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Arab Law Quarterly 24 (2010) 319-360 brill.nl/alq

Arab LawQuarterly

Sharīʿah and Conventional Law Objections to Derivatives: A Comparison

Sherin Kunhibava*Researcher, International Sharīʿah Research Academy (ISRA), Jalan Raja Laut, Malaysia

Balachandran Shanmugam**Professor of Finance, Taylor’s University Malaysia, Selangor, Malaysia

AbstractIn Islamic finance, many scholars advise against the use of derivatives, which is still in its infancy. Conventional law even voiced its objections to derivatives as early as the 17th cen-tury. This article surveys and compares the relationship between present-day legal objec-tions to derivatives in Islamic finance and those objections held in the past by conventional finance. It was found that objections to derivatives, held by both separate fields of finance, show similarities as well as differences. For example, both Islamic and conventional finance object to the gambling nature inherent in derivative trading; in contrast, under Sharīʿah law, the scope of Islamic finance’s objections is broader, including other elements such as uncer-tainty and ignorance. Furthermore, Sharīʿah scholars also object to option trading that requires payment of a fee and to futures trading that involves payment of a debt with a debt.

KeywordsSharīʿah; derivatives; Islamic finance; maisir; qimār; gharar ; conventional law; baiʿ ul-kālī bī l-kālī

1. Introduction

The word ‘derivative’ is a relatively new term in the commercial world; it was first used in US courts as late as 1982 and in the UK courts in 1995.1

* 2nd Floor, Annex Block, Menara Tun Razak, Jalan Laut, Malaysia. Tel.: +603-2781-4225; Fax: +603-2692-4094. E-mail: [email protected] or [email protected].

** No. 1 Jalan Taylor’s, 47500 Subang Jaya, Selangor Darul Ehsan, Malaysia. Tel.: + 603-5629 5744; Fax: + 603-5629 50016. E-mail: [email protected].

1 See, e.g., E.J. Swan, Building the Global Market: A 4000 Year History of Derivates, 1st edn. (Dordrecht: Kluwer Law International, 2000).

320 S. Kunhibava, B. Shanmugam / Arab Law Quarterly 24 (2010) 319-360

It is therefore not surprising that historical articles, cases and books do not mention the word ‘derivative’2 but rather ‘forwards’,3 ‘futures’4 and ‘options’.5 ‘Derivative’ has been defined as “. . . a financial instrument whose value depends on the value of other, more basic, variables”.6 ‘Derivative’ is a generic term that classifies instruments that display the same features. It became necessary to create a common terminology because of the sudden growth in financial engineering and the innovative use of such instru-ments. Some examples include Interest Rate Swaps, Forward Rate Agree-ments, Caps, Floors, Swap Options,7 Butterflies, Straddles, Condors and Strangles.8

The history of derivative trading can be traced back to Mesopotamia where primitive forms of forward contracts have been recorded.9 The more modern futures trading, as we know it today, began in the 17th century in the Japanese markets of Osaka and in the 19th century at the US Chicago

2 Discussion of derivatives in this article will be limited to conventional derivative con-tracts such as forwards, futures, and options. The legal history of derivatives show us that it was not until the late 20th century that other more exotic types of derivatives were created. In conventional finance, the legal objections to derivatives, occurring mainly in the late 19th and early 20th century, did not involve these more exotic derivatives. In Islamic finance, legal opinions and objections focus mainly on futures and options, and to a lesser extent on forward contracts. As long as there is opposition to basic derivative contracts themselves, there is very little chance that more advanced derivatives will play a role in Islamic finance. Therefore the more exotic derivatives are not discussed in this article.

3 The forward contract was recorded as the first, and most simple, derivative instrument to be used. A forward contract is where two parties undertake to complete a transaction at a future date but at a pre-determined price. See, e.g., O.I. Bacha, Financial Derivates Mar-kets and Application in Malaysia, (Malaysia: McGraw-Hill Malaysia, 2001).

4 A futures contract is basically a forward contract which is standardized with respect to contract size, maturity, product quality, place of delivery, etc. Future contracts are traded on exchanges, where all buyers and sellers transact through the exchange. Since there are many buyers and sellers transacting through the exchange, multiple coincidence will be solved; Ibid.

5 An option entitles the holder the right, but not the obligation, to buy (or sell) the underlying asset at a predetermined exercise price at or anytime before maturity. To acquire this right under an option, payment of a premium is required. J.C. Hull, Options Futures and Other Derivatives, 6th edn. (Prentice Hall, 2005) 1.

6 Ibid., at 2.7 See, e.g., Market Traders Institute Inc., Forex Trading Terms and Definitions (2002);

http://www.forextips.com/forex-terms-e.htm.8 See, e.g., A. Tickell, “Dangerous Derivatives: Controlling and Creating Risks in Inter-

national Money”, Geoforum, 31 (2000) 87.9 See, e.g., Swan, supra note 1.

S. Kunhibava, B. Shanmugam / Arab Law Quarterly 24 (2010) 319-360 321

Board of Trade (CBOT).10 Today most major cities have derivative markets worldwide.

Statistics show that derivatives are popular11 as well as useful because of their flexibility; e.g., they are easier to buy and sell than the underlying commodity or financial asset, such as agricultural commodities, metals, energy, currencies, and stock indexes. Derivatives are a useful alternative to holding the underlying commodity or financial asset; also a relatively small amount of capital is sufficient to trade in derivatives compared to the actual amount of money required to buy the commodity or financial asset itself. Other benefits have also been noted, such as better risk allocation and reduced information asymmetry.12

While the use of derivatives in conventional finance13 has taken tremen-dous positive strides,14 Islamic finance, i.e., banking and finance conducted in accordance with Sharīʿah’s principles, currently has no derivative market. Islamic law is the Sharīʿah, the basic requirement of which is

10 See, e.g., Tickell, supra note 8.11 See, e.g., the average daily volume of derivatives for the 1st quarter of 2007 reached a

record 3.87 million contracts at the Chicago Board of Trade (CBOT), one of the world’s leading derivatives exchanges. This is a 24% increase compared with the 1st quarter of 2006. See, e.g., Craig Grabiner, CBOT Sets Records for Quarterly ADV (2007); http://www.cbot.com/cbot/pub/cont_detail/0,3206,1036+47036,00.html. On the other hand, in 2008, NYSE EURONEXT’s derivatives trading operations on Liffe experienced “its busiest May ever”, leading to a 30% increase in total contracts traded year-to-date, compared to the same period in 2007”. In May, Liffe traded more than 91 million futures and option contracts, representing an average daily volume of 4.3 million, up 20.8% from the same month in 2007”, EURONEXT.Liffe, NYSE EURONEXT Business Summary for May 2008 (2008); http://www.euronext.com/news/press_releases/pressReleases-1731-EN.html?page=3. Furthermore, NYSE Liffe traded an average of 3.7 million futures and options during the 4th quarter of 2008, a 5% increase from the past year’s quarter; the average daily volume of derivatives for the 1st quarter of 2007 reached a record 3.87 mil-lion contracts at the CBOT, one of the world’s leading derivatives exchanges. See, e.g., NYSE EURONEXT, “EURONEXT Announces Fourth Quarter and Full Year 2008” (2009); http://www.euronext.com/news/press_releases/pressReleases-1731-EN.html.

12 See, e.g., H.R. Stoll & R.E. Whaley, “The New Option Markets”, in: Anne E. Peck (Ed.), Futures Markets: Their Economic Role (Washington, DC: American Enterprise Insti-tute for Public Policy Research, 1985); R.C. Merton, “Financial Innovation and the Man-agement and Regulation of Financial Institutions”, J. Bank Fin., 19 (1995) 461; J.R.L. Koski & J. Pontiff, “How are Derivates Used? Evidence from Mutual Fund Industry”, (Wharton School Center for Financial Institutions, Univ. of Pennsylvania, 1996).

13 In this article, conventional finance means finance as it is practiced today around the world in business that does not include Islamic finance.

14 Supra note 11.


that banking and finance must not contain elements of, inter alia, riba (interest), gharar (excessive uncertainty), maisir (something attained with-out effort), qimār (gambling) and jahālah (ignorance).15 The development of Islamic finance itself has been unparalleled as “no other financial indus-try, market or jurisdiction in the last decade has witnessed the staggering financial engineering and innovation of the Islamic finance industry”.16 With such growth seen in Islamic capital markets, one would expect simi-lar growth in Islamic derivative markets.

However, although scholars such as Kamali17 have argued that futures and options are permissible in Islamic finance, the overwhelming majority of scholars believe that forwards, futures, and options, as they are currently traded in conventional finance, are impermissible in Islamic finance.18

15 See, e.g., M.T. Usmani, An Introduction to Islamic Finance, (The Netherlands: Kluwer International, 2002).

16 B.K. Grewel, “Islamic Capital Market Growth and Trends”, IFN, 29 (2007) 29; avail-able at: http://www.islamicfinancenews.com/guide07pdf/icm-islamic%20capital.pdf.

17 See, e.g., M.H. Kamali, “Islamic Commercial Law: An Analysis of Futures”, Am. J. Islam. Soc. Sci., 13 (1996) 197; M.H. Kamali, “Islamic Commercial Law: An Analysis of Options”, J. Islam. Soc. Sci., 14 (1997) 17; M.H. Kamali, “Prospects for an Islamic Deriva-tive Market in Malaysia”, Thunderbird Int’l Business Rev., 4 (1999) 523; M.H. Kamali, Islamic Commercial Law: An Analysis of Futures and Options (UK: Islamic Texts Society, 2002); and M.H. Kamali, “Commodity Futures: An Islamic Legal Analysis”, Thunderbird Int’l Business Rev., 49 (2007) 309.

18 See, e.g., Y.T. Delorenzo, “Covered Options: Scholars Answers”; available at: http://muslim-investor.com/answers/covered-options.html; S. Mahmassani, al-Mawjibāt wa l-uqūd fī l-fiqh al-islāmī (1983); U. Chapra, “The Role of the Stock Exchange in an Islamic Econ-omy: Comments”, J. Res. Islamic Econ., 3 (1985) 75; A.M. Khan, “Commodity Exchange and Stock Exchange in Islamic Economy”, Am. J. Islam. Soc. Sci., 5 (1988) 91; M.T. Usmani, “Futures Options Swaps and Equity Instruments”, New Horizon, 9/June (1996); M. Obaidullah, (1998) “Financial Engineering with Islamic Options”, 6 Islamic Econ. Studies, 1, IRTI; M.A. El-Gamal, “Discussion Forum: Islamic Financial Derivatives”, IJIFS, 1 (1999) 1, available at: http://islamic-finance.net/journals/journal1/journal1index.pdf; F.M. Khan, “Islamic Futures and their Markets: With Special Reference to Their Role in Developing Rural Financial Market”, Research Paper No. 3, IRTI (2000); OIC Islamic Fiqh Academy, “Resolution and Recommendations of the Council of the Islamic Fiqh Academy 1985-2000”, 2000, available at: http://www.islamibankbd.com/page/oicres.htm#10(10/2); S. Naughton & T. Naughton, “Religion Ethics and Stock Trading: The Case of the Islamic Equities Market”, J. Business Ethics, 23 (2000) 145; M. Kahf, “Islam’s Stance on Commodities or Futures Market”, 2002, available at: http://www.islamonline.net/servlet/Satellite?cid=1119503544954&pagename=IslamOnline_English-Ask_Scholar52FFatwaE%2FPrintFatwaE; European Council for Fatwā and Research, Final Statement of the Twelfth Ordinary 6-10 of Dhulqi’dah, 1423 AH (2003), available at:


One academic has succinctly summarized the dilemma of using derivatives in Islamic finance: “Options and futures contracts cannot be traded under Sharīʿah, as they are too remote from the underlying assets [. . .] The con-cern in Islam is with gharar (contractual uncertainty)”.19

It is noteworthy that objections to the use of futures and options occurred as early as the 17th and continued into the 20th century in Japan, UK, US and Germany.20 Existing literature about Islamic as well as con-ventional finance aptly discusses the legality, or otherwise, of derivatives in these respective fields. However, a gap exists where little research has been undertaken to compare the legal objections held in the fields of Islamic and conventional finance. This article attempts to fill this gap by compar-ing legal objections to derivatives in Islamic finance with historical legal objections in conventional finance. This article will focus on legal objec-tions within UK and US jurisdictions for two reasons: first, both countries have a rich legal history that can be traced for this purpose and, second, the financial markets of both countries are among the largest in the world for derivative trading.21

This article is presented as follows. Section 2 explains and compares the meanings of qimār, maisir, jahālah and gharar. One must first understand the underlying prohibitions related to qimār, maisir, jahālah and gharar in order to comprehend the Sharīʿah’s legal objections to derivatives. Section 3 discusses in further detail Sharīʿah’s objections to derivatives. Section 4 introduces conventional law’s22 objections to derivatives and compares them with those of the Sharīʿah. Section 5 presents further deductions.

