Overcoming Shariah objections to derivatives in Islamic finance through comparative analysis

The objective of this research is to determine ways to overcome Shariah objections to derivatives in Islamic finance, through comparative analysis with conventional law. In Islamic finance, derivatives are still at the stage of infancy, where there is a lot of resistance from scholars against its usage. This research uncovered that these Shariah objections are very similar to earlier legal objections in conventional finance that attempted to ban or render illegal derivatives because they were considered to be, inter alia, instruments of gambling. Various laws, rules and regulations were enacted in conventional finance which eventually led to the legalisation of derivatives. This research attempts to focus on the laws that were enacted in the UK and US, to overcome or reduce the objections therein, and explore whether these laws can overcome similar objections in Islamic finance. This research followed the qualitative inquiry paradigm where two methods were used to collect data – the historical and the case study methodologies. Under the first stage the historical method was used to review laws in the UK and US from the 17th century to the 20th century. From the laws that were reviewed, only relevant provisions that may overcome the objections in Shariah against derivatives were selected, analysed and discussed. The second stage followed the case study methodology. Thirty semi-structured interviews were conducted with participants who had expertise in Islamic finance and conventional finance and/or law. The participants were asked on the need for derivatives in Islamic finance, the applicability of conventional laws in Islamic finance, and other recommendations on risk management solutions in Islamic finance. The transcribed interviews were analysed and interpreted using the qualitative software tool NVivo version 8. The findings of this research unveiled that the underlying objection in conventional finance against derivative usage was the prohibition of gambling, whereas in Shariah it is gharar. Gambling and gharar are not different types of objections, they are actually related. Analysis of the relationship between gambling and gharar led to the unearthing of the fact that maisir or gambling falls within the definition of gharar; in other words, gambling is a subset of gharar. Thus Islamic finance may learn from the legal history of derivative development in conventional law in relation to objections which relate to excessive speculation and gambling. Further, from the responses of the participants it was gathered that Islamic finance can turn towards conventional finance to use the laws therein as long as it complies with Shariah principles. Results also unveiled that derivative instruments such as futures and options, that have hedging properties, are needed in the Islamic financial industry today. Participants believed that futures and options are more useful than harmful to the economy. However, the participants opined that futures and options as they exist in their present form are not acceptable in Islamic finance. At the same time when the participants were queried whether, if all the objections towards derivatives could be overcome they would be accepted in Islamic finance, the participants answered that this was possible. The laws that have been enacted in conventional finance deal with issues of speculation, gambling and other abuses in the futures and options exchange such as dishonest behaviour, cornering and set-offs. These laws that were enacted in conventional finance may be used in Islamic finance to address similar issues.