Futures trading contracts in commodity markets: an Islamic legal analysis

Abstract

The importance of derivative instruments as tools of risk management is taken for granted in the modem financial system. Many Muslim scholars have stressed the need for a prudent utilisation of such instruments in Islamic equity markets, banking and finance. However, these instruments may not be totally in compliance with Islamic principles of mu`iimaliit. This study begins with a critical review of the previous works and proceeds to analyse the forward, futures and option contracts from an Islamic point of view. The present study also highlights their economic benefits, their reason d`etre, the legal aspect of these contracts which may or may not be acceptable from shari`ah perspective and then attempt is made to propose Islamic alternative whenever they are deemed necessary and appropriate. Derivatives are used in commodities, shares, currencies, interest bearing transactions and stock indices. The scope of the present analysis is, however, limited to derivative transactions based on commodities and shares. The use of these instruments in interest rate and currencies is out of the scope of the present study due to the involvement of riba. Stocks indices are also excluded due to their indulgence excessive risk or gharar. The discussion on the forward contract includes the forward commodity market, the possibility of trading gold on a forward basis and the forward market for currencies. An analogy has been drawn between the conventional forward contract and similar contracts in Islamic law such as bay al-salam, bay al-isti$llif and bay al-~fah. The present study rebuts the claim that there is no benefit in the conventional forward contract or that it contradicts the principle enshrined in the hadith "do not sell what is not with you". Several alternatives to the forward currencies are explored and debated. Among the proposals advanced here are the concept of mutual promise (muwii`dah) which is a mutual promise of currency exchange at the spot rate of exchange. These alternatives also include the concept of mutual loan where an equivalent amount of money in different currencies is exchanged between the two parties as benevolent loan (qard hasan) and the concept of a basket of currencies where the settlement of price between the importer and the exporter is made in several hard currencies. The final alternative is the idea of a cooperative fund whereby traders will participate by depositing a certain amount of money that will be managed by a third party in order to share the profit, if any, or face any risk associated with possible currency fluctuations. My analysis of the futures contract addresses the main arguments against such a contract. I have elaborated on the concept of sale prior to taking possession, the sale of debt for debt, hedging and the relationship between speculation and margin trading and relevance, if any, of speculation to financial crisis. The present research has also examined the importance of the clearinghouse, the role of intermediaries in futures market and the regulation of the futures industry. Generally I have referred, in my discussion of these issues, to the Malaysian derivatives industry and its regulatory framework. The efficacy of trading in options is accentuated by the need to avoid the problems associated with the forward and futures contracts. The present study proposes khiyiir alshart and bay· al- `arbiin as tools of risk management and as possible alternatives to options. In this connection I have argued that option does not involve the combination of two contracts in one transaction. The present analysis also addresses the use of `arbiin in currency exchange, commodities, financial services, shares trading and salam. The sale of pure rights, as it is in the case of options, is one of the hotly debated issues raised against the permissibility of options. The present study argues in favour of the sale of such rights relying on the general principles of Islamic commercial law and by referring to specific cases where a right is sold or exchanged for money. Included among the cases I have highlighted are the sale of the right of shuf`ah or preemption, the rights of easements or huqiiqq al-irtifiiq, the right of reservation over barren land (tafylr), intellectual property right and the right of option in khiyiir al-shart. The present research also deals with the permissibility of exchanging one`s right to bargain for something; a woman waiving her right of hadiinah or custody in exchange for something, or waiving one`s right to recover one`s gift in exchange for something. Finally, the present study raises the issue of involvement or otherwise of gambling in options and provides suitable response.