Sharīah and Conventional Law Objections to Derivatives: A Comparison

Abstract

In Islamic finance, many scholars advise against the use of derivatives, which is still in its infancy. Conventional law even voiced its objections to derivatives as early as the 17th century. This article surveys and compares the relationship between present-day legal objections to derivatives in Islamic finance and those objections held in the past by conventional finance. It was found that objections to derivatives, held by both separate fields of finance, show similarities as well as differences. For example, both Islamic and conventional finance object to the gambling nature inherent in derivative trading; in contrast, under Sharīah law, the scope of Islamic finance’s objections is broader, including other elements such as uncertainty and ignorance. Furthermore, Sharīah scholars also object to option trading that requires payment of a fee and to futures trading that involves payment of a debt with a debt.

Islamic finance and food commodity trading: is there a chance to hedge against price volatility and enhance food security?

“…For example, both Shariah law and other civil law regulations forbid cheating, exploitation, deliberate destruction and similar unlawful and unethical actions. As reported by Kunhibava and Shanmugam (2010) with reference to Wilson (2007), following harmonized ethical rules and regulations, Islamic-driven trade is more productive and socially beneficial.…”

“…He states that modern futures instruments, being standardized, monitored and regulated, provide significant benefits for the producers and traders and the creation of Shariah-based alternatives should not be ignored by Muslims. Kunhibava and Shanmugam (2010) compare conventional and Shariah approaches to derivatives. The authors outline similarities, among which are the negative attitude towards the 'gambling nature' of derivatives.…”

Re-visiting Current Debate on Shar¯ı‘ah Position of Derivatives

“…Still, there were many dissenting voices raising concerns against the ever growing reliance on derivative instruments. Kunhibava and Shanmugam (2010) discussed objections against derivatives in detail and indicated at least two fundamental legal issues concerning derivative contracts in conventional law. The first, futures contracts hold no enforceability as they involve merely the sale of promises and no transfer of possession is made and no actual physical delivery takes place.…”

“…However gharar implies higher degrees of vagueness in the contracts regarding the subject matter, the price, or delivery, and hence, forbidden in Islam. As Kunhibava and Shanmugam (2010) mention, gharar is more general in nature and encompasses the other elements like maysir and jahālah. High risk and the uncertainty of outcome lead all qimār/maysir transactions to gharar but all the gharar transactions are not maysir or qimār (Zuayli & Eissa, 2003).…”

“…The following hadith adequately defines and sums up various elements of gharar:-The Prophet forbade two kinds of sales: i.e. al-limais and an-nibadh (the former is a kind of sale in which the deal is completed if the buyer touches a thing, without seeing or checking it properly and the latter is a kind of a sale in which the deal is completed when the seller throws a thing towards the buyer giving him no opportunity to see, touch or check it) and (the Prophet forbade) also ishtimal as-samma' and al-ihtiba' in a single garment(Kunhibava & Shanmugam, 2010).…”