Standard Islamic Derivatives Contract Launched
Wednesday, March 03, 2010

The International Islamic Financial Market (IIFM) and the International Swaps and Derivatives Association, Inc. (ISDA) have launched a shari’ah-compliant tahawwut (hedging) master agreement for Islamic derivatives.

In a press release marking the launch of the new master agreement in Bahrain, its development was lauded as a breakthrough in Islamic finance and risk management, marking the introduction of the first globally standardized documentation for privately negotiated Islamic hedging products. The agreement is the first financial industry framework document that is applicable across all jurisdictions where Islamic finance is practiced.

IIFM and ISDA jointly developed the tahawwut documentation under the guidance and approval of the IIFM Shari’ah Advisory Panel for the project and in consultation with market participants. The published document consists of the tahawwut master agreement and an explanatory memorandum.

The new master agreement provides the structure under which institutions can transact Islamic hedging transactions such as profit-rate and currency swaps, which are estimated to represent most of today’s Islamic hedging transactions.

It is designed to be used between two principal counterparties. Parties understand that no interest shall be payable or receivable and no settlement based on valuation or without tangible assets is allowed. Moreover, the counterparties to the tahawwut master agreement make representations as to the fact that they enter into shari’ah-compliant transactions only.

Therefore, although the structure of the document is similar to the conventional ISDA master agreement, the key mechanisms and provisioning such as early termination events, closeout and netting are developed based on the Islamic shari’ah principles.

“Given the growing nature of the Islamic finance industry, the institutions operating on shari’ah principles can no longer afford to leave their positions un-hedged,” said Khalid Hamad, Chairman of IIFM and Executive Director of Banking Supervision at Central Bank of Bahrain. “Hence, some key hedging products are now becoming common across jurisdictions to mitigate risk. The ISDA/IIFM tahawwut master agreement gives the industry access to a truly global framework document which is neutral in terms of treatment to both the transacting parties and at the same time strictly conforms to shari’ah principles.”

“Standardization is a key element in the progress of Islamic finance though it is not a simple process as evident from the efforts put in to the development of this master agreement,” continued Ijlal Ahmed Alvi, Chief Executive Officer, IIFM. “A record number of drafts - 24 drafts – were developed during the industry consultation and shari’ah guidance process before ultimately reaching the final version, which is comprehensive as well as practical in terms of usage with no compromise to shari’ah principles."

“Demand for customized, privately negotiated hedging tools that conform to the principles of Islamic finance has increased in momentum,” added Eraj Shirvani, Chairman of ISDA and Managing Director, Head of Fixed Income for the EMEA Region, Credit Suisse. “The tahawwut master agreement provides the critical framework for the growth and evolution of shari’ah-compliant hedging instruments.”

In addition to developing documentation for Islamic transactions, ISDA in coordination with IIFM is in contact with various regulators in a number of Islamic jurisdictions, such as the Gulf Cooperation Council region, namely UAE, Bahrain and Qatar, plus Pakistan to improve the local legal framework for hedging products and close-out netting provisioning.