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My view on the religious permissibility of futures trading

Some Hadith are often cited to prohibit futures trading. However the problems these Hadith aim at do not exist in modern futures markets.

Posted 11 December 2020

As my deep interest in Islamic finance is well known, I am often contacted via my website for my views on Islamic finance issues, both technical views relating to tax, regulation and accounting, and also my religious views.

I am always willing to share my tax, regulatory, and accounting views, while making it clear that I accept no legal responsibility for them, since I no longer give advice in a professional capacity.

Equally, for religious questions, when giving my opinions, I always emphasise that each Muslim ultimately needs to decide for themselves, since each of us is individually accountable to God.

I recently received an email about commodities trading, and have copied the key part below:

I have read your posts and several articles/chapters from Hashim Kamali's writings on speculation and derivatives.

I do understand the perspective of speculators being necessary and useful since they allow hedgers to hedge. In modern trading systems the speculators would just be submitting their trades and the exchange/central authority matches them with any other market participant taking the opposite position, be it a speculator or hedger.

So there is some likelihood that a spectacular is just trading with another speculator, and this possibly occurs often. Is that considered permissible as well?

It is an interesting question that I haven't seen addressed anywhere!

As this is a subject where, thanks to Kamali's book mentioned below, I am familiar with the religious issues, I sent a relatively detailed response.

Later I decided to expand my response into my December column for the magazine "Islamic Finance News." You can read it below.

Futures trading: Economically beneficial. Religiously permissible?

An American Muslim recently asked me about commodity futures trading. He understood its purpose, as explained in my column published in IFN Volume 12 Issue 45. [See my page "Why commodity speculators are socially useful."

However, he was concerned that the exchange matches trades irrespective of whether the party is a speculator or a hedger. Accordingly, many contracts may involve a speculator trading with another speculator. Was this religiously permissible?

As always, empirical questions and religious questions need to be kept separate.

Empirically, it is clear that markets function better when speculators are freely able to take part in the market alongside commodity producers and commodity users. Arguments to the contrary come only from people who are economically naive.

For religious questions, each Muslim needs to decide for themself, as each of us is individually answerable to God. My view is that since futures markets are clearly empirically beneficial, one would need to find very strong religious arguments against them before concluding they were impermissible.

Those Shariah scholars who oppose futures trading rely upon Hadith where the Prophet prohibited the sale of what you do not own, and Hadith prohibiting the sale of goods where there was no opportunity to inspect them. For the purposes of discussion, it is simplest to treat these Hadith as authentic.

These Hadith prevent problems arising in normal life when you contract to sell something which you do not presently own and then are unable to supply it to the buyer. Similarly, requiring a customer to buy something without having the opportunity to inspect it creates significant scope for fraud, misrepresentation, unhappiness and conflict.

When it comes to futures trading, none of the problems that these Hadith seek to prevent is relevant.

The arrangements for posting margin and closing out transactions ensure that even if you contract to sell cotton (in the case of a cotton futures exchange) and then are unable to supply that cotton on the closeout date, there will be no economic harm to your counterparty.

In practice, even if your counterparty is a cotton user, they are unlikely to be waiting for delivery of bales of cotton from the central warehouse; users enter into futures transactions primarily to hedge price variation risk, while acquiring the cotton that they actually use from other sources. (For physical commodities, the central counterparty often maintains an inventory of the commodity, to enable delivery to take place if the user really requires physical delivery.)

Similarly, the absence of the ability to inspect is irrelevant. Each commodity exchange meticulously specifies the subject matter of the contract, so that neither the seller nor the buyer is left in any doubt regarding what they are contracting to deliver or receive should the contract proceed to physical delivery instead of being closed out by entering into an equal and opposite contract.

Accordingly, my opinion is that there is no religious impediment to futures trading as conducted in the world today through organised futures exchanges with central counterparties.

That is also the view expressed in the book "Islamic Commercial Law: An Analysis of Futures and Options" by Mohammad Hashim Kamali, who is Emeritus Professor, Founding Chairman and CEO, International Institute of Advanced Islamic Studies, Kuala Lumpur.

This was one of the first books I read on Islamic finance many years ago. If you have not read it, I recommend it highly.

 

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