2. Qimār, Maisir, Jahālah and Gharar

Qimār, or gambling, is strictly prohibited in Islam. As stated in the Qurʾān, verse 219 of Surah 2: “They ask thee concerning wine and gambling. Say: ‘In them is great sin, and some profit, for men; but the sin is greater than

http://www.e-cfr.org/eng/article.php?sid=37; M.A. El-Gari, Shari‘ah Injunctions on Futures Contracts”, (2006) IFN 16, www.islamicfinancenews.com; R. Wilson, “Global Islamic Capital Markets”, IFN (2007) 14, available at: www.islamicfinancenews.com.

19 Wilson, Ibid.20 See, e.g., Swan, supra note 1.21 Supra note 11.22 Conventional law in this article means laws enacted by a State (e.g. legislation) or

judiciary (e.g. case law) and excludes Shari‘ah law (Islamic law).


the profit’.”23 Qimār is often described as maisir which means something attained without effort,24 i.e., one of the main reasons that Islam forbids gambling. Other reasons state that gambling can result in the loss of one’s property without legal or proper exchange, in anger and frustration caused by loosing, in addictive and compulsive behaviours leading to bankruptcy, and in forgetting one’s duties as a Muslim.25

In contrast, jahālah, which means ignorance, can cause a sale to be declared invalid. For example, if the object of sale or its price were unknown to a buyer, due to ignorance, then it would be impossible to buy, sell or exchange money for the goods due to jahālah.26

Gharar, also forbidden in Islam, is more difficult to define.27 The term is more general and encompasses other elements, such as maisir and jahālah. Gharar has been defined as ‘danger’28 and ‘risk’29 but also as a transaction equal to a ‘zero-sum game with uncertain payoffs’.30 Al-Zarqā, in Al-Zuhaylī,31 has defined a gharar sale as the sale of probable items the existence or characteristics of which are uncertain, therefore making it a risky business similar to gambling.

Gharar sales are considered invalid precisely because of the excessive uncertainty and risks involved. An example of such a sale can be found in the Hadīth32 narrated by Abū Huraira:

The Prophet forbade two kinds of sales: i.e. al-limais and an-nibadh (the former is a kind of sale in which the deal is completed if the buyer touches a thing, without seeing

23 Translation by (A.Y. Ali, 1999). Another injunction on the prohibition of gambling in the Qurʾān can be found in verse 90, Surah 5, of the Qurʾān.

24 A.K. Damansar, The Sin Of Gambling Explained, 2007, available at (last visited 1 May 2007): http://revivalry.blogspot.com/search/label/Mu’amalat%20-%20Rulings.

25 See, e.g., Y. Al-Qardawi, The Lawful and the Prohibited in Islam (Al-halāl wa l-harām fī l-islām, trans. K. el-Helbawy) (US: American Trust Publ., 1994).

26 See W. Al-Zuhaylī, Financial Transactions in Islamic Jurisprudence (Fiqh al-Islāmī wa adillātuhu, trans. Mahmoud El-Gamal) (Dār al-Fikr, 2003).

27 See F.E. Vogel & S.L. Hayes III, Islamic Law and Finance: Religion, Risk and Return, 1st edn., Arabic and Islamic Law Series (Netherlands: Martinus Nijhoff Publishers, 1998).

28 Al-Zuhaylī, supra note 26 at 82.29 M.A. El-Gamal, An Economic Explication of the Prohibition of Gharar in Classical

Islamic Jurisprudence, 4th International Conference on Islamic Economics, Leicester, UK 2 (13-15 August 2000).

30 S. Al-Suwailem, “Towards an Objective Measure of Gharar in Exchange”, Islamic Econ. Studies, 7/1, 2 (2000) 1.

31 Al-Zuhaylī, supra note 26 at 83.32 Sayings and the conduct of the holy Prophet Muhammad (peace be upon him).


or checking it properly and the latter is a kind of a sale in which the deal is completed when the seller throws a thing towards the buyer giving him no opportunity to see, touch or check it) and (the Prophet forbade) also ishtimal as-samma’ and al-ihtiba’ in a single garment.33

Maisir or gambling due its high risk and uncertain outcome, as well as jahālah sales in which ignorance can lead to uncertainty, are gharar and therefore invalid. It follows that maisir, qimār and jahālah can be described as subsets of gharar. While excessive uncertainty makes all jahālah transac-tions gharar, not all gharar sales are jahālah, e.g., “in the case of buying a runaway slave with known characteristics”.34 Likewise, high risk and an uncertain outcome make all maisir or qimār transactions gharar, while not all gharar transactions are maisir or qimār. While gharar does not always result in a zero-sum35 outcome, e.g., the sale of milk from an udder, gam-bling always results in a zero-sum game.36 Jahālah and maisir or qimār are unrelated unless, in cases of extreme ignorance, a person makes a transac-tion that could be a gamble or is ignorant of the consequences or other facts about the game. Thus, jahālah and maisir or qimār are subsets of gharar.

It will now be possible to explain in detail how gharar, qimār, maisir, and jahālah relate to Sharīʿah’s objections to the use of derivatives in Islamic finance.

3. Sharīʿah’s Objections in Islamic Finance

When comparing Islamic and conventional finance, the sources of their legal objections to derivatives vary. Under Islamic law, for topics, such as the use of derivatives, not covered by the Qur’ān and Hadīth, fiqh37 must be called upon by Sharīʿah scholars to derive laws appropriate to the

33 Bukhārī, Complete Sahīh Bukhārī, Vol. 1, Book 8, No. 364; available at (last visited March12, 2007): http://www.usc.edu/dept/MSA/fundamentals/hadithsunnah/bukhari/008.sbt.html#001.008.364.

34 AL-Zuhaylī, supra note 26 at 109.35 This is a game where one party’s gain is the other party’s loss. 36 Al-Suwailem, supra note 30 at 64.37 The process of applying and deducing laws from the Shari‘ah, and the laws thereby

deduced, is collectively known as fiqh. I. Abdal-Haqq, “Islamic Law: An Overview of its Origin and Elements”, J. Islamic L., 1(1996) 1.


subject matter. Thus, the following discussion on legal objections in Islamic finance will mainly focus on interpretations by fiqh scholars.

Systems of Common and Civil law, in contrast, both involve interpreta-tion of statute and case laws and generally only vary in the degree of emphasis they placed on statute or case law. Hence, while the opinions of legal scholars will be discussed with regard to Sharīʿah and conventional laws, reference will also be made to cases and statutes.

Discussion about derivatives, such as forwards, futures and options, and their legality in light of Sharīʿah law only began in the 1980s when modern Islamic finance itself began to emerge and develop. Therefore, discussion of Sharīʿah’s objections to derivatives will focus on the period from 1980 onwards. However, reference to classical fiqh authorities will be made to explain how and why contemporary Islamic scholars object to financial derivatives.

Under Sharīʿah law, the main grounds upon which contemporary Islamic scholars base their objections to financial derivatives may be sum-marised as follows:

1. In futures transactions, because neither counter-value, i.e., money or goods, is present at the time of contract, the sale is not genuine but merely an exchange of promises. A sale is only valid under Sharīʿah law as long as only the price or delivery, but not both, is postponed.

2. For a sale to be valid, ownership of the item sold must exchange hands. Therefore, a seller who does not own the item cannot transfer ownership. The rationale behind ‘taking possession’ is to prevent gharar.38

3. Futures and option trading that involve speculation verge on maisir, qimār and gharar.

4. Option trading is merely the right to buy or sell, for which charging fees is impermissible.

5. Futures trading, where both counter-values are deferred, is the illegal exchange of one debt for another, i.e., baiʿ ul-kālī bī l-kālī.

38 This issue is sometimes separated from another legal objection to derivatives and that is that futures sales fall short of meeting the requirements of qabd or taking possession of goods prior to resale. See Kamali (1996), supra note 18. In this article these two issues will be discussed under one heading because both point to the issue of the seller not owning or possessing the goods before resale; furthermore, other legal opinions have discussed these two issues under one, and not two, legal objections. See OIC Islamic Fiqh Academy, supra note 18.


These five points are discussed in greater detail below.

3.1. Both Counter-values in Futures and Option Trading Are Non-existent or Deferred at the Time of Contract

In Islam, only contracts in which either one counter-value is deferred and non-existent are permissible, e.g., the salam39 contract. The Sharīʿah objects to the legality of derivatives when both counter-values are deferred and non-existent at the time of contract, as in the case of futures and options.

According to the Mejelle, the Ottoman Civil Code,40 Art. 197 provides that the “the thing sold must be in existence”. Art. 205 further provides that “the sale of a thing which is not in existence is void”.41

Mahmassani42 has stated that all contracts, except salam and istisnāʿ,43 for selling future goods are invalid under Sharīʿah law because of the state of non-existence. In the case of salam, or even istisnāʿ, contracts, only one counter-value is deferred at the time of sale which is allowed under Sharīʿah law. However, non-existence of both counter-values, in the case of futures and option contracts, amounts to gharar or unwarranted risk-taking due to uncertainty about the prospects for fulfilment. This opinion is also held by the Organisation of the Islamic Conference (OIC) Islamic Fiqh Academy. During its 7th session in 1412 H (9-14 May 1992), the Islamic Fiqh Acad-emy made the following resolution:

. . . where the contract provides for the delivery of described and secured merchandise at some future date, and payment of its price on delivery. It also stipulates that it shall

39 The baiʿ salam (baiʿ means contract) allows delivery of an asset at a predetermined future date where the price is paid in full today. Baiʿ salam can be compared to a forward contract except for the fact that, in a salam contract, only one party is deferring his obliga-tion under the contract. See, e.g., S.A. Rosly, Critical Issues on Islamic Banking and Finan-cial Markets: Islamic Economics, Banking and Finance, Investments, Takaful and Financial Planning (Author House, 2005).

40 Elaborated between 1869 and 1875 and based on the Hanafī law of fiqh.41 C.R. Tyser, D.G. Demetriades, I. Haqqī Effendi (trans.), The Mejelle English Transla-

tion of Majallaj El-Ahkam-i-Adilya and a Complete Code on Islamic Civil Law, (Petailing, Malaysia: The Other Press).

42 Mahmassani as quoted in Kamali (1996), supra note 17 at 203-204.43 Is a deferred sale contract, where the price is paid in installments as the work (e.g.,

manufacturing or building) progresses. The istisnāʿ contract will provide specifications about the product which the manufacturer will undertake to construct. See, e.g., N.T. Nik et al., Law and Practice of Islamic Banking and Finance, (Petaling Jaya, Malaysia: Sweet & Maxwell, 2003).


end with the actual delivery and receipt of the merchandise. This contract is not per-missible because of the deferment of the two elements of the exchange. It may be amended to meet the well-known conditions of ‘salam’ (advance payment). If it does so, it shall be permissible.44

The decision of the OIC Islamic Fiqh Academy was confirmed by the European Council for Fatwā and Research.45

Usmani46 also stated that futures transactions were illegal because, under Sharīʿah law, a sale or purchase cannot be made for a future date.

