The Future: Blockchain for Islamic Trade Finance
15.59 Blockchain technology is a new infrastructure for storing data and managing software applications.
It is essentially a database comprising records of multiple transactions which are collected into a block. A block of entries is recorded in electronic form and contains a cryptographic hash of the preceding block, which allows the blockchain to be linked together. These are stored as a ledger and can be distributed globally without a central repository.[1745] Essentially, anyone with an internet connection can retrieve information stored on a blockchain, allowing parties to engage directly with one another for a number of reasons including storing information, transferring value, and coordinating social or economicactivity. Furthermore, the transnational peer-to-peer networks upon which blockchain relies enable people to store non-repudiable data pseudonymously and in a transparent manner. When data is stored on a blockchain, its distributed network and consensus mechanisms and other characteristics, make it exceptionally hard to change or delete. No single party has the ability to modify or revise information once it has been recorded, lending it a great deal of transparency. However, the use of digital signatures and public-private key cryptography allows persons storing information on a blockchain to engage in transactions privately, without revealing their identity.[1746]
15.60
Trade-finance transactions can be given effect through blockchain-based smart contracts.[1747] Smart contracts are computer programmes that, once information has been given as an input, process that information according to rules set out in a contract and carry out actions as a result.
Consisting of binary ‘if... then' statements, terms are given as an input which, when fulfilled, are given effect. Smart contracts are automatically self-enforcing, meaning that they are able to carry out these actions without the intervention of a third party, reducing or possibly even eliminating the need for human oversight. Importantly, even though parties may have different incentives and are located in disparate countries, no single party can affect the execution of the smart contract’s code. In this way, the parties can be assured that the contract will be performed irrespective of their trust in the other party. They must only trust the blockchain, which is capable of enforcing the parties’ contractual terms.[1748] Smart contracts can be used to deal with basic economic transactions at a lower cost, higher speeds, and with greater reliability.[1749] Blockchain used in combination with a smart contract will create a trade, logistics, and supply chain infrastructure which incentivises Islamic trade finance to become significantly more efficient and transparent. These technologies will compel the industry to overcome its attachment to legal artifice in favour of adopting substantive trade practices that are more closely aligned with Islamic commercial principles.15.61
Trade finance, in particular letter of credit transactions, involves multiple stakeholders and is highly labour and paper intensive. Trade transactions are not yet digitalised in spite of a spate of recent efforts. A single shipment of roses from Kenya to Rotterdam generates a pile of paper 25cm high, while the cost is higher than the shipment of containers. On average more than 100 stakeholders are involved in this type of shipment.[1750] These interactions are highly costly and have led a number of banks to explore blockchain as a means of automating the process, improving efficiency and enhancing security.
Numerous proofs of concept have been developed successfully in the last few years and blockchain’s commercial application is imminent. For example, in 2016, the Bank of America Merill Lynch, HSBC, and the Infocomm Development Authority of Singapore developed a prototype using blockchain which mirrored a paper-intensive letter of credit transaction. Information between exporters, importers, and their respective banks was shared on a permissioned blockchain, which was then executed through a series of smart contracts.[1751] The prototype transaction illustrated that blockchain can streamline financial flows and enhance the security, transparency, speed, and reliability of supply chain financing. Smart contracts will help to streamline trade finance transactions, particularly those related to conventional letter of credit transactions and its nearly identical Islamic alternatives. The technology will make the role of some involved parties, such as correspondent banks, redundant.[1752] Notably, however, a murabaha transaction for trade-finance purposes still necessitates the involvement of the bank as a seller as a loan with interest is not permissible under sharia. In sum, blockchain has the potential of levelling the playing field in relation to logistics and related party costs, which would be particularly helpful as companies from developing countries are faced with costs almost double that of their developed country peers.[1753] These costs are the result of extensive paperwork and the fact that a wide array of stakeholders involved in border and customs procedures.15.62 Islamic trade finance, not unlike its conventional counterpart, has traditionally catered to mid- and large-sized businesses. The complexity and cost of murabaha-based trade finance has limited its scope as the industry has not been able to extend its sources of revenue.
Murabaha-based transactions include complex contractual drafting including numerous security documents, multiple legal opinions, seller-issued fatwas (Islamic legal opinion), and credit and payment services comprising a higher level of counterparty risk. These processes have made them unaffordable for smaller businesses, particularly those in developing countries where SME access to finance is particularly low.[1754] The use of blockchain may open up the industry to these smaller players by creating a marketplace that is open to any importer or exporter. Blockchain reduces the degree of coordination effort amongst numerous stakeholders involved in a trade financing transaction by allowing all of the tradefinance information to be brought into one trusted environment that can be accessed by the interested parties. Typically, stakeholders act in silo and in a sequential manner. Records, such as those of shippers, export brokers, import customs, banks, and transportation providers, are kept separately. Any party can alter them, which makes the process vulnerable to fraud.[1755] Where multiple authorisations are required for the export of a product, blockchain allows an exporter to submit the information just once. Agencies involved with the platform would then be able to validate the transaction or issue relevant documents.15.63 A smart contract can easily be programmed to give effect to a murabaha-based tradefinance agreement between the buyer (importer) and seller (Islamic bank). The murabaha
sales agreement, including security documents, fatwas, and legal opinions, can be recorded on a smart contract and shared between the importer (buyer) and the exporter (seller) and the supplier. The smart contract also allows for recording the details of any agency agreement between the buyer and the seller in relation to the purchase of the asset or commodity.
