ISDA/IIFM launches Islamic FX forward standards.

By: Reuters.


The International Islamic Financial Market (IIFM) launched standard templates on Monday for sharia compliant foreign exchange forwards, the latest effort by the industry body to improve hedging practices in the sector.

Islamic finance is expanding beyond its core centres in the Gulf and Southeast Asia, prompting the need for more cost effective tools to manage foreign currency risks.

The Bahrain-based IIFM, a non-profit organisation which develops specifications for Islamic finance contracts, outlined two templates to accommodate the main industry practices, although it expects one of them to eventually gain more favour.

The standards involve use of either one or two unilateral promises, known as wa'ad, which are committed separately by each counterparty, with the latter providing greater credit security.

"Based on market requirement and feedback, our assessment is that the use of two unilateral wa'ad structure will increase," chief executive Ijlal Ahmed Alvi told Reuters.

"Certain other FX products can now be explored under two unilateral wa'ad concept, which IIFM may look into in the future."

There are several hedging tools used in Islamic finance, some based on a cost-plus-profit arrangement known as murabaha, but these tend to be cumbersome and expensive, said Alvi.

Islamic finance follows religious principles which ban the charging of interest and shun ambiguity in contracts.

This means Islamic banks are precluded from traditional forwards as these become legally binding at the outset, leaving counterparties exposed to an overtly uncertain outcome in the eyes of scholars.

In an Islamic forward, the exchange rate is fixed at the outset but remains a promise until offer and acceptance is completed at the forward date, which is when the transaction becomes a contract.

The choice of wa'ad also means Islamic banks don't have to employ their balance sheets for their hedging needs, compared to previous practices under murabaha.

"These standards using the wa'ad structure will overcome this constraint and lead the way to handling other off-balance sheet hedging structures," said Naveed Khan, vice chairman of IIFM.

The IIFM, which developed the standards together with the International Swaps and Derivatives Association (ISDA), has previously launched templates for cross currency and profit rate swaps and the Islamic equivalents to repurchase agreements.

The body started operations in 2002, founded by the Islamic Development Bank and the central banks and monetary authorities of Bahrain, Brunei, Indonesia, Malaysia and Sudan. (Reporting by Bernardo Vizcaino; Editing by Kim Coghill).

Get the standards at:http://www.iifm.net/published-standards