These opinions are based on a number of Hadīth and the opinions of classical Shafī‘i, Hanbalī, and Hanafī fiqh jurists.47 According to Al-Zuhaylī,48 top scholars from all the schools of Islamic jurisprudence have agreed that the sale of non-existent goods, and goods that might cease to exist, is invalid: e.g., the “the sale of fruits and plants, before they appear [. . .] sale of pearls in shells, milk in udder, wool of the back of sheep, and

44 OIC Islamic Fiqh Academy, supra note 18.45 European Council for Fatwā and Research, supra note 18.46 Usmani, supra note 18 at 10.47 There are four main Sunni Schools (madhab): Hanafī, Mālikī, Shafī‘i, Hanbalī. Mad-

hab is ‘a method’ of interpreting religious material in the three major areas: belief, religious practice and law. The Schools originated in different places which had some impact on their methods and decision-making. The Hanafī School, established in Kufa, preserves many of the older Mesopotamian traditions. It based its rulings largely on raʾy, i.e., results of logical deduction by its scholars. The Mālikī School comes from Medina, and it also reflects its origin through its decisions. This school ruled heavily in favour of the practice (sunnah) of the local community of Medina because, at the time it was formed, the word sunnah did not yet mean ‘practice of the Prophet’. Imām Ash-Shafī‘i (d. 204/820 in Egypt) was the first to systematise Islamic Law. Originally, he studied both in Iraq and in Medina but he nei-ther agreed with the methodology of those older schools, in favour of the Traditionists, nor fully accepted their ideas. In his tractate, Risāla, balancing the two trends, he laid down the sources of Law, usūl al-fikh. He fixed them (in order of priority) to be: first Qur’ān then the Sunnah of the Prophet based on: Hadīth from the Prophet, Hadīth from the Companions of the Prophet ijmāʿ (consensus of the Ummah or Muslim community), qiyās (reasoning by analogy), but also istihsān. His system had become the basis of Islamic jurisprudence, and it was subsequently used by all the Schools. Ahmad Ibn Hanbal (d. 241/855), founder of the latest of the four madhabs had followed the Shafī‘i method with ever greater emphasis on the ahadīth, avoiding reasoning as far as possible although not completely denying it. See, e.g., A.R.I. Doi, Sharīʿah the Islamic Law, (London: TaHa Publ., 1984); and Abdal-Haqq, supra note 37.

48 Al-Zuhaylī, supra note 26 at 74.


a book before it is printed”.49 Examples of Hadīths that prohibit the sale of non-existent goods are:

1. Jābir narrated that the Messenger of Allāh (pbuh) forbade the selling of fruits until they ripen.50

2. Abū Bakhtarī reported: “I asked Ibn Abbās about the selling of dates. He replied: ‘The Prophet (pbuh) forbade the sale of dates until they became fit for eating and could be weighed.’ A man asked: ‘What to be weighed?’ Another man sitting beside Ibn Abbās replied: ‘Until they are estimated’.”51

3. Ibn Abbās reported: “The messenger of Allāh (pbuh) prohibited the sale of fruit before its quality is known, the sale of wool on the back of sheep, and the sale of milk in an udder”.52

Such contracts for non-existent goods are ruled invalid on the grounds of jahālah and the presence of gharar. Lack of knowledge about the quality and quantity of non-existent goods would make the contract a dubious and excessively risky business;53 for example, the sale of wool still growing on the back of sheep introduces uncertainty, making demarcation difficult.54

However, Imām Mālik55 opined that the sale of milk from the udders of a herd of sheep, over a specified number of days, is valid when the quality of milk is homogeneous and the herd’s productivity known. In contrast, the sale of milk from one sheep udder is not allowed. As for wool on the back of one sheep, Imām Mālik ruled that such a sale would be valid since the wool could be observed and delivered.56 This opinion illustrates that, where jahālah and gharar can be minimized, sale of non-existent goods may be allowed.

In the opinion of Ibn al-Qayyaim and his teacher Ibn Taymmiya from the Hanbalī School ( fuqahā’ ), the sale of goods non-existent at the time of contract is permissible, if custom has shown that the items will exist in the

49 Ibid. at 74-75.50 Sahīh Muslim, Vol. 1. The Translation of the Meaning of Summarized Sahīh Muslim,

Arabic—English, Number 915; 1 Bukhārī, Complete Sahīh Bukhārī, Book 8, Number 1487.51 Ibid. 52 Al-Tabranī quoted in Al-Zuhaylī, supra note 26 at 75.53 See, e.g., Al-Zuhaylī, supra note 26.54 Ibid.55 See supra note 47.56 Al-Zuhaylī, supra note 26 at 76.


future. Their reasoning was based on the fact that no clear prohibition could be found in either the Qurʾān or Hadīth and that Hadīths prohibit-ing the sale of non-existent goods were referring to situations involving excessive risk, uncertainty, and doubt about delivery. They stated that the sale of non-existent goods should be forbidden when information about its future existence was insufficient; i.e., prohibition is based on excessive risk and uncertainty (gharar), not on existence.57

Although a number of Muslim scholars have stipulated that goods in a contract must exist at the time the sale is concluded, i.e., a requirement essential if a sale is to be valid, Zahrā and Mahmor58 opine that the non-existence of the goods should not necessarily invalidate the sale.

A similar approach has been taken by Kahf.59 Although he agreed with the OIC Islamic Fiqh Academy’s decision that the classical fiqh position, which prohibits delay of both counter-values in a sales contract, would make the use of futures impermissible, he added a practical reservation to their decision regarding real-life contracts. Kahf opined that, due to the nature of businesses, parties need to plan in advance before contracting their products and input, regardless of their need to finance.

Kamali60 opines that the non-existence of counter-values in futures or option contracts will not lead to gharar because clearing houses function as a guarantee that uncertainty and therefore gharar will be prevented and contracts fulfilled.61

Finally, when the Sharīʿah Advisory Council of the Malaysian Securities Commission met for the 11th Meeting on 26 November 1997, it resolved that the futures contracts for crude palm oil were permissible. The Council discussed the issue of buying non-existent assets (baiʿ maʿdūm) and stated clearly that baiʿ maʿdūm was actually prohibited due to the presence of uncertainty, i.e., whether goods sold could actually be delivered. Baiʿ maʿdūm is prohibited because of the element gharar, not maʿdūm.62 There-

57 Ibid.58 M. Zahrā & S.M. Mahmor, “The Validity of Contracts When the Goods are Not Yet

in Existence in Islamic Law”, Arab. Law Q., 17 (2002) 379.59 Kahf, supra note 18.60 Kamali (1999), supra note 17.61 ‘This is an unprecedented gharar prevention measure in the history of commerce in

that the guarantee function we have here leaves nothing to chance, to the vagarities of cli-mate, politics, or the marketplace’, Ibid., at 532.

62 Securities Commission, Resolutions of the Securities Commission Advisory Council 77-78, 2nd edn., 2006.


fore, the non-existence of an underlying commodity or asset may cause a contract to be invalidated. However, upon further analysis, it is not the issue of non-existence but rather gharar that is pertinent here. If gharar can be eliminated, then the non-existence of goods at the time of contract should not be reason for its invalidation.

3.2. Futures Transactions Fail to Meet the Requirement of Taking Possession of Goods Prior to Resale

In futures and option transactions, the majority of buyers and sellers reverse their positions before delivery or maturity of the contract. This means that, for futures and options, physical delivery hardly ever takes place: e.g., 99% of all futures contracts are settled before maturity.63 Two features of deriva-tive trading, i.e., selling before delivery and selling goods not in one’s pos-session, have been subject to intense criticism by Islamic scholars and provide one of the grounds upon which they base their objections.

A. Khan64 states that, in a futures market, only 1% of the contracts result in actual exchange of goods upon maturation. Therefore he con-cludes that all transactions in the chain are unlawful: i.e., there is no phys-ical exchange or delivery of commodities and no one actually owns the commodity traded in successive sales. A. Khan65 reasons that various inter-mediaries make money without first putting time and energy into the commodity itself, thus without giving anything in recompense. Actual delivery of goods would be beneficial to the community by creating jobs from, e.g., storage, transport and packaging.

At its 7th Session held in 1412 H (9-14 May 1992), No. 63/1/7, the OIC Islamic Fiqh Academy opined as follows:

. . . the contract provides for the delivery of described and secured merchandise at some future date, and payment of its price on delivery. The contract, however, does not stipulate that it shall end with the actual delivery and receipt of the merchandise, and thus it may be terminated by an opposite contract. This type of contract is the most prevalent in the commodity markets. It is not at all permissible” [. . . moreover] “it is not permissible to sell a merchandise purchased under ‘salam’ terms with advance pay-ment unless the merchandise has already been received.

63 S. Al-Suwailem, Hedging in Islamic Finance, Occasional Paper No. 10, IRTI, 43 (2006).64 Khan A., supra note 18 at 98.65 Ibid. at 99.


This decision of the OIC Islamic Fiqh Academy was confirmed by the European Council for Fatwā and Research. A similar opinion was reached by the Islamic Fiqh Academy (India) at their 9th Seminar. Although it did not specifically name futures and option contracts, it did, however, opine that a “selling deal before getting possession” is prohibited because there is always a risk of rescission. This means that, unless the first buyer actually takes possession of the goods sold, it is possible that the goods might never fall under his ownership and that he might therefore be unable to hand them over to a second buyer.66

Usmani67 contends that, in most futures transactions, delivery or posses-sion of the commodity is not intended. In most cases, a transaction is finalized by settlement of the price difference only, which is not allowed under Sharīʿah law.

Naughton and Naughton68 and Chapra69 opine that short selling, i.e., the sale of securities that the seller neither owns at the time of sale nor intends to deliver, serves no proper function in the economy. The public interest would be better served by prohibiting short sales and requiring a 100% margin.

This same stance has been taken by El-Gari70 where he states that a com-modity bought under a forward or future contract must be delivered before being disposed of by sale, i.e. the buyer must wait until delivery in order to sell the same. “Commodities in organised futures markets are bought and sold several times before actual delivery; otherwise the market will fail to provide liquidity, which is an essential part of the mechanism. However, from a Sharīʿah perspective, even in standard sale contracts, the buyer is not permitted to sell before actual receipt of the purchased item.”71

These legal opinions are based on a number of Hadīth, examples of which follow:72

66 See, e.g., Islamic Fiqh Academy (India), 9th Seminar Buying and Selling Before Getting Possession; http://ifa-india.org/english/decision_Possession.html.

67 See, e.g., Usmani, supra note 18.68 See, e.g., Naughton & Naughton, supra note 18.69 See, e.g., Chapra, supra note 18.70 See, e.g., El-Gari, supra note 1.71 Ibid. at 16.72 See Kamali (1996, supra note 17 at 205-208) separated his analysis and discussion of

the first Hadīth (do not sell what you do not have) from the rest. He explained the latter three Hadīths under the requirement of qabd or possession (at 208-211). However, other scholars have made no such distinction between these two types of Hadīth (see, e.g., Al-Zuhaylī, supra note 26 at 74-76). The authors of this article take the latter approach, i.e.,


1. Hakim b. Hazzam relates that he asked the Prophet (pbuh): “A man comes to me and asks me to sell him something that I do not have. Should I sell it to him and then go and acquire it for him from the marketplace?” The Prophet (pbuh) replied: “Do not sell what you do not have.” [Sunān al-Tirmidhī (1232), Sunān Abū-Dāwūd (3503), Sunān al-Nasāʾī (4611), and Sunān Ibn Mājah (2187)].73

2. Ibn Abbās narrated that the Messenger of Allāh (pbuh) said: “He who purchases food should not sell until he takes possession of it.” Ibn Abbās said: “Every sale is subjected to this condition.”74

3. Abū Hurairah asked Marwan: “Have you legalised usury?” Marwan said: “No”. Then Abū Hurairah said: “You have legalised selling promissory notes whereas the Messenger of Allāh (pbuh) forbade selling foodstuff unless received by the seller.” Marwan then addressed the people and forbade selling such notes. Sulaiman said: “I saw the guards taking them away from the hands of people.”75

Legal scholars differ regarding what actually should not be sold before receiving possession. The Hanafīs have ruled that it is not permissible to resell a movable object of sale prior to receiving it. The Mālikīs ruled that it is not valid to sell foodstuffs prior to receipt, whether or not their genus is subject to riba. Hanbalīs ruled that the sale of food prior to receipt is not permissible, if the food is measured by volume, weight, or number. The Shafīʿīs ruled that it is not permissible to sell items, movable or immovable, if the seller’s ownership is incomplete.76

According to Al-Suwailem,77 Ibn Taymiyyah’s opinion is preferred. According to Ibn Taymiyyah:

. . . the meaning of ‘what you do not have’ is: ‘what you are unsure that you will be able to acquire’. It may be that the product being sold is not readily available in the mar-ketplace or may only be available at a price higher than the one that it is being sold for.

that all the Hadīth will be discussed under one category because both point to the issue of the seller not owning or possessing the goods before resale.

