Exploring Legal, Regulatory and Shari‘ah Compliance Issues in Islamic Financial Instruments:
Derivatives and Sukuk

Abstract

In general derivatives, futures, options and swaps are considered against the principles of shari‘ah for various reasons, such as the absence of asset-backed deals, dealing in prohibited transaction of debt, presence of element of gharar (uncertainty), gambling, absence or non-existence of subject matter, Short-Selling, sale of subject-matter without prior acquiring of possession or constructive possession, ghabn (market price manipulation), ‘ina (sale and buy-back), tawarruq (multiple buy-back sales involving no actual asset transfer), amongst others. In the recent past there have been attempts to find and explore Islamic hedging products having same functions as that of derivatives having link with real economy growth.
Financial transactions either linked with economic activities or they are pure financial instruments known as ‘synthetic’ transactions having no contribution to the real economy. Due to Muslim investors’ demand and excess saving due to oil wealth in the Gulf Cooperation Council, there is a demand for Islamic financial transactions. Therefore, derivatives in compliance with shari‘ah principles were developed. Sukuk are fine and popular example of such financial products and emerged as a strong substitute to conventional derivative products.
Sukuk are considered shari‘ah compliant but at the same time ethical and hence fits into the requirements of financial products to overcome the adverse effects of the financial crisis. This research, hence, explores and analyses sukuk as an Islamic securitization product. In addition, this research also investigates whether or not sukuk meet the standards and criteria of conventional securitization structures in order to safeguard the interests of different parties involved in it and the public at large. Furthermore, this research examines sukuk structures whereby it identifies further shari‘ah and ethical underlying principles for further product development, design under shari‘ah.
In responding to the research aims, this research attempted to peruse through original sources of both shari‘ah and English Common law on sukuk and the application of wa‘ad (undertaking) particularly in the context of sukuk and derivatives. While discussing the identified research aims in terms of determining the key legal, regulatory and shari‘ah compliance issues in the development of sukuk, the focus remained on the United Kingdom (UK), which attempts to become one of the leading centers of Islamic finance.
After foundational and exploratory research, this study concludes and answered the research questions that: (i) sukuk are based on shari‘ah principles; (ii), derivatives are allowed under shari‘ah; (iii) sukuk as Islamic derivative instruments are as efficient as that of conventional derivative products and apply the similar securitization principles; (iv) wa‘ad has the same authority as that of ‘aqd (contract) and can be compared with ‘promise’ and ‘promissory estoppel’ in Common law; (v) use of wa‘ad in equity-based sukuk is against the shari‘ah; (vi) usage of wa‘ad in derivatives like Foreign Currency Forward Options, Total Return Swaps and Short-Selling is inappropriate, and (vii) UK is an attractive country for promotion and growth of sukuk. For this purpose the results of the sub-research questions were: (a) UK has sufficient legislative and regulative infrastructure to entertain shari‘ah compliant products such as sukuk in the future (b) UK so far is impartial in the debate on shari‘ah compliance approval process of products (c) there is confusion about whether sukuk are categorised as debt instruments or Collective Investment Schemes. This study came with an extensive research and analysed growth of sukuk and its structures in UK with legislative and regulatory developments and concludes UK is a place where development of sukuk is phenomenal for the strategic significance of London Stock Exchange in the global market. Though not many sukuk are being issued in UK but it is a place where most of the sukuk are listed.