Derivative Instruments and Islamic Finance: Some Thoughts for a Reconsideration

This paper examines contemporary derivative instruments and the Islamic viewpoint of these new instruments. The validity and permissibility of these instruments appears to vary by scholar. Even where Islamic scholars have found them to be objectionable, their reasons for objection differs. Much of the work by Islamic scholars has been of a highly juridical nature. They examine derivatives within narrow confines of contractual arrangements and thereby miss the broader picture of why instruments like futures and options are needed in modern business environments. This paper analyzes forwards, futures and options, examines the evolution of these instruments, their unique benefits and makes a case for why they are needed. Islamic Finance instruments with derivative like features such as the Ba’i Salam and Istijrar contracts are also examined. Some of the key concerns that Islamic scholars have regarding derivatives is addressed. The paper is divided into four parts. Part 1, outlines the objective and introduces derivative instruments. Part 2, examines the Islamic viewpoint and shariah conditions for financial instruments. Part 3, examines Ba’i Salam and Istijrar contracts. Part 4, clarifies why some of the objections of Islamic scholars regarding features and trading mechanism may be misplaced and concludes