Towards restructuring the legalframework for payment system

in international Islamictrade finance

Umar OseniDepartment 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 systemin international Islamic trade finance vis-a-vis the new regime introduced by the Uniform Customs andPractice for Documentary Credits (UCP) 600 as well as the Sharı’ah Standard on Documentary Creditsissued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) andSharı’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’ahframework 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 applicableSharı’ah resolutions of Islamic financial institutions, does provide a good framework for aSharı’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 inthe available literature on the subject – harmonization or bifurcation of rules. The UCP 600 also allowsfor 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’ahframework on Documentary Credits, though bearing mind that there are other frameworks fordocumentary credit systems such as the International Standby Practices (ISP98) and letters of creditissued under Article 5 of the New York Uniform Commercial Code.

Practical implications – Islamic financial institutions should implement the provisions of theAAOIFI Sharı’ah standard on documentary credits but may require a different framework forinternational trade financing involving both Islamic banks and conventional banks.

Originality/value – Though few studies have been conducted on Sharı’ah issues regarding theapplication of the documentary credits, this seems to be the first time where a more proactive step istaken to propose two different frameworks for transactions involving Sharı’ah compliant financing.

Keywords International trade, Finance, Credit, Islam, Payments, Financial institutions,International trade finance, Letter of credit, Documentary credit, UCP 600, Islamic finance

Paper type Research paper

1. IntroductionIslamic finance is generally considered the fastest growing sector of the global financialsystem. This growth has been sustained even after the recent global economic plummetwith 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 theglobal financial market. However, it remains a resilient force to be reckoned with,considering its ethical approach and the need to expand Western businesses to the oil richGulf Cooperation Council (GCC) countries. With the integration of the Islamic finance

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Journal of International Trade Lawand PolicyVol. 12 No. 2, 2013pp. 108-129q Emerald Group Publishing Limited1477-0024DOI 10.1108/JITLP-10-2012-0016

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industry into the global financial system, there is an unprecedented transnational tradeintercourse among people of diverse backgrounds. This has repositioned the Islamicfinance industry as an important force for bridging the gap between the East and the West.

It is against the foregoing backdrop that this paper examines the dynamics ofinternational payment system in international Islamic trade finance through thedocumentary credit system. The latest rules for the documentary credit system introducedby the International Chamber of Commerce (ICC) is the Uniform Customs and Practice forDocumentary Credits (UCP 600) rules (Low, 2010) which is accepted and recognizedworldwide for international trade finance. Nonetheless, it is important to add that there areother frameworks for documentary credit system such as the International StandbyPractices (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 release of UCP 600 in 2007, research on the new regimefor international payment system has mushroomed and there has been growing intereston the dynamics of the system.

In a similar vein, there has been an increasing interest among few scholars to establishthe applicability of the documentary credit system of UCP 600 to the Islamic financialintermediation among Islamic banks across the world (Othman et al., 2010). While theUCP 600 is widely used by banks and financial institutions across the world, includingIslamic financial institutions, the Accounting and Auditing Organization for IslamicFinancial Institutions (AAOIFI, 2010a, b, pp. 195-211) issued its Sharı’ah standard ondocumentary credits in 2003. This paper sets out to examine the need to calibrate theexisting legal framework introduced by UCP 600 to allow for Sharı’ah-compliantdocumentary credit system for international Islamic trade finance. One of the importantquestions this study seeks to examine is whether it is possible to harmonize the UCPframework with Sharı’ah principles considering the Resolutions of Sharı’ah Boards ofmultinational Islamic financial institutions as well as the Sharı’ah Standard of AAOIFIon documentary credits.

While conceding to the fact that the current method of payment in international tradethrough the use of letter of credit (LC) as regulated by the UCP 600 – the widely acceptablegoverning law of LC – does not completely contradict the Islamic finance principles, thereare certain inconsistencies that need to be resolved through either a total overhauling ofthe current system or effecting some amendments of the system to ensure a standard,durable, feasible and viable framework for payment system in international trade. TheIslamic financial system has a lot to offer if the relevant modes of finances are injected intothe payment system in international trade.

This paper therefore examines the current framework for payment system ininternational trade with a view to recommending a viable alternative from the Islamicfinance perspective to serve as a launching pad for further networking among Islamicfinancial institutions across the world. Two frameworks will be proposed as clearlyoutlined in the available literature. First, the possibility of harmonizing UCP 600 withIslamic finance products by modifying the former to suit the needs of the Islamic economicsystem; and second, the feasibility of overhauling the UCP 600-based documentary systemof payment by producing an independent system for the Islamic banks across the word.Either of the two options will definitely be of tremendous benefit to multinationalcompanies across the world particularly those offering Sharı’ah compliant products(Abdul Gafoor, 2002; ‘Atiyyah, 1987).

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2. International Islamic trade financeThe history of international trade business among Muslims dates back to over14 centuries ago when ethical values where introduced in a society plagued withpre-Islamic exploitative practices in the Arabian Peninsula. These grand reformsintroduced through divine revelation and corresponding practices of Prophet Muhammad(PBUH) introduced a new economic order, which was later to become the bedrock of themodern practice of Islamic finance (Koehler, 2011). After a long period of decline inSharı’ah compliant international trade finance, the later part of the twentieth century sawthe gradual drift towards Sharı’ah compliant products with the re-emergence of theIslamic financial system. Given the fact that most Islamic finance products utilized in themodern international trade finance such as musharakah ( joint venture partnership),mudarabah (trust investment contract), murabahah (cost-plus financing), wakalah(agency contract), kafalah (suretyship), etc. are common products known to many withinand beyond the Islamic finance industry, this study does not intend to discuss them indetails. But the most commonly used products are discussed in the appropriate places toexplain how the International Islamic finance trade is structured.

From Singapore to Sharjah and Kuala Lumpur to Kuwait, many Islamic financialinstitutions actively engage in international Islamic trade finance through the facilitationof payments for exports and imports. From the top 345 Islamic financial institutions for2011 (The Banker, 2011), it was discovered that virtually all of them Islamic financialinstitutions considered adopt the prevailing documentary credit systems that are basedon the conventional framework which involve some non-Sharı’ah compliant elements.

2.1 The role of International Islamic Trade Finance CorporationAs part of its mission to further economic development, enhance social progress andadvance international trade of member countries, the Islamic Development Bank (IDB)established the International Islamic Trade Finance Corporation (ITFC, 2010) in May 2006but it formally commenced operations in 2008. With the primary objective of furtheringinter-trade among the members of the Organization of Islamic Cooperation (OIC), ITFC isbetter positioned as the main body for promoting international Islamic trade finance.Operating within the general framework of IDB and in broader terms, OIC, gives ITFC anuncommon opportunity to provide acceptable standards for a Sharı’ah-compliantframework for international trade financing. The IDB established the ITFC based on aninternational agreement generally known as the Articles of Agreement. Article 3 of thisagreement expressly establishes the body while Article 5 sets out the purpose ofestablishment:

The purpose of the Corporation shall be to promote trade of the member countries of theOrganization of Islamic Conference [now Cooperation] through providing trade finance andengaging in activities that facilitate intra-trade and international trade.