73 Quoted in S. Al-Suwailem, “Fatwā Archives Commerce and Employment’; http://www.islamtoday.com/show_detail_section.cfm?q_id=737&main_cat_id=5.

74 Sahīh Muslim, supra note 50 at Number 909.75 Ibid., Number 910.76 Al-Zuhaylī, supra note 26 at 121-122.77 Al-Suwailem, supra note 73.


In such circumstances, either the buyer or seller will be injured by the sale. [Refer to Ibn al-Qayyim, Zād al-Maʿād.]78

Therefore, according to this opinion, a product cannot be sold if it is not in the possession of the seller; otherwise the seller should request that his customer first give him more time to verify the product’s availability and price before purchase. On the other hand, “if the product is easily available to the seller from some other vendor or supplier at a known price, then from a legal standpoint it is effectively—though not literally—in the sell-er’s possession. In this case, such a sale does not come under the Prophet’s prohibition”.79

Kamali80 highlights that contemporary scholars such as Yūsuf Mūsā,81 Alī ʿAbd al-Qadir,82 and Yūsuf al-Qardawī83 have drawn attention to the fact that, during the Prophet’s time, the marketplace in Madinah was so small that regular delivery of supplies could not be guaranteed at any given time. This might clarify the explanation on prohibition stated in the Hadīth about uncertainty with regard to the ability to deliver. How-ever, in modern times, since a seller can locate goods of sale at almost any time and make the necessary deliveries, such prohibition would no longer be applicable.

With regard to the legal opinions mentioned above, before a sale can be considered valid, there must be transfer of ownership for the goods sold; therefore if the seller does not own the goods, he cannot transfer owner-ship. The paramount reason for such a prohibition would seem to be gharar, or uncertainty about delivery of the purchased goods.84 However, according to Ibn Taymiyyah, if the commodity or asset is easily available in the marketplace, then prohibition, which is meant to help avoid gharar, would not apply. This also has a practical aspect: a person prohibited from selling goods that he did not possess, but knew he could easily obtain, would first have to possess the goods before reselling them. This could delay completion of a commercial transaction and, besides being difficult to bring about, could greatly hamper international commerce.

78 Ibid.79 Ibid.80 Kamali (1996), supra note 17 at 207.81 M. Yūsuf Mūsā, al-Buyūʿ wa l-amaliyāt al-maliyah al-muasarah (1954). 82 A. Al-Qadir, al-Muawsuah al-ʿilmiyah wa l-amaliyah lī l-bunūk al-islāmiyyah (1982). 83 Y. Al-Qardawi, Bayʿ al-murabahah lī amir bī sh-shira (1987). 84 See, e.g., Obaidullah, supra note 18.


3.3. Futures and Option Trading Involves Speculation and Verges on Maisir, Qimār and Gharar

The foregoing discussion on gharar has shown that it is the underlying reason why scholars object to the sale of (1) non-existent objects, and (2) items not in one’s possession. The following discussion on gharar, in contrast, focuses on the issue of gambling, the zero-sum nature of deriva-tives, and pure uncertainty regarding the outcome of a contract.

A. Khan85 states that, in an Islamic framework, speculation per se is not unlawful. However, ‘speculators cannot thrive’ within an Islamic frame-work because each transaction requires physical delivery. Furthermore, speculation often requires borrowed funds on interest, which is forbidden in Islam. In addition, in an Islamic economy, a borrower’s liability is unlim-ited, which would not favour speculators averse to exposing all their assets to infinite risk. “Therefore we believe that the Islamic framework leaves little room for speculators”.86

Wilson87 discusses the validity of futures and options, explaining that under Sharīʿah law traders are expected to uphold the highest moral stan-dards. They must not only resist exploitation and be honest in all their dealings but also the trade itself should be productive and socially desir-able. Wilson opines that such requirements automatically preclude specu-lative behaviour, which is “both unproductive and socially undesirable because of its potentially exploitative nature”.88 Therefore, Wilson con-cludes that dealing in forwards, futures and options is “potentially corrupting”89 and that “options and futures contracts cannot be traded under Sharīʿah, as they are too remote from the underlying assets”,90 i.e., gharar.

Obaidullah91 asserts that excessive uncertainty, or gharar, leads to the possibility of speculation which is forbidden: “speculation in its worst form is gambling”. Obaidullah then goes on to question whether the use of conventional options involves excessive risk, noting that the buyer and seller have diametrically opposite expectations, i.e. the buyer’s gains equal

85 Khan A., supra note 18.86 Ibid., at 101.87 R. Wilson, “Islamic Financial Instruments”, Arab. Law Q., 6 (1991) 205-214;

Wilson (2007), supra note 18.88 Ibid at 209.89 Ibid.90 Wilson (2007), supra note 18 at 14.91 Obaidullah, supra note 18 at 84.


the seller’s losses and vice versa. Thus he concludes that the sale of options is a risky zero-sum game. Obaidullah explains that speculating on where random fluctuations will move the price of an underlying asset or com-modity in the future infers that the parties’ gains and losses also will be random, demonstrating that dealing in option contracts is nothing more than a game of chance. Gains are therefore in the nature of maisir, while the possibility of suffering default after incurring massive losses indicates gharar. Obaidullah concludes his discussion on options by stating that “options as an independent contract may not be a suitable form of hedging or managing risk [. . .] these can be used for speculating on price move-ments and generate unearned income, which violates Islamic norms of financial ethics”.92

Obaidullah93 reiterates and extends this argument to futures as well. He states that, in the case of options and futures in conventional financial markets, the presence of large-scale speculation is tolerated on the grounds that it provides liquidity and ensures market activity; speculators in the market are thought to improve operational efficiency by lowering the costs of transactions. However, such a trade-offs between tolerance of qimār and maysir with hedging facilities will not apply within an Islamic framework, which also objects to the zero-sum nature of the game.

DeLorenzo94 holds a similar opinion, stating that options and futures, both intangible, are part of zero-sum markets where gains result from cor-responding losses. He opines that this sort of economic activity is clearly forbidden under Sharīʿah law. He adds that, while proponents of futures and option markets may argue that such activities function to stabilise prices and regulate risk, as far as the Sharīʿah is concerned such markets produce nothing of value. He concludes that “options and futures amount to bets on the direction the market is moving in. Obviously, the ethics of this market are unacceptable”.95

El-Gamal96 stresses that, while financial options are pure gharar, this does not necessarily mean that they will always be considered invalid; if

92 Ibid., at 100.93 M. Obaidullah, “Financial Contracting in Currency Markets: An Islamic Evaluation,

IJIFS, 3(3) (2001)”; http://islamic-finance.net/journals/journal11/obaidvol3no3.pdf; M. Obaidullah, “Islamic Risk Management: Towards Greater Ethics and Efficiency”, IJIFS, 3(2) (2002); http://islamic-finance.net/journals/journal10/obaidvol3no2.pdf.

94 See, e.g., Delorenzo, supra note 18.95 Ibid.96 See, e.g., El-Gamal, supra note 18.


jurists one day find them to be overwhelmingly beneficial, then perhaps their use will be endorsed. As an example, El-Gamal, explains that the ‘salam contract’ contains gharar since the object of sale does not exist at the time of contract. However it is considered permissible due to the need for this type of contract to improve economic efficiency.

F. Khan97 opines that the current futures (and option) market, which developed from the forwards market, is a total departure from the original philosophical concept of forward sale. Today the futures market allows traders to buy and sell futures contracts without the intention of receiving or making delivery. F. Khan finds that producers or farmers are forced to compete with pure speculators and that the futures markets today are an independent industry where traders can earn income by trading risks with-out getting involved in the actual production or delivery of a commodity. Speculators can profit substantially in futures markets by guessing future prices without rendering or becoming involved in productive efforts. F. Khan feels that such profit through speculation discourages producers and farmers; when it is possible to make a profit in such a manner, then why bother about production itself ? He argues that the Islamic economic phi-losophy does not permit pure speculation; here the primary concern is the commodity itself, not merely the trade for the purpose of financial gain. The Islamic spirit of exchange is totally against a philosophy that isolates producers from the markets.

Kahf 98 believes that because, in speculative futures markets, only a small percentage of contracts are ever implemented, such contracts are inadmissible.

Al-Suwailem99 explains that, in a zero-sum game, one party gains at another’s expense, i.e., it is a “transfer of wealth for no counter-value”; this he opines is “condemned in the Qur’ān”. He explains that the direct con-flict of interest inherent in a zero-sum game may create hatred between the two parties, which is one reason the Qur’ān prohibits maisir: “Satan only wants to plant enmity and hatred among you through wine and maisir” (Q6:91). Al-Suwailem argues that the use of derivatives is a clear example of a zero-sum game, obliging an exchange of underlying assets for money, or certain amounts of money, at a future date. In the latter type of con-tract, the price difference between the time of contract to expiration date

97 See, e.g., Khan M.F., supra note 18.98 See, e.g., Kahf, supra note 18.99 Al-Suwailem, supra note 63 at 73.


is debited from one party and credited to another; this is why they are called contracts for differences. Al-Suwailem suggests that, to achieve a desirable transfer of risk, Islamic finance must utilize structures that allow for mutual gain, in other words, non-zero-sum games. “Such games, while implying the possibility of zero-sum outcome, permit a positive-sum out-come, and thus provide room for mutual benefits”.100

Contrary to the above arguments, Bacha,101 Kamali,102 Smolarski et al.,103 and the Malaysian Securities Commission’s Sharīʿah Advisory Council (SAC) opine that speculation per se on the futures and option markets are not impermissible within Islamic finance.

Bacha104 believes that elimination of speculative activity would hurt rather than help, because without speculators hedgers would suffer.

Kamali takes a similar viewpoint.105 In his opinion, speculation cannot be altogether eliminated; even Islamic transactions such as mudārabah and mushārakah are highly speculative. Kamali opines that “speculation deals in risks that are necessarily present, but gambling creates the risk that would otherwise be non-existent”.106 He argues that, in a futures market, the burden of risk shifts from those who are unwilling to take it to those who are and that, even if the motivations of a speculator could be identical with those of a gambler, there are differences between the two because futures speculation “reallocates risk from those who do not want it to those who do”.107 Kamali further contends that derivatives lack the vital element of gambling, i.e., the wrongful misappropriation of someone else’s prop-erty. He claims that derivatives facilitate price discovery, hedging ‘produc-tion planning’, ‘create trading vehicles’, and an ‘arena for profitable commerce that can avert the flight of much needed funds to foreign markets’.108

100 Ibid., at 85.101 O.I. Bacha, “Derivative Instruments and Islamic Finance: Some Thoughts for a

Reconsideration”, IJIFS, 1(1) (1999); http://islamic-finance.net/journals/journal1/art2.pdf.102 Kamali (1999), supra note 17.103 J. Smolarski et al., “Permissibility and use of Options for Hedging Purposes in Islamic

Finance”, Thunderbird Int’l. Rev., 48(3) (2006) 425.104 Bacha, supra note 101.105 Kamali (1999), supra note 17.106 Ibid., at 533.107 Ibid., at 534.108 Ibid., at 535.


