In almost all contemporary Islamic Finance structures and products, a fair amount of attention is given to how assets are being possessed, transferred and how the associated risks are being allocated. Similarly, retail investments are vetted and screened to understand whether an investor has possession of the underlying asset. What’s the big deal and obsession with possession? Why is it necessary in Islamic Finance?
The Source of the Principle
The condition and requriement of possession has come directly from the Prophet Muhammad (peace be upon him).
Hakeem ibn Hizaam said: I came to the Messenger of God (peace be upon him) and said: A man may come to me wanting to buy something that I do not possess; should I buy it for him from the marketplace then sell it to him? He said: “Do not sell that which you do not possess.” (Tirmidhi)
Ibn ‘Abbas narrates that the Messenger of God (peace be upon him) forbade selling foodstuff until one has received it in full. (Bukhari and Muslim)
Understanding Possession (Qabd)
Possession refers to having asset risk and control over the asset itself. Possession enables the owner to exercise their authority and will on the asset whilst bearing the risk and liability of the asset. This is irrespective of the asset physically being with the possessor, or through an agent or digitally accessible.
A contract and possession result in two different outcomes. A valid contract generally results in the transfer of ownership, whilst risk and liability of a sale item are transferred through delivery. Only when the purchaser takes possession of the asset does he bear the risk and liability.
The burning question is, why is possession required? What benefit does possession give? Some of the underlying reasons are as follows:
1. Riba is created without possession; any increase in the sale price of the asset is unjustified without possession. Such a premium is unwarranted and is a form of Riba as it is an additional gain in a contract without taking liability.
2. Before delivery in an exchange contract, the asset risk is borne by the seller. This means that if anything happens to the asset after the sale but before delivery, the seller will have to cancel and refund the counterparty. The counterparty is not at risk until delivery; therefore his side of the bargain is guaranteed whilst the asset is in the possession of the seller. As the risk of the asset is borne by the counterparty before delivery, trading the asset before taking delivery means that you are unjustly taking advantage of his possession and risk-bearing. It is as if you are ‘leveraging’ his risk and making a gain. Leveraging another’s risk and taking the gain for oneself is not Shariah compliant.
3. Trading before delivery attracts high levels of Gharar (uncertainty) to the contract. High levels of Gharar are prohibited in Islamic Finance. There is a high level of Gharar in selling before possessing because the delivery of any asset can never be guaranteed. If an asset was sold to a third party, the second transaction would be contingent and under stress awaiting the delivery in the first transaction. A failure to deliver in the first transaction would ultimately impact the second transaction and potentially create conflict, discord and economic loss to others who were seeking the positive performance in the first transaction. This Gharar creates a layer of additional risks in contracts, and therefore this type of Gharar is not tolerated.
4. Without possession, the sale of an asset is tantamount to trading debt, which is prohibited. This is because the subject matter remains a liability. Trading the debt and liability continuously downstream can link multiple parties together, creating systemic risk. Effectively, trading debt allows the recycling and sale of one subject matter multiple times, leaving all settlements contingent on the initial transaction. This can have major consequences as has been witnessed in the Global Financial Crisis of 2008 where collateralised mortgage obligations were being traded; an entire downstream of speculators were being serviced by a single homeowner upstream. Shariah safeguards against such systemic risk and disconnects this potential risk by making possession a requirement. Thereby, the risk of multiple parties is not threaded together.
Types of Possession
There are two contractual forms of possession:
- Actual Possession (physical delivery)
- Constructive Possession (Access through whichever medium)
Actual possession is physically taking receipt of the subject matter. Physical possession symbolises power, authority, exclusivity and control over the asset, which indicates to bearing the liability and risk of the asset. It is for these reasons that classical scholars used the word ‘yadd’ (hand) to refer to possession. The ‘hand’ on the asset grants the owner these rights and powers, and the ‘hand’ symbolises power, authority, exclusivity and control.
Constructive possession refers to the transfer of power, authority and control over an asset even if one does not physically have their grip on the asset. This includes the registration of a mortgage of immovables and (hypothecation) of mobile movables like cars, trains, steamers and airplanes through registration that is valid under the law. Registration stands in place of actual possession with respect to its rules and legal effects. The possession of documents, like bills of lading and warehouse receipts, issued in the name of the possessor or acknowledging his interest therein is deemed constructive possession of what the documents represent if the ascertainment of commodities, goods and appliances is attained through them along with the ability of the possessor to undertake transactions in them.
Considering the above, the obsession of possession in Islamic Finance is a real and sound obsession. It is rather a safeguard and mercy to reduce risks, ensure the economic system is not prone to systemic risks resulting from interconnected debt transactions and protect the society from conflict and discord. Every principle of Islamic Finance is there to benefit the economy and the society. Possession is central to that philosophy.