Meanwhile, members of the corporation were requested to domesticate the provisions of theagreement in their respective jurisdictions. A number of member jurisdictions havecomplied with this directive by domesticating the agreement to foster international trade.A good example of such jurisdictions is Malaysia, which gave effect to the agreementthrough the enactment of the International Islamic Trade Finance Corporation Act 2007(Act 669).

It is interesting to observe that in its drive towards ensuring inter-trade among the OICmembers, ITFC utilizes the documentary credit system. According to Article 8(2) (g) of its

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Articles of Agreement, ITFC has the power to “issue irrevocable reimbursementundertakings, or other similar arrangements, in connection with letters of credit issued forpurchase of goods.” It is not clear whether the ITFC has adopted the UCP 600. But sincethere is no evidence to the contrary, one may presume that it accepts any documentarysystem adopted by the OIC member countries. However, the aspect of reimbursementundertakings in connection with LC issued is a good incentive to promote internationaltrade among the concerned OIC countries. Many entrepreneurs will benefit from sucharrangement and this will afford them the opportunity to be able to favourably competewith their counterparts in the global market.

2.2 The international Islamic trade financing facilitiesDifferent Islamic banks utilize various Sharı’ah compliant facilities for international tradefinancing. It is important to briefly examine the most prominent financing facilitiesutilized in the Islamic finance industry (Mahayudin, 1997). Just like the conventionaldocumentary credits, the Islamic framework consists of a seamless web of contracts thatare hybridized in a manner where they still maintain their exclusiveness within thegeneral framework. The relevance of hybrid Islamic finance contracts within theframework of international payment system cannot be overstated considering the natureof such products and their feasibility of being structured into viable financing tools forinternational trade financing. This endeavour is necessary for further growth within theIslamic financial system particularly in transnational transactions involving two or moreIslamic financial institutions in different countries.

For the purpose of international trade, the following modes of financing and contractsare relevant: aqd al-bay (sale contract), wakalah, musharakah, mudarabah, murabahah,kafalah, ujrah (fees), and ta’wıdh (compensation). Trade financing is a very importanttool for economic regeneration in the modern crisis. Table I gives a comparison of majorfinancial instruments relevant in international trade financing from both conventionaland Islamic perspectives.

From Table I, it is clear that the conventional practice of trade financing is generallyinterest-based. In a similar fashion, international trade financing and payment is taintedwith interest-based transactions. This will be explained in details subsequently in this paperwhen the provisions of the UCP 600 are closely considered. This calls for an alternativeframework that would cater for the specific needs of the Islamic finance industry. To thisend, the major instruments for international Islamic trade financing are therefore discussedbelow in the light of the financial intermediation functions of Islamic financial institutions.

2.2.1 Islamic bank as an agent in the international trade transaction. Based on thewakalah model, which stands out in the structuring of international trade finance, the

Conventional trade financing Islamic trade financing

1. LC (fee-based) All LC (profit-based)2. Default of payment on LC (interest-based) Ta’widh compensation or damages (fixed fee)3. Percentage-based fee for LC (fee-based and interest-

based)Ujrah (fee-based)

4. Letter of guarantee (fee-based) Kafalah LC (not fee-based)5. Export credit refinancing (interest-based) Murabaha export credit refinancing (profit-

based)

Table I.Comparison of major

financial instruments ininternational trade

financing

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Islamic bank serves as an agent and duly acts for and on behalf of its client.Wakalah is anagency contract which may either be specific or general depending on the agreement of theparties involved (Ayub, 2007). Even though the rules underlying the wakalah conceptdiffer from the conventional agency contract, the two frameworks seek to serve the samepurpose in international trade finance. This is a form of an accessory contract which helpsin facilitating a process culminating in hybrid transactions. This contract is used in almostall the financial instruments. The utilitarian value of wakalah in Islamic financialtransactions has prompted its constant use in important transactions such as LC ininternational trade. In most cases,wakalahplays the role of a catalyst in such transactions.Ayub (2007, pp. 348-349) corroborated this fact where he observed that a:

Wakalah contract is used by Islamic financial institutions in respect of almost all modes likeMurabaha, Salam, Istisna’a, Ijarah, Diminishing Musharakah and activities like L/C, paymentand collection of bills, fund management and securitization [. . .] banks normally charge feesfor agency services rendered by them on behalf of their clients.

The basic rule is that Islamic banks can validly stipulate a fee for acting as agents ininternational trade finance.

2.2.2 Fees (ujrah) for services and imposition of compensation (Ta’wıdh) for defaults.Though interest-bearing transactions are prohibited in Islamic law, there is someallowance for commissions or fees for services rendered, and compensation in form ofpenalty for default of payment. Ujrah refers to commissions or fees charged for certainservices particularly in agency contracts, in Islamic finance. Fees, commissions andfixed charges for certain transactions are allowed in Islamic finance subject to the rulesof fairness, justice and mutual satisfaction (Islam, 2005). The nature of internationaltrade transactions provides for a chain of agency relationships where there is a need forpayment of ujrah. This fee should be based on the actual services rendered or a fixedpercentage of the total sum of the trade financing though many scholars do not allow apercentage-based fee for a LC. But a lump sum for services rendered is preferred(DeLorenzo, 2004). As a general rule, the fee is determined in accordance to theprevailing mercantile custom. The recently released Islamic interbank benchmark rate(IIBR) may serve as a unique indicator for benchmarking such fees (Thomson Reuters,2011).

In addition, Muslim jurists have developed the concept of compensation or damagesin the event of default of payment within a stipulated period of time. According to theResolutions of Sharı’ah Advisory Council of Bank Negara Malaysia, ta’widh is theproper mechanism to overcome the issue of default in payment by customers.The council resolved that:

[. . .] ta’widh (compensation) may be imposed on the defaulting customer who fails to meet hisobligation to pay the financing based on the following conditions: “Ta’widh may be chargedon late payment of financial obligations resulted” (sic) from exchange contracts (such as saleand lease) and qard; Ta’widh may only be imposed after the settlement date of the financingbecame due as agreed between both contracting parties; Islamic financial institution mayrecognize ta’widh as income on the basis that it is charged as compensation for actual losssuffered by the institution (Central Bank of Malaysia, 2010).

From the foregoing, it is clear that this concept can be a very useful tool in cases where theissuing bank delays the reimbursement of the money advanced to the seller in aninternational trade transaction using documentary credit. This is however subject to

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controversy among the Sharı’ah scholars, as some consider ta’widh as unlawful.Recourse to other means allowed in the Sharı’ah to handle such cases of default may beexplored.