Smolarski et al.109 also highlight these advantages of derivatives, claim-ing that the criticism that options are gharar and qimār fails to take into account their risk-reducing function, i.e., when options are bought and sold to protect against financial loss. The authors further argue that each option contract is “standardized in terms of duration, quantity, type of option and so on”.110 Therefore, mutual consent exists between parties at the time of the trade, settlement, and clearing processes. Furthermore, a third-party monitor ensures that these processes are carried out fairly according to the terms in the contract agreed upon by mutual consent. “This process helps to ensure that gharar prevention is maximized, since there is a substantial reduction in the risk within the financial system. Thus the requirement that functional and operational gharar be avoided is largely met.”111

During its 11th Meeting, on 26 November 1997, the SAC resolved that futures contracts on crude palm oil were permissible; during the 13th meeting, on 19 March 1998, it resolved that the mechanism of stock-index futures did not contradict Sharīʿah principles. The SAC ruled that stock-index trading is permissible as long as the stock index is based on Sharīʿah-compliant securities. Before ruling on permissibility under Sharīʿah law for both types of futures contracts, the SAC had first to con-sider the issues of (1) gambling, (2) gharar, (3) jahālah and (4) speculation.

On the issue of gambling, the SAC explained that the requirement imposed on a market player to deposit a payment as margin before initiat-ing a trade did not constitute a bet. Fluctuation in the price of a commod-ity (e.g., crude palm oil) is brought about by changes in demand in the (crude oil) futures market; this is not gambling because ‘gambling activi-ties depend solely on luck and are not related to demand and offer’.112 As for buying and selling the index, the SAC ruled that this is not gambling because it is not similar to losing a bet. The SAC explained that, when gambling, a player will lose all his money if he makes a wrong guess; the SAC opined that this does not happen in index trading because the total index has its own inherent value. “What happens is, the investor will expe-rience a decrease or increase in the value depending on the demand for the

109 Smolarski, supra note 91. 110 Ibid. at 437.111 Ibid.112 Securities Commission, supra note 62 at 76.


total number of shares that comprise the index component. Index trading does not involve any element of betting”.113

On the issue of gharar, the SAC defined gharar as something that is uncertain; e.g., the uncertainty in obtaining purchased goods and in receiv-ing potential profits. The SAC opined that profit and loss in the business world is a common factor that a trader should try to minimize. When trad-ing, e.g., a crude oil future on offer, a market player will know the con-tract’s specifications such as quantity, type, price and delivery date. Therefore gharar is not an issue in the contract. “All specifications are made clear in the contract, and surveillance and regulation are provided to ensure there is no cheating”.114

On the issue of stock-index futures, the SAC opined that such contracts do not contain elements of jahālah and gharar as their price and quantity are clearly know. “The price is determined by the market based on demand and supply”.115

On the issue of speculation, the SAC stated that speculation exists in all forms of business and is not unique to futures transactions.

It is the authors’ opinion that the underlying reasons supporting the SAC ruling seem to have been considered within a total vacuum, oblivious to the scholarly Sharīʿah opinions on derivatives at that time. First, in 1997 when the resolution was made, the SAC should have at the very least been aware of the arguments presented by F. Khan, A. Khan, the OIC Fiqh Council Fatwā, and Kamali. However, none of these arguments were coun-tered or supported. Second, with the exception of gharar, gambling, etc., none of the above authors’ arguments were dealt with appropriately. Third, the SAC did not discuss the actual nature of futures, although when trad-ing in commodity futures, most players do not take possession. If the SAC had sufficiently addressed various scholarly opinions present at that time, its resolution would definitely have been more persuasive and carried more authority.

In summary, the majority of scholars believe that speculation in deriva-tives leads to excessive uncertainty, which amounts to gambling. They opine that derivatives are a clear example of a zero-sum game and as mere contracts of differences a way to gamble and bet. The counter-argument seeks to highlight the advantages of derivatives, such as setting a price,

113 Ibid., at 81.114 Ibid., at 77.115 Ibid., at 81.


creating a vehicle for trade and an arena for profitable commerce. Further-more, it is argued that standardization of contracts, third-party monitor-ing, and mutual consent between contracting parties would help minimize gharar.

3.4. Options Are a Mere Right to Buy or Sell for which Charging Fees Is Impermissible

In an option contract, the right to buy (or sell) an underlying asset at a predetermined strike price requires payment of a fee.

According to Usmani,116 an option is a ‘promise’ which is itself permis-sible and “normally binding on the promisor”. However, the fact that an option transaction requires payment of a fee on the promise invalidates this type of derivative under Sharīʿah law. He opines that this ruling applies to all types of options, whether they be calls or puts, because options are rights, not physical assets, and therefore cannot be bought or sold. The OIC Islamic Fiqh Academy states that:117

Option contracts as currently applied in the world financial markets are a new type of contracts which do not come under any one of the Sharīʿah nominated contracts. Since the object of the contract is neither a sum of money nor a utility or a financial right which may be waived, then the contract is not permissible in Sharīʿah.

The OIC Islamic Fiqh Academy’s decision was confirmed by the European Council for Fatwā and Research.

This same stance is held by Delorenzo118 who opines that the sale of options is prohibited because it involves the sale of nothing more than a right to buy to another party.

Although the trading of intangibles, such as service and usufruct (manfāh), is recognized under Islamic law, the right given by an option may not be the same as usufruct. The option holder’s rights do not have a tangible or physical quality but are similar to a pre-emptive right, such as the right to custody and guardianship, which is allowed under Sharīʿah law but cannot be sold for monetary compensation.119

116 Usmani, supra note 18 at 10.117 OIC, supra note 18 at Resolution No. 63/1/7.118 See, e.g., Delorenzo, supra note 18.119 El-Gari, supra note 18 at 13.


Kamali120 disagrees that compensation is impermissible. He affirms that the concept ‘option’ is valid under Sharīʿah law because of the concept ‘al-ikhtiyārah’, the origin of which can be traced in the Sunnah, that has been further developed through initiative and ijtihād,121 in the juristic writings of the ʿulamāʾ (scholars learned in Islamic law). Regarding the issue of options as a mere right, and therefore unable to be bought or sold, Kamali classifies the right given under an option as an intangible (e.g., a service) and usufruct. He concludes that while the Shafī‘ī and Hanbalī schools have included usufruct under the definition of property, the Hanafī and Mālikī schools have not. However, Hanafī and Mālikī jurists from later periods have generally included usufruct in their definition of prop-erty. He continues his argument on whether compensation is allowed under the Sharīʿah; he states that the typical al-ikhtiyārah validated by the Sunnah is the option of stipulation (khiyār ash-shart) which grants a buyer the option, within a timeframe, either to ratify or revoke the contract. Under such an option, Kamali122 maintains that the Sunnah entitles the parties freedom to insert stipulations that meet their legitimate needs. Based on the argument of freedom to contract, Kamali opines that the freedom to insert stipulations in contracts includes the request for mone-tary compensation:

. . . or a fee for granting an option or a privilege. If the seller is entitled to stipulate for a security or a pawn, then it is a mere expansion of the same logic that he may charge the buyer and impose a fee or compensation in respect of such options and stipula-tions that are to the latter’s advantage.123

Thereby Kamali concludes that the imposition of a fee for rights granted by an option is valid under Sharīʿah law.

This stance taken by Kamali is strictly disputed by Obaidullah who124 does not dispute the validity of a sale with a condition where the condition is stipulation of an option, khiyār ash- shart. Obaidullah even states that the contractual price is valid if it includes any compensation for the ben-

120 Kamali (1997), supra note 17 at 27.121 “Exerting one’s reasoning faculty to determine a point of law”, Abdal-Haqq, supra

note 37 at 9.122 Ibid.123 Ibid., at 30.124 See, e.g., Obaidullah, supra note 18.


efit provided by the seller for being at a disadvantage. However, in conven-tional options:

[. . .] trading would imply separation of the compensation component and its up-front payment to the option writer or seller under a separate contract . . . a promise or obliga-tion cannot be the object of sale according to an overwhelming majority of scholars . . . In classical Sharīʿah law, before damān (compensation) can operate one needs to show some illicit act (tāddi) or negligence (tafrid) by the party required to compen-sate . . . Kamali also fails to cite a single reference of the great fuqahāʾ (a fiqh expert) of the past on the use of damān in the bayʿ wa shart framework.125

In other words, some disadvantage must have been occasioned before pay-ment of compensation is allowed.

In the authors’ opinion, the only issue here is whether a right given in an option is valid under a sale and purchase agreement as the subject matter of the sale. Because a ‘right’ is intangible, the Fiqh Academy,126 El-Gari,127 and Obaidullah128 argued that it is not a property. However, if ‘service’ and ‘usufruct’ can be categorized as property, and therefore may be the subject matter of a sale, why might this not also apply to a right provided by an option? The delineation between rights from services and usufruct seems artificial, especially when an option is used to hedge and gives the buyer rights with which to prevent losses. Kamali’s129 view appears to be more sound. Furthermore, the argument that a seller has to occasion a disadvantage for compensation to be given applies in options. Since an option buyer is not obliged to buy or sell the underlying com-modity, he may let the option lapse, in which case his greatest loss would be the premium. However, the seller’s gain would be the premium alone, and his losses could be unlimited depending on the price movement of the underlying asset. Because it is the seller, or writer, of the option who under-takes a more potentially disadvantageous position, therefore giving com-pensation should be allowed under such circumstances.

125 Ibid., at 80.126 See, e.g., OIC Islamic Fiqh Academy, supra note 18.127 See, e.g., El-Gari, supra note 18.128 See, e.g., Obaidullah, supra note 18.129 See, e.g., Kamali (1997), supra note 17.


3.5. Futures Sale Being the Deferment Of Both Counter-Values Is a Sale of One Debt For Another, Baiʿ Ul-Kālī Bī L-Kālī, which Is Forbidden

The exchange of a debt for a debt also known as baiʿ ud-dayn bī l-dayn or baiʿ ul-kālī bī l-kālī has generally been found to be prohibited in Islamic law by Islamic scholars.130 Imām Ibn Hanbal, founder of the Hanbalī School, ruled that common consensus (ijmāʿ an-nās) has forbidden the sale of debts.131 There is also a Hadīth which reports that: Mūsā ibn Ubayd reported from Abd Allāh ibn Umar simply that the “the Prophet prohib-ited baiʿ ul-kālī bī l-kālī”.132

This general prohibition has been prescribed to futures, where it is con-cluded that the sale of futures contracts, where the parties can offset their transactions by selling the ‘debts’ owed them to other parties before the delivery of the underlying asset, will amount to a sale of a debt and is therefore prohibited.133 This objection has been refuted by Kamali.134 He claims135 that evidence shows that no common consensus has been reached regarding prohibiting an exchange of debts because the legal schools have recorded divergent rulings as to the definition of baiʿ al-kālī bī l-kālī. Even the Hadīth that only appears in several collections is considered unreliable by many prominent scholars. Furthermore, Kamali argues that, because a number of scholars actually find exchange of debts permissible, in the absence of a clear prohibition on the sale of a debt, the principle of permis-sibility must prevail, provided that it is devoid of riba and gharar. As for futures trading itself, Kamali states that the nature of the futures contract makes it a contract between the purchaser (or seller) and the clearing house only. No third party is involved in the transaction; thereby there are no uncertainties regarding clearance and delivery. “In other words, the price was a debt on the clearing house, which is the principle party in the transaction . . . it acts in the capacity of a fully committed guarantor”.136 Therefore, futures contracts involve the fulfilment of obligations and the repayment of debt by the debtor, which is allowed under Islamic law.

130 Al-Zuhaylī, supra note 26 at 79.131 See, e.g., Kamali (1996), supra note 17. 132 Shawkani at 176, in Ibid., at 212.133 See, e.g., Obaidullah , supra note 93.134 See, e.g., Kamali (1996), supra note 18.135 Ibid., at 212–214.136 Ibid., at 213.


In the authors’ opinion, the argument set forth by Kamali appears to be very valid with regard to this objection to futures, because of the nature of futures transactions. It is a fact that clearing houses acts as seller for each buyer and buyer for each seller in all futures transactions. Each transaction is guaranteed. There is no direct interaction between traders. Therefore, there is no exchange of one debt for another, because each transaction ends during the exchange of buying or selling the contract.

