This content is from: Local Insights

UAE’s triumph of form over substance

Mian Muhammad Nazir
Derivatives are one of the most important techniques that financial institutions employ to manage certain risks. However, the ability of Islamic financial institutions (IFIs) to benefit from financial derivatives for risk mitigation purposes is limited as many of the conventional derivatives, in their current form and substance, do not align with the principles of shariah. Many IFIs use shariah-compliant alternatives of most of the financial derivatives in accordance with the guidance of their shariah boards. These alternatives appear to meet the shariah requirements in respect of the form; nonetheless, there remain many issues from the substance perspective that need to be considered seriously in order to have a clear and uniform position throughout the system of Islamic banking, sooner rather than later.

Simpler forms of financial derivatives that aim to serve purely as risk mitigation techniques can easily be transformed into shariah-compliant instruments with a wider shariah acceptability. However, some of the more complex and exotic derivatives (particularly credit-linked notes) that entail a dominant financial gain with a possibility of excessive risk will certainly be viewed as instruments breaching shariah principles which prohibit speculation, gambling and so on. Such instruments are not purely for risk mitigation purposes. The ability of IFIs to benefit from such instruments will certainly raise questions and hence affect the overall credibility of Islamic banking and finance, which so far has narrowly escaped the negative effect of such products due to the absence of shariah clearance from the shariah boards.

At this stage, while these complex derivatives are making their way into the Islamic finance industry, it would be appropriate to seek guidance of the founding shariah scholars of Islamic banking who would be in a better position to assess the pros and cons of such products from a shariah perspective and to opine on whether to allow a triumph of form over substance or to stay with the conservative approach that distinguishes Islamic banking from conventional banking.

Mian Muhammad Nazir

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