2.2.3 Islamic banks as partners in the international trade transaction. In a somewhatdifferent form of contract when compared with the conventional international tradefinancing, the Islamic financial institutions may actively serve as partners in theinternational trade transaction (Al-Harran, 1993). The underlying contract may eitherbe based onmudarabah ormusharakah contracts, and there are situations where Islamiclaw allows for consequential or incidental contracts where the parties could opt for a newcontract arrangement through some form of restructuring of the contractual relationshipas a result of default of payment. This participative arrangement allows the parties toshare profits as well as losses and jointly own the goods in international transactions(Ahmad, 1995). These contractual arrangements generally preclude circumstances ofdefault in payment. In a well-structured arrangement, one may envisage a situationwhere the client and all the banks involved, i.e. the issuing and correspondent bank, formsuch a partnership.

These partnerships may be used as original contracts for international tradefinancing or as incidental contracts. In the latter situation, the parties mutually enter intoa new contract to hedge the risk of an existing default. That is, in a normal internationaltrade transaction involving a correspondent bank, if after receiving the necessarydocuments, the client fails to pay within the contractual period or pays a portion of theamount due, the parties may enter into a new trust investment partnership (mudarabah).In such a situation, the ownership of the goods now rests in both parties under the newarrangement and the ownership of each partner is determined by the amount each ofthem paid for the goods (DeLorenzo, 2004). Therefore, the partners (client andthe financial institution) share the profit and losses, if any in accordance to theirrespective contributions. It is however important to point out that mudarabah will bemore appropriate in situations where the client is unable to pay any amount in whichcase the bank becomes the rabb al-mal (capital provider) and the client becomes themudarib (entrepreneur). On the other hand, if the client pays a portion of the money due,the bank also contributes its own quota and, through that, the parties enter into a newjoint venture partnership. In this case, musharakah is more appropriate.

2.2.4 Islamic bank as a guarantor of payment in the international trade transaction.Two other important Islamic financial instruments that are very useful in internationaltrade financing are kafalah (guarantee) and rahn (collateral security). Kafalah is theguarantee or security for a loan since a general rule in Islamic transactions is that allloans must be repaid in due course. The law allows the lender to demand some securityfor the loan advanced to which he may have recourse in the event of failure of theborrower to repay the loan (Ayub, 2007). In international trade financing, kafalah is avery important tool by which the bank is asked to guarantee the company’s standing tofacilitate the delivery of goods to the latter. As a general rule in Islamic law, a bank is notallowed to collect a fee or commission for guarantee but may collect such fees for itsagency functions in the transaction which include fees “associated with informationcollection, cost-benefit analyses for the relevant projects, the costs of collection andpayment of relevant amounts, etc.” (Al-Zuhayli, 2002, p. 40).

The second related financial instrument is rahn (collateral security) in internationaltrade financing. It is lawful for the Islamic bank to take collateral from clients

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in international trade financing in order to secure the payment of the amount due in theLC. In a more practical manner, rather than demanding for a collateral while openinga line of credit, the parties may decide to use the goods as collateral. The goods mayremain the collateral in return for the amount paid out on behalf of the client subject tothe applicable principles underpinning a standard rahn contract. This may be a firststep towards an outright sale of the goods on behalf of the client in the event of hisinability to redeem the debt within a reasonable time (DeLorenzo, 2004).

2.2.5 Islamic bank as a seller/buyer of goods in the international trade transaction.Against the backdrop of utilizing the goods in international trade financing as collateralfor the amount due, the Islamic bank may decide to sell the goods after a reasonable time.However, it is always important and contractually humane to insert such a provision inthe underlying contract ab initio. Therefore, in the event of a default of payment or inextreme situations where the client becomes bankrupt, it is lawful for the bank tosell the goods to a third party through a contract of sale (aqd al-bay). The proceeds of thesale are thereafter used in settling the account of the client by paying the seller(through the correspondent bank). If the proceeds exceed the amount the client owes theseller, the remaining amount is returned to the client after deducting all applicableadministrative fees incurred by the Islamic bank in selling the goods. Alternatively,the bank may mutually agree with the client to purchase the goods from the latter. In thiscase, the ownership of the goods lies in the bank. When the bank eventually decides to sellthe goods, it is entitled to all the profits to the absolute exclusion of others.

As one of the most widely utilized financing techniques in the modern Islamic financeindustry, murabahah is being used in Sharı’ah compliant international trade financing(see the case study of PT Angels Products facilitated by ITFC). This is a unique mode offinancing where commodities are sold on a cost-plus basis. This cost-plus financingtechnique is a contract that is premised on trustworthiness since the seller must declarethe original price to the buyer, and any additional expenses incurred plus the amount ofprofit added. The role of the financial institutions in murabahah transactions is in formof financial intermediaries (Nethercott, 2012). In relation to international trade financing,murabahah allows the buyer to finance his purchase with deferred payments while thefinancier, the Islamic bank, will be entitled to a predetermined profit as agreed upon bythe parties (Al-Harran, 1993). The relationship between the financier and the buyer issimilar to an agency relationship (wakalah). Just like other modes of financing,murabahah is a valuable product for international trade financing. It is important to addan important procedural caveat here to avoid the abuse of this financing technique.The Islamic bank does not merely act as an agent here, as in other models, it owns thegoods once they are delivered before transferring them to the client. Hence, while thebank can conclude a murabahah transaction with the client on certain goods, the bankcannot open a line of LC before purchasing the goods from the supplier. This is premisedon the general principle in Islamic commercial law that you cannot sell what you do nothave (DeLorenzo, 2004). The order of sequence of the transactions must be strictlyobserved to avoid practices that are alien to Islamic law.

2.3 A case study of an Islamic international trade facilityThere is no doubt that the nature of modern international trade where Sharı’ah compliantcompanies need to deal with conventional companies and financial institutions hastriggered some challenges in the Islamic finance industry. This is part of the reason why

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different scholars have advocated for some sort of harmonization of the Sharı’ahframework with UCP 600 – the most acceptable documentary credit system (Hashim et al.,2012; Othman et al., 2010). Nevertheless, the existing literature on this particular issuemerely advocates for harmonization without necessarily explaining how to go about it.This is not surprising, as the process of harmonization of the documentary credit system isvery demanding and may likely become, at best, faithful endeavours on the rocks.