Having discussed in detail the five main objections to derivatives under Sharīʿah law, focus will now be on the legal objections to derivatives in conventional finance, including comparison with objections under Sharīʿah law.

4. Legal Objections of Derivatives in Conventional Finance

Legal objections to derivatives are not a recent phenomenon in conven-tional finance, as their history began thousands of years ago. In ancient Israel, the laws of the Mosaic code, which originated around 1250 BC, prohibited the sale of future goods. A valid sale required a transfer of money in exchange for specific existent property in the seller’s possession, which would be consumed by the buyer taking possession of it.137 Later, in the 7th century BC, Greek law givers, who transmitted laws verbally through verse, forbade transactions in commodities for future dealings, possibly to reduce litigation in the event of default.138 Even Plato’s Laws reflect that, when a contract is drawn up, the transfer and receipt of the price should be made on the spot without delaying the sale or purchase:

When goods are exchanged by selling and buying, a man shall deliver them, and receive the price of them, at a fixed place in the agora, and have done with the matter; but he shall not buy or sell anywhere else, nor give credit. And if in any other manner or in any other place there be an exchange of one thing for another, and the seller give credit to the man who buys from him, he must do this on the understanding that the law gives no protection in cases of things sold not in accordance with these regulations.139

However, delving into legal history would neither be within the scope of nor consonant with the aim of this article, which is to compare both

137 See, e.g., Swan, supra note 1.138 Ibid.139 Plato, Laws, Book X (360 BC): available at: http://classics.mit.edu/Plato/laws.html.


Sharīʿah and conventional legal objections to derivatives. Sharīʿah’s objec-tions dating from the 1980s are based on modern-day exchange of futures and option derivatives that only emerged in the 17th century at the time of the Dojima rice market in Japan and later in the 19th century with the establishment of the US CBOT.

The main legal grounds underlying conventional finance’s objections to derivatives can be summarised as follows:

1. Futures involve the mere sale of promises which is unenforceable, i.e., because they do not involve simultaneous transfer of possession, there is no actual physical delivery.

2. Futures are contracts for differences which amounts to wagering and is therefore illegal.

It can be established prima facie that the above legal objections to deriva-tives are similar to, if not the same as, Sharīʿah’s objections discussed above. However, the Sharīʿah includes two additional objections not raised by conventional finance: (1) a future which is a deferment of both counter-values is a sale of one debt for another, i.e., baiʿ ul-kālī bī l-kālī, which is forbidden, and (2) an option is a mere right to buy or sell so that charging fees is not permissible. However, a proper comparative analysis of the objections under Sharīʿah and conventional finance is only possible after first discussing in detail the legal objections in conventional finance.

4.1. Futures Involve the Mere Sale of Promises Which Is Unenforceable

Historically a sale of promises or an executory contract could not be enforced because the promisor had received no benefit.140 This is seen in Glanville’s Tractatus141 where it is stated that a sale is “enforceable only when (1) the thing sold has been delivered, or (2) all or part of the price has been paid, or (3) earnest has been given. In the first two cases neither party can withdraw from the contract, but where only earnest has been given, the seller can retain any earnest given but has no remedy for a buy-

140 See, e.g., W.M. McGovern, “Contract in Medieval England: The Necessity for Quid Pro Quo and a Sum Certain”, Am. J. Leg. Hist., 13 (1969) 173.

141 Glanvill’s Tractatus de Legibus et Cunsuetudini bus Angliae, written between 1185 and 1190, is regarded as one of the first in the series of books on English common law. G.B. Adams, “The origin of the common law”, 34(2) Yale L.J., 115 (1924).


er’s breach”.142 This requirement, that sale of promises is unenforceable, affects derivatives because at the time of contract promises are made with-out an exchange of any counter-value. In the case of futures, where a small margin is deposited, this would be the same as an earnest described above, where no action is possible even if an earnest has been given.

Application of this principle is seen in the case of Bryan v Lewis,143 where a sale of promises was held to be unenforceable. In this case, (in February) the plaintiff sold nutmegs not in his possession to the defendant (a minor) to be paid and delivered at a future date (6 May). Thereafter (in March) the plaintiff bought nutmegs to deliver to the defendant. On the date of delivery, 6 May, the defendant was unable to pay. Abbott LCJ held that:

. . . if a man sells goods to be delivered on a future day, and neither has the goods at the time, nor has entered into any prior contract to buy them nor has any reasonable expectation of receiving them by consignment, but means to go into the market and to buy the goods which he has contracted to deliver, he cannot maintain an action upon such a contract. Such a contract amounts, on the part of the vendor, to a wager on the price of the commodity, and is attended with the most mischievous consequences.144

Thus, the case of Bryan v Lewis prohibited the sale of promises where goods are non-existent at the time of contract, even when the plaintiff already had in his possession the commodity at the date of delivery. This objection resembles the orthodox view of Mahmassani,145 the OIC Fiqh Academy fatwā146 confirmed by the European Council for Fatwā and Research,147 and Usmani148 that deferment of both counterparts of the exchange will invalidate the contract.

The judge, Abbott LCJ (who was knighted Lord Tenterden in 1827) even went so far to explain that the reason for invalidating the contract was due to the fact that the seller would be wagering on the price of the com-modity. On this point, Lord Tenterden later stated:

142 Glanvill quoted in McGovern, supra note 140 at 176.143 Bryan v. Lewis, 171 Eng Rep 1058 (1826).144 Ibid., at 1059.145 Mahmassani, supra note 18.146 OIC, supra note 18 at resolution no. 63/1/7.147 European Council for Fatwā and Research, supra note 18.148 Usmani, supra note 18.


If two persons enter into a contract under the semblance of a sale of goods, not intend-ing really to buy or sell the commodity but merely as a gambling speculation, and to pay the difference of the market price on a particular day, like a time bargain in stocks, such a contract is illegal at common law, and no action will lie to enforce it.149

The decision in Bryan v Lewis would not remain law, and 10 years later it was distinguished in the case of Wells v Porter.150 In this case, the plaintiff, a broker, sued for failure of payment of debts owed by the defendant as a result of the plaintiff’s option transactions to make or take future delivery of foreign government bonds. Bosenquet J, the presiding judge, held as follows: first, that Lord Tenterden’s decision in Bryan v Lewis was a mere dictum and thus non-binding; second, in that case, the fact that the defen-dant was a minor had made the judge look unfavourably on the claim (although no mention was made of this by Abbot LCJ); and third, in Bryan v Lewis, there was no reasonable expectation about obtaining the object of the contract which was not the case here because the defendant had reasonably expected to obtain the goods stated in the contract. Bosenquet J further added that, where an agent has performed work, he should receive compensation even though the contract under which he had worked was void.

What can be seen from this case is that Bosenquet J has distinguished Wells v Porter from Bryan v Lewis.151 When Bosenquet J laid down the test, i.e. whether there was a reasonable expectation that the goods in the con-tract would be obtained, he meant whether there was a reasonable expecta-tion that the goods in the contract would be obtained at the time of contract. The fact that, in Bryan v Lewis, the plaintiff had already obtained the nutmegs after the time of contract but before the date of delivery did not satisfy the test.

149 Quoted in Wells v. Porter, Eng. Rep., 132 (1836) 278, 280.150 Ibid.151 The decision in Wells v Porter also involved the issue whether the contract between

the plaintiff and defendant was void at statute under the Stock Jobbing Act, 7 Geo 2, England (1734), which barred option dealings and futures contracts in stocks. This Act was repealed in 1860. See R.W. Ferguson, “Commercial Expectations and the Guarantee of the Law: Sales Transactions in Mid-Nineteenth Century England”, in: G.R. Rubin and D. Sugarman (Eds.), Law Economy, and Society, 1750-1914: Essays in the History of English Law (1984). Tindal CJ in Wells v Porter held that the Stock Broking Act did not apply to foreign securities. This decision was confirmed by the same court in Oakely v. Rigby, 5 Law J. Rep. (NS) CP 256 (1836) and Elsworth v Cole, 6 Law Rep (NS) Exch. 50 ( 1836).


When comparing conventional law’s objections with those of the Sharīʿah, one sees that two of Sharīʿah’s objections resemble the ‘reasonable expectation test’. The test for reasonable expectation to obtain goods in the contract is very similar to the more lenient opinion by Ibn Taymiyya as cited by Al-Suwailem,152 Zahrā and Mahor,153 and Kahf.154 Under Sharīʿah law, scholars have opined that selling non-existent goods which might not be deliverable is impermissible, i.e., it is not the non-existence of goods per se but rather the excessive gharar involved. Where goods have been defined, are known, and can be obtained, then prohibition will not apply. This is similar to the ‘reasonable expectation test’ laid down in Wells v Porter. It is opined that both tests developed are the same.

Furthermore, the ‘reasonable expectation test’ is also similar to the sec-ond objection of Sharīʿah scholars, i.e., that futures sale fall short of meet-ing the requirements of taking possession of the goods prior to reselling. Here Al-Suwailem,155 following the opinion of Ibn Taymiyya, opined that if the product or counter-value is easily available to the seller from some other vendor or supplier at a known price, then, from a legal standpoint, it is effectively in the seller’s possession and therefore the contract is valid.

Nevertheless the ‘reasonable expectation test’ under conventional law was further extended in the case of Hibblewhite v M’Morine,156 where the judgment made by Abbot LCJ in Bryan v Lewis was severely criticized.157 All three judges (Parker B, Alderson B and Maule B) in Hibblewhite v M’Morine unanimously agreed that the decision made by Lord Tenterden was wrong. In this case, an agreement was made between the plaintiff and defendant that the plaintiff would sell to the defendant 50 shares, to be transferred and paid for in the future. At the time of contract, the plaintiff was not in possession of the shares but was ready to deliver and transfer them at the future date. The defendant neither accepted nor paid for the shares. The defendant argued that, at the time of contract, the plaintiff neither had in his possession nor had a reasonable expectation of obtaining the shares, i.e., circumstances which therefore invalidated the contract. The court held in favour of the plaintiff. Alderson B held:

152 Al-Suwailem, supra note 73.153 Zahrā & Mahmor, supra note 58.154 Kahf, supra note 18.155 Al-Suwailem, supra note 73.156 Hibblewhite v. M’Morine, 5 M & W 462 (1839).157 The case of Bryan v. Lewis was overruled in Thacker v. Hardy 4 QBD 685 (1878).


I think the dictum of Lord Tenterden cannot be supported. There is no principle in its favour. It would put an end to half the contracts made in the course of trade. Suppose a vendor makes a contract for the delivery of goods, which may be performed by the delivery of any goods of the kind bargained for: whether he has them in possession at the time of the contract or not, can make no difference, if he has them ready to be delivered at the time the contract is to be fulfilled.158

This case, therefore, has extended the test of reasonable expectation in that, as long as the commodity is available and in the seller’s possession at the time of delivery, the contract remains valid. Therefore, the sale of a promise is permissible as long as the seller can deliver the commodities at the future date. This ruling seems to have surpassed the objection under Sharīʿah law, since the requirement for minimizing gharar still has to be fulfilled before a contract is deemed valid.

Under conventional law, notwithstanding the uncertainty or riskiness of obtaining goods named in the contract or the ability to fulfil, the contract would be deemed valid if the seller was able to perform the contract at the future date. This resembles Kamali’s counterview159 when he opined that, in relation to futures or options, the function of the clearing house to guar-antee exists for the purpose of preventing gharar; therefore the non-existence of counter-values in futures or option contracts will not represent gharar.

The approach used in England was followed by the US Supreme Court in the case of Clews v. Jamieson160 which held that a contract for the sale of goods to be delivered at a future date is valid, even when the seller neither has the goods nor any means of obtaining them other than buying them in the marketplace himself.

To summarise, legal history and the development about whether a con-tract becomes invalid when parties do not possess the counter-value in the contract very closely mirrors the Sharīʿah scholars’ objections in Islamic finance. As for conventional finance, while the issue of selling an item, which one neither has nor can obtain by any reasonable means, may have been finally recognised in the UK and US, there was still an issue about the intention, i.e., of whether contracting parties really intend to deliver. If there is no such intention, then a contract will be null and void. The next section discusses this issue.

