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Islamic finance body IIFM launches FX forward standards
Islamic finance is expanding beyond its core centers 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 counter party, 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 said.
"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 counter parties 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.
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