Therefore, it is important to consider a case study provided by ITFC, which itfacilitated successfully, using Sharı’ah trade financing facility of structuredmurabahah.Even though many Islamic financial institutions in the GCC countries and SoutheastAsia are actively involved in Sharı’ah compliant international trade financing, we havechosen this case study to establish the relevance of ITFC as a global body that should bemore proactive like the ICC in fostering Islamic international trade. The case study is thePT Angels Products – Structured Murabahah Trade Finance arranged by the ITFC.Table II presents the basic details of the transaction. The transaction is a $25 milliontrade financing by ITFC for PT Angels Products, an Indonesian sugar refiner. The ITFCdid the legal documentation and concluded the deal on October 1, 2009. While requiringPT Angels Products to pay 20 per cent of the invoice into a designated ITFC CollectionAccount, the ITFC honoured the LC opened by the supplier (Czarnikow Group). Thegoods are shipped to a designated warehouse where the collateral manager, PetersonMitra Indonesia ascertained the weight of the sugar and issued a warehouse receipt toITFC. While the goods remain under the ownership of ITFC, PT Angels Productsperiodically purchases smaller quantities of the raw sugar from the warehouse forrefining and pays into the designated collection account. Since the underlying contract isa structured murabahah, the price includes the mark-up cost and line management fee.Upon the receipt of payment, ITFC (2009) instructs the collection manager to release thequantity of raw sugar requested to the buyer.

Even though the product supplied in this case study by Czarnikow Groupheadquartered in London is generally Sharı’ah compliant, it appears the payment systemproposed by the company does not totally satisfy the requirements of such compliance.Though it is not clear from the available facts the kind of documentary credit used in thetransaction, it is more likely the main parties – ITFC and the Czarnikow Group – usedUCP. This justifies the earlier assertion that the road towards the harmonization of thedocumentary credit system with special reference to UCP 600 and the Sharı’ahframework is not as smooth as proposed by some Islamic finance experts.

PT Angels Products – structured murabahah trade finance

Mandated lead arranger (MLA) International Islamic Trade Finance Corporation (ITFC)Client PT Angels Products (Indonesian sugar refiner)Amount $25 million – warehouse financingTenor Maximum tenor of three months on revolving basisCollateral manager Peterson Mitra Indonesia (on behalf of Control Union)Supplier Czarnikow GroupDate of signing October 1, 2009

Source: ITFC (2009)

Table II.Example of a structuredinternational murabahah

financing

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3. The documentary credit system in international tradeThough there are different methods of payment in international trade, payment bydocumentary credits is the most widely used among importers and exporters acrossthe world due to its practicability, flexibility, and reliability[1]. It is the most securedmethod through which a seller can obtain the price of goods he has sold to a buyer (Dayand Griffin, 1993). In order to shed some light into prevailing practices in internationalpayment system based on UCP 600, this section briefly sets out the nature andimportance, mechanism, and fundamental principles in the documentary credit system.

3.1 The nature and importance of documentary creditsDocumentary credit is the most widely used payment system in international trade in themodern world. In simple terms, documentary credit is a promise of a banker to pay whenspecified shipping documents are presented to it (Sellman, 1999, p. 122). This is a specialarrangement with certain banks in the buyer’s and seller’s countries, respectively, tofacilitate an international trade transaction. According to Kingman-Brundage andSchulz (1986, p. 66), “[a] letter of credit is a complex, practical instrument whosegoverning principles have developed over time as a result of customary bankingpractice”. In line with the foregoing definition, Article 2 of UCP 600 defines “Credits” inthe following terms: “Credit means any arrangement, however named or described, thatis irrevocable and thereby constitutes a definite undertaking of the issuing bank tohonour a complying presentation” (UCP 600). Normally, a credit is established under anunderlying contract of sale.

“The value of this system thus lies in the security that it affords to all the partiesconcerned” (Day and Griffin, 1993, p. 155). Provided the correct documents are tendered,the seller is assured the payment of his price by the advising (corresponding) bank.On the other hand, the advising bank must receive the complete documents before theseller can draw for the price. The documents serve as security for the money disbursed tothe seller pending the reimbursement from the issuing bank. In a similar vein, theIssuing Bank receives the documents from the advising bank and holds them assecurity for payment by the buyer (Day and Griffin, 1993). Without this system therewould not be trustworthiness in international trade. This is the reason why thecourts have described documentary credits as “the life blood of internationalcommerce”[2].

Even though there are some other alternatives, the LC of most international tradetransactions are generally governed by the UCP (2007 Revision, ICC Publication No. 600)known as UCP 600[3]. According to Article 1 of the UCP 600, the rules apply to alldocumentary credits where they have been expressly incorporated into the text of thecredit. They are binding on all the parties involved in the chain of transactions. Thoughit has been observed by some experts that UCP is not law, it could be given effect of law ifadopted since it is considered binding on the parties (Bergami, 2007, p. 5). Therefore,UCP is a set of private rules which is given the force of law when parties voluntarily optfor it. Therefore, though the UCP may not be regarded as a law itself, it validly representsthe current legal framework for payment system in international trade.

3.2 Mechanism of a documentary credit transactionIn the locus classicus ofGuaranty Trust Co. of NewYork v.Hannay&Co.[4], Scrutton L.J.described the mechanism of a documentary credit transaction in extenso and further

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highlighted the reasons for its use in international trade. For a better understandingof the philosophy behind documentary credits, it is appropriate to quote his dicta on thereason behind the documentary credit system:

The enormous volume of sales of produce by a vendor in one country to a purchaser inanother has led to the creation of an equally great financial system intervening betweenvendor and purchaser, and designed to enable commercial transactions to be carried out withthe greatest money convenience to both parties (Day and Griffin, 1993, p. 155).

The modern documentary system is more sophisticated with technologicaladvancement and the emergence of complex commercial transactions. This hasresulted in the constant review of the UCP to ensure maximum security for all the partiesinvolved in the chain of transactions. As a form of collateral, it is often required that thebank retains the documents of title “for its liability on the acceptance, and the purchasercan make arrangements to sell and deliver the goods”[4].

Though there are five different contracts in a typical documentary credit transaction,one of them is an implied contract. The mechanism can therefore be briefly described inthe five stages enumerated in Table III.

3.3 Fundamental principles in documentary credit systemThere are two fundamental principles in documentary credit system, which the partiesmust honour. The first is the autonomy of the documentary credit, while the second is thedoctrine of strict compliance. As earlier discussed, the documentary credit is separateand totally independent of the underlying contract of sale between the buyer and seller.The banks are not bound nor concerned with the underlying contract[5]. This principlewas given approval by Lord Denning M.R. inPower Curber International Ltd v.NationalBank of Kuwait[6] where it was held inter alia:

Stage Contract Procedure and details

1 Underlying contract anddocumentary credit

An underlying contract of sale between the buyer(importer) and seller (exporter) in different countrieswhere it is agreed that payment shall be effected througha documentary credit

2 Issuance of LC The buyer (applicant) instructs the Issuing bank (bank athis place of business) to open a documentary credit infavour of the seller (beneficiary). The LC is issued at thisstage

3 Agreement between issuing bankand advising bank

The issuing bank arranges with another bank (advisingbank) at the seller’s place of business through a contractto negotiate, accept or pay the seller’s draft when thecorrect documents are tendered

4 Contract between advising bankand seller

A contract between the advising bank and the sellerwhere the former informs the latter that it will negotiate,accept or pay his draft upon the delivery of the stipulateddocuments

5 Implied contract between issuingbank and seller

An implied contract between the issuing bank and thebeneficiary (seller) which is an obligation to pay for thesupply of goods in contract of sale on behalf of theapplicant (buyer)

Table III.Stages of a typical

documentary credittransaction

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It is vital that every bank which issues a letter of credit should honour its obligations.The bank is in no way concerned with any dispute that the buyer may have with the seller.The buyer may say that the goods are not up to contract. Nevertheless, the bank must honourits obligations. A letter of credit is like a bill of exchange given for the price of the goods. Itranks as cash and must be honoured.

