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Islamic derivatives standard to launch soon
February 16, 2010 / 10:12 AM / 8 years ago

Islamic derivatives standard to launch soon

MANAMA (Reuters) - The launch of the first template for an over-the-counter Islamic derivative contract is “imminent” and will encourage more companies to hedge their risks, an executive at a bank involved in its creation said on Tuesday.

<p>Credit Agricole Corporate Investment Banking's Managing Director of Global Islamic Banking, Simon Eedle, speaks during his interview at the Reuters Islamic Banking and Finance Summit in Manama, February 16, 2010. REUTERS/Hamad I Mohammed</p>

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 (CAGR.PA), told the Reuters Islamic Banking and Finance Summit on Tuesday.

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.

The Islamic finance industry is governed by a patchwork of national banking regulations, its own standard-setting bodies and scholars interpreting Islamic laws, making contracts much more complicated.

Designing a two-party derivatives contract could previously take six to nine months, which will be considerably reduced by this master agreement, Eedle added.

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, virtually excluding most of the mainstream derivatives instruments.

MORE HEDGING SEEN

Eedle said the agreement might persuade institutions with doubts over the legitimacy of using these instruments to hedge their risks more easily.

“You will see more hedging on the corporate products because there is a standard there,” he said.

On Monday, Munir Khan, head of Islamic finance department at law firm Simmons and Simmons in Dubai, said there is growing demand for hedging and Sharia-compliant derivatives product, such as profit rate swaps, which would be used solely for hedging and not speculation.

“Clients are starting to look at hedging their risks more,” he said. “The whole industry is developing very rapidly ... and we’re seeing a huge amount of work in that area.”

In addition, 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.

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 encourage a replication of conventional banking,” Eedle said.

Reporting by Frederik Richter, Dinesh Nair and Raissa Kasolowsky; Writing by Dinesh Nair; Editing by Hans Peters

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