ISDA to launch sharia-proof derivative standard

A global derivatives organisation plans to launch standards for over-the-counter Sharia-compliant derivative contracts, opening further growth opportunities for Islamic finance.

The template for the contracts should be available early next year and would offer a key tool in Islamic-compliant risk management, the International Swaps and Derivatives Association (ISDA) told newswire Reuters.

"It standardises the main terms that go with every transaction. This saves time as volumes grow, so that market participants can focus on the commercial side rather than the legal one," said Peter Werner, policy director at ISDA.

The aim of the contract is to make Shariah over-the-counter (OTC) derivatives contracts more quickly available by providing a legal framework, and will benefit Islamic banks and Islamic-compliant investors.

OTC derivatives, or swaps, are privately negotiated deals between investors and counterparties. Sharia requires the underlying assets to be tangible, such as commodities, excluding most mainstream derivatives instruments.

ISDA's master agreement, to be known as Ta'Hawwut or "hedging". Risk hedging is a key feature in Islamic finance, which forbids "gharar" or preventable ambiguity in contract essentials such as price.

Data from the Bank for International Settlements show the notional amount of OTC deals outstanding was just over $596 billion at the end of last year, including forex, interest rate, equity linked, commodity, and credit default swaps.

It is unclear how large a proportion of that market is compliant with Islamic law.

"The master agreement will help in increasing the activity as it will refer to a mechanism which will be most widely acceptable and used," said Ijlal Alvi at International Islamic Financial Market, who is working with ISDA on the project.

ISDA is also lobbying for regulation changes in the Gulf Cooperation Council countries.

"Dealing with the contractual issues is one leg, the second one is to get regulatory framework," Werner said.

Others took a more sceptical view of the rise of Sharia-compliant derivative products, because there are different interpretations of Shariah and there is no single set of globally accepted standards.

"The possibility of such derivatives being marketed as Sharia-compliant should not be ruled out," said Usman Hayat, director Islamic Finance & ESG Investing at the Chartered Financial Analyst Institute.

"Having said that, I'd not expect the market for such instruments to be large or acceptable to the mainstream."

On Tuesday, Malaysia's central bank said it would issue guidelines to encourage a more standardised application of Islamic finance contracts. (Reuters)