The only exception to the rule of autonomy of the documentary credit where the bankshould refuse to pay is when it is proved to its satisfaction that the documents arefraudulent and the seller was involved in the fraud. In this fraud exception, bothelements must be satisfied concurrently[7].

The second fundamental principle that relates to strict compliance is based onapparent conformity. The documents tendered must be original and comply with thedescription given in the credit. If the documents comply with the description given,the bank is obliged to pay against them (Sellman, 1999, p. 143). The mandate given tothe Issuing Bank in regards to the documents by the buyer must be complied with inline with the doctrine of strict compliance. Any bank, which pays, on non-conformingdocuments will be strictly liable to the buyer.

4. Sharı’ah rulings of Sharı’ah bodies on LCThe re-emergence of the Islamic financial system in a global scale tremendouslyrekindled the need for international Sharı’ah compliant trade financing. Theestablishment of Islamic commercial banks in the 1970s and the further developmentof the Islamic finance industry in the 1980s and 1990s saw a gradual increase ininternational trade financing by Islamic financial institutions. As expected, the Islamicfinance industry emerged as a niche of a global financial system that has crystallized overthe years. So, operating within the conventional system poses a lot of challenges toIslamic financing of international trade business. There was (or there is still) theconflicting needs to integrate into the global financial system as well as maintain theunfeigned commitment to Sharı’ah rules. In order to overcome this challenge, the Islamicbanks resorted to notable Sharı’ah scholars and Sharı’ah Boards on every aspect of theconventional payment system of documentary credit. This later brought about a numberof Sharı’ah rulings in the 1980s and 1990s and ultimately led to the issuance of the AAOIFISharı’ah Standard on documentary credit in 2003. While this section begins withother Sharı’ah rulings by international bodies, it lays emphasis on the AAOIFI Sharı’ahStandard since it is more systematic and comprehensive in its approach representing themodern codification of fundamentals of Islamic commercial rules. Specifically, thissection examines the Sharı’ah rulings of the International Islamic Fiqh Academy of OIC,the Kuwait Finance House (KFH), and of course, the AAOIFI framework.

4.1 Islamic Fiqh Academy of the OICThe ruling of the Islamic Fiqh Academy on letter of guarantee is relevant to thedocumentary credit system. Since the issue before the academy, which promptedthe issuance of the ruling, was letter of guarantee, the applicable Sharı’ah principle ofkafalah (suretyship or guarantee) was discussed among the Sharı’ah scholars and itwas resolved that since kafalah is a benevolent contract, there should not be a fee forissuing letters of guarantee. This is premised on the fact that when the guarantor ismade to pay the guaranteed sum, this will be tantamount to interest on loan generatedthrough the guarantee contract (IDB, 2010, p. 18). In other words, in the case of default

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on the part of the customer, the guarantor bank will pay the guaranteed sum. So, thecustomer is now liable to pay back the guaranteed sum paid by the bank on its behalfas well as an additional fee. Such a transaction is likened to the form of riba prohibitedin the Qur’an. Against this background, the academy resolved:

. First. It is not permitted to charge a fee for issuing a letter of guarantee (in which,customarily, the amount and the period of guarantee are considered) whether it iswith or without cover.

. Second. The administrative expenses for issuing a letter of guarantee of bothkind (sic) are permissible by Shari’a, provided they do not exceed actual expensesfor services of the same kind. In the event a partial or total cover is presented, it ispermissible to take into account, when estimate of expenses is determined, thepossible effort which may be required to provide the cover (IDB, 2000, p. 19).

It is clear that reasonable administrative expenses for issuing the letter of guarantee arepermissible but fixed fees for the amount guaranteed as part of the guarantee contractare not allowed. As will be seen in subsequent Sharı’ah resolutions, this general positionis maintained in other questions relating to letters of credit issued by Islamic financialinstitutions. For instance, the Sharı’ah Board of Faisal Islamic Bank of Bahrain followedthe same line of argument in its resolution on a similar question involving the issuance ofa LC (Faisal Islamic Bank of Bahrain, 1993; Ab Rahman, 2005).

4.2 Sharı’ah rulings on documentary credit system of selected banksJust like the first generation Islamic banks such as the Jordan Islamic Bank, Dubai IslamicBank, and Faisal Islamic Bank, the KFH has been actively involved in internationalSharı’ah compliant trade financing. Expectedly, this has spurred a number of questionsbrought before the Sharı’ah Board of the financial institution. Most of the questions relateto certain elements in the continuum of transactions introduced in the conventionaldocumentary credit system. Though these first generation of Islamic banks havedifferent modes of financing international trade through the documentary credit systemin seemingly Sharı’ah compliant methods, it has consistently strove to maintain Sharı’ahcompliance of the whole process. But the fact remains that it sometimes contract withconventional foreign companies, particularly in Murabahah LC transaction, where itcomplies with the governing law of the payment system proposed by a foreign supplier.

As earlier observed, the selected Sharı’ah rulings on documentary credit consideredhere cover a wide range of issues which were mined from the rulings reported inDeLorenzo (2004, pp. 87-117). For ease of understanding, Table IV identifies the majorquestions as well as the corresponding Sharı’ah rulings in a structured form.

The above rulings are based on the first encounter of the Islamic banks with theglobal financial system laden with strict regulations on international trade finance.However, most of the Islamic banks have overcome that stage in the history of Sharı’ahcompliant international trade finance. It may not be wrong to assert that the coming ofAAOIFI ushered in a new international regime for documentary credit albeit in form ofnon-binding standards.

4.3 The AAOIFI Sharı’ah standard on the documentary credit systemThough issues are usually brought before the Sharı’ah Board of AAOIFI for its resolutions,as an international standard-setting body, it is more proactive in its primary objective

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Table IV.Sharı’ah rulings ondocumentary credit

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of issuing accounting, auditing, governance and Sharı’ah standards to put the globalIslamic finance industry on a sound and robust regulatory footing for its products to be ableto compete favourably in the global marketplace. This section examines the AAOIFIdocumentary credit system vis-a-vis the payment system in international trade finance. Tothis end, AAOIFI issued its Sharı’ah Standard on documentary credit. Known as theAAOIFI Sharı’ah Standard No. 14, the documentary credit framework gives a generaldefinition of the system, general features of existing documentary credit systems, andgeneral Sharı’ah rulings and regulations to serve as specific guidelines for Islamic financialinstitutions that finance international Sharı’ah compliant trade (AAOIFI, 2010a).

