Introduction

The International Swaps and Derivatives Association, Inc. (ISDA) and the International Islamic Financial Market (IIFM) have today published an agreed form of master agreement under which institutions may trade Shariah compliant hedging derivatives. The Ta’Hawwut Master Agreement (the Master Agreement) is, similar to the 2002 or 1992 ISDA Master Agreement, a framework agreement governing the contractual relationship between the parties, with transactions documented by way of confirmations.

Structural overview

The Master Agreement permits parties to enter into transactions which may be documented immediately (each a Transaction) as well as transactions due to occur in the future (Designated Future transactions). Using Transactions and Designated Future transactions, parties are able to create cash flows similar to the cash flows created in conventional derivatives products.

Similarities to the 2002 and 1992 ISDA Master Agreements

In many respects the Master Agreement adopts a similar approach as that set out in the 2002 and 1992 ISDA Master Agreements, in particular:

  1. condition precedent - the Master Agreement retains the right of a party to withhold payments and deliveries if an event of default or a potential event of default has occurred with respect to the other party;
  2. netting of payments - the Master Agreement adopts the same position in respect of netting of payments as provided for in the ISDA 2002 Master Agreement (payments in the same currency, due on the same date in respect of the same transaction will automatically be netted, with the ability to opt for multiple transaction payment netting)
  3. set-off - as described in further detail below, following close out of the Master Agreement a single net sum is not payable as would be the position under the 2002 or 1992 ISDA Master Agreement. Accordingly, the scope of the set-off provisions in the Master Agreement have been amended to allow such amounts to be capable of being set off; and
  4. events of default and termination events - the events set out in the Master Agreement are very similar to those contained in the ISDA 2002 Master Agreement, but have been extended to apply to Designated Future transactions

Close out arrangement

Unlike the 2002 or 1992 ISDA Master Agreements, which each provide for the payment of a single net sum following close out, the close out mechanism under the Master Agreement provides that following the designation of an early termination date (the Early Termination Date):

  1. in respect of Transactions in which all assets due to be delivered have been delivered (Fully Delivered Terminated Transactions), all payments due after the Early Termination Date shall be due and payable in full; and
  2. in respect of Transactions in which all assets due to be delivered have not been delivered (Non-Fully Delivered Terminated Transactions) and all Designated Future transactions, the Relevant Index Amount (as explained below) shall be determined.

The Relevant Index Amount is determined through market quotations and, where market quotations cannot be determined or would not provide a commercially reasonable result, on the basis of loss. In this respect the Master Agreement uses an approach similar to that set out in the 1992 ISDA Master Agreement.

In entering into the Master Agreement, each party automatically issues a Wa’ad (a promise to perform in the future) to enter into a Musawama (a contract for the sale of assets) following the designation of an Early Termination Date. The party to whom the Relevant Index Amount is due may exercise the Wa’ad given in its favour and sell pre-agreed assets in exchange for the cost price of such assets and the Relevant Index Amount. If, in breach of the Wa’ad it has issued, a party fails to purchase the assets under a Musawama, liquidated damages are determined and payable.

Documentation

The Master Agreement, and the form of schedule to be negotiated by the parties, has been published jointly by ISDA and IIFM.

Parties wishing to transact under the Master Agreement will still be required to develop confirmations to document Transactions. In addition, where parties intend to enter into Designated Future transactions, documents (each a DFT Terms Agreement) will need to be developed in order to bind the parties to enter into, and to give a value to, Designated Future transactions.