Islamic Investor: Islamic Investor: - Islamic Finance News

CHAPTER
Islamic Hedging &
Risk Management Solutions
The Islamic banking and finance industry continues to cross one
milestone after another. The case for Shariah compliant hedging
solutions has become obvious and strong especially in recent years
as Islamic institutions have made deep inroads in both retail and
corporate segments and across diverse geographies, thus developing a
global perspective for the industry. AHSAN ALI of Standard Chartered
Saadiq shares his views.
There has been considerable discussion amongst Shariah
scholars, regulators, governing bodies and industry players
as to whether derivatives are acceptable from a Shariah
perspective. Now many accept the use of hedging as a tool for
prudence and risk management.
Furthermore, recent market events have increased awareness
regarding the need for hedging. As a result, it has become
increasingly important for Islamic fi nance practitioners to have
access to hedging solutions in order to compete in a fast moving
and volatile marketplace. Thus, they are an important tool for
the next phase of development for the Islamic fi nance industry.
Introduction
The Islamic fi nance industry continues to grow at a rapid pace
in all its key markets, especially the Middle East and Southeast
Asia. An industry which began its development with basic trade
and fi nancing-related products is now witnessing expansion
in all areas of banking and fi nance, including sophisticated
project and asset fi nancings, hedging products and investment
solutions covering diverse asset classes from equities to
shipping and aviation funds.
As product offerings become more complicated, so do the risks
associated with such offerings – both for the provider and the
user. One such risk is the issue related to hedging in Islamic
fi nancial transactions. Islamic institutions and consequently
Islamic customers, both corporate and retail, are exposed to
a number of risks, such as rate and currency risk exposures.
The case for hedging solutions
Islamic banks active in the retail space offer long-term fi nancing
products such as auto and mortgage fi nancings. As these
products have gained momentum, the need for Islamic banks
to offer fi xed price solutions in a competitive manner has
increased. They consequently need to hedge their rate risks to
ensure their asset and liability sides are both matched in terms
of profi t rate risk.
The same argument holds equally true for corporate customers.
Usually, corporate customers are offered fi nancing facilities
based on fl oating benchmarks. In addition, they are usually
exposed to currency mismatches as part of their day-to-day
business activities. As such, any currency and market rate
fl uctuations could have serious consequences if solutions are
not provided and the risk is not addressed and mitigated in an
adequate manner.
As product offerings
become more complicated,
so do the risks associated
with such offerings
Another emerging area for hedging which should not be
overlooked is commodity hedging. There is a strong case
for commodity hedging simply because it can help minimize
risks for both large and small-scale businesses. From a
farmer to a metal trader to a large commodity house, all of
them require their exposures to be hedged against adverse
price movement risk. The availability of hedging solutions can
help in effi cient planning in relevant sectors but especially in
the commodity sector given that it can have quick and direct
impact on businesses as well as the average end-consumer
and consequently the overall society. The idea, like in all other
hedging solutions, is to have effective risk management tools
available to use as and when required and necessary.
Finally, the most compelling need for Islamic hedging solutions
is to manage risks of Islamic fi nancial institutions and provide
them with the capability to compete in the market in an effective
manner. The availability of basic hedging instruments will
open additional avenues for both investors and customers on
a variety of fronts including capital markets, structured trade
fi nance, project fi nance and overall balance sheet management
16 September 2011