158 Hibblewhite v. M’Morine, supra note 156 at 197.159 Kamali (1999), supra note 17.160 Clews v. Jamieson, U.S. LEXIS 2758 (1900).


4.2. Futures Sales Being Contracts for Differences Amounts to Wagering and Is Therefore Illegal

Futures transactions are most often closed not by delivery of physical goods but rather by payment of the difference between the strike price in the contract and spot price of the underlying asset upon closure. This act of paying the difference in price was interpreted as being nothing more than a wager with no intention to deliver the underlying asset or commodity. Both the English and US courts dealt extensively with the legality of such transactions.

In the case of Greenland v Dyer,161 Lord Tenterden held that a contract for future price differences would be void.162 However, in the case of Morgan v Ferber,163 Tindall CJ held that, while contracts that intend to be settled by payment of differences are indeed a wager, because common law considers wagers to be valid (at that time, with certain exceptions), such a contract was valid. This seemingly liberal view on the validity of contracts of differences, albeit wagers, was short lived. In 1845, the Gaming Act was passed which rendered all contracts or agreements which were wagers as null and void and unenforceable in the courts. According to s.18 of the Act:

18. Wagers not recoverable at Law. All contracts or agreements, whether by parole or in writing, by way of gaming or wagering, shall be null and void; and no suit shall be brought or maintained in any court of law and equity for recovering any sum of money or valuable thing alleged to be won upon any wager. . . .164

Since in Morgan v Ferber the Court had already held that futures contracts settled by differences were wagers, they were rendered unenforceable in court after the Gaming Act 1845. In effect, sales for future delivery were deemed void and unenforceable, where settlement would not include an intention to deliver but rather an expectation to be paid the difference in price. This statute gave rise to the ‘intent test’ that was applied in both UK and US courts to determine the legality of futures.

161 Greenland v. Dyer, 6 Law J Rep KB 345 (1828).162 Although in the case at hand the bills of exchange were valid because they were not

contracts for future difference.163 Morgan v. Ferber, 6 La J Rep CP 75 (1837).164 This Section 18 of the Gaming Act 1845 was repealed only in 2005 under the

Gaming Act 2005 c. 19 s.334(1)(c).


In the case of Grizewood v Blane,165 the plaintiff and defendant entered into a contract for the sale of railway company shares at a future date. The parties agreed that no actual shares would change hands but that settle-ment would be by payment of differences in price. When the defendant failed to pay, the plaintiff initiated a law suit. The defendant claimed that the contract was an illegal wager under s.18 of the Gaming Act 1845. However, evidence showed that there had been former dealings between the parties where they had settled only the difference in the contract price, without delivery. At the trial, the Lord Chief Justice Jervis instructed the jury that it was their responsibility to decide upon the intentions of the plaintiff and defendant at the time of contract: i.e., if neither party actually intended to purchase or sell the shares in question, then the contract would become null and void as a gambling transaction. The jury found in favour of the defendant; in other words the transaction was a gambling transac-tion. All three judges (Cresswell J, Talfourd J and Jervis CJ) in the case approved the decision. Jervis CJ stated:

I thought the evidence abundantly justified the conclusion the jury came to. I cer-tainly meant to ask the jury what was the intention of the parties, as understood by both of them, at the time of entering into the contract. That was the whole contest throughout the trial. The transaction was clearly gambling, and a practise which every-one must condemn.166

From this case emerged the ‘intent test’ to determine the intention of the parties, i.e., whether they intended to buy and sell the underlying asset or settle through differences. This was approved in the case of Barry v Croskey167 where the Vice Chancellor Sir William Page Woode cited with approval Grizewood v Blane and reiterated the test as “a bona fide intention to pur-chase or deliver the shares”.168

The ‘intent test’ established in Grizewood v Blane was adopted shortly thereafter by the House of Lords in Universal Stock Exchange v Strachan.169 In this case, the House of Lords was required to decide, inter alia, whether the trial judge, Cave J, had appropriately briefed the jury when he stated: “the question which you have to try is whether these transactions were real

165 Grizewood v. Blane, 11 CB 526 (1851).166 Ibid. at 584.167 Barry v. Croskey, 2 J. & H. 1 (1861).168 Ibid., at 957.169 Universal Stock Exchange v. Strachan, A.C. 166 (1896).


bargains for purchase of stock, or whether they were simply gambling transactions intended to end in payment of differences . . .”.170 The Law Lords (Lord Halsbury LC, Lord Herschell, Lord Macnaghten, and Lord Morris) concurred that the trial judge had appropriately briefed the jury; according to Lord Hershell: “As to misdirection, I can see none. The learned judge appears to have laid down the law certainly not too favourably for the plaintiff ”.171

Comparing the ‘intent test’ with Sharīʿah’s objections, one can see that two of Sharīʿah’s objections show similarities to this objection under con-ventional law.

First, under Section 3.2 above, the Sharīʿah requires that the commodity be physically delivered or taken possession of before being resold, which is similar to the requirement imposed by various courts starting with Grizewood v Blane, i.e., that a futures contract will be deemed invalid if there is no intention to deliver the underlying asset.

Second, under Section 3.3 above, the Sharīʿah’s objection that futures and option trading verge on maisir, qimār and gharar would also seem to overlap with the underlying reason why the ‘intent test’ was developed, i.e., to distinguish between futures and option contracts that are mere con-tracts of difference or gambling contracts from those that are true contracts with an intention to deliver. Therefore, one may find that this objection raised in conventional finance parallels or resembles objections in Islamic finance.

As for the intent test developed in the UK, this was followed in a num-ber of cases in the US.172 A significant case, which summarises the position of the US courts at that point in time, is Irwin v Williar 173 in the US Cir-cuit Court. In this case, the plaintiffs sued the defendant for the difference in price that was their due from the sale of wheat for future delivery. The defendant claimed, inter alia, that the contract was void because it was a

170 Ibid., at 167.171 Ibid., at 172.172 In re Chandler, N.D. Ill Fed Cas. No. 2,590 (1874); In re Green, W.D. Wis Fed. Cas.

No. 5,751 (1877), Justh v. Holiday, Mackey 2 D. C. 346 (1883); Pickering v. Cease, 79 Ill 328 (1876); Rumsey v. Berry, 65 Me. 570 (1876); Yerkes v. Salomon, 11 Hun 471 N.Y. Sup. Ct. (1877); Gregory v. Wendell, 39 Mich. 337 (1878); Williams v. Tiedeman, 6 Mo. App. 269 (1878); Cassard v. Hinman, J Bosw 207 N.Y. Super. Ct. (1857); Marshall v. Thur-ston 3 Lea 740 Tenn (1879), Noyes v Spaulding, 27 Vt 420 (1855); Barnard v. Backhaus, 52 Wis 593 (1881).

173 Irwin v Williar, 110 U.S. 499 (1883).


wager. The Court noted that it was the practise at the Corn and Flour Exchange at Baltimore (The Exchange) where the transaction had taken place that a commission merchant (or broker) would often enter a buy or sell contract on behalf of his customer in his own name, thereby becoming personally liable to the contract, while in many cases the principal was unknown. The Court also noted that it was the practise of the Exchange that customers’ buy or sell orders were usually made on the floor of the Exchange by open public offer to the members of the board assembled there. The Court also noted that two commission merchants often set-off one contract against another between themselves, thereby mutually sur-rendering or cancelling the contracts by settling the difference in price and substituting in their books the name of the new customer. The Court therefore took note of the fact that payment of difference was a customary practise in the exchanges where transactions took place. Notwithstanding this, Mr. Justice Mathews for the court decided that:

The generally accepted doctrine in this country is . . . that a contract for the sale of goods to be delivered at a future day is valid, even though the seller has not the goods, nor any other means of getting them than to go into the market and buy them; but such a contract is only valid when the parties really intend and agree that the goods are to be delivered by the seller and the price and the price to be paid by the buyer; and, if under the guise of such a contract, the real intent be merely to speculate in the rise or fall of prices, and the goods are not to be delivered, but one party is to pay to the other the difference between the contract price and the market price of the goods at the date fixed for executing the contract, then the whole transaction constitutes nothing more than a wager, and is null and void. And this is the law in England by force of the statute of 8 & 9 Vict c.109, s.18, altering the common law in that respect.174 (emphasis added)

Thus the court in Irwin v Williar concluded that payment of difference, where there is no intention to deliver the commodities, amounts to a wager, making the contract null and void, i.e., contracts at the exchange represent speculative gambling transactions. This is exactly the same opin-ion taken by various Sharīʿah scholars with regard to objections about futures contracts. Under Sharīʿah law, speculation that took place at futures and option exchanges was considered a zero-sum game where no delivery of the commodity was intended. The scholars opined that, without an intent to deliver the underlying asset, such futures and options were imper-missible; the intention of the parties was therefore to gamble on commod-

174 Ibid., at 508-509.


ity prices rather than to manage their risks. In Irwin v Williar, Mr. Justice Mathews for the court also added that, although the broker is innocent of any violation of the law, since he is privy to the “unlawful design of the parties, and brings them together for the very purpose of entering into an illegal agreement”,175 the broker cannot recover for services rendered or any losses suffered as a result.

The intent test was written into the statute of almost every state in the US.176 An example of this can be seen in The Michigan Penal Code, Act 328 of 1931, s.311 (formerly section 1 of Act 199 of 1887):

175 Ibid., 510.176 “Whether such legislation purports to outlaw bucket-shops, or wagering contracts in

general, it is, for the most part, merely a reiteration of the common-law test of intent at the time of making the contract—Statutes declaring criminal the maintenance of a bucket-shop: ALA. CODE (Michie, 1928) 5 3579; ARIZ. CODE (Struckmeyer, 1928) 0 4677; CAL. GEN. LAWS (Deering, 1923) tit. 75, 8 2; Colo. Laws 1931, c. 57, §I ; COXN. GEN. STAT. 61930) s.5 6345, 6346; D. C. CODE (1929) tit. 6, §§158, 159; FLA. COMP. LAWS (1927) s.8 7889, 7899; ILL.REV. STAT. (Cahill, 1931) c. 38, §§317, 318; IND.ANN. STAT. (Burns, 1926) §2691; IOWACODE (1931) §§9895, 9899, 9901 ; KAN. REV. STAT. ANN. (1923) C. 50, s. 122; ME. REV. STAT. (1930) C. 136, s.0 14, 15; MASS. GEN. LAWS (1921) C. 271, §§35, 36; Mich. Acts 1931, no. 328, s.8 126-28; MINN. STAT. (Mason, 1927) §§10488, 10489; Mo. REV. STAT. (1929) s.04316-18; MONT. REV. CODE (Choate, 1921) §11159; KEB. COMP. STAT. (1929) s.8 28-955, 28-956; K. H. PUB. LAWS (1926) c. 384, s. 23; K. Y. PENAL LAW (1909) s. 390; K. D. COMP. LAWS ANN. (1913) 8 9699; OHIO GEN. CODE (Page, 1932) s.8 13071, 13079 ; Ore. Laws 1931, c. 395, 0 2; PA. STAT. ANN. (Purdon, 1930) tit. 18, §1011; R. I . GEN. LAWS (1923) C. 406, 8 I ; S. D. COMP. LAWS (1929) 3925; VT. GEN. LAWS (1917) s. 7081; VA. CODE ANN. (Michie, 1930) §§4714, 4715; WASH. CODE (Pierce, 1919) 8932 ; W.VA. CODE (1931) c. 61, art. 10, 18; WIS. STAT. (1929) 348,175; WYO. REV. STAT. ANN. (1931) 32-924. Statutes declaring gambling contracts criminal: ALA. CODE (Michie, 1928) s 3576; ARIZ. CODE (Struckmeyer, 1928) 4680; FLA. COMP. LAWS (1927) 7890; KAN. REV.S TAT.A NN. (1923) C. 50, s. 121; LA. CONST&. STAT.( Wolff, 1920) CONST.a, rt. 189; Ibid., p. 452; MINX. STAT. (Mason, 1927) s.0 10223-1, 10223-2; Mo. REV. STAT. (1929) 4324; S. D. COMP. LAWS (1929) 3925; TENN. CODE (1932) 7821. Statutes declaring gambling contracts void: ALA. CODE (Michie, 1928) 6816; CAL. CONST. art. 4, §26; ILL. REV. STAT. (Cahill, 1931) c. 38, s. 309; MASS. GEN. LAWS (1921) C. 137, 4; K. J. COMP. STAT. (1910) pp. 2623-24; N. Y. PENALLAW (1909) 992; OHIO GEN. CODE (Page, 1932) s. 5965; PA. STAT. ANN. (Purdon, 1930) tit. 18, 1016; S. C. CIV. CODE (1922) §5165; S. D. CORIP. LAWS (1929) §3929; TENN. CODE (1932) §7819, 7820; VA. CODE ANN. (Michie, 1930) s. 5558; W. VA. CODE (1931) C. 55, art. 9, I ; WIS. STAT. (1929) s. 241.24; WYO. REV. STAT. ASS. (1931) 48-201. In Missouri, if either party to a contract intends not to deliver or receive, irrespective of the other party’s intent or knowledge of such intent,


