3 Reasons Why Forwards and Futures Are Not Permissible

3 Reasons Why Forwards and Futures Are Not Permissible

Investors often become curious if forwards and futures are permissible in Islam because they are important financial products. There are some different articles about its impermissibility in Islam. Stating that they both are prohibited because the contracts do not comply with the Islamic law principles. So, today we discuss if forwards and futures are really impermissible and what are the reasons behind it.

What are forwards?

Forwards are financial derivative contracts that settle at the end of the contract. It is an arrangement where the buyer and the seller negotiate and agree on the contract terms—such as its expiration date, what underlying asset should they deliver and other factors. Considering this kind of nature of the contract, we do not trade forwards on an exchange.

What are futures?

On the other hand, futures obligate the buyer to purchase or the seller to sell an asset at a set price at a pre-agreed future date. These types of contracts have fixed maturity dates, and they are traded on an exchange. So, futures meet the daily changes every day until the end of the contract.

Are Forwards And Futures Permissible In Islam?

Shariah Scholars believe that 3 aspects of forwards and futures are problematic in Islam

  1. both forwards and futures permit an individual to buy goods that do not exist when signing a contract. It is against a fundamental principle of the Islamic law that specifies goods at the time of actual agreement.
  2. even if forward or futures exist at the time of contract, they both allow the trader to sell the goods even before owning that property (i.e., short-selling). Thus, it opposes another principle of Islamic law that demands a seller to have ownership of the object at the time of the contract.
  3. forwards and futures allow buyers to resell the goods or set the contract obligations before actual delivery. According to Shariah, physical delivery of the object must happen before resale or settlement. For sure, it violates the possession-and-delivery (qabdh) criteria of Islamic law.

These three requirements (existence, ownership, possessions) are essential from an Islamic perspective. Therefore, forwards and futures are not permissible in Islam. If we miss any of the above-mentioned elements, we can consider the contract invalid because of the presumption of gharar.
Even though conventional forwards and futures are not Shariah-Compliant because they violate the three requirements, Islamic jurisprudence offers some other examples of contracts that do not fulfil the three requirements but accept them as exceptional cases.

Forward and Futures as Hedging Purposes

Islamic financial institutions (IFIs) use a variety of contracts in shariah that have features similar to derivatives for hedging, such as salam, istisna, urbun (earnest money), and hamish jiddiyyah (security deposit).

In addition, IFIs use some of Islamic contracts to create products with features similar to forwards and futures. Such contracts are including commodity murabahah, musawamah, bay al inah, bay bi thaman ajil, tawaruq, and wa’d

Islamic banks only use derivatives are for risk management and hedging purposes. Islamic derivatives are used to protect against currency fluctuations. Furthermore, Islamic banks also use them to protect against price fluctuations in commodities. Islamic financial institutions and businesses would incur significant losses if Islamic derivatives and hedging mechanisms were not available.

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