United States: Structured Thoughts: Sharia-Compliant Structured Products

The same features that continue to attract investors to structured products have recently garnered the interest of Islamic investors. Structured products provide retail investors with access to sophisticated payout structures and allow exposure to particular underlying securities in which a direct investment may be impossible or prohibitively expensive. As the international securities markets begin to show signs of renewed life, issuers will likely position themselves to take advantage of the largely untapped market of Sharia-compliant structured products. In this issue of Structured Thoughts, we explore some Sharia-compliant mechanisms that issuers can synthesize into Sharia-compliant structured products.


There are three broad principles that underlie the majority of the rules of Islamic finance. First, Sharia prohibits riba, which is generally considered to be equivalent to loan interest (this particular type of riba is also called ribaal- naseeyah). The restrictions of riba, however, are arguably broad enough to include any practice where one party profits without assuming any risk. For example, the exchange of a certain amount of a commodity for a different amount of the same commodity is prohibited as a form of riba called riba-al-fadl.

The second prohibition lies on the other end of the risk-taking spectrum. Specifically, Islam prohibits the practice of gharar, which roughly translates to "uncertainty" or excessive risk taking. Under this principle, Sharia prohibits speculative practices and practices where at least one party to a contract is excessively uncertain of the outcome of the contract. The uncertainty can relate to any part of the contract, including consideration, payout, and tenure.

The third and most straightforward rule prohibits investment in companies that engage in haram (i.e., forbidden) activities. Haram is a broad term that includes dealing in pork-related foods, alcohol, gambling, and pornography. A company's capital structure is also relevant in that the company may not derive a substantial portion of its revenue from practicing riba, nor can it rely heavily on interest-bearing loans to maintain its operations. Investors commonly employ an equity screen to comply with this rule. For example, Dow Jones Islamic Market IndexesSM (DJIM) applies the following exclusionary screens: 1

Industry Screens

Financial Ratio Screens

  • Alcohol
  • Pork-related products
  • Conventional financial services
  • Entertainment
  • Tobacco
  • Weapons and defense

None of the following may exceed 33%:

  • Total debt divided by trailing 12-month average market capitalization
  • The sum of a company's cash and interest-bearing securities divided by trailing 12-month average market capitalization
  • Accounts receivables divided by trailing 12- month average market capitalization

While the above screen may prohibit investments that are in, or linked to, bank holding companies that operate conventional banking subsidiaries, it does not necessarily bar investments in securities issued by an Islamic subsidiary of a bank holding company. Sharia scholars generally agree that it is permissible for bank holding companies to offer Islamic banking services through wholly owned Islamic subsidiaries.2

Principal Protection

Although principal protection seemingly violates the prohibition of risk-free profit, the economic effect of principal protection can be achieved by combining different Sharia-compliant structures. Here, we describe a principal-protected structured note that could be linked to a single stock, a stock basket, or a commodity (the "underlying"), and is based on combining a murabaha contract with a arbun sale.

Murabaha: A murabaha contract is a sale with a markup. Commonly, murabaha contracts are used in purchase financing arrangements where the financier agrees to purchase an item at the market price, then sells the item to its client at a markup on a deferred payment basis. In this example, the issuer of the notes (the "SPV") will be the financier and will sell a commodity to an Islamic bank on a deferred payment basis.

Arbun: A arbun payment is equivalent to a down payment towards the purchase of a specified item at a specified price, and within a specified time frame. If the buyer decides not to purchase the item, or if the specified time lapses, the seller may keep the arbun. The buyer, however, may decide to purchase the item at the pre-specified price at any time during the specified period.3 Arbun sales have been used to synthesize call option behavior since conventional options generally fail the gharar test described above.

Figures 1.1 & 1.2: Principal-Protected Structured Product

$C= Arbun (down payment/call premium) amount
$K=Agreed upon price of underlying in Arbun contract (strike)
$P= Spot price of underlying at maturity (t=T)

As described in Figure 1.1 above, an Islamic investment fund (or SPV) will enter into two agreements with an Islamic investment bank at settlement. The first is a murabaha contract in which the SPV sells $100-$C worth of a commodity to the bank in exchange for $100 at maturity. The SPV will purchase the commodity used in the murabaha contract from the open market at spot. The second is a arbun contract granting the SPV the right to purchase the underlying at maturity for $K (the strike price). The price of the underlying at maturity ("P") determines the payout to the investor as follows:

Scenario 1: $P is greater than $K: As shown in Figure 1.2, if P is greater than K at maturity, the SPV will choose to complete the arbun sale and will receive the underlying security at K. The SPV will subsequently sell the underlying in the open market for P and remit $P - $K to the investor. The SPV will also receive $100 in murabaha proceeds from the Islamic bank, which it will also remit to the investor.

