The debate over the permissibility or otherwise of futures trading in Islamic law continues to invoke responses from basically two opposite camps: the conservative [ulama’, and the modern reformer- and the two still remain far apart. There are many detailed issues that need to be raised and an overall evaluation to be attempted. This is the basic hypothesis of this essay: to review and evaluate the responses from the perspective of Islamic law, and wherever necessary, to attempt a fresh analysis and response. Futures trading proceeds over a variety of commodities and financial products, some of which are interest-bearing, and some which proceed over prohibited substances. These are precluded from the scope of this essay. The only sector of futures that is considered here is futures trading in commodities such food grains, oils and pulses, which are essential foodstuffs and which present a pressing case for reconsideration and review.
I. Introductory Remarks
Ever since the inception of organized futures markets in the early 1970s, new products and trading formulas in various sectors of the derivatives markets have increased and futures contracts are currently available in a large number of commodities, ranging from food grains, oil and oil seeds, sugar, coffee, livestock, eggs, orange juice, cotton, rubber, precious metals, and currencies. In terms of volume, futures’ trading has far exceeded trading levels in conventional stocks and it is now the single most voluminous mode of commerce on the global scale.
What basically prompted the formation of futures market was the fear of the buyers and sellers of commodities over the unwanted movement of prices. The sellers of commodities feared drastic reduction in the prices of their goods whereas the buyers or potential buyers were wary of price hikes at the time they might have needed to buy. The conventional remedy available to them was for the buyer to buy the commodity at the desired price and then keep it until the time he needed to use it. The buyer would in that case incur costs of transportation and storage etc., and would also have to pay for what he bought in full. If the seller wished to keep his goods until a future date, he too would incur costs of carriage. In both cases, the costs of carriage would add to the prices that would most likely be passed on to the consumer. The futures market provided a mechanism that sought to overcome these difficulties by making it possible for buyers and sellers to enter the market when they needed to at considerably lower costs. These costs according to one estimate could be as low as one-tenth to one-twentieth of the cost of carriage of cash market transactions.1 Farmers, commodity merchants and factory owners were thus enabled to lock-in a favorable position for the goods they needed in the months ahead or sell their goods well ahead of time at favorable prices. The futures market opened new possibilities for management of risk over production, marketing and investment planning. These benefits are also not confined to individual traders. Developing countries that need sizeable investment capital can considerably improve their prospects of obtaining it from the international market if they provide the investors with effective risk management facilities. Futures and options can thus contribute to the prospects of attracting investment and enhancing the financing capabilities of developing countries.2 It is normal for major producers of goods to want to have a greater influence over the pricing of their products. In the case, for example, of palm oil of which Malaysia is the leading producer, until the early 1980s palm oil prices were being determined by traders and speculators in London. Since the inception of a futures market in Kuala Lumpur in 1983, Malaysia has not only become the principal player in the pricing of palm oil but also benefits by the spin-off activity from palm oil futures, such as employment opportunities, training of skilled labor force and so forth.
A similar initiative is long overdue with regard to petroleum products of which the Middle East and Gulf countries are the major producers. Trading in oil products currently takes place in New York, London and Singapore etc., but not in the Middle East itself. The major producers of oil are thus excluded from the benefits that flow from derivatives trading in this sector. One might even say that the establishment of derivatives market for oil and oil products by Muslim countries is a necessity. The majority of the OPEC member countries with the exception of Venezuela are Muslim countries. Since Islamic financial institutions cannot invest in interest-based products, bonds and currencies, it is all the more important for them to open derivatives markets in commodities. This would also help to at least partially alleviate the problem over the flight of capital from the Middle East to the Western markets.
Absence of adequate investment facilities is a major reason for the continued flight of funds from the oil-rich countries of the Middle East to the West. In a Financial Times article, Roula Khalaf wrote that “acceptance of Islamic banking is growing,” but that the Qur’anic prohibition of receiving or paying interest has meant that “about 75 percent of Islamic banking funds are invested in short-term commodity (futures) trades.” To give an indication as to where the money goes, Khalaf wrote that commodity trading is conducted “in return for a fee by a middleman – often a Western bank, like Citibank – that arranges for a trader to buy goods on the Islamic bank’s behalf … and the Western banks have always been happy to oblige.”3 Contrary to expectation, and in view of the Shari[ah principle of permissibility (ibahah) that renders all commercial transactions permissible in the absence of a clear prohibition, one is confronted with a rather discouraging form of taqlid (imitation) in the verdict of the Makkah-based Fiqh Academy, its equivalent in Jeddah, and also of many Muslim scholars who have proscribed futures trading and declared it totally forbidden. This body of opinion is founded mainly on the premise that futures trading do not fulfill the requirements of the conventional law of sale as stipulated in the fiqh al-mu[amalat. The fact that futures represent a new phenomenon is totally ignored.
The title of Khalaf’s article, “An Inherent Contradiction,” portrays the concern of Islamic banks and investors to observe the letter of the Qur’an on usury but also underscores their failure to act for the benefit and prosperity of the Muslim masses. Part of the problem is that the Shari[ah advisors to these institutions have limited their understanding of the Shari[ah only to the fiqh textbooks and have not paid much attention to the dismaying economic predicament of the Muslims. In answer to the question whether Islamic banks may invest in futures, Khalaf wrote that “it depends on the bank’s Shari[ah board, whose members are experts in the Koran but less so in the field of bank options …. It is up to each institution to say what is Islamic.”4 This essay is presented in nine sections, beginning with a statement of issues in section two, which is followed by a description of the futures contract, and a literature review in the next two sections. “Sell not what is not with you” is a Hadith text, which is analyzed in section five. This is followed, in turn, by an analysis of sale prior to taking possession (qabd) and a similar analysis of sale of debts (bay[ al-dayn) and risk-taking (gharar) in the succeeding two sections. Section eight briefly addresses the off-setting transaction in futures, followed by a review of the Qur’anic verse of mudayanah (2:283), and a conclusion. Scope does not permit addressing other areas of derivatives, such as options and swaps, which is why I confine this analysis only to futures trading in commodities.