Towards restructuring the legal framework for payment system in international Islamic trade finance

• Pages: 108-129
• DOI: https://doi.org/10.1108/JITLP-10-2012-0016
• Published date: 14 June 2013
• Date: 14 June 2013
• Author: Umar Oseni
• Subject Matter: Economics

Towards restructuring the legal

framework for payment system

in international Islamic

trade finance

Umar Oseni

Department of Civil Law, Ahmad Ibrahim Kulliyyah (Faculty) of Laws,

International Islamic University Malaysia, Kuala Lumpur, Malaysia

Abstract

Purpose – The purpose of this paper is to examine the current legal framework for payment system

in international Islamic trade finance vis-a

`-vis the new regime introduced by the Uniform Customs and

Practice for Documentary Credits (UCP) 600 as well as the Sharı

¯’ah Standard on Documentary Credits

issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and

Sharı

¯’ah Resolutions of selected Sharı

¯’ah Boards of Islamic financial institutions.

Design/methodology/approach – A partial comparison of both the UCP 600 and the Sharı

¯’ah

framework for documentary credit is given through the content analysis of relevant sources.

Findings – The AAOIFI Sharı

¯’ah Standard on Documentary Credits, as well as other applicable

Sharı

¯’ah resolutions of Islamic financial institutions, does provide a good framework for a

Sharı

¯’ah-compliant documentary credit system, which is unique to trade in Islamic finance products,

but there is scope for further improvement, taking into consideration the two possibilities proposed in

the available literature on the subject – harmonization or bifurcation of rules. The UCP 600 also allows

for the exclusion or modification of the rules to suit the specific needs of the Islamic finance industry.

Research limitations/implications – This study focuses only on UCP 600 and the Sharı

¯’ah

framework on Documentary Credits, though bearing mind that there are other frameworks for

documentary credit systems such as the International Standby Practices (ISP98) and letters of credit

issued under Article 5 of the New York Uniform Commercial Code.

Practical implications – Islamic financial institutions should implement the provisions of the

AAOIFI Sharı

¯’ah standard on documentary credits but may require a different framework for

international trade financing involving both Islamic banks and conventional banks.

Originality/value – Though few studies have been conducted on Sharı

¯’ah issues regarding the

application of the documentary credits, this seems to be the first time where a more proactive step is

taken to propose two different frameworks for transactions involving Sharı

¯’ah compliant financing.

Keywords Internationaltrade, Finance, Credit, Islam, Payments,Financial institutions,

Internationaltrade finance, Letter of credit, Documentarycredit, UCP 600, Islamic finance

Paper type Research paper

1. Introduction

Islamic finance is generally considered the fastest growing sector ofthe global financial

system. This growthhas been sustained even after the recentglobal economic plummet

with Sharı

¯’ah-compliant assets hitting a record $1.3 trillion globally by the end of 2011.

With a 25-30 per cent annual growth, Islamic finance represents about 1 per cent of the

global financial market. However, it remains a resilient force to be reckoned with,

consideringits ethical approach and theneed to expand Western businessesto the oil rich

Gulf Cooperation Council (GCC) countries. With the integration of the Islamic finance

The current issue and full text archive of this journal is available at

www.emeraldinsight.com/1477-0024.htm

Journal of International Trade Law

and Policy

Vol. 12 No. 2, 2013

pp. 108-129

qEmerald Group Publishing Limited

1477-0024

DOI 10.1108/JITLP-10-2012-0016

JITLP

12,2

108

industry into the global financial system, there is an unprecedented transnational trade

intercourse among people of diverse backgrounds. This has repositioned the Islamic

financeindustry as an importantforce for bridging thegap between the East and theWest.

It is against the foregoing backdrop that this paper examines the dynamics of

international payment system in international Islamic trade finance through the

documentarycredit system. The latestrules for the documentarycredit system introduced

by the InternationalChamber of Commerce (ICC) is the UniformCustoms and Practice for

Documentary Credits (UCP 600) rules (Low, 2010) which is accepted and recognized

worldwidefor international trade finance.Nonetheless, it is importantto add that there are

other frameworks for documentary credit system such as the International Standby

Practices (ISP98) published by the Institute of International Banking Law and Practice,

and letters of credit issued under Article 5 of the New York Uniform Commercial Code

(Wood,2008). Meanwhile, since the releaseof UCP 600 in 2007, researchon the new regime

for international payment system has mushroomed and there has been growinginterest

on the dynamics of the system.

In a similar vein, therehas been an increasing interest among few scholars to establish

the applicability of the documentary credit system of UCP 600 to the Islamic financial

intermediation among Islamic banks across the world (Othman et al., 2010). While the

UCP 600 is widely used by banks and financial institutions across the world, including

Islamic financial institutions, the Accounting and Auditing Organization for Islamic

Financial Institutions (AAOIFI, 2010a, b, pp. 195-211) issued its Sharı

¯’ah standard on

documentary credits in 2003. This paper sets out to examine the need to calibrate the

existing legal framework introduced by UCP 600 to allow for Sharı

¯’ah-compliant

documentary credit system for international Islamictrade finance. One of the important

questions this study seeks to examine is whether it is possible to harmonize the UCP

framework with Sharı

¯’ah principles considering the Resolutions of Sharı

¯’ah Boards of

multinational Islamic financial institutionsas well as the Sharı

¯’ah Standard of AAOIFI

on documentary credits.

While conceding to the factthat the current method of payment in international trade

throughthe use of letter of credit (LC) as regulated by the UCP600 – thewidely acceptable

governinglaw of LC – does not completely contradictthe Islamic finance principles,there

are certain inconsistencies that need to be resolved through either a total overhauling of

the current system or effecting some amendments of the system to ensure a standard,

durable, feasible and viable framework for payment system in international trade. The

Islamicfinancial system has a lot to offerif the relevant modes of financesare injected into

the payment system in international trade.

This paper therefore examines the current framework for payment system in

international trade with a view to recommending a viable alternative from the Islamic

finance perspective to serve as a launching pad for further networking among Islamic

financial institutions across the world. Two frameworks will be proposed as clearly

outlined in the available literature. First, the possibility of harmonizing UCP 600 with

Islamicfinance products by modifyingthe former to suit theneeds of the Islamic economic

system;and second, the feasibilityof overhaulingthe UCP 600-based documentarysystem

of payment by producing an independent systemfor the Islamic banks across the word.

Either of the two options will definitely be of tremendous benefit to multinational

companies across the world particularly those offering Sharı

¯’ah compliant products

(Abdul Gafoor, 2002;‘Atiyyah, 1987).

International

Islamic trade

finance

109