* Scholar says tawarruq structure valid if conditions met
* Structure must comply with AAOIFI rules
* Structure should be part of a series of transactions
* Debate over validity has split Islamic finance sector
KUALA LUMPUR, Aug 11 - Tawarruq must meet the standards of industry body AAOIFI and cannot be a standalone funding tool, a top scholar said, outlining conditions for the use of a structure that has split the sharia banking sector.
Tawarruq is a bedrock of the $1 trillion Islamic finance industry and is widely used as a financing and liquidity management instrument.
But growing disputes about the permissibility of some forms of tawarruq under the sharia have thrown markets into disarray, with practitioners warning of catastrophic consequences if the structure were to be revoked.
Seeking to calm investor worries, influential sharia scholar Sheikh Yusuf Talal DeLorenzo said tawarruq is allowed when it is applied properly, adding arguments against it are removed from commercial realities.
"Tawarruq from my perspective has been carefully researched and explained by AAOIFI," the 60-year old American scholar told Reuters in an interview, referring to the Accounting and Auditing Organisation for Islamic Financial Institutions, which sets guidelines used by much of the industry.
"AAOIFI has developed a standard through its own methodology which is very thorough and that standard, as far as I'm concerned, still stands. There's a great deal of misunderstanding in the marketplace that's a disconnect between scholars who are actively involved in the field of finance and scholars who are not."
Other prominent sharia scholars such as Sheikh Nizam Yaquby, Mohd Daud Bakar and Mohammad Akram Laldin have also recently defended the use of tawarruq.
The International Council of Fiqh Academy, a leading industry body driven by the Organisation of Islamic Conferences, had earlier ruled organised and reverse tawarruq to be "a deception" that seeks to disguise the use of usury.
Confusion over the structure's status has been compounded by by the fact that compliance with standards of Islamic finance industry bodies such as AAOIFI and IFSB is voluntary, and there is no ultimate arbiter in case of disputes.
In its basic form, tawarruq is an asset sale to a purchaser with deferred payment terms. The purchaser then sells the asset to a third party to get funds. Organised tawarruq is similar although the transactions are executed through banks.
Reverse tawarruq is akin to organised tawarruq, although the buyer would be a financial institution seeking liquidity.
"If tawarruq were suddenly withdrawn, this would have a dramatic effect because many Islamic financiers routinely use this instrument as a means of liquidity management and to provide their customers with working capital facilities," law firm Denton Wilde Sapte had said in a note in May.
DeLorenzo, however, said tawarruq should not be used as a financing instrument on its own.
"Modern tawarruq is not intended as a transaction in and of itself. Rather it is intended as a means to an end," said DeLorenzo, a scholar of Islamic transactional law, who sits on about 15 sharia boards including AAOIFI.
"What people don't understand unfortunately is that they think tawarruq is just a way of disguising a loan. It's really a link in a transactional chain." (Click on [ID:nISLAMIC] for more Islamic finance stories and <ISLAMIC> for a speed guide)