750.311 Gambling in stocks, bonds, grain or produce. Sec. 311. Gambling in stocks, bonds, grain, etc.—It shall be unlawful for any corpora-tion, association, firm, co-partnership or person to keep or cause to be kept by any agent or employee within this state, any office, store or other place, wherein is con-ducted or permitted the pretended buying or selling of the shares of stocks or bonds of any corporation, or petroleum, cotton, grain, provisions or other produce, either on margins or otherwise, without any intention of receiving and paying for the property so bought or of delivering the property so sold; or wherein is conducted or permitted the pretended buying or selling of such property on margins, when the party selling the same or offering to sell the same does not have the property on hand to deliver upon such sale; or when the party buying any of such property, or offering to buy the same, does not intend actually to receive the same if purchased or to deliver the same if sold; all such acts and all purchases and sales, or contracts and agreements for the purchase and sale of any of the property aforesaid in manner aforesaid, and all offers to sell the same or to purchase the same in manner aforesaid, as well as all transactions in stocks, bonds, petroleum, cotton, grains or provisions in the manner as aforesaid, on margins for future or optional delivery, are hereby declared gambling and criminal acts, whether the person buying or selling or offering to buy or sell acts for himself or as an agent, employee or broker for any firm, co-partnership, company, corporation, association or broker’s office. (emphasis added)

From the wording of the statute, where the parties have no intention to deliver, contracts would be considered as gambling and therefore criminal; this injunction also applies to those individuals acting as agents and brokers.

However, the intent test was ‘stretched’ in Board of Trade of the City of Chicago v. Christie Grain and Stock Company.177 In this case, the Chicago Board of Trade brought a suit to prevent the defendant from using and distributing quotations of prices on the Board (collected by the Board and distributed only among persons whom they approved), without the Board’s consent and contrary to its regulations. The defendant pleaded that the Board was a gambling institution whose operations violated the Illinois statutes against bucket-shops and gambling contracts and therefore that the Board had no property right in its quotations which a Court of Equity should protect. Mr. Justice Holmes in the Supreme Court held that the intent of brokers to close out their contracts by “setting-off ” or “ringing-out” did not invalidate their transactions:

the contract is criminal and void. Mo. REV. STAT. (1929) s.8 4324-25”; “Legislation Affecting Commodity and Stock Exchanges, Harvard L. Rev.”, 45 (1932) 912, 917.

177 Board of Trade of the City of Chicago v. Christie Grain and Stock Company 198 U.S 236 Sup. Ct. (1904).


The fact that contracts are satisfied in this was by set-off and the payment of differ-ences detracts in no degree from the good faith of the parties, and if the parties knew when they make such contracts that they are very likely to have a chance to satisfy them in that way and intend to make use of it, that fact is perfectly consistent with a serious business purpose and an intent that the contract shall mean what it says.178

The judge first held that neither a Board of Trade nor contracts traded within its walls were illegal, notwithstanding that physical delivery did not take place because ‘setting-off ’ and ‘ringing-out’ constituted delivery. Fur-thermore, Holmes J’s judgement implied that contracts established on “the board of trade were entitled to be regarded as serious regardless of whether the parties intended their future contracts to transfer corporeal commodities”.179 In essence, this case seems to have set aside the ‘intent to deliver for validity test’ in Grizewood v Blane and replaced it by a much more liberal test of whether the contract had been made for the purpose of serious business.

However, this liberal view was short lived. In the case of Dickson et al. v Uhlmann Grain Co.,180 the respondents Uhlmann Grain Company brought an action against Dickson, claiming that Dickson had employed it as bro-ker to purchase and sell grain on the Chicago, Winnipeg, and Minneapolis Exchanges and that he had agreed to pay commission for any services and reimburse it for any advances made—which Dickson had failed to do. In contrast, Dickson claimed that the transactions under which the indebted-ness was claimed were entirely gambling contracts and thus illegal under the law. He further claimed that the intention had been to settle the con-tracts based on differences in market prices and that the transactions were not his actual dealings in grain futures but rather pretence or mere gam-bling on the rise and fall of market prices of grain. The company’s counter-argument was that the transactions involving sale of grain for future delivery were commonly conducted on the Chicago and Minneapolis Boards of Trade which had been legally established under The [Federal] Grain Futures Act 1922 and therefore all transactions made by the com-pany were legal under the Act. Dickson replied that none of the alleged contracts made by the Boards of Trade were entered into on his behalf; i.e., that they were devices employed by the Company on its own behalf. This was claimed because the Company had established a branch in Carrollton

178 Ibid., at 248.179 Swan, supra note 1 at 249.180 Dickson et al. v. Uhlmann Grain Co., 288 U.S. 188 (1933).


where Dickson had placed a buy order; this order was communicated by the branch to its Kansas City office, after which the Company would enter into contracts at some other Board of Trade for future purchase or sale of grain. Dickson claimed that the branch in Carrollton was actually a bucket shop set up to gamble against the state laws of Missouri.181 It was also understood that no grain had ever been delivered and that the branch manager at Carrollton had actually assured Dickson et al. that they would never have to deliver or receive the grain.

Mr. Justice Brandeis, on behalf of the Circuit Court of Appeals for the Eighth Circuit, held the following:182 (1) That the contracts entered into between the Grain Company Uhlmann and the Exchanges may be assumed to be valid as they were validly entered into under the Federal Law, i.e. The Grain Futures Act 1922. Here the contract requiring scrutiny is the one between Dickson and the Carrollton branch. The former transaction with the Exchange did not necessarily make the latter transaction with Dickson valid. (2) That the evidence showed that transactions in the Carrollton branch were not “in fact orders to enter into contracts on behalf of the defendants to purchase or sell for future delivery but were devices know-ingly employed by the company solely to enable them to gamble”,183 in other words the branch was nothing more than a bucket shop and there-fore illegal under Missouri law. The Company was therefore party to an illegal contract and could not claim for commissions. (3) That the Grain Futures Act 1922 did not supersede any applicable laws in Missouri, mak-ing gambling in grain futures illegal. In effect, Dickson v Uhlmann tried to discourage speculation by declining to enforce speculative contracts,

181 The Missouri Bucket Shop Law, Rev. Stat. (1929) ss. 4316-4323, defines transactions in grain declared to constitute gambling and makes it punishable either to enter into such transaction or to keep an establishment to enter into such transactions. Section 4317 declares that a bucket shop is a place where there is buying and selling of commodities so called on behalf of other parties, and a shop is gambling and illegal.

182 However, Mr. Justice Butler dissenting opined that the contracts carried out in Carrollton were not governed by the Missouri laws, and furthermore that the branch in Carrollton was not a bucket shop and was therefore not illegal. In other words, the respon-dents should have been able to claim their commission. Butler J stated: “There is no evi-dence of any violation of the bucket shop laws, nor is there any suggestion that the transactions shown can be held illegal except by force of the Missouri statute. I do not disagree with the majority that the Federal Grain Futures Act has not superseded the stat-utes of Missouri applicable to these transactions.” Dickson et al. v. Uhlmann Grain Co., supra note 180 at 206.

183 Ibid., at 194.


although there are those who believe that this constitutes a “confused and futile policy”.184

In reply to many cases and litigation and in an attempt to remedy spec-ulative activity on the Exchanges, more Federal legislation was put in place in the US and Statutes in the UK.

In summation, these authors’ opine that there is definitely a similar sen-timent between the objections of Sharīʿah scholars and those seen in these cases under conventional law. Speculation, with an intention to hedge, is thus permissible under Sharīʿah and conventional law. However, both Sharīʿah and conventional law object to such speculation where evidence shows no intention to deliver underlying assets but rather only use pay-ment of difference akin to gambling. Under Sharīʿah law, the majority of scholars believe that speculation in derivatives leads to excessive uncer-tainty which amounts to gambling. They opine that derivatives are a clear example of a zero-sum game and that they are simply contracts of differ-ence or a means of gambling and betting. One can thus conclude that objections raised under Sharīʿah law are similar to those raised above, in relation to futures contracts where no delivery is intended and transactions are purely speculative, i.e. amounting to nothing more than an illegal gam-ble or wager that is null and void or harām.

5. Further Deductions

A comparison of objections under Sharīʿah and conventional law shows a similarity. Upon further analysis, one can deduce that the underlying objection against the use of derivatives in conventional finance is the pro-hibition of gambling. In contrast, under Sharīʿah law, it is gharar. Objec-tions based on gambling and gharar are not different but rather actually related. As discussed in Section 2, maisir or gambling falls within the defi-nition of gharar, i.e., gambling is a subset of gharar which means that gharar includes additional elements such as jahālah or ignorance. Follow-ing this line of reasoning, one may deduct that, since the underlying objection to derivatives is gharar under Sharīʿah law and gambling under conven-tional law, it follows that the objections to derivatives in Islamic finance are broader than in conventional law. Furthermore, when comparing Sharīʿah

184 Telford Taylor, “Trading in Commodities Futures—A New Standard of Legality?”, Yale Law J., 43 (1933) 67.


and conventional law objections to derivatives, it was discovered that two Sharīʿah objections did not have a parallel under conventional law.

The two objections are that: (1) futures sales being a deferment of both counter-values are the sale of one debt for another, and (2) option sales are a mere right to buy or sell for which charging fees is impermissible. Thus, while legal objections to derivatives in Islamic finance is wider than in conventional finance, there are still similarities in relation to speculation and gambling. It is possible that Islamic finance may learn from the rich legal history of conventional finance regarding speculation and gambling in relation to derivatives, and vice versa.

Having discovered that the legal objections are similar in relation to gambling and speculation, it can be deduced that Islamic finance may be able to learn from the errors and successes of conventional finance with regard to passing laws to curb speculation and gambling on futures and option exchanges over time. Thus further research should be carried out to explore this possible avenue with Islamic and conventional finance learn-ing from each other how to deal with speculation and gambling on an exchange.

6. Conclusions

This article has surveyed and compared the relationship between present-day legal objections to derivatives in Islamic finance and those objections held in the past by conventional finance. Objections made by both fields of finance have shown similarities as well as differences. For example, both Islamic and conventional finance object to the gambling nature inherent in derivative trading; in contrast, under Sharīʿah law, the scope of Islamic finance’s objections is broader, including other elements such as uncer-tainty and ignorance. Furthermore, Sharīʿah scholars also object to option trading which requires paying a fee and to futures trading which involves paying a debt with a debt. This research further finds that, since both fields of finance object to the elements of speculation and gambling, Islamic finance can perhaps learn from studying the rich history of laws and regu-lations passed as conventional finance tried to regulate speculation and gambling. Their successes and failures can be used in Islamic finance to help control or curb speculation.

sharīʿah and conventional law objections to …repository.um.edu.my/16656/1/alq 24,4_319-360...

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