Islamic derivatives struggle for traction in Gulf

Islamic derivatives are still struggling to gain traction in the Gulf, six months after the launch of a much-touted over-the-counter contract aimed at creating a standard legal framework for hedging products.

Experts said the contract, known as the Tahawwut Master Agreement, in theory provides Islamic institutions with a simpler template for risk management that has been approved by sharia scholars.

But the contract has been slow to catch on among Islamic institutions in the region as many are put off by the dense language of the document and still question the sharia compliance of hedging products, which are often associated with speculation.

"Some of the provisions are difficult to understand for lay people because the document itself is very technical and difficult to navigate for those that aren't as familiar with derivatives," said Muneer Khan, partner for Islamic finance at law firm Simmons & Simmons.

The concept of tahawwut in Islam means to manage risk. But in the financial industry, hedging can either imply managing risk or can be used as a form of gambling and speculation, which is forbidden in Islam.

Sheikh Muddassir Siddiqui, an Islamic scholar and partner at Denton, Wilde Sapte, said hedging risk was especially important within the growing $1 trillion Islamic finance industry to keep institutions competitive with their conventional counterparts.

But since the tahawwut agreement provides a template, rather than a standardised hedging product, there is concern that different products may vary in compliance based on additional documentation. And some institutions that are not as familiar with the derivatives industry are reluctant to take the risk.

"The international banks have already had their own bespoke derivatives contracts in place for some time, making it easy to adapt to the tahawwut agreement," said one Bahrain-based Islamic banker who asked to remain anonymous.

"But many local Gulf institutions struggle with the concept, which has negative connotations, and rather than going out to get more education about Islamic derivatives, they prefer not to act at all."

He said despite efforts to publicise the tahawwut agreement since its launch and industry workshops to explain how Islamic derivatives work, interest among local banks has been lacklustre.

"It's unfortunate because bankers need to be able to sell derivatives to their sharia boards and if they're not comfortable with the agreement, then the sharia boards don't stand a chance," he said.

Harris Irfan, head of Islamic products at Barclays Capital, said the tahawwut agreement was an important first-step in creating much-needed derivatives products in the Islamic finance industry, but the fear of the unknown was hindering growth.

"At the moment, demand is still quite low, which is disappointing but not necessarily surprising," he said.

Still, not all bankers are worried at the slow development of the derivatives industry, saying the slow uptake is the result of flat market conditions.

"You want to hedge when there's volatility," said Afaq Khan, chief executive of Standard Chartered Saadiq, who also backed the contract. "There's no urgency at the moment, not because there's no interest, but primarily because of the market."