The impact of Shariah compliant derivatives as a hedging strategy on the Islamic financial institutions

Abstract

This study was started with the objective of exploring the Islamic financial institutions (IFIs) that currently operate in an increasingly sophisticated and highly competitive market. These IFIs face challenges in maintaining the alternative ethical features within the pressures to achieve sustainability of economic growth. In response to this, IFIs concentrate their efforts on minimising the risks inherent in the financial transactions. This is because IFIs seem to follow the market logic that believes in the greater needs to use various derivatives products and hedging instruments to control the financial stability. The importance of financial derivatives, for instance as a means of risk management is recognized in the modern financial system. However, the IFIs’ approach to embracing financial derivatives is somewhat incompatible with Shariah guidelines that prohibit the acts of taking excessive uncertainty (gharar) and debt-based transactions. On the other hand, IFIs, argue that the need to guarantee investors’ return using derivatives is a way of protecting the public interest or maslahah. Within this context, this study has three main objectives. First, to explore the process of negotiations, translations, modifications of Shariah compliance principles to engage with derivatives transactions in IFIs. Second, to explore the key issues and challenges faced by IFIs in engaging with Shariah-compliant derivatives transactions. Lastly, to analyse the perception of market players and policymakers on the impact of the Shariah-compliant derivatives on IFIs. This proposed study uses the organisational identity theory as a lens in framing the discussion to achieve the above research objectives. Using the Qualitative approach, this study is expected to fill the gap in the knowledge of Islamic derivatives and aims to add wider-scoped derivatives literature. Moreover, this study seeks to make a larger contribution to the global Islamic financial markets by proposing comprehensive justification of the acceptability of Shariah-compliant derivatives in line with the objective of Shariah (maqasid al-Shariah) as well as to provide certain recommendations for the use of Islamic derivatives transactions as hedging tools in promoting their instruments in IFIs worldwide.
Key words: Shariah Compliant Derivatives, Hedging Strategy, Business Demands,
Ethical Identity, Islamic Finance Stakeholders, Beyond Hedging

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ORCID for Nunung Nurul Hidayah: orcid.org/0000-0003-3178-4584

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