Sharia-compliant derivatives - a contradiction in terms?: FT

Posted by Stacy-Marie Ishmael on Feb 11 16:11.

Reuters is running an interesting story on Islamic banks’ struggles to develop hedging tools to cope with market volatility.

Not all Islamic scholars believe the use of derivatives is permitted by Sharia law - which leaves more conservative institutions with “few instruments to guard against wild swings in currency and interest rate movements,” according to the Reuters story.

“To the extent there are not enough sharia-compliant liquidity and risk management products, then clearly Islamic finance would be disadvantaged compared to conventional banks and would be less able to manage their liquidity risks,” said Hussein Hassan, head of Islamic structuring at Deutsche Bank .

The $1 trillion industry bans banking structures that are vague or ambiguous to avoid exploitation — a rule which some argue shuts out the use of common hedging instruments such as currency and interest rate swaps and futures contracts.

There are two major schools of thought on derivatives in the the world of Islamic finance. One view is that derivatives are necessarily speculative, and so would contravene the prohibition on gambling. Scholars who take this approach also tend to argue that since it is not always clear what the underlying assets referenced by a derivative are, use of the product violates the prescription that only tangible assets can be bought or sold.

The second, less conservative view is that derivatives are permitted as long as they are used solely to hedge existing positions.

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