Scenario 2: $P is less than or equal to $K: Here, the SPV will not complete the arbun sale forfeiting $C. The SPV will, however, still receive $100 in murabaha proceeds, and will remit that amount to the investor.

Therefore, the payout to an investor, as shown in Figure 2, is identical to the payout on a conventional uncapped, unleveraged, principal-protected note. Figure 2 assumes the strike price ($K) to be equal to the spot price of the underlying at settlement.

Figure 2: Payout on a Principal-Protected Sharia-compliant note

Choice of Market Measure

While the principal-protected structure described above is applicable to structured notes linked to a market measure that can be easily exchanged through a arbun contract, investors are likely to seek exposure to a wider range of market measures, such as foreign exchange rates, fund shares, or economic indicators. The structure described below provides this exposure by using two mutually exclusive bilateral promises (each a wa'd) between the issuer and an Islamic investment fund.

Figures 3.1 & 3.2: Dual Wa'd-Based Structured Product

$P0= Spot price of underlying at pricing (t=0)
$PT= Spot price of underlying at maturity (t=T)

In this structure, the SPV purchases a commodity from the open market using the proceeds from the sale of the notes. At the same time, the SPV unilaterally promises to the sell the commodity to the Islamic Bank at the settlement price, and the Islamic Bank unilaterally promises to purchase the commodity for the same settlement price. The parties will agree to calculate the settlement price at maturity as a function of the change in the value of the underlying market measure.

At maturity, the Islamic Bank will purchase the commodity from the SPV at the settlement price since it will be profitable for one of the parties to enforce the other's unilateral promise regardless of the then market value of the commodity. More specifically, if the price of the underlying increases from pricing to maturity, the SPV will hold the bank to its promise to purchase the commodity. Conversely, if the price of the underlying decreases from pricing to maturity, the bank will hold the SPV to its promise. Given that the Islamic Bank will own the commodity at maturity, the choice of commodity could be critical, since it could provide a built-in hedge for the bank.

The dual wa'd structure is employed here because Sharia prohibits sales contracts in which the price is not fixed when the parties enter into the contract. Some Sharia scholars hold that unilateral promises, however, are not subject to the same restrictions as sales contracts, and allow for a greater degree of uncertainty. For a more detailed discussion of the Sharia concerns related to this structure, please see Deutsche Bank's academic paper discussing the subject.4

The effectiveness of this structure depends heavily on the enforceability of unilateral promises, and the Islamic finance community has not yet reached a consensus on this issue. Some jurists hold that enforcing dual unilateral promises amounts to an impermissible forward contract; others will enforce a promise only if the promisee reasonably relied on the promise to their detriment; and some will enforce dual promises as long as no other part of the agreement is impermissible.


It is important to note that the Islamic finance industry is in a state of flux, and that prevailing jurist opinions may differ substantially across jurisdictions. It is advisable, therefore, to remain attuned to the publications of the Islamic Financial Services Board (IFSB), the Islamic Fiqh Academy, and the Accounting and Auditing Organization for Islamic Finance Institutions (AAOIFI).


1. Dow Jones Islamic Markets, "Dow Jones Islamic Market IndexesSM World Measures with a New Perspective," http://djdharmaindexes.com/mdsidx/downloads/brochure_info/Islamic_broch.pdf.

2. See, e.g., About HSBC Amanah, http://www.hsbcamanah.com/amanah/about-amanah/; About Citi Islamic, http://www.citibank.com/ciib/homepage/aboutus/intro.htm.

3. See Decision number 72(3/8) Regarding Arbun Sale (June 27, 1993), Islamic Fiqh Academy. (Decision available in Arabic at http://www.fiqhacademy.org.sa/qrarat/8-3.htm).

4. Press Release, Deutsche Bank AG, "Deutsche Bank publishes White Paper to increase supply of Sharia compliant alternative investments" (January 30, 2007), http://www.db.com/presse/en/content/press_releases_2007_3347.htm

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions