In the Name of Allah, the Entirely Merciful, the Especially Merciful
All praise is due to Allah, Lord of the worlds, may the blessings and peace of Allah be upon our master Muhammad, the seal of prophets, on his family, and all his companions.
Resolution No. 224(8/23)
On
Hedging in Financial Transactions: Principles and Rules
The Council of the International Islamic Fiqh Academy of the Organization of Islamic Cooperation, held in its twenty-third Session in al-Madinah al-Munawarah on 19-23 Safar 1440, corresponding to 28 October-01 November 2018.
Having reviewed the recommendations issued from the scientific seminar on Hedging in Financial Transactions : Principles and Rules, held by the Academy in the Emirate of Dubai on 26-27 April 2016 in cooperation with the Islamic Affairs and Charitable Activities Department through the Islamic Economy Fiqh Forum in its second Session.
Having listened to the discussions,
Resolves the following
First: Meanings of Basic Terms (Concepts)
1)The Concept of Hedging :
- The general meaning of the concept of hedging is covering and prevention, i.e. protection as defined by Fuqaha (Islamic jurists).
- In financial terminology, the concept of hedging means: standardized procedures to manage risks by controlling, minimizing, or eliminating, by transferring them to another party.
- In technical terminology, the concept of hedging means: ‘the protection against risks, and reducing their effects without restricting its concept to common transactions in financial markets, which are mostly based on riba (usury), and netting risks.
These formulas include derivatives which also include futures, options, and swaps. Some of these formulas have already been deemed illicit by the Academy resolution, such as in the case of options, most of futures, as well as deferred exchanges, by virtue of the resolution concept on financial markets.’
2. The Concept of Risk
Linguistic meaning: The probability of loss (or destruction.)
In financial terminology, it is the probability of loss of money or profit, or the profit being less than expected.
According to this definition, the risk does not dissociate from economic activity, and Shariah addressed documentation contracts such betting, bail “assurance”, and so forth, in order to protect both parties in the contract against the netting risks. Risks are generally unwanted because they expose money to loss.
- As for the meaning of “covering”, it is using the available means for the protection against loss, decrease, or damage.
Covering is, within this context, more general than the capital guarantee because guaranty is the commitment by a particular party to assume whatever happens to the capital; i.e. loss, decrease, or damage. However, covering is the preservation of the capital, and it hence includes direct and indirect guarantees.
Second: the Stance of Shariah on risks hedging
1-Hedging means, in general, the protection and preservation of wealth against risks, and it agrees in this meaning with Maqasid al-Shariah(objectives of Islamic law) in preserving wealth.
2-The Shariah ruling on the practical application depends on the extent of commitment to the formulas and mechanisms of hedging in its different forms and their compliance with the rules of Shariah. Every formula requires detailed research and precision-making regarding the extent of its Shariah-compliance.
Third: Shariah Regulations for Hedging Formulas and Methods
1-Hedging formulas should not involve or pave the way to Riba, and it should not contain gharar (uncertainty) as this ascribes to consuming people’s wealth unjustly.
2-The hedging formula should itself be permissible in Shariah.
3-The hedging formula should not lead to selling debts without its nominal value, and to exchange illicit items as it has been observed in the interest-based financial markets.
4-Hedging formulas should not lead to selling abstract rights, like selling options which are prohibited by the Academy resolution no. 63 (1/7) paragraph 2 (b). Moreover, it should not lead to netting on commitment, such as the payment on the guarantee, prohibited by the Academy resolution no. 12 (12/2).
5-The consideration of the objectives of Shariah when formulating hedging contracts, their outcomes, and their various effects in different aspects because the consideration of outcomes is a fundamental principle in Shariah.
6-In cases of non-infringement, or terms violation, hedging contracts should not lead to the capital guarantee, or an expected profit, whether the guarantee is on the manager, the investor, or the agent.
7) It is not permissible to make of the risk in itself a subject of netting.
8) The real objective of hedging instruments should be the preservation of wealth and not the speculation of prices variances.
Recommendations
The Council recommends the following:
- Given the multiplicity of hedging formulas, methods, and mechanisms in the operational applications of Islamic financial institutions, and regarding it as one of the contemporary issues which can broadly adopt the principles of Ijtihad within the framework of the exalted Shariah, the Academy recommends holding scientific symposiums in cooperation with Islamic financial institutions to study hedging instruments and transactions that are practised by Islamic financial institutions or which have been approved by their councils. This is in order to verify the extent of its compliance with the regulations and conditions approved by the Academy resolutions and recommendations.
- Urging leaders and officials of Islamic financial institutions to draw from formulas and contracts approved by the International Islamic Fiqh Academy, the Islamic Fiqh Council of the Muslim World League, and other reliable Fiqh councils when it comes to formulating hedging contracts and transactions. For example; salam contract (forward contract for purchasing a product), salam muwazi contract (parallel Salam contract), murabaha al-amir bi-shera (cost-plus financing for purchasing orders), istisna’a contract (forward contract for manufacturing a product), istisna’a muwazi contract (parallel Istisna’a contract), khiyar al-shart (conditional options).
All of these transactions should be based on Shariah regulations stated in their respective resolutions.
Allah Knows Best.
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