As an international standard-setting body for Islamic financial institutions, AAOIFItakes into consideration all forms of documentary credits with a view to addressingtheir general features to guide the Islamic finance industry. This represents a modernapproach in Sharı’ah rulings, which is a step forward from the previous approachesadopted by diverse Sharı’ah Boards of Islamic banks. AAOIFI takes into considerationthe prevailing documentary system with a detailed enumeration of the different stagesof documentary credit. The reason for this is not far-fetched – Islamic financialinstitutions operate within the global financial system. It appears AAOIFI adopts theharmonization approach where it proposes Sharı’ah compliant practices within thegeneral framework of the ICC rules. Article 3/2/2 of the AAOIFI Sharı’ah Standard ondocumentary credit provides that “It is permissible to secure international transactionsusing documentary credit provided that the secured transactions do not violate therules of the Shari’a”. Furthermore, AAOIFI expressly mentions the InternationalCommercial Terms (INCOTERMS 2000) and UCP 500 (now 600) (AAOIFI, 2010a,p. 257). But it subjects these rules to the rules of Sharı’ah where it expressly states:

When the contract stipulates that its interpretation is subject to INCOTERMS (issue 2000)or the United Nation’s Convention in respect of the International sale of goods or any otherreference, then such potential interpretation is circumscribed with a condition that it must notviolate the rules of the Shari’a[8].

The foregoing Sharı’ah ruling of AAOIFI reemphasizes the legality of agency contractsas well as institutional guarantee, which automatically makes the documentary creditpermissible though subject to the overarching rules of Sharı’ah. The restrictionprovided by the standard is the prohibition of dealing in, or opening line of credit for,goods that are inherently prohibited by the Sharı’ah or contracts that are void ab intioor voidable according to the rules of Islamic commercial transactions. So, the cardinalpoint here is that the underlying contract, which triggers the opening of a line of credit,must be absolutely Sharı’ah compliant. In addition, AAOIFI allows the use of letters ofguarantee in international trade financing. Nonetheless, it introduced general Sharı’ahrules that reflect the relationship of Islamic financial institutions and correspondentconventional institutions in issues that relate to documentary credit. While referring toa universally acceptable documentary credit such as UCP 600 albeit indirectly, AAOIFImakes it clear that if such rules are incorporated into the underlying agreement:

[. . .] it is necessary to qualify such a statement with the stipulation that it will not violateShari’a rules and principles. It is preferable that the institution present alternatives that couldbe agreed upon between the institution and the correspondent banks[9].

It further adds that it is important to explicitly state in the contract that any provisionstipulating interest in the whole transaction will not be acted upon as well as any other

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trading activity that contravenes the principles of the Sharı’ah[10]. It thereforeconcludes with an important advice to Islamic financial institutions reiterating theprinciples already stated:

The institution should arrange its relationship with other institutions and correspondentbanks on the basis of non-payment of interest and avoidance of prohibited transactions withrespect to covering operations between the correspondent banks when such relationshipsinvolve settlement of inter-bank obligations resulting from documentary credit and otherbanking operations[11].

While this final advice seems interesting, the practicability of it in an increasinglyglobalized financial market leaves much to be desired. This further complicates theway forward towards restructuring the legal framework for international Islamic tradefinance. The argument seems to be lost between two major scholarly worldviews:bifurcation or harmonization?

5. Bifurcation or harmonization: UCP 600 and the Sharı’ah frameworksIt is important to begin with the clarification of the Sharı’ah framework. The AAOIFIStandard, being the most recently codified framework that represents the Sharı’ahposition is used in this section to represent the general Sharı’ah framework. From a reviewof existing literature, there are two different positions regarding the restructuring of thelegal framework for documentary credit system to accommodate the specific needs ofIslamic financial institutions. While the first is the bifurcation between the applicablegoverning law of payment system involving Sharı’ah-complaint products exclusivelyand the existing framework for conventional financing, the second relates toharmonization of the conventional documentary credits and the Sharı’ah framework.

5.1 The process of harmonization: application of Sharı’ah principles to UCP 600A general underlying principle in Islamic law of transactions is the avoidance ofdiscrepancies, prohibition of uncertainties and any form of interest-bearingtransactions. We may need to conduct a brief anatomical expose on UCP 600 in thelight of Islamic jurisprudence. It is therefore pertinent to begin with the observation thatthe arrangement of articles in the UCP 600 does not follow a logical sequence based onsubject-matter (ReedSmith Richards Butler, 2007). Articles 1-3 simply provide for theapplication of UCP, the relevant definitions and interpretations, respectively, whichare necessary for the understanding of the provisions of the rules. A new legal regimebrought by the revised UCP 600 is that every LC opened under the rules is consideredirrevocable[12]. Art. 3 provides inter alia that “a credit is irrevocable even if there is noindication to that effect”. This is confirmed by the actual definition of credit given in Art.2 which considers it as irrevocable and a definite undertaking that must be honoured.To crown it all, Art. 10 provides that a credit cannot be cancelled without the agreementof the beneficiary who, in this chain of transactions, is the seller. Since the wholedocumentary credit transaction comprises chains of contracts, we shall again apply theprinciples of Islamic law of transactions to determine the validity or otherwise of sucha stern stipulation. A contractual relationship, once concluded, is considered sacred andmust be honoured by the parties involved under Islamic law. However, there are options(al-khiyar) in certain circumstances where a party to a contract has the right to eitheraccept or rescind it depending on the nature of the issue (Ma’sum Billah, 1426/2006,p. 120). Such stipulations are usually added as part of the terms of the contract. This kind

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of contract where options have been added is called revocable contract[13]. There arestandard rules regulating revocable contracts in Islamic law of contract. But since thistranscends the scope of this research, it suffices to generally state that Islamic lawrecognizes revocable contracts[14]. Any stipulation in a contract that makes a creditirrevocable in its entirety may cause myriad of hardships, which may not be in line withthe purpose of law in Islamic jurisprudence. Therefore, it appears that such a stipulationmay be considered void to the extent of its inconsistency in the eyes of Islamic law.

