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Salam contracts are used to purchase a good or products – with delivery at a later date – by locking in a price today.
By that very narrow definition, salam contracts appear to be no different than a futures contract. That said, by form and function, there are several differences between the two – differences that in many ways make futures (and derivatives in general) haram.
Read more about: Your Basic Guide of Salam Contracts
Salam contracts are tailored to be Shariah-compliant. They are designed to focus on real economic transactions without speculation or interest. By making it mandatory to secure payment at the time of signing the contract,
it prevents the contract from resembling a loan and warding off any potential interest payments. Furthermore, setting out specific terms on quality and delivery as well choosing standardized goods, minimizes the risks with failing to meet delivery targets as well as minimizing price speculation, thus avoiding Gharar (over speculation).
There are several elements in a standard futures contract that make it haram. For one, they allow for the use of interest – either through margin trading or other forms of leverage.
And because of the mechanisms and methods of trading them, futures, as well as other derivatives, are also break guidelines on gharar (over speculation) and maysir (gambling). We dive further into specifics below.
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While delivery of a good in a salam contract can be deferred, payment must be made immediately following the signing of a contract. Partial payment or payment in installments is not allowed, as one of the key functions of a salam contract is to secure financing for the manufacturer or procurer.
In the case of a futures contract, the buyer and seller can agree on a price ahead of the delivery, but the buyer isn’t required to make full payment immediately. Buyers and sellers deposit a margin and settle by cash payment or physical delivery.
This not only removes the protections given to the seller, but puts it in gharar territory, making it haram. “A sale is only valid under Shariah law as long as only the price or delivery, but not both, is postponed, according to a paper by the Shariah Review Bureau – an organization dedicated to assessing Shariah compliance in business and finance.
A salam contract is between a specific buyer and a specific seller, who are contractually obligated to each other. The seller is obligated to deliver the good at the designated specifications and quality at the appropriate time, at which point the buyer takes ownership.
This is fundamentally different in futures contracts, which themselves are tradeable. The buyer who initially signed the contract can subsequently sell off the contract to someone else, who can sell the contract once again.
This violates a key principle in Islamic commerce, which forbids the sale of a good that one does not own, according to the Shariah Review Bureau.
Goods in a salam contract must meet certain requirements, namely, that they must be well-defined, standardized and fungible, making them ideal for agricultural and other commodities.
This specificity isn’t required in a futures contract, whose underlying assets can vary greatly. Futures are standardized with the exception of the item being sold, the amount and the delivery date, allowing them to be traded in an exchange. The products being sold through them, however, are not.
The risks associated with a salam contract falls purely on the production side, and whether the seller of can meet the delivery, specificity and quality control requirements.
The seller would then have to contend with other forms of risk, including market fluctuations in the price of production inputs.
By design, futures contracts are tradeable. This adds an addition market risk on the buyer if they plan to sell off the contract in an exchange.
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