In real-time the Islamic bank or its buyer/agent will have the capability to review the agreement and to carry out the purchase of the goods on behalf of the importer/buyer. Once the goods are purchased, the seller can initiate a second smart contract detailing the sale of the goods to the buyer. As Islamic commercial law requires a separate meeting of the minds for each contract of sale, an entirely self-executing smart contract would contravene its rules, which are meant to provide clarity to contracting parties and thereby avoid gharar. Therefore, smart contracts incorporating murabaha transactions would require the same binding promise (wad) which, while putatively allowing the transactions to be carried out individually, binds the buyer to a legally enforceable purchase undertaking. The parties' agreement would still be required prior to each sales transaction, which, while slowing the execution of the smart contract, does not wholly denude the technology of its numerous advantages.[1756] Blockchain's facilitation of easy access to data and end-to-end transparency of the entire value chain would create a level playing field for all parties involved in a trade transaction. The exchange of trade data including the trader's credit history increases the speed, efficiency, and security of financing.color=black face="Times New Roman">[1757] Other events along the supply chain such as a customs agent's confirmation of approval or the approval of a bill of lading would not require action by the bank.15.64
The code of a smart contract is remarkably similar to many terms and conditions normally found in a contract. There has been a good deal of debate amongst legal scholars as to whether a smart contract constitutes a legally valid contract.[1758] The balance of arguments now weighs heavily in favour of smart contracts being fully capable of giving rise to a legally binding contract under English and American common law as well as Spanish civil law legal systems.[1759] A judicial taskforce of the United Kingdom has concluded the same in a much anticipated public statement.[1760] The sharia is capable of viewing smart contracts similarly as Islamic jurists are primarily concerned with the avoidance of prohibited elements in transactions, ie riba and gharar as well as what is recognised as legitimate property, eg excluding alcohol, pork, pornography, and armaments.
The rules of contract formation, vitiating factors, and remedies have largely been outsourced to municipal systems of law such as English and New York law which are the vehicular legal systems in which crossborder Islamic finance contracts are given effect. Jurists have been prepared to treat Islamic contractual rules far more flexibly than these seemingly fixed prohibitions as reflected in numerous contractual practices including the binding promise (wad) discussed above. Subsidiary rules can change with time and place and societal developments such as technological advancement.[1761] Moreover, legal stratagems known as hiyal are widely viewed as necessary tools which allow Islamic law to adapt to modern financial markets.[1762] Hiyal are the means by which legal theory can be put into practice, narrowing the gap between ideals and reality.[1763] Classical Hanafi jurists, in particular, viewed hiyal as the means by which one could make lawful that which otherwise is unlawful; to create what the Hanafis called ‘makharij (singular: makhraj) or ‘exits’.[1764]15.65 Some have argued that an agreement to execute the code could be legally valid so long as the terms of the code was expressed in human language.[1765] Indeed, more abstract legal concepts such as ‘force majeure’ or ‘good judgement’ may require a broader contractual framework, particularly in relation to complex transactions and associated definitions of non-operational clauses such as choice of law, competent jurisdiction, or any dispute resolution mechanisms.[1766] Furthermore, a written agreement has the advantage of providing a roadmap of the parties’ contractual intentions as these may need to be investigated should the code give effect to unwanted outcomes. This is particularly so given the irreversibility of smart contracts which makes it nearly impossible for the code to be changed or stopped once the process has been activated. The outcome is recorded on the blockchain and is immutable.[1767] While the immutability of the code is designed to minimise or even abolish disputes, inevitably human language which feeds into code is prone to error or ambiguity and disputes will arise. Because smart contracts are either in the process of being executed or have already been executed, the aggrieved party will need to go to the court to remedy a contract. In all cases, the remedy must come after the execution of the contract and reference to an agreement in human language will be necessary.[1768] The sharia is capable of accommodating these operational requirements so long as its major principles remain intact.
15.66 A number of legal, regulatory, and interoperability issues must be addressed, particularly in less developed countries, for the technology to deliver its potential. While a more detailed analysis is beyond the scope of this chapter, one final observation regarding electronic communications legislation is warranted due to its significance. Legislation recognising the validity of e-signatures, e-documents, and e-transactions including blockchain transactions is essential.[1769] A robust regulatory framework for the digital market is crucial in supporting consumer trust. Yet many developing countries have lagged behind in promulgating ecommerce legislation and other aspects of their legal systems such as consumer protection laws and data protection laws, which may explain why many consumers in developing countries actively engage in social media while they abstain from online shopping.[1770]
VII.