Gamble or risk control? Islamic hedging row rages

MANAMA (Reuters) - Demand for hedge funds and for Islamic finance is booming, which makes a hedge fund that complies with Islamic law the holy grail for fund managers who want to tap huge liquidity in the Gulf.

But most Islamic finance industry players say the two sides are incompatible and that common hedge fund strategies break Islamic law.

Others say that Islamic finance, in order to prosper, needs to develop tools to enable investors to hedge against risk, but that does not necessarily mean hedge funds.

“It’s absolutely imperative that the Islamic finance industry has hedging tools,” said Afaq Khan, head of Islamic banking at Standard Chartered.

“You have to segregate the two. Hedge funds are work in progress. Islamic derivatives for hedging purposes are absolutely allowed as a risk management tool,” he added.

Standard Chartered does not offer Islamic hedge funds but is one of a number of lenders offering Islamic hedging products in a bid to meet growing demand from the world’s 1.2 billion Muslims for financial services that comply with their beliefs.

Many common hedging practices are seen as speculative bets on currency and stock movements. Hedge fund strategies such as short selling are considered haram, or forbidden, by Islamic law.

Lending on interest, the trading of debt and gambling are all haram. Practices deemed acceptable by Islamic law, known as sharia, are halal.

Short-selling involves borrowing shares and selling them in the hope of making a profit by buying them back at a cheaper price. If the price of the shares goes up, the investor loses money.

Critics of hedging strategies say such speculative transactions contravene Islam’s ban on gambling.

HEDGING NECESSARY

Delegates chuckled after a speaker scheduled to talk about hedge funds that comply with Islamic law told a conference in Bahrain he had nothing to say because such funds did not exist.

“There are some who claim to have Islamic hedge funds in the market. Yes there are three or four, but no one has invested in them, so to me they don’t exist,” said Antoine Massad, chief executive of Man Investments Middle East, part of Man Group.

“Hedge funds use leverage, derivatives etc - all of that is haram. It’s not only not halal; it’s haram,” he added.

Others argue that hedge fund strategies have great potential for Islamic finance, which is hamstrung by a shortage of instruments to manage risk, especially long-term risk.

Many hedging strategies have their origins in risk reduction, which is in the spirit of Islam’s prohibition on gambling, they say, pointing to examples of farmers acting to reduce their exposure to fluctuations in commodity prices.

The Islamic finance industry’s ability to provide fixed-rate mortgages, underwrite life insurance or finance long-term infrastructure projects is hampered by its inability to manage the risk of long-term exposure, hedging advocates say.

“This (hedging) will give you the ability to manage your risk properly. You cannot leave your investments exposed,” Bahrain Central Bank Governor Rasheed al-Maraj told reporters at the Islamic finance conference last week.

ISLAMIC VEIL

Standard Chartered, Deutsche Bank and BNP Paribas are among the banks that already offer or are developing Islamic hedging instruments.

Deutsche Global Markets Director Harris Irfan said hedge funds that claim to be Islamic may not appeal to investors, because they try to mimic traditional hedge fund practices.

Deutsche tries to match hedge fund performance, rather than practice, he said. Hedge funds are typically designed to deliver so-called alpha returns that exceed those of the broader market.

“As long as you stay within the boundaries of sharia, you have structures and instruments which follow sharia principles, then there’s no reason why you can’t have a sharia-compliant hedge fund,” Irfan said.

Funds try to replicate hedging strategies in ways that will secure a fatwa, or decree from scholars declaring them sharia-compliant.

On the bankerme.com Web side, Islamic finance consultant Michael Gassner describes deal structures that hedge funds combine in a complicated series of steps to win Islamic approval.

But Ahmed Abbas, of Bahrain’s Liquidity Management Centre, criticized such mechanisms as false to the spirit of sharia. “I don’t care, if you take 20 Islamic steps in order to short sell, you cannot sell what you don’t own.

“Islamic banking is not about drawing an Islamic veil over something un-Islamic.”