Furthermore, Art. 9-11 set out the form and notification of credits with provisions onadvising of credits and amendments. Art. 4-8 and 13-16 provide for liabilities andresponsibilities of the parties based on the contractual relationship of the chain ofcontracts. Though there are various contractual issues provided for in these articlesthat are in line with the Islamic law of contract, two striking provisions call for revision.Art. 13 (b) (iii) places the burden of any loss of interest plus any expenses incurred on theissuing bank in a bank-to-bank reimbursement arrangements if reimbursement is notprovided on first demand by a reimbursing bank in accordance with the terms andconditions of the credit. In Islamic law of contract governing commercial issues of thiskind, the issuing bank cannot be held responsible for such delay in reimbursement as torequire the payment of any loss of interest. This contradicts the overarching prohibitionof interest-bearing transactions in Islamic law (Usmani, 2002; El-Gamal, 2000; Oseni andHassan, 2010; Chapra, 1985; Kahf and Khan, 1992; Masood, 1984; Mills and Presley,1999; Siddiqui, 1983). Any delay in reimbursement on the part of the issuing bank in abank-to-bank reimbursement arrangement may result in payment of extra expensesincurred in effecting the payment or service charge. In a similar vein, Art. 16 (g) providesfor a claim of refund with interest of any reimbursement already made when an issuingor a confirming bank refuses to honour the presentation of the relevant documents. Thisprovision is against the salient principles of the Sharı’ah which prohibit interest. In suchsituations, the issuing bank or confirming bank should only be entitled to claim a refundand any other service charges (such as ujrah or agency fee) as earlier explained. Anyfurther step taken that involves the computation of interest is not allowed in Islamic law.

Art. 17-28 provide for the nature of complying documents to be presented to theadvising or confirming bank. Though Art. 30 allows for tolerance in credit amount,quantity and unit prices, this may result to uncertainties which are not allowed in Islamiccommercial law. All uncertainties (gharar) and discrepancies in the amount of supply inrelation to quantity and prices are not condoned in Islamic commercial law. Allsupplies must comply with contract description. However, a waiver of discrepancies, ifany, must be with the consent of the buyer. Furthermore, Art. 31-39 largely satisfy therequirements of Islamic law of finance with different provisions relating toadministrative procedures.

A major limitation to the UCP 600 is the non-provision of the governing law andjurisdiction of the contract. When parties incorporate the rules of UCP 600 into theunderlying contract of sale, this itself constitutes a contract. Disputes arising from thiscontract or chain of contracts within the whole credit system have not been providedfor. In recent years, the problem of the proper law of this contract as well asjurisdictional issues has been raised without a definite solution. This has created anarea of uncertainties in the application of the UCP itself. The solution to this is for theseller and buyer to provide for the court of which country or arbitration institution thatwill have jurisdiction over any dispute that may arise out of the LC and the choice

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of law must be made (ReedSmith Richards Butler, 2007). The parties may consider theinclusion of this into the LC. In Islamic law, transactions tainted with uncertainties inform of gharar are prohibited.

Since harmonization of legal rules within the sphere of international trade promoteseconomic integration, one may wonder how interest matters, fees, insurance terms,contracts and indeed government rules. The proponents of harmonization of rules havenot preferred answers to these issues. It is worth of note that the available literature on thissubject, though still very rare, are from the Muslim world, broadly defined. That is, theproponents of Islamic finance tend to propose harmonization of rules but this ultimatelyboils down to the underlying philosophy behind this concept of harmonization. It thusappears that the concept of harmonization in comparative law is a common term withdifferent conceptions. The degrees of harmonization also vary particularly when it relatesto two seemingly different worldviews. Studies such as Othman et al. (2010) andHashim et al. (2012) and suggest that harmonization seems to be the way forward throughthe application of Sharı’ah principles to the conventional documentary credit system.

The proponents of harmonization of legal rules rely on Article 1 of UCP 600. Thecurrent framework of UCP 600 allows for parties to exclude the application of cetainprinciples. Article 1 allows for all the parties to modify or exclude certain provisionsfrom their credit (Othman et al., 2010). Since there are provisions in the UCP 600 thatallow for partial or total exclusion of the rules, Islamic financial institutions across theworld may make some standing rules for their customers who wish to exclude certainarticles or expressly modify the UCP by the credit[15]. While this seems to be a way outfor Islamic financial institutions, it is doubtful whether such exclusion is possible whendealing with conventional foreign companies or financial institutions. Furthermore, theproponents of the harmonization theory suggest that ta’widh could be utilized as asubstitute for the interest matters since the reference to interest in UCP 600 relates topenalty for a delayed reimbursement. With regards, to insurance and the application ofINCOTERMS, takaful (Islamic insurance) is proposed while using ex-work or free onboard (FOB) to allow the buyer to procure a Sharı’ah-compliant insurance policy fromhis or her own country (Othman et al., 2010).

5.2 Bifurcation of documentary credits into two frameworksThe second view is a step towards the total overhauling of the current payment system ininternational trade with the growing number of Islamic financial institutions across theworld. According to the proponents of this standpoint, regulatory bodies like AAOIFI andthe Islamic Financial Services Board (IFSB) could come up with internationally acceptableguidelines in form of rules for the regulation of the documentary credit based on theIslamic law of finance. It has to be established that the Islamic banks have multi-facetedroles in the global economy. Therefore, there is need for a comprehensive financial systemthat can stand the test of time at the global level. Such rules to be promulgated will bewidely used by the Islamic financial institutions across the world (Lahsansa, 2007).

Given the fact that previous research on this issue have advocated for theharmonization of the UCP framework with the Sharı’ah requirements, the current studytakes a totally different approach where it proposes a two-pronged solution. For economicintegration, harmonization of rules as proposed by AAOIFI seems to be the mostappropriate solution while the bifurcation option might be useful in transactionsinvolving only Islamic financial institutions in different jurisdictions. It is possible to have

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separate rules for the documentary credit system affecting Islamic financial institutionsalone, while other rules regulate transactions involving a mixed business relationshipwhere there are both Islamic financial institutions and conventional banks. The ITFC isin a unique position to propose separate governing rules for international Islamic tradefinancing involving exclusively Islamic financial institutions and Sharı’ah compliantcompanies. As it has undertook to promote inter-trade among OIC member countries,ITFC needs to take a step further by coming up with binding rules for documentary creditbased on the AAOIFI framework to be adopted by all OIC countries and incorporated ininternational trade contracts involving member countries.

Nevertheless, it is pertinent to observe that the default rule in Islamic jurisprudenceemphasizes on the permissibility of things and dispositions that are not expresslyprohibited under the law. Therefore, all aspects of the documentary credit system thatdo not contradict any legal text in Islamic law is deemed to be Sharı’ah-compliant, andhence, part of the law. While it is argued that global integration of Islamic finance ininternational trade is paramount in the future development of the industry, what isevident in practice leaves much to be desired. Even in circumstances where Islamicfinancial institutions trade transact with one another while adopting UCP 600, it isuncommon for the parties to practically exclude certain provisions of the rules.

