GameStop and the question of using Salam Contracts to short shares.

GameStop stock trading saga and the news related to it have ignited various discussions in terms of ethical, digital, economic, and other aspects. It has yet again shown the power of social media and the impact it can have on the political, economic, and financial landscape especially if organized to channel the masses into taking collective action.

The events are a hot topic of discussion on Islamic finance forums as well, with discussions ranging from markets being used for gambling, Shariah aspects of participating in social media driven organized buying, ethical and compliance nature of short selling, use of commodity murabaha for short selling, etc.

However, one question that is frequently been coming up at various Islamic Finance (IF) training sessions, IF social media forums, and pre-meeting chatter in offices is the possibility of use of Salam contracts to short sell shares. The debate of using Salam for this purpose is not new, with a majority of scholars holding the view of its impermissibility.

This seems to be a perplexing position especially since Salam contracts allow the selling of assets that one does not own; a key ingredient in all short sale contracts.

Salam is a type of sale contract allowed by Shariah in which the seller sells commodities by specification, the price is to be paid in full and upfront, while the delivery of goods is to be made at a future date.

As an exception to the general rules of the sale in Shariah, it does not require the seller to own or possess the assets before selling.

Another major rule that makes people think that Salam is an exact fit for short selling shares is that Salam is only allowed for commodities that are homogenous. Hence Salam is allowed for commodities like sugar, rice, oil, dates, cars of the same make and model, etc. However, Salam will not be possible for goods that are unique or different from each other like diamonds or paintings.  

However, there are 3 reasons which make Salam contracts impermissible or impractical to use for shorting shares:

1)    Salam is a sale by specification not identification

When contracting Salam, it is required that the goods to be delivered on a future date are specified by quality rather than identification of goods. Hence when executing Salam for rice the Buyer and the Seller should specify the goods in terms of type, quality, and quantity.

In case while contracting Salam the buyer and the seller identify the goods that need to be delivered either by pinpointing or by stating the delivery should be of 100 bags of rice currently stored in Warehouse #1, the Salam contract will not be valid.

Equity shareowners are actually owners of the company. An equity share represents an undivided ownership share in the assets of the company. These assets are existing and identified in form of inventory, hardware, plant, machinery, fixture & fittings, etc.

Hence while trading the shares the parties are actually selling a share in these assets. Hence contracting a Salam contract for shares would result in a Salam contract for these identified assets which would be contrary to the rules of Salam and make the Salam contract invalid.

2)    The changing nature of shares

The underlying assets of any company are changing on a daily basis. This is specifically true in terms of accounts receivables, cash, inventory, and other short-term assets. Hence when contracting Salam for shares, the composition of underlying assets that the share represents on the contract date will be different from the day the shares are actually delivered in a Salam contract. Hence not resulting in fulfillment of the terms of the contract. The issue arises since the delivery in Salam is on a future date

3)       Salam cannot be done for commodities of a particular field.

 While executing Salam the buyer and seller cannot agree that the commodity shall be from a specific field.

Salam is a contract for future delivery hence limiting the contract to the produce of any particular field or plant would result in uncertainty or gharar in completing the delivery in case that factory or field gets destroyed, bankrupt, or ceases to produce for any reason.

The requirement of not identifying the field reduces the gharar by allowing the seller to purchase the subject matter of Salam from the market and honor the delivery in the Salam contract on the delivery date.

The same issues would arise, in the case of equity shares since the shares are of a particular company. In case subsequent to the contract of Salam the company files for bankruptcy, shares are banned from trading, are not available for trading due to limited float, or any other reason the seller will not be in a position to honor the delivery under the Salam contract.   

 Suleman Muhammad is the Head of Products at Muzn Islamic Banking. He specializes in providing Islamic structuring solutions and trainings to clients, businesses, and financial institutions.

The views expressed by the author are his personal.