DMCC.

A potential purchaser who wants to acquire the assets can do so through one of the DMCC’s 16 member banks.

Since conventional loans are not permissible in Islam, Dubai-based HSBC Bank Middle East also offers the option of processing a commodity Murabaha-contract through its HSBC Amanah a long-standing player in the Islamic banking market.

Under Murabaha, the bank acquires the assets for a specific order by a customer. The bank pays for the commodities immediately at a spot price. Since interest is forbidden the financial institution then sells the entire load of goods at a deferred payment but at a higher price to the purchaser.

Reducing default risk

With the margin added to the spot price the purchase becomes permissible. The bank can reduce the default risk of the purchaser by demanding a down-payment or a letter of credit which proves the liquidity and good-standing of the customer. Murabaha is frequently used to synthesise money market transactions.

The advantage of the paperless, online-based GMR-system is 24/7-access from any place in the world. It is accessible to traders in Singapore, South Korea and Malaysia and will be soon expanding to Europe and the US.

In order to enhance Shariah-compliant commodity trading, the DMCC announced in March that it is currently setting up a separate entity called the Dubai Commodity Asset Management DCAM.

DCAM, established with an initial capital of $6.8m, entered in a joint-venture with DIFC-based Shariah Capital. The joint venture firm, Dubai Shariah Asset Management (DSAM), will be owned 51% by the DMCC and 49% by Shariah Capital.

See also:
Why many Islamic bonds are not Shariah compliant
Islamic hotels spread beyond Gulf