6. Conclusion and policy implication for Islamic international tradeThe above exposition aims to give a basic understanding of the key principles involved inthe documentary credit system with a view to proposing areas of reforms that will suit theneeds and yearnings of Islamic financial institutions across the world. There is the need forinternational standard practice among the growing sprouts of Islamic banks and financialinstitutions across the world. It is either the Islamic banks continue to utilise the UCP 600but with certain modifications as proposed in this paper or a long-term plan is commencedto create a new legal framework for international trade payment and financing exclusivelyfor Islamic financial institutions. Whatever be the case, it is essential for the Islamicfinancial institutions to make necessary exclusions or modifications while using UCP 600.

At its core, the issues of restructuring the legal framework for payment system ininternational trade requires close attention considering the geometric growth of thenumber of Islamic financial institutions in the modern world. Though modern juristsfrom different jurisdictions have grappled with the modes of finances available withinthe general framework of Islamic finance, one thing is clear that the premise upon whichthey, respectively, base their opinions is the need to promote an interest-free economy inall circumstances. While keeping in mind the need for global economic integration, topbodies like AAOIFI and IFSB should come up with a Sharı’ah-based payment system ininternational trade, which may complement the existing framework. Alternatively, theIslamic Fiqh Council of OIC may convene an international workshop of Islamic financialinstitutions across the world to come out with acceptable standards for internationaltrade payment and financing based on Islamic law. This without doubt falls within thejuristic jurisdiction of either AAOIFI or OIC to network and engineer all the Islamicfinancial institutions in the modern world to an Islamic alternative of credit transactions.AAOIFI and other standard-setting bodies in the Islamic finance industry should notonly be seen to be reactionary in evaluating current trends in the global financial marketinfluenced by over two centuries of the practice of conventional banking, but must alsobe proactive in proposing original frameworks for the industry.

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Finally, it is important to reiterate the need to modernize and develop the Islamicfinancial system to meet the growing needs of customers without compromising an inchof Sharı’ah compliance requirements. This undoubtedly requires a review of existingregulatory and legal frameworks particularly at the international level to standardizeglobal Islamic banking practices. Within the context of this study, uniformity is requiredamong different regulatory regimes of Islamic finance at the global level to promotecross border transactions that will stand the test of time (Ibrahim, 2007). Therefore,restructuring the legal framework for cross border trade financing requires a new set ofrules that will complement the existing frameworks. Best practices in the globalpayment system should be adapted to suit the specific needs of the Islamic financialinstitutions. In conclusion, one may strike a fair balance between the two theories –harmonization and bifurcation – by proposing a middle course, which allows for globaleconomic integration through the harmonization of rules while promotingSharı’ah-complaint procedures that are exclusive for transactions involving onlyIslamic financial institutions.

Notes

1. Other notable methods of payment include direct payment (payment on open account),payment by bills of exchange, and collection arrangements. For a detailed discussion on eachof these methods of financing in international trade, see Cox (1994), Beecham and Whiting(1991) and Watson (1997).

2. See the dicta of Donaldson L.J. in The Bhoja Trader [1981] 2 Lloyd’s Rep. 256 At 257.

3. The latest revision of the UCP that governs the operation of letters of credit used ininternational trade is UCP 600, which came into effect on July 1, 2007. This is the sixthrevision of the rules since 1933 when the ICC first promulgated it. It contains 39 articles,which is a “comprehensive and practical working aid” to all parties involved in internationaltrade practices particularly in areas where payment has to be effected. As a work of a privateinternational organization, practitioners have universally accepted the UCP across the worlddespite their economic and judicial divergence.

4. [1918] 2 KB 623 at 659.

5. See Article 4 of UCP 600.

6. [1981] 2 WLR at 1241.

7. See the case of United City Merchants v. Royal Bank of Canada [1983] 1 AC 168, where theHouse of Lords held that: “To this general principle, there is one established exception: thatis, where the seller, for the purpose of drawing on the credit, fraudulently presents to theconfirming bank documents that contain material representation of fact that to hisknowledge are untrue. The exception for fraud [. . .] is a clear application of the maxim exturpi causa non oritur actio [. . .]. The courts will not allow their process to be used bya dishonest person to carry out a fraud.”

8. Article 3/2/3 of AAOIFI Sharı’ah Standard No. 14 on Documentary credit (AAOIFI, 2010a, p. 258).

9. AAOIFI Sharı’ah Standard No. 14 on documentary credit (AAOIFI, 2010a), Article 3/7/1.

10. AAOIFI Sharı’ah Standard No. 14 on documentary credit (AAOIFI, 2010a), Article 3/7/2.

11. AAOIFI Sharı’ah Standard No. 14 on documentary credit (AAOIFI, 2010a), Article 3/7/6.

12. Under the former legal regime of UCP 500, there was provision for both revocable andirrevocable credits. This was clearly envisaged in Art. 6 of UCP 500 though it favouredirrevocable over revocable credits.

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13. Such stipulations can be in form of option of session (khiyar al-majlis), option by stipulation(khiyar al-shart), option of description (khiyar al-wasf ), option of sight (khiyar al-ru’yah),option of designation (khiyar al-ta’ayın), option for fraud or deceit (khiyar al-tadlıs), option formistake (khiyar al-ghalat), option of the blind man (khiyar al-’a‘ma), option for defect (khiyaral-’aib) (Ma’sum Billah, 2006, pp. 120-129).

14. The reason for this is premised on the underlying principle in Islamic law which provides forsimplicity in the affairs of mankind and the avoidance of hardships in all circumstances.This will assist in avoiding misunderstanding among the parties and promote futurebusiness relationships. Qur’an 2: 185 provides: “[. . .] God intends for you ease, and He doesnot want to make things difficult for you [. . .].”

15. Art. 1 UCP provides: “The Uniform Customs and Practice for Documentary Credits, 2007Revision, ICC Publication no. 600 (‘UCP’) are rules that apply to any documentary credit(‘credit’) (including, to the extent to which they may be applicable, any standby LC) when thetext of the credit expressly indicates that it is subject to these rules. They are binding on allparties thereto unless expressly modified or excluded by the credit.”

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About the authorDr Umar Oseni is an Assistant Professor at Ahmad Ibrahim Kulliyyah (Faculty) of Laws,International Islamic University Malaysia and an Affiliate of the Islamic Finance Project of theHarvard Law School. Previously, he was a Visiting Fellow at Islamic Legal Studies Program,Harvard Law School, USA. He has published widely on current legal and regulatory issues inIslamic finance. He is a co-author of the first Textbook on Islamic Finance titled Islamic Bankingand Finance: Principles and Practice (Pearson Education Limited, UK, 2013 forthcoming). He isalso a co-editor of Essential Readings in Legal and Regulatory Issues in Islamic Finance (CERTPublications, Kuala Lumpur, 2013). Dr Umar Oseni can be contacted at: umaroseni@iium.edu.my

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