Derivatives in Islamic Finance

DERIVATIVES IN ISLAMIC FINANCE

ANDREAS A. JOBST (forthcoming in Islamic Economic Studies, Vol. 15, No. 1)
Paper presented at the International Conference on Islamic Capital Markets held in Jakarta, Indonesia during August 27-29, 2007 jointly organized by Islamic Research and Training Institute (IRTI) of the Islamic Development Bank (IDB), Jeddah, Saudi Arabia, and Muamalat Institute, Jakarta, Indonesia.

DERIVATIVES IN ISLAMIC FINANCE
ANDREAS A. JOBST# ABSTRACT Despite their importance for financial sector development, derivatives are few and far between in countries where the compatibility of capital market transactions with Islamic law requires the development of Shari[ah-compliant structures. Islamic finance is governed by the Shari[ah, which bans speculation, but stipulates that income must be derived as profits from shared business risk rather than interest or guaranteed return. This paper explains the fundamental legal principles of Islamic finance, which includes the presentation of a valuation model that helps illustrate the Shari[ah-compliant synthetication of conventional finance through an implicit derivative arrangement. Based on the current use of accepted risk transfer mechanisms in Islamic structured finance, the paper explore the validity of derivatives from an Islamic legal point of view and summarizes the key objections of Shari[ah scholars that challenge the permissibility of derivatives under Islamic law. In conclusion, the paper delivers suggestions for Shari[ah compliance of derivatives. Keywords: derivatives, securitization, structured finance, Islamic banking, Islamic finance, sovereign securitization, Shari[ah compliance, sukuk, mudarabah, ijarah, murabahah, riba, istisna[, gharar, maisir, maslahah. JEL Classification: D81, G15, M20.

# International Monetary Fund (IMF), Monetary and Capital Markets Department (MCM), 700 19th Street, NW, Washington, D.C. 20431, USA; e-mail: [e-mail]. The views expressed in this paper are

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