Islamic derivatives contract soon

The launch of the first template for an over-the-counter Islamic derivative contract is "imminent", an executive at a bank involved in its creation said yesterday.

The contract, which is expected to pave the way for quicker and cheaper Islamic risk management and more frequent cross-currency transactions, was initially due to be launched a year ago. "It will be launched imminently," Simon Eedle, Managing Director of Islamic Banking at Credit Agricole CIB, said at a summit yesterday.

The bank, as well as the IIFM, an industry body backed by the central banks of several Muslim countries, has been working with the International Swaps and Derivatives Association (ISDA) on the contract.

The contract – to be known as Ta'Hawwut or hedging – would create a standard legal framework for OTC derivatives in the Islamic market, whereas currently contracts are arranged on an ad hoc basis.

"It will save time," Eedle said, adding that it will also help the industry in managing its asset liabilities.

OTC derivatives, or swaps, are privately negotiated deals between investors and counterparties and are commonly used to hedge against interest rate risk and default risk.

Islamic institutions have limited access to derivative products mainly because Islamic law requires the underlying assets in any transaction to be tangible.

ISDA's endorsement of the template will mean it will be quickly be accepted by banks and institutions, Eedle said.

"The fact that it is endorsed by ISDA will force the Western banks on to the standard very quickly, because the risk culture in conventional banks is to adopt market standards," he said.

In addition, institutions with doubts over the legitimacy of using these instruments to hedge their risks may now be more easily persuaded to do so, he said.

Islamic scholars are split on the legitimacy of derivatives; some see them as permissible instruments to hedge risks but others as speculative transactions, which Islam forbids.

Some Islamic operators have used a contract known as Arbun to replicate call options. "Of course on the balance of it, we don't want the agreement to encourage speculation. This documentation is not produced to to encourage a replication of conventional banking," Eedle said.

In November 2006, Malaysia's Bank Islam and Bank Muamalat Malaysia, agreed to execute a derivative master agreement for the documentation of Islamic derivative transactions.

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